Despite escalating capex reaching almost 160% of the original forecast, construction is about to begin on the world's largest aluminium smelter to be built in a single phase – Qatalum.

A joint venture between Qatar Petroleum and Hydro Aluminium, Qatalum will produce 585,000 tonnes of primary aluminium per year when it reaches full production in 2010. The greenfield plant and dedicated 1,250MW power plant are being built under a BOO concession in the north-eastern part of Mesaieed Industrial City, approximately 40 kilometres south of capital Doha, with first production due in late 2009.

An original estimate for Qatalum of $3 billion was revised in November 2006 to $4.5 billion, and now stands at over $4.7 billion. The biggest cost hurdles were the addition of an extra potline, increasing production capacity by 15,000 tonnes, along with rising capital and material costs.

High equipment prices not only increased costs, but indirectly led to reduced ECA funding – Coface and Hermes were at one point expected to be involved with GIEK in a $600 million ECA tranche, but increased equipment costs necessitated ruthless sourcing of the cheapest suppliers. German and French equipment manufacturers were thus edged out, leaving Coface and Hermes uninterested in the deal.

The sponsors managed this compound of financial concerns by increasing leverage on the deal. The tenor was pushed up to 16.5 years, and a 30% balloon payment was added to keep the semi-annual payments throughout the tenor, down.

Cost rises were kept to a minimum by an unusual low-risk contracting structure devised by Hydro. The project was awarded not as one or two major contracts, but split up into around a dozen smaller EPCs that more companies are capable of handling, thereby increasing competition and minimizing costs.

A wide range of contractors are thus involved, including: Fata Group and K Home International on the anode baking plant and cast house, General Electric with Doosan Heavy Industries & Construction on the captive power plant, Achirodon Construction on the marine works, Saudi Arabian Trading & Construction on a residential village for the 1,000 workers, ABB on a high-voltage power-rectifier, Solios Carbone on a paste plant and SNC-Lavalin on a FEED contract for the main buildings.

A marketing and off-take deal with Hydro parent company Norsk Hydro guarantees sale of all produce, although not at a fixed price. Hydro will also be supplying the potline technology, and most of the alumina (although some will be bought on the open market), as well as training staff and workers.

In 2005 Hydro announced that it was unable to secure power contracts at sustainable prices for two of its primary aluminium plants in Germany. Locating the new plant in Qatar will keep gas feedstock cost low – Qatar's North field is the largest non-associated gas reservoir in the world. Long-term fixed prices for feedstock are between $0.75 and $1 per million BTUs, compared to between $6 and $10 in the west. Power equates to 35% of production costs for aluminium, making such power savings crucial. The Commodities Research Unit in London estimates power savings give the Middle East a production advantage over other locations worth at least $200 per tonne. Qatalum's gas feed will be provided by Qatar Petroleum from phase 2 of the Al-Khaleej gas development.

The attractiveness of Qatar as a location has spawned repeated attempts to make Doha an aluminium producer over the last 20 years; British Aersospace, Dubal and BHP Billiton have all investigated the possibility of launching an aluminium plant in the area. Government focus, however, has previously been on other investment sectors, with petrochemicals and gas prioritised over aluminium.

The project reached financial close on 23 August this year, with a total cost of $4.739 billion funded on a 58/42 debt to equity ratio. The debt is split into a $2.4 billion commercial bank tranche, arranged by a group of 31 international and regional banks, and a $350 million export credit tranche provided by GIEK.

Favourable pricing, of 40bp pre-completion, rising to 60bp till year 8.5, 70bp till year 11.5 and an eventual 85bp thereafter, has been achieved thanks to pricing being agreed in May before the turmoil of the credit crunch hit markets. The sacrifice for a debt price that is low even for a pre-summer-squeeze figure is a high minimum DSCR of 1.78, rising throughout the project, with a long-life coverage ratio of 1.98. Commenting on the low pricing, EDC says that in the Middle East a simple case of supply and demand, with a succession of strong assets with strong sponsors becoming available, is keeping pricing down.

The bulk of the commercial debt is in the form of a $2.25 billion term loan, with 21 of the involved banks also arranging a $150 million letter of credit facility, both on a 16.5 year tenor. BNP Paribas secured the role of financial adviser, ahead of HSBC, Citigroup, RBS and Standard Chartered. Due to the level of fragmentation of the debt, no syndication is expected. The two sponsors are equally funding the remaining $1.989 billion in equity, leading to the uncommon situation for a Qatari deal of the foreign sponsor taking an equal shareholding in the project company. White & Case advised QP and Hydro; Skadden Arps Slate Meagher & Flom advised the lenders.

Since the Heads of Agreement signing on 5 December 2004, the Qatalum project has encountered a number of obstacles aside from cost escalations. In November 2006 the proposed port section of the project had to be relocated and scaled back to a jetty to pass the Environmental Impact Assessment from the Supreme Council for Environment and Natural Resources.

In addition to project changes, Hydro Aluminium's parent company, Norsk Hydro, underwent a major profile change during the course of the project that threatened to reduce the attractiveness of Hydro as a borrower, despite the deal being non-recourse. Divesting its oil and energy sectors, worth 80% of the company, to Statoil in December 2006 necessitated the new aluminium-only company to be re-rated. The corporate rating went from a split A-/A from Standard & Poor's and Moody's to a BBB+ from Standard & Poor's and equivalent from Moody's – Qatalum, however, did not suffer.

Enthusiasm from lenders when the deal went to market ultimately dispelled any fears about lack of lender appetite – the deal was oversubscribed by more than $1 billion. To accommodate a greater number of lenders, tickets were downsized from $100 million to around $60 million, although BBVA, DnB NOR, ING, Nordea and Mizuho retained tickets of around $100 million, whilst primary investor EDC picked up tickets worth $300 million in support of key customer SNC-Lavalin. EDC's heavy investment continues its increasing appetite for Middle East deals in recent years, reflecting the growing involvement of Canadian contractors in the region.

Qatalum is just a part of wider plans for both QP and Hydro. In March 2007 QP was looking to raise $27 billion in debt for the next three years' capital expenditure. Last month Norsk Hydro announced it would be almost doubling capital expenditure, taking 2008-2009 totals to NKr12 billion ($2.2 billion), and is currently in talks about building an aluminium smelter in Iceland.

The benefits to each company are varied; the divergence from its portfolio of gas-based industries will be the major benefit to QP, whilst Hydro is aiming to raise primary production from 1.7 million tonnes per year to 2 million. Qatalum itself could play a part in further expansion for both sponsors; a proposed phase 2 would see production double to 1.2 million tonnes per year.

Qatalum
Status: Closed 23 August 2007
Size: $4.739 billion
Location: Qatar
Description: Construction of 585,000 tonne per year greenfield aluminium plant and dedicated 1,250MW power plant
Sponsors: Qatar Petroleum (50%), Hydro Aluminium (50%)
Financial adviser: BNP Paribas
Equity: $1.989 billion
Total debt: $2.75 billion
Term loan: $2.25 billion
Tenor: 16.5 years
Mandated arrangers: Export Development Canada ($300 million), Banco Bilbao Vizcaya Argentaria, DnB NOR, ING Groep, Nordea Bank (all $100 million), Mizuho Corporate Bank ($90 million), HVB Group ($75 million), Arab Bank, Arab Banking Corp, Arab Petroleum Investments Corp, Bank of Tokyo-Mitsubishi, Barclays Capital, BNP Paribas, Calyon, China Construction Bank Corp, Commerzbank, Doha Bank, Fortis, Goldman Sachs Group, Gulf International Bank, Intesa Sanpaolo, Kreditanstalt fuer Wiederaufbau, Mashreqbank, National Australia Bank, NATIXIS, Royal Bank of Scotland Group, Société Générale, Standard Chartered, Sumitomo Mitsui Banking Corp, WestLB, Woori Bank (all $57.708 million)
L/C facility: $150 million
Tenor: 16.5 years
Export credit: $350 million
ECA: GIEK
Mandated arranger: DnB NOR
Legal counsel to borrower: White & Case LLP
Legal counsel to lender: Skadden Arps Slate Meagher & Flom