Azerbaijan ACG: Stepping out

Azerbaijan's state oil company, SOCAR, has benefited, like many of its peers, from the current increase in oil prices and increased lender tolerance for emerging markets resources credits. Now it is following in the footsteps of borrowers in Russia and elsewhere by raising uncovered, though highly structured, debt from commercial banks. Three times in 2006 it raised financing against its share of reserves in the Azeri, Chirag and Gunashli (ACG) offshore oilfields.

But closing its debut commercial bank financing was its most complex and challenging deal, since it involved refinancing loans from its fellow developers of the ACG fields, and working within the scope of the fields' existing operating agreements. The $750 million loan dispensed with the enhancements of multilateral or export credit agency lenders, and constituted the largest syndicated financing for a Azeri borrower when it sold down early in 2006.

The backdrop to the financing is the 1994 production sharing agreement by which Azerbaijan, and SOCAR, brought in foreign investors to exploit the ACG fields. SOCAR was originally the vehicle both for the Azeri government's receipt of royalties and a 20% equity partner in the field. But SOCAR did not have the resources to carry its share of the development costs, and came to an agreement with two of its partners – Exxon (after 1999 ExxonMobil) and Türkiye Petrolleri A.O. (TPAO, the Turkish state oil company) – for them to help SOCAR with the shortfall.

In addition to the sale of a 5% share to each of the partners, the agreement also included a debt facility. This was to be repaid, with interest, from SOCAR's share of the cost oil from the fields' production sharing agreement. This cost oil, which compensates the developers for their outlays on field development, is shared in a more generous fashion with the outside operators, and the profit oil accrues in larger part to the state.

The loans from Exxon and TPAO, which were concluded in 1997-8, carry high rates of interest – roughly 400bp over Libor – and prevent SOCAR from controlling a larger share of its output. Since then, SOCAR's profile has increased, particularly since it was among the sponsors of the Baku-Tblisi-Ceyhan oil pipeline, one of the region' most high-profile infrastructure projects. In 2004 it raised $80 million for the South Caucasus Gas Pipeline, and $110 million for the Shah Deniz condensate field, which fills the pipeline, in both instances from the European Bank for Reconstruction and Development.

By 2004, the project had been producing oil for seven years, the Chriag field at 144,000 barrels per day, with first drilling taking place at the Azeri field for the third phase of the development. The composition of the shareholders in ACG's operator, the Azerbaijan International Operating Company (AIOC), is now BP (34.1%, the operator), Chevron (originally Unocal, 10.2%), INPEX (10%, bought from Lukoil in late 2004), SOCAR (10%), Statoil (8.6%), ExxonMobil (8%), TPAO (6.8%), Devon (5.6%), Itochu (3.9%), and Amerada Hess (2.7%).

In September 2005, the sponsor began discussions with BNP Paribas over a loan to refinance the conveyance of production Payment agreements. This refinancing carried with it some complications – not least the opposition of the two providers. Not only were they earning a healthy margin on their loan, but the repayment mechanism allowed them to book the oil they were due as reserves.

However, even though SOCAR no longer acted as the conduit for the Azeri government's receivables under the production sharing agreement, it is still state-owned, and the carry payment partners were not likely to insist upon their 400bp margin at the cost of future opportunities in the country. TPAO and ExxonMobil ultimately agreed to the refinancing, and SOCAR looked to borrow enough not just to pay off the remaining balance, but to fund any additional cash calls at the ACG project.

The resultant deal is properly described as a pre-export finance facility, although it blends the disciplines of reserve-based lending, some project finance, and commodity finance. Project finance, in the sense that the underwriter had to understand and accommodate the potential for additional expenditures at the project, and maintain confidence in BP's operating the project. Reserve-based lending, in that lender's analysis had to encompass the operator's ability to access the fields' 5 billion barrels of proven reserves in a cost-effective and timely value.

But ultimately, operating and reserve risk is minimal, since the Caspian Sea reserves have largely lived up to their billing, and the pace of oil production is accelerating rapidly. But the second phase of the ACG development was not complete when the financing closed in December 2005, and the third phase – Deepwater Gunashli – is now under development. Lenders did need to be comfortable that the necessary infrastructure was on course for deployment in time to start production in the middle of 2008.

The only mitigation that lenders really require is an offtake agreement – in this instance with Glencore Energy UK and S.E.T. Select Energy. The contract does not mitigate price or volume risk, but it does ensure that there will be a ready market for SOCAR's share, and gives the lenders some offshore revenues to dedicate to debt repayment. If production increases to 1 million barrels per day by 2009, SOCAR will have 100,000 barrels per day to put towards payment, a huge increase on the 13,000 barrels per day it had at financial close.

BNP's decision to underwrite the debt in December, and fund $682 million of it immediately, was bold, although syndication of the debt went off without a hitch. The underwriter brought in ABN Amro, Bank of Tokyo-Mitsubishi UFJ, Calyon, ING, Natexis, Société Générale, Standard Bank, WestLB, Rothschild, Commerzbank, HVB, KBC, Royal Bank of Scotland, and SMBC as participants.

The five-year debt priced at between 175bp and 200bp over Libor, according to the date to maturity. The reception it received says a lot about the improved perceptions of Azerbaijan, and SOCAR's operations, in the international lending community. Since that date, the sponsor has raised additional financing on the back of its share of the field's profit oil. But before the close of Azerbaijan ACG the country's largest syndicated loan had been a $56 million deal for International Bank of Azerbaijan.

Azerbaijan ACG Ltd
Status: Closed 23 December 2005, syndicated February 2006
Size: $750 million
Location: Offshore Azerbaijan
Description: Refinancing of partner debt from, and completion of development of 10% share of ACG field development
Sponsor: State Oil Company of the Azerbaijan Republic
Lead arranger: BNP Paribas
Tenor: Five years
Financial advisers: Hawkpoint Partners, Wighams Capital Partners
Sponsor legal adviser: Chadbourne & Parke
Lender legal adviser: Allen & Overy
Reserve audit: Netherland, Sewell & Associates