The political and economic disconnect in Peru is close to bewildering. Foreign investment of $2.33 billion in 2005 helped drive economic growth of 6.5%, fuelling some of the biggest ticket corporate and project financings in Latin America. All this appears to have gone unnoticed, however, obscured by the avalanche of criticism that has engulfed President Alejandro Toledo – the one-time shoeshine boy that made good after winning a scholarship to study in the US.

"In spite of a challenging domestic political scene, the government has implemented and been highly professional in its management of monetary and fiscal policy, which has offered investors substantial growth potential with low inflation and foreign exchange risk," says John Graham, investment officer in the private sector department of the Inter-American Development Bank. "The boom in the energy and mining sectors in particular has been a magnet for international investors."

Hunt for opportunities

In project finance terms this has manifested itself with Phelps Dodge's $850 million Cerro Verde mine expansion and the $811 million Camisea gas pipeline, put together by Transportadora de Gas del Peru, owned jointly by Tecgas, Pluspetrol, Hunt Oil, SK Corp, Sonatrach and Graña y Montero. This year looks set to feature another Latin American benchmark, if the financing of Peru LNG's $3 billion investment plans, including a LNG export terminal and a 400km pipeline extension, can be completed.

According to Alejandro Valencia, a director in the project finance group at Societe Generale, adviser to the consortium of Hunt Oil (50%), SK Corp (30%) and Repsol YPF (20%), "Peru LNG, a Peruvian entity, will be the borrower and we expect the project to be financed at a minimum debt-to-equity ratio of 60/40."

The size of the project, between $2.8 billion and $3 billion, means the company is in talks with multilaterals, investment banks and local institutions to fund the deal. The upgrade of SK Corp's credit rating has further underlined the strength of the project, Valencia says, with all three partners now boasting investment grade ratings.

Repsol YPF has signed an offtake agreement for the LNG plant's output of 4.2 million tonnes per year and is planning on shipping this to its own planned terminals in Mexico as well as terminals in Chile and the US. The Spanish partner has already won a bid to build an LNG import facility in Lazaro Cardenas and is also optimistic of winning a bid launched by the Comision Federal de Electricidad (CFE, the Mexican state power company) in Manzanillo, further up the Pacific coast.

Repsol narrowly missed out on a similar import terminal proposal in Chile, after ENAP selected BG to construct the project, although BG and Repsol are expected to reach some kind of swap agreement that could still see Peruvian LNG going to its neighbour. There are other import terminals being proposed in El Salvador as well as the US.

EPC winds blow in

With the offtake agreement in place, the only remaining key agreements, says Valencia, are the construction contract and the conclusion of an agreement with TGP for the shipment of gas from the fields in the Amazon to the beginning of the new 400km pipeline to Pampa Melchorita. Construction of the plant is due to start this year with completion scheduled for 2009. "The EPC is a key contract," he says. "There are so many projects throughout the world and some of the contractors are thin in terms of resources, and consequently prices have gone up considerably. Sakhalin, for instance, is an example of this trend."

In the next two months, he says, the cost will be determined, giving a clearer idea of the financing requirements of the project. Total costs of the pipeline, should be around $600 million, with the LNG plant costing another $2 billion. The sponsors have an optimistic timetable. "We hope to have a request for proposals in June or so. Our hope is that in the summer we could select the mandated lead arrangers and close by the end of the year or in the first quarter of next year," says Valencia.

To reduce construction risk there will be some form of completion guarantee during construction. A multilateral element, similar to those used in Cerro Verde and the Camisea pipeline projects, is the first step. For this Peru LNG has already held talks with the US Ex-Im and IDB, which are in the process of selecting the lenders' legal counsel.

"The IDB has the upper hand at this point, since with TGP they had to do a thorough environmental and social due diligence. But we are going to see if it makes sense to have two separate A loans," says Valencia. "This could be $1.8 billion to $2 billion, which for Latin America is going to be a big financing and very challenging. There is a chance that we will see a couple of multilaterals." The International Finance Corporation is also keen on participating in the project.

But in the structuring of the Camisea pipeline, says Sergio Galvis, head of the global project finance group at Sullivan & Cromwell, the local markets proved to be very competitive. "They found the domestic market to be a very viable complement to a multi-sourced international project financing, and that is important. What that means is getting a funding deal done is not that hard," he says.

Funds still flush

Peruvian pension funds are awash with liquidity as a result of pension reforms, but are restricted in their ability to channel these funds overseas. Assets under management now stand at $7 billion, and are growing at $700 million a year. Peruvian Pension funds and local banks took $350 million of the $811 million Camisea financing and Cerro Verde filed with the Peruvian securities regulators in December for up to $250 million.

As well as a viable source of funding, the presence of local pension funds adds another level of security for international lenders. "It is one of the elements of mitigating against political risk. So that what you are hurting [if there is any political action] are people's pensions, which is not a popular thing to do. It's a reliable source for the strategic owners of the project but it should also serve as additional comfort for the international debt lenders," says Galvis.

Peru LNG's forthcoming offering could set new boundaries in terms of the size of the local market participation. Valencia says the local tranche could be as high as $400 milllion. "A big tranche, $300 million to $400 million, will go to the local market," he says. "That market is very liquid, since funds have a mass of cash under management and are restricted about what they can do outside Peru and they are looking for things to do."

Banco Credito de Peru, which led a recent $150 million corporate bond issue for Hunt Oil, is leading the pack in the bid to be appointed lead arranger for this local tranche. It arranged Hunt Oil's $150 million corporate bond placement in December. The paper is secured against future cash flows generated from its participation in exploration of Block 88 of the Camisea fields.

The success of Hunt Oil's recent corporate placement, and the $350 million local placement as part of the TGP deal, demonstrate that the local players are still keen on these types of assets and have few problems with taking on exposure to Hunt and its partners. The Argentine exploration partner, Pluspetrol, is also working on a placement of between $70 million and $100 million that is likely to be well received in the market.

Fitch Ratings' Peruvian partner Apoyo & Asociados Internacionales assigned the TGP bonds an AAA credit rating in December 2004. The financing was both the largest amount and the longest tenor ever placed in the Peruvian bond market. Hunt Oil's corporate bond issue was also given an AAA rating.

Greener pastures

Other deals that demonstrate the strong appetite for commodity-backed project financings include Phelps Dodge's Cerro Verde copper mine expansion. According to Galvis this is a good example of how Peru is going through a period of strong financial and economic conditions. "That had many elements that illustrate the confidence in the country: the high commodity price, the interest in the Asia-China market with the Japanese trading company involved. It was very illustrative of how attractive Peru has become," he says. Sullivan & Cromwell advised Japanese traders, Sumitomo Metals and Sumitomo Corporation, which have a combined 21% stake in the mine.

The expansion will use $443 million in equity, which Phelps raised through the sales of stakes in the project to its partners. The Japan Bank for International Cooperation is providing a $247.5 million facility through SMBC, as agent bank, and Bank of Tokyo-Mitsubishi. The deal also featured a $25 million loan from KfW, with the remainder coming as an uncovered commercial facility.

The sponsor has applied for a Peruvian issue of up to $250 million, but the full size of this has yet to be determined. Citigroup is advising the sponsor on the financing, and is likely to underwrite the local issue. With commodity prices showing no sign of slipping, oil and mining projects are driving the economic recovery, but the success of these schemes has improved the prospects for road deals and other infrastructure projects.

Roads, recovery and rhetoric

"Over the short-to-medium term, the government is expected to push new initiatives in the transportation and water sectors, where Peru is in need of substantial investment," says the IDB's Graham. In the short-term the bank is following closely the concession of the Port of Callao (South Dock), "the first in a series of port concessions that are absolutely critical to Peru's competitiveness in the global marketplace". The port needs at least $175 million in investment, according to the Peruvian agency Proinversion.

Odebrecht's $185 million Olmos irrigation and hydroelectric project is expected to be the next project to come to the market. Funding will be needed for the construction of the Limon Dam on the Huancabamba River in the Andes and a 15km outflow tunnel.

Road projects include the Trans-Oceanic Highway, a $613 million, four-year plan to construct and improve more the than 700km of roads that connect Peru's southern port cities with Brazil. Odebrecht is a 70% partner in the concession with two Peruvian companies, Graña y Montero and JJ Camet, which are working on the engineering and environmental studies. The contract includes a 25-year concession to operate and maintain the highway. Talks to establish a Free Trade Agreement with the US "will only add to growth prospects and require a new round of infrastructure upgrade through domestic and international investment, alike," according to Graham.

Even the prospect of elections and the tilt towards the left witnessed in Latin America has failed to push these types of projects off track. There was uncertainty surrounding the left-wing candidate Ollanta Humala at the end of last year but polls now indicate that more conservative candidates are likely to prevail. "At the end of last year there were statements by JP Morgan and ChaseManhattan that did not recommend investing in Peru given the uncertainty.

Investors are now incorporating this in their analysis and it has calmed down a lot," says Julio Loc, analyst at Apoyo & Asociados. The agency upgraded its country ceiling to BB in November last year and improved its currency outlook to positive in December when Humala started to decline in the polls.

At times of political uncertainty, the overwhelming factor has been the strength of the legal framework in Peru, according to Galvis. "In terms of where foreign investors are involved I think this is an example where foreign investment agreements can become useful," he says. "Peru has a pretty good history in terms of stability agreements and even in the worst of times these have been observed and respected and that has a positive effect."