The Chinese boom has had much more of an impact on international lenders elsewhere in Asia than in China proper. But the most obvious exception is the petrochemicals segment, where projects have been enjoying extremely favourable operating conditions. And a series of new projects and refinancings, both inside and outside China, have been exploiting buoyant demand, and eager lenders.

The current environment is one in which even marginal producers, those that have been struggling for several years, can post healthy results. And this despite record high prices for crude oil, which traditionally drives the price of feedstock ? whether gas, naphtha or oil, for petrochemicals projects. Chinese manufacturing, highly dependent on plastics and other materials derived from petrochemicals has been the key driver of high prices for output.

Financing of petrochemical projects tends to follow a highly cyclical pattern, one largely governed by world prices. While they sometimes receive some form of price support from sponsors of offtakers, price risk is usually something to which lenders must acclimatise themselves. But, at least at the initial phase, lenders tend to exercise stringent control over accounts, repayment schedules, and distributions.

The next phase of a petrochemicals project consists of its migration to a standalone corporate finance structure ? and financing terms to match. This second phase is where lenders often find themselves when a downturn hits. Restructuring a deal can be a fraught, high-stakes business, and one whose timing is highly dependent on the vagaries of the market price.

This time round, lenders have been dealing with a mixture of greenfield financings, refinancings, and restructurings of distressed projects. But all of these are the beneficiaries of the improved climate ? and renewed competition for arranging and advisory mandates at banks.

China unbound

The first deals out of the gate were the large Chinese petrochemicals projects ? SECCO, Nanjing and Nanhai. These deals, which closed between the middle of 2002 and the end of 2003, marked the rebirth of both the Chinese project finance market, which had been quiet since 1999's Chengdu Number 9 water deal, and the Asian petrochemicals market, which had been a backwater next to the progress made in the Middle East.

The market's attention has largely, and rightly, focused on the roles of Chinese banks in the transactions, the extent to which sponsor guarantees are necessary to close deals, and what the financings meant for future dealflow in the region. Subsequent financings, such as Guangdong, and the forthcoming Fujian and Tanguh deals, have largely settled these questions. What banks and sponsors are less certain of is the impact of these, and future Chinese projects, on existing producers in the region.

The initial evidence is fairly positive ? transactions such as the Optimal refinancing, the successful refinancing of Rayong, the forthcoming refinancing, and planned IPO, of Titan Petrochemicals, and Indonesia's Tuban project, have all been bright spots. But several of these financings suggest that, while either conceived as export earners, or structured to mimic such a business profile, these regional projects will have to adjust to markets where Chinese and Middle Eastern projects dominate.

Trustee with a twist

The $400 million offshore financing for PT Trans-Pacific Petrochemical Indotama (TPPI) is only the most dramatic example of this trend. TPPI, which closed in May 2004, involves the rehabilitation of the Tuban Petrochemical Complex, an aromatics plant designed to produce 500,000 million tonnes per year (tpy) of paraxylene and 400,000 million tpy of benzene, toluene and orthoxylene. SMBC underwrote and lead arranged the deal, joined by WestLB (arranger), HVB (arranger), UFJ Bank (co-arranger), Standard Chartered (co-arranger), Fortis (co-arranger), Bank of Tokyo-Mitsubishi, (lead manager), and Natexis (lead manager).

The rationale for the project is the need for Indonesian producers to cut their reliance upon imported basic petrochemicals. The Tirtamas group initially proposed the project in 1996, and work at started at the site when the Asian crisis intervened. The partially degraded mothballed site was assumed by a majority-owned subsidiary of the Indonesian Bank Restructuring Agency. Additional shareholders in the project include Pertamina (with 15%), and Itochu of Japan, with 4.25%.

The project's output is to be sold largely into the domestic market, and thus lenders cannot be assured of a solid offshore dollar-denominated revenue stream. In an echo of the earlier Blue Sky financing, the sponsors used a Japanese trading house to buttress the economics of the project, as well as secure JBIC/NEXI financing. It also relies heavily on Pertamina, despite the state-owned company being a minority shareholder.

The financing's credit is based on sales of low sulphur waxy residue (LSWR) from Pertamina to Mitsui & Co. Mitsui is also extending $200 million of the debt, supported by JBIC, and intends to sell the LSWR to Japanese generators, which are the only buyers of the substance, used extensively in Japan in part because of current difficulties at the country's nuclear generators.

The sales take place through the intermediary company KerisPetro Finance, which is based in the Netherlands for tax reasons. KerisPetro buys the LSWR from Pertamina and sells it to Mitsui, and also issues product delivery instruments to Pertamina for the value of the distillates that TPPI will produce, and Pertamina buy. This solution, required to reflect Pertamina's position as more of an offtaker than a sponsor, is more complex, and more innovative than either the trustee borrowing structure familiar from Indonesian deals, or the Blue Sky swap arrangement (for details, please search ?TPPI? and ?Blue Sky? on www.projectfinancemagazine.com).

Pertamina is understood to have plans for new methanol capacity, and independent Indonesian producer Medco is examining plans to expand its Bunyun methanol plant. Brunei, which shares the Borneo hydrocarbon reserves with Indonesia, also wants to capture more of the downstream elements of its crude export business.

Optimal elements

The TPPI structure is one suited to Indonesia's growing economy but battered financial system. Few other regional economies, with the possible exception of the Philippines, would qualify. Most of them have developed extremely robust banking systems, which have become much more important to financing ? and refinancing ? petrochemical facilities that sell into domestic markets.

One of the high points of this trend was the has been the $803 million equivalent financing for Optimal Group, a joint venture between Dow, Sasol and Petronas. The financing consisted of RM1.27 billion ($335 million) in Ringgit bonds and $468 million in dollar bank facilities. The bond element has led the bookrunners, HSBC and Maybank, to bill the deal as the largest project bond in Asia since the 1997 crisis.

The claim is essentially true, although the instruments sold to Malaysian investors ? Al-Bai Bithaman Ajil Islamic debt securities (BaIDS) ? are barely analogous to a cross-border 144A dollar bond. The financing is split between three operating subsidiaries ? Olefins, Glycos and Chemicals. Olefins, which raised $200 million in bank debt, and RM250 million in Ringgit bonds, has a take-or-pay agreement with Dow for its output, and does not have any further sponsor support.

The other two subsidiaries, which are more interlinked, benefited from cash deficiency support, and while borrowing separately are treated as part of the same credit. Their debt has a longer tenor, at eight years for the bank debt and up to 10 years for some of the 10 tranches of bonds. Olefins borrows for five years both in dollars and Ringgits.

The bonds do have a reserve account that accumulates cash equal to 25% of outstanding principal, a six-month debt service reserve, and the aforementioned cash reserve. The bonds were four times oversubscribed, and the bank debt 30% over. The Optimal ventures are located in the Kerteh industrial area on the east coast of Peninsular includes a 600,000 tpy ethane and propane cracker, and production units for ethylene oxide, glycol and butanol.

But Optimal is acutely aware of the competitive threat from producers in China and the Middle East. And also aware that petrochemicals enjoys a seven- to ten-year cycle, and that the current peak has about two years left, according to Optimal management. But the figures speak to a boom time for producers ? Optimal's operating profit increased to roughly RM810 million for the year ended 31 March, following a RM69 million loss a year earlier, on the back of an increase in sales of 80%.

Optimal, like TPPI, is in large part designed to pay back sponsors for equity that kept developments alive during the lean period. But banks have also been executing advisory mandates that rescue deeply troubled corporates. SG recently advised on the restructuring of the Rayong refinery project in Thailand.

Rayong restructures

Rayong was the recipient of $1.5 billion in financing, the most recent a Chase- and Scotia-led deal that had the misfortune to go to market as the 1997 crisis hit. Rayong Refinery Company owns a 145,000 bpsd hydrocracker that has been operational since 1996. Its shareholders until this year were Shell (64%) and PTT (34%).
Rayong's woes were twofold ? depressed demand post-1997, which has only recently recovered, and revenue streams in devalued Baht that barely covered dollar debt service. Banks had already taken provisions on their exposure, and hedge funds had moved into the void left by departing lenders.

Those remaining were fortunate that PTT, the Thai gas producer, is anxious to increase its presence in the petrochemicals segment. PTT bought out Shell's stake in the project, and provided a $250 million subordinated loan to the project, while existing lenders received roughly 85 cents on the dollar. The refinery is now the subject of just over $600 million in debt.

PTT has been able to realise a better operational structure by combining its operations with those of the Star Petroleum Refining Company, under an agreement signed in 1999. Star, another casualty of the crisis, achieved a rescheduling of its debts in 2002, through a package led by the International Finance Corporation, Bank of America, Mizuho, Deutsche Bank and Bangkok Bank. Sources familiar with the deal suggest that another restructuring could imminent. Star's sponsors are ChevronTexaco (64%) and PTT (36%).

Rayong's creditors are likely to have been able to strike an even better deal had they been prepared to be patient ? a more sustained period of demand might have spurred PTT to sweeten its terms. Using similar logic, Standard Chartered extended a $100 million liquidity facility to Qenos, a 50/50 joint venture between Orica of Australia and ExxonMobil. It makes olefins, polyethylene (HDPE, LDPE and LLDPE), polypropylene and synthetic rubber.

It had been suffering from the downturn in petrochemicals prices, and lenders, led by Citigroup and KBC, were preparing for bankruptcy. The project had apparently examined a debtor-in-possession financing, Orica had written off its $123.2 million investment in the venture, and it was examining a sale. The restructuring involved the infusion of $7.5 million each from the sponsors, as well as new terms with Australian and International lenders.

Titan clashes

And so, on the back of this success, Standard Chartered launched its first headline arranging mandate into the market ? a $700 million refinancing for the Titan Petrochemicals project in Malaysia. The deal will be a stern test of whether current conditions are sufficient for any borrower to access competitive financing.

The deal breaks down into a $500 million seven-year term loan and $200 million 18-month bridge, designed to carry the borrower forward to an IPO. The deal is to be priced at 250bp over Libor. Optimal could borrow at between 44.5bp and 70bp. Joint leads on the deal are DBS, Rashid Hussain, Malayan Banking and WestLB.

The deal has its detractors ? Titan's feedstock is naphtha, which tends to be more expensive than gas. Nevertheless, Titan's results are promising ? it made RM154 million ($41 million) last year, an improvement on a loss of RM84.2 million in 2002 and RM300 million in 2001.

And according to one source close to the financing ?those who have been complaining about the credit of the deal don't have a true understanding of the dynamics of the petrochemicals industry. Using naptha enables the plant to produce a much greater variety of chemicals than many of its competitors, particularly those in the Middle East.? Titan is a 900,000-tonne capacity facility located in Pasir Gudang, Johor, and supplies 55% of domestic polypropylene demand and a 41% of the local polyethylene market. Its sponsors are Westlake of the US and PNB.

The deal brought in SMBC, KBC, Chinatrust, Shanghai Commerce, Bumiputra Commerce, Azora Bank, BNP Paribas and Calyon in initial syndication, a turnout that makes a wider syndication less likely. The $200 million bridge will be repaid by the IPO, but if this does not happen the loan's language is flexible enough to allow this to be extended.

Nevertheless, the deal has struggled against perceptions of a weak credit, and this bank deal arrived after an earlier bond deal faltered in the face of an adverse ratings agency verdict. But, as the source notes ?This deal is half the original debt level, and we've helped the borrower avoid a restructuring. Yet we have in place a robust structure that protects lenders by aggressively trapping cash and taking advantage of the current positive environment for petrochemicals producers.?

Whether the broader investor universe reacts as well to Titan will be tested when it completes an IPO ? slated for June 2005. But the projects lenders have understood that timing is key in the current market.