CNOOC may no longer be the darling of the investment community, but away from the stock market, the company is a favorite for international energy majors and banks, eager to participate in the Chinese oil, gas and petrochemicals market.

Much of CNOOC's focus at present is on the gas sector. CNOOC and its partners concluded the financing for the Guangdong Dapeng LNG Terminal and Trunkline earlier in the year. This kept Catherine Zhou Lin, the GM Treasury and Risk Managment at the GDLNG project company, as well as Ma Zenghrong, manager in CNOOC's Capital Management department, busy for most of the last year. Financing of the Fujian LNG project is currently under discussion. Bankers suggest the company is assessing at least three more major gas projects.

CNOOC agreed to discuss its gas business, and associated financing deals with Project Finance. However, because most of the gas projects it is considering are still tentative, the only specific development that CNOOC was willing to discuss, apart from Guangdong and Fujian, was the Zhejiang LNG project (another mooted terminal and trunkline scheme).

CNOOC responded in writing to questions from Project Finance, stating that it is currently conducting a pre-feasibility study examination of the Zhejiang LNG project, together with the Zhejiang Provincial Government. "At this preliminary stage it is still too early for us to anticipate when construction would begin," says the company. According to its written response, it will begin discussions with banks for the Zhejiang project during the feasibility study stage.

CNOOC's reluctance to discuss other projects probably reflects some uncertainty in the company about the future of China's gas market. As one analyst observes, the LNG terminal projects now underway will eventually face competition from piped gas, from the East-West Project and Kovytka. Whether demand over the next ten years will be sufficient for all the planned natural gas supply that is scheduled is the billion-dollar question.

CNOOC did not respond to suggestions that future LNG and gas projects are being slow tracked to allow the company time to assess the evolving supply/demand picture. CNOOC sources, officially at least, are bullish. 'With the rapid economic growth China is experiencing, the fast-growing demand for energy and the growing awareness of environment issues, especially in China's southeast costal areas, the natural gas market is huge,' states the company.

Earlier this year other CNOOC officials suggested that China's demand for natural gas was expected to rise about 12% a year for the next 15 years, outstripping proven reserves, and reaching around 1 trillion barrels a year by 2020. By 2020, CNOOC forecasts that China will have to import almost half its liquefied natural gas, including 10% via a pipeline from Russia and Central Asia.

Market sources say the firm does not yet have any partners for the Zhejiang project. Potential partners will have to be discussed jointly with the Provincial Government. Nor has a financial adviser been appointed for Zhejiang LNG or any other potential LNG project, apart from Fujian.

The bank market expects a financial adviser to be appointed for any major gas venture. ABN Amro and HSBC were appointed respectively as financial advisors for the Guangdong LNG Project and Fujian LNG Project.

Gas supply for the Fujian LNG project has already been agreed. CNOOC says that it signed a 25-year supply purchase agreement (SPA) in October 2002 with Tangguh LNG, for an annual contract quantity of 2.6 million tonnes. Zhongmin Investment Limited is CNOOC's local partner in the Fujian project.

However, CNOOC still has a considerable amount of work to do to wrap up supply contracts for its other, potential gas projects. According to a source close to the project. There is no SPA yet for Zhejiang LNG, although a letter of intent (LOI) has been signed between CNOOC and Australia's Gorgon gas project to supply the domestic gas market generally. This LOI will only be developed into a supply agreement at the feasibility study stage, says the source.

While the parent company looks to sign a purchase agreement with Gorgon, CNOOC Limited plans to purchase an equity stake in the development. Last October, CNOOC also signed an agreement to acquire 5% of Australia's largest oil field, the North West Shelf Gas Project, for $320 million.

Similarly, CNOOC announced in May that its wholly-owned subsidiary, CNOOC Muturi Limited, had completed the acquisition of an additional 21% interest in the Muturi Production Sharing Contract (PSC) in Indonesia, for a total of $105 million. This purchase will increase CNOOC Limited's interest in the Muturi PSC from 44% to 65%, and its interest in the Tangguh LNG Project will increase from 12.5% to 17%. CNOOC's finance department did not reveal how the acquisition was financed.

An industry analyst estimates that CNOOC will inject equity worth 30% of total capex for future LNG and gas projects. However, the analyst adds: "CNOOC's equity portion is subject to joint venture contract HOAs [heads of agreements] with other sponsors."

Several market sources have expressed concerns about CNOOC's forthcoming Fujian project. According to CNOOC, the SPA was signed on 26 September 2002. Site preparation started in August 2003. The heads of agreement for the gas supply was signed and the project company established in October last year. The problem that market sources have identified concerns demand for the natural gas in and around Fujian Province. According to one financier: "we understand there is not enough demand to support the SPA."

Another banker dismisses such concerns. "Purchase agreements have already been signed, which quantitatively match the SPA," he says. The company adds that the offtakers of the Fujian project comprise both independent power plants (IPPs) and city gas distributors. "The IPPs are taking the major portion of the gas in the initial years of the project," CNOOC states, adding that it hopes to complete the project financing by end of this year.

Financing approach

Project financing is the funding method of choice for most of CNOOC's domestic gas ventures. At the moment, the company has no plans to raise further funds in the capital markets (either bonds or equity) in the next 12 months, which might have been used to fund its gas projects.

Like Guangdong LNG, Fujian will be financed on a limited recourse basis. The main differences compared with the Guangdong LNG financing will be in the terms, not the structure of the financing. CNOOC officials say: "the proportion of US Dollar and RMB loans in the Fujian LNG development depends on the equipment procurement arrangement. We estimate the ratio of US Dollars loan to RMB may be a little bit lower than in the Guangdong financing due to a greater proportion of the project's equipment coming from domestic suppliers."

In the Guangdong financing, the debt comprises a RMB2.8 billion loan with a term of up to 18 years, a $219 million, 15 year US Dollar facility, and a RMB585 million working capital facility provided on a 3 year, renewable basis. The working capital facility can be drawn in either RMB or US Dollars. Chinese banks are providing both the US Dollar and RMB loans.

A banker involved in the Fujian deal adds: "the tenor of the loans in the Fujian project will not necessarily be similar to the Guangdong project, given the different construction period, contractual arrangements, cost structures and economics."

On the issue of completion guarantees and cash deficiency support, it has still to be decided whether this kind of sponsor support will be included in the Fujian scheme. There were no completion guarantees or cash deficiency in the Guangdong financing. CNOOC does disclose, however, that there is 12 months delay in start-up insurance,? a comprehensive construction insurance programme to mitigate the risks of a delay in completion. Sponsor support is also present in the Nanhai financing.

The 100% sponsor guarantee during Nanhai Petrochemicals' construction highlights lenders' concerns about the unusual nature of the contractor arrangements. Rather than having one overall turnkey contractor, the sponsors divided the contracts between the 12 different process units that make up the plant.

For the Guangdong financing, lenders could take comfort from the fact that the sponsors had found buyers (on a take-or-pay basis) for all of the LNG throughput for the first phase of the project. Annual throughput in this first phase will be 3 million tonnes per year. Approximately 30% of Guangdong's natural gas is destined for town gas distributors, including Shenzhen Gas, Guangzhou Gas, and Hong Kong & China Gas. The other 70% will be sold to five power stations in Guangdong. One of these power stations is an existing oil-fired plant being converted to natural gas.

CNOOC's finance team is now clearly at ease with international standard project finance transactions following the close of transactions funding other large scale CNOOC projects. "In its home market CNOOC has already gone through the $4.3 billion CSPC Nanhai Petrochemicals financing and the $850 million Guangdong deal. But its experience of projects with international partners and project finance goes much further back than that," says Mitchell Stocks, partner at Latham & Watkins in Hong Kong (Latham & Watkins advised the lenders in the Nanhai deal). The lawyer notes that CNOOC was formed back in 1982 with a more external focus than most Chinese state owned enterprises. As a result, it was one of the first companies in China to build relations with western firms.

For the Guangdong LNG financing, CNOOC gained experience in leading two rounds of road-shows and issuing both preliminary information memoranda and information memoranda. "Having spent considerable time discussing the project to local and international banks, CNOOC could also see they were in a strong position because of the amount of appetite amongst domestic banks market for projects of this nature," says a foreign banker. "That is why they pursued a funding approach which included neither completion guarantees nor cash deficiency support," the banker suggests.

Because of this feature and what Bruce Macfarlane, executive director, project finance and structured debt at ABN Amro calls, "the strong fundamentals and robust structuring of the project," additional sponsor support was not necessary. The banker adds: "the terms that we were finally able to negotiate with the lenders were very attractive and quite honestly I don't think completion guarantees or cash deficiency support would have resulted in any material improvement in the terms."

The Guangdong LNG financing was also a success partly because of its high-profile, pilot nature. Banks viewed it as a strategic national project, one with strong implicit government support. CNOOC agrees. "Guangdong LNG attracted a lot of attention from PRC banks and support from all layers of government," says the company.

Macfarlane says, "the BP secondees were able to leverage their experience in other project financings and CNOOC was able to bring its strong relationships and understanding of the PRC energy markets to bear for the benefit of the project," says the banker.

CNOOC targets completion of the Guangdong LNG project by the end of June 2006, at which point a post-construction refinancing will be a possibility. CNOOC says it is not considering such a possibility at present but adds, "the financing terms leave us the flexibility to refinance when necessary."

Macfarlane, however, believes a refinancing is unlikely. "The project benefited greatly from being the pioneer of the LNG business in China and associated prestige. I don't think these terms will be repeatable. Whilst a refinancing has been allowed for, its hard to see how the terms could be significantly improved."