Refineries traditionally make poor candidates for project financings. Margins in the business are poor, and the commodity-dependent business is both volatile and cyclical. Power sponsors should be worried that ratings agencies sometimes see it as the model that the generation sector will eventually emulate. Indeed bankers' last memories of deals for refineries are of the Star and Rayong deals from 10 years ago, which have performed indifferently at best.

But the most significant, and well received, financing to come out of the Middle East this year was for the Sohar Refinery project. This deal featured a high degree of leverage and a tenor of 14 years. This was the result of government support that enabled the project to draw on lender interest from across the region.

The Sohar Refinery Company is a joint venture between the Government of Oman's finance ministry (80%) and the state-owned Oman Oil Company (20%). It has been formed to build a new refinery in the Sohar Industrial Area, a development zone roughly 200km north-west of Muscat.

The sultanate's existing refinery is at Mina Al Fahal, close to Muscat, and has little room for expansion. Muscat has expanded, and the refinery is located within a cove, providing a strong environmental impetus to choosing a new site. The existing refinery does not produce much beyond a heavy residue that can be used as heating oil.

The new facility has a capacity of 116,400 barrels per day, and will produce LPG, propylene, naphtha, gasoline, kerosene, gas oil, fuel oil and sulphur. It uses feedstock from the existing refinery, delivered via a 260km pipeline. The propylene, equivalent to 7% of production, will be used to feed a proposed polypropylene plant to be constructed nearby.

The output will be sold back to the supplier, the Oman Refinery Company (ORC), also owned by the government. As such the credit behind the project is the government's, since the contract works much like a tolling agreement. The output for export will be sold to BP, but BP buys from ORC, and is thus not part of the project's credit.

The Omani government wraps most of the project's credit, right down to a guarantee of completion. JGC of Japan is the project's EPC contractor, but is providing only limited liquidated damages. The government, however, will make whole lenders even in the event of force majeure. Availability and performance payments will cover debt service and a minimum equity return.

The EPC contractor has attracted funding from JBIC and Nexi. JBIC has provided a $262 million direct loan, while Nexi has provided cover for another $262 million facility - 97.5% political and 95% commercial. Six months before close, the Japanese export credit agencies had not even read the term sheet, so their speed in working with the commercial banks towards close is impressive.

The commercial banks provided, without cover, $645.9 million, which includes an $84.8 million contingency portion. The 10 banks out of the 13 approached by the sponsors signed up for equal commitments - an initial underwriting commitment of $90 million each. They are Gulf International Bank, BNP Paribas, HSBC, Arab Bank, ANZ Investment Bank, Bank of Tokyo-Mitsubishi, Credit Agricole Indosuez, Mizuho Financial Group, SG and Sumitomo Mitsui Banking Corporation.

The deal was understood by participants as Oman government risk with a premium - after a series of bids from the arrangers pricing settled at roughly 90bp over Libor, rising to roughly 120bp later on. This represents a premium over government debt, although government debt usually has a shorter tenor.

The 14-year maturity is better than that usually possible for the sultanate, and is made possible by the nature of the asset, which will cater to the growing Omani demand for gasoline. While the guarantee assuages most lender concerns, the fundamentals for the project enabled lenders to go out this long.

The strong credit also enabled the sponsor to achieve 90% leverage, since it only has to contribute $129.9 million. Make-whole provisions, however, negate any temptation to walk away. The sponsor's future plans to monetize more of its hydrocarbons resources also make such a course of action unlikely.

In syndication, the leads expressed bemusement at the popularity of the deal. Whether or not this was false modesty, the deal has certainly benefited from the dearth of project paper in the market this year. Lenders from elsewhere in the region, including Bahrain and Saudi Arabia, were drawn to the quasi-sovereign credit story. German lenders without much of a history of participation in these deals also made a strong showing.

The remuneration offered to lenders will have helped, however. Fees on the Sohar loan are 110bp over Libor at the top-level and margins on the loan start at 90bp over Libor during construction, 115bp over Libor for the first five years after which pricing will step up to 130bp over Libor, then to 145bp over Libor and finally to 160bp over Libor by year 14. The margin on the Nexi tranche is 60bp over Libor.

This solid showing is important since, while Oman is unlikely to become the force in hydrocarbons financing that Qatar has become, there will be a solid pipeline of deals forthcoming. The refinery will be at the centre of an industrial development area where Oman Oil will attempt to capture as much value from is oil reserves as possible.

If the Omani government wants to keep as much of the industry in its own hands as possible, then the Sohar refinery template will be an attractive option. It ensures attractive pricing and a strong response in syndication.

Sohar Oil Refinery

Status: closed 16 December 2003

Location: Sohar, Oman

Description: Construction of a new refinery

Sponsor: Sohar Refinery Company (a wholly owned government company)

Total project cost: $1.3 billion

Lead arrangers: Gulf International Bank, BNP Paribas, HSBC, Arab Bank, ANZ Investment Bank, Bank of Tokyo-Mitsubishi, Credit Agricole Indosuez, Mizuho Financial Group, SG, Sumitomo Mitsui Banking Corporation.

Multilateral support: JBIC, Nexi

Financial advisor to the sponsor: Bank of America

Lawyers to the sponsor: Clifford Chance (international) Mansoor Jamal, (Omani law)

Lawyers to the lenders: Linklaters (international),

SASLO (Omani law).

EPC contractor: JGC Corporation