The fact that Tyumen Oil Company (TNK) is discussing a $900 million environmental protection project at the Samotlor oil field with multilateral lenders speaks volumes about changing conditions for Russian project financings.

TNK is talking about up to $500 million in loans for the project with the European Bank for Reconstruction and Development (EBRD), the Overseas Private Investment Corporation (Opic) and commercial banks.

The Samotlor field accounts for 40% of TNK's total output, 330,000 barrels per day. Irrational development in Soviet times left uneven infrastructure and widespread ground pollution. In 2001 TNK secured $400 million in credits guaranteed by Eximbank for a programme to raise production by 40%.

A ten-year field development programme, presented to a seminar in Washington DC early last month by Ivan Menshikov, TNK's head of project finance, will cut oil pollution and further raise the field's efficiency. It provides for the reconditioning of 900km of pipelines per year, and the recovery of 640 hectares of polluted land per year, up to 2010. TNK spokesman Vladimir Bobylev said that the company is at an early stage of talks with Opic and that "various other institutions" had expressed interest in the project.

But it is TNK's ground-breaking $6.75 billion agreement with BP, announced in February, to merge assets and create Russia's third largest oil producer - Russia's largest slice of foreign direct investment yet  - that both gave impetus to the environmental protection programme, and made TNK an even more attractive target for lenders.

The merger will put TNK, Sidanko, Onako, the Kovykta gas project in east Siberia, and other Russian and Ukrainian oil and gas assets owned by Alfa-Access-Renova (TNK's owners) and BP, into a new company, TNK-BP, which the two sides will own on a 50-50 basis. BP will bring to the new company not only Western expectations on environmental standards, but also greater financing opportunities - the extent of which can be judged from TNK's aggressive behaviour in the structured finance and eurobond markets.

When TNK's tie-up with BP was agreed in February, Raiffeisen Bank was in the midst of syndicating a $200 million three-year deal to TNK with a record-breaking margin of 3%: the BP announcement stirred up an extra flurry of interest from banks. Then TNK tapped its $400 million five-year eurobond, issued in October with an 11% coupon, for another $300 million. And last month it mandated ING Bank to syndicate another record-breaking structured deal: a $200 million five-year pre-export financing of crude oil exports with flexible offtake arrangements. The 2.6% margin, the Russian market's lowest yet, will fall to under 2.5% if and when the BP deal is completed and the first tranche of BP's payment to TNK's owners goes through.

The ripple effect in the hydrocarbons sector

TNK drew down that record-breaking loan on 22 April, the same day that plans were announced for the biggest ever all-Russian merger, between Yukos and Sibneft. The agreement, scheduled for completion by year-end, is for Yukos to buy Sibneft for $3 billion plus 28.9% of the new company, and become YukosSibneft, the world's fourth largest oil producer. It will have pulling-power for financiers and political clout unprecedented for a Russian oil company.

This merger, BP's pioneering equity investment, and the remarkable economic recovery built on the last two years' high oil prices, has produced an infinitely friendlier environment for project financiers than even a year ago -  and both international and Russian banks are falling over themselves to offer the oil and gas companies a wide variety of forms of credit.

The eurobond boom of the last six months has taken tenors out to 10 years for Gazprom (on its giant $1.75 billion February issue) and to seven years for Sibneft (for its $500 million issue in November, just before the victory of a joint Sibneft-TNK bid in the Slavneft privatisation auction). Market sources say that Sberbank, the largest state-owned Russian bank, is now offering seven-year rouble financings. Sberbank, which can do deals quickly and with minimal documentation, is also understood recently to have offered Sibneft a three-year deal priced all in at 570bp over Libor. A Moscow-based banker commented: "Sberbank has not previously offered Libor-based loans. That price is not much higher than the western banks are charging when you count in the margin and all fees."

Western banks are now offering unsecured loans. Transneft, the state-owned pipeline monopoly, took a $116 million three-year clean loan, now in syndication, from Raiffeisen Bank, to refinance the first stage of the Baltic Pipeline System (Baltiiskaia truboprovodnaia sistema or BTS) project. And last month Gazprom is understood to have invited banks to bid for a three-year unsecured syndication. One European project financier grumbled: "Some banks think clean lending is appropriate and this will change the shape of the market considerably." However a source at a western bank's Moscow office said: "Clean lending will not go out beyond three years. Project finance is a different market."

Upstream ups steam

Of the Russian upstream projects, the Prirazlomnoe field being developed jointly by Gazprom and Rosneft (see www.projectfinancemagazine.com February 2003) is probably the front runner. A source at the EBRD confirms that the bank is in discussions with Rosneft, which has also talked to commercial lenders. One of these, ABN Amro, last month won a mandate from Rosneft to arrange a five-year, $600 million, pre-export loan that will refinance the purchase by Rosneft in February of Severnaya Neft, the fast-growing but legally conflicted producer based in Timan Pechora province.

Lukoil, whose directors are discussing a ten-year, $19 billion investment programme, is bound to remain a key project finance target - and last month further strengthened its relationship with the EBRD by agreeing a six-year $80 million deal to finance an environmental protection programme. Half of the loan, to Lukoil's northern Urals production subsidiary Lukoil-Perm, is being syndicated to commercial banks; ABN Amro is sole underwriter, joint arranger and bookrunner.

The project, announced on 7 April, provides for a reduction in Lukoil-Perm's flaring of gas to 20% of associated gas output - as compared to a 52% average across Russian oil fields - by 2005. Lukoil-Perm will convert the gas to supply the local power network, which has suffered shortages in recent winters. Portions of the loan will also be used to develop the Sibirskoye oil field in Perm region, upgrade management information systems, and refinance a $45 million loan made by the EBRD in 1998 to Permtex, a Lukoil-Perm subsidiary due to be fully merged with the parent company in mid-2003.

The Lukoil-Perm deal followed the announcement on 31 March that half of the IFC's $150 million, six-year refinancing of Lukoil's share in the Karachaganak project in Kazakhstan (reported in Project Finance November 2002) has been succesfully syndicated to eight commercial banks: ABN Amro, HVB, Credit Lyonnais, ING, Natexis, Raiffeisen, SG and West LB. An IFC spokesman pointed out: "We have broken new ground here, by bringing in international commercial banks for a long-term financing in Kazakhstan under the IFC's umbrella." A project financier close to the deal commented: "The risk is on Lukoil as a borrower, although the fact that at Karachaganak it is in partnership with three western oil majors gives extra comfort. Lukoil is an attractive target: it had a big say in who was approached, and everybody came back with a 'yes'."

Another notable deal is the innovative three-year, $40 million revolving reserves-based financing arranged by Standard Bank for Khantymansiiskneftegazgeologiya, the largest of three production subsidiaries of Khanty Mansiysk Oil Corporation (KMOC). On 22 April Marathon Oil announced that it had acquired KMOC, including all its debt commitments, from its Russian-American private owners in a $275 million cash merger transaction. KMOC, which produced 615,000 tonnes of oil in 2001, first came to the structured loan market last year with a $20 million, two-year deal syndicated by Commerzbank. But the interesting thing about Standard's follow-up deal is not so much the borrower as the structure's potential for other smaller Russian producers.

Andrew Bartlett of Standard's structured finance team in London, which arranged the deal, says the structure is hybrid: the bank retains a capture on offtake proceeds, but also has a share pledge on Khantymansiiskneftegazgeologiya. On the latter, net present value is worked out by taking into account both undeveloped and developed reserves (like most Russian producers, this one has a higher proportion of undeveloped reserves than in, say, most US oil companies) and imposing a series of risk ratios. Bartlett said: "The assets are revalued regularly during the life of the loan, enabling the shape of the financing to follow the shape of the assets. There's been a great deal of interest in the deal in the market generally."

Gail Coleman, chief financial officer of KMOC, says: "We were constantly pushing banks to give us longer grace periods on structured export deals. Then we were offered this arrangement, which is more suitable." KMOC pays a commitment fee, but Coleman says that it is "well worth it" to have a revolving deal that starts amortising after the first 12 months.

PSA confusion

Amidst all the positive news, there is a small dark cloud - as usual, over Russia's ill-fated production sharing agreement (PSA) legislation. Early last month the government approved amendments to the PSA law - which has been trundling through parliament for several years - that would strip of PSA status and put out to auction almost all the 33 potential PSA projects, excluding only Sakhalin III, Prirazlomnoe, Shtokman and Lukoil's northern Caspian shelf project. On 11 April the parliamentary budget committee toughened the draft further, deleting reference to specific exclusions from the auction procedure; Rosneft and Gazprom responded by writing to parliament and calling on it to throw out the draft as a whole; and on 22 April parliament agreed to the government's request to postpone further discussion of the problem until mid-May.

The uncertainty hardly improves the investment environment. The same might be said for a statement last month by the natural resources ministry that it is considering withdrawing the licence for the Kovykta gas field, which is controlled by the BP-TNK alliance, with whom Gazprom is negotiating for greater participation. Moscow sources believe the ministry's threat is effectively part of the negotiating process.

Sakhalin still waiting on long term sales

Discussions on the $9 billion Sakhalin II (second phase) project - slated to become the largest project financing ever in the oil and gas sector - are currently focused on changes in the Far Eastern market for liquefied natural gas (LNG). Alfred de Witte, deputy project finance manager at Sakhalin Energy, the project management company controlled by Shell, said last month: "We see some challenges ahead. Traditionally, investment decisions on LNG projects could be made on the basis of one or two big contracts. But there is a changing emphasis in LNG markets."

In Japan and Korea, established markets including electricity generation and LNG are being liberalised, de Witte told the EuroForum conference on Russian oil and gas projects in Moscow. "Companies that have been seen as good credits are now operating in more competitive markets than previously. There is a variation in supply contracts: previously these were take-or-pay, in future we will see a combination of long- and short-term contracts. Customers want variations in supply terms and that reduces the certainty for lenders. We see the emergence of supply-side tenders." A liquid spot market for LNG is developing in east Asia, with the accompanying growth of derivatives trading, he added.

A project financier at a western European bank who has been involved in talks on Sakhalin II commented: "If the sponsors are going to project finance an LNG project, they need to demonstrate long-term sales contracts. The Sakhalin sponsors are close to securing them, but don't have them yet. The trouble is that the buyers in Tokyo and Seoul who have classically been on the other side of 20- or 25-year contracts don't need to tie themselves down. Everyone expects the deal to go ahead, comfortably. It will have substantial backing from JBIC, but will need a wider base than that."

Pipeline dilemmas

Russia's oil and gas-driven boom means that pipeline projects are more likely to get funding now than at any time in the past decade. Transneft set the ball rolling by announcing plans for the relatively short-term and inexpensive phase two expansion of the BTS - only to be upstaged by the government, which on 17 April surprised the industry by dropping opposition to the longer-term Murmansk pipeline project favoured by the oil companies.

The BTS expansion will raise the system's capacity from 12 million tonnes of crude to 42 million tonnes of crude per year and cost up to $1 billion. The project was given the go-ahead by the government in March and is scheduled for completion by next year. Transneft last month announced that it is in talks about the project with Sberbank, which is expected to provide a considerable part of the funding. Sergei Skatershchikov of OilGazNet, financial advisers to Transneft, said that debt financing from Sberbank could be combined with a domestic bond issue. "The Russian bond market is strong at the moment and Transneft is now in the process of mandating domestic banks to arrange an issue." He added that there is unlikely to be a project finance element to the BTS expansion because of "constraints on procurement policy" implicit in project finance structures.

But the BTS expansion plan could be amended in the light of the government's surprise decision on 17 April to sanction construction of a pipeline from west Siberia to Murmansk and an ice-free terminal to load tankers bound for the US. The pipeline, proposed last year by Lukoil with support from Yukos, Surgutneftegaz, TNK and Sibneft, would have a capacity of 60-100 million tonnes per year and cost between $3.4 billion and $4.5 billion. The government was unenthusiastic because the oil companies proposed to build the pipeline themselves, placing a large question mark over Transneft's transportation monopoly. Under scenarios now reported in the Russian press to be under discussion by ministers, Transneft would retain control of the pipeline, while the oil companies would receive low tariffs, preferential access, and possibly minority holdings.

In the Far East, there is a choice between two pipelines, and competition between Japan and China, both eager customers for future Russian oil flows, is a key factor. A 30 million tonnes per year line from Angarsk in east Siberia to Daqing in China is favoured by Yukos, which has prime reserves in eastern Siberia and an indication from the Chinese oil company CNPC that it is ready to buy 20 million tonnes per year. The alternative is a longer, larger line from Angarsk to Nakhodka, the Russian Far Eastern port that serves routes to Japan.

Japanese deputy prime minister Iwao Okamato was reported last month to have told his Russian opposite number, Viktor Khristenko, that Japan is ready to lend up to $6 billion to the project. Semyon Vainshtok, chairman of Transneft, appears convinced by Yukos's arguments: he said in an interview with Reuters that it would be difficult to make the Nakhodka alternative profitable. The Russian government has asked for blueprints of both pipelines to be made ready by 1 May; no doubt they will be studied in detail before Chinese president Hu Jintao's visit to Moscow this month.