Times have been hard for Central Asia in the past, and the situation is not improving. Under intense western scrutiny, the former Turkestan fell neatly into five divided countries: Turkmenistan, Tajikistan, Uzbekistan, Kazakhstan and Kyrgyzstan. Flanking these are Azerbaijan, Georgia and Afghanistan, with Russia close to hand overlooking the basin.

The five Stans are relatively poverty-stricken, and rely almost exclusively on international demand for oil and gas ? domestic demand is very low, and this should make them a potential playground for project bankers. More than two thirds of exploited natural gas and crude oil fields serve European markets, with Russia second on the list as a consumer. Deal flow is currently weak, and this has at its root a number of factors. The official line is that there are problems with transportation and construction risk in pipelines. But the real risks are more ominous and far less predictable.

The political climate could arguably be described as appalling, and although oil companies flocked to the basin after the end of almost 70 years of communism, when Turkestan became five states it sent shivers down the spines of many Western sponsors, which are still today generally the offtakers of the region's product. There is no appetite for lending long-term money, and the legal framework is not especially attractive to investors.

As well as this, trying to tap capital markets or issue bonds which are sub-investment grade is difficult. With a speculative sovereign rating, it is still a matter of trust with the governments of the region. However, with well-structured political risk insurance and the impressive security provided by sponsor-offtaker vested interest, lenders are beginning to step into the region. One project is the Baku-Tbilisi-Ceyhan (BTC) pipeline, a $2.985 billion project running across three countries. The documents were signed on 1 August 2002.

Eight oil companies formed the BTC Pipeline Company; BP (38.2%) led the consortium, which included the State Oil Company of the Azerbaijan Republic (SOCAR) (25%), Statoil (9.6%), Turkish Petroleum (TPAO) (7.5%), Unocal (8.9%), Eni (5%), Itochu (3.4%) and Amerada Hess (2.4%), and entered into a Production Sharing Agreement (PSA). In addition, TotalFinaElf has acquired the right to purchase a 5% interest in BTC Co. Those involved in the deal say it is a ?far reaching effort to establish Azerbaijan as an important source of energy for world markets.?

The USA admininistration has actively rallied support behind the BTC project, as the export route ? a modern-day Silk Road ? runs through Georgia and Turkey, and gives the country some economic independence from Russia and Iran. Russia has controlled Azerbaijan since the early 1800s and the Azeri people make up Iran's largest ethnic group.

Once in operation, the BTC capacity will be one million barrels per day. The BTC Company's next step is to seek financing and political risk insurance from multilaterals, so the World Bank, other multilateral and governmental financing organisations and commerical lenders can expect to be approached. US Ex-Im and JBIC are actively examining the transaction and have retained advisors. Construction is scheduled for completion by 2005 and is planned to come online in tandem with another oil export project, phase I of the Azeri-Chirag-Gunashli (ACG) field. The ACG oil field is an offshore development in its early stages. The next phase will need an additional expenditure of around $5.5 billion. Funding will be sought from similar sources to the BTC Company.

Azerbaijan oil and gas, of which offshore reserves are thought to exceed those of the North Sea, will also be exploited under another project, the 11.9tcf Shah Deniz gas discovery. Shareholders are Statoil (25.5%), BP (25.5%), SOCAR (10%), OIEC (10%), TotalFinaElf (10%), LukAgip (10%) and TPAO (9%). This is an offshore, $3.2 billion development with a related $1.7 billion pipeline system. Antony Higginson, partner at Baker Botts, lawyers to a number of corporates with interests in the region, says: ?Together, these projects probably represent the largest active energy infrastructure development in the world.?

Across the basin and into Turkmenistan, however, two projects have been shelved. There is a certain reluctance on the part of putative participants to disclose where the fault lay, but a US-driven bid to find new export routes failed. The first project was to be similar to the BTC route, running from Turkmenistan, through Azerbaijan and Georgia and out to the Turkish Mediterranean coast. The second was pipeline running from Turkmenistan, into Afghanistan and ending in Pakistan. One market player commented that this might have stabilised the region by joining together economic interests. However, the confidence was not there, and it does not take long to work out why.

Afghanistan is something of an unknown quantity when it comes to reserves. Speculation has it that it is sitting on incredible gas resources, but the ongoing instability and war there has made focussed exploration very difficult. The exhaustive effort to topple the Taliban regime has now provided a window within which reserves may be found, and undoubtedly tapped by Western sponsors. Whether projects will start signing in the mid-long term though is another matter: the future is as uncertain as it could be.

In Kazakhstan, the future is brighter. Debt of $65 million was recently raised in the debt markets by sponsor OJSC Karazhanbasmunai, a wholly-owned subsidiary of Nations Energy Company. The project signed last month. Funds will support the development of the Karazhanbas oil field, based in western Kazakhstan. This loan has a three-year tenor and is likely to be taken out by a longer-term facility on maturity. KBC led the transaction with Hypovereinsbank and Bayerische Landesbank as co-arrangers. CSFB came in as a lead manager.

The Karazhanbas project boded well for future Kazakhstan financings, as the debt is both non-recourse and has no ECA cover, showing confidence in the project and security against a pre-existing offtake agreement. It highlights an appetite for commercial debt backing upstream oil projects in the country.

Kazakhstan in particular has been an attractive destination for exploration and production players despite having a government that is, according to one market player, ?an unstable business?. The shareholder mix is good and three refineries are up and running ? Pavladar, Atyrau and Shimkem, the last of which is owned 100% by Hurricane Hydrocarbons and is the largest of the three.

Another Kazakhstan pipeline, again cross-country, is the Caspian Pipeline Company's (CPC) main export pipeline. This starts in western Kazakhstan and is operated on the back of the $2 billion TengizChevrOil (TCO) field as an add-on. Market analysts say the only way TCO could get oil to market is by building this pipeline. It starts near the TCO field and carries on to Russia's Black Sea ports. TCO is another major project in the region looking for financing, and is backed by ChevronTexaco.

Along with an announcement in July this year of the expansion of TCO as a standalone pipeline project, deal team leaders launched an $800 million Sour Gas Injection (SGI) project to boost output by 3 million tonnes per year. TCO was first set up in 1993 with a 40-year contract. This year's figures are expected to reach 12.7 million tonnes of crude. To raise crude shipment capacity TCO entered into talks with the CPC consortium. CPC runs most of TCO's oil now, whereas it was previously transported by rail. US major ExxonMobil and Lukoil subsidiary Lukarco also have a share in the TCO project.

For any oil and gas project in Central Asia, the legal framework makes closing deals complex, time-consuming and costly. The body of relevant legislation is generally not robust enough, and so Western law firms advise on the majority of projects, with supplementary advice from regional lawyers on technicalities.

One London banker highlights a private concern for bankers lending into the region. He says: ?Things are done completely differently out there. For one part, if things go wrong, bankers can be held at gunpoint, threatened or even abducted ? as in the case of one Lukoil senior vice president. We're not used to that here ? but it's how it operates in some other countries.?

Market players cite BNP Paribas, SocGen, JP Morgan (not renowned for getting involved in projects) and ABN Amro as banks which have business in the region. Generally, says one insurer of political risk and its effect on deal flow, ?we're not seeing much in Kazakhstan, although many people are positive because it has just been upgraded two notches. I would still be cautious ? as new laws are being passed all the time.?

The new laws he refers to are a set of regulations on investors' rights ? who owns what. These are constantly being amended and therefore make political risk insurance and lending very difficult to gauge or put in trust.

He adds: ?Most of the Stans are still ruled by an autocratic regime, the same Soviet-style parties operating under a different name, and this is unpredictable. As a result, we have deals done with production sharing agreements (PSAs), which is not unusual for an emerging market, and insurance premiums on the higher end of the spectrum in terms of buying political risk insurance ? this can be upwards of 4% per year.?

One common mechanism to reduce costs and lower political risk on a project is to keep revenues from major oil project in offshore accounts over which the lender has a pledge. The lender, therefore, has security over future revenues ? lending money against the credit of offtake agreements. Another mechanism is to lend to a project where the sponsors are the offtakers ? a popular financing route.

Despite rumours of problems with parent companies' outstanding debt, KazMuniGas, owned by Kazakhoil, Kaztransgas and Kaztransoil, has attracted the interest of ABN Amro in a lending role, which is currently working on a project with KazMuniGas in the region at the moment. It is still in relatively early stages and so not much has been disclosed about the transaction. More details of the project are due out later this year.

However, one banker who is lending in the region at the moment said of the financing climate: ?Companies do much of the funding. ECAs could get involved, or the International Finance Corporation (IFC) or EBRD could come in ? but banks can take it on for about five years without ECAs. Money is always short-term.? Says another source; ?Not all banks see a big risk ? they just use shorter-term loans.?

Russia has the best reputation in the region, typically with five-year tenors and plenty of foreign investment. ?It is a better environment?, says one market player. The Russian government recently introduced tax breaks and incentives for more foreign direct investment. This is generally accepted as a positive step, but there are distant rumbles that this could pave the way for an increase in corruption in the region.

Looking at the entire basin, although reserves are good and export revenue is needed, the region still has a reputation for being protective about resources, taxing heavily or tapping into revenues. This has also been a factor to make bankers hesitant about lending into projects. The old Ukraine story of tapping into pipelines is still used for illustration, and mud sticks.

Although deal flow is slow right now, many see a gradual uptake in deals within the next few years. This will be affected heavily by any military action in or near the region and this unpredictability needs to be mitigated by well-structured financing. ?More activity will make it a lot more viable, and external finance will play a more important part than it used to.?

For the most part, it is important to stress that this region as an emerging market. To support deals, transactions are done using a PSA. And to support the legal framework ? especially for cross-country pipelines or routes taking resources from oilfields in the Stans or in Russia out to the Black Sea or Turkish ports ? there is the complex and relatively young Host Government Agreement. Governments must be brought together by lawyers to sign agreements, which back up the regional legal framework and make deals safer. This can take months or even years and is becoming common in the region as a safety net against cross-country transportation risks.

Opinion is divided on lending potential and project activity in Central Asian oil and gas. Political risk insurance, as ever, is the backbone of the matter.