A six-year, $200 million loan to the Russo-Finnish joint venture Severtek, due to close in August, presents an alternative to production sharing agreements (PSAs) as the framework for financing Russian hydrocarbons projects.

The loan, arranged by the European Bank for Reconstruction and Development and HypoVereinsbank, is the Russian oil sector's first syndicated project financing. A source close to the deal said appetite among the limited club of ten banks invited to join - which included Credit Lyonnais, Banque Natexis, ING, and others with track records in Russia - "far outstripped" the $70 million available in syndication.

Sponsors are Russia's largest oil producer, Lukoil, and Fortum of Finland, each of which holds 50% of Severtek. The loan will finance drilling, and construction of a pipeline and other infrastructure, to bring on stream the South Shapkino field north of the Arctic circle in the Nenets autonomous region.

Conventional wisdom that Russian projects would be financed under PSAs, or not at all, came under challenge last year. The combination of president Vladimir Putin's reforms and strong oil prices had warmed the political, economic and legal climate faster than had previously seemed possible - while, paradoxically, the process of finalizing PSA legislation remained untouched by the changes. Normative acts covering cost recovery and other issues remained stuck in a Bermuda triangle of inter-ministerial wrangling and projects listed under the legislation stalled. Yukos chairman Mikhail Khodorkovsky and other Russian oil magnates suggested that onshore projects, for a start, could go ahead under the simplified tax regime that came into force earlier this year.

The EBRD rose to the challenge. Its board approved the Severtek deal in February, and it has taken $100 million of the deal as a senior A loan. Hypo, which has a long relationship with Lukoil, was brought in to underwrite the commercial part of the deal and is understood to be taking $30 million itself.

Kevin Bortz, director of the EBRD's natural resources team, said: "The deal offers an alternative structure to PSAs, and the EBRD hopes it will create a new model for co-operation between Russian and western energy companies." Certainly it sets a new benchmark for project financings, and market sources suggested that Sual's planned $2 billion alumina-aluminium production complex in the Komi republic could be the next beneficiary. "Willingness by the EBRD and Hypo to go that little bit further helped; so did general economic conditions," said Irina Chernobai of White & Case, who acted for the arrangers.

The lenders have recourse to the sponsors until oil starts flowing; recourse then falls away, although some items such as licence risk will stay with the sponsors. This was the subject of tough negotiation: "the difficult bit was dividing risks between the banks, the company and the sponsors, particularly with regard to the licence", said a source close to the deal.

The sponsors are unencumbered by a long-term export offtake agreement, and were pleasantly surprised that the EBRD agreed to such terms. "There is great flexibility in terms of how the crude is marketed," said a source close to Severtek. "The ultimate objective is the highest possible netback. There are obligations to report on that, which the sponsors have assured the lenders they are more than happy to meet." The EBRD's Bortz said: "Lenders feel quite comfortable with a non-PSA project, and that issue was not raised in discussions on the deal. More interest was focussed on discussing the options on transport and marketing."

Production is scheduled to start next year and to reach a maximum volume of 2.6 million tonnes per year. Oil will be transported from South Shapkino to KomiTek's Kharyaga-Usinsk pipeline through Severtek's new pipeline; south to Usinsk via KomiTek's pipeline; and thence to Ukhta by Transneft, the Russian pipeline monopoly. From there it can continue to the Baltic port of Primorsk by the recently-upgraded trunk pipeline, or be transported, probably to Finland, by train - with the added advantage that it would not be included in Transneft's export quota system.

It is likely that one or both of the sponsors would refine oil from the project. Lukoil is considering using nearby refining assets in which it has interests. And Kalervo Makinen, deputy head of oil/gas exploration & production at Fortum, said: "It makes sense for us to refine oil from South Shapkino at Porvoo, to which it can be transported by sea or rail."

The fact that Fortum will soon produce oil in Russia for its own refineries says much about the changed political and economic climate. Historically, Russian crude accounted for most of Finnish refineries' feedstock, but its share fell from 60%+ in the 1980s to 10% in the mid-1990s, as chaos overtook the Russian economy and Finland sought to diversify. The return of political stability to Russia triggered Fortum's decision not only to switch back to Russian feedstock again but also to concentrate its own upstream operations in the Russian far north, where its technical experience is an asset. Following president Putin's visit to Finland in September last year, Fortum committed itself to South Shapkino with an initial $10 million investment, and simultaneously retained Waterous to dispose of its interest in the Suneinah concession in Oman.

The South Shapkino field has 23 million tonnes of proven and probable reserves, and the whole territory covered by Severtek's licences has a total of 41 million tonnes. The total project cost is $355 million, to be met from the EBRD-led loan and from equity investment by the sponsors. The 98.5km pipeline to the field is nearly complete, along with a supply road. Other main items are the drilling of 14 oil production, six water injection and two gas injection wells and the building of a central processing facility and staff facilities. Green technologies in which Fortum has built up a body of expertise will be used to meet standards on permafrost protection and emission levels.

The Severtek project has proved more enduring than corporate entities involved in it. Fortum's predecessor, Neste, first expressed an interest in the South Shapkino field - in response to an invitation from the Soviet oil ministry - in 1988. When Severtek was constituted in 1996, it was owned 50% by Russian oil producer KomiTek, 30% by Elf Hydrocarbures and 20% by Neste. In 1999 Elf, soon to become part of Total Final Elf, transferred its interest to Neste, soon to be renamed Fortum. And KomiTek was bought by Lukoil - with which the EBRD established a relationship two years ago with its then-largest loan to the Russian onshore oil sector, a three-year $150 million working capital facility.

Severtek
Status: in syndication, scheduled to close mid-AugustSize: $355 million (total project cost)Location: South Shapkino, Nenets autonomous republic, northern RussiaDescription: development of an Arctic oil field with 23 million tonnes of reservesSponsors: Lukoil and FortumDebt: $200 million Lead arrangers: EBRD and HypovereinsbankLawyers to the sponsors: Vinson & ElkinsLawyers to the lenders: White & Case