In this economic climate, even Gazprom has to work extra hard to service loans. The king of Russian exporters announced on April 1 1999 that it would not meet certain technical ratios under its $2.5 billion project finance loan agreement arranged by Dresdner. It has requested a waiver of minimum ratio requirements. A source close to the arranger says: ?It's certainly not a matter of Gazprom being unable to service the debt. It's an early warning signal, and the fact we received it shows that the structure is working.? Gazprom says reduced gas revenues will not affect its ability to meet payment obligations, but did mean the technical ratios ?have not been or will not be met?.

The announcement is symptomatic of how much things have changed for project finance in Russia. When the Gazprom deal signed in 1997, to finance the Yamal-Europe pipeline project, sponsors and lenders felt that it heralded a new era for project finance. It was followed by a further $3 billion syndicated loan to Gazprom by Dresdner and SG, and Dm1.7 billion ($919.6 million), co-arranged and syndicated by Dresdner, for a Mannesmann pipe supply contract, of which Dm1.5 billion is covered by Hermes with no sovereign guarantee. Such was the enthusiasm for Gazprom before the August 1998 banking meltdown that the market for its paper is now illiquid, says one banker. ?You could look at it two ways: either, that they blitzed the market while it was hot, or, that they just issued too much.?

Nobody doubts Gazprom's ability to service loans, or its overall potential ? least of all BASF of Germany, whose subsidiary Wintershall announced on March 31 a long-term oil and gas exploration partnership with Gazprom. But the reversal of Russia's fortunes has been so complete that even Gazprom is hard hit ? caught, like all exporters, between poor commodity prices and the fallout from the banking collapse.

That combination, difficult for Gazprom, has proved deadly for other deals that project financiers hoped would pave the way to new markets. Look at the $105 million pre-export facility syndicated by the European Bank for Reconstruction and Development (EBRD) to Magnitogorsk Metallurgical Combine (MMK). The two participating Russian banks, Tokobank and Inkombank, who were to provide $10 million, have both collapsed. Western banks that syndicated $60 million have dumped their exposure. The EBRD disbursed $20 million to MMK in 1998 and senior management has approved continuation of the A loan. But disputes with MMK, in particular relating to EBRD corporate governance, transparency and accounting standards, threaten to bring the whole process to a halt.

A similar EBRD syndication, of $110 million to rolled steel products maker Oskol Electrometallurgical Combine (OEMK) to build a new steel mill, never even got started. In early 1997, with the EBRD deal in the pipeline, Oskol received Dm350 million, syndicated by BHF and guaranteed by Hermes, to buy technology from Siemens and other German companies. BHF added a further $10 million bridge facility, expecting that it, too, would be taken out by the EBRD money. But the EBRD announced in November 1998 that it was delaying disbursement and now BHF is trying to restructure.

What happened? A source close to the two deals says the August banking collapse brought back into focus underlying problems of transition to the market including, crucially, management standards. ?If a western company finds itself in adverse market conditions, it manages its cash more carefully. It is able to use fixed instruments, to borrow from banks. Post-Soviet organizations do not have the sophistication. Management standards remain low.?

At Tyumen Oil Company, which is about to raise a $600 million-plus loan and break the rule that now there is no new project finance for Russia, finance director Alan Bigman agrees that changing management culture is important: ?Raising the non-guaranteed portion is not as easy as it would have been a year ago. But TNK is one of the only companies in Russia that can attract this sort of finance. Changes in management have made that possible.? The loan, to be guaranteed by US Ex-Im bank and with possible International Finance Corporation (IFC) and EBRD participation, is to finance the modernization and reconstruction of the $390 million Samotlor oil field and the $250 million Ryazan refinery.

Obstacles to restarting business

The question of how to get business going again with the Russian exporters is the toughest one for western bankers. Nick Greene, executive director at West LB, says: ?Soft oil prices have resulted in deferrals of discussions on project finance while, with few exceptions, the metals companies are not sufficiently developed to be strong candidates. So it's difficult. The commercial banks are frustrated by transfer risk ? problems associated with mandatory repatriation and conversion of export revenues. The multilaterals are not going to do A loans without B loans, and there are not going to be B loans as long as there is transfer risk.?

Other commercial bankers say that, at the moment when the multinationals could have made the greatest difference, they have not acted decisively enough. But Vittorio Juker, head of the EBRD's natural resources team in London, says that Russian oil companies' needs have changed drastically in the past few months: ?They need corporate and long-term finance. They also need working capital. We may even be in a situation where project finance will simply become less relevant.? The EBRD is ?studying closely? the issue of pump-priming working capital finance, he added. Nicholas Ollivant, senior banker at EBRD's Moscow office, says that many Russian companies ? even commercially viable ones ? are now saddled with a ?bad match? of dollar debt and rouble revenues. ?A lender has no way of covering himself forward. So he puts in equity instead of debt, and that raises a set of other questions.?

Long-term outlook

Project financiers are more confident long-term than mid-term, and big oil and gas projects are still in the frame. Edmund Glentworth of the oil and gas group of Deutsche's project finance department in London says: ?Some of the major projects coming onstream in the CIS in the next 10 years ? and the Sakhalin projects are a good example ? will require massive funds. Project finance may well be desirable for two reasons. First, it is likely that western partners will want to mitigate exposure, either by purchasing political risk insurance and/or by involving external financing for all or part of their needs, in order to take risks off balance sheet. They will want the IFC or EBRD to be involved for the ?halo effect' in case anything goes wrong. Second, the local partners ? Russian oil companies ? simply will not have the cash to share their part of any project.?

Glentworth adds that unless and until capital markets are reopened to Russian companies the multilaterals, export credit agencies, and to a limited extent the commercial banks, would remain the only sources of finance. Given the country's CC credit rating and crisis of public finances ?this is not likely to be any time soon?.

Neither the August crisis nor low world prices have destroyed the oil majors' appetites for new projects. They may even have been whetted by amendments to the production sharing agreement (PSA) law that took effect this year. This should make the PSA law what it was meant to be, a special legal framework to protect foreign investors from many aspects of Russian risk.

Grant Bowie of Royal Dutch Shell in London says his company is participating in PSAs including Salym Petroleum Development, a 50-50 venture with Evikon of Russia to develop the Salym oil field in Siberia, and the Komsomol project in west Siberia. Shell's partners are Quintana Minerals of the US and Purneftegaz, a Rosneft subsidiary. Says Bowie: ?The oil price outlook means it is much more difficult to make projects viable, particularly if located a long way from market.

Timan Pechora and northern territories might be able to find a northern evacuation route, but setting it up will be costly. For the west Siberian fields the logical way out is through the Transneft pipeline system, and we would be looking for a long-term commitment to access.? Other industry sources prefer projects with exit routes other than Transneft, which is disadvantaged by country risk for Russia and other CIS republics.

There have been decisions to pull out of projects ? for example BP-Amoco's announcement in March that they were quitting the Priobskoye field in Siberia, and the withdrawal by BHP Petroleum of Australia from a partnership with Gazprom and Rosshelf to develop the Prirazlomnoye field off the Arctic coast. But still bigger projects are moving ahead. Exxon Neftegas, a subsidiary of Exxon Corp, reached preliminary agreement on January 12 with Rosneft and a related company, Rosneft-Sakhalinmorneftegaz, to develop two blocks in the Sakhalin III field, and is now awaiting PSA approvals from the State Duma, the Sakhalin oblast and the Russian federal government.

Two PSA deals to develop the far northern Timan Pechora oil and gas field ? one between Conoco and Lukoil, and another between Exxon, Texaco and Lukoil ? are drafted, and were due to be signed on March 26 during Russian prime minister Yevgeny Primakov's visit to Washington. The Balkan war intervened and Primakov's plane turned around over the Atlantic and took him home ... but industry sources expect the projects to go ahead nonetheless.

Long term, the main oil company may well need to finance any or all of their share. This is the best, or perhaps the only serious, prospect for project finance in Russia.

Legislative framework

Amendments to the PSA law signed by president Yeltsin on January 7, and the Enabling Law signed on February 10, are big steps forward. The Enabling Law clarifies that the PSA law takes precedence over all other laws that contradict it, and amends the tax, foreign investment and underground resources laws in line with the PSA law ? thus resolving a problem that has bedevilled the PSA law since it was passed in 1995. Normative acts that clarify how the law will be applied are being drafted by a series of ministries and financial authorities.

Says Shell's Bowie: ?The PSA law is not perfect, but with the appropriate normative acts and a harmonized tax code it is something we could work under.? The first draft normative act, on cost recovery, was ?unacceptable? in its form, says Bowie, but he expects that the government will take note of western investors' views.

Prime minister Primakov had taken account of past representations from potential investors and it is hoped that it will continue to do so.

Lawyers and foreign investors are also watching the progress of a new draft law on foreign investment under discussion in a Duma sub-committee. The Foreign Investment Advisory Council and three other foreign business organizations wrote to prime minister Primakov in December, stating that the draft retained ?serious obstacles?, including: the majority of provisions having a ?purely declarative nature?; a ?grandfather clause? safeguarding investment conditions that includes ?restrictive provisions?; no firm guarantees of import customs duty and VAT exemptions ? unlike the foreign investment law; and no clear definition of a ?priority investment project? eligible for tax exemptions. But it should be noted that the law remains in draft form and, with two elections approaching, anything could happen to it.

As a senior banking source commented: ?Russia remains a capricious environment. The long-term potential for projects is unquestionable, but more must be done to welcome foreign investors to realize that potential.?