The Eu3.9 billion ($5.7 billion) limited recourse debt package for Phase 1 of the Nord Stream pipeline has signed. Strong demand for the credit led to a 60% oversubscription and a reduction in bank allocations across the board. The deal funds Phase 1 of the 1,220km Nord Stream sub-sea gas pipeline linking Russia and Germany via the Baltic Sea. Construction is scheduled to begin when the Baltic Sea is ice-free in early April 2010 and is scheduled to be finished by the end of 2011, with the second pipeline up and running a year later.

The facility is split between an Eu800 million 10-year uncovered tranche and Eu3.1 billion of 16-year covered debt backed by Germany's Hermes (Eu1.6 billion) and UFK (Eu1 billion), and Italy's Sace (Eu500 million). The Hermes, UFK and Sace facilities offer commercial and political risk insurance of 95%, 90% and 100% respectively. Given the bank appetite the deal priced at just under the model margins. The model margin on the commercial tranche was 275bp over Euribor during the guaranteed pre-completion phase, 430bp at operation and rises to 450bp at year 7. In the model the covered tranche is priced at between 160bp and 180bp. All facilities are fully amortising.

There is also Eu1.5 billion of equity from Nord Stream shareholders Gazprom (51%), BASF/Wintershall (20%), E.ON Ruhrgas, (20%) and NV Nederlandse Gasunie (9%). GDF Suez has agreed to purchase a 9% stake in the project – 4.5% from each of E.ON and BASF/Wintershall – but that deal has not yet been finalised.

The capex of phase 1 is Eu4.54 billion and the capex of phase 2 is Eu2.9 billion. Phase 1 includes some of the work for  pipeline 2 (design, shoreline approaches and control room).

The financing is anchored on a 22-year transportation agreement with the shipper, Gazprom Export, supported by a Gazprom performance guarantee. The project is essentially enhanced Gazprom risk, with the benefit of structuring and blue chip European sponsors and offtakers.

The transportation fee is calculated on a cost-plus basis to make sure the sponsors achieve a set internal rate of return. The agreement is for 100% of the 27.5 billion-cubic-meter annual capacity on a ship-or-pay basis, so banks are taking no volume or market risk.
Lenders benefit from full and complete completion guarantees from shareholders and a minimum debt service coverage ratio (MDSCR) provision. If the coverage ratio falls below a trigger of 1.275x the tariff under the transport agreement is increased so that the DSCR is preserved at 1.275x. There is a 12-month debt service reserve account when phase 1 is operational which falls to a six-month reserve when both pipelines are operational.

Nord Stream plans to hedge the interest rate on at least 50%, and up to 80%, of the debt. A swap competition with pricing of around 12bp has already taken place and the swaps will be in place at financial close and first drawdown, which is due in April. There is limited foreign exchange risk, because all of the major contracts are denominated in Euros, and any residual risk from currency movements would be mitigated with the MDSCR provision.

Following a market-sounding earlier in 2010, the planned uncovered tenor of 14 years was reduced to 10 years and the sweet/sour ratio, or the ratio covered to uncovered debt, set at 80/20. UFK, Hermes and Sace were crucial to the success of the deal.

Asking lenders to assume onshore Russian risk appeared to be a difficult proposition in early 2009 but an offshore structure was not viable. After an extensive legal due diligence the sponsors decided that an offshore structure ran the risk of being deemed illegal under Russian tax repatriation laws. Financial obligations are an exception to the repatriation rules, but Nord Stream is an operating obligation.

Nord Stream initially received 38 bank responses, but the bank group was whittled down to 29 that entered firm bids, of which 26 were selected. Banks were offered four ticket sizes from Eu100 million to Eu300 million, with a preference for the banks to fund the covered facilities pro rata 20:80. At least one bank was originally excluded, after offering to commit only to the uncovered tranche, but the bank went back to Nord Stream and asked to enter a compliant bid, and eventually joined the club on a blended ticket, such was the momentum for the deal.

There are a few surprising names in the bank club, a reflection of the strategic importance of the project and the pull of the sponsors. Notably the deal features six southern European banks: BBVA, Caja Madrid, BES, Mediobanca, Intesa Sanpaolo and Unicredit. Unicredit secured a role as UFK adviser and has told potential arranging banks the UFK and Hermes commitments would be eligible to be pfandbriefe collateral. German government offers UFK financing, which is administered by PwC, with the aim of securing secure strategic raw material supplies.

The deal had been scheduled to reach financial close by the end of 2009 but it was delayed by the sheer volume – roughly 1,500 pages – of documentation involved. One benefit of the delay is that almost all of the conditions precedent have been fulfilled. All environmental licenses and permits for the five jurisdictions the pipeline traverses have been obtained.

Unusually, Swiss law governs the gas transportation agreement, because Nord Stream AG is Swiss-incorporated, and Switzerland is considered a neutral jurisdiction by both the EU and Russia. The differences of interpretation between Swiss and Anglo-Saxon law required extensive due diligence but lenders were comfortable with the fact that in a civil law jurisdiction courts look at the fairness of the provisions rather than a black-and-white interpretation.

Now that the trajectory of bank pricing has peaked and is falling, Nord Stream can take advantage of the momentum it has built with phase 1, and will almost certainly extract far tighter pricing, and possibly longer tenors, on the Eu2.5 billion debt required for phase 2. Already one bank has approached Nord Stream for consent to sell down some of its debt for phase 1 in the secondary market, and another has approached the borrower about phase 2.

Commerzbank, RBS and SG, financial advisers on phase 1, have a rolling mandate, together with legal adviser, White & Case for the second phase of Nord Stream, a second pipeline that will run substantially along the same route. The total project cost for both pipelines is about Eu7.4 billion met by a 30/70 equity-debt split. Requests for proposals for phase 2 will go out to banks in the middle of 2010. The facility is likely to have a large component of ECA debt – both Hermes and Sace are in advanced talks – and share the same documentation as phase 1. Financial close is likely before 2011.

Nord Stream AG
Status: Bank commitments signed 16 March 2009, financial close expected in April 2009
Size: Eu4.54 billion (capex)
Location: Baltic Sea
Description: Eu3.9 billion debt financing of the first subsea gas pipeline from Russia to Germany
Sponsors: Gazprom (51%), BASF/ Wintershall (20%), E.ON Ruhrgas, (20%) and NV Nederlandse Gasunie (9%)
Financial advisers: Commerzbank, Royal Bank of Scotland and Societe Generale
Cover providers: Hermes, Sace and UFK
Mandated lead arrangers: Credit Agricole (documentation and commercial facility agent), Commerzbank (Hermes agent), Societe Generale (Sace and intercreditor bank), Deutsche Bank (accounts bank), Unicredit (UFK adviser), BTMU, BayernLB, BBVA, BNP Paribas, Caja Madrid, Credit Suisse, Dexia, DZ Bank, BES, Fortis Bank Nederland, ING, Intesa Sanpaolo, KfW Ipex-Bank, Mediobanca, Natixis, Nordea, RBS, RZB, Standard Bank, SMBC and WestLB
German government UFK adviser: PwC
Borrower legal counsel: White & Case
Lender legal counsel: Clifford Chance
Gazprom Export counsel (gas transportation agreement): Linklaters