Russia has a tempestuous record in accommodating foreign oil and gas investment, which makes the senior debt agree­ments for the Nord Stream 2 and Yuzhno-Russkoye projects, both closed this year, all the more impressive. Nord Stream, the second stage of the $8.8 billion twin 1,220km gas pipe-line running between Russia and Germany under the Baltic Sea was the first to close. Yuzhno-Russkoye – a Eu1.3 bil­lion ($1.2 billion) oil and gas field pro­ject to tap into reserves of around 833.5 billion cubic metres of gas – soon followed.

These two deals were particularly symbolic giving the concurrent high-profile collapse of a pro­pos­ed alliance bet­ween BP and state-owned company Rosneft. The partnership was plunged into disarray after disputes bet­ween BP and its fellow shareholder in the TNK-BP 50/50 joint venture, Alfa-Access-Renova, regard­ing what rights the company had over explor­a­tion rights in Russia. The dis­pute de­rail­ed the agree­ment with Ros­neft, which covered the East-Prinovoz­emel­sky field, and Rosneft sub­se­quently signed a new agreement for the field with ExxonMobil.

Vladimir Ryashin, a Moscow-based oil and gas adviser at Instock, believes the fallout from this was the biggest challenge of this year for the market. “In spite of strong support for the Russian government the two com­pa­nies were not able to finalise the agree­ment, because of the protest of Russian shareholders of TNK-BP,” he says.

Outside edge

The messy dispute over the Rosneft venture within TNK-BP, which recalled the 2008 dispute between the TNK shareholders, could have darkened the hopes of outside investors in Russia. But while companies such as Ikea have been prepared to vote with their feet to express dissatisfaction with the country’s business environment, oil companies, from Venezuela to Japan, have remained committed to Russia and won exploration licenses.

“The achievement of this year is the complete change in the rhetoric of the Russian authorities, compared with previous times, in the way they describe conditions for offshore development,” Ryashin continues. “Before, it was only granted to national state companies, namely Gazprom, Rosneft and Gazprom Neft. As this year demonstrated, with significant progress by international oil majors in challenging for offshore projects, we can see the positive results of a shift in politics.”

This suggests growing stability and bankability in the once-notorious market. There is also a string of proposed projects (see table) that reached agreement up to and during the collapse of the BP-Rosneft deal, show­ing that confidence in Russia re­mains. These deals are likely to require billions of dollars in financing and ob­servers say that Russia’s current sup­por­tive stance suggests that it knows it needs outside developers and banks to help fund such developments.

The list of international oil compa­nies active in Russia this year is diverse. Total, for instance, came in as a partner with StatoilHydro and Gazprom on the Shtokman field development and also became the first foreign firm to sign-up to the Eu20 billion Yamal liquefied natural gas (LNG) scheme. The French giant recently took a 20% stake in scheme with local partner Novatek looking to offer a further 29% stake to additional international investors.

Other notable agreements include ExxonMobil’s replacement of BP as Rosneft’s partner on East-Prinovozemelsky on the Arctic shelf, while Gazprom brought in Eni (20%), Électricité de France (15%) and BASF (15%) on its Eu10 billion ($11 billion) South Stream project. Gazprom also brought it BASF (15.5%), EON (15.5%), Nederlandse (9%) and GDF Suez (9%) on Nord Stream and BASF’s Wintershall in Yuzhno-Russkoye.

Such international involvement, of course, has its drawbacks. Projects take years to piece together before reaching financial close when they involve multiple Russian and international sponsors. The Nord Stream consortium, for example, was established in 2005 and the project took five years to reach financial close.

Sponsors differ, for instance, over where they want a pipeline to run or how to fund it, which becomes even more complicated when the number of sponsors increases or the controlling Russian shareholder wished to modify the terms of an agreement. The other pivotal issue is that, in such agree­ments, there have been very few deals of significant scale, scope and com­plexi­ty to successfully close. Most pro­jects have been domestic affairs, which is why Nord Stream and Yuzhno-Russkoye are viewed as so important; they have establish a new benchmark.

“One of the biggest factors for clos­ing these large projects is a lack of precedent,” says Robin Baker, head of energy project finance at Societe Gen­erale. “Major Russian oil and gas pro­jects have historically been dominated by the large state-owned entities that would either finance it through equity or money borrowed from, largely, state-owned banks. There were few project finance structures developed for international commercial debt.”

Setting the standards

Both Nord Stream and Yuzhno-Russkoye benefited from being led by Gazprom. The Yuzhno-Russkoye financing closed in May and followed on from two successive one-year bridge loans. The first signed in 2009 and consisted of Eu193 million and $1.085 billion as two tranches.

The two facilities were divided between a euro and US dollar tranches with Gazprom taking a Eu125 million and a $705 million loan (priced at 450bp) while minority share­holder Wintershall received Eu68 million and $380 million (priced at 125bp). The mandated lead arrangers were Societe Generale (also financial adviser), BNP Paribas, Credit Agri­cole, ING, Citi, Intesa, UniCredit, Mizuho and SMBC.

This was refinanced in June 2010, with a new nine-month bridge (when the margins were reduced to 175bp and to 62.5bp), with the sponsors working to close a long-term loan package going into 2011. The refinancing centred on a $1.53 billion debt package alongside $322 mil­lion in equity. There was a Eu474 million ($687 mil­lion) term loan, and the $657.4 term loan priced around 250bp as well as a R5.9 billion ($208.5 million) tranche. The ruble debt came from Gazprombank and had a fixed interest rate of 11.4%.

The long-term offshore financing brought in 13 banks: Gazprombank; Intesa; BTMU; Credit Agricole; ING; Mizuho; Natixis; SMBC; UniCredit; BNP Paribas’ WestLB; and DZ Bank. Syndication was 60% oversubscribed. To underscore the levels of interest from commercial banks, there was no export credit agency coverage on the debt.

“The Yuzhno-Russkoye financing was not a miniperm loan but a fully amortising one,” Baker comments. “The length of the tenor may seem short on the face of it but it is more than reasonable for a reserve-backed financing. If anything, it is actually longer because reserve-backed finan­c­ings rarely go beyond five years.”

In the case of Nord Stream, the 26 banks that came into its club deal in October 2010 were approached this September about reducing the margins on the debt. The negotiations relate to the Eu3.9 billion ($5.3 billion) Nord Stream phase 1, which has divided between an Eu800 million 10-year uncovered tranche and a Eu3.1 billion of package backed by Germany’s Hermes (Eu1.6 billion) and UFK (Eu1 billion), and Italy’s Sace (Eu500 million) with a 16-year tenor. Pric­ing on that ranged from 275bp to 450bp on the commercial arm while the covered debt priced between 160bp and 180bp.

The refinancing has always been an option for the spon­sors. Phase 1 closed in October 2009, when the commercial risk was greater and the financial markets were more volatile. Phase 2 closed in 3Q 2010 when the project was more advanced and the markets more relaxed, so the pricing dropped to 160bp while the Hermes, UFK and SACE facility ranged from 110bp to 120bp. The plan was always to look at merging the margins.

Once again, banks were eager to parti­cipate. Phase 1 lend­ers were Credit Agri­cole, Commerzbank, Societe Gen­er­­ale, Deutsche Bank, Unicredit, 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. Phase 2 brought in additional lenders Barclays, Citibank, DekaBank, Mizuho, Natixis and SEB.

“The banks are always keen to finance those projects where they expect low levels of risk and a large financing requirement,” Ryashin says. “But there is a high level of activity in the oil industry worldwide and banks have a choice of oil projects at which they can direct funding.”

There is even discussion of a bond refinancing for Nord Stream post-completion. Historically bonds have not been the preferred route for oil and gas deals but, after a number of recent energy-related issuances in North America, it could be an attractive – and viable – option for Nord Stream.

A few dollars more

International banks are becoming more comfortable with long-term commitments to Russian deals despite the risks and legal quirks often associated with the country. Nord Stream is a case in point. One of the challenges was Russia’s foreign currency law, which states any company that exports goods or services has to repatriate the profits back to Russia.

“Nord Stream is the pipeline rather than the product so it is not an export project,” Baker explains. “The project itself is not in Russia but the revenues used to repay the debt come from a tariff paid exclusively by Gazprom. Gazprom’s gas sales revenues are paid in Euros offshore but all have to be repatriated to Russian domestic accounts from which the tariff can then be paid.”

So will future deals benefit from Yuzhno-Russkoye and Nord Stream? The project list instills some optimism. Deals on the drawing board include the 900km South Stream pipeline and the 1,510km Caspian Pipeline, as well as a string of LNG schemes, which observers claim could be the genuine big ticket oil and gas financings in Russia. Sakhalin is likely to be expanded and there are projects planned for Yamal, Shtokman and Vladivostok.

But capital costs remain high and any proposed liquefaction terminals will compete for capital with more advanced pro­jects in Asia and Australia, though some of these, notably the Australian plants, are equally expensive.

In addition, Yuzhno-Russkoye and Nord Stream both featured multi-currency debt facilities, the like of which have come under more pressure because of sovereign rating and ex­change rate volatility. Oil companies, with predominantly dollar revenues still want some of their financing to be in dollars, but some European banks with strong oil and gas franchises are finding it expensive to obtain dollars, which filters through to debt pricing. “Dollars are certainly more stressed than euros at the moment but dollar financings are still getting done, even if some banks are said to prefer euros,” Baker states. “This has some impact on loan pricing, but the energy busi­ness is strongly supported by banks worldwide and there remains ample dollar financing for good projects.”

Likewise, Russian banks support many of the oil and gas deals so it is more likely that international involvement will be limited to these few large schemes in the pipeline. “There are opportunities in Russia but the deal flow is not heavy; there will be half a dozen projects that will require long-term international investment and attract commercial banks,” Baker concludes.

Next year will see the presidential election in Russia, which means much of the state’s attention and resources will be redirected into that area. The knock-on effect is that the execution of existing projects will face further delays.

Ryashin says: “On the one hand the top management at Russian oil companies is deeply involved in politics and very linked with the establishment, on the other hand the management of those companies is strongly vertical and hierarchic. In such a situation the lack of top management’s attention can suspend for a while these companies’ decision-making processes.”

Former president Vladimir Putin has also declared his inten­tion to stand next year and, in the eyes of many, is in a good position to reclaim the presidency. So after that there could well be another reshuffle of Russia’s power struc­tures. “The expectation for at least the first half of the next year is some slowdown,” Ryashin concludes. “In that situ­ation the main challenge for Russian oil com­panies will be to get some progress in essential areas with foreign partners.” ■

Russia's upcoming big-ticket oil and gas projects

Project	Description	Russian sponsor	International sponsors	Estimated size
Shtokman LNG	The development of the Shtokman field in the Barents Sea to produce pipeline gas and LNG	Gazprom	StatoilHydro, Total	$20bn
Artic Shelf	The development of oil and gas projects in the Arctic shelf	Rosneft	ExxonMobil	$20bn
South Stream	A gas pipeline to run under the Black Sea	Gazprom	Eni, EDF, BASF	$10bn
Nord Stream	A project for two 1,220km gas pipelines between Russia and Germany, running through the Baltic Sea	Gazprom	BASF, EON, Nederlandse, GDF Suez	$8.8bn
Yuzhno-Russkoye	An oil and gas field is located in the Krasnoselkupsky district of the Yamal-Nenets autonomous okrug	Gazprom	BASF, E.ON Ruhrgas	$1.4bn
Yamal LNG	An LNG plant at the Yuzho-Tambeiskoye deposit	Novatek	Total	$10bn
Caspian Pipeline Extension	A project to double the capacity of a 100km pipeline	Transneft	KazMunaiGaz, Chevron, Shell, Mobil, ENI, BG Group	$5.8bn
Sakhalin Extension	A second LNG terminal	Gazprom	Shell, Mitsui, Mitsubishi	Unknown
Vladivostok LNG	A 4,500km pipleine from Yakutia-Khabarovsk-Vladivostok	Gazprom	INPEX, ITOCHU Corporation , Japan Petroleum Exploration , Marubeni Corporation and ITOCHU Oil Exploration	$7bn

Source: Project Finance Research