Tucked halfway up the Saudi Arabian side of the Persian Gulf, few people had heard of the tiny sheikdom of Qatar before the second round of the Gulf War. It was catapulted to fame by Al Jazera – the Arabic language satellite channel funded by the Emir Sheik Hamad Al Thani – during the current Middle East crisis

For all its quiet past, the little country is starting to make a big impact in the LNG industry and the Qatargas II project is leading the charge.

Stefan Budzinski, head of oil and gas project finance at BNP Paribas – inter-creditor arrangers and one of the arrangers for the loan – says: ‘It’s a mega project; the third largest project financing ever behind the Channel Tunnel and the Taiwan High Speed Rail Link, and the largest ever for the energy sector. It’s huge.’

Located at the northern end of the rocky, arid peninsula that makes up the tiny sheikdom, the Qatargas II project is the largest integrated LNG project in the world and is designed to process gas from the country’s giant offshore North Field.

Lying in shallow waters in the Persian Gulf, the North Field is the largest non-associated gas field in the world and has recoverable reserves of 13 trillion cubic metres – 6 per cent of the world’s total.

The stellar performance of the Qatari economy in recent years has seen the country’s GDP jump a massive 35 per cent in 2003. This has been aided by the stable government of Al-Thani which has presided over a well-managed economic expansion since he ousted his father in a bloodless coup in 1996 – making investment into the Qatari LNG industry an attractive prospect.

Despite significant cash reserves and a 40 year history of developing oil and gas deposits, the state oil company Qatar Petroleum (QP) needed an outside partner to complete this project and chose one of the biggest companies in the business – US major ExxonMobil. The resulting Qatargas II development is a JV that QP has a 70 per cent controlling stake in, with ExxonMobil holding the other 30 per cent.

Covering all aspects of upstream gas development the Qatargas II project include the construction of two onshore LNG trains at the Ras Laffan industrial city and associated offshore gas supply facilities.

When these two trains come onstream in 2007 they will produce 15.6 million tonnes per year of LNG that will supply the UK market via the South Hook receiving terminal in south Wales, which is still under construction. An LNG facility of this size offers significant benefits for the economy of Qatar and the balance sheet of ExxonMobil, but they will not be the only beneficiaries from this undersea bonanza – the UK economy will also gain significantly.

With observers of the UK’s energy industry revising their estimates of the country’s gas reserves downward, regular supplies of LNG on this scale is a positive development for UK industry and consumers alike, and diversifies the country’s energy supply away from its current reliance on imports from Russia.

It may seem anathema to view a country from the turbulent Middle East region as safe alternative to a European neighbour, but Qatar’s proximity to Saudi Arabia has given rise to a misleading impression of the country. This geographic proximity has led to a long history of inter-twining families and ideas between the countries, but the political systems are poles apart.

With a massive annual income is spread generously by the Emir throughout the population that numbers less than 150,000, Qatar lacks the socio-economic factors that make Saudi Arabia such a volatile area for investment at the moment. Transaction

The financial details of the Qatargas II project are a riot of superlatives and a melee of firsts that all fight for your attention and provide a landmark in non-recourse financing.

Qatargas II is the largest energy project financing ever the first financing on a full LNG chain related basis the first LNG project with complete exposure to market risk the first train of the development will be the biggest in the world

There was also a great deal of demand across the banking sector to be involved in the Qatargas II project.

‘The LNG sector is very sexy at the moment,’ says Budzinski, ‘it’s got good sponsors, the projects are done well and the banks see a lot of potential there.’

This strong level of demand for LNG is demonstrated by Qatargas II’s production being sold directly onto the UK’s gas grid – contrasting with the traditional approach which was dependent on developers securing future sales agreements for the LNG, and then using these to secure the required financing.

Key to this innovative development is the existence of an open market for gas supplies in the UK giving the parties involved the opportunity to put gas sales onto the open market. And this is one aspect of the Qatargas II project that is likely to have long-term implications. The biggest growth market for LNG is the US which also has a market price for gas and therefore opens the door for chain-integrated financing of future LNG developments on a larger scale.

Whether this model of financing can be extended beyond these two countries is dependent upon the creation of liquid gas markets that mirror those in the UK and America.

The sheer number of institutions involved in the financing is impressive. There were 36 commercial banks involved as lead arrangers of the loan for the production facilities in Qatar and they collectively underwrote a US$3.6bn tranche of the financing. By the time the Islamic banks, export credit agencies and a loan from ExxonMobil have been added to the mix and the financing for the terminal is included, the total number of institutions involved rises to 58, and the debt raised by their sponsors and their financial advisor, the Royal Bank of Scotland, increases to US$7.6bn making Qatargas II the single largest energy project financing ever.

These numbers, though eye-catching, are merely an upsized version of a normal project financing transaction and, according to Philip Stopford, who led the White & Case legal team that advised the sponsors on the project, this was not the most interesting aspect of the deal.

He says: ‘What was challenging, and what makes this deal stand out is that it is the first time an LNG project has financed the whole chain of production – from extracting the gas in Qatar to bringing it onto the UK market.’

This contrasts with the traditional model where gas is supplied to either third-party gas suppliers to feed into their domestic power grids, or to utilities to fuel their power station. But with ExxonMobil already having a strong presence in the UK gas distribution market it was possible to sew-up the entire chain of development in one package.

This brought difficulties of its own Stopford says. ‘The sponsors and their advisors had to design a financing that would preserve the integrity of the chain, without having an overlap of lenders in part of the chain, with lenders in the other.’

The Islamic financing, unsurprising given the project’s location, provided a significant element of the loan, with the US$530m Islamic tranche awarded on one of the longest tenors ever for such a transaction.

The biggest challenge this posed was synchronising the differing requirement of Islamic and commercial banks. Islamic finance is based on the lender buying the asset and then leasing it back to the borrower for a fixed period whereupon they take over full ownership. This creates an obvious imbalance between the Islamic and commercial portion of the debt in the case of liquidation of Qatargas II as the Islamic lenders would be left with ownership of a fixed asset while the rest of those involved are left with a security interest.

‘We had to put in place a mechanism whereby the Islamic banks had ownership of the assets but in the case of liquidation all parties had an equal claim to all the assets – but after we had agreed the principles it became a relatively simple exercise to integrate the different forms of lending,’ says Stopford.

It seems that as long as the structural issues related to Islamic financing are dealt with, there is no reason that this form of debt cannot form a significant portion of future LNG, or indeed other major infrastructure projects in the region, given that Sharia-compliant loans are now competitive with commercial banks both in pricing and tenor with only market liquidity acting as break on their use.

With Qatargas II comprising so many different elements, it is difficult to judge what is the most significant but perhaps the projects’ use as template for future LNG developments will be its legacy.

‘There are many commercial elements to be taken into consideration, but it is certainly a model that will be used for future developments. This is a pre-cursor to the next wave which will be for the US. LNG is no longer a rich man’s niche energy source – for country’s like Japan, for example – and the market for it is set to expand in a big way,’ says Budzinski.

The project at a glance