The €2 billion (US$2.61 billion) Yuzhno-Russkoye gas field project, as well as being the largest project financing of its kind in Russia to date could, through its unconventional multi-currency, limited-recourse structure serve as a model for future large-scale energy project finance deals in the country.

The development of the Yuzhno-Russkoye field is also a project of key significance to Northern Europe’s energy security, given that this field alone could in theory provide all of Russia’s gas exports to Germany for fifteen years.

Background and Scope

The Yuzhno-Russkoye, situated some 3,500 km northeast of Moscow in the Yamal-Nenets region of North-Western Siberia, was discovered in 1969 but no moves were made to develop it for nearly 30 years. Initial preparation for development started in 1997 but it took until December 2007 for skirmishes over the ownership of operating company Severneftegazprom (SNGP) to settle down and for development of the field to be launched.

By the time the inaugural ceremony was held, SNGP was a joint venture majority owned by Gazprom in partnership with two German companies, BASF subsidiary Wintershall and E.On Ruhrgas Exploration and Production. The Russian partner holds a 50 per cent stake with the German companies holding 25 per cent minus one share each. Wintershall has also received a non-voting preferred share in the original capital of SNGP, giving the company a 35 per cent share in the venture’s economic outputs.

Investment by German companies in upstream development in Russia was a natural continuation of the relationship established on the Nord Stream pipeline [Projects Database]. One observer described it as, “almost inevitable.”

Initial production at the huge field, stretching over 900 square kilometres and estimated to have recoverable reserves of more than 600 billion cubic metres (bcm) of natural gas, began in 2007 with 26 gas wells producing a total 15 million cubic metres of gas per day. Since then, production has plateaued at 25 bcm of gas per year, expected to last 17 years. By comparison, Gazprom currently supplies Germany with almost 40 bcm of natural gas a year from all of its fields combined.

Although gas from the Yuzhno-Russkoye field feeds in to Russia’s domestic network of pipelines additional capacity resulting from this development is understood to be destined for the Nord Stream pipeline linking Russian gas production to the North European market.

Russia’s Ministry of Natural Resources has issued an extended production licence for the field to last until 2043.

Financing

Initial financing of the project began with a bridge loan agreed in 2008 [Projects Database] and due to expire at the end of March 2011. The building of a core bank group at this early stage of the process was a key element of a proactive syndication strategy that allowed the financial advisers to present and explain the evolution of what proved to be a complex and original financing structure to a bank market at the height of the credit crunch.

When the sponsors approached the market for long term financing to cover the initial bridge loan the project was 1.5 times oversubscribed. Fourteen banks (13 international banks and one Russian) provided commitments to an innovative three-currency facility. The debt was split between rouble, euro and dollar denominated tranches as follows:

• €474 million (equivalent to 43 per cent of the total)
• US$658 million (43 per cent)
• RUB5.9 billion (14 per cent)

Because the project relies on rouble-denominated revenues, the addition of a locally financed tranche acts as a natural currency hedge for the project.

Signing took place in Moscow on 16 March 2011 and the deal reached financial on 25 May 2011. A total of 14 commercial banks provided over €1.1 billion (US$1.57 billion) of debt:

• Bank of Tokyo Mitsubishi
• BNP Paribas
• Credit Agricole CIB
• DZ Bank
• Gazprombank (sole lender to the rouble tranche)
• ING
• Intesa San Paolo
• Mizuho
• Natixis
• SMBC
• Societe Europeenne de Banque
• Societe Generale
• UniCredit
• WestLB

All tranches of debt have an eight-year maturity with pricing set at approximately 250bps. A detailed breakdown of ticket sizes can be found here [Projects Database].

Société Générale CIB and RPFB Project Finance were joint financial advisers. Herbert Smith acted as legal adviser to the sponsors and Linklaters advised the lenders. Willis was insurance consultant, DeGolyer & MacNaughtpon was reserves consultant, Ernst & Young acted as tax consultants and PKF was consulted on the model audit.

Challenges and Innovation

In addition to the challenges posed by the multi-currency approach the loan was also agreed under Russian law, the potential adverse effects of which also had to be mitigated via a suite of bespoke limited-recourse guarantees and indemnities.

The finance was structured as a blend combining reserve-based finance and project finance structures with relatively low cover ratios which reflect the stable gas production profile and the robust contractual structure.

In project finance terms Russia is still in some ways an emerging market and some of the challenges encountered on the Yuzhno-Russkoye project are unique to the operating environment in the country. Société Générale CIB and RPFB Project Finance, joint financial advisers on the project, were appointed in 2007 but initially worked on the basis of summaries of crucial gas supply agreements because the instinctively tight-lipped sponsors considered the original documents to be commercially sensitive.

Syndication of the Yuzhno-Russkoye project was launched at the height of the global financial crisis, taking to the market an intricate structure combining reserve-based and project finance structures and multicurrency tranches arranged under Russian law and rouble revenues. Yet, in spite of these challenges, the project came in oversubscribed at both the bridge loan and long term finance stages.

In addition to this remarkable success, the structure of the financing, described in some quarters as ground-breaking, is likely to serve as a model for future project financing in Russia’s lucrative energy sector as well as in the broader CIS region.