by Simon Pirani
No project is completely impossible. The trick this year in Russia will be to work out which of the near-impossible and difficult ones are worth spending time and money on.
Take the Prirazlomnoe oil field on the Arctic shelf, which the sponsors have discussed in general terms with German and Dutch project financiers. The licence is held by Sevmorneftegaz, an operating company constituted last year as a joint venture between Rosneft, Russia’s only remaining large state-owned oil company, and Gazprom, the state-controlled gas monopoly. The field – which should hit maximum annual oil output, 7.55 million tonnes, after five years, and produce a total of 74.6 million tonnes over 22 years – requires $900 million for construction and outfitting of platforms, Sevmorneftegaz general director Ivan Chernov estimated recently. The Sevmashpredpriyatiye construction yard is now refurbishing an icebreaker platform for the field, from which drilling work will start in 2004.
Dmitry Panteleev, spokesman for Rosneft, told Project Finance that investment prior to the signing of a production sharing agreement (PSA) for Prirazlomnoe will be financed by the sponsors – who have earmarked $150 million each for the project in 2003 – and that “we are seeking to raise 100% of the financing for work done under the PSA”. That’s the tricky part.
It’s hardly that Gazprom – which has hundreds of millions of four- and five-year loans secured on its gas export contracts to western Europe, and which announced on 23 January that it will this year issue a eurobond of up to $1 billion for a term of up to ten years – is seen as an unattractive borrower. Nor does Rosneft have problems in that respect: in November last year it took a four-and-a-half year $200 million loan, at 365 basis points (bps) over Libor, from a syndicate headed by BNP, Hypo Vereinsbank and International Moscow Bank – and that came on top of a $250 million loan from Sberbank in June, a $150 million three-year deal syndicated by ABN Amro in April and a $150 million five-year eurobond launched in November 2001. Market rumours suggest that ABN Amro, which has a long-standing relationship with Rosneft, was ready to provide up to another $700 million of three-year money secured on export receivables should Rosneft have won the privatisation auction in December of a $1.7 billion controlling share of Slavneft. (In the event a Rosneft-related entity was disqualified and a joint Sibneft-TNK bid won out.)
But there is still a fairly deep ditch between five-year secured money and project finance for even slightly longer terms, and the banks are hesitating to jump. A western European banker familiar with Prirazlomnoe says: “A number of banks may well look at financing aspects of the project, but it’s at a very preliminary stage. It’s all about maturity constraints. The mere fact that there is a project company rather than a corporate borrower does not necessarily mean people will go further than five years. Once a project goes into production, you have a structure secured on export receivables that we all recognise. The least thing you need up to that point is someone to take some of that country risk.”
That someone, in smaller deals done last year, has been, primarily, the European Bank for Reconstruction and Development, and, to a lesser extent, other multilaterals. But a billion-dollar project for Russian sponsors may be more than can be sold to the commercial banks this year.
Market sources say that the EBRD was last month sweating to syndicate a $100 million-plus, seven-year deal for Severgal, a joint venture owned 75% by the Russian steel company Severstal and 25% by the western European producer Arcelor, to build a hot dip galvanised steel shop at the Severstal plant at Cherepovets, north of Moscow. It is understood that there is recourse to the sponsors for the first two years of the loan, which is transferred to the joint venture entity once production gets underway. But nervous bankers are believed to have asked for covenants on Severstal itself covering the lifetime of the loan. A source close to the deal said: “The sponsors’ reputations are completely spotless. The real problem seems to be that seven years is just too long at present.” Nevertheless, the deal was expected to be signed at the end of January.
From trade structures to project deals
From Severstal’s point of view, the banks’ hesitation in taking up the Severgal loan seems incredibly harsh. The company has proved itself to be the metals sector’s most reliable borrower; it went into the August 1998 financial crisis with $300 million of debt and never missed a beat on repayments. It has almost completely eschewed the mid-term trade finance market since then, insisting that it needs and deserves finance for longer-term investment purposes.
But getting banks to move far from tightly-structured deals has not been easy. There is a striking contrast between banks’ cautious conservatism on project finance and the orgy of structured trade finance deals signed last year. All last year, banks lavished ever more fully-secured mid-term millions on commodities exporters, with the result that margins kept tightening and tenors kept increasing. By the start of this year, margins in that market hit a low of 3% over Libor, on a $200 million three-year loan, with a six-month grace period, syndicated by Raiffeisen to Russia’s fourth-largest oil company, TNK, and announced on 8 January – and bankers believe they could go down further still.
The trends towards longer tenors and lower margins has been steady. In February last year, Lukoil, Russia’s biggest oil producer, took a $300 million loan from a syndicate led by ING and Raiffeisen bank with a precedent-setting four-and-a-half year tenor. Sibneft improved on that in June, with a five-year $450 million deal arranged by Citigroup, BNP Paribas and West LB, with a 350bps margin for a three-and-a-half year portion and a 410bps margin for the five-year portion. A $200 million three-year loan deal syndicated to TNK by Deutsche Bank almost simultaneously raised eyebrows in the market with a margin of 325bp over Libor – but by December last year ING, Societe Generale and Citigroup had syndicated a deal of the same size, and with an 18-month grace period before repayment, at the same margin. And in November Gazprom showed that its quasi-state reputation, its long-term export contracts with western European customers and its sheer size continue to make it especially attractive, and borrowed $450 million for four-and-a-half years at Libor + 375bps from a syndicate headed by ABN Amro, Dexia, Hypo Vereinsbank and West LB.
The sole significant breakthrough to longer-term project finance in the hydrocarbons sector was a six-year $200 million deal, half directly from the EBRD and half from a syndicate headed by Hypo Vereinsbank, for the SeverTek project, a 50-50 joint venture by Lukoil and Fortum of Finland. Vladimir Matias, head of Hypo’s project and asset finance division in Moscow, said: “It remains difficult to do project finance and structured deals without involvement of multilateral institutions like EBRD or IFC, due to the level of comfort they provide to commercial banks, i.e. mitigation of country and currency transfer risks. This umbrella role of multilateral institutions is of a great importance, especially in the project pre-completion phase where banks are usually dealing with uncovered Russian risk.
“In the pre-completion phase the projects are not in production with exports generating offshore receivables which, in turn, could mitigate the associated country and country risks. As a consequence, you need financial structures that could provide enough comfort during the project construction period. It is the task of financial advisors and project finance arrangers to find such structures where, inter alia, a project financing with (or in certain cases without) involvement of multilaterals would be bankable.”
EBRD doing what it should
The Severgal and Severtek deals are part of a consistent campaign effort by the EBRD to encourage commercial banks to take long term project finance risk in Russia. Lorenz Jorgensen, director of syndications at the EBRD, says: “A majority of the present market is secured on export receivables or has export credit agency (ECA) cover. Whilst this is useful, it is only a part of what the Russian economy needs. The EBRD has maintained an orientation to long term project finance – and currently plays an irreplaceable role.” A key deal was a $108 million seven-and-a-half year loan, signed in February last year, to a joint venture between General Motors of the US and the Russian motor manufacturer Avtovaz, to build a new plant to produce the Chevrolet-Niva, an off-road sports vehicle. The EBRD also took an equity stake in the venture, based at Togliatti, Avtovaz’s home town on the Volga, where the first vehicles came off the production line in October last year. Portions of the loan were taken by Raiffeisen and by the Dutch development bank FMO.
The EBRD has also syndicated portions of project-related corporate loans, such as a mid-term $70 million loan to Mosenergo, the Moscow power distribution company, a portion of which goes on capital investment. The deal was signed on 29 December last year. A three-and-a-half year loan to Togliattiazot, Russia’s largest ammonia producer, signed in December 2001 and half of which was syndicated, is notable because the company hopes to follow it up by raising project finance for an ammonia pipeline to the port of Novorossiisk. The EBRD is also lending heavily to public sector projects in Russia (see box).
Legal and political conditions
Repeated claims that Russia would achieve investment grade ratings shortly after the presidential elections in early 2004 were made last year, during a surge of enthusiasm for Russia by emerging market investors, who were suffering disenchantment with Brazil, Argentina and Turkey. A more sceptical view is suggested by a report issued in mid-January by Standard & Poors, which emphasises just how much has to be achieved to bridge the two-notch gap from Russia’s current BB+ rating to investment grade.
“Political risk still remains a constraint”, says S&P; economic growth is constrained by a Europe that is “in no hurry to give Russia improved access to its markets” and the demands for protectionism by powerful Russian business leaders; and the power of the major monopolies, concentrated ownership of productive assets, “still very deficient property protection rights, and the potential for abuse of power and arbitrary decision-making” as disincentives for investors – and of course for lenders. The agency pays homage to the stability brought by president Putin and by high oil prices, but underlines that it “does not expect Russia’s creditworthiness to improve in the near future”.
For the big hydrocarbons projects, production sharing agreement (PSA) legislation, which was seen as a means of fencing off many of these risks, has been caught in parliamentary committees for so long that it seems to have disappeared. The big Russian companies are exasperated, as Insaf Saifullin of the Gazprom development department reminded a seminar in the Russian parliament on 22 January. And foreign investors keep repeating that PSA frameworks have to be in place for big offshore projects to go ahead; the US ambassador to Russia, Alexander Vershbow, made the point again in an interview last month. But project financiers say that in many cases a PSA framework is not needed, as the non-PSA Severtek deal demonstrated.
Lawyers working on non-PSA project deals in Russia believe that conditions are improving, slowly but consistently. Laura Brank, partner at Chadbourne & Parke, says: “Several recent judicial decisions have given cause for optimism. The Supreme Court ruled for a wide interpretation of ‘inventory’ in cases where a lender has pledge over goods on inventory. This supercedes decisions of lower courts that had compelled us to ask borrowers to provide monthly details of inventory as part of the deal. Legislative changes have helped too: the new bankruptcy law means that one can take pledge over a plant that means exactly that, and not simply a percentage of an overall bankruptcy settlement. Pledges over bank accounts are still ahead of us.” Doug Peel, partner at White & Case, says: “Lenders want to have security over a project company’s onshore bank accounts: this remains a real problem in Russia.”
Currency liberalisation has kept moving forward too, but has further to go. Brank says the complete suspension of conversion requirements for ECA deals with Russian companies licenced to hold accounts offshore (which includes most of the big commodity exporters) shows things are moving in the right direction. Peel says a useful next step would be for the Central Bank to licence all payments on security and guarantees up front, so that it is no longer necessary to apply for licences (with the risk of the application being rejected) when the security is enforced or guarantee is called. “Better still would be to reform the currency regime to remove the licensing requirement all together.”
When all is said and done, Russia remains sub-investment grade, and will for some time to come. Project financing will depend on the skill of the deal-makers in innovating new structures.