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The Project Financing of Cross-Border Pipelines a Presentation to the Energy Charter Workshop Brussels

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The Project Financing of Cross-Border Pipelines

a presentation to the

Energy Charter Workshop
Brussels

by

Rubin Weston
Chadbourne & Parke

17 October 2006

Regis House, 45 King William Street
London EC4R 9AN
Tel: +44 (0) 20 7337 8031 [email protected]

© 2006, CHADBOURNE & PARKE All Rights Reserved

Chadbourne & Parke: Legal Leaders in Energy



Representing EBRD on the $180 million and $170 million financings of LUKoil’s and SOCAR’s respective investments in the Shah Deniz gas field and the South Caucasus Gas Pipeline



Representing SOCAR on a $750 million loan facility in respect of the repayment of carry financing provided by TPAO and Exxon in respect of the ACG oil field and the financing of future cash calls



Representing IFC on a $82 million loan to SC Petrotel-Lukoil SA to finance the modernisation of its refinery in Ploesti, Romania

Represented Black Sea Trade and Development Bank and IFC on the financing of the Galata Gas Field, located offshore of Varna, Bulgaria in the Black Sea, the first limited recourse upstream project financing in the Black Sea



Represented Transneft on a US $150 million syndicated receivable based financing facility arranged by Raiffeisen, Transneft’s first syndicated loan

Represented IFC on the financing for a portion of LUKoil’s share of development of the Karachaganak field, the largest limited recourse petroleum project financing in Kazakhstan



Represented Nations Energy on a US $150 million syndicated financing arranged by CSFB for the development of the Karazhanbas oil field in Kazakhstan and the Mishovdag and Kelameddin oil fields in Azerbaijan

Represented Rosneft in connection with its participation in the Sakhalin 5 Project

2

Overview of Presentation:

 Challenges Presented by Cross Border Pipeline Financings  Types of Financing  What is Project Finance?  What are the risks?  Case Studies: BTC Oil Pipeline and the South Caucasus Gas
Pipeline

3

Challenges Presented by Pipeline Financings

 High initial investment and delay in revenue generation creates a significant completion risk

 Number of parties involved, diversity of interests:

 public sector divergent interests:

 export country Ö high price  transit country Ö high tariff  country receiving hydrocarbon Ö low price and low tariff

 private sector divergent interests:

  •  companies of
  • - supply

- transportation - purchase

 public sector v. private sector  this diversity of interests creates an increased risk of conflict

 History of vulnerability to disruption and of generating conflict

 e.g. oil pipeline established by Iraq Petroleum Company in 1930s to establish an export route for Iraqi oil through Syria was closed for a substantial part of its operating life

4

Types of Financing

 Sovereign  Sponsor  Credit supported financing  Project financing

5

Sovereign/Sponsor Financing

 Sovereign and/or sponsor can finance a transaction from its own resources or by raising finance by:

 bank borrowing  accessing the capital markets  raising equity (sponsor only)

 CPC Pipeline financed by 50:50 division between states (Russian,
Kazakhstan, Sultanate of Oman) and the project participants

6

Credit Supported Loans

 Possible sources of guarantees:

 parent companies  sovereign states

 The underlying transaction must be fundamentally sound (i.e. cash flows should be sufficient to service debt)

 Recourse to provider of credit support throughout the duration of the Loan.

7

What is Project Finance?

 Project Finance is non-recourse or limited recourse finance,

predicated primarily on the merits of the project rather than on the credit of the project sponsor(s)

 Parties to a project financing:
Either:

A financing of the project vehicle

 project sponsor(s): no/limited recourse in respect of the borrower's obligations to the lender

 borrower/project company: special purpose vehicle (SPV) that owns the pipeline and has no obligations or liabilities outside the project

 host governments: grant the concessions necessary for the project to be implemented

 lenders

8

What is Project Finance? (cont’d)

OR

A financing of a project participant

 borrower: SPV, but constitutes a participant in the project, rather than the project company itself

 project company: may be required to enter into a direct agreement with the lender with respect to certain matters (e.g. acknowledgement of the rights of the lender upon the enforcement of its security)

 sponsor: the company which owns the borrower; no/limited recourse in respect of the borrower's obligations to the lender

 host governments: grant the concessions necessary for the project to be implemented

 lenders

9

Project Finance: Financing the Project Vehicle

Host
Government

Direct
Agreement

Concession (Host Government Agreement)

  • Bank
  • Sponsor(s)

Project
Vehicle (SPV)

Limited Recourse
Security over Shareholding(s)

10

Project Finance: Financing a Sponsor

Host
Government

Direct
Agreement
Concession (HGA)

Security over Shareholding in
Sponsor

Parent
Company
Project

Company
(SPV)
Bank

Shareholding in Sponsor

Loan

Sponsor

Direct Agreement

11

Project Finance: Security Package

 Security, may include the following:

 Pledge of shares in borrower  Assignment of rights under project agreements  Assignment of insurance proceeds  Charge of offshore bank accounts  Charge over property

 Guarantees and other support from the sponsor:

 Guarantees

 completion  cost overrun

 Support Agreements

 share retention  managerial support

12

What are the Risks?

 Potential lenders will evaluate various types of risk, including the following risks:

 Upstream  Completion  Operation  Market
 Political  Legal  Tax  Regulatory  Environmental
 Price / Tariff
 Conflict

13

BTC and SCP: Project Summaries

  • Baku-Tblisi-Ceyhan (BTC)
  • South Caucasus Pipeline (SCP)

  •  Integrated, one pipeline
  •  Integrated, one pipeline

company - South Caucasus Pipeline Company company - BTC Company
 1,768 km pipeline from Baku to

  • Ceyhan
  •  690 km gas pipeline connecting

the Shah Deniz gas field to markets in Azerbaijan, Georgia and Turkey. Pipeline runs from Sangachal terminal through Georgia to Turkey
 One million barrels per day capacity; capable of expansion

 Provides capacity for the ACG
PSA participants plus other founder investors from the North Caspian area
 20 bcm per annum design capacity

14

BTC/SCP: Pipeline Routes

15

BTC/SCP: Contractual Framework

The contractual framework can be divided as follows:  Inter-Governmental Agreements / Host Government Agreements

 grant the rights and privileges necessary for pipeline construction and operation

 BTC/SCP documents provide a framework for future cross-border pipeline projects

 Commercial Agreements

 Organisational (constitutional documents and shareholders’ agreement)

 dictate relationships between participants in the project vehicle, including,

 financing obligations (i.e. basis pursuant to which cash calls are paid)  process by which shares can be transferred  appointment of operator  voting requirements for specific decisions  return on investment, payment of dividends  consequences of default

 Third party

 dictate relationships between the project vehicle and third parties

16

BTC: Contractual Framework

IGA

Turkey
Georgia
Azerbaijan

HGAs

BTC

Third Party Agreements
Organisational
Documents

17

SCPC: Contractual Framework

IGA
IGA

  • Georgia
  • Azerbaijan

HGAs

SCPC

Turkey

Third Party Agreements
Organisational
Documents

18

BTC/SCP: Financing Arrangements

  • BTC Financing Arrangements
  • SOCAR/SCP Financing Arrangements

  •  $2.589 billion of debt (up to 12 year
  •  EBRD provided $60 million of

  • financing to Azerbaijan (South
  • term)

Caucasus Pipeline) Limited
 Approximate debt amounts
(AzSCP), a wholly-owned subsidiary

of SOCAR, and $70 million to Lukoil Overseas Midstream Shah Deniz Ltd (Lukoil Midstream), a wholly-owned subsidiary of Lukoil Overseas. Each borrower is a 10% shareholder in South Caucasus Pipeline Company, the owner of the pipeline
($millions):

 IFC/EBRD A/B Loans 500

  •  ECA facilities
  • 766

 JBIC Overseas

  • Investment Loan
  • 300

  • 100
  •  OPIC PRI Loan

 Sponsor Senior Loans 923

 Commercial bank (15) participation
 EBRD is syndicating a portion of

around $1 billion its loans to commercial lenders

 Security included
 Security included:

 completion guarantees
 completion guarantee / debt service undertaking
 share pledges in SCP and AGSC

 assignment of agreements including revenues under the Transportation Agreement
 assignment of AzSCP’s and Lukoil
Midstream’s rights under project agreements

 pledge of AzSCP’s and Lukoil
Midstream’s offshore bank accounts

19

BTC/SCP: Risk Analysis

 Upstream

 Azeri-Chirag-Gunashli field is expected to yield in excess of 5bn barrels of oil; peak production of 1 million barrels/day; additional production expected from North Caspian

 Shah Deniz is estimated to have sufficient reserves and production

 Completion

 financial commitment from sponsors – SCP: Substantial Equity
– BTC: Substantial Equity and
Sponsor Loans

 high level of confidence in sponsors

 BTC: BOTAS entered into a lump sum (fixed price) turnkey contract for the Turkish section of the pipeline, which the Turkish government guaranteed

20

BTC/SCP: Risk Analysis (cont'd)

 Operation

 quality of sponsors  shipper commitments

 Market

 BTC/oil: western markets  SCP/gas: BOTAS (Turkey)

 Price / Tariff

 a minimum return is guaranteed, regardless of volumes shipped

21

BTC/SCP: Risk Analysis (cont'd)

 Legal

 IGAs and HGAs override local laws and address key legal risks  HGAs provide for international arbitration

 Tax

 favourable regime established by HGAs

 Regulatory

 facilitated by HGAs

 Political risk

 lGAs and HGAs provide a forum for co-operation and dispute resolution

 Environmental

 IFIs stringent requirements (including Equator Principles) met

22

BTC/SCP: Risk Analysis (cont'd)

 Conflict

 common interest in success of pipelines

 Countries:

 Azerbaijan: export markets  Georgia: cheap gas  Turkey: allows tankers to bypass the Turkish Straits

 SCP: contractual arrangements in place to ensure that a party cannot default upstream whilst its sister company benefits midstream and visa-versa

 Azerbaijan and Turkey have taken 25% and 6.7% shareholdings in BTC;
Azerbaijan (via a commercial affiliate of SOCAR) has a 10% shareholding in SCPC

 IGAs and HGAs attempt to establish a fair balance between all parties

23

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