GasGas TransitTransit RisksRisks inin EurasiaEurasia andand theirtheir ImpactsImpacts onon TransitTransit InfrastructureInfrastructure DevelopmentDevelopment

Paul Shapiro, Senior Banker,Banker, EBRD Natural Resources Team 19-20 October 2004 ▪ Brussels, Belgium TheThe EuropeanEuropean gasgas imbalanceimbalance

500 z Shortage 100bcma 450 within next 7 years 400 – current import + 1/3 350 300

250 – 50% already under MTOE contract => to be met 200

15 0 – 50 bcma new Shortage from projected 10 0 Demand Net Contracted imports

volumes => to be 50 Indigenous production

contracted 0 2001 2005 2010 2015 2020

Source: Eurogas ChallengesChallenges forfor increasedincreased FSUFSU exportsexports toto WesternWestern EuropeEurope z Meeting these increased gas flows to Europe is a challenge: – New field development in remote areas – Refurbishment of existing gas transportation systems – Construction of new gas transmission infrastructure – Securing adequate contractual arrangements – Management of political issues at both ends KeyKey projectsprojects forfor thethe future:future: MidstreamMidstream

z Ukrainian gas transit system upgrade: $1bn? – International consortium – Political hurdles z TransBaltic gas pipeline: $6bn? – Financing of Russian stake – With or without Shtokman? z Yamal-Europe II: $2bn? StrongStrong AsianAsian GasGas DemandDemand GrowthGrowth

South Korean Gas Consumption, 1986-2002

25 22.8 20.93 18.95 20 16.94

14.87 13.91

15 12.2

9.26 10 7.65 5.75 4.62 Billion Cubic Meters 5 3.51 3.03 2.12 2.75 2.63 0.85

0 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 SiberiaSiberia--AsiaAsia GasGas PipelinePipeline ProposalsProposals

Current and Proposed Asian Pipelines SakhalinSakhalin IIII PhasePhase 22 -- KeyKey ProjectProject infrastructure infrastructure Detail 1

PA-B Okha 41 km PA-B to Nikolayevsk 14” Gas - shore Line na-Amure 14” Oil Additional offshore Detail 1 Onshore Tie-in point Line Piltun with pig traps for all PA-A Boatasyn pipelines platform

172 km Piltun Nogliki 17.5 km PA-A to shoreline to Katangli shore OPF Oil & Gas Detail 2 20” Oil Line DeKastri Nysh 20” Gas pipelines Boatasyn Line Russia Aleksandrovsk- stretching Sakhalinskiy 20” Oil line Detail 2 Sakhalin 20” Gas line Development of the length Island LUN-A of the Lunskoye gas field BS#1 4.5” glycol 636 km 636 km 172 km onshore return island 48” Gas Line 24” Oil Line to OPF through offshore

Poronaysk 2 x 30” platform 48” Gas multiphase Gas Compression Oil Booster OPF (BS#2) (BS#2) Nysh 24” Oil

636 km Domestic Supply Detail 3 Off-Take OPF to OET 24” Liquid Line

48” Gas Line LNG Construction of Plant Oil Export Terminal

Yuzhno- LNG plant and oil Sakhalinsk 36” 5.5 km Detail 3 Loading Line export terminal LNG Tanker TLU GeneralGeneral PerspectivePerspective

z Huge investment need by 2010 – At least $10bn upstream + $10bn midstream z Very high investment concentration – $1bn entry ticket minimum z Substantial legal challenges – Legal framework in FSU / Offtake arrangement in EU z Many sector reforms necessary z Large political hurdles Regional cooperation z Huge competition from the East z Generic project finance challenges RegionalRegional andand SectorSector ReformReform IssuesIssues

z Technical Issues z Unbundling of Activities and Services z Rationalise Tariffs, Transit Fees and Taxes z Enforce Payment Discipline z Regulatory Framework z Attracting Strategic Investors and Privatisation z Political Issues z Civil and Social Progress z Environmental Issues TechnicalTechnical IssuesIssues

z Routing of infrastructure to Soviet production z General deficiency of internal and transit pipes for current export demand z Antiquated pumps and metering z Lack of batching and separation facilities z Deficient local parts and service industry z Current expense of “clean” technology UnUn--bundlingbundling

z Gas trading, transit and bulk sales z Long distance gas transport – high pressure network z Local gas distribution z Gas Storage z Unbundling removes distorting cross- subsidies and promotes commercialisation RationaliseRationalise TarrifsTarrifs,, TransitTransit FeesFees andand TaxesTaxes

z Full cost recapture tariffs with incentive for maintenance and investment z Geographic price differentiation for transit cost z Full deduction for tax purposes of necessary depreciation PaymentPayment DisciplineDiscipline

z Comprehensive gas metering z Progressive restriction of supply for late or non-payment z Forgiveness, conversion or other renegotiation of arrears z Build sinking fund for arrears from profit RegulatoryRegulatory FrameworkFramework

z Service Obligations z Conditions of third party access z Monitoring of gas trading z Bulk and end user tariff setting and monitoring mechanisms z Independent regulatory body PoliticalPolitical IssuesIssues

z Patronage and Funding z Affordability, Subsidies and Welfare z International Competition

Economic, Military and Ideological Offensive and Defensive z Governance and Efficiency EnvironmentalEnvironmental IssuesIssues

z Legacy of Environmental Damage z Demands for impact minimization z Differentiation of social impacts z Agitation for “Renewables” CivilCivil andand SocialSocial IssuesIssues

z Routing z Human Rights z Consultation process and compensation z Shift in focus from purely environmental aspects of large oil and gas projects to more ‘political’ topics like – Revenue management – Transparency – Corruption – Democracy Safe,Safe, FairFair andand SustainableSustainable

z Environmental and health and safety aspects z Fairness and transparency for all parties involved – Tariff payments to Governments – Consultation – Land compensation – Publish what you pay / receive – Disclosure of key agreements z Benefits for the local population – Community investment programmes – Transparent revenue allocation – Regional development initiative GenericGeneric RisksRisks

z Construction / Completion Risk – contractual structure (delays, cost over-runs, etc.) z Operational Risk – technological integration and experience / viability z Utilisation / Supply Risk – type of throughput arrangement – fundamentals (Market/Competition) GenericGeneric RisksRisks cont.cont. z Competition / Market – effect of oil price (linked to gas and oil products) – regional supply / demand – impact on tariff z Political & Regulatory Risks – regulatory intervention (tariffs & export volumes) – political turmoil / disputes / violence / nationalisation – discriminatory taxation RisksRisks andand theirtheir mitigationmitigation

z Economic & financial – minimised through financial package and due diligence z Technical risks – reliance on strong and technically competent sponsor z Environmental risks – sponsor commitment to appropriate guidelines z Political risks – minimised through involvement of IFI’s and ECA’s LessonsLessons LearnedLearned

Chernogorskoye, Komiarcticoil, Polar Lights, Samotlor, West Siberia II Oil, Chernogorneft, Geoilbent, Gas Transit and Gas Transit II, SeverTEK z engagement of independent technical adviser to review condition of the borrower’s assets z advance structuring of reporting for the Bank’s monitoring purposes z conducting sensitivity analysis on the basis of conservative assumptions z ability of a relatively small project to create a transition impact HOWHOW EBRDEBRD CANCAN ASSISTASSIST AvailableAvailable FinancingFinancing SourcesSources z Equity – Strategic investors (oil and gas majors) – Investment funds (limited scope) – IFI’s (EBRD, IFC) z Debt Financing – IFI's (EBRD, IFC) (own funds) – EIB (European portion) – Commercial banks (participating in IFI B Loans) – ECAs (Hermes, Coface, JBIC, Exim…) z Capital Markets – Equity (IPO's) – Bonds DebtDebt asas FinancingFinancing SourceSource

z Loans – Tailor made instruments with negotiated conditions – Bank lenders familiar with different structures z Bonds – Relatively rapid issuance process – No covenants for straight instruments – Tradable instruments – But lack of flexibility PurePure ProjectProject FinanceFinance isis nono longerlonger anan optionoption z Lenders and Sponsors will have to structure projects that go beyond funding project cost Sustainability + Good Governance are high on the agenda – International Financial Institutions (Extractive Industry Review) – Commercial Banks (Equator Principles) – Socially Responsible Investors – NGOs and civil society – Governments (EITI) EBRDEBRD NGONGO involvementinvolvement

z Committed to dialogue with NGOs from an early stage z Addressing NGO issues with Sponsors z Acting as “catalyst” to facilitate dialogue between Governments, independent experts and Sponsors z Multi-Stakeholder-Forums seeking dialogue with directly affected people to verify ‘mood on the ground’ z Continue dialogue with NGOs during project implementation ContactContact DetailsDetails

Paul Shapiro Senior Banker Natural Resources Team European Bank for Reconstruction and Development 1 Exchange Sq. London, EC2A 2JN Tel. 44 (0) 207 338 6244 Fax 44 (0) 207 338 6101 Mob. 44 (0) 7764 230 775 MoreMore information:information: www.ebrd.comwww.ebrd.com