Lending to Oil & Gas Industry of Kazakhstan:Current Status and Prospects
Kozhakhan Abenov, Member of the Board ABN AMRO Bank Kazakhstan
Despite the dominant role of the oil and gas industry in the economy of the Republic of Kazakhstan, the volume of debt financing in this sector remains very modest. In this paper we analyze the main reasons of the present situation, and forecast the expected developments.
The role of oil and gas sector in the economy of the Republic of Kazakhstan is well known, as this sector accounts for over 55% of the country’s export revenues, 70% of foreign direct investments, and 30% of GDP. Moreover, the share of oil and gas sector in the economy will quickly grow as a result of the completion of the Caspian pipeline, and accelerated development of the major oil deposits of Tengiz, Karachaganak and Kashagan. Apart from these mega-projects, other major oil producers announced plans for substantial increase of oil production, including the national oil and gas company Kazakhoil and Hurricane Kumkol Munai.
The development of hydrocarbon deposits and infrastructure are capital intensive projects, which normally consume large volume of debt finance in form of bank credits, or issue of debt securities (bonds). However, in Kazakhstan this is not the case - almost all oil and gas projects (both of Kazakh companies, and with foreign investor participation) are financed by shareholder’s own funds. The oil and gas sector accounts for just 10% (!) of the domestic banks’ credit portfolios, which is far less than their lending to trading companies. As for the foreign banks, the volume of their financing of oil and gas projects in Kazakhstan is also very low So far the foreign banks provided syndicated loans to the largest Kazakhstani banks, rather than directly to oil producers.
As the 1998 crisis in Russia has demonstrated, lending to major oil and gas producers is, on average, less risky than lending to domestic banks or lending to trading companies. So what is the reason for extremely low amount of debt financing to the oil and gas sector in Kazakhstan? Obviously, there must be some fundamental reasons that constrained commercial lending in such an attractive industry. Understanding of these reasons may assist the oil companies and the banks to forecast possible developments of the situation, and possibly, to adjust their financing strategy.
MAIN SOURCES OF DEBT FINANCING
The following are some of the major sources of debt financing, which are not related to the borrower’s shareholders:
• Domestic banks’ loans
• Issue of bonds on the domestic securities market
• Loans from the recently established State Development Bank
• Loans provided by the foreign banks
• Issue of bonds in the international securities market (eurobonds)
• Financing from business partners, e.g. equipment suppliers, oil purchasers, joint venture partners
• Financing from export credit agencies (ECA’s) of OECD countries
• Financing from multilateral agencies, such as EBRD, the World Bank, ADB
• Venture capital funds
In this article we will not go into details of each of the above mentioned financing source, but will review their most important features and common requirements for financing the oil and gas projects in Kazakhstan.
FINANCING FROM KAZAKHSTANI SOURCES
The main factors which constrained financing of the oil and gas sector by the Kazakhstani banks include:
• High cost of funds - until recently, Kazakhstani banks charged at least 15% per annum interest rate for loans denominated in US Dollars, while before 1999 the typical interest rates were 20% p.a. and even higher. Only short-term trade transactions can bear such high cost of borrowing, whereas most of the long-term oil&gas projects cannot bear such costs.
• High interest rates were only partially driven by the cost of deposits in the local banks. The main reason for high interest rates charged by local banks was the high yield of the state securities (until 2000). As, in contrast to loan interest, the income from investment in state securities is tax-free, the loan interest rates were substantially higher than the yield on state securities.
• Short tenor of Kazakh bank loans - as the deposit base of local banks consists mainly of the short-term deposits and demand deposits, until recently Kazakh banks preferred short-term lending for tenors of up to one-year.
• Small lending capacity - most of the oil&gas projects are capital intensive, and require tens or hundreds of millions of US Dollars, while in case of projects similar to Tengiz development, we may talk about billions of US Dollars. At the same time, even the largest Kazakhstani banks cannot lend to a single borrower more than 20 to 30 million US Dollars, as the risk on a single borrower may not exceed 25% of the bank’s equity (legal restriction). Consequently, Kazakhstani banks can finance development of only small and medium sized projects, or provide working capital finance.
Despite all of the above, we note that during the last year some positive developments took place:
• interest rates have reduced dramatically, as a result of both (i) the inflow of liquidity in the banking market due to growth of deposits, increased liquidity of exporters, and syndicated loans provided by foreign banks, and (ii) a sharp decrease of yield on state securities to levels below 6% p.a.;
• Lengthening the tenors of deposits in the banks, and issuance of long-term bonds by the major banks, which enabled the banks to provide loans for longer terms (from 2 to 5 years);
Growth of the banking system and merger of banks, which increases the size of loans which can be granted by a bank to a single borrower.
We believe that these trends will continue in the middle term. As a result, the role of Kazakhstani banks in financing medium-sized borrowers (those with annual production of up to 5 million tons) will increase. However, the capacity of Kazakhstani banks to finance larger projects will remain insufficient.
During last year we have witnessed emergence of a new source of debt financing - the issue of corporate bonds in the domestic securities market. This very promising source of debt financing has emerged due to quick growth of private pension funds, coupled with the reduction of yields on government securities. This new financing source is very promising due to a number of reasons:
• Long tenors of financing - local bond issue enables financing for comparatively long tenors of 5 to 7 years, which in perspective can be increased to over 10 years. These long tenors are a natural result of the long-term nature of the pension savings;
• Financing volumes - if the growth of pension funds continues as projected, and the privatization of the State Pension Fund happens, we expect that a bond issue for financing of a single borrower (project) may exceed USD 80 million by the end of the next year, and will exceed USD 100 million by mid-2003. This is a considerable amount for a medium-sized borrower, and will significantly exceed the capacity of any of the Kazakhstani commercial banks. In long-term perspective, the development of the Kazakh bond market will be also stimulated by the in flow of funds from insurance companies and Kazakhstani banks.
• Stability - in contrast to the foreign banks and international bond market, the Kazakhstani bond market is far more stable, and is less sensitive to changes of foreign investors sentiment towards the «emerging markets».
We expect that within the next 2-3 years the local bond market will replace the Kazakhstani banks in the area of financing the medium-sized oil&gas projects. Consequently, we would recommend the prospective borrowers to learn about the requirements for the issue of domestic bonds and obtaining the «A»-listing on the Kazakhstani Stock Exchange. This process is rather expensive and time consuming, as financial audit and disclosure of information are required. Therefore, it is justifiable only for sufficiently large companies (to Kazakh standards), who have annual turnover of not less that USD 10 million. For smaller companies, bank loans will remain the main source of debt financing.
FINANCING FROM INTERNATIONAL SOURCES
Like the case of domestic lending, the volume of financing from foreign sources to Kazakhstani oil and gas sector is also relatively low, if we do not count shareholder loans (which we consider quasi-equity financing). However, the reasons for such situation are different for large projects, sponsored by foreign owners (i.e. Tengizchevroil, Karachaganak, CPC, OKIOC), and for the «purely» Kazakhstani borrowers.
In our opinion, the main reasons which prevented debt financing of large projects sponsored by foreign owners, are:
• Financing costs - the major foreign shareholders regarded project financing (i.e. debt financing to the project without recourse to shareholders) to be too costly. As the cost of borrowing for such shareholders - companies like Chevron, Agip, ExxonMobil - is substantially lower, than the cost of borrowing for their Kazakhstani projects, the shareholders preferred to raise the loans themselves, and to inject funds to their Kazakhstani projects through shareholder loans or equity. The high cost of project financing was due to the financial market’s perception of political risks of Kazakhstan, and the negative perception of political risks related to the transit of Kazakhstani oil through Russia. At the same time, the shareholders perceived such political risks differently than the prospective lenders, and were not ready to pay high risk premium.
• Time required - in addition to financial costs, arranging of project financing can take substantial time, ranging from 1 to 2 years. Therefore, at the initial stages of project development, most foreign oil and gas companies focussed their efforts on quick development of their projects, without any delay for arranging project financing.
• Loss of operational flexibility - apart from financial costs, and the time consumption, project financing may significantly limit the freedom of the project company and its shareholders, and also may require disclosure of commercially sensitive information.
• «Harmonization» of shareholders - all large projects in Kazakhstan have several shareholders (major international oil companies), who have different views on the necessity, acceptable structure, and the costs of project financing.
Due to the above, the volume of debt financing from foreign financiers remained comparatively low. One of the largest deals was ca. USD 200 million US and Canadian notes issue by Hurricane Hydrocarbons in 1996, for financing the acquisition of Kazakh oil producer Yuzhneftegas. The bonds were mainly purchased by venture capital investors, some of which were shareholders of Hurricane Hydrocarbons.
However, the following developments may change the attitude of major oil companies towards project financing in Kazakhstan:
• Increasing exposure of shareholders - as a result of the merger of major international oil companies, which coincides with a rapid increase of capital expenditures in large Kazakh (and other Caspian) projects, the amount of risk exposure for some project shareholders amounts to billions of dollars. This is a significant exposure to the Caspian region, even for major oil companies. Therefore, some international oil companies may take a more favorable view towards arranging non-recourse project financing, as a way to reduce their own exposure in the region and bringing more political leverage (in case of involvement of multilateral lenders). This tendency may also be stimulated by statements of some government officials about possible revisions of contracts with foreign investors, possible cancellation of guarantees for stability of legal and tax regime, and attempts to establish export quotas.
• Situation in the financial market - during the last year the perception of Kazakhstani and Russian risks has improved in the international financial markets. This is evidenced by the increase of Kazakhstan’s country rating to BB (Ba2) level, and the return of Russian borrowers to the medium-term syndicated loan market. At the same time, the risk of transit of Kazakhstani oil through Russian territory has significantly decreased due to the launch of CPC pipeline, and the development of alternative transportation routes through Caspian. As a result of the improving perception of political risks, the project financing costs may decrease to a level acceptable to foreign shareholders of Kazakh oil&gas projects. This is also supported by the fact that many projects have already reached stable production phase, and became capable to service debt on a standalone basis.
We therefore believe that in the coming 2 to 3 years we will witness large project financing deals in Kazakhstan, with participation of foreign commercial banks, bond investors, and probably either multilateral institutions, or export credit agencies. At present such projects have taken place in Azerbaijan (AIOC financing) and in Russia (Sakhalin-2, Blue Stream, and others).
«Pure Kazakhstani» projects. Let us now consider Kazakhstani oil&gas companies and projects without involvement of major foreign shareholders. Similar to the large projects considered above, the volume of debt financing from international lenders in this sector is still very low, but as a result of completely different reasons:
• Lack of transparency - obviously, no foreign lender will finance a Kazakhstani borrower without a clear understanding of its financial position, oil reserves, trading counterparts, business partners, etc. Until recently, majority of Kazakhstani companies were not sufficiently transparent: they did not have financial audit and audit of reserves in accordance with international standards, while information about business partners was often regarded as confidential. In this respect, many large Russian companies were much more transparent, and as a result they were more successful in attracting foreign debt finance.
• Insufficient scale - in order to attract foreign lenders, the amount of a transaction has to be sufficient: at least USD 50 million in case of a short-term syndicated loan, and not less than USD100 to 200 million in case of a long-term project financing or a bond issue. Until recently, the number of Kazakhstani projects and companies which had capacity to efficiently utilize such volume of debt financing was very limited.
• Lack of understanding of international lenders - most of Kazakhstani borrowers understand the requirements and decision making process of Kazakhstani banks, which they often extrapolate to foreign creditors. However, the perception of risks, credit standards, level of disclosure, and decision making process of international lenders often differs from those of Kazakhstani banks.
However, we would like to note that the situation has improved along all of the aforesaid issues. First of all, the major Kazakhstani companies have become more transparent. As an example, NNK Kazakhoil has carried out an audit of the oil reserves and financial audit in accordance with international standards. The company also has disclosed a lot of information in the process of preparing for the first bond issue in the domestic market, as well as preparation for a Eurobond issue. Similar process of becoming more transparent is taking place in other large Kazakhstani companies.
Secondly, industry restructuring and consolidation of assets around several major national companies (Kazakhoil, Kaztransoil, and Kaztransgas) took place. As a result, there are now companies which reached «critical mass» allowing them to attract syndicated loans from international banks, and to issue bonds in the international capital markets. In addition to emergence of these large companies, there was progress in development of large projects, such as the reconstruction of Atyrau Refinery (estimated cost of ca. USD308 million), construction of the Kenkiyak-Atyrau pipeline (estimated cost of ca. USD 170 million), development of Alibekmola oil field and Amangeldy gas deposit.
Thirdly, some of the largest Kazakhstani companies gained more experience with foreign lenders and investors, and they now have a better understanding of their requirements and capabilities.
The progress in the aforesaid areas has coincided with an increase of oil prices, an improvement in the macroeconomic situation in Kazakhstan, and a better perception of the country risks in the international financial market. This should allow the largest Kazakhstani companies to start raising sizable amount of financing in the international financial market in the nearest future. The successful placement of a USD 150 million Eurobond issue by NOTC Kaztransoil became an evidence of a fundamental change of situation. In addition to the Eurobond issue by the major Kazakhstani companies, we expect syndicated loans from international banks for terms ranging between 1 to 5 years, with size of deals ranging between USD 50 and USD 200 million per transaction.
There are various objective reasons which restricted commercial debt financing to oil&gas companies and projects in Kazakhstan. However, we expect that within the next 2 to 3 years there will be fast growth of debt financing both from Kazakhstani and international sources. In order to benefit from these financing opportunities, the potential borrowers should have the «critical mass»; understand the peculiarities and requirements of the potential lenders, and develop a proper financing strategy.
The Corporate Bonds Market in Kazakhstan Damir Karassayev
Moscow Almaty Kiev Minsk Where Next? Alexandr Dilbazi
Financing of the Kazakh Mining Iindustry by Banks Asyl Khamitov, Valery Nalobin