CHAPTER 23 TRENDS IN FINANCING MINING AND OIL AND GAS PROJECTS

• Jurisdiction: Derecho Internacional

International Mining and Oil & Gas Law, Development and Investment
(Apr 2009)
CHAPTER 23
TRENDS IN FINANCING MINING AND OIL AND GAS PROJECTS
Nabil Khodadad
Partner
Dewey & LeBoeuf
London

Nabil Khodadad is a partner based in the London office of Dewey & LeBoeuf and co-heads the firm's Project Finance Group. Nabil has advised on the development and financing of mining and metals, oil and gas, pipeline, petrochemical, power and other projects in more than 35 countries. Nabil has been ranked as a leading project finance, mining and energy lawyer by Chambers & Partners in the 2007, 2008 and 2009 Chambers UK Guides and in the 2007 and 2008 Chambers Global Guides, and is a member of the Documentation Committee of the London Market Association. Nabil's experience includes advising: Newmont on the IFC-led financing of the Ahafo gold mining project in Ghana; Preem Petroleum AB on an approximately $3.5 billion syndicated financing arranged by Skandinaviska Enskil Banken AB and Svenska Handelsbanken AB with respect to its refineries in Sweden; a consortium consisting of Korean Gas Corp (KOGAS), LG International, Honam Deasan Petrochemical Corp, STX Energy, SK Gas Co and Uzbekneftegas on the development and financing of a +$2 billion upstream gas and petrochemicals project in Uzbekistan; SOCAR on a $750 million loan facility arranged by BNP Paribas to finance its share of investment in the Azeri, Chirag and deepwater Gunashli offshore oil and condensate fields, Project Finance magazine's "European Oil & Gas Deal of the Year" for 2006; Royal Bank of Scotland as arranger of senior secured limited recourse financing in respect of the underground expansion of the Amantaytau Gold Mine and related infrastructure; Zarafshan-Newmont on the EBRD-led financing of its project to heap leach gold bearing ore stock-piled near the Muruntau Mine in Uzbekistan, a Project Finance International "Deal of the Year"; Billiton on its acquisition of an equity stake in Carbones del Cerrejon and on its acquisition, together with Glencore and Anglo American, of Cerrejon Zona Norte, a Colombian company with an interest in the Cerrejon Norte coal mine, for $476 million; Blueprint and Lalaben on separate $480 million and $300 million syndicated financings backed by oil receiveables; EBRD on the $350 million financing of LUKoil's and SOCAR's investments in the Shah Deniz gas field and the South Caucasus Gas Pipeline; IFC and the Black Sea Trade and Development Bank on financing extended to Melrose Resources for the development of the Galata gas field located offshore Varna, Bulgaria in the Black Sea; IFC in connection with its financing for the revamping, modernization and start-up of S.C. Petrotel-Lukoil's refinery in Romania; and Nations Energy on a $200 million secured pre-export loan facility arranged by CSFB International with respect to production from the Karazhanbas oil field in Kazakhstan.

This paper explores the impact of (i) the recent global financial crisis, (ii) the fall of commodity prices, (iii) the growing importance of sustainability and transparency, and (iv) the resurgence of resource nationalism on the availability, structure and terms and conditions of debt financing¹ for oil and gas and mining projects.

I. Global Financial Crisis

We are currently in the depths of a global financial and economic crisis. The World Bank projects global growth of-1.7% for 2009.² The picture for the developed world is even more bleak: the OECD has recently projected growth of -4.3% for 2009.³ Most analysts believe that the world is unlikely to emerge from recession until 2010 at the earliest.

The global financial crisis has besieged the world financial and economic system in four waves.⁴ The first wave started in the summer of 2007, with the growing

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recognition that sub-prime mortgages were going into default at a higher than expected rate, and led to what became known as the "Credit Crunch". Since many mortgages were repackaged and securitized, the lack of transparency made these assets "toxic" and hard to value or sell at any price. Although the volume of syndicated lending was somewhat down after mid-2007, it was still very active until September 2008.⁵ In the first half of 2008, many analysts were optimistic that the financial crisis would not lead to recession. For example, Lloyds TSB in May 2008 asserted that "while there will only be a gradual resolution of the credit crisis, it looks like the worst may indeed be over".⁶ In their April 2008 report Lloyds TSB confidently predicted that although UK growth would slow to just 2% for 2008, as a whole "the UK economy is not heading for a recession".⁷

The second wave of the financial crisis broke in September 2008 with the demise of Lehman Brothers. The failure of Lehman Brothers on September 15, 2008 led to anxiety over the creditworthiness of the banking system. The collapse of Lehman Brothers triggered a variety of credit obligations under credit default swaps and the market woke up to the fact that insurance companies and investment banks had sold trillions of dollars of credit default swaps and that these instruments were not limited to the housing market. It also turns out that many banks that were involved in the sub-prime market were also heavily involved in credit default swaps. The US Treasury was forced to seize control over AIG (a significant participant in the credit default swaps market) and Washington Mutual, and to encourage the takeover of Merrill Lynch by Bank of America. The resulting chaos in the financial system caused a global panic in stock markets which further weakened the assets of many banks and financial institutions. The crisis quickly spread to Europe where Belgium and the Netherlands were forced to bail out Fortis, the UK was forced to nationalise Bradford & Bingley, Iceland was forced to take control over its three largest banks, and Ireland felt compelled to guarantee all deposits in all of its banks, amounting to €400 billion, an amount which was twice its annual GDP.

With uncertainty about the financial condition of the banking industry, interbank lending volumes plummeted. Overnight LIBOR⁸ more than doubled from 3.11% on

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September 15 (the day that Lehman Brothers failed) to 6.44% the following day.⁹ Banks were so wary of lending to each other overnight that at the end of September, they required an unprecedented lending premium of 400% above the Federal Reserve Bank's target rate.¹⁰ Faced with this freeze in the interbank lending market, the US Treasury was forced to announce on October 14, 2008 that instead of buying distressed assets, it would recapitalise the US banking system by purchasing up to US$250 billion of senior preferred shares in nine large US banks. Without such government intervention and support, the international capital markets would have pulled cash from any financial institution perceived to be undercapitalised. After the US Treasury department announced its recapitalisation programme, overnight LIBOR fell dramatically to 1.94% and interbank borrowing volumes increased ten fold.¹¹ While the banking panic subsided somewhat following efforts by the US government and governments around the world to promote the solvency and liquidity of the financial sector, the cost of private sector borrowing has increased and the availability of credit has shrunk.

In the third wave, the financial crisis and the resulting stock market panic created a massive realignment of expectations that led to recession in the developed world. The pessimism about economic growth caused not only stock markets, but also global commodity markets to plunge, including crude oil and base metal prices. The resulting asset deflation caused consumption to plunge, further weakening any prospects for economic growth.

In the fourth wave, the economic contagion in the developed countries spread to emerging markets and plunged the world into a global recession. By the last quarter of 2008, the Credit Crunch which had started in the US as a result of fears over the sub-prime mortgage market had turned into the worst global financial crisis and economic recession since the 1930s.

In retrospect, the collapse of Lehman Brothers in September 2008 appears to have been the watershed moment when the credit crisis intensified and put the world on the path to a full blown global economic recession. Once Lehman Brothers collapsed and investors lost faith in the banking system, it was remarkable how quickly the contagion spread around the world and highlights the urgent need for a global regulatory structure capable of regulating financial institutions that operate around

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the globe.

Impact of the Global Economic Crisis on Natural Resource and other Project Financings

When the Credit Crunch first broke in 2007, many bankers thought that project finance would benefit from a flight to quality. Project finance benefits from low default rates, and even when project finance loans go into default, the holders of senior debt have over the last 15 years experienced a 72% recovery rate.¹² At first glance, the statistics appear to suggest that project finance has been immune to the global economic crisis because 2008 was a banner year for project finance. In 2008, project finance loan volumes hit US$250.5 billion, up from US$220 billion in 2007.¹³ The key to understanding the credit crisis is that it is not just about credit, but also about liquidity. While project finance loans benefit from historically low default rates, project loans are more complex and have longer tenors than other types of loans and are therefore less liquid. For this reason, it should not be surprising that project finance activity dropped in the last quarter of 2008 and in the first quarter of 2009.¹⁴

Project Financings are Becoming More Challenging

The global financial crisis has made it much more difficult to obtain financing for oil and gas, mining and...