Russian LNG projects risky due to political/business threats: S&P

Singapore (Platts)--28Jun2006

Political risk, opaque legal and business systems, and Russia's short
history of contract law and enforcement are key threats to the development of
the country's liquefied natural gas business, ratings agency Standard & Poor's
said in a recent report.
The report titled "Russian LNG Finance: Profitable? Probably. Risky?
Certainly" noted that Russia would have to rely on high-yield debt or the bank
market to fund LNG projects. It however added that the country might not have
trouble raising money given lenders' appetite for risk and penchant for energy
projects.
Referring to Gazprom's recent abrupt but short disruption of gas
supplies to Europe and the Yukos affair, S&P said these incidents will linger
as overhanging risks in the mind of lenders to Russian LNG projects.
"Consequently, these risks will likely put Russian LNG debt in the
high-yield category...despite highly rated Western joint venture partners and
Russia's enormous stranded gas reserves," S&P said in its report published
last week.
"Therefore, Western oil majors, which would otherwise rely upon the
customary off-balance-sheet debt that has funded most LNG joint ventures,
instead may have to absorb the risks and use their own corporate balance
sheets to finance new Russian projects."

TECHNICAL CHALLENGES LESS DAUNTING THAN POLITICAL ONES
Russia has nearly twice Qatar's 910 trillion cubic feet and Iran's 971
Tcf gas reserves. It already exports about 30% of its 57 Bcf/day of production
via Gazprom-owned pipelines to Europe.
About 131 Tcf of Russia's reserve base, however, is gas beyond the reach
of Gazprom's pipelines, stranded below the icy waters around the Sakhalin
Islands or in the newly discovered giant Artic Shtokman field in which Gazprom
has a majority stake.
The technical challenge of producing and exporting LNG from the Artic
sites or the Sakhalin Islands will be much more difficult and more expensive
than from more benign locations in the Middle East or Southeast Asia. But
those problems will likely be solved, noted S&P. LNG commodity risk is
reasonably known and manageable. And even Shell's 100% budget overrun at
Sakhalin II should not be a problem at today's prices, said S&P.
The Sakhalin LNG project comprising two 4.8 million mt/year liquefaction
trains is scheduled to begin production in 2008 and has so far tied up 7.33
million mt/year of LNG output under term contracts spanning 20-24 years,
mostly with Japanese companies.
However, politics will always be a consideration - that energy is
becoming a potential arm of Russian foreign policy will weigh on lenders'
minds, S&P said.

LACK OF BUSINESS, LEGAL TRANSPARENCY SEEN AS KEY RISK
Yet, the number one risk to Russian LNG ventures will come from Russia's
lack of transparency in its business and legal dealings, S&P stressed.
The lack of a strong business and legal institutional framework will make
contract-based financings and secured lendings--the two hallmarks of LNG
finance--much riskier than they would otherwise be.
Typically, lenders will buy political insurance to protect against some
of these country risks, such as expropriation. This might not work in Russia,
where the risk could manifest itself as increased regulatory pressures or
alleged tax arrears--the official cause behind the Yukos affair.
Without an effective political insurance policy, project financing of a
Russian LNG deal will have to rely on high-yield debt or the bank market, S&P
said.
However, that is not a nail in the coffin--quite the opposite in fact.
Over the last few years, high-yield-financed projects have had little
trouble raising money. Quite an appetite exists for risk among many
fixed-income investors in search of high yields, and so such a project might
be able to raise enough debt to make an LNG project feasible.
Banks of late have also been aggressively lending to energy projects. And
given current oil prices, a Russian LNG project could probably easily afford
higher cost debt, the report concluded.

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