By Patrick Gill
PROJECT FINANCE IN the strict sense of the term has not yet developed in Kazakhstan but this is expected to change as the market grows. Despite the lack of pure project finance, with the establishment of a special purpose vehicle, companies have no shortage of financing options for their investment needs. Bank loans, bond issues and initial public offerings are tried and tested ways of raising capital that have served Kazakh companies well. Part of the reason why project finance has not taken off is that the Kazakh banking sector is well enough developed to offer cheaper alternatives. With a diversifying economy and an improving legal framework, there is the potential for larger-scale, classic project financing, bankers say.
We have seen very little true project financing, where the financing structure was based on the performance of the project itself, says Jurgen Rigterink, head of ABN Amro in Kazakhstan. But this is changing now. ABN is currently analysing a couple of large deals of over $1 billion relying on the fundamentals themselves, instead of having a guarantee from a sponsor. This will develop further this year. Furthermore, we expect a significant increase in public-private partnerships, particularly related to improving the countrys infrastructure. The development of PPPs is expected to provide further impetus for the kind of infrastructure projects that typically use project finance.
Rigterink says Kazakhstans strong macroeconomic outlook should underpin growth in project finance. We see several multi-billion dollar projects; the limitations are relatively few, and the breadth and liquidity of the market are increasing.
In theory, Kazakhstan should be fertile ground for project finance, with high-cost energy, mining and infrastructure projects to be developed. But project financing at present generally covers projects in the $10 million to $200 million range, which is small by global standards.
Laura Brank, head of law firm Chadbourne & Parke in the CIS, says most of the firms work in Kazakhstan is project finance-based, but that it is not pure project finance in the western sense.
No one was thinking project finance in Kazakhstan a few years ago but it is very active right now, she says. Among other projects, the firm has advised on Lukoils stake in the Karachaganak field, and the Caspian Pipeline Consortium. The firm is currently working on projects in the power and real estate sectors. Brank says the local legislative framework means that project finance is easier to carry out in Kazakhstan than in neighbouring Russia. For example, oil and gas licences in Russia are usually non-transferable, whereas in Kazakhstan they can be used as security by lenders, making projects easier to finance.
Brank says one of the main obstacles to the development of project finance in Kazakhstan might be the array of other financing options open to Kazakh companies, which are often happy to tap the bond markets instead.
A number of changes are still necessary to give project finance a wider appeal to both lenders and borrowers, according to Kamila Syzdykova, senior project finance manager at Halyk Bank. The development of innovative technologies and involvement of venture capital funds would be one significant step, she says, particularly as the latter could spur a culture of equity participation in projects.
A change would be if equity could be used to offset 100% of the leverage, she says. This would make projects more attractive if structures could be developed where venture capital can be injected in the form of equity with a put option of five to seven years. Apparently in recognition of this need, the government established a National Innovation Fund in 2003 to stimulate investment in technology and the growth of venture capital funds. Such funds remain in their infancy, however.
Halyk is typical of local banks in working on relatively small project finance transactions, and takes on loan amounts starting from $10 million. The main thing is that the project can be tailored to project finance, regardless of the sum, Syzdykova says. Although banks are restricted to lending 25% of equity capital in any one project, Kazakh law imposes no specific limits on project finance, leaving banks to make internal decisions based on the profitability of each credit line.
Bankers say the risks in project financing in Kazakhstan are not necessarily greater than in other markets. Offtake risk is the main risk, according to Syzdykova. Judging the eventual demand for the service provided by the project is particularly important, as often no market has previously existed for them. A new mechanism to mitigate risk, such as some kind of insurance, would enhance project finance. But, as things stand, no one would offer such insurance and it would push up costs significantly, she says.
ABN Amros Rigterink is more sanguine. Offtake is always one of the biggest risks anyhow, he says. There is always a lot of emphasis on the structure, and that is not much higher here.
Regulatory and administrative issues are other particularly important issues in planning projects in Kazakhstan. Particularly with energy projects, obtaining the appropriate commitments from the government can be crucial. Anti-monopoly scrutiny and tariff planning are two areas that need careful thought. You could end up with highly regulated tariffs that will not cover the financing, says Bek Muslimov, head of project finance at Kazkommertsbank.
Government recourse for projects is another important factor, bankers say. Many deals depend on how committed the government is to its pledge to diversify the economy away from oil and gas and to develop projects in new areas, says one banker. The last interesting project we saw was in wind power, but we declined it because it didnt have government recourse, he says. The Kazakh government has set up a number of development banks specifically with the aim of funding national infrastructure projects, however. The Development Bank of Kazakhstan was established in 2001 to issue medium-term and long-term low interest loans to the manufacturing sector and finances projects of more than $5 million with a payback period of up to 20 years. The bank has $720 million invested in 13 projects and aims to double this amount by the end of 2008. Meanwhile the Investment Fund of Kazakhstan finances non-mineral resource projects by taking minority stakes.
|No one was thinking project finance in Kazakhstan a few years ago but it is very active right now|
Laura Brank, Chadbourne & Parke
Project companies, supported by receivables, are still in nascent form, while the mechanism of assignment of rights has not been tested in the courts, Brank says. For areas such as assignments of receivables, a combination of Kazakh and English law is often used.
But many companies in the energy and mining sectors are sitting on undeveloped properties that will require significant financing if they are to graduate from the exploration stage. With numerous firms owning greenfield operations that simply have licences and modest levels of output but significant financing needs, the use of project finance is likely to increase.
Kazkommertsbanks Muslimov points to a number of areas where Kazakh companies will turn to classic project finance. The real estate boom means construction materials manufacturing and the cement industry could see deals this or next year, while the expanding consumer sector and infrastructure projects such as power generation could drive further demand, he says. He says it is often cheaper to access the debt capital markets directly than set up a special purpose vehicle and use project finance, however.
With project finance in the strict sense of the term yet to develop, many larger companies have already used bond issuance successfully; the fixed income market remains heavily dominated by banks, which account for about two-thirds of the $3.3 billion of outstanding corporate bonds. Cash-rich exporters of natural resources have tended to finance their projects internally or through IPOs, meanwhile. Secondary stock issues are another option: Kazkommertsbank itself is currently planning an issue of more than $1 billion to local and foreign investors to fund the extension of its CIS network and increase its stocks liquidity.
ABN Amros Rigterink says that the debt market is becoming a more important source of funding for a wider range of Kazakh companies. Access to debt capital markets is expanding to a wider range of borrowers, he says. On the bond side, only tier one banks could tap the market before, whereas now tier two banks are also able to. And this will continue.
Rigterink says the established players will continue to issue larger, standard bonds while, on the syndicated side, bonds will go beyond five years to seven years and upward. In 2004, ABN Amro advised on Tengizchevroils $1.1 billion issue, one of the largest corporate bonds from Kazakhstan in recent years. Now it says it is working on a similar deal for an issuer outside the financial groups.
Another alternative for Kazakh companies is straightforward bank financing, which is the preferred route for many, perhaps because it requires less disclosure from the borrower than a bond issue. However, improving corporate governance standards are likely to make it gradually easier for Kazakh companies to finance their expansion via the debt markets.