Kayan – Orchestrating funding sources
The Saudi Kayan story is a tale that is as interesting as it is long. By Laurent Devin and Antoine Gustin, BNP Paribas, and Nicholas Wong and Edmund Boyo, Clifford Chance.
It started at the beginning of this decade when a small group of Saudi entrepreneurs, who formed Project Management Development Company (PMD), had a vision. The vision was to expand the product slate of petrochemicals produced in Saudi Arabia so as to derive greater added value from the oil and gas resources available in the Saudi Arabia, as well as to facilitate the potential development of new downstream industries in the Kingdom.
The Saudi Government embraced this vision as it was aligned with its "Saudisation" policy of promoting diversified industry in the Kingdom and so creating additional employment for Saudi nationals. Hence in 2003, PMD received a butane and ethane feedstock allocation from Saudi Aramco. The allocation was one of the largest ever awarded by Saudi Aramco and was one of the first to a private sector company. It should, however, be noted that butane had not (and has still not) been cracked in the Kingdom and some viewed the allocation with a degree of scepticism.
From then on, things started to move forward with greater speed. Clifford Chance was appointed as legal adviser and a few months later Fluor was appointed as the project management contractor. With both of these key appointments made, the process of pre-qualifying potential contractors and technologies and preparing specifications/tender documents began.
In order to raise the equity required for the project, PMD established Al-Kayan Petrochemical Company (a joint stock company), which closed its private placement in October 2005 with a paid up share capital of US$824m. The private placement was heavily oversubscribed, notwithstanding the fact that Al-Kayan Petrochemical Company's one and only asset at that time was the allocation letter from Saudi Aramco (which PMD had transferred to it). Shortly thereafter, with the momentum picking up, PMD appointed Arab Banking Corporation, Samba Financial Group and BNP Paribas as its financial advisers.
PMD was faced with an overheated construction market, which resulted in project costs spiralling to US$6bn. To counter this and the fact that only limited sponsor support would be available from Al-Kayan Petrochemical Company, it was decided that the project would have to be financed with a 60/40 debt/equity ratio and that a 50% international JV partner would have to be introduced to the project.
Given the limited sponsor support that would be on offer and concerns regarding the bankability of the project, PMD decided to pursue a "wrapped" construction strategy, which came at a cost – namely, a further significant increase in the total project cost. Most of the potential international JV partners were alarmed by the unpredictability of construction costs in an ever-tightening construction market, but the project caught the imagination of SABIC, which was were keen to diversify its product slate in line with its 2020 Vision.
SABIC took control of the project in June 2006 and, with hindsight, it proved to be the project's white knight. By the time SABIC took charge, all of the consultants required for the project had been appointed and were hard at work. In addition, PMD had seconded more than 100 engineers to the offices of Fluor in Camberley, England.
With the parameters of the project now having been more clearly defined, SABIC determined that the financing plan would have to be based on revised project costs of US$10bn, therefore requiring US$4bn of equity and US$6bn of long term non-recourse debt. SABIC was willing to contribute 35% of the equity required with a further 20% coming from Al-Kayan Petrochemical Company. The remainder of the required equity would come from the Saudi public through an IPO.
The IPO in itself presented a challenge, as one of the new requirements of the Capital Market Authority of Saudi Arabia was that the full amount of the debt financing required by the project had to be underwritten. This was a major hurdle given that the financial institutions solicited to provide the underwriting were only in the middle of their due diligence. Following limited due diligence and lengthy negotiations, SABIC was able to secure an underwriting commitment from the five initial mandated lead arranger (which comprised the three financial advisers and two other financial institutions).
The IPO was launched to the market in May 2007. At the time of its closing, the IPO was the second largest ever in the Kingdom and with SABIC as the project sponsor it was exceptionally well received by the market and raised US$1.8bn, a clear testimony to the appeal of the SABIC name to private and institutional investors in the Kingdom.
With the IPO successfully closed, SABIC still had to further develop its financing plan for the project. Finding the right mix of funding sources for a project of this scale and complexity was the Gordian knot that had to be severed by SABIC, its three financial advisers and its legal adviser. Market liquidity was carefully analysed and it was determined that the bulk of the financing would have to be sourced from ECAs and Islamic funders.
Due to the contracting strategy (which, with SABIC's involvement, changed from wrapped LSTK to cost-reimbursable EPCMs with an option to convert to LSTKs as a consequence of the sponsor support that SABIC would provide, the tight construction market and the time constraints imposed in the gas allocation letter) adopted for the project, the initial approach to the ECAs was somewhat unconventional.
At that time, it was unclear from where the goods and services required for the project would be sourced. SABIC and its advisers therefore had to approach a wide variety of ECAs without knowing whether there would be significant amounts of goods and services sourced from their respective jurisdictions to justify their involvement in the proposed financing.
The aim of this approach was not so much to create competition among the ECAs but rather to ensure maximum flexibility for the construction team to source goods and services competitively. The intention was also to engage the ECAs as early as possible to ensure the refinancing of development costs during the so-called "reach back" period. In their discussions with the ECAs, BNP Paribas actively promoted the concept of "made by" as opposed to "made in", thereby encouraging the ECAs to provide financing mainly on the back of their domestic contractor rather than on the back of the equipment and services sourced in their respective jurisdiction.
Although the commitment letters provided by the ECAs with whom SABIC had been in talks were very similar, one in particular stood out. SACE agreed to make US$500m available on a fully untied basis, a record for the new SACE untied programme. SACE made that decision as a result of the strategic importance of Saudi Arabia and SABIC.
This early commitment allowed SABIC greater flexibility in its selection process, which was necessary to reduce the number of ECAs and so ensure that the financing plan could be developed as efficiently as possible. Given that a significant amount of goods and services would be sourced from South Korea and given the flexibility shown by the South Korean ECAs, KEIC and KEXIM were selected and each committed to provide US$500m. ECGD, which had participated in the Yansab project financing, was also selected and provided a commitment of US$500m.
It was SABIC's objective to maximise the size of the Islamic tranches and to take full advantage of the available Islamic financing capacity both locally and internationally. The financing structure consisted of two Islamic tranches. In respect of the first tranche, SABIC and, in particular, Arab Banking Corporation developed a strong relationship with Al Rajhi Banking and Investment Corporation, which provided a US$640m Islamic working capital facility on a Sharia-compliant basis (murabaha).
The second global Islamic tranche raised US$1.03bn and was made available to all invited financial institutions and was based on the commonly used forward lease structure (ijara mowsoufa fil thimma). At the time of signing, this was the largest Islamic tranche in a project financing. The structure utilised provides for the project company to procure the construction and development of certain assets on behalf of Islamic investors. Once constructed, the assets are delivered to an asset custodian on behalf of the Islamic investors, who then leases them back to the project company. The repayment terms under the lease agreement are the same as the commercial facility.
SABIC and its advisers had determined very early on that the optimum amount to be raised from commercial banks (Islamic and conventional) on a competitive basis was about US$2bn. This proved to be accurate as 13 local, regional and international financial institutions ultimately committed US$1.8bn. The pricing on all tranches was at a record low level notwithstanding the on-going "credit crunch" and this should be credited to SABIC's credibility and standing in the market.
SABIC built on existing strong relationships with PIF and SIDF to secure financing for the project on favourable commercial terms. SABIC raised in excess of US$1bn from PIF and it is expected that a further US$533m will be raised from SIDF by the end of 2008. To the extent that the SIDF financing arrangements are not concluded within this timeframe, SABIC has agreed to procure alternative financing in place of SIDF.
Saudi Kayan represents a real milestone in project finance history for a number of reasons. First, the product slate in the Kingdom will be diversified significantly, thus assisting with the implementation of the Saudisation policy of the government and the 2020 Vision of SABIC. Second, the contracting strategy adopted (an unwrapped cost reimbursable EPCMs with an option to convert to LSTK) ensured competitive sourcing of goods and services while ensuring ECA coverage.
Third, public participation in the project was ensured through the second largest IPO in the Kingdom at the time of closing. Fourth, an innovative multi-sourced financing was arranged including Islamic tranches in aggregate in excess of US$1.6bn with a murabaha working capital facility in an amount of US$640m. Fifth, an untied facility in an unprecedented amount of US$500m was provided by SACE, with otherwise favourable eligibility and reach-back criteria being agreed to by the other participating ECAs. Finally a successful syndication at competitive pricing was achieved during the height of the credit crunch.