In March 2003, financing arrangements for Indonesia’s US$280 million Project Blue Sky were signed in Jakarta. The project, which involved the upgrading of two Indonesian refineries, aims at boosting Pertamina's production of unleaded gasoline for the domestic market.

The project is the first major structured finance deal in Indonesia in nearly three years and represents a significant advancement in the development of environmentally friendly energy resources in the country.

The Project

The project involves the enhancement of the Balongan and Cilacap oil refineries The facilities will produce environmentally friendly unleaded gasoline.

The company will add a combined total of 73,500 b/d in new HOMC production facilities at the Balongan and Cilacap refineries. High octane mogas component, or HOMC, is an additive that can replace lead for raising the octane level of gasoline. Traditionally, Pertamina has imported most of its HOMC needs.

Items to be constructed include a naphtha hydrotreater (52,000 BPSD), a PENEX isomerization plant (23,000 BPSD) and a CCR reformer (29,000 BPSD), along with related offsite facilities such storage tanks for raw materials and the refined product.

The scope of the TEC and Rekayasa consortium includes design, supply of the equipment and materials, construction, and commissioning supervision. The plants are scheduled to be completed in 2005.

Background

Indonesia's rapid population growth, in addition to industrial expansion has led to severe environmental degradation in the country. The daily use of leaded gasoline has caused serious pollution problems. In 2000, atmospheric lead pollution was at 1.3 micrograms (mg) per cubic meter (cu m) in Jakarta, above the World Health Organization limit of 0.5-1.0 mg/cu m. The World Bank has identified lead emissions from gasoline as the greatest environmental danger to Indonesians.

In order to combat the problem, the government launched the Blue Sky Initiative in 1996, with a government target of zero leaded gasoline by January 2000. Yet the project received a set back in 1997-1998 as the Asian economic crisis derailed Pertamina’s plan to borrow in order to build the catalytic reformer necessary to produce sufficient quantities of unleaded gasoline. The crisis also accelerated natural resource depletion as environmental regulations were set aside and people opted for less expensive and environmentally damaging production and harvesting methods.

After three years of delay, an interministerial committee chaired by the Transportation Minister regenerated the Blue Sky Program in July 1999. The Minister of Mines and Energy subsequently issued a decree specifying January 2003 as the lead phaseout date.

Unleaded gasoline was first introduced to Jakarta in 2001, followed by neighbouring regions in West Java. The enhancement of the two Indonesian refineries in question should boost Pertamina's production of unleaded gasoline to levels that can meet the goals of the Blue Sky program.

Financing

The total project cost is US$280 million. Pertamina selected Mitsui as lead arranger for the financing and product offtaker in December 2001, and after more than a year of discussion and negotiation, the agreements were concluded by the parties concerned. The Japan Bank for International Cooperation (JBIC) provided funds to a special purpose vehicle of Mitsui that is providing US$120 million. The Bank of Tokyo-Mitsubishi Ltd., Crédit Lyonnais, ING Bank N.V. and UFJ Bank Limited will provide a US$80 million loan in a separate tranche.

As the diagram below shows, Pertamina will supply lowsulphur waxy residue (LSWR) and decant oil produced from its existing refineries to Mitsui. The proceeds from the sale of these petroleum products will be paid to a trustee (the independent trustee borrower is JPMorgan Chase in New York) and allocated as the sole source of debt service of the loan.

Figure 1:

Legal Issues

Indonesian oil and gas project financings are generally not radically different from others closed since the Asian crisis. However, the Blue Sky Project transaction differs by the fact there is no link between completion and the start of repayment of the debt and the source of repayment of the debt (proceeds of the sale of LSWR coming from 5 refineries) is unconnected to the progress of the work.

Features of the contractual structure include:

(1) Loan Agreement between the Lenders and the Trustee

Lenders advance the entire loan amount under the Loan Agreement to the Trustee acting on behalf of Pertamina. Revenue from the sale of products under the Product Sales and Purchase Agreement form the source of debt service for repayment of the loan.

(2) Product Sales and Purchase Agreement between Pertamina and Mitsui

Under the Product Sales and Purchase Agreement Pertamina supplies low sulfur waxy residue and decant oil from five refineries (including the two refineries which are being upgraded) to Mitsui. The sales proceeds are paid into a trustee account established under the Trust Agreement.

(3) Trust Agreement between Pertamina and the Trustee

Under the Trust Agreement Pertamina appoints a Trustee in New York. The lenders enter into the Loan Agreement with the Trustee and disburse the entire loan amount to the Trustee.

(4) Operator's Agreement between Pertamina and the Lenders

Pertamina and the lenders enter into an Operator's Agreement under which Pertamina provides certain undertakings to the lenders in relation to the project. To the extent a default by Pertamina in the performance of these undertakings causes the sales proceeds under the Product Sale and Purchase Agreement to be insufficient to meet the Trustee's payment obligation under the Loan Agreement, Pertamina is obligated to pay the Lenders an amount equal to the shortfall.

(5) EPC Contracts between Pertamina and the EPC contractor

Under the two EPC contracts (one contract for each refinery), the EPC contractors agree to carry out the upgrade works to the Balongan and Cilacap refineries on a turnkey lump sum basis.

Figure 2: The Contractual Structure

Risks

The project was financed at a time when many international investors were concerned about political and socio-economic conditions in Indonesia.

Comfort was brought to the transaction through several factors. Firstly, both Mitsui & Co and Pertamina ensured significant commitment. Mitsui & Co agreed to offtake and pay on a long term basis for minimum volumes of oil products to be produced by five refineries belonging to Pertamina. Recent operations of Pertamina's refineries have also demonstrated their ability to sustain high levels of production.

Secondly, the project benefited from strong economics. In order to mitigate price risk on petroleum products, the lenders  have decided to assume a low level of crude oil price as a worse case and to fix the minimum volumes to be delivered by Pertamina under the Product Sales Agreement at a level allowing a repayment of the debt without modifying the intial repayment schedule under this assumption.

Thirdly, the political risk is mitigated by the geographical diversification in terms of the refineries' location as the products stem from five refineries. Two are on Java, including Cilacap; two are on Sumatra; and one on Kalimantan. The inability of a refinery to produce due to unexpected political events, is thus remedied.

Lastly, the offshorised financing structure brought comfort to the deal. Under the trustee borrowing structure, Mitsui will be instructed by Pertamina to channel all the sale proceeds denominated in US dollars under the product sales and purchase agreement into a trustee account established under the trust agreement between Pertamina and JP Morgan. According to Bertrand Baot of Credit Lyonnais: "The cash waterfall mechanism in the Trustee ensures the repayment of the debt as a priority over any other expenses and thus covers the refining margin risk".

Conclusion

Given recent economic conditions in Indonesia and the importance of developing domestic fuel resources on an environmentally friendly basis, the Blue Sky project is of particular significance.

As the first project finance deal in Indonesia where the construction is completely unconnected from the repayment of the debt, the transaction sets a precedent.

It is hoped the project will allow the funding and development of projects that might otherwise have faced problems in raising funds on a stand-alone basis.