The first project sukuk issue for the Satorp refinery aims to diversify the investor base for the project and broaden possibilities for the Saudi capital markets. By Isla Binnie.
Satorp, the joint venture between state-run Saudi Aramco and French supermajor Total, launched the world’s first project sukuk issue in September, completing a complex financing package for the Jubail oil refinery in Saudi Arabia. While the innovation in project financing may inspire imitators, the unique details of the deal mark it out as a hard act to follow.
A 14-year Sharia-compliant offering of about SR3.75bn (US$1bn) achieved keen pricing of 95bp over six-month SAIBOR, meeting tight guidance of 95bp–105bp over the benchmark thanks to the financial and reputational support of its sponsors. Leads Banque Saudi Fransi, Deutsche Bank and Samba Capital took roadshows for the deal to an exclusively Saudi investor base, whose constituents were keen to recognise the credibility of the names behind the refinery project.
“The sponsors are guaranteeing this, so the risk factor is very low; it’s a good investment and there’s a lot of cash in the Kingdom,” Fawaz Nawwab, chief executive of Satorp, told reporters in September when he announced a scheduled completion date for the Jubail project. The US$14bn greenfield development will process 400,000bpd of Saudi heavy crude when fully operational in December 2013.
While the overall project enjoys a construction guarantee from both sponsors, Saudi Aramco acts as sole guarantor of the sukuk during the refinery’s construction phase. The energy behemoth requires little credit risk analysis from Saudi investors, who are able to take comfort in the guarantees that come with government ownership.
“I think the Satorp sukuk holders would take comfort from the undertakings given by Saudi Aramco,” said Massoud Janekeh, head of Islamic capital markets at Bank of London and the Middle East.
Satorp’s decision to invest time and effort, and make an unprecedented project sukuk issue was partly motivated by affairs of state. The standard five-year sukuk format is popular with Saudi investors, who buy them to hold, but the 14-year tenor makes this an entirely different offering.
“It was important for Satorp to develop the capital markets in the Kingdom,” said one person close to the deal, who declined to be named. “It was in the national interest.”
The Saudi Capital Markets Authority had been keen for some time to develop the Kingdom’s capital markets, so a combination of shareholder loans and a robust guarantee provided firm ground to develop and implement an innovative financing structure, which, it is hoped, will have what one DCM official called a “waterfall effect” and provide a template for future deals in the Kingdom.
An intricate US$8.5bn overall funding package for the project, agreed in June 2010, includes loans from public investment funds, and export credit agency financing and commercial bank financing from both Islamic and conventional institutions. According to Satorp, commitments were received for more than US$13.5bn.
“This is quite a complex structure because it is not a straightforward debt funding of an existing business. It involves construction and development of a new asset. It includes a number of funding banks for different aspects of the project in a complex intercreditor arrangement, and furthermore it is created as a joint venture between two equity investors in Saudi Aramco and Total,” said Janekeh.
The structure of the joint venture follows the Islamic principle of musharaka, which provides guidelines on partnership and joint investment. Under this arrangement, Saudi Aramco holds 62.5% of Satorp and Total maintains a 37.5% stake. The purpose of the partnership, according to the sukuk prospectus, is “to earn profit from the application of the capital contributions of the partners in accordance with the business plan”.
The final bond segment of the financing took longer to arrange than the rest of the package, so Saudi Aramco and Total provided senior shareholder loans of US$497.5m each. The sponsors’ US$995m loan allowed the construction process to continue while the bond portion was being drawn up. According to the sukuk prospectus, the senior shareholder loans are expected to be cancelled on the settlement of the sukuk.
Stringent sukuk standards
Structuring a Sharia-compliant bond to fund a project under construction is contentious and agreeing all the finer points is always time-consuming. The new refinery at Jubail is to this day a long way off completion.
“By July 2009 all of the EPC contracts had been awarded and the project teams mobilised to their respective package locations all around the world to begin building the various units of the refinery, which would eventually be shipped back to Saudi Arabia to be assembled like a colossal puzzle,” the company declares on its website, which includes a countdown to the Jubail project’s completion.
The fragmented nature of the asset was a headache for the financing. “You certainly can finance assets under construction Islamically but it is easier, cleaner to organise an ijara contract around a built, tangible asset,” said Karim Nassif, a credit analyst at Standard & Poor’s.
The fact that tangible assets were at least in the process of being built finally earned scholarly approval for the sukuk segment. Allen & Overy acted as legal counsel for the issuing project company.
The sukuk issue is structured under an istisna contract for construction, and an ijara forward lease agreement, through which investors receive returns based on the future lease of project assets. “This is the first project sukuk issue, so it enters new territory,” said one DCM official familiar with the deal.
This groundbreaking use of an alternative financing method was partly intended to diversify the creditor base. Given that regional bank loans tend to carry a five to eight-year maturity and several different lenders had already pledged a considerable contribution through the other funding strands, there was a clear motivation to establish a long-term facility aimed at a different class of investor.
Nevertheless, sources involved in the deal pointed out that Satorp could have chosen to plug the final gap in the project with a conventional Rule 144a project bond instead of sukuk, and conducted a detailed cost-benefit analysis of the options. The CMA’s interest in deepening local capital markets motivated the decision to take the road less travelled, with its attendant costs. “Typically, arranging an Islamic deal requires extra resources,” said S&P’s Nassif.
The Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) and scholars appointed to scrutinise each specific deal ensure that strict guidelines are followed, increasing the time and expense required to arrange even a typical sukuk offering where there is no question over the assets backing it.
Despite being arranged slightly later, the sukuk portion carries the same tenor as the rest of the financing bundle, which matures in 2025. Other Sharia-compliant facilities had already been agreed, requiring negotiation with numerous Sharia boards to fulfil the issuer’s desire to involve as many entities as possible.
“By a process of education, six ECAs not necessarily familiar with Islamic finance became comfortable with the sukuk,” said the person close to the deal. “The question the issuer had to ask about the sukuk specifically was whether the investor base was there.”
Liquidity versus stability
It is well-documented that both Islamic and conventional bank treasuries in the region are reliably keen buyers of sukuk; the dearth of Sharia-compliant assets means Islamic institutions rarely receive as large an allocation as they would like, and non-Islamic investors relish the opportunity to diversify. Furthermore, because Islamic institutions tend to keep sukuk on their books rather than taking advantage of the tradable nature of the certificates, conventional investors know that the assets are likely to be held to maturity, so are willing to sacrifice liquidity for stability.
The minimum allocation of sukuk certificates on this deal was SR1m. This high commitment threshold means that the certificates made their way into very deep pockets in a market perennially awash with cash.
“The project company borrowed a great deal in riyals because the currency was available,” the analyst said. “The main bank financing also involved a substantial riyal tranche.” The sheer size and its sponsors’ clout set it apart from comparable offerings, even within the liquid Gulf market. Saudi Aramco is effectively controlled by the Kingdom’s government, with access to the attendant cash reserves.
“This was a domestic deal just short of a billion dollars,” said one analyst familiar with the deal. “I don’t think anyone in the GCC (outside Saudi Arabia) could replicate it without crossing borders.”
In a region where lending lines follow established relationships, Saudi Aramco already has longstanding connections with local banks, so should not struggle to cover its funding needs even when international banks retrench. The firm’s lack of an international rating would have made it less likely to price such an unusually long-tenor sukuk offering in an international market roiled by credit concerns.
The complexity of the overall financing package and the repayment process may also have been a concern outside the domestic market. Recent defaults, including that of Dubai World, have raised the issue of sukuk enforceability.
For example, although creditors of debt-ridden Nakheel have begun to receive repayments in sukuk format, a promised listing on the Nasdaq Dubai was delayed, frustrating creditors who wished to redeem the paper for cash, albeit at a discount.
“With so many different financings going on at the same time, should anything happen to Saudi Aramco, the ranking and priority of the sukuk obligations vis a vis other bank facilities would not be straightforward,” said the analyst.
Given that Saudi Aramco is backed by a state that possesses about 20% of the world’s proven petroleum reserves, the chances of anything happening to prevent it honouring its obligations seem negligible. The world’s first project sukuk issue may not open the floodgates to many similar deals, but an unassailable credit, a liquid market and a perennially desirable commodity combined to allow a remarkably innovative financing.