Article Blue Sky

This article appeared in slightly different form in The Journal of Structured and Project Finance, Spring 2004.

Pertamina’s Blue Sky Project Heralds Return of Innovative Project Financing

in Indonesia By George Crozer

Indonesia has undergone considerable economic, political, and social change in the

aftermath of the 1997 financial crisis. Major trade, structural, and macro policy reforms have led

to a more stable economy and the return of foreign investment. In 2003, the Government of

Indonesia approved $13.2 billion dollars in foreign direct investment on a total of 1,024

projects1. One successful example of such investment is the $280 million Blue Sky project,

which is the first major structured finance deal in Indonesia in nearly four years.

Sponsored by Pertamina, the project involves the upgrade of the oil refineries at

Balongan and Cilacap both in Central Java to enable the production of larger quantities of

unleaded gasoline for the domestic market2. With the goal of ending Indonesia’s reliance on

leaded gasoline, the Blue Sky project is expected to significantly reduce air pollution in Jakarta

and other urban areas by advancing the development of environmentally friendly energy

resources.

For structured and project finance professionals, the deal is also notable because it applies

a trustee borrowing scheme structure in which an offshore trustee acts as the borrower and is

1 Jan. 20, 2004, Indonesia Reports Jump in Foreign Investment Approvals But Few New

Projects, Agence France-Presse.

2 White & Case previously represented Pertamina on the green field Balongan and Cilacap expansion projects as well as subsequent upgrades and debottlenecking projects in Cilacap.

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paid directly by the offtaker, and because the source of repayment of the project debt is not

connected to the work that is being financed by the debt.

Background

Indonesia's rapid population growth and industrial expansion has led to environmental

degradation in the country; in particular, use of leaded gasoline has caused serious pollution

problems. Atmospheric lead pollution in Jakarta has been measured at 1.3 micrograms (mg) per

cubic meter (cu m), well 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. The initiative included plans

to install a catalytic reformer and isomerization unit at Balongan, and to modify the catalytic

reforming unit at Cilacap and install an isomerization unit.

However, the project received a setback in 1997-1998 as the Asian economic crisis

derailed Pertamina's plans for financing. The crisis also exacerbated environmental problems as

regulations were set aside and people opted for less expensive, though more environmentally

damaging production and harvesting methods.

After three years of delay, an interministerial committee chaired by the Transportation

Minister resurrected the Blue Sky Program in July 1999. The Minister of Mines and Energy

subsequently issued a decree specifying January 2003 as the lead phase out date. This set in

motion the financing and contracting processes, and it took approximately a year from the

negotiation of term sheets to final closing.

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The plant upgrades are scheduled to be completed in 2005. Under the engineering,

procurement and construction (EPC) contract, the Japanese company Toyo Engineering

Corporation is upgrading the two refineries at Balongan and Cilacap in partnership with

Indonesia’s PT Rekayasa Industri. The key element is the addition of facilities to produce high

octane mogas component, or HOMC, an additive that can replace lead for raising the octane

level of gasoline. The Blue Sky initiative will add a combined total of 73,500 b/d in new HOMC

production facilities refineries.

The scope of the Toyo Engineering and Rekayasa consortium work includes design,

supply of the equipment and materials, construction, and commissioning supervision. Items to be

constructed at the refineries 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.

Pertamina will supply low sulphur waxy residue (LSWR) and decant oil produced from

its five existing refineries (including Balongan and Cilacap) to Mitsui. The proceeds from the

sale of these petroleum products will be paid to and allocated as the sole source of debt service of

the loan.

Financing

The total project cost is US$280 million, with $200 million in financing and $80 million

provided by Pertamina. Mitsui was selected by Pertamina as lead arranger for the financing and

product offtaker in December 2001, and the agreements were concluded after more than a year of

negotiation. The financing comprises a $120 million direct loan from Japan Bank for

International Cooperation (JBIC) and a separate tranche of $80 million in an uncovered


commercial bank loan co-arranged by Credit Lyonnais (coordinating bank), UFJ Bank Limited

(technical bank and facility agent), Bank of Tokyo-Mitsubishi and ING Bank N.V. The four

banks lent to the project on a club basis, committing $20 million apiece.

The commercial and JBIC loans have a 4.5-year tenor and are provided parri passu, with

the commercial facility priced at 275bp over Libor. JBIC’s loan is in support of the EPC contract

with Toyo Engineering.

Under the trustee borrowing structure, Mitsui pays all the proceeds under the product

sales and purchase agreement into a trustee account (denominated in U.S. dollars) established

under the trust agreement between Pertamina and JP Morgan. The cash waterfall mechanism in

the Trustee arrangement ensures the repayment of the debt as a priority over any other expenses

and thus covers the refining margin risk.

The trustee borrower scheme was originally developed in the late 1980s to provide off-

balance sheet non recourse financing for projects sponsored by Indonesian government entities.

New York is typically the location of choice for the trustee, as New York law permits the trustee

to own the cashflow from the offtaker.

The Blue Sky contractual structure also is distinct because the source of repayment of the

debt is not connected to the work that is being financed by the debt. Rather than being serviced

by income from the sale of unleaded petrol from the Balongan and Cilacap refineries themselves,

the project debt is serviced from sales of unrelated products produced at the Pertamina refineries.

These five refineries were chosen as the source of the debt service because they produce oil

commodities in which the project offtaker (Mitsui & Co) was willing to take a large position.

Although the offtaker is obliged to take and pay for the refineries’ output, its risk is reduced


because of the marketable nature of the product. As debt service is not dependent on the

completion of the Blue Sky project, no construction guarantees were needed.

While not a completely new concept, the debt servicing structure is rare. In Indonesia,

several other deals have had similar characteristics; for example, the Bontang LNG project

allowed contingent debt service support from other assets, but this was never called upon. Also

the original Balongan refinery project financing provided for debt service to be paid from sales

of a slate of products from other Pertamina refineries.

The Blue Sky contractual structure is as follows and illustrated in Figure 1:

Figure 1

(1) Loan Agreement between the Lenders and the Trustee

Lenders advance the entire loan amount under the Loan Agreement to the Trustee.

Revenue from the sale of products under the Product Sales and Purchase

Agreement forms 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 on a

repayment period by repayment period basis, i.e., the debt cannot be accelerated

against Pertamina. These undertakings are very basic, such as not to breach the

product sales agreement, to insure the relevant refineries and the like. However

the Lenders bear a number of major risks, including market, buyer, default and

force majeure.


(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

lump sum turnkey basis.

Risk Mitigation

The Blue Sky project was financed at a time when many international investors were

concerned about political and socio-economic conditions in Indonesia, as well as the fact that a

new law regulating the Indonesian oil and gas industry was not yet fully implemented. The new

law caused uncertainty regarding Pertamina’s status, specifically on the issue of whether the

company would continue to be the owner of the refineries against which the funds were being

lent.

A number of features gave lenders sufficient reassurance to lend on an uncovered basis,

including the use of the trustee borrowing structure and the presence of the JBIC. These are

important factors since the uncovered loan is one of the few recent Indonesian bank facilities to

close without political risk insurance or some form of ECA or multinational guarantee. A banker

involved in the financing recently stated that partly because of JBIC’s involvement the banks

took the view that political risk insurance cover did not add a lot to the deal and would have

meant higher pricing with little additional benefit.

Political risk is also mitigated by the geographical diversification of the five refineries'

locations. Two are on Java (Balongan and Cilacap); two are on Sumatra (Plaju and Dumai) ; and

one on Kalimantan (Balikpapan). The arrangement gives the lenders additional security because

even if two of the five refineries responsible for repaying the debt are not operating, debt service


could continue as planned. In addition, all of the refineries have a long track record of successful

operations.

Another feature reducing financing risk is the fact that the debt is to be paid before capital

and operating expenditure. Also, in order to mitigate price risk on petroleum products, the

lenders 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 having to modify the initial repayment schedule.

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. The project’s use of a trustee borrowing scheme and the fact that the

project work is unconnected from the repayment of the debt sets a precedent for innovative

structuring and financing. Moreover, World Bank lending stipulations that prohibit state

companies from providing security for new borrowings will ensure that trustee borrowings

similar to those implemented in the Blue Sky project will continue to be utilized in Indonesia.

###

Blue Sky: Project Information

Sponsors: Pertamina

Total project costs: US$280 million


Project debt: US$200 million

Lead Arrangers: Mitsui and Co (arrangers for the US$120 million Japan Bank for

International Cooperation funding)

Arrangers: The Bank of Tokyo-Mitsubishi Ltd., Crédit Lyonnais, ING Bank N.V. and UFJ

Bank Limited (arrangers for the US$80 million commercial lenders portion)

EPC Contractor: Toyo Engineering Corporation, PT Rekayasa Industri

Sponsor counsel: White & Case LLP

Lender counsel: Paul, Weiss, Rifkind, Wharton & Garrison

About the Author Hong Kong partner George Crozer is a project finance lawyer with White & Case LLP and Chair of the Executive Committee for the firm in the Asia Pacific region. He can be reached at [email protected] . White & Case represented Pertamina in the Blue Sky financing, which was named 2003 Asia Pacific Oil and Gas Deal of the Year by Project Finance International.


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