PROJECT FINANCE DRIVEN EXECUTION STRATEGY

June, 2015
Contents

Introduction

Financing options

Project execution methods

SOCAR Polymer: project structure

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Major Projects are Different

Great Economic Impact!

$1$10 billion dollars of direct investment
Economic life: 25-30 years
Economic flow of 510 billion $US/year
Generates 1,0001,200 new jobs

Great Chances of Failure

According to IPA1
Failure rate (cost, schedule, operating problems)
Major projects: 65%
All other projects: 37%
Major project results
Cost growth > 60%
Schedule slip > 30%
Finance availability
Change in market conditions
1. Source: IPA Presentation at COAA

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Financing options

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Financing Options

1. Equity & Shareholder Loans Only

2. Corporate Finance
This financing is only suitable where the company has an operating history and
there are existing cash flows

3. Project Finance
Financing predicated on the projected cashflows from the pipeline rather the credit
of the Borrower
Borrower is typically an SPV with no operating history and no existing cash flows

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Debt Financing Decision Tree

What is the
Is Investment Most Appropriate Which Debt
Bankable? Borrowing Market?
Structure?

Positive NPV
Acceptable credit risk
Adequate legal and fiscal Loan
environment Corporate Financing

No Yes

Financing
No Financing
Possible

Project Financing Bond

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Elements of a Project Financing

Project company (special purpose vehicle):

Project Company
The project company is holder of all rights and duties
in connection with the project and its financing

Cash-Flow Relevance Relevance of cash-flow: The borrowers financial standing

depends significantly on the project companies' expected cash-
flow and not on the common rating criteria (e.g. balance sheet
ratios)

Non/Limited Recourse Recourse: After project completion, the banks have no (non-
recourse financing) or only limited (limited-recourse-financing)
recourse options to the assets of the sponsors, but full
recourse to all project assets

Risk Distribution Risk distribution: Project risks are structured in a way to

adequately allocate them among the involved parties

Project Finance

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Project Finance compared to traditional corporate finance

ADVANTAGES DISADVANTAGES

Typically off-balance sheet for Sponsor(s) Higher transaction costs

Risk transfer to lenders Longest transaction process

Longest tenors Complex documentation: Term Sheet 15 pages

1500 pages of finance documents
Suitable where more than one Sponsor

Provides independent third part confirmation of

Projects viability

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Legal Aspects of Project Finance: Key Project Finance Ratios

Debt Service Cover Loan Life Cover Ratio Loan Life Cover Ratio
Ratio (DSCR) (LLCR) (EQUITY)
(LLCR) IRR

RELEVANT FORMULAE
Cash Flow available NPV of Cash Flow
for debt service available for debt service
DSCR = LLCR =
Debt Service Outstanding debt amount

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Project Execution Methods

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 Major Projects Risk Mitigation

The typical risk profile will only be achieved with proper project management processes

Total Project Risk

Risk

Engineering Execution Construction

Scope Growth, Pricing Craft Productivity
Engineering Productivity Quantities

THE BIG PROBLEMS USUALLY CAN BE TRACED TO MISTAKES

VERY EARLY IN THE PROJECT

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Typical Execution Methods

Unbundled - separate contracts for Engineering, Procurement (or by Owner)

and Construction
Reimbursable EPC sometimes called EPCM or Cost-Plus. Contractor works
on a man-hour rate
Lump Sum EPC can be turn key (termed LSTK) or non-turn key (see later);
can be either competitively bid or single source

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Execution Model

Pre-Approvals
Final Investment
Decision is made
EPC contract is placed
Basic Front End
Feasibility Design by Engineering Detailed Start-Up &
Procurement Construction
Licensors FEED Design Commission

Define chosen solution,

Fix EPC strategy, +/- 10% Capex
Select licensor,
Approve project design basis, +/- 30% Capex
Identify business opportunity
Evaluate and screen options, +/- 40% Capex

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Project Execution Where Project Finance is Used

Competitive LSTK EPC is by far the preferred contracting strategy:

+ For risk averse owners it provides price transparency, fixed price and schedule,
with maximum transfer of price risk to the Contractor
+ For Lenders it is suitable for limited recourse project finance, as schedule and
overrun risk is transferred from the project and there is single point responsibility
- Requires detailed front end work to define the ITB, thus longer project schedule

In tight EPC markets owners have experimented with other contract

strategies, often with poor outcomes

EPC LSTK contract is placed

Basic Front End
Feasibility Design by Engineering Detailed Start-Up &
Procurement Construction
Licensors Design Commission
FEED

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Types of EPC Contract

Banks require:

Fixed Price
Fixed Schedule

Banks also want to know that the Fixed Price is competitive and in line with
the market
This leads naturally towards Competitive LSTK contracting for project
finance
Other contracting strategies are known and can be financed (though Sponsor
completion guarantees become necessary if cost over-run or schedule over-
run risks are not otherwise covered)
Reimbursable contracts provide no cost or schedule assurance and are the
least attractive for project finance

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Legal Aspects of Project Finance: EPC Contract - Issues

Key issues are:

Completion Risk

Guarantees and Liabilities for:

Performance failure
Schedule delay
Liability levels for each underperformance

Overall liability limits

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Legal Aspects of Project Finance: EPC Contractual Completion Turn Key Contract

COMMERCIAL
OPERATION

READY FOR
MECHANICAL
COMPLETION START UP
CONSTRUCTION PRECOMMISSIONING COMMISSIONING
INITIAL OPERATION
START UP AND PERFORMANCE TESTING

ERECTION Specification
Product
BY AREA BY SYSTEM SYSTEMS
BY SYSTEM COMBINED PERFORMANCE TESTS

HANDOVER
OF
FACILITIES
EPC Contractor responsible until Commercial Operation DEFECT LIABILITY

Single Point of Responsibility Decreased Risk PERIOD

COMMENCES

Schedule
LDs

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SOCAR Polymer: project structure

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Global Trends impact the production chain within SOCAR

Chain 1. Modernization of BHAR refinery, Azerikimya

and construction of PP&HDPE plants

SOCAR
Polymer
Azerikimya

BHAR Chain 2. New GPP and Petrochemical

complex

LLDPE,
PP,
HDPE

GPP

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SOCAR Polymer: project snapshot
Location: Located at Sumgait Chemical Industrial Park with major tax and duty exemptions granted for 7
years (profit, property, VAT and other taxes)

Configuration: 120 KTA HDPE and 184 KTA PP Plants with U&O

Start-up date: 2018 (PP) and 2018 (HDPE)

Feedstock supply: Ethylene, propylene and hydrogen feedstock to be supplied by SOCAR on a deliver or
pay basis

Total project costs: $ 750 m. (40% equity, 60 % debt)

Borrowing Structure: non recourse project finance + local bonds

Target Markets: 30% domestic, the rest to be exported to Turkey, Europe, CIS and other contries

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Low raw materials costs allow products to stay competitive in the region

$/ton
1600

1400
59 48
1200 149
175

1000

800 46
158
600
55 1078 1138
77
400 146 177
623
200
337 339

0
Saudi Arabia Russia Azerbaijan West Europe Israel
Net raw materials Other variable costs Fixed costs

Source: IHS 21
Main target markets for the export are West Europe and Turkey

100%
4%
9%
7%

18%
80% 21%

60%

34%
51%

40%

20%
34% 11%

11%
0%
HDPE PP
Azerbaijan W Europe Turkey Russia C Europe

Source: IHS 22
Leading experts have been involved in project execution

EPC Tecnimont SpA (for PP, U&O)

PMC Fluor

Legal Advisors Vinson & Elkins / PSG

Lenders Legal Advisors Baker Botts / B.M.

Market consultant IHS

Lenders' Insurance Consultant BankServe Insurance Services

Lenders Technical Consultant Jacobs Consultancy

Environmental and social impact assessment Golder Associates

Lender Gazprombank JSC

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Project management

Typical project management SOCAR Polymer

Owner Owner

PMC IPMT

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Legal & Contractual Structure of the Project

Polymer Pasha AKKIK

Ecoland
Construction Holdings
SOCAR

Domestic Sale of Product

Feedstock Supply and
Contingent Equity Support
SOCAR

$ / AZN
Polymer
Investments
Fluor
(Azerbaijan)
PMC-
Contractor
100%

Tecnimont
EPC-
SOCAR Polymer
Contractor
LLC
(Azerbaijan)
GUARANTOR

Intercompany Loan
Security over Product

(Interest free)
bank accounts Offtake

100%
Agreement

Export Sales of
$ Products
Gazprombank (JSC)
GPB International S.A. SOCAR
Polymer SOCAR and
Security over Overseas $ SOCAR
LENDERS Overseas (Dubai)
bank accounts (Guernsey)
BORROWER OFFTAKERS
Debt service

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Risk mitigation for Project Financing

Construction Phase
Bankable EPC and PMC agreements with experienced and creditworthy contractors
Limited recourse to SOCAR via capped Contingent Equity Support valid until Project
Completion Date
Criteria of the Project Completion Test compliant with industry standards
Construction phase insurances (Construction All Risks, Marine Cargo, Third Party Liability)
Positive results of technical DD based on LTC report
Positive opinion of Insurance Advisor

Operational Phase
Bankable Feedstock Supply Agreement and Polymer Offtake Agreement:
Fixed margin
Volume guarantee by SOCAR
Most of Project agreements are governed by English law
Bankable operational phase insurance programme (Physical Damage, Business Interruption,
Third Party Liability, Terrorism, etc.)
Strong marketing projections and Project competitive position based on Lenders Marketing
Consultant opinion

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Success guarantors

Investment grade rating with stable outlook: BBB- (S&P), Baa3

(Moodys), BBB- (Fitch)

Stable legislative framework

Cost competitive value chain structure

Multiple export routes and growing domestic demand

Utilization of top tier industry players

Established relations with Gazprombank and its participation in the

other projects

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