The approximately US$2.5 billion Sohar Aluminium smelter project (the Sohar Aluminium Project), which closed in December 2005, was a landmark deal in the Middle East and particularly in Oman. The Sohar Aluminium Project was the first greenfield aluminium smelter to be built in the Middle East in the last 25 years and will be able to produce 350,000 tonnes of aluminium ingots per year, representing an important step for Oman’s economy as it seeks to diversify its economic base. Capitalizing on Oman’s oil and gas reserves, it is anticipated that the Sohar Aluminium Project will contribute significantly to Oman’s GDP and in doing so create significant employment opportunities.
The Sohar Aluminium Project – whose sponsors are Oman Oil Company, Abu Dhabi Water and Electricity Authority (ADWEA) and Alcan – will consist of a primary aluminium smelter including carbon and casting facilities, raw materials handling facilities, unloading and uploading facilities at the port of Sohar, storage facilities in the Sohar Industrial Area and a 1,000mw combined gas cycle turbine power plant to power the aluminium smelter.
The financing plan for the project involved US$1.545 billion of external indebtedness and approximately US$900 million in equity. The commercial debt component consisted of a US$1.2 billion commercial bank tranche and a US$85 million letter of credit facility. An important component of the financing was a US$260 million Islamic financing tranche. The Islamic financing tranche represented, at the time of signing, the first Islamic financing tranche in a multi-sourced project financing in Oman. The US$260 million Islamic facility was arranged by leading regional and international banks: the Islamic arrangers were ABN AMRO Bank, Citibank, Arab Bank, Calyon, Gulf International Bank, WestLB, Royal Bank of Scotland, Abu Dhabi Commercial Bank, BNP Paribas, Société Générale and Standard Chartered Bank.
Islamic financing tranches using the Istisnah (a sale of assets to be constructed) and Ijarah (an Islamic lease) combination had been successfully used elsewhere in the Gulf in large financings, including the US$530 million Islamic tranche in the Qatargas II financing in 2004. Since the Sohar Aluminium smelter project, the structure has also recently been used as part of the financing plan for the US$5.8 billion financing for the US$9.9 billion Petro-Rabigh project in Saudi Arabia.
In Sohar, the Ijarah/Istisnah combination was documented with an Istisnah agreement, a forward lease agreement (Ijarah fil Zimma), a service agency agreement, sale and purchase undertakings, an investment agency agreement and a common terms agreement.
The Istisnah agreement operates during the construction phase of the Sohar Aluminium Project. Under the terms of this agreement, the Sohar Aluminium Project company (the company) undertakes to develop the Islamic financed assets (including certain gas turbines, generators and electrical transmission equipment) on behalf of a special purpose company (SPC) owned for and on behalf of the Islamic participants by the Islamic facility agent. The company undertook to develop the Islamic financed assets in accordance with the specifications of the EPC and EPCM construction contracts (the company was permitted to subcontract such obligations to another person) and to arrange for delivery of such assets on or before a specified completion date. When the Islamic financed assets are delivered to the company in accordance with the foregoing requirements, title to (and possession of) such assets passes to the SPC.
Ijarah fil zimma
At the same time as entering into the Istisnah agreement, the company entered into a lease agreement (Ijarah fil Zimma) with the SPC for the operational phase of the project (the period following delivery of the Islamic financed assets to the SPC pursuant to the Istisnah agreement until a date equivalent to the final maturity date under the commercial bank tranche). Under the lease agreement, the company leases the Islamic financed assets from the SPC in return for lease payments (comprising of a fixed and a variable element). The lease payments under the lease agreement are broadly equivalent to the principal and interest payments under the commercial bank tranche and are made at the same times as the equivalent payments under the commercial bank tranche.
Service agency agreement
As per other Ijarah/Istisnah financings, the SPC (in its capacity as lessor) is responsible for all major maintenance (repair, replacement and maintenance of a capital nature without which the Islamic financed assets could not reasonably be used by the company). Such obligations, together with insurance obligations and obligations to pay ownership taxes, are subcontracted to the company (acting in its capacity as service agent) via a service agency agreement. The company is responsible for all repair and maintenance (other than major maintenance) in accordance with the lease agreement.
Sale and purchase undertakings
The company is entitled to terminate the lease agreement voluntarily – in much the same way as the company would be entitled to cancel and/or prepay the commercial bank tranche. The Islamic facility agent and SPC (in its capacity as lessor under the lease agreement) grant in favor of the company (in its capacity as lessee under the lease agreement) a sale undertaking pursuant to which they undertake to sell the Islamic financed assets to the company at an exercise price equal to an agreed “lease termination payment”. (This corresponds to a voluntary prepayment of the entire amount outstanding under the Islamic facility).
Likewise, in certain default scenarios, the Islamic facility agent and SPC are entitled to require the company to repurchase the Islamic asset and to terminate the lease agreement. The company (in its capacity as lessee under the lease agreement) grants in favour of the Islamic facility agent and SPC (in its capacity as lessor under the lease agreement) a purchase undertaking, pursuant to which it undertakes to purchase the Islamic financed assets from the SPC when a “purchase event” has occurred and is continuing at an exercise price equal to an agreed “lease termination payment.” (A purchase event arises when an event giving rise to a mandatory prepayment (applicable to the Islamic facility and requiring prepayment in full of the Islamic facility) has occurred, or a decision has been taken in accordance with the finance documents to accelerate and exercise other remedies).
On receipt of the relevant “lease termination payment” or at the end of the lease period, on payment of the final lease payment, the assets will be transferred back to the company.
SPC structure and inter-creditor issues
An important element of the structure that was used in the Sohar financing and which has been used elsewhere in Ijarah/Istisnah financings in the Middle East is the use of the SPC to act (on behalf of the Islamic participants) as the “purchaser” under the Istisnah agreement and the “lessor” under the lease agreement. The SPC structure has perceived benefits for both the Islamic participants (such as protecting the participants from the risks associated with the ownership of the Islamic financed assets, e.g. potential environmental liabilities) and the company (the Islamic financed assets are not held by the Islamic participants directly and therefore are isolated from the risk of insolvency to an Islamic participant).
The relationship between the SPC and the Islamic participants is governed by an investment agency agreement which also includes mechanics for the Islamic participants to make contributions towards phase payments, regulates payments to and from the SPC by the Islamic participants and also transfers by the Islamic participants. In addition, the Islamic participants provided the security trustee (on behalf of the wider lending group) with security over the SPC’s shares and the Islamic financed assets. This security was provided to secure the Islamic participants’ performance of their obligations under the inter-creditor agreement and to ensure that the Islamic participants would not have preferential access to the Islamic financed assets (which for structural reasons are otherwise not part of the security pool available to the wider lending group).
Craig Nethercott is a partner in White & Case’s global Energy, Infrastructure, Project and Asset Finance Practice. He has worked on a variety of project finance transactions throughout the Middle East (including Islamic financings in Egypt, Yemen, Oman, Qatar and Saudi Arabia). Craig most recently advised Saudi Aramco with respect to the Rabigh Project.
Sohar Aluminium Company LLC