PROJECT FINANCE DRIVEN EXECUTION STRATEGY

June, 2015

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Contents

Introduction

Financing options

Project execution methods

SOCAR Polymer: project structure

Great Economic Impact! • $1–$10 billion dollars of direct investment• Economic life: 25-30 years• Economic flow of 5–10 billion $US/year• Generates 1,000–1,200 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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Major Projects are Different

Financing options

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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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Financing Options

Positive NPV Acceptable credit risk Adequate legal and fiscal

environment

Is Investment Bankable?

No Yes

No Financing Financing Possible

What is the Most Appropriate Borrowing Structure?

Corporate Financing

Project Financing

Which DebtMarket?

Loan

Bond

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Debt Financing Decision Tree

• Project company (special purpose vehicle):

The project company is holder of all rights and duties

in connection with the project and its financing

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

adequately allocate them among the involved parties

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• Relevance of cash-flow: The borrower’s financial standing

depends significantly on the project companies' expected cash-

flow and not on the common rating criteria (e.g. balance sheet

ratios)

• 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 fullrecourse to all project assets

Project Company

Cash-Flow Relevance

Non/Limited Recourse

Risk Distribution

Project Finance

Elements of a Project Financing

Typically off-balance sheet for Sponsor(s)

Risk transfer to lenders

Longest tenors

Suitable where more than one Sponsor

Provides independent third part confirmation of Project’s viability

Higher transaction costs

Longest transaction process

Complex documentation: Term Sheet 15 pages →

1500 pages of finance documents

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ADVANTAGES DISADVANTAGES

Project Finance compared to traditional corporate finance

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Loan Life Cover Ratio (LLCR)

Debt Service Cover Ratio (DSCR)

Loan Life Cover Ratio (LLCR) (EQUITY) IRR

Debt Service

Cash Flow available for debt service

DSCR = Outstanding debt amount

NPV of Cash Flowavailable for debt service

LLCR =

RELEVANT FORMULAE

Legal Aspects of Project Finance: Key Project Finance Ratios

Project Execution Methods

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Engineering Execution ConstructionScope Growth, Pricing Craft ProductivityEngineering Productivity Quantities

Total Project Risk

Risk

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

THE BIG PROBLEMS USUALLY CAN BE TRACED TO MISTAKES VERY EARLY IN THE PROJECT

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Major Projects – Risk Mitigation

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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Typical Execution Methods

Define chosen solution, Fix EPC strategy, +/- 10% Capex

Identify business opportunityEvaluate and screen options, +/- 40% Capex

Select licensor,Approve project design basis, +/- 30% Capex

Final InvestmentDecision is made

EPC contract is placed

FeasibilityBasic

Design by Licensors

DetailedDesign

Procurement Construction Start-Up & Commission

Front EndEngineering

FEED

Pre-Approvals

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Execution Model

■ 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

FeasibilityBasic

Design by Licensors

DetailedDesign Procurement Construction Start-Up &

Commission

Front EndEngineering

FEED

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Project Execution Where Project Finance is Used

■ 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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Types of EPC Contract

■ 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 Contract - Issues

CONSTRUCTION PRECOMMISSIONING

START UP

ERECTION

BY AREABY SYSTEM

BY SYSTEM

SpecificationProduct

PERFORMANCE TESTS

COMMISSIONING

READY FORSTART UP

SYSTEMS COMBINED

HANDOVEROF

FACILITIES

MECHANICALCOMPLETION

INITIAL OPERATIONAND PERFORMANCE TESTING

COMMERCIALOPERATION

ScheduleLDs

DEFECT LIABILITY PERIOD

COMMENCES

EPC Contractor responsible until Commercial OperationSingle Point of Responsibility – Decreased Risk

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

SOCAR Polymer: project structure

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Global Trends impact the production chain within SOCAR

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GPP

LLDPE, PP,

HDPE

BHAR

SOCAR Polymer

Chain 1. Modernization of BHAR refinery, Azerikimyaand construction of PP&HDPE plants

Chain 2. New GPP and Petrochemical complex

Azerikimya

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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337 339

623

1078 1138

146 177

158

175149

77 55

46

59 48

0

200

400

600

800

1000

1200

1400

1600

Saudi Arabia Russia Azerbaijan West Europe Israel

Net raw materials Other variable costs Fixed costs

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

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$/ton

Source: IHS

Main target markets for the export are West Europe and Turkey

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34%

11%

34%

11%

21%

51%

7%

18%

4%9%

0%

20%

40%

60%

80%

100%

HDPE PP

Azerbaijan W Europe Turkey Russia C Europe

Source: IHS

Leading experts have been involved in project execution

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• Tecnimont SpA (for PP, U&O)EPC

• FluorPMC

• Vinson & Elkins / PSGLegal Advisors

Lenders’ Technical Consultant • Jacobs Consultancy

• Baker Botts / B.M.Lenders’ Legal Advisors

Market consultant • IHS

Lender • Gazprombank JSC

Lenders' Insurance Consultant • BankServe Insurance Services

Environmental and social impact assessment • Golder Associates

Project management

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Owner Owner

Typical project management SOCAR Polymer

PMC IPMT

Legal & Contractual Structure of the Project

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SOCAR PolymerLLC

(Azerbaijan)GUARANTOR

Polymer Construction

PashaHoldings

Ecoland AKKIKSOCAR

SOCAR Polymer

Investments(Azerbaijan)

Security over bank accounts

Inte

rcom

pany

Loan

(In

tere

st fr

ee)

100%

SOCAR PolymerOverseas

(Guernsey)BORROWER

SOCAR andSOCAR

Overseas (Dubai)OFFTAKERS

Gazprombank (JSC)GPB International S.A.

LENDERS

$

Security overbank accounts

Export Sales of Products

$

100%$

/ AZN

Feed

stoc

k Sup

ply

and

Dom

estic

Sale

of P

rodu

ct

Debt service

ProductOfftake

Agreement

TecnimontEPC-

Contractor

Cont

inge

nt E

quity

Sup

port

FluorPMC-

Contractor

Risk mitigation for Project Financing

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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

Success guarantors

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• Investment grade rating with stable outlook: BBB- (S&P), Baa3 (Moody’s), 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 theother projects