Indonesia mulls gas asset-backed security

Indonesia mulls gas asset-backed security

HONG KONG (Dow Jones): Despite earlier skepticism, a plan for an Indonesian bond issue backed by sales of West Natuna natural gas to Singapore could be the answer to the country's search for cheaper offshore funding.

Talk of an Indonesian asset-backed security has been around for at least the past two years, said one dealer. But the idea resurfaced recently as plans to pipe natural gas to Singapore took shape, and as a steady stream of revenue looked more assured following the inauguration last month of a 640-kilometer underwater pipeline linking Singapore with Indonesia's Natuna Sea natural gas fields.

The West Natuna gas sales to Singapore, which started Jan. 3, are expected to provide US$7 billion and $8 billion in revenues to the Indonesian government over the next 22 years, said a banker making a pitch for the bond deal.

The Indonesian government sent out invitations last week for banks to bid for the proposed deal's mandate, he said.

When the idea resurfaced late last year, many primary market dealers were skeptical such a bond could be put together because of political uncertainties and a lack of detail on the assets to be securitized.

Bankers say that the planned security has to be structured in such a way that guarantees that Singapore gets a steady, undisrupted stream of natural gas, Singapore pays the gas, and the cash flow from the sale is used to pay bondholders.

As Singapore has a very high-grade credit rating, the securitization deal wouldn't need to address any potential default. But the deal needs to guarantee bondholders that Indonesia won't turn off the gas tap or divert the money for other uses before debt payments are honored.

With the right structure, analysts say, Indonesia's securitization plan could receive an investment grade rating of 'BBB-' or above. This is way above Indonesia's sovereign ratings of 'B3' from Moody's Investors Service and 'B-' from Standard & Poor's.

To issue a straight U.S. dollar-denominated bond without the backing of the gas revenues from Singapore, Indonesia would have to price it at a spread of about 778 basis points over U.S. Treasurys or at a 15 percent coupon rate, a very unlikely prospect.

Even if it bites the bullet and go for such an expensive paper, dwindling investor confidence in the country's future would mean the bond attracting very little attention internationally, analysts said.

Backed by gas sales

Thus, the best way forward for Indonesia, say primary dealers and analysts, is for a securitization riding on the back of Indonesia's sale of natural gas from West Natuna to Singapore. Such an issue could get a significant credit enhancement, which means cheaper financing.

Under such a plan, the income from the gas exports would be assigned to a Special Purpose Vehicle, or SPV, another securitization specialist who is also pitching for the deal explained. The SPV would then issue the bonds, backing them with those revenues.

"The government would assign all future income to the SPV (and the SPV) would be legally bound to pay" noteholders, said the securitization specialist.

Doing so diminishes the risk of a future government disposing of the revenues, and would secure debt servicing to bondholders.

To further ensure such debt servicing, the final structure will likely include reserve accounts that would cover the debt payments in case the SPV is unable to pay.

Also, the reserves will have to be held offshore, that is, outside of Indonesia, in order to keep the SPV separate from the Indonesian authorities.

By adding those features, Indonesia could raise the credit rating of its proposed bond further to about the 'BBB-' level. From there, the issuer could take out insurance policies to cover some of its political and market risks, boosting the rating to the 'A' level.

A key aspect in enhancing the deal's credit rating is to separate it from its actual issuer - Indonesia.

The country's current political instability, difficulties in passing laws through Parliament, and overall political, social and economic uncertainty aren't helping investor confidence.

The securitization would be "launched at a time when Indonesia is under a lot of pressure," said an analyst.

Given the uncertain political future of Indonesia, the question of what would happen to the income from the West Natuna gas sales under future governments also weighs on its credit rating.

The key here is to "look at the flow and determine the likelihood of government intervention," said an analyst.

The fact that the natural gas is pumped from offshore islands and transferred directly to Singapore and that there can be no other route for the gas brings credit enhancement to the securitization project.

The direct pipeline diminishes the risk of diverging the gas flow away from Singapore and breaching the export contract. And given little motive for Indonesia to turn off the tap, analysts say that the contract lies on strong bases.

"What has been produced has to be transferred to Singapore," said the securitization specialist.

He admitted that a military intervention on the offshore gas platforms is possible, but a lack of sale options and rational reasons to turn off the tap that would result from such an action renders the military action unlikely.

The Indonesian government's intention to give greater regional autonomy and grant them some claim over the income from natural resources within their regions could also cast some doubt over the future of the SPV's claim over the gas income.

The regional autonomy issue can be handled by giving the regions an equity stake in the project rather than touching the revenues, the securitization specialist noted. That way, the change in equity stakes between the government and the region will bear no consequence on the cash flow and the SPV's claim on the income, he added.

Tenor and size for the deal haven't been determined yet, as the government still hasn't released the West Natuna-Singapore contract's cash profile.

However, early indications heard on the market point to a long tenor of at least six years and possibly longer than 10 years.

Under current political circumstances, the process can take a long time, bankers agreed. There wasn't any specific timing on the deal, but the securitization specialist suggested that the deal could hit the market by the end of the second quarter of this year, while other suggested the second half of the year.

It's not certain either what the proceeds from the bond would be used for, but Indonesia has a budget deficit which is expected to amount to some Rp 52.12 trillion ($1 = IDR9,450), or 3.7 percent of gross domestic product, this year.

Indonesian state-run oil and gas company PT Pertamina is operating the pipeline with three foreign partners, Conoco Indonesia Inc. Ltd., a wholly-owned unit of U.S.-based Conoco Inc. ,Gulf Indonesia Resources Ltd., which is 72 percent-owned by Gulf Canada Resources Ltd., and Premier Oil Natuna Sea Ltd., a unit of UK-based Premier Oil PLC.