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

Spring 2004.

Pertaminas 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 Indonesias 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

Jan. 20, 2004, Indonesia Reports Jump in Foreign Investment Approvals But Few New
Projects, Agence France-Presse.

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
Indonesias 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

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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. JBICs 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 offbalance 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

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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.

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(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.

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(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 Pertaminas 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 JBICs 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

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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 projects 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

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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., Crdit 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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