After more than half a century of frigid political and economic ties, Pakistan and Russia on 15 July 2021 passed a major milestone to rebuild strategic cooperation. On the conclusion of four days of rather tense negotiations, they signed Heads of Terms (HoTs) of shareholders agreement for the construction of an 1100-km gas pipeline from Port Qasim, Karachi to Lahore at an estimated cost of USD 2.5-3.0 billion by end 2023.
To recall, Pakistan and Russia had started off economic strategic cooperation with two major initiatives. In 1961, Pakistan set up its largest exploration and production firm, the Oil and Gas Development Company Ltd (OGDCL), with the Soviet (then Union of Soviet Socialist Republics – USSR) technical expertise along with a long term financial support of RUB 27 million to finance equipment and services of exports for exploration.
This was followed by another strategic engagement for establishment of Pakistan’s largest industrial complex. In January 1969, Pakistan took services of Tiajproex- port of USSR for feasibility study and then techno-financial assistance in January 1971 for construction of Pakistan Steel Mills under the supervision of Soviet experts.
Despite such a strong takeoff, bilateral cooperation, however, remained almost non-existent for the following five decades due to diplomatic tensions associated with cold war politics. A few private sector business ventures remained bitter deals.
It is, therefore, a historic development that after a lot of challenges for almost eight years including those relating to certain US sanctions, Pakistan and Russia were able to sign the Head of Terms of Agreement for the implementation of the Pakstream Gas Pipeline Project – commonly known as North-South Gas project. The USD 2.5 billion gas pipeline is to originate from Port Qasim – the centre of LNG import terminals – to load centre around Kasur near Lahore to meet the energy needs of industry upcountry.
The project justifies the feasibility of new upcoming LNG terminals to create gas transportation capacity from ports in the South to consumption centres in the North. It should have been completed by 2017-18, according to original plans. However, the timelines to finalize the contractual agreements with Russia on a ‘strategic government-to-government’ basis were changed six times between 2015 and 2020.
Under an Inter-Governmental Agreement (IGA) signed in October 2015, the governments of Pakistan and Russia agreed on the cooperation of a milestone project to develop gas transmission infrastructure of 56” pipeline diameter, costing USD 2.25-2.5 billion to enhance the energy security of Pakistan to meet gas transport requirements for about 40 years.
Pakstream Gas Pipeline Project was announced in the Joint Statement of Pakistan-Russia Inter Governmental Commission in November 2014. With relevant approvals on both sides, the IGA was signed in Islamabad by Petroleum Ministers on both sides on 16 October 2015. In April 2015, ECC cleared the project model and constituted a price negotiation committee and then approved a financing model of 1.2 billion cubic feet per day (BCFD) capacity pipeline (LNG-III) by the Sui companies. The ECC in February 2020 decided to fund the project through GIDC. The Supreme Court decision on GIDC followed in August 2020 for utilization of GIDC on such development projects. The Federal Cabinet ratified it. Meanwhile, an amended IGA has been signed on 28 May to replace the October 2015 IGA. At present, structure of Russian consortium has been finalized being seventh version in the last
five years in which Russian nominated entity has been identified as FSUE (Russian Ministry of Energy), ETK (Execution specialist), and PAO TMK (Production specialist) – with a company namely, PAKSTREAM LLC.
The two sides have now agreed over 74 percent shareholding to Pakistani gas companies and 26 percent to Russian firms in the special purpose vehicle (SPV) for the project. This envisaged both ‘put option’ and ‘call option’ to Russian side which meant its entities could move out of the project if the project is not found feasible or increase its shareholding to 49 percent if it is able to provide attractive financing arrangements acceptable to Pakistan. In any case, Pakistani entities would maintain majority shareholding.
Leaving out the 18 percent rate of return in foreign exchange, the two sides have agreed over a tariff calculation mechanism on cost plus basis already in vogue as explained by the chairman and members of Oil & Gas Regulatory Authority (Ogra) who were especially made part of the process. This meant all prudent costs both in terms of variable and fixed cost components as already permissible under third party access.
The Russian side would arrange funding for foreign exchange components through supplier credit or typical project financing to cover imported items like steel, consultancies, pipelines and related products and materials not available in Pakistan and the concession agreement for the pipeline would remain effective for 25-30 years.
There would be no throughput (gas quantity) guarantees but payment of tariff and return to the Russian entities to the consortium would be ensured through normal security package and standby letters of credit (SBLCs) as available to international investors including independent power producers (IPPs). The pipeline size was agreed to 56 inch diameter to cater for next 30-40 years of energy needs in the country that would ensure 700-800 MMCFD (million cubic feet per day) of free gas flow and could go up to 2000 MMCFD with compressors.
The arrangement would enable the two Sui gas companies to improve their capabilities to operate 56 inch pipelines and compete for similar international projects. The post-construction operations and maintenance of the project would be the responsibility of the Sui companies whose staff would be trained abroad during the construction period.
The Sui companies did not have technical capacity to lay pipelines across canals, rivers and railway tracks, hence the require- ment for Russian expertise.
The next steps would be the signing shareholders agreement, financial agreement, gas transportation agreement and lenders agreement during which time the Russian side would complete the front end engineering design (FEED) and the Pakistani side to arrange dollar financing of local currency component against Rs321 billion worth of Gas Infrastructure Development Cess (GIDC).
The two parties “defined the principles regarding shareholding structure, corporate structure, capital structure, and financing arrangements, options and guarantees as well as other essential clauses”, noted the minutes of the meeting. Furthermore, both the parties reviewed and exchanged the draft of the risk matrix of the project with a view to finalize the risk mitigation strategy.
The agreed and finalized heads of terms were signed by the authorized representatives of the Russian Nominated Entity (RNE) – Pakstream LLC and its consortium partners Federal State Unitary Enterprise (FSUE), Centre of Operations Services of Russian Energy ministry and Eurasian Pipeline Consortium Ltd and PAO TMK and managing director of Pakistani Nominated Entity – Interstate Gas Systems (ISGS). The two sides committed to expeditiously implement the project to meet the emerging energy security scenario of Pakistan to ensure investment commitments by upcoming LNG terminals. The results of the technical studies and route related work done through international consultants by Russian party were discussed and the Pakistan side was impressed with the quality and depth of analysis in the technical studies that would be ground to the FEED.
“It became clear that Russian party has a good level of preparedness for the offtake of the project”, the two sides noted.
The parties agreed to hold joint technical sessions of the nominated entities within 30 days to exchange information on the project implementation status, set technical specifications and prepare a project roadmap after the signing of the shareholding agreement. The format and time of the event will be mutually agreed to.
Sui Companies shared the preliminary work done on the project and expressed the technical limitations of Pakistan in building 56” diameter pipeline and desired to partici- pate in the project via subcontracting or otherwise and be partners in the operation and maintenance (O&M) contracts.
The Russian party stated that due to an in-depth understanding of the on-ground situation and experience in the gas pipeline industry, the Sui Companies will be in a better position to be the partners for O&M and sub-contracting the development work. The Russian side undertook to utilize Pakistani resources to the maximum possible extent, engaging the Sui companies and other Pakistani subcontractors for the project and offering to train Pakistani human resources within Pakistan and in Russian training institutions as well as opportunities for development of local suppliers.
