DRAMATIC CHANGES IN the way project finance deals in the Middle East are structured are being predicted by leading banks involved in advising the sponsors and arranging the loans.
They forecast that an era in which the banks have fought to offer ever cheaper money for periods of up to 20 years will come to an end later this year as sponsors accept more realistic terms. The market will also be tested as some of the big natural gas projects seek to raise $2 billion-plus in non-recourse finance.
Other trends include a more significant role for regional banks, such as Arab Banking Corporation (ABC), National Bank of Abu Dhabi and Gulf International Bank (GIB), which have built up expertise in an attempt to win more advisory and lead-manager business. Bankers also expect a sharp increase in the involvement of export credit agencies, whose participation in the past five years has been limited. More Islamic banks are also expected to take part – most transactions now contain a Shariah-compliant element.
The market is also affected by the fall in the number of banks looking for this type of business – some estimates put those capable of offering advisory services at fewer than 10. This reflects the reluctance of some of the main US and European contractors, which have problems in domestic markets, to take on new projects.
Despite the political uncertainty caused by war in Iraq, though, the project finance market in the Middle East is alive and well.
Every year since the mid-1990s several big transactions have taken place and, in contrast to many other emerging markets that have used this method of finance, there have been a consistent flow of projects and not many problems. A consensus estimate of bankers puts the total business done since 1995 at over $40 billion.
“While one or two have needed restructuring – and this has been approached with complete professionalism and realism by all parties – there has been no history of default or credit loss for project finance banks in the region,” says Ghazi Abdul Jawad, chief executive of the Arab Banking Corporation.
Many oil, gas, petrochemical and industrial projects have already been financed this way, including greenfield projects that lack government support. The market has continued to expand despite political uncertainties, a volatile oil price and recessions in many offtake markets.
Even the downturn predicted in the aftermath of the September 11 2001 attacks on the US did not materialize. In the 18 months since then more than $10 billion-worth of project finance deals have been arranged, some $5.5 billion of that in the three months after the attacks. Around $15 billion-worth are in the pipeline, most of which will be signed and syndicated towards the end of this year or in 2004.
Jawad says the fundamentals for project finance in the Gulf Cooperation Council states (Saudi Arabia, Oman, Qatar, the UAE, Bahrain and Kuwait) remain strong. These he identifies as “the availability of low-cost feedstock, a skilled and inexpensive workforce, growing demand both locally and internationally and relative proximity to many export offtake markets”.
This trend should be sustained as the GCC continues its ever faster industrial development. “Project finance will remain a crucial mechanism for attracting finance for viable projects,” Jawad says.
There are plenty of quasi-public and private-sector projects, particularly in Abu Dhabi, Qatar, Oman and Saudi Arabia, that the sponsors could bring to market.
However, bankers are not expecting a rush of deals amid the present uncertainty.
“A lot of projects are at the planning stage and there will be a lot of advisory business in the coming months. But sponsors are delaying before going ahead with the external financing for new projects,” says Declan Hegarty, the Dubai-based assistant director, investment banking, at HSBC.
Even if there is some delay until the region settles down after the Gulf war, most of the projects will eventually go ahead. “In part this is due to the continued increase in energy-related demand and to privatization. But it is also due to a desire on the part of GCC governments to diversify the economy – the desire to have downstream gas and oil industries and to expand industries, like steel, where there is a regional as well as an export market. Moreover the evidence of the last two years is that it works extremely well for sponsors in terms of gains in productivity and cost savings,” says Deepak Kohli, head of corporate finance at the National Bank of Abu Dhabi (NBAD).
Some projects have already been successfully syndicated this year or are under way. Around $1.2 billion has been raised for the Umm Al Nar power and water project in Abu Dhabi through a deal for which the advisers were the NBAD and CSFB. The lead arranger banks included HSBC, Bank of Tokyo Mitsubishi Gulf International Bank, NBAD and the Abu Dhabi Islamic Bank.
Another significant deal was the $900 million transaction in Qatar for the Oryx gas-to-liquids project. Royal Bank of Scotland was lead manager and there were 15 lead arrangers.
The final touches are now being put to a $1.5 billion deal for Alba Aluminium’s expansion in Bahrain, where the adviser is US specialist boutique Taylor de Jong, which has a joint venture with local bank Apicorp. However, some bankers claim that the deal is taking longer than it should to reach completion.
Attention is now switching to some projects – now at the advisory stage – that will break new ground in size by looking to raise $2 billion or more. Until now, the largest has been the Shuweihat power and water project in Abu Dhabi, which completed a $1.64 billion financing in December 2001.
Qatar, which has been one of the most aggressive users of project finance, is planning to raise $2 billion each for the expansion of Ras Laffan Gas (Rasgas), for which the adviser is BNP Paribas, and for Qatar Gas, with RBS as adviser.
Abu Dhabi, which has also extensively used non-recourse financing for its power and water plants, may try to raise more than $2 billion for the Dolphin gas project. CSFB is no longer an adviser – Dolphin has decided to increase its in-house expertise.
Abu Dhabi is also pressing ahead with smaller projects, including a $300 million reverse osmosis plant, while a project in another UAE emirate, Fujairah Water & Electricity, may soon consider converting its bridge funding of $950 million to a project finance deal.
The biggest prize of all will be the financing of the independent power and water projects in Saudi Arabia, which will eventually require billions of dollar of funding.
Saudi Electricity (SEC) and the Saline Water Conversion Corporation (SWCC) are looking for advisers. Several questions need to be resolved before progress is made. Some plants are intended to be part of the contract between leading international oil companies and the government to develop downstream gas industries. That agreement is long delayed and it is not clear whether these will now be open to other bidders.
A further problem is that power generators will find themselves stuck between what is effectively a monopoly supplier, Saudi Aramco, and a government organization that sells subsidized electricity to consumers. Decisions on the body responsible for subsidies have yet to be made.
There is also the question of whether the Saudi authorities want a competitive market for suppliers or are prepared to offer a guaranteed uptake; that decision is further complicated by the gap between 7,000MW base demand and 14,000MW peak demand.
The next Saudi projects are expected to be the $1 billion Jubail petrochemical complex 2 and the $250 million petrochemical plant for Saudi Indo Petrochemical, though these are still at an early stage. “We see Saudi Arabian market as potentially very important,” says Hegarty.
Alongside these plans are several petrochemical and industrial developments for which advisers have been appointed but which are unlikely to be started until 2004. These include QChem 2 ($700 million to $900 million, with RBS advising), Qatofin ($700 million to $900 million with HSBC as adviser) and Qatar Steel ($400 million with HSBC and QNB advising).
Oman is looking closely at a number of projects, including a $700 million LNG plant for which Citibank is adviser. In addition, an adviser is soon to be appointed for an aluminium smelter and there are plans for a $1 billion greenfield refinery at Sohar.
It remains to be seen how easy it will be to finance such projects on the terms that sponsors have come to expect. Increased demand runs parallel with a fall in the number of banks and contractors willing to undertake non-recourse financing.
Bankers are concerned about the falling number of bidders for each contract. “It is not unusual to have only a couple of serious bidders. The most active contractors used to be the American firms but they have problems in other parts of the world, including the US and UK. Consequently, they want to reduce their levels of debt,” says Aditya Srivastava, regional director, project and sectoral finance, at Société Générale.
The position is not much better for the banks. Only 15 to 20 international banks worldwide are able to take advisory and lead arranger roles. In the Middle East, regional and local banks are playing a more active role but in most cases this is as providers of finance rather than on the value-added side.
The wave of US and European bank mergers in recent years has reduced the number of players, and many of those banks that remain in the business have decided that the returns on non-recourse financing do not justify the risks. “While there is a core group of international banks that are active in term lending to well-structured projects in the region, banks in many parts of the world do not have any appetite for term lending for projects,” says Hegarty.
Of the US banks, only Citibank and Bank of America have any interest and that is mostly limited to offering advisory services. The Japanese banks are reduced to a core of Tokyo Mitsubishi, Mizuho and Sumitomo, with the consequence that the final credit limit falls significantly. The leading European banks are RBS, BNP Paribas, Société Générale and Crédit Agricole.
The critical question is whether regional and national banks can fill the gap. Project finance is now a major business area for Bahrain-based regional institutions such as ABC, GIB and Apicorp, which has a joint venture with Taylor de Jong – they are marketing their advisory and lead arranger capabilities very aggressively.
NBAD takes one of these roles in most Abu Dhabi projects and some of the higher-rated national banks, such as National Bank of Dubai and Qatar National Bank, are increasingly active. These national and aspirant regional banks are now likely to be lead arrangers in their home markets.
The Arab banks are now more ready to lend money for 15 to 20 years than in the past, when they preferred seven-year to 10-year financing. But they are determined to be more than mere providers of funds and believe they have the expertise to offer advisory services.
They will, says Jawad, be seen “increasingly, as we have at ABC, taking a leadership position in structuring and arranging these transactions”.
However, those working for international banks remain more sceptical about the ability of regional institutions to deliver a non-recourse financing package on their own. According to one banker: “There is still a bit of sniffiness about having a purely local group. To raise money from institutions outside the region, you need to have an international bank operating in a lead level. When you assemble a lead arranger group, you need now a mix of local and international banks.”
Another says: “Local banks have more expertise but it is not yet at the level where sponsors would trust major projects to them acting on their own. If you need to sell down to international markets, then an international bank is needed.”
The reduction in conventional financing is in part being replaced by Islamic funds. The $1.5 billion Alba smelter expansion deal in Bahrain, for example, has a $200 million Islamic component.
“The Islamic market is growing in quality in terms of liquidity and syndication. Islamic components are now able to match the conventional market in terms of pricing. Islamic investors still go alongside a conventional tranche but they will at some stage be able to do projects on their own,” says Hegarty.
A further consequence of the reduction in banks active in project finance has been the return of the export credit agencies. In the mid-1990s, it was almost impossible to raise money for major projects without the support of export credit agencies. However, as more banks became comfortable about taking direct project risk, the appetite for ECA finance reduced.
“Now the number of banks actively pursuing large project finance deals on a global basis has been eroding, and because we are down to a core of 17 to 20 or so banks that still have the appetite to underwrite project debt, there simply isn’t enough money around to fund all these projects, so multilateral development agencies are looking to export credit agencies again as a source of finance. For the right project, the agencies are often prepared to guarantee more than half the project debt,” says Mark Yassin, head of global project and structured finance at ABC.
The net effect of all these changes in the supply of and demand for finance, say bankers, should be that the power will shift from the sponsors to the lenders.
However, all the evidence suggests that this is not yet the case – the Umm Al Nar power and water project, for example, had little difficulty in raising 20-year money, and other power projects are able to get 18-year to 20-year finance.
Sponsors are still getting good terms, particularly in Qatar and the UAE, with competition still intense, in particular for advisory roles. They are, though, finding it harder to do so in Saudi Arabia.
Bankers contrast the position in Qatar, where projects are almost certain to reach a financial close, with that of Saudi Arabia, where there are invariably delays. “Advisers look for a retainer fee here rather than a success fee,” says a banker.
Even in Saudi Arabia, sponsors are still pushing successfully for the best terms. According to Yassin: “The sponsors are still pushing the envelope in terms of structure, tenor and pricing. The longer tenors of 14 to 20 years are pushing the terms beyond the economic means of the project, and this is all happening at the expense of the banks. Sponsors are, as such, getting their money back faster than banks – which is not a very prudent risk for bankers to assume.”
Another banker notes: “The market is still competitive and the pricing and terms for transactions are better than one would expect from an external risk perception. This is driven by the amount of liquidity that is still around.”
Bankers, though, argue that this cannot last for ever because the amount of money available for long-term project finance debt is rapidly shrinking. “There will be a structural change in terms of project finance lending and a correction is yet to be seen,” says Yassin. “The industry will automatically transform itself and it is inevitable that project finance banks will soon opt for shorter terms and higher margins. This will apply particularly when Basle II kicks in and the risk weightings assigned to project finance transactions go higher.”
Sponsors used to be able to get tight deals because banks were seeking higher league table positions. It is now possible to pick up project finance assets cheaply on the secondary market. “The discounts are so steep that, while it is good to be well placed in a league table, there are even greater advantages from picking up cheap paper in the secondary market,” says Srivastava.
However, the sponsors will not give in without a struggle. None of them wants to be the first to accept less generous terms. But when that happens, the balance of power is likely to shift quite rapidly.
Local markets pile on the points in uncertain times
While the world’s stock markets bounced up and down in reaction to news coming out of Iraq last month, equity markets in the Middle East rallied strongly throughout the conflict.
The Tadawul All Share Index (Tasi) of the Saudi Stock Exchange, the largest in the region, set a new all-time high on April 7, reaching 3016.88 before settling down to 2906.43 at the close on April 28. The Tasi has risen 15.33% so far this year.
In Kuwait, the Kuwait Stock Exchange (KSE), the second largest in the Gulf, also smashed records. On March 30, the KSE broke through its previous all-time high of 2823.4 set in November 1997, and has not looked back since. It closed at 3385.1 at the end of trading on April 28, up over 50% since January.
Other markets including Oman, Qatar, and the UAE have also posted strong gains. Since January, the Muscat Stock Market Index has risen 12%, the Doha Stock Market Index 17.2%, and the SC UAE Gen Index 7.4%.
Perhaps surprisingly for many unfamiliar with the region who could be forgiven for thinking the war would weigh heavily on regional markets, equity investors interpreted both the initial invasion and its outcome positively. This is in stunning contrast to popular perceptions about the war which have been decidedly less favourable.
Regional corporates are excited by the possibility that they might be able to play a significant role in the lucrative reconstruction of Iraq.
The construction sector has therefore been a particularly strong performer. Non-US companies, particularly French, German, and Russian, may not be optimistic about their chances of winning juicy contracts, but regional companies believe they are well placed to win substantial roles at the subcontractor level.
The popular antipathy towards the US invasion did make itself felt in the business world but only in isolated incidents. A number of Saudi firms, including Saudi dairy giant Al-Safi Danone, are known to have turned down lucrative contracts to supply the coalition troops while the war was still being waged.
The rally is supported by strong earnings. National Bank of Kuwait, for example, posted record quarterly results of $96 million.
But according to Zahed Chowdhury, HSBC’s GCC equity analyst in Dubai, the markets could soon be heading for a minor correction. “Valuations are getting steep,” says Chowdhury. “In Kuwait many stocks are now trading in the top percentiles of their historical price to book earnings multiples and we can expect some profit taking.”
Poor liquidity, political risk, and t+7 clearing that takes place on a Saturday, have traditionally been enough to deter most foreign investors from the region’s equity markets. But investors from outside the Middle East have taken note and the rally has enticed a number of European funds to the region.
Investors in major markets are now concentrating again on earnings, following what many see as a positive outcome to the invasion, and see little to excite them. The oil-exporting economies of the GCC on the other hand, have positive indicators to look forward to following what most of their populations saw as a disastrous war.
While non-oil exporting countries in the Middle East will continue to suffer from regional tensions affecting tourism revenue, particularly in countries such as Egypt, the IMF expects growth in the region to hit 5.1% this year, up from 3.9% in 2002.
