For almost four years, the Middle East’s capital projects market has surged as the region’s oil producers have sought to take advantage of sustained high oil prices and high production levels to push ahead with their infrastructure investment programmes.

At the mid-point of 2015, with almost $2.8 trillion-worth of projects planned or under way in the GCC according to MEED’s Gulf Projects Index, the region’s projects market is close to an all-time high.

But the outlook is changing rapidly. While the Gulf state’s huge foreign exchange reserves, built up over a decade of budget surpluses, provide enough financial capacity to sustain high levels of government spending in the short term, the fall in oil prices since June 2014 is placing increasing pressure on government finances in the longer term.

“The drop in oil prices is a very significant change in the fundamentals of the region,” says HSBC’s regional head of global trade and receivables finance, Kwabena Ayirebi. “While most of the oil-exporting countries have deep war chests of money, every government in the region is reviewing its project plans and reviewing how it is funding its projects.”

Cost savings

Ayirebi’s analysis is supported by reports of spending reviews across many of the region’s high-spending capitals. In Doha, the Qatar Foundation is reported to be seeking about 30 per cent in cost savings, directly affecting the pace of awards and the execution of non-critical projects. Abu Dhabi is also reported to be making similar levels of cuts to government spending.

These spending reviews, however, will not lead to a sudden collapse in projects spending, says Ayirebi. “What we are seeing is that the primary infrastructure projects around transport, ports, power, desalination and so on are going ahead at this stage,” he says. “The nice-to-have projects, however – the ones not essential for economic programmes – are the ones that are being delayed.

“Dubai and Qatar have particular focus because they have to deliver global events in 2020 and 2022 [the World Expo and the Fifa football World Cup, respectively]. Whether oil goes up to $150 a barrel or down to zero, these are not going to be delayed. They have to have everything completed by those dates.”

Meanwhile, in Saudi Arabia, Riyadh is going through a wholesale project spending review after a wide-ranging government reshuffle that followed the accession in January of King Salman bin Abdulaziz al-Saud.

“My view is that over the next year or two, Riyadh will maintain the momentum in spending,” says Ayirebi. “Riyadh announced recently that it will continue to spend, so clearly it does not wish to signal any weakness in the economy, particularly in this transition period. And its foreign exchange reserves are about 100 per cent of GDP, so they have the depth of economy to continue supporting projects spending for the next three years.”

But the change in the economics of the region is altering the landscape for infrastructure financing, creating new opportunities and challenges for banks as governments seek to tap new, more efficient models of project finance that will enable them to continue pushing ahead with their capital investment programmes.

ECA funding

“They are likely to be reviewing their structures and how they fund projects,” says Ayirebi. “I expect to see governments looking at using export credit agency (ECA) funding or asking contractors to bring funding to projects, which is not something that was traditionally done in this region.”

“I expect to see ECA funding increasingly becoming a core part of infrastructure financing in the region,” he adds. “And that will give
financial institutions the comfort to provide long-term funding.”

However, Ayirebi says that while international contractors are increasingly keen to find innovative ways to support the aims of their projects, there are also growing concerns in the regional construction supply chain that contractors are being asked to carry too much of the financial risk.

“We are in an era when large infrastructure companies are having to look around the world for growth, and they are coming to this region and are willing to provide funding,” says Ayirebi.

“In this region, there is very little concern about the government’s credit risk,” he says. “But contractors are saying that they are being asked to carry too much of the project risk and that there is a need to start sharing this around with the paymasters.

Supply chain

“Ultimately, it’s a negotiation between the contractor and the paymaster; that’s what it comes down to. We support both at various stages through the transaction and we look at the whole of the supply chain on an infrastructure project: paymaster, contractor, subcontractors and all their suppliers. And we put structures around it where we support the whole of the supply chain within an infrastructure project.”

Ayirebi also sees an increasing role for the public-private partnership (PPP) model, where investors provide equity investment in a project alongside debt funding.

The GCC region has built up a strong track record of delivering power and water projects through the independent water and power project model. However, these schemes have benefited from having sovereign guaranteed offtake agreements, providing investors and lenders with a guaranteed revenues stream over the lifetime of the project.

Applying the same contract structures to transport and infrastructure projects, where a single government customer does not exist, has proved more difficult to develop.

“It is an interesting one,” says Ayirebi. “If you are an equity investor in this space, it is more or less all about your comfort around the cash flows coming out. With transport, if you look at this region and the revenue models around, you don’t have a clear taxation region. But Dubai has shown with the Salik [road toll] system that you can structure cash flows from a road project.”

Airport projects are one area of transport infrastructure where PPP models are being used successfully in the region, at Medina airport, and Ayirebi says this is an important opportunity.

“Airports are a major focus for the region,” he says. “In Dubai, you have Al-Maktoum International airport. Hamad International airport in Doha is being extended. Oman, Kuwait and Saudi Arabia all have airport programmes.”

Rail projects

Rail – in particular, metros – is another major growth segment for the region. But it is also challenging for private investors.

“In rail, you have major projects in Cairo, Riyadh, Mecca, Jeddah and elsewhere around the region,” says Ayirebi. “But, as with roads, it is difficult to predict cash flows on some of the rail projects.”

This challenge can be addressed through correct structuring, though. “A rail project will have lots of packages,” he says. “You have got the station packages, substation packages and so on. They can be viewed very separately. Some international companies will look at building the substations, some at building the actual railway, and there are different aspects behind each one.”

Despite the impact of lower oil prices on the finances of the region’s oil producers, Ayirebi says the underlying fundamentals of the region mean that the GCC will continue to be one of the strongest infrastructure development markets anywhere in the world for the foreseeable future.

“The GCC oil producers are the key markets,” he says. “The driver behind their infrastructure investment programmes is the need to diversify their economies. About 50 per cent of the GCC population is under 25, so the fundamental requirement is to provide sustainable jobs for their populations. And, at the moment, they have got the wherewithal to fund infrastructure projects. So the major oil exporters, such as Saudi Arabia, Qatar, the UAE and Kuwait, will be primarily the countries that will spend.

“For non-exporting countries like Bahrain to carry out extensive investment, however, requires the big oil exporters to support them.”

Egypt recovery

In addition to the GCC’s hot markets, the Gulf projects industry, ranging from financiers through to construction contractors, is becoming increasingly interested in the recovery in Egypt that followed the election in May 2014 of President Abdul Fattah al-Sisi.

In February 2015, Al-Sisi announced that Egypt needed $200bn-$300bn of investment to turn the country’s economy around after three years of political turmoil.

At a huge investment conference held in March at the Red Sea resort of Sharm el-Sheikh, Cairo unveiled a massive infrastructure spending programme and received about $140bn in investment pledges from government and business across the region.  

For HSBC, Egypt’s recovery represents a major opportunity, but with some significant challenges.“HSBC is supporting large multinationals and local companies in undertaking the projects in Egypt, which we see as vital to supporting the economic growth,” says Ayirebi. “The main question is around the funding and payment capacity. Many large contracts and sheer size provide challenges around regulatory constraints.

“There is still a lot of work in the Middle East and a lot of companies are still approaching us for work in the Middle East. A lot of companies are looking at, and coming into, this region. With Europe slowing down, a lot of European contractors are looking around for opportunities and looking into the Middle East. If we look East, we see the Chinese, the Japanese and the Koreans.

“The Chinese in particular are coming. In Saudi, we are seeing the Chinese partnering with some of the Western companies because they can bring low-cost imports, while people still appreciate the perceived quality from Western firms.”