Challenges and opportunities

29 June 2015

HSBC hosted a round table in May, bringing together leaders from the transport infrastructure industry

By the middle of last year there were high hopes for the region’s construction sector in 2015, with governments expected to drive ahead with a raft of new infrastructure projects.

Then, in the second half of last year, there was a sharp decline in oil prices, and by the start of this year those hopes had been dashed as project cancellations seemed a more likely outcome than new schemes making progress.

Although activity in the oil and gas sector has shifted down a few gears, the impact on infrastructure has been limited. But if prices remain subdued there is an expectation that activity could start to wane.

“There has been a slowdown in oil and gas, across the region,” says Simon Andrews, vice-president Europe, Middle East and Africa at US contractor KBR. “Infrastructure has shown no signs of slowing down yet, but if oil prices stay down then there will be pressure. That said, there is infrastructure and social infrastructure that needs to be delivered.”

Focus shifting

The changing market dynamics have altered the priorities of project clients. “The conversation with clients has changed,” says Andrews. “Price is still important, but it has moved to certainty of delivery. Scheduling is important for social infrastructure, and then there are other factors: Qatar is driven by the 2022 World Cup, for example.”

The need to drive ahead with new projects, coupled with the drop in government resources set aside to fund new projects, creates challenges and opportunities for firms looking to help deliver new infrastructure in the region. Clients will have to explore new methods of funding and delivering projects, something they have historically shown limited interest in.

“Government entities don’t have strong demand for PFI [private finance initiatives] or PPP [public-private partnerships], but the private sector does,” says Jason Li, deputy general manager of China Harbour.

Before new infrastructure projects are conceived, clients should have clarity on what they are actually trying to deliver.

“Often clients are not procuring infrastructure, they are actually procuring an outcome. It is about determining an end goal and working back from there,” says Alexander Pohl, global head of infrastructure/global trade and receivables finance at HSBC.

“The luxury of all equity funding, which has been a common approach in the Middle East while oil prices were high, means it is your money and you can do pretty much what you like. As soon as you move to a third-party funding model, there are structural requirements that are imposed upon you, which can be quite a shock to the system to accept. However, it does open a pool of liquidity that enables infrastructure investment to continue to occur.”

The region has used alternative funding models, such as PPPs, for its projects over the past decade, with mixed results. The most successful examples have come from the power sector, where some of the largest projects have been procured and developed under independent power project (IPP) and independent water and power project (IWPP) models. In Saudi Arabia and Oman, IPP and IWPP procurement models have been used for 12 and 13 major power projects respectively. Abu Dhabi has been at the forefront of creating a suitable IPP model for the GCC’s utility sector, with 11 major projects having been procured as PPPs to date.

Following suit

Other GCC states are following their example, with Kuwait having awarded the contract for its first IWPP, Al-Zour North, in late 2013, and Dubai appointing Saudi Arabia’s Acwa Power to develop its first IPP in 2015.

The successful implementation of the PPP model for utilities is thanks in part to the ability to determine demand and well-defined offtake agreements.

“In established markets, it is easier to formulate offtake agreements. Right from the outset you have a good indication of what the usage will be,” says Harj Dhaliwal, project director, Parsons – Etihad Rail & Aecom joint venture.

For transport schemes, the PPP model was rocked in 2011 when Abu Dhabi’s Department of Transport (DoT) dropped plans to develop the $3bn Mafraq-Ghweifat road as a PPP after it had shortlisted two bidders. The project was later divided into a series of traditional construction contracts.

“There have been some false starts when it comes to PPP,” says Jonathan Eveleigh, group business development manager at UAE-based Khansaheb Civil Engineering. “There have also been some successes and, although they have gathered some momentum, [PPP] remains a ‘nice to have’, not an actual need.”

On a more positive note, the GCC’s first airport expansion project developed using a PPP has become operational following on-time completion of construction work, which began in 2011. Saudi Arabia’s General Authority of Civil Aviation (Gaca) awarded the 25-year concession in 2011 for the development, operation and maintenance of Prince Mohammad bin Abdulaziz airport in Medina to Tibah Airports Development Company, a special-purpose vehicle created for the project.

With lower hydrocarbons revenues and more constrained budgets, government clients will have to explore the possibility of using PPP more. The need for sources of funding separate from state coffers means there is likely to be an educational process as clients learn there are different versions of PPP. Government clients put off by one method that does not work for them may find another that does.

RTA invites bids

One regional organisation that is looking at the PPP model to deliver projects is Dubai’s Roads & Transport Authority (RTA). It sought proposals from bidders in May for the Union Oasis PPP real estate development, in the Deira area of Dubai.

In mid-May, Kuwait reignited its stalling PPP programme with the newly formed Kuwait Authority for Partnership Projects (KAPP), which plans to oversee the development of power projects, rail schemes and tourism projects using partnerships with the private sector.

For the region’s PPP ambitions to be realised, clients must be willing to change. “For PPP to be successful, clients have to give over some control, and there have been examples of where this ‘leap of faith’ has met with resistance,” says Neil Walmsley, director and Middle East planning leader at UK-based Arup. “PPP is a method for procuring a service. It is not infrastructure, and that goes against the perceived wisdom in the market today.”

BOT model

Some contractors are keen to see the build-operate-transfer (BOT) structure used more in the region. “The BOT model can also work, and we see strong demand,” says Li. “In the past, it was hassle-free for contractors. Consultants do the design, we are then told what to build, we build it and get paid. That will change with the design-and-build and BOT models.”

Another funding solution is export credit guarantees provided by foreign governments. The most talked about possible transaction is the UK government’s offer to provide funding support for the expansion of Al-Maktoum International airport in Dubai. UK Export Finance (UKEF) is providing $2bn-worth of export guarantees for the scheme, which, if used, could see UK contractors and consultants working on the $33bn project over the next 10 years.

As institutions look to fund new schemes there are concerns about the changing legal backdrop that need to be addressed. The Federation Internationale des Ingenieurs-Conseils (Fidic) contracts used in the region are typically modified to favour clients, but organisational stability and transparency are also important.

Airport projects

In the case of Dubai’s airports, Dubai Aviation Engineering Projects was formed in 2012, replacing the Department of Civil Aviation (DCA) as the client body responsible for the delivery of airport projects in Dubai. The move led to concerns from companies that worked on earlier airport projects – notably Terminal 3 and Concourse 2 at Dubai International airport – that any outstanding payments, claims or disputes lodged with DCA would no longer be properly honoured.

For institutions considering funding new airport projects in the emirate, this is an issue that has to be resolved, with some sort of sovereign guarantee being a possible solution.

Away from state-owned projects, the private sector also has significant funding requirements. This year, the property markets in the region, notably in Dubai, have been subdued, with prices softening by a few percentage points. The impact of the decline has been a dramatic reduction in off-plan sales, and property developers are now looking for alternative sources of funding to get their developments started.

Some developers are using contractors to arrange finance with banks and other institutions. One firm that has successfully been able to secure funding for private sector projects is Beijing-based China State Construction Engineering Corporation. For example, in 2013 it formed a special purpose vehicle to invest in a hotel resort that it is building for Skai Holdings on Dubai’s Palm Jumeirah.

“Our role has been as a finance arranger rather than an investor,” says Feng Rui, regional director of China State’s project finance and investment department. “Our main goal is not to invest in a project; it is to get the construction work. We want to work with professional financial institutions like HSBC and give clients the security that their project will be delivered.”

For the Palm project, Skai Holdings awarded China State the estimated $272m contract to build the Viceroy Dubai Palm Jumeirah, scheduled to be completed in 2016.

China State Construction’s contracts demonstrate Dubai has begun to explore new ways of funding its projects.

By proving there is a way where there is a will, other regional markets should also be encouraged to explore different funding options for their projects. “If there is confidence that a place will grow, then there is confidence to build infrastructure. Developing infrastructure needs vision and money,” says Walmsley. “Dubai has the vision and has found ways to attract investment. Other cities have the money, but the desire is not as strong.”

Round table participants

Christian Abrahamson, deputy director, project planning, Bechtel

Wolfgang Aeugle, head of sales, Middle East, Bombardier

Simon Andrews, vice-president, Europe, Middle East and Africa, KBR

Arthur Bruce, rail advisor to CEO, rail agency, Roads & Transport Authority

Harj Dhaliwal, project director, Parsons

Johnathan Everleigh, group business development manager, Khansaheb Civil Engineering

Colin Foreman, news editor, MEED

Jason Li, deputy general manager, China Harbour

Alexander Pohl, global head of infrastructure/global trade and receivables finance, HSBC

Richard Thompson, editorial director, MEED (moderator)

Neil Walmsley, director and Middle East planning leader, Arup

Feng Rui, director, project finance and investment department, China State Construction Engineering Corporation

Sponsor’s comment: Cost-effective funding gains ground

The way in which infrastructure projects in the Middle East and North Africa are procured and funded is potentially set to change, given the prevailing economic conditions.

The region’s governments are pushing forwards with ambitious multibillion-dollar infrastructure investment programmes designed to drive long-term economic growth and lessen their reliance on oil and gas revenues.

Not only do these projects require vast amounts of investment, many are facing tight deadlines. For the Expo 2020, for example, Dubai needs to have the right transport systems, hotels and leisure facilities in place, ready to welcome the hike in visitors.

Typically, infrastructure developments in the region have been funded directly from the purses of governments. Given the size of the projects pipeline and the potential impact of sustained low oil prices on government budgets, a fresh debate is emerging about potentially more efficient and cost-effective ways of financing the region’s new airports, ports, railways and power stations.

The use of public-private partnership (PPP) and build-operate-transfer models has become a key topic of conversation again. Funding backed by international export credit agencies is also being considered as a way of plugging any gaps in the financing of megaprojects such as the expansion of Dubai’s Al-Maktoum airport.

The region has already experimented with PPP models in recent years, most successfully in the power and water sector.

The private sector is often happier to take on the risk of a power project rather than a transport scheme, given that it is considered easier to calculate the prospective demand and revenue a power plant will generate compared with a new airport or railway line. 

There have been some notable exceptions to this trend, with Saudi Arabia’s Medina airport funded under a PPP model in 2011. Yet as market conditions evolve this year, there is a growing awareness that PPP could be applied to a greater range of sectors as a means of cost-effectively delivering projects on time.

In May this year, Kuwait restarted its PPP programme to fund and procure power, transport and tourism projects.

The changing way in which projects will be developed will inevitably offer private investors and lenders a wealth of new opportunities to do business in the Middle East.

Alexander Pohl, global head of infrastructure for trade and receivables finance, HSBC

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