As the table opposite shows, the development of the Gulf project finance market is racing up an exponential curve. As recently as a couple of years ago, total deal flow over a 12-month period was unlikely to top $8,000 million. If the full menu is ordered, more than $20,000 million worth of transactions could be digested by the end of next year. The implications of such a feast are wide-ranging, but the underlying truth is that borrowers and lenders alike are going to have to improve their table manners.
On the demand side there is no wavering commitment, but rather an ever-increasing acceptance of the private finance argument. At a time when budgetary prudence has become more of a reality than just a talking point, the case for leverage, risk sharing and efficiency has overridden concerns about foreign ownership. Of course, regional privatisation programmes – the key stimulus to project finance demand – have to date focused more on the involvement of the private sector in greenfield projects than the sale of existing assets. But even the deal flow in this area is rising fast, potentially opening the door to a whole new market of acquisition finance.
However, an addiction to the benefits of project finance has not developed evenly throughout the Gulf. Kuwait remains only an occasional user, mainly due to parliamentary opposition and a uniquely troublesome budgetary surplus. Cash-rich Abu Dhabi has limited its habit to the power and water sector. Dubai remains convinced that it can be more efficient than the private sector and that it can squeeze finance from the banking sector more effectively through different tactics. The string of bilateral deals signed by Dubai Aluminium over the summer lends weight to its conviction.
The real connoisseurs of project finance can be found in Qatar, Oman and increasingly in Saudi Arabia. This pattern is unlikely to change dramatically, though the balance might shift. Doha’s finances become ever more robust as its up- and downstream gas projects come on line, and it will probably seek to increase the levels of equity participation in its next wave of projects. However, the proportional reduction in the use of debt will be more than balanced by increased deal flow. If potential refinancings come to market, more than $3,500 million of finance could be signed in Qatar by the end of next year.
Despite this, Doha is in danger of losing its status as the regional project finance capital. The urge for economic liberalisation in Saudi Arabia is growing stronger and a core part of the process is the use of private sector finance to fund industrial and infrastructure developments. From petrochemicals to power projects, the deals are queuing up and, if delays are kept to a minimum, $5,000 million worth of finance could be arranged by the end of 2003.
The supply side of the equation is also in flux. The mix of international and local banks participating in regional project finance transactions is altering, as are the nature of their roles and the pools of liquidity being tapped.
Recent MEED surveys have tracked the coming of age of the regional banking sector. Its proportion of underwriting rose from 36 per cent of the deal flow in 2000 to 42 per cent in 2001, and the trend is likely to continue this year. The main drivers have been the development of more sophisticated and capable structured finance teams at regional institutions and the surging levels of liquidity in a number of key regional markets.
High oil prices over the last three years have induced a radical restructuring of regional bank strategies. The traditional focus on the liabilities side of the balance sheet has given way to a concentration on asset management. Combined with a hunger for the fees earned at the senior end of transactions, this has led to the clear upgrading of many regional banks’ participation in project finance.
This wider role has been accelerated by a narrowing of international participation. A number of global finance houses have pulled back from lending into the region – ABN Amro and Deutsche Bank, for example, have become reluctant to use their balance sheets in the Gulf. For some, this is part of broader strategic realignments, for others the risk/reward profile of regional transactions has become unattractive.
While there has been a slight increase in pricing patterns over the last 12 months, there is still little meat in lending spreads and most of the fat can be found in advisory and lead arranging fees. International bankers complain that the local banks – with their different view of GCC risk – have been allowed to set pricing and that this has created a falsely cheap market. This may or may not be a fair assessment, but the reality is that increasing volumes of regional debt end up on regional bank balance sheets.
The implications of this shift are important. Regional liquidity may be high now, but this will not last indefinitely, particularly in the face of ravenous regional demand for debt. There is also the lurking danger of a more imminent squeeze at the long-tenor end of the spectrum. Due to the underdevelopment of regional capital markets, local banks have little access to long-tenor funding. With project developers constantly looking to push out the tenor of their borrowings, concerns over asset/liability tenor mismatches have risen. While they are mitigated by strong equity bases and secure deposits, the possibility remains that one long-tenor syndication too many might be attempted.
The need for access to alternative funding sources has risen up the agenda, but it remains more discussed than acted on. A surprisingly high proportion of transactions have, in their infancy, had theoretical bond tranches mooted, but in a price-sensitive region such solutions are invariably not competitive. However, attempts to develop regional capital markets continue and local bond tranches might begin to appear in the medium term: the forthcoming Alba deal might be an important marker.
More promising still is the growing use of Islamically-structured facilities, as the recent Al-Hidd and Shuweihat transactions have shown. With a growing number of Islamic banks willing to participate in such deals, an important new funding pool is developing.
The evolution of the entire project finance market will be determined by the changing shapes of the demand and supply sides of the equation, but external factors always threaten to interfere. Just as nervousness after 11 September hit the Shuweihat and Salalah power financings, so regional conflict could disrupt future financings – even if the underlying deal structures are not affected.
MEED Project Finance Conference
15-16 October 2002, Sheraton, Bahrain