The launch of the Dubai Metro in 2009 sparked a wave of interest in rail projects around the GCC. It also serves as a cautionary tale for governments as they consider how to procure rail schemes.

Although the Dubai Metro launched on schedule in September 2009, it was not until a year later that the emirate’s government finally worked out how to pay for it.

The Dubai Metro ended up costing about twice the original budget. The government put the final price tag at AED29.6bn ($8bn) and contractors on the project will not be fully repaid until 2017.

As is typical for Dubai in its infrastructure development, it did not intend to use long-term finance for the metro. Instead, the government was forced to do so as a result of being unable to pay contractors on time, and had to restructure those liabilities into a longer-term debt.

Obstacles ahead

The funding issues surrounding the Dubai Metro illustrate the problems that other states face as they look to develop their own public transport projects. With more than $100bn of rail projects in the GCC set to be developed over the next decade, the challenge is immense.

In practice, most railways around the world depend heavily on direct government funding, particularly passenger services. This is primarily due to the risks involved with rail projects, which the private sector is often unwilling to bear.

In order to fulfil wider government policy objectives focused on reducing traffic congestion on roads, ticket prices for train journeys are usually kept artificially low. This means that even with heavy usage, a significant government subsidy is required to cover operating costs, let alone ensure a profit for private sector investors.

Both Saudi Arabia and Kuwait have explored the idea of using public-private partnership (PPP) models as a way to develop metro projects. They now appear to have dropped those plans.

At the end of 2012, a plan to develop Saudi Arabia’s Mecca Mass Rail Transit (MMRT) system as a PPP was scrapped and Riyadh decided to fund the project directly from the state purse. The complexity of structuring the scheme as a PPP, coupled with the government’s ample financial resources, led to the decision, according to sources close to the project.

Shortly afterwards, in early 2013, Kuwait put plans to develop a metro and rail project on hold while it reviewed procurement methods. More than a year’s work on developing the projects as PPPs had already been done.

The fate of those schemes echoes that of earlier attempts to use the PPP model for regional rail projects. In 2007, Saudi Arabia had been planning to use a PPP structure to develop the Saudi Landbridge, a freight line linking the kingdom’s Gulf and Red Sea coasts. The deal floundered as a result of the unusually long, 50-year concession period, and the fact that lenders were unwilling to take traffic risks on the scheme.

With more than $100bn of rail projects in the GCC set to be developed over the next decade, the challenge is immense

After the project eventually collapsed as a PPP in 2009, it was two more years before the government gave the scheme the green light to go ahead with state funding. One banker in the kingdom says that once it became clear that the private sector was unwilling to fund the scheme, a much wider review of its economics was prompted.

Other projects, including the Riyadh Metro and Doha Metro, are also being funded directly from government balance sheets. The only notable exception to this is Etihad Rail, the AED40bn project that aims to fulfil both the UAE’s part of the GCC-wide rail network and ambitions to connect the country’s seven emirates.

Bank deal

Etihad Rail has already managed to borrow AED4.7bn from a group of local and international banks to finance its first phase, an industrial line linking Habshan and Ruwais. This deal was made possible by the project being structured around an offtake agreement with Abu Dhabi National Oil Company (Adnoc).

Bankers involved in the deal say Adnoc’s involvement was a critical aspect of them agreeing to fund the project. Future phases of the rail network will focus on passenger services; as a result, Etihad Rail has admitted it will need significant government support in place to persuade banks to lend money. As yet, there has been no official announcement about how the rest of the Etihad Rail project will be funded.

The travails of other attempts in the region to use private finance suggests that strong sovereign support, and relatively short-tenor loans, will be required if Etihad Rail is to convince banks or the capital markets to fund its development.

Unlike other parts of the world, the GCC countries are broadly able to directly fund rail schemes. Although this may be an easier option, it does remove the additional layer of scrutiny that inviting private sector financiers into a project provides.