The sub-prime crisis is still unfolding, and could yet take world banking’s total losses reported to well over $100bn. Banks have cut lending and are asking for higher returns in the deals they do. The US, despite a series of interest rates cuts, is teetering on the brink of recession.

And yet the Gulf project finance market is looking ahead with confidence, as delegates at MEED’s Middle East Project Finance conference in Bahrain heard.

MEED Projects reports that there is now more than $1.6bn worth of major projects in the GCC, at least half of which will require some form of long-term bank finance. Most are essential infrastructure, industrial, commercial and residential projects. They will have to be completed.

There were doubts before the conference about whether the project finance market, worth about $40,000m in 2007, would grow again in this year. The consensus after the conference is that it will, perhaps to as much as $50bn.

Balance of opportunity

Darren Davies, head of structured finance at HSBC Middle East, forecast that the GCC – which was the world’s second largest project finance market in 2007 – would be the biggest in 2008. This year some of the deals will be refinancings. Nevertheless, there will be enough work to keep everyone involved with Gulf project finance busy and prosperous.

The size of individual deals is also bound to grow. Construction costs have doubled in less than five years. Gulf financings of $4bn are no longer uncommon. This suggests that the balance of opportunity is shifting towards large financial institutions with sufficient capital to support long-term project lending. The challenge for the smaller players, including the GCC’s own project finance providers, is to find ways of competing with the behemoths.

The big question is how far interest rates must rise to persuade the market to deliver the money that GCC projects will need. The era of easy money is over. Spreads are increasing. The average this year could be twice the level recorded in 2006; 100 basis points above the London interbank offered rate (Libor) may be required for the more complex and larger commercial project finance transactions.

Currency hedging

The biggest problem will face those wishing to raise funds in dollars. In Saudi Arabia, the cost of borrowing in the US currency has become prohibitively high. Elsewhere in the region, borrowers may have to consider local currencies or even euros. The optimists argue that the real cost of borrowing will, in effect, be unchanged since currency hedging can offset the dollar’s weakness. Not everyone is convinced.

GCC project sponsors now have a much broader range of choice. Ten years ago, their principal options were local, regional or international banks. Today, export credit agencies seeking to secure a portion of the world’s most buoyant construction market for their domestic suppliers have thrown the door open to borrowers seeking project finance.

The Japan Bank for International Co-operation (JBIC), which increased its loans to the GCC by more than $4bn in 2007, is ready to keep on lending. Practically every major export credit agency is open for more project finance business in the GCC.

Financings of a lifetime

Saudi Arabia’s Public Investment Fund (PIF) and the Saudi Industrial Development Fund (SIDF) are prepared to back large project financings in Saudi Arabia. Infrastructure funds are being set up to invest in Gulf projects. They include a new $1bn fund under formation by Abu Dhabi Commercial Bank, in partnership with Australia’s Macquarie Bank. Borrowers hope that the region’s sharia-compliant banks will eventually become major players in the project finance market.

For financiers and advisers, the GCC project finance market is becoming one of the most interesting places in the world to work because of the scale and diversity of major financings in the pipeline.

Just three of the many due this year are financings of a lifetime.
1. The Saudi Arabian Mining Company (Maaden) will finalise its Maaden Phosphate Company project finance deal this spring
2. It also aims to launch the financing for the Maaden Aluminium Company by the end of 2008. They will involve about $8bn in long-term loans from multiple sources.
3. At the end of February, bids were opened for the Saudi Landbridge railway line from Jeddah to Riyadh. It will be the most complex project financing ever attempted in the region.

Cutting-edge capabilities

GCC project finance is emerging as a global force. In the next decade, it will develop cutting-edge capabilities that will be competitive in other markets. It is an exciting prospect.

But two things are missing.

The first is a strategy for the Gulf project finance industry to develop the skills and governance structures to ensure that it makes a long-term contribution to the regional economy.

The second is construction partners capable of executing monster industrial, infrastructure and residential projects on time and on budget.

Gulf finance is working on the former. The shortage of the latter will become an increasing issue as the great Gulf building boom rolls on – and one that the bankers will soon be unable to ignore.