Long-term funding returns to the Gulf

27 October 2009

The completion in mid October of the $3.5bn financing for the Shuweihat 2 independent power and water project (IWPP) in Abu Dhabi is a milestone for the region’s project finance sector.

It is significant not just because of the size of the deal but also because the project’s sponsors and their advisers have succeeded in arranging a debt package that pushes the current market norms in terms of both margin and tenor.

The Shuweihat 2 financing includes a 22-year commercial bank loan of $1.1bn, with pricing starting at 260 basis points above the London interbank offered rate (Libor), a price that significantly undercuts other deals in the sector this year, such as the 300 basis points over Libor offered on the $400m international bank tranche of the Rabigh IWPP in Saudi Arabia, which closed in July.

Debt appetite

Shuweihat 2 also demonstrates that, despite the constraints on bank lending since the financial crisis began last year, there is appetite at both international and regional banks for longer-term debt.

But many bankers are wary of drawing conclusions about the state of project finance from one deal, and say that Shuweihat 2 may not be a good indicator of future trends.

“Shuweihat 2 was a very positive sign for the project finance market,” says one banker close to the deal. “But it is still uncertain if it signals the return of 20-year debt to the projects market.”

“Shuweihat 2 has one of the best sponsors in the region in the Abu Dhabi Water & Electricity Authority [Adwea] and is being built in a country with a very developed and supportive framework for these kinds of projects,” says Christophe Mariot, regional head of project finance at French bank BNP Paribas.

Project sponsors elsewhere in the region would find it more difficult to get banks to agree to similar terms, Mariot suggests.

Even by the standards of project finance deals in the region, which typically take many months to complete, Shuweihat 2 has a long history. First launched in 2008, it was one of the first deals in the region to be hit by the global financial crisis when the underwriter, French bank Calyon, implemented the market disruption clause and sought to renegotiate its commitment to the project.

In response, Adwea put in place a bridging loan to finance the beginning of construction. At that point it seemed inconceivable that long-term finance for the project would take a further 20 months to put in place.

Most of the other projects in the region that have sought to raise debt funding in the past 12 months have turned to shorter-term loan arrangements. For example, the $2.1bn Addur IWPP in Bahrain, being developed by Kuwaiti finance house Gulf Investment Corporation and France-based energy company GDF Suez, raised $1.3bn in debt with a maturity of eight years, with refinancing after eight years to bring the project’s debt into line with its 25-year power off-take agreement with the Bahraini government.

In the years leading up to the current financial crisis, project sponsors in the region benefited from the easy availability of funding on the global financial markets, which allowed lenders to agree to longer-term loans, while competition for Middle East clients drove interest rates so low that some banks were lending at a loss.

The drying-up of the global credit markets following the bursting of the US property bubble in late 2007 put an end to that.

“Eight years ago, making a 10-year loan to Citigroup sounded like one of the safest bets in the world,” says one Dubai-based banker at an international bank. “Now the world looks a lot less certain about which borrowers will still be there in 20 years’ time.”

“Shuweihat 2 was a very positive sign for the project finance market, but it is still uncertain if it signals a return of 20-year debt”

Banker close to the deal

The reluctance of lenders to make long-term loans has hit several projects in the region, including Oman’s Salalah IWPP, which failed to get a 17.5-year debt arrangement from banks earlier this year. Salalah has now returned to the financial markets.

But the Shuweihat 2 deal, together with the $2.5bn, 20-year debt raised by Acwa Power International on the Rabigh independent power project in Saudi Arabia, shows there is appetite among regional and international banks for long-term loans, provided the project is right.

“Project financing is by nature long term, since long-term financing is critical to the economics of the project, as well as to the econ-omics of the project sponsors,” says Ghazali Inam, head of project and structured finance at Arab Bank.

Inam expects to see sponsors trying to lengthen the tenors on project debt in 2010.

While sponsors are likely to struggle to push out tenors on loans in the short to medium term, they are likely to be more successful in pushing down the pricing on project finance.

Sources close to the $9.6bn project to build a new export oil refinery at Jubail on Saudi Arabia’s Gulf coast say the project’s sponsors, state-owned oil company Saudi Aramco and France’s Total, are aiming to secure $8bn in project finance at prices similar to those on Shuweihat 2.

“Banks are still risk-averse and sponsors are taking a very careful approach, not taking any risks that could jeopardise their projects’ financing,” says Inam. “I believe pricing will continue in the same ball park as 2009, at least for the first half of 2010, and gradually come down to reasonable levels, but still remain higher than it was in 2007.”

“It is important to remember that, even though margins have risen, Libor has fallen so much that overall funding costs are still comparable to a few years ago,” says Mariot.

Others are not confident that the banks have so much room to give on price.

“You have to remember that this is still a market where liquidity is constrained,” says one Dubai-based international banker. “For most banks, the internal cost of funding is around 200 basis points above Libor, meaning that any business they do will have to be priced above that.”

Most major projects that have raised debt finance over the past 12 months will be refinanced when the markets recover. Bankers are expecting that the Addur IWPP will return to the market to be refinanced in 2010.

If the credit markets remain tight, and the tenor of typical project finance deals remains at about 12-15-years, project sponsors and developers in the region will have to start incorporating debt refinancing into their project economics.

In this situation, developers on projects where there is a government off-take agreement could submit bids using medium-term finance of about 12-15 years, priced at current margin levels.


These bids would include a clause stating that, in the event of a refinancing deal that substantially reduces the cost of the debt but lengthens the duration of the loan, the developer will renegotiate the off-take tariff with the government.

Such arrangements will enable sponsor and developer to get projects started at the current market pricing, while factoring into the deal the potential benefits from a recovery in the banking market.

Given the need for utilities projects in the region, getting projects started after a long period of stunted activity will be strategically important for governments.

“In 2010, tenors will start to be stretched, but there is still not much appetite to go back to 20-year debt,” says the head of project finance at one regional bank. “Banks are more likely to compromise at about 12-15 years.”

For now, bankers and sponsors will be watching the $9.6bn Jubail refinery financing to assess the level of appetite for such a huge project.

The refinery benefits from having some of the strongest sponsors in the region, but faces difficulties because of the sheer size of the debt it is trying to raise, and some banks are growing cautious about fresh loans to Saudi Arabia in the wake of corporate scandals at local conglomerates Saad Group and Ahmad Hamad al-Gosaibi & Brothers.

But the refinery’s size and name will bring back to the table many banks that have sat out 2009. With many projects now likely to offer them shorter tenors and better pricing, it may be enough to get them lending again in 2010.

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