Private financing resurfaces in region

04 November 2015

Governments need to create effective and transparent institutions to succeed this time around

  • Clear structure and decision-making procedures must be in place, while providing space for the private sector to come up with the best solution
  • There is still healthy appetite from regional and international banks to invest in the Middle East’s infrastructure programme
  • Government clients are also looking at other ways to procure major infrastructure projects while reducing debt on their balance sheets

At MEED’s recent Oman Projects Forum, the sultanate’s Commerce and Industry Minister, Ali Massoud al-Sunaidy, revealed that the Supreme Council was preparing regulations to enable the use of public-private partnerships (PPPs) to develop major infrastructure and housing projects.

Muscat is expected to appoint an adviser before the end of November to work towards establishing a PPP unit to facilitate the planned infrastructure programme. This move makes Oman the latest GCC oil exporter to turn to the private sector to assist with infrastructure development as government reserves continue to feel the impact of low oil prices.

“PPP has a role to play in the [Middle East] market,” says Dominic Holt, director of deals, capital projects and infrastructure at the US’ PwC. “Oman is looking at a PPP unit, Kuwait recently revised its PPP law to encourage further progress, and the UAE [Dubai] has recently issued a PPP law. We think the PPP mechanism will be more prominent [in the region] going forward. This is partly due to the low oil price, which is putting pressure on public spending.”

According to Abraham Akkawi, partner for transaction advisory services at UK-based EY, Saudi Arabia is also planning to ramp up its PPP pipeline. “[Riyadh] has already used PPP for Medina airport and recently issued a RFP [request for proposals] for Taif [airport],” he says. “The government is looking to use more PPP projects to overcome challenges of less revenue.”

Wider outlook

It is not just oil-rich GCC countries looking to integrate the private sector into their infrastructure schemes. Egypt has set out plans to develop more than 20 major infrastructure projects through its PPP Central Unit.

While partnerships with the private sector have been used throughout the Middle East successfully for major power and water projects over the past two decades, previous efforts to implement the PPP model for other large infrastructure schemes have often failed.

The cancellation of the UAE’s proposed $3bn Mafraq-Ghweifat highway PPP in May 2011, after three years of negotiations, was viewed by many to have signalled the death knell for PPPs in the Middle East. Coming less than a year after plans for Abu Dhabi’s Tawam PPP hospital were scrapped, the decision to cancel the highway project was a significant blow for regional supporters of the PPP model.

The scheme was considered a key pathfinder project for private project financing in the post-global recession era. However, with the price of oil having more than halved since then, the Middle East’s largest economies have been forced to dip significantly into public accounts to fund infrastructure projects, and PPP offers an opportunity to reduce pressure on rapidly dwindling government reserves.

On the backburner

Some within the region’s project finance market feel PPP was never completely abolished from government plans, but was put on the backburner while hydrocarbons revenues reached almost record levels.

“[PPPs] never left; governments decided for different reasons to use less of them,” says Akkawi. “One of the main reasons was that they thought it was faster to deliver infrastructure directly, and also many didn’t understand the ramifications of PPP as it was a new concept to the region.”

While there are contrasting opinions on the previous success of PPPs in the Middle East, the benefits of the model are clear.

PPP advantages

“PPP is good for public balance sheets, but also importantly ensures robust contracting structures and allows clients to gain from knowledge share,” says Holt.

Under a PPP structure, the acquisition of technical knowledge and expertise can also be blended with improved budgetary performance.

“Clients are looking at getting into PPPs, not to create revenues but to deliver projects on time and on budget,” says Akkawi. “PPP produces more certainty for timelines and budgets.”

While there may be debate across the region’s project and finance sectors on which PPP schemes should be prioritised, agreement on the ingredients for succeeding with the model is unanimous. For PPP schemes to succeed and gain support from banks, clear structure and decision-making procedures must be in place, while providing space for the private sector to come up with the best solution.

Onus on government

“Now that the signals are coming to the market, it is up to the governments to push ahead with actual projects,” says Holt. “For projects that do come to the market, particularly in markets where PPP has not been used previously, up-front thought is key. It is very important that by the time projects come to the market, there is a clear procurement structure and contractual framework. This must contain a robust payment mechanism, appropriate risk share allocation and suitable off-take agreements.”

“For PPP to succeed, it is vital that authorities don’t come to the market with a fully developed offer. Authorities need to come to the market with a concrete and developed structure, and make sure all of the facilitating laws are in place. Whether decisions are made at a dedicated PPP unit or individual ministry level, it is important the core terms – such as procurement mechanisms and contractual structures – are clear so that banks and sponsors know what they are entering into”

Akkawi agrees that a clearly defined structure is vital to get the best value from the PPP model. “Banks are looking for certainty with PPP; this is not just in the Middle East, but worldwide,” he says. “If there is no certainty with structure, banks will shy away from it, or do it with a high rate. Governments must understand these risks and not put all the risk on the private sector. The  authorities must be prepared to take underlying risk.”

Currency risk

While the falling oil price and a slower recovery than expected from the global financial and eurozone crises has had an impact on liquidity, there is still healthy appetite from regional and international banks to invest in the Middle East’s infrastructure programme.

“There is definitely appetite there,” says a source at a major global bank based in the region.  “But the correct structures need to be in place, and questions on risk must be addressed suitably, particularly regarding currency risk in Egypt.”

Due to the long term nature of PPP agreements, usually 20-30 years, appropriate risk allocation for banks and sponsors to support schemes is crucial.

A sovereign guarantee to ensure obligations will be met in the case that the client defaults is regarded as a basic prerequisite for any PPP scheme, particularly due to the long-term nature of the contract. While this may be an issue for Iraq, which is facing significant fiscal difficulties as a result of the ongoing security problems and years of budget mismanagement, the majority of states pursuing PPP schemes in the region will be willing to offer sovereign guarantees. The more difficult issue is foreign exchange (forex) guarantees.

Egypt potential

In March, hosting an economic development conference open to the world’s largest companies and investors, Egypt launched itself onto the international projects stage and more than $100bn-worth of investment was pledged for infrastructure investment from governments, multilaterals and private businesses.

A central component of Cairo’s development plans is its PPP programme, which currently consists of more than 20 projects, ranging from wastewater plants to sport stadiums. While the size of the country’s PPP pipeline has drawn substantial international interest, concerns remain about forex risk, with most of the projects to be paid for in Egyptian pounds.

The government is preparing to issue a forex guarantee for utility projects, including renewable energy schemes planned, and the Central PPP Unit has undertaken a degree of forex risk on the Abu Rawash wastewater scheme between the commencement of bidding and the project’s financial close.

However, according to sources close to the programme, the Egyptian government is not planning to undertake any forex guarantees for any of the other schemes, which may dissuade potential investors.

While an absence of currency risk guarantees may put some lenders off, there is still expected to be interest in the programme.

“I believe there will be interest from banks, albeit at a higher value,” says a UK-based consultant. “If there is no forex guarantee, sponsors or developers will undertake risk, not the banks, or accept lower return.”

Alternative financing

While PPPs are planned to be developed on a wider basis, government clients are also looking at other ways to procure major infrastructure projects while reducing debt on their balance sheets.

One method that appears to be becoming more popular is contractor financing, where contractors utilise export credit agencies (ECAs) to guarantee loans. An example of this is the UK’s Carillion, which, through its local joint venture Al-Futtaim Carillion, won major construction contracts in the UAE with the support of UK export credit guarantees.

“Contractor financing is shorter-term than PPP – about 10 years,” says Akkawi. “What makes it attractive is the ECA support – contractors aren’t taking on too much risk. As the asset is not fully in control of developers or banks, they will look for sovereign guarantees to support it.”

With the oil price not expected to return to the $100-plus highs of recent years, and population and industrial growth continuing to increase at rapid rates, the region’s governments are under pressure to find the best way to deliver infrastructure while contending with falling revenues.

PPPs offer a suitable solution to the problem, harnessing technical expertise and international experience to deliver projects while keeping debt off balance sheets. While the conviction to use PPPs appears to be growing across the region, it is vital that governments are able to follow their words with action and create effective and transparent institutions to gain the support of regional and international lending institutions.

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