Several projects across the Middle East are expected to launch bond issues later this year in the most promising signs yet that capital market funding could become a viable source of financing projects.

Sources in the banking sector say that as many as six project bonds could be launched this year, including the refinancing of the Zayed University and the Dolphin Energy pipeline, both in the UAE. Other potential project bonds could be issued by the Barzan gas project in Qatar and Saudi Aramco’s Jubail Refinery.

There is an economic rationale for using bonds to refinance deals booked at peak pricing

Jonathan Robinson, HSBC

Zayed University is the closest to being able to launch a deal into the market. A $1bn project finance deal for the development closed in November 2009, and Mubadala, the sponsor behind the scheme, is currently looking for banks to run bond issue.

That deal is expected to be worth about $1bn and will be used to refinance the debt put in place by the 11 banks on the original deal.

Middle East bond issues
Date Volume ($m) Number of bonds issued
2009 Q1 6,816 9
2009 Q2 12,391 8
2009 Q3 9,755 14
2009 Q4 16,924 22
2010 Q1 6,681 8
2010 Q2 7,825 12
2010 Q3 8,872 14
2010 Q4 14,818 22
2011 YTD 6,405 8
YTD=Year-to-date. Source: Dealogic

Saudi Aramco and France’s Total are also planning to issue a sukuk (Islamic bond) to Saudi investors to finance the $12bn Jubail refinery. That deal has been in the works since December 2009, but bankers close to the deal say it has been held up at the Capital Market Authority (CMA) in Saudi Arabia awaiting their approval.

Dolphin Energy is also considering a bond issue, according to bankers close to the company. In July 2009, Dolphin completed a $3.5bn refinancing, which included issuing a successful $1.25bn bond. It is now considering another bond issue that could be used to refinance some of the bank debt.

Bankers also say that Abu Dhabi Electricity and Water Authority (Adwea) is considering using the bond markets to refinance some of the debt on at least one of its independent power projects in the emirate. One banker close to Adwea says, “Adwea has had several meetings with banks where they have pitched accessing the bond markets. They are starting to consider it more seriously as the next logical thing to do.”

Although bankers have long talked about the opportunity of financing projects through the bond markets, most schemes are overwhelmingly funded through bank debt, equity, and export credit agencies. That is expected to change as new banking regulations, Basel 3, will force banks to put more of their capital aside for long term loans, making lending to projects less profitable for banks.

“The interest in project bonds is driven by banks becoming less willing to look at long tenor project finance, Basel 3 has forced the issue,” says Jacco Keijzer, head of debt capital markets at Royal Bank of Scotland. “Project bonds can fill that gap.”

Project sponsors and lenders hope that by issuing project bonds they can reduce the amount of project lending banks have to carry on their balance sheets. That will give banks more room to lend on schemes that bond investors would typically steer clear off.

“Banks need turnover as they can’t hold some of this paper on their books for 20 to 25 years,” says a regional project finance banker. He adds that he hopes to see six or seven project bonds launched in 2011.

“The bond market is a very good option for completed projects, but is harder if there is some construction risk,” adds the banker.

Bond investors are typically wary of investing in schemes before they are completed and have proven cash flows, although bankers say deals can be structured to appeal to fixed income investors. It remains more likely though the majority of project bonds will be used to refinance bank debt on completed schemes, particularly ones financed during 2009-10 when pricing was high as a result of the financial crisis.

“There is an economic rationale for using bonds to refinance deals booked at peak pricing,” says Jonathan Robinson, head of project finance at the UK’s HSBC. “However, challenges remain, including developing a regional market with appetite for long-dated project risk, and further tapping the experienced investor base in Europe and the Americas.”

Over the past few years, bankers have often raised the prospect of the project bond market developing, but so far only a handful of deals have been done.