Financing for projects in the region’s power and water sector has been in short supply since Qatar’s Ras Laffan C power and water desalination scheme closed in August last year. The drying up of liquidity, the soaring cost of debt and risk-aversion among banks resulted in many Gulf power and water projects being shelved or cancelled in late 2008 and early 2009.
Consequently, the $2.1bn raised in June for Bahrain’s Addur independent water and power project (IWPP), which was the first power and water financing deal to close in the region this year, has caused a considerable stir. In total, 18 banks are providing $1.7bn in debt to the project, with the remaining $400m of the $2.1bn deal being equity. Some sources in the project finance industry say the deal marks the beginning of a recovery in the sector’s project finance market.
“The market is waking up from the slumber it has been in over the past 10 months and there have now been a few transactions,” says one regional banker.
Following the closure of the Addur deal, the $2.5bn Rabigh independent power project in Saudi Arabia reached financial close in July, and, in the same month, Abu Dhabi’s Dolphin Energy closed a $3.5bn refinancing.
The fact that these projects were due to have closed in 2008 and have only now been able to secure funding shows the strain that the project finance market has been under. “This year has been spent trying to close the legacy deals from last year,” says Harold Fairfull, managing director of UK-headquartered Consilium, which provides financial advisory services on many projects in the Middle East. “But we have most definitely hit the bottom now.”
In addition to these three deals closing, Kuwait has announced its first IWPP at Al-Zour and more are to come across the GCC – for example, Oman has two IWPPs and two independent power plants (IPPs) in the pipeline.
However, the financing of Bahrain’s Addur project highlights some changes in the way deals are being structured, most notably the short tenor of the debt. The $2.1bn loan secured by Addur runs for eight years at 350 basis points over the London interbank offered rate (Libor). By contrast, before the global financial downturn struck in October 2008, project debt would typically run beyond 15 years, at prices of less than 100 points over Libor.
“Banks do not want to be stuck in any deal for 20 years,” says Fairfull. “In the current climate, they are wary about having a big mismatch between their assets and liabilities.”
But while the cost of debt remains high, debt margins have begun to stabilise over the past few months to an average of 250 basis points over Libor, which is helping to revive confidence in the market.
“The expectation is margins will continue to fall for the rest of this year, and through until early 2010,” says Fairfull.
However, any signs of recovery have yet to reach Saudi Arabia. The kingdom has had to abandon the IPP model for its Yanbu and Ras al-Zour projects. A request for prequalification on the Yanbu project was issued in October 2007, while tenders were put out for the $5.5bn Ras al-Zour scheme in June 2007.
The difficulty in securing the financing has dogged the two projects since they were tendered, and the government decided in April to step in. It is now tendering both projects as engineering, procurement and construction (EPC) contracts.
Saudi Arabia’s acute power and water shortage means it has an urgent need to get the projects under way. The kingdom’s electricity demand is forecast to climb from its current 38,000MW to more than 60,000MW by 2025.
“It [Riyadh’s intervention] was really a question of timing,” says Irfan Said, head of project and structured finance at Saudi investment bank Samba Financial Group. “On the one hand, the government’s objective is to promote the IPP model, but on the other, IPPs take longer to close and demand greater transparency.”
While the project finance market is beginning to recover, the slowdown in the construction market means there is a pool of EPC contractors that are hungry for work. However, it is unlikely many projects will opt for the EPC model given the region’s concerted efforts to privatise the power and water sector in recent years. “The EPC model requires a huge amount of balance sheet commitment from the governments, which is what they are trying to move away from,” says Said.
With the region’s governments reluctant to shoulder the burden of financing, and banks still reluctant to lend, export credit agencies are playing a greater role in financially supporting power and water projects.
In particular, Japan Bank for International Co-operation (JBIC) has become a well-known name in the Gulf project finance market.
“For the megaprojects that require $2bn debt, JBIC is going to be an absolutely essential component of that,” says Fairfull. “Even raising $1bn for a single project through just commercial banks is extremely challenging today.”
JBIC has committed $1bn to the forthcoming $3.2bn Shuweihat 2 IWPP in Abu Dhabi, for which 12 banks confirmed their involvement in mid August.
Alongside JBIC, two South Korean agencies, Export Import Bank of Korea (Kexim) and Korea Export Insurance Corporation (KEIC), have also played key roles in financing Gulf schemes. KEIC covered the dollar-denominated tranche of about $400m for the $2.5bn Rabigh IPP in Saudi Arabia, which closed in July.
However, international banks’ involvement in the market remains solid, as shown by the commitment to Shuweihat 2 from Germany’s Bayern LB, France’s BNP Paribas and Societe Generale, and the UK’s HSBC and Standard Chartered Bank. “Most commercial bank finance will still come from the international banks,” says Fairfull. “They are wanted by the procurers and the sponsors because they have the structuring skills to be able to put the deals together. I do not see how local banks can play that role.”
The way the debt is being structured has also changed, with risk-averse banks favouring simple, conventional forms of financing. In particular, soft and hard ‘mini-perm’ structures have come to the fore, with the latter being used to help structure the debt on the $2.1bn Addur IWPP. Hard mini-perm is a structure where legal maturity is typically set at about seven years, forcing the borrower to refinance before maturity or face default. By contrast, with soft mini-perms, the legal maturity of the bank loan remains long-term – 26 years for a 28-year concession – but the sponsors are given incentives to refinance the loan by an earlier date.
With projects spanning an average of 20 years, the project finance market relies heavily on long-term financing. Consequently, one of the most fundamental challenges to the industry is the poor state of the secondary debt market. Banks today are refusing to underwrite debt because they worry they will no longer be able to package it and sell it on to investors through the process known as securitisation.
“I think that market is probably going to be restrained for a while,” says Said. “There is secondary market activity, where people will sell or buy loans in the secondary market once a deal has been done, but securitisation has gone out the window, along with any exotically structured deals.”
Use of the secondary market will be dependent on confidence returning. The fact that there are now several project finance deals on the horizon should play a part in this.
Bids for Saudi Arabia’s Riyadh PP11 project are due in the first week of December, with an award likely towards the beginning of next year. In addition, requests for proposals were recently issued for Oman’s Sohar 2 and Barqa 3 schemes, while advisers are due to be appointed on the Duqm and Ghubrah schemes, also in Oman. Meanwhile, Abu Dhabi announced in June that it will invite bids for the Taweelah C IWPP by the end of this year.
Therefore, Shuweihat 2 is likely to be the only deal other than the Addur IWPP that will close in 2009. “Things are still happening at a very low level,” says one regional banker. “Transactions are at 10 per cent of the level they were a year earlier, and there are still fundamental issues, such as availability of dollars. But things will improve from here on.”
In the meantime, it is clear that government-sponsored projects are going to be favoured by the banks. “Obviously, there is a lot of stress on the corporate side and banks feel a lot more comfortable about contractually based projects where there is support, either explicit or implicit, from the government,” says Said. “Whether it is a concession agreement or power or water-purchase agreement, banks will be looking for some basis where a creditworthy off-taker stands behind the payment.”