Over the past 12 months, there has been a significant shift in the nature of projects seeking financing in the Gulf. With governments placing a priority on developing strategic national assets, infrastructure projects are taking precedence over industrial schemes.
Nowhere is this more pronounced than in the power sector. With demand for electricity fast outpacing supply, the race to build new generating capacity is on. “There is a lot of catch-up required on social infrastructure and this will offset the decline in the petrochemicals sector,” says Darren Davis, head of project finance at HSBC.
There have been an estimated $30bn worth of independent water and power projects (IWPPs) undertaken in the region since the first was launched at Al-Manah in Oman in 1994, and the pace of development has accelerated, with seven IWPPs signed in 2007 and a similar number expected this year.
But the region faces difficulties when it comes to raising the finance needed to develop these schemes. “The financing challenges are increasingly large projects, EPC [engineering pro-cure-ment and construction] prices increasing dramatically and EPC market tightness meaning that the risk allocation is changing,” says Ranald Spiers, chief executive officer, Middle East & Africa, for developer International Power.
According to Spiers, the cost of EPC for power has almost doubled from $450 a kW of capacity in 2003 to $850 a kW in 2007, while desalination projects have risen by 40 per cent from $5 a gallon in 2003 to $7 a gallon last year.
Project developers must raise more cash to deliver the same thing. But with costs spiralling and feedstock issues a key concern, lenders are being cautious and finance margins are increasing. “Higher capital costs mean that cash flows are stretched more thinly, and there is substantial reliance on international debt capital,” says Davis.
It also means that more international debt sources will become important, as dollars become increasingly difficult to obtain.
Qatar Electricity & Water Company (QEWC) recently learned the hard way about the risks in the Gulf's contracting market. At MEED's project finance conference in Bahrain in February, chief operating officer Jimmy Chung revealed it had suffered a fall in profits of $158m from $772m in 2006 to $614m in 2007 after the arrival of a gas turbine was delayed by several months. “There was a liquidated damages claim to pay to Kahramaa [Qatar General Electricity & Water Corporation] after the delay at Ras Laffan B and we took a $100m hit,” says Chung.
Contractor Siemens was unable to procure the turbine in time to meet the original 2007 deadline and, as a result, the power station cannot be commissioned until June 2008. Because of this, QEWC had to compensate the offtaker, Kahramaa, for failing to produce the power agreed. In turn, QEWC is pursuing Siemens for remuneration.
“Eventually we will settle,” says Chung. “Cost is a major issue and we are working closely with EPC contractors to ensure they meet their schedules. But the reality is they are very stretched. We have to be aware of the challenge of meeting deadlines, and have the ability to withstand such challenges.”
There are plenty of opportunities for Qatar to apply these lessons on upcoming projects. Bids are being submitted for its power station at Ras Laffan C. “We have a $300m bridge to cover equity financing and we close in March on this,” says Chung. “A $3bn conventional facility will cover all other sources and we are looking for financial close in the third quarter of 2008.”
Power demand is set to outstrip supply in Qatar by 2009 and will do so until Ras Laffan C comes on line in 2010. QEWC is fast-tracking the scheme and hopes to begin producing power by March 2010, and to complete the 2,600MW capacity by April 2011. This will be a significant challenge in the current environment. According to Spiers, any contractor ordering a turbine today will not get it until 2013.
Qatar's supply shortfall is despite two power plants coming on stream over the next two years. The Ras Abu Fontas station B2 has just come on line with 567MW and is about to begin its desalination operations. The 2,000MW, $2bn Mesaieed A power station project is planned for completion by the end of this year, although Chung says this could run into 2009. QEWC owns 40 per cent of the project and the balance is owned by Qatar Petroleum and Marubeni.
Like Qatar, the region's biggest independent water and power project (IWPP) market, Saudi Arabia is launching new IWPPs, but it is also experimenting with an alternative project structure to push these forward. According to Saudi Electricity Company (SEC), which serves 5 million customers, there are 15GW of IWPPs under way with deals on Shuaibah and Shuqaiq, Marrafiq at Jubail and Saudi Aramco itself having closed 6.6GW worth of private projects to date. A further 4.7GW of projects are due this year and power requirements for the economic cities account for the remainder of the 15GW.
SEC estimates that a further 35GW of capacity is required in the kingdom over the next 10 years, and will invest $53bn on delivering a proportion of this requirement, along with improving its transmission and distribution networks.
To deliver this, the company will use a partnership model new to the kingdom, where it will form a joint stock company with the developers to raise the finance and let EPC and operation and maintenance contracts. Three projects, worth a total of $8bn, are to be tendered under this structure (see table, page 51) and will generate 5.2GW as they come on line between 2012 and 2015.
To make these projects attractive to private investors and improve its own borrowing potential, SEC has been pursuing a restructuring programme to improve corporate efficiency along with its balance sheet. SEC points out it has achieved an expansion of 40 per cent over the past six years but has reduced manpower by 5 per cent. The government owns 81 per cent of the company's shares, as listed on the Tadawul, and also has a range of favourable ratings from Moody's Investors Services' A1 to Standard & Poor's AA- and Fitch Ratings' A+.
“We are committed to private involvement and will be using build-own-operate contracts so there is no transfer of assets,” says Amer al-Swaha, head of the IPP programme at SEC. “The assets will stay with the private company. We are also looking for higher equity participation of 80:20, not 60:40.”
Previous schemes have left the private companies with a smaller equity stake and loss of the asset at the end of the contract. Developers have responded favourably to the new terms. “The more of the asset that is available, the more we love it,” says Spiers.
Critically, SEC is also guaranteeing the fuel stock and will be signing 20-year power purchase agreements (PPAs). “We want to avoid the mismatch of having a long-life power station with medium-term loans,” says Al-Swaha.
Obtaining private capital for the generation assets has an important side effect for SEC, allowing it to invest more in transmission and distribution. “It helps to move expenditure to transmission and distribution,” says Al-Swaha. “Completing the national grid by connecting the central and eastern connectors with the west and the south is the key priority.”
These partnerships are part of a larger masterplan for SEC, which is looking to launch an initial public offering (IPO) for some of its ventures in the longer term. Despite the kingdom having up to six government bodies responsible for power generation, all organisations are discussing the creation of a single offtaker to buy the power. “We are having a serious evaluation of setting up a single offtaker,” says Omar al-Ghandi, head of Saudi Arabia's Water & Electricity Company (WEC).
But this might not prove to be popular among corporate banks, which prefer to maintain a broad spread of exposure by using a number of offtakers.
WEC itself is hard at work tendering its fourth IWPP at Ras al-Zour, which is set to become the largest desalination plant in the world, using heavy crude fuel oil to produce 220 million gallons a day of drinking water, alongside up to 1,100 MW of power. The project follows on from Shuaibah and Shuqaiq IWPPs and the Shuaibah expansion independent water project.
“WEC envisages the project company will secure funding for the total project budget from debt facilities, shareholder funding and internally generated cash flows,” says Al-Ghandi. “The first-ranked bidder will be responsible for raising all debt facilities on behalf of the project company.”
The scheme is budgeted to cost $3bn and bidders must obtain committed facilities of no less than 50 per cent of its debt finance requirement.
In terms of sources of finance, conventional debt, equity, Islamic finance and export credit agencies will all play a part in the power sector. The key challenge in 2008 is the availability of contractors and equipment and, more critically, where to place the risk of construction price escalation. “With the developer, offtaker or EPC contractor?” asks Spiers.
This is the question that power infrastructure sponsors will have to resolve, as contractors will increasingly refuse to take on risk in 2008. In Qatar, it seems that the contractor will be made to pay eventually, but in a service providers' market, contractors can afford to turn clients down and it will be those with the best risk management who get the best contracting resources.
Table: Independent power projects in Saudi Arabia ($m)
|Power station||Capacity (MW)||Fuel||Stage 1||PCOD|
|Rabigh power plant||1,200||HFO||April 2012||April 2015|
|Riyadh||2,000||Gas||April 2013||April 2014|
|Qurayah||2,000||HAC||April 2014||April 2015|
Total value of projects is $8bn. HFO=heavy fuel oil; HAC=heavy Arabian crude; PCOD=project commercial operation date. Source: Saudi Electricity Company