Meanwhile bankers wait for the bigger deals expected in 2009.

The rapid growth in the region’s project finance market in recent years has not been maintained so far in 2008. The lack of dollar availability caused by a sharp contracting of the credit markets and the consequent increase in the cost of funding has forced developers to cut their project portfolios.

Bankers have also become frustrated with the costs incurred in entering into bids with contractors for projects they do not win, and are threatening to charge them for the services they provide in support of their bids. This would bring them into line with legal and financial advisers who charge regardless of whether a bid is successful. Such a move could limit bidders for schemes as contractors fighting against soaring material costs will be reluctant to incur additional charges.

Against this background, however, Saudi project sponsors are still managing to obtain debt financing. Saudi Arabian Mining Company (Maaden) announced in mid-June that it had secured loans for its $3.9bn phosphate joint venture with Saudi Basic Industries Corporation (Sabic), attracting Japanese and South Korean export credit support. It also attracted $1bn from the Saudi Public Investment Fund (PIF) and $135m from the Saudi Industrial Development Fund (SIDF). This is expected to be added to nearly $2.5bn raised through an initial public offering.

The $6bn Saudi Kayan petrochemicals financing, another Sabic-backed project, also reached financial close in June 2008, having been out in the market since September 2007.

Fewer deals

Gulf project financiers point out that such deals are likely to be the exception rather than the rule. The Maaden financing looks likely to be one of the few major transactions in the kingdom this year.

“The driver for the past four or five years has been the petrochemicals industry, but there are no more gas or ethane allocation letters coming out of the ministry, so the big splurge of those projects is over for the moment,” says Bimal Desai, a partner at Allen & Overy who has worked on some of the biggest deals in the region, including the $1.8bn National Chevron Phillips petrochemicals project financing transactions in Saudi Arabia.

Bankers and sponsors alike are looking to 2009 for the bigger deals. The two Saudi Aramco-backed export refineries at Jubail and Yanbu will be seeking financing alongside independent power projects (IPPs) at Rabigh and Yanbu. The Ras Tanura financing - the biggest single deal currently in the market, with a $10bn price tag - is still some way off completion, says one project adviser. Sponsors Saudi Aramco and the US’ Dow Petrochemical Company shortlisted six international banks and seven regional banks in February.

This leaves much of the attention focused on a series of mid-sized infrastructure deals, including several power, water and transport projects. The biggest infrastructure deal by a long way is the $7bn Saudi Landbridge rail scheme, linking Jeddah to the Gulf coast. With the construction contract going to the Tarabot consortium in May, participating banks are preparing to discuss the terms of the project financing with the aim of taking it to market either late this year or early in 2009.

However, the Landbridge is likely to prove a highly intricate transaction, involving the full range of available sources, including a $1bn Islamic tranche and extensive support from the PIF and SIDF.

The debt finance component is likely to be 70 per cent, on a similar scale to Ras Tanura, say analysts. “Landbridge is atypical, even for the infrastructure projects we have here in the kingdom,” says the head of project finance at one of Saudi Arabia’s largest banks. “The complication is that revenue estimates are hard to determine and depend on the competitive response of the road haulage industry. The government has stepped in to support it, but there is still a great deal of uncertainty over the revenue estimates.”

The rest of the deals in the market are likely to be much smaller. “There will be lots more social infrastructure, but smaller in size, with a lot of water and wastewater treatment deals,” says Desai. “But there are bigger transactions in the pipeline - some of the economic cities are potentially huge, including an aluminium smelter. Then there is the north-south rail link.”

The question is whether the projects can be financed on schedule in a restricted global liquidity environment, and whether local Saudi banks have the capacity to take on these projects to compensate for the lack of appetite among international banks. Regional banks, such as National Bank of Kuwait, have declared their intention to expand project financing, but there is still uncertainty over whether local institutions can raise enough of the dollars required.

Table: Forthcoming Saudi project finance deals

Lending capacity

“The banks are capable of meeting riyal demand, so it is a question of whether they are going to have dollars available at the right price to meet the dollar demand for these projects,” says Craig Nethercott, a partner in energy, infrastructure, project and asset finance at law firm White & Case. “It may improve, but the low pricing we have seen in the recent past would not be attractive compared with the current cost of dollar funding.”

Banks can raise far more in riyals than they can in dollars, which links back to the wider issue of the currency peg. Many local banks do not want to lend dollars in case the peg is removed. While there are no signs that the monetary authorities are ready to take such a momen-tous step, it is still a concern for the banks.

“Accessing dollar finance is pretty important,” says Tarun Puri, head of project finance at Bahrain-based Gulf International Bank (GIB). “It is a major cause of concern for everyone, whether on the borrowing or lending side of the business.”

There is no sense of panic yet, and observers say some good may come of the reduced availability of dollar funding. Higher-risk investments such as real estate projects could receive less financial attention as a result. “We can prioritise the good [project] over the less good,” says John Sfakianakis, chief economist at local bank Sabb. “Banks and project providers need to consider what is mandatory and what is not.”

Saudi institutions are able to exploit a wider array of local sources to get their more attractive deals done. “There is enough appetite out there,” says the Saudi project financier. “Right now, you can raise about $1.5bn a deal from Saudi banks, but the cloud on the horizon is the riyal peg to the dollar. The central bank has to exercise monetary policy through other means than interest rates. What it has been doing is increasing the reserve ratio of the banks. If it pursues this more aggressively, it could raise some liquidity issues.”

The lending capacity of Saudi banks has come under pressure because of the increased cash reserve ratio requirement of 12 per cent, up from 10 per cent, set by the Saudi Arabian Monetary Agency (Sama), the central bank. Though Saudi banks have been able to grow their loan books aggressively, despite higher reserve requirements, double-digit inflation means that Sama is not inclined to relax this requirement.

Times are therefore getting tougher for the local banks, just as they have for the international banks reeling from the credit crunch. For sponsors looking to go to market with a major Saudi project financing, it means scrabbling around for a far wider variety of sources. For infrastructure projects, this is a particular problem as the export credit agencies, which figure prominently in financing structures for Saudi petrochemicals deals, cannot participate.

However, arrangers can tap into the Saudi state’s ample financial resources. “You can get $1bn from the PIF, another $1.5bn from the local banks, and $500m from the SIDF,” says the Saudi banker. “If you put that together it is about $3bn. If it is not an infrastructure project, you can get another $1bn from an export credit agency. That is $4bn, and it is an underestimate as there is still some interest from the international banks.”

Growing margins may entice international banks into lending. Margins are up by an average of 15-20 basis points over the London interbank offered rate (Libor) compared with July 2007, and in some cases more. One Saudi banker says the cost of funding is running at 130-150 basis points over Libor, depending on the project. “That is basically just pricing the liquidity,” says Puri. “It is not the project risks that have changed.”

In the UAE, project financiers have introduced market flex arrangements that allow lead arrangers to adjust margins during the syndication process. This has yet to be formally used in the kingdom, but the structure of transactions does need to cover some foreign exchange risk between the dollar and riyal markets, particularly for export-related deals.

“The main issue is that we are pricing things differently than in the past,” says the Saudi banker. “You always had your credit risk margin to cover the credit risk, but added to that is implicitly a liquidity risk margin in dollars, because frequently we cannot fund ourselves at Libor.”

The key message is that for the banks, Saudi project risk has become more complicated because of the pressures of building around the dollar peg. “These issues will be reflected in the wave of deals on the horizon, but these are not 2008 deals,” says Nethercott.

Ultimately, Saudi Arabia is simply not as decoupled from the global financial system as it would like to think. “The banks will come to a point where the amount of projects they are supporting will surpass the amount of liquidity on their books,” says Sfakianakis. “The supply will not be able to keep up, so the question is, where do they look for additional financing?
“By the time they look for sourcing from outside, the world might have overcome the crunch, or it might not.”