As global liquidity dries up, Gulf governments will be increasingly called upon to provide project funding.
For project sponsors surveying the finance market today, it is almost unbelievable that just 18 months ago, banks were queuing up to lend them money.
Bankers say that until recently, many project sponsors believed the finance market would bounce back, while finance houses were becoming increasingly sceptical.
“The banks in the market and the sponsors have been heading in completely opposite directions for the past eight months,” says one Bahrain-based financial adviser.
The most recent bad news shows it will be some time before a favourable market returns. Following the collapse or state-backed rescues of banks and insurance firms in the US and Europe, the Bush administration initially failed to persuade Congress to back a $700bn bail-out plan for US banks.
As MEED went to press, efforts were continuing in major global financial centres to shore up the banking system.
The interbank lending market has seized up because of concerns over the collapse of further financial institutions, which is in turn driving up funding costs.
“The project finance market in the region is dead,” says one regional bank syndications head. “And there will be no signs of life until early 2009 at the earliest.”
Only a dozen large banks are still keen to finance projects in the region, reduced from about 50 banks at the beginning of 2007.
The rising cost of dollar funding has priced many banks out of the market, and in many cases, regional banks are refusing to lend any long-term dollars except to their biggest existing clients.
“The sentiment among sponsors now is that anything that can be delayed should be,” says Ghazali Inam, global corporate finance head at Arab Bank, one of the few banks still actively considering deals.
This will inevitably hit some of the more speculative projects planned for the region. But many of the projects that finance houses have been working on are essential infrastructure schemes. More than $20bn worth of projects will need to raise finance over the next few months, including $18bn worth of independent water and power projects (IWPP).
At the moment, only the smallest state-backed schemes are close to securing finance.
The question now for sponsors is where they can raise this cash. “There is no room for altering the schedule of these projects because of the growing demand for power,” says Irfan Said, project and structured finance head at Saudi Arabia’s Samba.
Although the credit crunch has affected the ability of sponsors to finance projects, the underlying credit risk is largely unchanged from 18 months ago, and the oil price is still giving governments healthy budget surpluses.
“For most of the power projects, the respective governments remain equity investors in the projects, so banks have that comfort from a credit-risk perspective,” says Tarun Puri, head of project finance at Bahrain-based Gulf International Bank. “Banks are not doubting the projects, it is purely a liquidity problem.”
“All of the [IWPP] projects are being launched simultaneously without any co-ordination among the various power and water authorities of the GCC countries and the consortiums that are the preferred bidders,” says Inam.
“Given the liquidity squeeze, there is no capacity in the bank market to simultaneously fund all the IWPPs in the next six to nine months.”
“Governments of the Middle East will have to step in and bridge the liquidity gap while the banking market recovers,” says the syndications head.
Bankers in the project sector say the recovery could take 18-24 months. Fortunately for Gulf governments, they are in a better position than most of their peers around the world, as they can tap into their oil wealth.
“With the huge fiscal surpluses being generated, it would be easy for them just to do these projects on government balance sheets,” says one London-based project finance head.
However, while Riyadh has the Saudi Industrial Development Fund and the Public Investment Fund to invest in projects, other Gulf states lack similar organisations.
Sovereign wealth funds do have the liquidity, but it is doubtful whether they have the skills to analyse investments in infrastructure, or be able to move quickly enough. The two Saudi funds are already criticised by many Saudi bankers for being too slow.
One source at Abu Dhabi Investment Authority (Adia), the world’s biggest sovereign wealth fund, says investment in domestic infrastructure is not part of the organisation’s strategy. But other organisations in the UAE, such as Mubadala Development Company and the Abu Dhabi Investment Council (Adic), which took control of Adia’s domestic assets in 2006, could be used to plug the liquidity shortfall.
For example, Mubadala’s recent joint venture with the US’ GE will include a fund to invest in infrastructure in the Middle East.
“Sovereign funds do have a lot of liquidity, but I doubt if they currently have the ability to move quickly enough to invest in infrastructure,” says a source at one private infrastructure investment fund.
“It would be better for the banking system, including the project market, if some of that liquidity was put on deposit in the banking system for the banks to redistribute.”
The crucial question of whether the governments want to help in this way also remains unanswered.
The UAE has agreed to provide AED50bn ($13.6bn) in additional liquidity and Kuwait has also taken steps to support its market. But most governments have resisted taking significant measures.
“While it is possible that governments could step in, there is no evidence yet that they will,” says the London-based project finance head.
For the deals that need to be financed while the market is in turmoil, there is universal agreement that they will have a difficult time.
Greater reliance on Islamic banks is another option. In the case of Ras Laffan C, the $3.9bn IWPP in Qatar that closed in September, Islamic banks came in to fund the final $250m tranche of the project.
However, there are still doubts over how much the nascent Islamic banking sector can really offer in terms of additional liquidity.
“Islamic banks still have a long way to go before they can offer truly substantial additional liquidity to the projects market,” says one Saudi banker.
In any event, the cost of debt is likely to rise to more than 200 basis points over the London interbank offered rate (Libor).
“Typically, overall pricing is set by the debt margins about half way through the financing,” says one Dubai-based financier at a major financial adviser. “Now pricing is set by the last dollar raised.”
This indicates that price rises still have further to go. For power projects, that could cause serious problems for governments seeking to set tariffs for the public based on the costs of the provider.
French banks Calyon and Natixis, and Germany’s BayernLB, are underwriting the Shuweihat 2 (S2) IWPP in Abu Dhabi and some are nervous about the deal.
“We don’t know when we might launch this to the syndication market,” says a source at one of the banks.
“If it is left any longer, banks will have closed their books for 2008 and we will be left with huge underwritings to carry over the year-end reporting season.”
The banks will not welcome predictions for the next year. “[I think] 2009 will be slower than 2008,” says the syndications head.
“The outlook for 2009 is extremely difficult to predict, and much of it will depend on the impact of the US government’s $700bn rescue package,” says Puri.
There could be some positive effects caused by projects struggling to get funding though. It could force the region to reassess the scale of its ambitions in light of what is achievable.
“The problem for the Middle East is that projects have just become too big,” says the London-based project finance head.
“If things struggle for a while, it could help relieve the overstretched construction market and convince sponsors that some schemes are just too big to get financed.”