In late 2011, Qatar Petroleum completed the financing for the $10bn Barzan gas project, making it the largest project finance deal in the world that year. Despite a European banking crisis, a deteriorating global economic outlook and a dearth of dollar liquidity in regional banks, the deal gave the impression that the Middle East project finance market was in rude health.

The reality is quite different. Last year, just $23bn-worth of deals were closed in the Middle East, compared with $27bn in 2010 and $57bn in 2007, the peak of the regional construction boom. The Barzan deal accounted for almost half of last year’s total. The bank group included several “opportunistic” lenders, who hoped that by funding Barzan they would be able to position themselves for future investment banking work from the gas-rich state. They are not expected to start appearing in other project finance deals elsewhere in the region.

Limited lenders for projects

This will be a big disappointment for many project sponsors in the region. According to MEED estimates, about $35bn-worth of projects will try to raise funding in 2012. Without a dramatic boost to confidence in the financial sector or the arrival of a new source of funding, the total capacity in the market will remain at about $20bn-25bn.

“Not everyone who wants capital in 2012 will necessarily get it,” says Jonathan Robinson, head of project and export finance at the UK’s HSBC. “The number of banks doing project finance lending has dropped dramatically and, for the ones that remain, capacity to lend has also dropped dramatically.”

The eurozone crisis has forced many banks, particularly French lenders, to sell off assets in the secondary market to boost their liquidity and has left them with limited resources for booking new deals. “We will still support key clients where we can, but anything over 20 years you can forget it,” says the syndications head at one European bank.

Local banks can offer an additional pool of liquidity, but that liquidity tends to be concentrated in the banks’ local currency, meaning they will generally only lend to projects in their home country. Some banks say there is a possibility European banks could start lending in euro-denominated tranches if the single currency zone gets its house in order, but that is not yet looking likely. Bond markets, while an attractive option, have also failed to show they are a workable alternative to bank lending.

“Capital markets have to be part of the medium- to long-term solution for funding projects, but right now the Middle East is overwhelmingly dominated by greenfield schemes, which are a challenge for the bond markets,” says Robinson.

The one project bond completed in 2011 was arranged for a joint venture of Saudi Aramco and France’s Total for their Jubail refinery. The deal was sold exclusively to Saudi investors. Although bankers have welcomed the attempt by Aramco to try to create a market for project bonds, they are still a long way from being a significant source of liquidity for projects in the region.

The Barzan deal was originally due to include an international bond issue, but that plan was dropped in favour of a Qatar sovereign bond because of market volatility. Not every project can rely on a strong sovereign sponsor to step in if the debt markets do not look attractive.

The success of Barzan made the UK’s Royal Bank of Scotland (RBS) the biggest project finance adviser in the region in 2011, a position that could be repeated next year. RBS is working with the local Riyad Bank on the $20bn Sadara petrochemicals scheme, a joint venture of Aramco and the US’ Dow Chemical. Sources close to that deal say they are aiming for financial close in the last quarter of 2012. If they hit that target, RBS will have again advised on the largest deal in the region.

Liquidity pools popular

RBS is also adviser on what is likely to be the first deal to be launched to the market this year, the second phase expansion of the Emirates Aluminium project in the UAE. The scheme is expected to cost about $5bn, with financing split between bank loans, export credit agencies (ECAs) and a bond issue. The Sadara scheme is planning to tap those same liquidity pools, as well as local liquidity in the banking and sukuk (Islamic bond) markets.

“The best financing strategy at the moment is to go to as many sources of liquidity as possible in overlapping amounts,” says one project finance head at an international bank. “That means that if one of those gets caught short, you have a back-up already in place.”

This will require a continued focus on the use of ECAs, more attention shifting to the bond markets and greater use of multi-currency financings. The potential for banks from Japan, China and the US to play a greater role in funding projects will also need to be explored more fully this year, especially with several projects of more than $10bn hoping to raise funding. So far, the depth of liquidity in these alternative funding options is unknown. How much appetite there is among local banks for lending in their domestic currencies, or even cross-border around the region, is unclear.

Despite this, there are few signs the financial crisis is hitting the size of projects in the Middle East. Along with the Sadara project, a $20bn nuclear power scheme in Abu Dhabi and the $10bn Yanbu refinery, a project of Aramco and China’s Sinopec, are expected to try to raise funding in 2012.

It will not be possible to fund these schemes through bank lending alone. Some of the projects in the pipeline may have to wait until 2013, or even longer, before they are able to reach financial close.

Complications ahead to close project finance deals

As project finance deals tap more sources of liquidity, an already complex asset class will become even more complicated for the advisers to structure and it could mean it takes even longer to reach financial close.

That could be the cost of getting things done. Clearly the model has to change. The challenge now is moving from a position of constrained bank market capacity, to one with mature alternative sources of funding, but this could take several years to develop. In the meantime, the pressures on the project finance market will remain intense, and some schemes will undoubtedly suffer delays and problems raising the liquidity they need.

As one European project finance banker says, “One thing is for sure, there is no way we will raise $35bn with the same sleepy project finance model we have all got used to over the past few years.”