Tight market hits big deals

20 March 2008
With dollar liquidity at a new low, it is becoming increasingly difficult to raise financing for the many megaprojects planned in the region.

The $25bn Ras Tanura chemicals and plastics complex in Saudi Arabia, informally referred to as “the beast” by one banker shortlisted for the advisory role on the project, will become the world's largest project financing deal when it comes to the market in 2009.

The prospect is causing excitement and trepidation among financial advisers. Whichever combination of local and international banks wins the mandate will have not only the kudos (and fees) from working on the biggest project deal ever completed, but also the problem of how to raise so much money when the outlook for the global economy looks increasingly uncertain and dollar liquidity is at a new low.

Bankers across the region have become weary whenever Ras Tanura is mentioned. Even without the credit crunch, structuring a deal of Ras Tanura's size is difficult.

Commercial banks are only able to provide about $2bn worth of project finance loans, Islamic banks a further $1bn, while other debt investors such as export credit agencies (ECAs) could provide about $2bn. Short-term instruments such as equity bridge loans can provide $3bn and bonds could take the debt up to $10bn, before equity investment is looked at.

However, with banks reeling from the knock-on effects of the sub-prime crisis and the credit crunch, financing deals of even half this size is difficult. Several projects in the $3-10bn range are planned in 2008, including the $6bn Mecca-Medina rail link; the $5bn Saudi Landbridge; the $6.8bn expansion of Abu Dhabi airport; the $4bn Borouge Petrochemicals project; and the $3bn Ras al-Zour power and water project in Saudi Arabia.

Funding challenges

“There is not the same ease in bringing $2-3bn worth of debt to the market as there was seven months ago,” says Rajan Malik, vice-president and head of syndication at Gulf International Bank in Bahrain.

The three key challenges in funding projects of this size in 2008 will be inflation making the cost of contractors and debt prohibitive, problems faced by local banks in getting hold of US dollars, and the lack of demand among all banks to take on underwriting risk. “Before the credit crisis, loan prices and structures were extremely aggressive,” says Ali Sheikh, director of project finance at Dubai's NBD Investment Bank. “We are going through a period at the other end of the spectrum, with loan prices rising and lenders becoming conservative.”

This increase in the cost of debt will put pressure on project economics. “Rising EPC costs combined with higher interest [rates] are changing the economics of some of these huge projects coming up, especially in the petrochemicals sector,” says one former financial adviser to project companies.

In some cases, oil price assumptions are rising, making the projects appear more economically attractive, he adds. This would leave them particularly susceptible to any drop in the oil price, although no significant change in oil prices is forecast in the short term.

When projects of this size do reach the stage of being structured financially, one of the first issues will be managing the many different investors that will have to take part in these projects. ECAs have quickly developed from being niche players in the Middle East project finance market to a vital source of additional liquidity for huge project financings. For example, at the end of 2007, Japan Bank for International Co-operation had about $6.5bn invested in GCC projects, up from less than $500m in 2003 (see feature, page 63).

With the balance sheet capabilities to invest as much as $1.5bn in a single project, far beyond any commercial bank investment, financial advisers have welcomed ECA's increased participation in the sector. However, it is not without problems.

“Although ECAs offer a deep pool of additional liquidity, they present a whole new set of problems in terms of structuring a deal,” says one Bahrain-based project finance banker. “If you have the Italian ECA on board, that means you cannot source anything from [North] Korea; if you use the Koreans, you cannot get any US turbines.”

Because of the nature of ECAs as sovereign banks, reflecting different diplomatic positions, managing a large number becomes increasingly complex, although a degree of acceptance is starting to set in at ECAs, according to many project bankers.

Even with the best market conditions, it would be difficult to raise a few billion dollars. Now it looks even more difficult. “Convincing banks to take on large syndications in the current market will be a big problem,” says one banker at a regional institution. “Last year, I was prepared to underwrite $700m under the expectation that I may be left holding $120-100m. Now there is a good chance I could be left with $300m and holding that asset for quite a while. With the bigger deals that are a few billion dollars, let alone Ras Tanura, the market will be saturated with banks trying to sell down their exposure to these projects.”

If the banks can be convinced to take on syndication risk, the next problem will be getting that debt syndicated. Over the next 12 months, convincing regional banks to take on long-dated, dollar-denominated debt will become increasingly difficult. “We have no dollar liquidity at the moment,” says one banker at a major Qatari bank. “We can lend in Qatari riyals but cannot do any big dollar deals.”

Saturated market

Opportunities to expand the investor pool through the use of project bonds are also limited. “There has been a lot of talk about project bonds and US investors do have a growing appetite for Middle East securities,” says one Dubai-based banker at an international bank. “But given the malaise in the credit markets, any debt issuance will be very challenging.”

While this all paints a bleak picture of the possibilities for financing, there is some cause for optimism. The fact that so many banks are vying for the advisory mandate on Ras Tanura indicates they believe they will be able to raise the cash.

“Good projects with good sponsors will always be able to get finance,” says Krishnan. “In the current market, it is better to have more equity, and the credit crunch has not affected the availability of equity investment. So projects will probably look at less debt and more equity, with a view to refinancing the equity in a few years when the market has recovered.”

Government sponsorship will play an even greater role in strengthening projects. “Because large projects here in the GCC benefit from strong government support, with wider pricing, we expect eventually most of the major projects will get done, given the typically strong project fundamentals and low political risk,” says Sheikh.

With record oil prices giving governments huge surpluses, it is easy to conclude that they should just accept the new market conditions and be prepared to pay steeper interest costs than they are used to so the deals get done. In many ways, that will be key to successfully funding megaprojects. Most bankers say that while raising money is difficult, the debt is there for the right price.

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