Cold capital

The Middle East's district cooling sector is set to continue growing, but there are financial challenges ahead.

Marietta: district cooling is a capital intensive business and large-scale investments are needed in the sector in the next decade.
Marietta: district cooling is a capital intensive business and large-scale investments are needed in the sector in the next decade.

As the district cooling sector continues to grow in scale and importance in the Middle East, the opportunities within the region are also being recognised at a global level. But with opportunities come challenges, one of the biggest of which for firms is establishing a financial strategy to cope with the number of developments underway and planned for the future.

The topic was tackled by a series of industry experts during October at the IDEA International District Cooling Symposium in Dubai hosted by the Middle East Chapter of the International District Energy Association (IDEA).

 

If you want to start out in this sector today you�d better have some excellent access to capital.

Entitled Collaborating, co-operating and constructing the future, the symposium programme covered market trends and opened discussions on ways to overcome the obstacles to further growth, including the need for solid capital and financial strategies.

 

"District cooling is a capital intensive business," stressed Tabreed deputy CEO Karl Marietta. "This aggressive [market] growth requires capital and as we are a private company the shareholders expect a return on their equity," he added.

Tabreed has recently posted healthy profits, however the speed of industry growth means that alternative means of gaining capital investment are being investigated.

The prime drivers for the market growth are high oil prices, low interest rates and ample liquidity in the banks, explained Mohammed Elshentenawy, chief financial officer, Palm District Cooling. And this market is showing little sign of slowing: "It is forecast that there will be investments [in the construction sector] by 2015 of US $45 billion (AED165 billion) according to the projects released in the region to date.

These need to be funded and capitalised, however this $45 billion investment is proportionally small compared to the total investments announced for the region," stated Elshentenawy. These overall investments include a predicted spend of $1.5 trillion in the oil industry by 2011; "All of these investments will be competing for the same funds," he warned.
 

So how much investment is needed for the district cooing sector in the short to medium term? "We estimate that [Tabreed] needs to raise 3.5 billion Dirhams by 2012 [to fund future district cooling projects] and we need to raise 1.2 billion Dirhams of this by 2008," reported Marietta.

Several options are being considered by the firm to raise this equity, including returning to the shareholders for another rights issue, a route which the firm would rather avoid Marietta stated. "We are focussing on a product that's been used lately - a convertible bond or sukuk," he stated. "The advantage of this is that the shares get seen as closer to the market, so shareholders are more willing to issue shares," he explained.

 

It is critical [for firms] to secure a decent rating level and funds for the financial institutes.

A further method of raising funds is through private equity or by the sale of assets. Again, both of these methods are being investigated by Tabreed as potential solutions to enable the continued growth of the firm. "Tabreed is a holding company and has a number of subsidiaries which we could sell. We are not considering this seriously now, but it is an option," Marietta stressed.

In terms of debt, the firm plans to continue to raise funds using Islamic methods. There are two reasons why this is beneficial to privately-owned district cooling firms explained Marietta: longer terms are possible; plus with sukuk's, although a shorter term is involved it is not necessary to put down a lot of money when refinancing.

"We are all trying to find the mix that will maximise funds to shareholders, while taking into account the ability of the company's to deliver what they promised," stressed Elshentenawy. The key drivers to financial success, stressed Elshentenawy, whether capital or off of the balance sheet is to ensure that robust project parameters exist, including whether it is financially feasible and contracts are bankable.

"It is critical to secure a decent rating level and funds for the financial institutes," stressed Elshentenawy. "Another issue is how to identify and allocate risk parameters and cover these contractually in order to get financing for projects. A key point is identifying what banks and ratings agencies are looking for and trying to put the pieces in the right place to make your projects attractive ," he added.

External market forces cannot be ignored when trying to establish financing for district cooling projects warned Elshentenawy, and these can come from unexpected global sources.

"With the sub prime mortgage meltdown that took place in the US earlier this year people thought that the region was isolated, but we saw some of the major financial institutions in this region tightening their liquidity," explained Elshentenawy. "Some external factors beyond the control of your company will affect your decisions and plans," he stressed. One of the main issues in the region is the continuing rate of inflation due to the weakness of the US dollar, to which the local currencies are pegged.
 

The increasing size of both district cooling plants and overall projects must also be considered as should the role of the developer. "Master developers in the region are in the prime business of developing real estate projects and are now asking [district cooling providers] to accept terms and conditions on concession agreements that will allow us to get financing from international lenders.

It's quite a complex process and there is a learning curve to go through to enable us to do this," stressed Elshentenawy.

 

The UAE is leading the way in changing the business model to higher efficiency.

Such international funding is, however, likely to become more common on future projects. Marietta confirmed that Tabreed is also looking to Europe and Asia for financing and the other major district cooling providers are expected to make similar moves.

And it is not only capital costs that are an issue for the sector, life cycle costs must also be considered. "The first cost of a district cooling system is actually small compared to the life cycle costs of the plant," stressed Dan Mizesko, managing partner, US Chiller Services, "The chiller drives the energy cost in a district cooling plant.

If chilled water plants don't operate as intended in design the number one reason is a lack of commissioning and maintenance," he added. By applying these strategic services to a plant their efficiency and cost-effectiveness will improve, which are primary concerns of the current market.

"The traditional hvac market was driven by capital costs and there was little incentive to provide high net solutions to owners, but we are now seeing a need for a new model that rewards all in the life cycle chain," explained Tom Pierson, chief executive offficer, TAS.

"We have got a convergence where on a macro scale there is a push saying we have got constraints and want to have a higher efficiency, meanwhile at the bottom we have a model where firms are looking to make money - both factors are pushing towards higher efficiency and the UAE is leading the way in changing this business model," he added.

With district cooling providers generally operating the plants for long-term concession periods after the project is complete it is clear that these issues must also be tackled. And as Marietta warned: "There are many things that you have to do be successful in this industry, but if you want to start out [in the district cooling sector] today you'd better have some excellent access to capital."

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