Cash in hand
Funding major infrastructure projects in the region is increasing
The market for funding major infrastructure projects in the GCC is continuing to improve as a result of strengthening finances of both local and international banks.
“There has been a significant increase in bank liquidity in the last 12-24 months,” says Richard Keenan, a partner at law firm Chadbourne & Parke. “This has been driven by the return of the French banks.
“Some have been reporting very robust liquidity conditions.”
Keenan explains that the GCC’s project finance market got underway around 20 years ago, with Oman being the earliest adopter. Abu Dhabi also began using project finance markets in the late 1990s, while Saudi Arabia’s Supreme Economic Council began plans for its privatisation programme in 2002, with the first project launched two years later.
Other markets have been slower to embrace project finance, but this also appears to be changing as spending on all types of infrastructure ramps up across the region.
In September last year, QNB Group said GCC governments spent $112bn on capital projects in 2012, and predicted this would increase in 2013, with the percentage of government GDP outlay on infrastructure forecasted to rise from 7.2% to 8.1%. Government-declared infrastructure projects to be delivered over the next 7-10 years are now valued at $80bn.
Adrian Creed, an Abu Dhabi-based partner at law firm Clyde & Co, said that the project finance market in the region went through a slump in the wake of the financial crisis. Governments that had been keen to use the model “were hit firstly by the fact that most of the lenders disappeared”. Moreover, big-ticket programmes planned for North Africa were impacted by the Arab Spring.
“Many of the deals that were on the drawing board did not go through,” says Creed. “These are long-term finance deals done over 20 years. They need political stability.”
However, market conditions have improved rapidly over the past 12-24 months. Maarten Wolfs, a partner in PwC’s infrastructure finance division based in Abu Dhabi, says that both the amount of liquidity in the GCC’s project finance market and the pricing of loans has improved due to a growing appetite from Japanese banks to finance projects.
“Japanese banks and the region’s banks are stepping up their efforts and providing long-term financing.
“Export credit agencies are also providing liquidity, and the fact that other markets in the developed world are still depressed makes it more attractive.
“When there is a lot of activity, you get a herd mentality. Everyone wants to get involved.”
Keenan says that one thing lenders are seeking is more divergence in the type of projects being financed.
According to Wolfs, the bulk are currently in the oil, gas and petrochemicals sector.
“Between them, you’re looking at 40% of every dollar spent in project finance in the region,” he says.
The next-biggest market is utilities, which makes up around 20% of the market. Around 10% of project financing is used for real estate deals, including hospitality and tourism projects. There is also a potentially huge demand for using project finance for affordable housing projects.
Currently, Wolfs says social infrastructure such as housing or schools is not yet viewed as a major part of the project finance market.
“That’s not to say it’s not important, just that there hasn’t been that many,” he says.
Creed believes that could change. The first major social housing public-private partnership (PPP) deal in the region – Bahrain’s $450mn Naseej project – completed fundraising in October 2013. It will see more than 2,800 social and affordable housing units being built at two separate locations in the country.
“All eyes are on the project in Bahrain, which could well be a test case or a precedent model for similar projects rolled out across the Gulf,” says Creed.
Keenan’s firm advised a group including the International Finance Corporation, the European Investment Bank and export credit agency EKF on the Tafila Wind Farm project – a $236mn, 117MW wind farm in Jordan that achieved financial close in November 2013.
He believes renewable projects across the Middle East will be another area of interest.
“There has been a lot of talking, but there haven’t been a lot of opportunities.
“For banks, the priority has been to keep diversified,” he adds.
Creed says banks would like to see opportunities around other sectors like roads, airports, public transport, hospitals and the education sector.
The difficulty with this, according to Wolfs, is financing an oil & gas or a power plant is much easier in terms of deal structuring.
Governments generally agree to buy power from a plant for a set period and often back this up with clauses stating that they will buy it out if that agreement ends. Lenders to the project also gain security on assets such as plant turbines.
“It’s a lot easier to draw a line around a tank field than it is around a metro or a hospital,” he says.
In terms of countries, Saudi Arabia dominates, and was the third-biggest destination country for project finance in 2013, although this was largely due to the $10.5bn deal to fund the $19.3bn Sadara chemical complex being built in Jubail for a Saudi Aramco/Dow Chemical Company joint venture.
David Brazier, a Riyadh-based director of Deloitte’s Infrastructure & Capital Projects team, said that the way in which the Kingdom has engaged with private funders has differed across various parts of the economy, or government departments.
“With the ministry of transport, for instance, the Kingdom has basically leased all of its ports to private operators. The Saudi Railways Organisation has used a different structure whereby they have taken finance from the Public Investment Fund for projects.
“In roads, however, they have not done any Public-Private Partnerships or Private Finance Initiatives, which is something that has been popular in other parts of the world like the UK through setting of tolls or shadow tolls.”
The reason for this, he says, is due to different imperatives. In the UK and other markets, private finance was undertaken as a way of not increasing public sector borrowing to fund capital projects – so schools, roads and other assets could be paid out of revenue budgets over a longer period instead.
“The driver here is different. They have cash to make investments, what they’re looking for is other benefits – building skills and thinking about the whole-life cost of a project.
“They don’t need construction to be paid for by the private sector, but they want a more targeted delivery performance. They have a constructive view about it.”
Oman is the most mature market, and provides the “gold standard” in terms of its structuring of deals, according to Wolfs.
“They have the right guarantees, and there is an arm’s length relationship between the state and the developer.”
Abu Dhabi, too, offers a “clear definition of risk” between public and private partners.
Qatar has made use of project finance for some deals, such as the $500mn Ras Laffan A2 project that closed in December 2013. Kuwait’s Partnership Technical Bureau (PTB), which is overseeing the country’s attempt to secure more private sector investment, is being advised by PwC’s team on projects to set up a public-private partnership to run schools, and a proposed waste-to-energy plant.
Keenan’s team also advised on the financing of the new Az-Zour North Independent Water & Power plant in Kuwait – a $1.8bn project which was the first private finance deal to take place under PTB’s remit.
Dubai, on the other hand, has done little in the project finance space to date, preferring to keep assets such as water and power projects in state hands. This may change, though, with a traditional coal-fired plant currently being considered by DEWA and potential for developments in solar.
In terms of future market trends, Wolfs said that the fact all of the $500mn for the Ras Laffan project was provided by Qatari banks was an example of the increasing sophistication of the local market.
“I am really starting to see the regional banks step up to the plate and provide long term limited recourse debt with competitive margins and sensible covenants,” he said.
This includes greater use of Islamic Finance, which is a trend likely to grow.
Since deals are often structured in a way where a bank can take an asset such as a turbine and rent it back to the project’s owner, it is attractive to Islamic lenders as it doesn’t involve any interest payments, which are forbidden under Sharia laws.
“There is a lot of Islamic money available and project finance is well suited to that,” says Creed. “Until now, only a handful have played a part and they are not the biggest but that is changing.”