How The Arab Spring Is Affecting The Project Finance Market In The Middle East
By Sohail Barkatali
Portions of the Middle East remain in turmoil. Syria, Libya, Yemen, Egypt, Tunisia, Bahrain and Iraq are unsettled to varying degrees. A panel of experts talked in Paris in July about the extent to which the political instability has taken a toll on the willingness of developers and lenders to undertake new infrastructure projects in the region. The panelists are Philip Helmes, chief executive officer of Helmes & Co, a consultancy that is active in the region, Roland Kahalé, head of project finance (power sector) for the Middle East and Africa at BNP Paribas, and Peter Goodall, global head of natural resources at Crédit Agricole. The moderator is Sohail Barkatali with Chadbourne in Dubai.
MR. BARKATALI: What is different about the market today than seven or eight months ago?
MR. KAHALE: The market is differentiating among countries. Banks are returning to the fundamentals and analyzing what differentiates one country from another, which countries are weak and which are resilient to the crisis. This is a good thing for the long term.
It is harder to lend at the moment to support projects
in Egypt, Tunisia, Bahrain and Syria and maybe to a degree
The fundamentals in many other countries in the region remain strong. Oil prices are still high and that is providing a boost to the economies of the Gulf Cooperation Council countries. The credit ratings of most of the GCC countries like Abu Dhabi, Qatar, Oman and Saudi Arabia did not change, while the credit ratings of the countries hit by the crisis were downgraded.
MR. GOODALL: I think it is worth remembering that in 2010, we were in a market that was recovering quickly from the crises of 2008 and 2009. If you had asked bankers what their principal concern was toward the end of 2010, they would have said regulation of liquidity ratios and where the market was going. Pricing was starting to move down because bankers were behaving like lemmings. Lemmings are very small, furry
creatures that throw themselves off cliff edges without
apparent reason. Banks will see a price going down and follow it in the same way.
The last thing they would have imagined is a sovereign risk in the Persian Gulf countries. It really was a shock to everyone to see that happen first in North Africa and then spread into the GCC. It has become a real issue today for credit committees at banks. There is a sense that people are backpedalling from doing business in a number of the countries.
MR. BARKATALI: Banks are picking and choosing their projects with more care and with greater attention to political risk within particular countries. Where do you see the best
MR. GOODALL: Transactions that were conceived and launched in 2008 and 2009 take anywhere from three to five years to come through financing and construction completion. Three years ago, we were in the middle of a global financial crisis, so the project pipeline is slimmer and the opportunities are rather few and far between right now.
Clearly there are massive needs. For example, we hear about $88 billion that must be spent in Qatar in advance of the World Cup in 2022, including a port, an elevated railway and a bridge to Bahrain. There are still projects moving forward in the Emirates. Liquidity is somewhat tenuous. A number of banks have pulled out of the region. There are concerns over risk. However, the deal flow is not overwhelming, so deals are not being held up by a lack of liquidity.
MR. KAHALE: There should be a lot of opportunity in North Africa in the long run. Morocco is benefiting from the uncertain political climate in Egypt and Tunisia. We see a number of deals there, mainly in the conventional power and renewables
sectors. There are perhaps four or five transactions that are likely to move ahead in parallel. In the GCC, opportunities remain in the proven markets like Abu Dhabi, Saudi Arabia and Oman. Qatar did not tender any new power projects in the last three years. Also, Dubai and Kuwait have both launched their first independent power projects, and the market is reacting positively.
MR. BARKATALI: Phil Helmes, what does the Arab spring mean from the standpoint of a project manager?
MR. HELMES: I work with a number of the sponsors and large engineering firms. A couple of my clients, including a big government contractor in the United States, are looking favorably at the region. The US contractor, who is very conservative, decided to switch strategy and embarked on a new strategy of stepping up its presence. It is setting up offices, moving people and trying to go after new infrastructure projects.
In Egypt, we submitted a proposal in 2008 for the first nuclear power plant. The contract was awarded in 2009. The project is continuing to move forward without any apparent impact. On the other hand, a private petrochemical project on the Suez peninsula in which we are involved is slowed considerably with only local and national bank participation, the risk profile worsened, and that project is limping along.
We just submitted a proposal two weeks ago for another project in Egypt. It appears that certain projects will move forward. Most of the ministries seem to be stable.
Right now the military is in control and things seem fairly stable. There is the potential after the elections for the situation to change. We think private sector projects are more likely to be affected by the election than public sector ones.
We competed recently for a technical advisory role in a large nuclear project in Abu Dhabi. The project seems to be moving along fine. We have clients who are actively pursuing work in Saudi Arabia, particularly in the power and the water sectors. They see Saudi Arabia as stable with plenty of opportunities.
MR. BARKATALI: Where is the financing coming from? Is there liquidity in the market? What is it going to take to finance these deals?
MR. GOODALL: It would be extremely difficult to raise bank financing for long-term projects in Egypt. Most people are waiting to see what happens in the elections. There is concern about the potential outcomes. Maybe I am being a little pessimistic, but that is our view of the situation at the present time.
MR. KAHALE: I agree. Elections are expected between now and the end of the year. There is uncertainty in the short term. Banks need to understand the path forward before they will lend on a long-term basis.
MR. BARKATALI: Moving away from Egypt, but staying with liquidity issues, how do you see the other Gulf countries? There are projects being tendered currently in Oman, Kuwait, Dubai and Saudi Arabia.
MR. KAHALE: There are not as many projects as we were seeing in 2007 in the power sector. A few deals are getting done in the main markets with proven models.
There is enough liquidity on a long-term basis to close
In Saudi Arabia, local liquidity supports a lot of these projects on a long-term basis on very aggressive terms.
In the other GCC countries, we see Korean and Japanese contractors are bringing financing from Japan and South Korean sources. The commercial tranches we see on these deals are not large, and there is enough liquidity on a long-term basis from the commercial banks to fill such gaps.
MR. GOODALL: The French banks are the most active banks in the project finance market according to the league tables. Overall volumes were down in the first quarter. It was a low point in terms of transactions. A huge portion of what got done was in Asia, particularly in India. French and Japanese banks remain active, and a number of other European banks are still playing along with a few American banks.
It is absolutely right to say there is enough liquidity for the pending deals, given the alternative sources of funding that are being used. We are seeing the export credit and multi-lateral lending agencies and local banks take more active roles. A contractor looking for a financing for something other than a mega-project will have to really rely on the local bank market or else take banks from its home country with it. The large project finance banks are not looking today at the smaller transactions.
MR. BARKATALI: So it is a case of look at what you can bring from home. There is commercial funding available. Export credit agencies are playing an active role. What about Islamic finance and the bond market?
MR. GOODALL: The project bond market has been seen as the next savior of project finance for as long as I can remember. The deal volumes have been very modest. There is a lot of talk at the moment, particularly in the Emirates, about using the bond market for refinancing: for example, for the refinancing of the Dolphin facility between Qatar and the Emirates and of Zayed University? One would think those long-term stable cash flows are the sort of thing that would attract bond investors, but it has not happened yet.
MR. KAHALE: We are seeing Islamic financing used mainly in Saudi Arabia as an alternative or complement to a commercial bank tranche. Most banks in Saudi Arabia can do either commercial lending or Islamic finance transactions.
In terms of the bond market, we are all waiting. Everyone is talking about the bond market, and for sure it is the latest trend. Abu Dhabi is probably the most advanced in looking at refinancing its existing projects in the bond market. There are some challenges to refinancing in the bond market in terms of breaking existing swaps and the economic value to sponsors.
Banks are still feeling their way about what must be done by 2019 to comply with the new capital ratios required by Basel III. The general direction is that there will be less long-term commercial bank financing. The bond market is important because it has the potential to substitute for the loss of liquidity as capital ratios tighten for commercial banks.
MR. HELMES: How large does a project have to be before it will be of interest to the commercial bank market? How large is too large for the current market?
MR. GOODALL: A project that costs less than $400 to $500 million is unlikely to be of interest to the project finance market. The banks are not underwriting projects today. Deals are being done as on a club basis.
MR. KAHALE: In 2007, there were probably 40 banks active in the project finance market. I remember an integrated water and power project in Saudi Arabia where we invited 32 banks and all 32 banks participated, with the result that we had to reduce their tickets. There was no issue in 2007 in project size. Today, some of these 40 banks merged or disappeared, and some have stopped project financing. There are probably a dozen active international banks in the project market in the Middle East.
Advice for Governments Tenders
MR. BARKATALI: What advice would you give to governments in the region about to tender new infrastructure projects? What can they do to ensure that the projects will be able to secure financing?
MR. KAHALE: I think today there is no need really to change the financing model that is currently in place. Deals are getting done on the basis of the existing model in places like Abu Dhabi and Saudi Arabia. Kuwait is following the proven model, and the feedback from the market has been very positive.
MR. GOODALL: Saudi Arabia is a good example of how things are working currently. There is massive liquidity in the local bank market. We have a bank affiliate ourselves in the Kingdom that has the capacity to lend very large tickets. The Saudi government has demonstrated a willingness to spend huge sums of money for rail and other basic infrastructure to support mining and petrochemicals projects. The government commitment to the downstream infrastructure is critical to luring the commercial banks to finance the upstream facilities.
MR. HELMES: Speaking from the perspective of a sponsor
or construction contractor, these are massive projects. What
we look for is a clear set of rules for the solicitation and a
We put a large consortium together to bid on the Saudi land bridge. It started out fine. We spent a good deal of money. We followed the procedure, but we had concerns about how the project could be financed and still meet the objectives of Saudi Arabia. There was never any real dialogue with the bidders, and it drifted into a low bid situation. They wasted a year playing with the low bidder. In the end, the project could not be financed and the enthusiasm for the project waned and nobody wanted to do it over.
Compare that to our experience in Egypt. We put together a bid for a very sizeable project. The request for proposals was clear. The bidding had an odd start because 30 people showed up for the initial meeting. Everybody sat there. The chairman came out and said, “Welcome to Cairo. Do you have any questions?” That was the meeting. We all looked at each other. Somebody started to ask technical questions, but the meeting could not have lasted more than an hour. Despite the inauspicious start, the government followed the procurement rules to the letter. There was a public opening of bids. The deal went to the lowest bidder. The government sent letters to keep the other bids alive. The initial winner could not close. The deal went to the second bidder. It closed. The government let everybody know. We were disappointed we didn’t win, but the process was transparent and fair.
MR. BARKATALI: How about other jurisdictions that recently tendered independent power projects: Kuwait and Dubai? Neither jurisdiction has a strong track record of using project financing for power deals. What will it take to do a deal in those countries?
MR. GOODALL: Banks have balance sheet constraints. Why do a project in Kuwait as opposed to a project elsewhere? It helps if there is the potential for a broader range of business for the bank than the one loan. Maybe the sponsor is a company that you work with in project finance, perhaps in capital markets, perhaps as a day-to-day banker in its home country. A
relationship driver is important.
The risk allocation must also leave the bank with the same exposure that it would have been prepared to take before political unrest intervened in the region. That may mean bringing in multilaterals or export credit agencies to take political risk and maximizing borrowing from local banks through Islamic financing or some other form of liquidity.
MR. BARKATALI: Roland Kahalé, how would you finance a project in Dubai? Dubai’s relationship with banks has been slightly estranged.
MR. KAHALE: Dubai’s initial plan was to issue a project combining power and water, making it a very large project. Before issuing the RFP, they reduced the scope just to power, and I think that that was a very good initiative. The size of the project is manageable, and the timing is good because the EPC market today is much more favorable than it was. We still need to see how much support there will be for the project from government financing institutions.
MR. HELMES: Contractors do both power and wastewater, but through different divisions. It makes it easier on bidders to separate big projects by discipline. Many of the EPC contractors prefer that.
MR. GOODALL: We haven’t really touched on pricing except to say that it stabilized and then came down toward the end of 2010 without getting anywhere near the levels we saw previously. There will be a premium to pay without a shadow of a doubt. And pricing will not return to pre-2008 levels any time soon because, in addition to the perception that there is greater political risk, you also have banks liquidity costs that are much higher than where they were previously.
MR. BARKATALI: Do the same considerations apply to the other jurisdictions?
MR. GOODALL: It is difficult to generalize. We mentioned Morocco as being a friendly environment where things could be done, but we do not have a massive history of project financing in Morocco. In Egypt, we are in a wait-and-see mode for at least a few months. Tunisia is “wait and see how things evolve.”
MR. BARKATALI: What is the future for projects in the
MR. KAHALE: The fundamentals are there currently in the GCC countries to support project finance. Bahrain today is
facing issues. North Africa has a strong potential, and I am
optimistic for Egypt and Tunisia.
MR. HELMES: Contractors sense opportunity to earn fees for services, especially on government-related projects in Saudi Arabia. The nuclear power area is intriguing, with the nuclear power plants in Jordan, Abu Dhabi and Egypt. It will be interesting how these projects can be financed. With a nuclear power plant, you put in oodles of money without knowing whether the project will work until it is commissioned. The project can take 10 years to build. You are floating out there a long time with no cash flow from operations. I just don’t know how you’re going to finance that, but I see a lot of fee business.
MR. GOODALL: Our position at Crédit Agricole is that we have affirmed our desire to continue in the project finance market. Construction finance is one of the planks of development. We have a three-year plan that puts a lot of weight on the construction finance business. Beyond that, it will be a question of choosing among deals and getting the pricing right. I tend to think that there are a lot of issues that can be resolved through pricing for the banks. I am optimistic for the Middle East and North Africa. Let’s not forget that the governments are cash rich. So as far as the contractors are concerned, the governments can get things done. They can write checks.
MR. BARKATALI: Phil Helmes, how do you see the EPC contractor market in the region developing and growing?
MR. HELMES: The region has money. There is less money in the US market. The number one rule for contractors is to follow the money. That is why one of our clients decided to drop some other strategic locations and focus on the Middle East. The EPC contractors do not have a lot of their own capital to put at risk. They need to team up with strong balance sheet sponsors like equipment manufacturers who can bring part of the financing in exchange for selling equipment. ¥