The State of Project Financing in the Near East
Financing projects in the Near East remains challenging. The commercial banks have largely disappeared. However, Saudi and other regional banks are active and are offering attractive terms. The Japan Bank for International Cooperation and the Korean export credit agencies have become increasingly aggressive in finding ways to support contractors and investors from their regions outside the OECD consensus terms. Other development banks and export credit agencies are also eager to support development in the region. Saudi Arabia is a bright spot, especially for solar companies. Political risk coverage is available in some countries at rates that reflect varying degrees of perceived risk.
A group of panelists talked about these and other issues in the region at an emerging markets conference that Chadbourne hosted in Washington in January. The panelists are Hussein Ibish, a senior fellow at the American Task Force on Palestine, Daniel Wagner, CEO of country risk solutions, Jorge Jaramillo, principal counsel, at the International Finance Corporation, Terry Newendorp, president of Taylor DeJong, Nancy Rivera, managing director, structured finance, at the Overseas Private Investment Corporation, Aman Sachdeva, principal and CEO of Synergy Consulting, and Julie Martin, managing director at insurance brokerage Marsh & McLennan. Kenneth Hansen and Noam Ayali with Chadbourne in Washington asked questions.
MR. IBISH: The Arab Spring is having a significant effect on projects in the region.
First, all assets possessed by the state are up for grabs. Everything that might have been considered relatively secure two years ago can no longer be considered stable or secure, so any kind of risk management assessment must take that into account, even when things look secure and predictable in the immediate term. Morocco is an example where, in the medium and long term, everything is up for grabs. Caution is highly advisable.
Second, so far, revolutions and regime changes have been restricted to republics such as Tunisia, Egypt, Libya, Syria and, to some extent, Yemen. The monarchies are relatively stable. The Gulf states are trying to manage the transitions through various forms of power projection, particularly influencing through money. They are united. This includes Qatar and Saudi Arabia, who have not agreed on much over the past 15 years or so. They agree that if revolutions must occur, they should be restricted to republics and must be prevented from happening in monarchies, including Jordan and Morocco. The big challenge is to prevent a revolution from happening in Jordan. The Gulf states also agree that, if there is to be a new order, it must be dominated by Islamists. They do not agree on what variety and no one is keen on any of them, frankly, but they prefer them to liberals. The big danger is Jordan, because the social contract in Jordan is in tatters. The Jordanian monarchy and Jordan are more or less synonymous. It is hard to imagine Jordan continuing as it is without the monarchy, and the monarchy is not functioning as it ought to within the Jordanian social contract. Its core constituency is in very bad shape, so it is in grave danger.
The other monarchy that is brutal is Saudi Arabia, with its high unemployment and large population. It is possible that in the long run, or even the medium run, unrest could spread to monarchies.
Third, there is a gradual disintegration or fragmentation underway in the “mandate states” of Lebanon, Palestine, Syria and Iraq. The outcome for Syria is not clear, but it is clear that the old centralized Syrian republic from Damascus will not survive. Whatever happens will entail some form of state fragmentation. It means that Jordan is all that is left in the Levant, if you understand Israel, Gaza and the West Bank to be a fragmented form of the former mandate of Palestine. That calls attention to the future of Jordan and its survival as a centralized unified state if Iraq, Lebanon, Palestine and Syria have all failed. It means that anyone doing business in the Levantine states must think in terms of doing business with non-state or sub-state actors. The obvious example is the Kurdish region in Iraq. It is not a sovereign entity, but it behaves as if it were. A similar reality may emerge in Syria. It already exists in Lebanon to some extent and certainly when it comes to the Palestinians. It may emerge in other places as well.
Fourth, the notion is taking root in Washington that it is inevitable, irrelevant or desirable that Islamists come to power as a result of these uprisings in post-dictatorship Arab societies. It is not inevitable as seen in three contiguous North African states that have had post-dictatorship elections with three completely different outcomes for the Islamists. In Egypt, there was a solid victory for the Islamists that, while eroding, is still there. Islamists received a plurality in Tunisia and suffered an outright defeat in Libya. Their rise to power is not irrelevant because the Islamists across the board share a paranoid and chauvinist world view that is unfriendly to the West. Yes, the Muslim Brotherhood in Egypt are businessmen who understand the idea of contracts. However, in the medium run, a confrontation with the West over values and perceived interests is virtually inevitable.
Finally, all of this tumult means that there are tremendous opportunities as well as tremendous risks. It is almost a cliché now to point to Libya as a country that has foreign exchange. It is exporting increasing amounts of energy and making increasing amounts of money.
The divisions that I am talking about tend to be sub-national. Only a few states like Morocco and Egypt have either a very long integrated history or are so small and so rich that they are immune from this.
MR. WAGNER: It does not pay to generalize about this part of the world. If you do, you will inevitably make mistakes.
It is worth comparing the flow of foreign direct investment to various countries in the region. You might be a bit surprised at some of the statistics. I looked at the UN conference on trade and development, foreign direct investment, inbound statistics comparing 2009 and 2011. Tunisia was down 35% over those two years, and Syria was down 27%. Compare this with Jordan, which was down 38%, but Jordan did not have any particular conflict during this period. Compare, for example, Egypt, which was down over 100% between those two years, with Qatar, which started out with $8.1 billion in foreign direct investment in 2009 and ended up with negative $900 million, since the outbound was more than the inbound. Oman was down 53%, Kuwait was down 64% and Saudi Arabia was down 50%. These countries did not have conflicts, and yet they all suffered the same malady. You could argue that this was in large part due to what was going on in the neighborhood.
Inbound foreign direct investment to developed countries was also significantly down during this period. Japan was down 86% between those two years. Australia, Canada, Germany and the United Kingdom all suffered. When we think about the relative risks involved in investing in any of these places, we have to look at each project individually. We also have to look at each individual investment climate and make a determination. While all of those countries that I just listed had big problems, Israel was up 248% and Turkey was up 189%. Investors were making distinctions among acceptable projects, risks and countries.
Many of you will be familiar with the World Bank Group’s “ease-of-doing-business” rankings. It was interesting to compare a few countries. Tunisia ranked 50. Luxembourg ranked 56. Luxembourg was rated as more risky than Tunisia in 2011. Egypt ranked 109, Russia 112, and the West Bank and Gaza 135. Not great, but Brazil and India are ranked 130 and 132, respectively. Does that stop people from investing in Brazil and India? No.
Expropriation has been on the increase, more generally, since 1988. Particularly in the primary resources sector, it has been going up like a rocket. In the natural resource sector, where governments have perceived that their own interests are very much served by expropriating assets, they have not hesitated to do so, and yet, ironically, the natural resource sector is where many of the investments have gone.
MR. HANSEN: Jorge Jamarillo, you have just heard that the Middle East has not been a great place lately for inbound investment. You moved from the International Finance Corporation headquarters in Washington to Cairo. Why?
MR. JARAMILLO: I started with IFC in 2000 and moved to Cairo in 2004, a year after the US-led invasion of Iraq. At that time, there was a lot of interest in reform and democracy in the region. I joined the Cairo office with a group of “rainmakers” on the business side and other officers who had a mandate to expand an existing advisory services facility into something called “Private Enterprise Partnership MENA.” The IFC office in Cairo in 2004 was pretty much like a representative office of an international bank with about 15 or 20 people. They were not processing transactions. It was more focused on helping visitors on mission and arranging meetings and logistical support for them. The office turned into a 120-person office, and our investment commitments increased from $206 million in 2004 to $1.5 billion in 2008. Last year, we reached $2.2 billion in investments during that year in the Middle East. Similarly our expenditures on advisory services moved from less than
$5 million in 2006 to more than $20 million annually last year.
I lived in Egypt for eight years from 2004 to 2012. I moved back to Washington in September, so I have a first-hand account of what happened there during the Arab Spring.
Egypt has the largest Arab population in the world. In 2004, Egypt had a new, reforming cabinet. Some of the ministers in the cabinet, like the minister of finance or the minister of investments, were enlightened, brilliant people, and they opened up the economy. There was also freedom of expression, and people had access to all kinds of information. In a way, the cabinet was a victim of its own success. When the Arab Spring started in Egypt, people were asking for changes like terminating the emergency laws and stopping police force abuses, but the thing gained momentum and then combined with demands for dignity and social justice for the Egyptian people. They did not want to feel, as put by the military, like cattle being passed from the hands of the father to the hands of his son.
On January 28, 2011, I was in Cairo. On that day and the following day, the telephone lines, both fixed and mobile, were cut, internet access was cut, and the gates of some prisons were opened. Thousands of criminals were released while the police force was sent home. I saw how civil society managed to organize itself peacefully. Now, as it happens in any revolution, people are fighting to figure out their new identities. There is uncertainty and, therefore, the investment climate is not very conducive for new investments. I remember a Republican US Senator went there to witness the presidential elections and commented that it took 10 years for the United States to find its way after the American Revolution.
IFC has tried since the Arab Spring to help in maintaining investors’ confidence in the country and, to that end, we made big investments. For example, we were part of a syndicate that mobilized more than $2 billion to refinance a fertilizer group. A few months later, we did another big transaction of $100 million with a construction company that was a revolving credit line for working capital. Nevertheless, at the moment, most of IFC’s work out of Cairo is by advisory services, but we hope that investments from places other than the Gulf will resume.
MR. NEWENDORP: We had two clients in Egypt whose deals in the oil and gas sector fell through in 2012. Project finance takes a long time, but we cannot really wait around indefinitely for improvement in the investment climate.
Sticking with oil and gas, there has been a reasonable amount of activity in Tunisia with new leases and exploration. In Libya, the Italians have been in the trenches, but are having a great deal of difficulty getting their deals put together. In Jordan, we had two significant deals die quickly in the second half of 2012. There is an enormous amount of concern among investors in the Gulf states about the monarchy in Jordan. It is too bad because Jordan has been a beacon of stability for some time.
Bahrain is a big problem. Bahrain had two deals that it would have liked to launch in 2013. One was the expansion of the Bapco refinery, and the other is expansion of the Alba aluminum smelter. There is major difficulty in attracting even regional bank debt, let alone the European banks. The European banks are not active in Bahrain right now. Two of them have maintained offices with skeleton crews primarily to provide investment advisory services.
On the flip side, a tremendous amount of liquidity exists in local Saudi banks where things have been extremely busy. There is an enormous appetite for projects in Saudi Arabia, particularly among the Koreans and Japanese. JBIC multiplied its financing commitment for Saudi Arabia. It is trying to facilitate greater Japanese penetration into some of the Saudi power and petrochemical projects.
Both the United Arab Emirates and Qatar are solid. The banks are liquid and are supporting transactions both in their own markets and in the region. One of the major beneficiaries of what has gone wrong in Egypt is Morocco. We see a huge amount of activity, including large oil and gas companies who would have shunned Morocco in the past and are now pouring money into developing offshore concessions. A tremendous amount of interest exists for projects in Morocco and the Kurdistan Republic.
Three years ago, there was one international oil and gas company active in Kurdistan; today, there are more than 35 compared to five who are active in southern Iraq. That says a lot about where people are willing to invest.
Within the Middle East as a whole, project finance debt is available from banks in Saudi Arabia, the UAE and Qatar. The European banks have saved some capacity for their favorite clients and countries. By and large, the European banks want to re-enter the project finance market with large corporate lending to mid-size and smaller clients in the oil and gas space and even in the infrastructure space. Project finance lending in 2012 in the MENA region was largely a story about export credit agencies. It was not a story about commercial banks.
MS. RIVERA: The Overseas Private Investment Corporation has a deep interest in the region as the US government’s development bank.
Before the Arab Spring, we were committed to the region, particularly Iraq. With the growing priority in Afghanistan and Pakistan, that interest spread east. We have been trying to pull business to the region. Part of what the US government promised the region after the Arab Spring is for OPIC to be even more engaged than it had been in the past.
OPIC announced shortly after the Arab Spring that it would deploy more than $1 billion as quickly as possible. However, the private sector hit the pause button. The commercial banks are missing in action. At this point, you need multilateral financing to double up and work overtime to fill the gap. The confluence of the Arab Spring and the lack of depth in the credit markets has made the job that much more difficult.
I want to go through the countries from west to east and give you a flavor of what OPIC has been doing. Bear in mind that, even under normal circumstances, project financing of investments in these countries is difficult. The difficulty is compounded by the fact that many key countries have only transition governments. It is hard to find decision makers in key government departments who can be expected to remain in place for a long time. It is a grim picture, but we have been successful with putting money into this market on an expedited basis. We have done it by focusing on the pieces that continue to function. That may not be infrastructure, which really is the engine of these economies, but it certainly is SME lending or funding of the small and medium-sized enterprises that are the other economic engine.
Done well, SME lending is a relatively safe investment. We lend to banks, non-governmental organizations and other players who have the ability to relend funds readily to make a difference. We are not afraid of lending medium and longer term, so people can do things that they would not be able to do with what would otherwise be only a six-month or one-year facility.
Going from west to east, we would love to do more in Morocco. Morocco has traditionally been dominated by European, not American, investment. However, there are some interesting opportunities there, in particular in the energy and power sectors.
We have experience with Algeria. It is not an easy country in which to do business. You can do a great deal with Sonelgas and Soneltract in the oil and gas sector, but after that it’s pretty limited.
We are very keen on supporting Tunisia. We have a franchising facility in place in Tunisia where anybody who is operating or setting up an American franchise can borrow money through this medium-term facility.
We are not open in Libya.
Egypt is the other big country that we are emphasizing. We have put several hundred million dollars into the financial sector for SME lending. We are very interested in supporting infrastructure investments in Egypt. We have spent a lot of time trying to figure out how to get money to, through, with or alongside the government, but it will take longer.
We understand the value of supporting Jordan, and we continue to do so. It is a country where we have a significant amount of exposure. The last time I checked it was probably more than $700 million, which is a sizeable number for a portfolio that is about $15 billion in total. We just closed a deal that will disburse in two weeks for the third or fourth independent power project in the country. It was the European Bank of Reconstruction and Development’s first deal in the region. EBRD is now very active and keen to support this sector. If you are looking for money, it is a good place to start.
We have been supporting Iraq for some time. It is another challenging country. There are interesting opportunities, especially in the north. We have been trying to support a broad range of projects in Iraq from hotels to power generation to upstream oil and gas.
The Gulf for all practical purposes is closed for OPIC, because it is relatively high income, and we shy away from those countries.
Although we are not active in Saudi Arabia, if I were not at OPIC, I would be going after Saudi Arabia like mad. They have a very ambitious agenda. Saudi Arabia has decided to restructure its power sector to have 20% of generation come from solar. The program has been somewhat delayed, but people are expecting that it will kick off in earnest as early as next year. The economics, if you are in that space, are phenomenal because you can have a significant amount of run-on business.
MR. SACHDEVA: Our firm has seen quite a bit of change over the last 15 years in the MENA region. Commercial banks are pretty much gone. I can remember discussions in 2005 when developers considered any conversation with the US Export-Import Bank or JBIC torture. They no longer have the luxury.
Requests for proposals from governments in the region used to remain open for a four-to-six-month time frame. You had to submit a firm price bid. The only adjustment that these bids allowed were for movements in live work, and nothing else. You had to negotiate your EPC contract and all the underlying agreements within that time frame. That meant there was no question of ever talking to the export credit agencies because all you could get within four to six months from them was a letter of interest.
JBIC changed that. JBIC has gone outside of the OECD consensus terms time and again. It has been quite aggressive. You are talking about tenors for projects in Saudi Arabia and Abu Dhabi of 20 to 25 years. No European banks will do that.
Three years ago, there was a lot of activity in Egypt. All of that has pretty much stopped. We were involved in a refinery in 2011, that was just a one-off deal where there was a gap of about $100 million, and a regional company came through with the money. That refinery is now under construction. That is the only deal of which I am aware.
In Jordan, we are currently working with the Chinese on a large oil shale mine and independent power project. Four IPPs have closed in Jordan, all with direct foreign investment or export credit agency money. There is no commercial bank appetite for Jordan. The deal on which we are working currently is really large. It is with the Chinese, so the project will be Chinese owned, with a Chinese EPC contractor and Chinese financing.
We are involved in a very early stage deal in the West Bank. We have not worked out the financing, but I would expect again it to be with the export credits agencies or the Islamic Development Bank.
Bahrain has pretty much shut down. There was one wastewater deal that got done a few years ago before the Arab Spring. It is currently under construction.
Saudi Arabia continues to amaze. It has issued at least one tender every six months for large, $2 to $2.5 billion deals, but Saudi banks come through with 25-year tenors and pricing at 125 basis points above LIBOR. The tariffs in that region are all 2¢ to 2.5¢ a kilowatt hour, including fuel. We work for the sponsors, and the returns are really tight. Buildings have been done because of the local banks. In a $2 billion financing, you will find local banks taking up to $1.7 to $1.8 billion, leaving a small tranche to be financed by foreign lenders.
We have not seen the regional banks much in the United Arab Emirates. The UAE banks took a hit after the dip in Dubai, so you do not get more than 10- or 12-year tenors from them.
Kuwait has been talking about privatization for 10 to 12 years. It finally completed its first deal in the last few weeks, so I expect a lot of interest from all the top power companies. I expect Kuwait to generate continued interest.
Pricing Political Risk
MS. MARTIN: I see it from a slightly different perspective. Marsh is a large insurance broker. I work in a political risk and structured credit practice. We place coverage for banks, but also for investors, and my particular practice is more focused on equity than debt.
The Arab Spring was a wake-up call for investors, not just companies located in the region, but also in other places around the world. They were surprised by the events and the rapidity with which they occurred. I remember visiting an oil and gas company in Houston with investments in Syria four or five years ago. It told me it did not need insurance for that because Syria was a very stable place and nothing was going to happen. The Arab Spring caused many companies to look at insurance, and we saw an increase in demand worldwide, but particularly in the MENA region for those investors who were still following through on investments that had already started.
We have not seen a lot of new investment, although there has been some. In the immediate aftermath of the Arab Spring, most of the private market underwriters were taking a “wait-and-see” position. We were working with one client that wanted to expand an existing investment in Jordan. While it did not have coverage on the original investment, it decided to take coverage on the whole project including the expansion. When we went out to the market to obtain indications, we were turned down by the private market. We had interest from all of the official markets — the Multilateral Investment Guarantee Agency [part of the World Bank], OPIC and ISIC [affiliated with the Islamic Development Bank]. The coverage was ultimately placed with a public market entity. Having an official agency as a partner gave the insured company more comfort.
Since then, underwriters have reopened in some of the countries, but it really depends on the project and country. A good project in a not-so-great country probably could get political risk insurance protection. However, the option are limited. For places like Syria, there is no coverage. No one will insure a burning house. For places like Iraq, Libya and Egypt, it may be possible to find limited coverage for very special projects, short term in nature or mobile assets, but it will be very difficult to find coverage for longer term or bigger projects.
MS. RIVERA: OPIC is open in those countries. There are no issues whatsoever if you are American.
MS. MARTIN: There are still some underwriting concerns in some of those countries.
For the first time, we are seeing investors in Saudi Arabia asking for coverage. There are already some capacity issues for Saudi Arabia. We recently placed a multi-country program, and one of the countries in the program with a very large exposure was Saudi Arabia. We had some underwriters who could not participate at all because they had reached their maximum exposure capacity already in Saudi Arabia. It was a large program. We have 31 markets on it, so it was a very big syndicated risk where we tried to squeeze out all of the capacity that we could. I was surprised that some political risk insurance markets were already out of capacity for Saudi Arabia.
We are also seeing what I would call “contract frustration”-type approaches where people are selling projects to ministries or entities in Saudi Arabia for installment payments over a long term. Underwriters are not concerned so much about the payment risk because, obviously, it is a wealthy country, but they are concerned that contracts may be cancelled or changed by political risk events in the future.
MR. HANSEN: Is the availability of public-sector financing enough to get some equity investors to commit to projects in the region? Can the agencies really make a difference?
MR. NEWENDORP: The answer is yes for Koreans who are now dominating power sector in Saudi Arabia. K-ExIm and K-Sure made a political decision to open the Saudi market to Koreans and to compete head to head with the Japanese, and it has succeeded beyond their wildest dreams. The Japanese are now struggling to catch up.
MS. RIVERA: It is absolutely the case. If we know that the equity needs an X% return, and we feel that it is an acceptable return — because we are not going to support projects that have incentives that are not proper, right? — we will try to find the right combination of government and private sector financing. If you are a strategic investor — not just a financial investor — who knows the business and what he is doing, then I think there is a deal to be had.
MR. SACHDEVA: JBIC really led that market in the Middle East. It has an interesting product called an “overseas investment look” or OIL. If there is Japanese equity, then it can get around the OECD consensus so it is not constrained by tenor and pricing. JBIC did a deal in Abu Dhabi about five or six years ago where it priced at 60% or 70% of commercial bank pricing. K-ExIm started doing that and offers a similar credit called OBS, where it tries to get around the OECD consensus. K-ExIm has played a very big role in that market supporting Korean contractors and has helped a large developer in getting a number of deals done. I helped structure a deal in Saudi Arabia where we got the Korean Trade Insurance Corporation or KEIC to give a $400 million guarantee for a Chinese contract. It is an indication of the level of interest that export credit agencies, including US Ex-Im have demonstrated.
MR. HANSEN: What can you say about asset values in the various countries? Have they been plummeting?
MR. NEWENDORP: Real estate in Dubai is a real bargain these days.
MR. SACHDEVA: There are bright spots, but I cannot say anything positive about it.
MR. HANSEN: So for the bottom-fishing crowd, it is probably a terrific opportunity.
MR. AYALI: One way to assess risk across the region is to get a better sense as to how the political risk insurers are pricing insurance. I wonder if Julie Martin or Nancy Rivera has a sense what the premiums apply in the different countries for different asset classes on political risk insurance.
MS. MARTIN: That requires a complicated answer. It really depends on what is the insurance covers and how it is structured, what the country is, how many markets you need to secure full coverage and other things like that.
For example, for this big program that we just built with 31 markets, the markets at the top are earning a lot less than the markets at the bottom who are closer to the risk, but I would say it is about 50 basis points times the coverage limit, but there were also indications for a single project in Iraq that priced at a rate above 300 basis points times the limit.
I just recently did an infrastructure project in Algeria with a good client, and it was around 135 basis points times the coverage limit. We have seen prices reach 500 basis points, but such high premiums are rare. It is rare to find somebody willing to pay that much and somebody willing to provide coverage even at that rate.
MS. RIVERA: At OPIC, we are open in all of those markets, and we still continue to price off a rate card, so if you go to the OPIC website, you will see for the different types of coverages what the range of pricing is for any given situation.
MR. WAGNER: In my experience, I’ve seen contract frustration rates go as high as 25% and be paid because, when you have a 300% mark up, 25% still represents a 275% profit. To give you some perspective, I was in Papua New Guinea two weeks ago and I learned that, in this place, which is perceived to be extremely risky, four-point coverage can be obtained for 100 to 120 basis points, which is just shocking to me, and if you take the breach of contract out of it, it can be under 100 basis points. The short answer is that where investors find insurers are interested, there will be competition to get into the game, and where insurers simply are not interested, it does not matter what the price is. The risk will not be insurable.