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Infrastructure
Privately financed infrastructure projects in the Middle East
are competing for funding with the insatiable demands of the
oil, gas and petrochemicals sectors as the amount of liquidity
available shrinks. However, argue Afonso Reis e Sousa and
Scott Flippen of the investment bank Taylor-DeJongh, lenders
should view the pipeline of new projects as an enormous
business opportunity.
Opportunity
Beckons
z The privately financed in the past when oil prices dropped as Dubai and Doha airports in the
infrastructure market in the Middle dramatically as they had previously works. These projects follow the
East today faces some significant risen. successful financing of the Queen
challenges. The sector has to compete In addition, the sheer scale of Alia International Airport expansion
for finance against the region’s oil- the region’s infrastructure needs is in Jordan. In addition to airports,
linked industries at a time when staggering. In order to satisfy the several important port and rail
the sub-prime crisis has sucked a projected 10 per cent increase in projects are moving forward this
substantial amount of liquidity out electricity demand annually (and year, including a $6 billion deep
of the banking market, as well as associated desalination), Gulf water port in Qatar, the $10 billion
cope with rising construction costs. Cooperation Council utilities are Khalifa Port & Industrial Zone
And with government treasuries contemplating adding 60,000 mega development in Abu Dhabi, and the
bulging with oil revenue, some argue watts of new independent water and Saudi Landbridge, a $2.5 billion
over whether the private sector is power projects (IWPP) capacity by project designed to provide a rail link
needed at all to fund the region’s 2015 – equivalent to 80 per cent of between the Red Sea and the Gulf.
infrastructure needs. current capacity. The requirements Work is also starting on the $2 billion
The answer lies in part with for water and sewage infrastructure friendship bridge between Qatar and
the understandable reluctance of are similarly astounding. Bahrain.
governments to increase public There are also signs that the Finally, there are even signs of a
spending, because they remember all transport sector is set to take off, nascent social infrastructure market
too well how they have been burned with major expansions of both the in the Gulf. In April 2007 the Abu
Quantum - Finance In Perspective - Issue 4 17
Infrastructure
A CAPITAL TRADITION
The Middle East is no stranger to major capital finance). According to Project Finance International,
projects. Oil majors and petrochemical companies last year saw the United Arab Emirates ranked fifth
have been working with the region’s national globally in the volume of project finance bank loans
oil companies for years and have successfully received ($11.7 billion), ahead of both China and
mobilised private capital for hydrocarbon-related India – despite the fact that China’s and India’s
projects, par ticularly in the countries that make GDP are respectively 73 times and 30 times that
up the Gulf Cooperation Council. Governments of the UAE.
have also enjoyed increasing success in attracting As a whole, the Middle East region borrowed
private power developers to finance and build some $39.1 billion (Char t 1 and Char t 2), almost
independent water and power projects (IWPPs). 20 per cent more than the combined bond
The majority of this activity has historically been and bank loan volumes dispersed in the US
financed through limited recourse bank debt (project market.
CHART 1 – MIDDLE EAST PROJECT FINANCE LOAN VOLUME BY COUNTRY,
2007
Jordan $385 USD millions
}
UAE $11,718 USD millions
}
Bahrain $641 USD millions
} }
}
Qatar $9,547 USD millions
Kuwait $1,400 USD millions
Oman $3,317 USD millions
}
Egypt $4,051 USD millions
} } Saudi Arabia $8,080 USD millions
Source: Project Finance International League Tables.
CHART 2 – MIDDLE EAST CLOSED PROJECT FINANCE TRANSACTIONS
BY SECTOR, 2005-2007
} Oil & Gas 33%
}
Other 2%
Transport 4%
} } Petrochemical 28%
Industrial 14%
}
Source: Infrastructure Journal
Projects Database.
Power 19%
}
18 Quantum - Finance In Perspective - Issue 4
Infrastructure
CHART 3 – MAJOR PROJECTS PIPELINE FOR 2008
30 Oil & Gas
Petrochemical
Power
25
Industrial
Transport
Municipal PPP/PFI
20
Mining
USD Billions
15
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Source: Middle East Economic Digest.
Dhabi Development company, years infrastructure could overtake It was, therefore, no surprise that
Mubadala announced the close of hydrocarbons as the most important the sub-prime crisis and the resulting
a $410 million financing for UAE sector in the project market – no credit crunch had a noticeable impact
University. The scheme was the first mean feat indeed. on project financings in the Middle
education project to close in the GCC Dealing with the consequences East, particularly on pricing.
and, in true Gulf fashion, was also the of the sub-prime crisis is For example, Qatar Steel Company
world’s largest single education Public potentially more complex, not least (Qasco) postponed its planned
Private Partnership (PPP) project. because it comes after a period of financing after an initial attempt in
Overall, it appears that there is economic growth in the Middle October 2007 due to deteriorating
a good mix of infrastructure deals East which was largely funded by debt market conditions. Qasco
in prospect for the Middle East international banks. The banks were purportedly withdrew from the market
in 2008, but these projects will attracted by the region’s inherent after lenders expressed unwillingness
have to compete with some major cost competitiveness, improving to guarantee pricing during the
petrochemical and oil & gas projects country risk profiles and – in the syndication period and insisted on
(Chart 3). However, for the first case of IWPPs – long-term offtake imposing a “market flex” condition
time in recent memory there are no guarantees from credit-worthy – a term that had been absent from
Qatari LNG deals on the horizon, governments. And, as banks became Middle East deals since late 2001.
and this year will also see the end of increasingly comfortable with the Market flex is designed to protect
the wave of mega petrochemical deals region, competition increased and mandated lead arrangers by allowing
in Saudi Arabia. Over the next few margins tightened. them to increase margins in the event
Quantum - Finance In Perspective - Issue 4 19
Infrastructure
MAJOR ADDITIONAL SOURCES OF INFRASTRUCTURE FINANCE
REgIONAL COMMERCIAL BANkS too have been unaffected by the sub-prime crisis
Regional banks have already stepped in to take and can offer both long tenures and large tranches
part in project loan syndication, albeit more often on competitive terms. ECAs have historically been
as participants than as lead arrangers, a role for criticised by project sponsors for being slow and
which many regional banks still lack the necessary bureaucratic, but have worked hard to change that
underwriting capacity. The infrastructure financing image and have in many cases evolved and adapted to
potential of these banks is somewhat constrained by market needs. They and other multilateral institutions
their unwillingness to provide long-term loans, given such as the International Finance Corporation (IFC)
that their main source of funding remains short-term and the Islamic Development Bank (IDB), also play
deposits. Regional banks also face increased costs in an important role in mitigating country risk in places
securing large amounts of dollars. That said, regional such as the Levant, Yemen and North Africa. A case in
banks have been able to step up to major projects, point is the Queen Alia International Airport expansion,
as evidenced by the $1.37 billion Sohar Refinery where a significant portion of that project’s limited
refinancing in Oman, which received funding from only recourse debt funding was provided by the IDB and
two international banks, compared to ten local and the IFC. Multilateral capacity, however, may be limited
regional banks. Before the credit crunch that ratio by the development goals of the respective institution,
would have been reversed. while ECA financing capacity will be dependent on the
amount of equipment and materials procurement from
ISLAMIC FINANCE the respective agency’s home country.
Islamic financiers are making significant inroads as
a source of project financing and are poised to play PROJECT BOND MARkET
an even greater role in infrastructure finance. Islamic The sub-prime crisis has effectively shut down the
finance products are one of the fastest growing asset international project bond market for the near future.
classes in the region, and the sub-prime crisis has had However, there is hope that the market will recover,
little direct affect on the industry: Shariah law prohibits as evidenced by the structure of the recently closed
the trading of debt, so the complex instruments that $7 billion Emirates Aluminum (Emal) financing, which
were used to trade sub-prime debt were absent from includes a $2 billion bond tranche targeted to close
Islamic banks’ balance sheets. Even for banks that at the end of 2009. Sponsors and lenders both seem
have announced large write-downs, the Islamic finance reasonably comfortable with the financing risk that
units have been a source of strength and reported this structure entails, inspiring confidence that the
robust returns. Sukuks (Shariah-compliant bonds) bond market will return.
have been especially popular as corporate finance
instruments for infrastructure projects such as the SOVEREIgN WEALTH FUNDS
Dubai Airport expansion, and are expected to play an With the current flood of petrodollars filling their
increasing role going forward. However, the market bank accounts, it seems only logical that the region’s
capacity is still relatively limited (no major project has sovereign wealth funds should become major sources
been funded to date wholly from Islamic sources) of funding for regional infrastructure projects. There
and is more widely used to complement conventional is legitimate concern among governments regarding
sources of finance. bloated public budgets and the resulting exposure to
oil prices. However, deploying funds as a lender via
AgENCy LENDERS structured finance transactions would bring discipline
Export Credit Agencies (ECAs) are once again to the process as well as match the funds’ long-term
becoming an important source of funding. They investment horizons.
20 Quantum - Finance In Perspective - Issue 4
Infrastructure
“
material and human resources. And
the problems of cost have been
The enormous number of large exacerbated by dollar depreciation:
projects being built within a
the region’s construction industry
imports a significant amount of
relatively confined area has equipment from Europe and is almost
wholly reliant on labour imported
put a great deal of additional from South Asia.
None of the problems facing
pressure on contractors, who infrastructure finance is insuperable,
and a critical part of the solution will
find themselves increasingly come from the increased availability
of additional funding sources. The
competing with each other for international commercial banks,
which had great success in this
scarce material and human “ market due to their ability to provide
resources. And the problems of
lowest-cost funding, may have lost
their competitive edge due to the
cost have been exacerbated by credit crunch. But this has opened
the door for other financiers to play
dollar depreciation. a wider role in the infrastructure
market. Liquidity at competitive
prices now comes from regional
commercial banks, Islamic finance,
agency lenders and sovereign wealth
funds, while borrowers can also tap
the project bond market (see Major
additional sources of infrastructure
that they are unable to syndicate the Liquidity may not even be the finance box).
debt. Qasco is expected to return to biggest issue faced by Middle East There is no doubt that at the
the markets later this year, but there projects. Before the US housing very moment that the infrastructure
is no certainty that it will obtain market took centre stage, the most market in the Middle East is poised
better pricing or lighter covenants publicised issue in the region was the for growth, the sub-prime crisis
than were offered in 2007. rise in construction costs. A number has thrown the region a curve ball.
It is easy to blame the credit crunch of factors are leading to higher The pipeline of future projects is
for the more stringent financing terms investment costs and increased risks. bulging at a time when the largest
that have recently been seen in the Higher commodity prices have made source of financing, the international
Middle East, and it certainly has played this a global phenomenon, but the banking community, is experiencing
a large role. Margins on many deals in Middle East, where everything – a liquidity crunch.
the region have increased by 10 to 30 including labour – has to be imported, However, the region is fortunate
basis points since the beginning of the has been especially sensitive to the in that there are a number of
sub-prime crisis. But this may not be the problem. alternative sources of funding that
complete explanation. For, while lack The enormous number of large can step in to fill the gap. But all of
of liquidity has been partly responsible projects being built within a relatively these alternative sources will need to
for this, it is also true that banks were confined area has put a great deal of reach their full potential in order to
chafing against the wafer-thin margins additional pressure on contractors, keep the market, and especially the
and have seized the opportunity to take who find themselves increasingly much-publicised mega-projects, on
back some ground. competing with each other for scarce track. Q
Quantum - Finance In Perspective - Issue 4 21
