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Aug 18 2008

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Middle East finance: Stretched at both ends

The need for infrastructure expansion is urgent and almost universal across the MENA region. But at a time of global banking turmoil, funding the packed project pipeline is proving challenging

From ports to power stations, governments across the MENA region are facing massive new infrastructure demands brought on by fast-growing populations and in many cases past underinvestment and project delays. Unfortunately, the challenge of financing the raft of upgrades and expansions in the pipeline is currently coinciding with a global contraction of bank liquidity, forcing international commercial banks – traditionally the mainstay of project finance, particularly in the Gulf – to exercise increased caution and selectivity in lending, while demanding wider margins to cover their own higher cost of funds.

Friends in need

The good news for civil infrastructure projects, however, is that they typically benefit from strong political will and support: while international banks might baulk at lending to a non-essential, private-sector industrial scheme—as they have recently done in the case of the Shadeed Steel plant in Oman planned by Abu Dhabi-based Al-Ghaith Holdings—the government-backed, urgently-needed expansion of power, water and wastewater infrastructure across the region is far more bankable. In the case of governments and state-affiliated borrowers, there is the additional pull exerted on banks by the desire to maintain a relationship with prolific and proven sponsors such as Qatar Petroleum — which takes stakes in Qatar’s private power and water projects—and Saudi Arabia’s various state-owned utilities.

Infrastructure finance in the region is concentrated primarily in the power and water sectors and, to a lesser but growing extent, in transport facilities: the use of the public/private partnership (PPP) model for social infrastructure such as housing, schools and hospitals is virtually non-existent in MENA, partly because of the uncertainty of returns for investors and the inevitable need for governments to provide some form of subsidy to make the costs charged by the private sector acceptable to end-user citizens. Bahrain is tentatively investigating partnering the private sector in tackling an urgent shortage of affordable housing, but the initiative is in its infancy.

Growing populations and ambitious industrial development will ensure that the power sector continues to dominate infrastructure finance needs across the region. GCC governments, although the most able to finance such projects from their own oil-revenue-inflated balance sheets, are firm converts to private power and water generation—Kuwait and Dubai being the exceptions—and are continuing to provide a solid pipeline of traditional limited-recourse, bank-financed deals: financial close was reached in early August on Qatar’s US$3.9bn Ras Laffan C independent water and power project (IWPP) while the US$5.5bn Ras al-Zour IWPP financing in Saudi Arabia should be signed off by the end of the year. However, both schemes illustrate the need for sponsors to seek alternative financing sources to straightforward conventional commercial bank loans—and particularly show the critical role that Japan Bank for International Co-operation (JBIC) is playing in the GCC at present. The Japanese-government-owned export credit agency (ECA) and development bank extended a US$1.5bn loan for Ras Laffan C and is backing two of the bidders on Ras al-Zour to the tune of US$3bn.

Islamic finance oversold?

Debt packages in both states have also included Islamic tranches: Islamic project finance has in general proved something of a damp squib in recent years, with tenors and pricing on deals impossible for GCC Islamic banks to meet profitably. However, the Islamic Development Bank and Qatar Islamic Bank underwrote a portion of the Ras Laffan C finance, while all three of the IWPPs so far financed in Saudi Arabia— Shuaibah , Shuqaiq and Marafiq —have included more sizeable chunks of sharia-compliant finance.

Private sector financing of transport infrastructure has been slower to take off in the GCC. Limited-recourse financing was initially envisaged for Dubai Metro, but was abandoned in favour of government funding, raised partly through bond issuance, and sales of land along the route. Similarly, sukuk issuance partly funded the Dubai International Airport expansion and the new airport planned at Jebel Ali. However, a raft of Saudi projects are expected to blaze the trail for transport PPPs in the region while the kingdom already deployed the approach on the new Hajj Terminal at King Abdulaziz International Airport , with a private consortium appointed to expand and run the facility in early 2007. However, the scheme was awarded on a build-transfer-operate (BTO) basis rather than the more usual build-operate-transfer in order that the private sector would at no point actually own such a sensitive asset.

Overall then, financing essential MENA infrastructure projects is still very much possible, even in the face of massive regional competition for funds and tough global borrowing conditions. Nevertheless, clients, sponsors and advisers are being forced to examine more complex, multi-sourced and innovative packages while accepting – in the case of the GCC’s serial borrowers – that the trend towards ever tighter debt pricing is, at least temporarily, being reversed.

SOURCE: Business Middle East