Project financing, particularly in the Gulf, has seen a trend towards covenant dilution, but with the increases in project size and complexity that could start to change, suggests Rodolphe Olard, INGs Managing Director, Global Head of Project Finance Advisory, Structured Finance/Natural Resources. Here, in an exclusive interview with MEES, he outlines anticipated developments and pinpoints the activity hotspots.
Recently, many Gulf oil and gas and petrochemical sector projects have been financed with looser covenants than in the past, and have secured record low margins and fees as banks, with their considerable liquidity, have remained keen to take on commodity project risk, given the strong oil prices and competitive advantages of low cost gas-based projects. However, financing requirements per project are increasing as a result of the rise in engineering, procurement and construction (EPC) costs and also with the trend towards mega-complexes which integrate world-scale refineries and multi product petrochemical facilities. An example is the planned Ras Tanura refining, petrochemicals, chemicals, and plastics complex Saudi Aramco is sponsoring in partnership with the US Dow Chemical, which is expected to cost over $22bn (MEES , 21 May).
The increased size of many projects suggests that EPC services will be split amongst contractors, and that, also, in order to keep costs down, EPC contractors will increasingly out-source engineering services. This increases perceived risk levels for lenders, and they are expected to request completion guarantees from sponsors. Recently, as part of the trend towards looser covenants, a few projects have not carried completion guarantees, but, says Mr Olard, with very larger projects of $10bn-plus, it would be difficult not to have one.
The push to produce specialty chemicals in the Gulf makes the case for a completion guarantee even more compelling, he adds. Beyond the market risks of a multiplicity of smaller volumes that are more end-customer oriented, there are also risks inherent in using new technologies. Many of the sponsors of these projects will be looking at new technologies in order to bring flexibility to their product ranges and this is a risk that lenders may be reluctant to shoulder. For new technologies the emphasis will be on very detailed due diligence and the need to have the new technology risk covered by a sponsor completion guarantee and potentially some post completion undertaking during the initial operating years, he said. While there could be many units around the world producing the specialty products that are new to Gulf sponsors, some of the plants already operating outside the region have been shareholder financed, so the risks have not yet been analyzed by lenders, he added.
Greater Due Diligence
The marketing side for specialty products will also require greater due diligence by lenders. With many commodity petrochemicals a detailed assessment of market conditions is not often necessary, because Gulf producers costs are amongst the lowest cost globally. However, many want to move further downstream to the specialty chemicals, in order to add value. But here, producers who are geographically closer to their customers may have an advantage because they understand their specific requirements better. SABIC was mindful of this point when it paid $11.6bn to acquire GE Plastics, buying a marketing network as well as new production facilities. So if creditworthy sponsors are going to be expected to provide completion guarantees, where technologies are deemed to be higher risk, projects developed by companies with constrained balance sheets may have to remain on the commodity end of the market, where risks are better understood by the market, Mr Olard said.
For mega-projects, sponsors can no longer rely solely on the bank market, and instead need to tap other sources of debt funding such as export credit agencies (ECAs), Islamic finance, capital markets and local development institutions in some countries like Saudi Arabia. Per project sponsors can typically expect to secure around $2.5bn from the bank market, but the rest will come from other sources, such as Islamic finance, although raising beyond $1bn for a project from this small but growing market has not yet been fully explored. So the two sources of finance that are expected to see increased use are ECAs and debt capital markets, said Mr Olard. The drawback with ECA finance is that it is tied to the use of goods and services from the ECAs host country (although flexibility varies between agencies). JBIC, which provided a direct loan of $2.5bn to the $9.9bn Petro-Rabigh project (which has so far been Saudi Arabias largest project financing) could be instrumental in making these mega projects happen if Japanese contractors, investors and/or offtakers are involved, said Mr Olard. But ultimately the project finance market needs to evolve to focus more on regional debt capital markets, which have yet to emerge fully in the Gulf, he added.
Mega-projects will need to tap every source of funding and the extent of the requirements make it unlikely that sources of finance will be played off against each other in an attempt to foster pricing competition, as they have been in other financings. This could also tighten up covenants and provide some support to margins. While covenants have loosened for Gulf oil projects, project finance covenants are still pretty tight compared with other forms of structured finance such as leveraged finance, stressed Mr Olard. Nonetheless, he pointed out that lenders have a particularly strong appetite for oil, gas, LNG, petrochemical and metals risk in the region, and thus aggressive structures will still be presented to the market.
Margin trajectory is difficult to predict, but recently there have been suggestions that the bottom has been reached. Mr Olard believes their direction will depend on how many projects are launched. So far this year in the Gulf region, a smaller number of projects have sought funding than last year, so the downwards pressure has been maintained. However, if a number of large projects approach the market within a few weeks of each other, lending capacity will be tested and margins could rebound. This could also signal the return of large underwritings rather than club deals that have been the norm in Qatar, Kuwait and Saudi Arabia of late. The question is what level will margins and fees need to be for the big projects that will be tested in the next 12-18 months, he said. Banks remain hungry for this business, but some may have suffered as a result of the US subprime mortgage crisis spreading to the global credit markets and may be more conservative in their credit appetite. Currently it is unclear how many banks have been affected, and among those that are, how many will chose to exit temporarily project finance, which remains a sought after sector for a growing number of banks. Its still a very attractive market for a lot of banks because it gives them the possibility of controlling risks through the project and financing structures, noted Mr Olard, predicting that the current credit market debacle was unlikely to have a huge impact for well-structured projects, unless the situation continued to deteriorate.
Most Active Regions/Sectors
With oil prices expected to remain high, the number of projects in the region is growing and there are many opportunities to provide funding. Over a short-to-medium time horizon of 18 months to three years, the countries that will see considerable project and structured finance activity are Russia, Kazakhstan, Saudi Arabia and North African nations, said Mr Olard, formerly at HSBC and recently appointed as INGs top project advisor. ING is already very active in the financing of natural resources projects in the MENA and Caspian regions, as well as in South East Asia and the Americas, but has started to invest in advisory as it looks to participate from project inception through to financial close. The Dutch bank will be covering the region from London, with the support of existing debt arranging teams in Amsterdam and dedicated coverage offices in Dubai and Moscow. Saudi Arabia will be dominated by the large refinery and petrochemical financings, while Russia will see pipeline developments and downstream projects in petrochemical and metals. In the Caspian he expects Chinese banks to come in as new financiers, following Chinas large oil and gas companies investments there. In Algeria a number of petrochemical projects will be looking for financing in the next 6-12 months, such as the Orascom Construction Industries, Bahwan and Total joint ventures with Sonatrach. Kazakhstan is expected to need funds for petrochemical projects, while Egypt continues to be a source of investment and potential financing opportunities, he said.
Over the longer term, Mr Olard anticipates that development in Qatar will resume, although the slowdown in activity this year will be carried over into next year due to the moratorium in North Field development. Over the longer term he predicts that Turkmenistan could become important to project financiers, but the current regime will need to mark its difference with the previous one. Libya also has sizeable oil and gas development needs and is open to foreign investment, while Iran given its massive oil and gas reserves will be a land of opportunities, if the international politics are resolved, he said. On the metals and mining side, he attaches growing importance to sub-Saharan Africa. For oil and gas upstream projects, there will be little needing for external funding because the international oil companies and national oil companies will continue to finance them using their own balance sheets, predicts Mr Olard, noting that some cross-border pipeline projects will offer opportunities for external funding such as the Nigeria-Niger-Algeria gas pipeline.
