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Middle EastMay 1 2006

Project finance needs grow

A new generation of mega-projects is creating huge opportunities for local and ‘suitcase’ bankers, writes Jon Marks in Riyadh.
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With crude selling at $50-$60 a barrel, the world’s biggest oil exporter is awash with cash, creating unprecedented opportunities across a range of sectors. And with King Abdullah committing his government to the reform of top-heavy state structures, deep changes are under way in the Saudi economy. In this dynamic environment, banks can expect to play a bigger role in financing projects.

Project financiers see the growth of petrochemicals and other business, and with it the emergence of a new generation of local investors, as a major boost to business. New players are coming in, including a couple of heavily capitalised, new Gulf-based banks that are expected to be focused on winning this business once they are fully established.

The need to finance projects is high on policy makers’ agendas. Speaking at the 2006 Jeddah Economic Forum, Saudi Arabian Monetary Agency (Sama) vice-governor Mohammed Al-Jasser said: “We are issuing new licences for foreign banks so that more private finance will be available for mega-projects.”

Several of the banks that are entering the kingdom are project finance specialists. HSBC Saudi Arabia, for example, will operate in parallel with the HSBC group’s local venture, SABB (the recently rebranded Saudi British Bank), whose project finance operations it is taking over in a move to provide full investment banking services.

Such is the demand that there is room for a lot of players. The advent of a new generation of “mega-projects [is] undoubtedly stimulating banks”, a monetary source tells The Banker in Riyadh. “We understand and welcome some of the big players coming in but project finance banks don’t physically have to be here – those coming in have specific goals, to develop their existing corporate and investment activities.”

The message from Riyadh is that the so-called ‘suitcase bankers’ will continue to function, but big investors will be strongly placed to exploit the projects that are opening up. Big ticket project finance is attracting established local players, several of the 11 newcomers agreed by Sama and many of the bigger suitcase banks, which must content themselves with a physical presence outside the kingdom.

What Riyadh needs

An increasing number of project facilities is apparent in the market, offering apparently ever longer tenors and tight margins. According to one senior banker in Riyadh: “There is now an imbalance between risk and reward in project finance, which is reflected in pricing, with too much competition for positions in loans that do not offer attractive terms. I sometimes wonder, why are we all chasing after as little as 50 basis points (bp)… that looks very unattractive compared with the risk-adjusted return on consumer or corporate finance.”

Some of the deals are huge, requiring a mix of debt financing, as well as strong equity input. This was signalled by Saudi Arabia’s most important project financing to date, when the government-owned Shuaiba Water and Electricity Company authorised a group led by the local Riyad Bank to raise funds for the SR9.375bn ($2.5bn) first of the four independent water and power projects (IWPPs), supported by conventional financing, Islamic finance and export credit.

Riyad Bank is among the local banks that are raising funds for business development. In mid-April, it listed the first $500m tranche of a $1.6bn European medium-term note (EMTN) programme on the Luxembourg Stock Exchange, priced at about 36bp over Libor.

On April 15, Al Rajhi Bank signed a maiden $500m three-year murabaha financing facility in Bahrain. The largest Islamic bank went to the market for a $300m loan, but it was oversubscribed by $535m when lead arrangers Arab Bank, Calyon, Gulf International Bank, Malayan Banking Bhd (Maybank), Standard Chartered Bank and WestLB closed the facility at $500m.

Saudi banks in general continue to show a strong performance. On April 16, National Commercial Bank (NCB) chairman Abdullah Bahamdain announced a year-on-year 52.2% increase in Q1 net income, to nearly SR1.9bn. NCB remains the largest Saudi bank, with total assets 8.8% up in Q1 06 to SR143.86bn.

Much more to come

Saudi Arabia is starting to feature again on export financiers’ scanners. The $5.8bn debt package that is being put together for the Saudi Aramco/Sumitomo Chemical Company joint venture Rabigh Refining and Petrochemical Company (PetroRabigh) project, sited at an existing refinery complex on the Red Sea, brought in The Japan Bank for International Co-operation (JBIC) as lead financier.

JBIC is providing a $2.5bn loan, with commercial credits from a syndicate of 19 banks. The parastatal Public Investment Fund of Saudi Arabia is to provide at least $1bn in lending, while the two sponsors are to inject equity covering about 40% of the project costs, which have more than doubled from the original $4.3bn budget to a total $9.8bn. HSBC is adviser on the Islamic tranche and mandated lead on conventional and Islamic debt tranches.

Smaller facilities

Not all facilities are that big. Typical of the new generation of loans, Alujain Corporation subsidiary National Petrochemical Industrial Company (NatPet) has signed a $411m, 11-year loan agreement with seven Arab and international banks, including four local institutions – Samba, Banque Saudi Fransi, NCB and Saudi Hollandi – plus Arab Banking Corporation, BNP Paribas and Abu Dhabi Commercial Bank, to part-finance a propylene and polypropylene complex in Yanbu Industrial City.

Whether the bank calls itself ‘conventional’ or ‘Islamic’, about 98% of Saudi retail transactions are now done in Islamic terms and, increasingly, Islamic instruments are being sought for other deals.

SABB managing director John Coverdale points to the bank’s Islamic interest rate swap facility as an example of what can be done. “Islamic solutions are there, conceptually, but now the market has to develop and instruments have to be developed to be compatible.”

SABB also raised a Eurobond, which HSBC Saudi Arabia chief executive Tim Grey says “was strongly supported by Sama as a way of deepening the market, even though [the central bank] has not done a Eurobond of its own”.

Market deepens

The market is getting deeper, Arab National Bank (ANB) managing director Dr Robert Eid tells The Banker. “Now, there is a degree of sustainability that wasn’t apparent in 1973 [the Arab-Israeli war price spike]. Then, we were entering uncharted waters [and] economies were unprepared to digest income. Now the infrastructure is in place [and] Saudi Arabia has learned how to develop its industries.”

Speaking in Jeddah, Mr Al-Jasser said that more long-term financial instruments were needed to spur the involvement of domestic institutions in developing those industries, building on the base established through the issue of sukuk (Islamic corporate bonds).

HSBC is working on a first sukuk for petrochemicals giant Saudi Arabia Basic Industries Corporation (Sabic), which, Mr Grey says, “will start a domestic bond market”.

The Capital Markets Authority (CMA) has been working to get corporate bonds listed on the Tadawul (Saudi stock market) and Sama is supportive of these moves, says Mr Grey. In an interview with The Banker, he says that the central bank “understands that we will be creating a yield curve and agrees with the need to get other issues in”.

HSBC is adviser on five schemes in the petrochemicals sector alone, reflecting the opening up to local and international capital made possible by reform. Sabic no longer has a monopoly on big ticket schemes, although not all the new schemes will go ahead: issues include who is allocated essential ethane feedstock by Saudi Aramco.

Capital markets

Despite the recent ‘meltdown’ in the Saudi and other Gulf stock exchanges – a correction whose ramifications continue (see The Banker, April 2006) – capital markets are set to play a much bigger role in financing projects. However, there is much to do. “There is a huge pipeline of new projects but the capital markets are not really there to pick up their part of the bill,” according to ANB’s Mr Eid.

He agrees that in a highly competitive market, pricing has become an issue. “It may need a rebalancing of returns”, to maintain banks’ interest in committing such long-term funding, argues Mr Eid.

According to one project finance specialist: “The most tantalising element of the Rabigh deal is whether Saudi Aramco and Sumitomo Chemicals go ahead with the projected float.” This could involve a 25%-30% stake in the project. Aramco said in January that the joint venture would float once the complex started operations in 2008; it was subsequently suggested that an earlier float would help to offset rising project costs. Saudi Aramco has proposed a float price of SR50 per share. Although that would make it one of the Gulf’s biggest initial public offerings (IPO), Sumitomo officials have reportedly argued that a flotation could raise much more cash, based on Sabic’s December 2005 IPO of its Yansab subsidiary, also priced at SR50 per share.

In a fevered local market, Yansab stock sold at SR700 on its debut, even though the plant is not due to start production until 2008 and does not expect to profit until 2010. The intensity of the Yansab experience is unlikely to be repeated soon but, as one senior local banker put it, “even if the stock doesn’t sell at 700 on the first morning it is traded, it might still go at 300”.

Saudi Arabian Airlines is expected to float 30% of its shares in an IPO, approved in March by the powerful Supreme Economic Council (SEC) chaired by King Abdullah.

The markets will also be used to allow a range of investors to buy into new banks, with the government deciding to list 70% of the shares in the new Inmaa Bank. The bank will be capitalised at SR15bn, with 30% to be paid up by the state General Investment Fund, General Pensions Authority and General Organisation for Social Insurance.

Huge range of projects

Petrochemicals have earned many of the headlines but the Saudi project boom is arriving in a number of other sectors, too. Following the ground-breaking Shuaiba deal, the next IWPP – the 850mw, 47 million gallon-a-day Shuqaiq unit – is expected to feature an IPO. Bidders for the $1.2bn IWPP must submit to the state Water and Electricity Company (WEC) by July 30, bringing with them $600m in committed financing facilities, a minimum of one international bank and a maximum of two local banks.

The movement on IWPPs reflects a wider acceleration in the pace of electricity and water sector liberalisation in the kingdom. The figures involved are mind-boggling. State-owned Saline Water Conversion Corporation is now the world’s largest single seawater desalinator, according to its chairman, Fehied Fahad Al-Sharif. Saudi Arabia is producing about three million cubic metres a day (m3/d) from 30 plants, transporting water through more than 4000 kilometres of pipelines. However, Mr Al-Sharif observes, the kingdom needs nine million m3/d and 90,000mw in the next 20 years and that will have to be paid for.

A similar observation is made by Electricity and Co-generation Regulatory Authority (ECRA) senior adviser Samir Zakhary, who notes that Saudi demand for power has risen from 300mw in 1970 to more than 50,000mw in 2002. This recognition has prompted the authorities to open the way for the Shoaiba and Shuqaiq IWPPs, to be followed by the estimated $3bn Ras Al-Zour phase one and $1.4bn Jubail phase three schemes.

Support from above

One Saudi insider notes that the Shuaiba IWPP was only made to work after it was recognised that “a number of short cuts around the Saudi system were needed”. Thus, the project company was formed by royal decree to help overcome technical problems in Saudi company law, and the project vehicle’s low capitalisation (SR5m) was intended to overcome the ‘trapped cash’ problem that might have attended such a big scheme.

Among the several precedents set, which should mean future projects go faster, the power and water purchase agreement had to be structured in a way that might not fall foul of the Sharia (Islamic law) courts. All of these things were written into the deal, establishing useful precedents for next time.

King Abdullah has shown an unexpected enthusiasm for backing schemes that help to stimulate jobs and growth using the markets, helping to reverse Saudi Arabia’s predilection for a top-heavy, state-led economy. “Don’t expect [state oil giant] Saudi Aramco to be privatised but we are seeing increased private sector activity and investment opportunities all the time – and this seems to come right from the top,” says a senior diplomat in Riyadh.

Since 9/11, more money has returned to the Gulf than seemed possible before the attacks on New York and Washington redefined relations between the West and the Islamic world. But huge amounts of Saudi and other Gulf private capital remain outside the region, ready to be put to lucrative use.

Promoting big projects is one way of helping to keep Saudi capital in the kingdom and put it to a useful purpose, the monetary source says. “There are still huge amounts of Saudi capital abroad. Its geographical spread is a function of the absorptive capacity of the economy.”

This “absorptive capacity” is “changing a bit with mega-projects and capital inflows – IPOs show that people want to invest – but a lot still flows out,” he says.

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