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Middle EastMarch 3 2004

Market road to project finance

The Gulf region has become a focus of attention for global project financiers. Saudi Arabia has come late to this, but could yet prove the biggest draw of all, writes Kevin Godier.
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When international project finance schemes were in their infancy in the early 1990s, Saudi Arabia was always one of those markets referred to as “back burner material” by bankers. The reasons were numerous: the government and its powerful parastatals wanted to retain control of infrastructure; the legal and regulatory systems were insufficiently developed; local banks were usually flush with cash; and, perhaps most importantly, there was the sensitive question of the guarantees required to draw in investors and lenders.

The Saudi leadership has watched and waited carefully as neighbouring markets such as Abu Dhabi, Oman and Qatar have laid down project finance templates and sucked in tens of billions of overseas dollars. They have gradually reformed the economy and slowly expanded its private sector, but have baulked several times at committing to private finance, such as when a build-own-operate (BOO) contract covering a 1750MW steam power plant for Saudi Consolidated Electric Company in the West was discarded in favour of a more traditional engineering, procurement and construction (EPC) contract.

Now, however, the government is attempting to join the regional trend, at a time when confidence is sky-high following the kingdom’s best annual economic performance since 1981, which included record oil revenues. Post-Iraq confidence in the wider Middle East region among financiers also seems to have returned, as illustrated by a huge recent over-subscription to the debt package for Oman’s Sohar refinery deal and the intense interest generated by Qatar’s latest gas expansion schemes.

Infrastructure plans

Over the longer term, the Saudi government has indicated that it wishes the private sector to develop, finance and build major infrastructure projects in a range of sectors, including railways, mobile telephone networks, and, of course, the oil and gas sectors.

But these plans remain embryonic. For now, the private financing focus is firmly targeted on the power and water sector, where parastatals such as Saudi Aramco, Saudi Electricity Company (SEC) and the Saline Water Conversion Corporation (SWCC) are beginning to use limited recourse financing techniques for key expansion projects. As well as setting up a robust regulatory framework for private investment over the last three years, plus a merged Electricity and Water Ministry to provide new clarity, the government has shown the crucial willingness to provide tailored backstop guarantees for the new raft of projects, thereby boosting bank and investor confidence.

IWPP charge

Four independent water and power projects (IWPPs) are scheduled to start production over the next six years. Heading the queue is a landmark 700MW and 176 million gallons per day IWPP planned at Shouaiba, south of Jeddah, where the selected developer will build the estimated $1.5bn-$2bn facility and sell its entire capacity and output to the Water & Electricity Company (WEC), jointly owned by SEC and SWCC.

The level of bank debt required is likely to be over $1bn, and will emerge from the tender process, whose “fast-track” timetable has a financing conclusion pencilled in for end-2004. But there is much concern about what will be the precise nature of the state guarantees that will be unveiled in the tender documents to back the project’s 20-year power and water purchase agreement (PWPA). The details were due to be included in requests for proposals (RFPs) originally targeted for send-out in October 2003, but the RFPs will now be issued in the first quarter of 2004, according to HSBC, the government’s advisory bank.

Key to success

As other power and water projects across the Middle East have shown, the guarantee facility is key to Shouaiba’s chances of success, and indeed to the wider IWPP programme. “We are looking to close the deal as quickly as possible”, said a source close to the IWPP programme, who confirmed that the RFP delays were directly linked to the shaping of the revenue guarantee by the government.

“It is broadly accepted that there is a need for guarantees, but the Ministry of Finance (MoF) cannot provide these willy-nilly, or it would be flooded with requests,” the source said. “What happens is that a whole discussion that takes place at the political level between the Ministry of Electricity and Water and the MoF. Everything in Saudi Arabia has to be consensus-driven. Once things are agreed, they can be announced to the world, but it takes time.”

Because the deal will establish the country’s first BOO project template, delays are inevitable, says a London-based banker specialising in Middle East transactions. “If you look at Abu Dhabi, you will see that the first limited recourse project, Taweelah A2, took some time to go through, because the government insisted on nailing down a watertight set of agreements,” he notes. “All of the subsequent projects in Abu Dhabi were much quicker.”

Sadaf template

A delay of some two years was the reality when a 15-year, $170m limited recourse financing was put in place for the Saudi Petrochemical Company (Sadaf)’s captive 250MW co-generation power project in Jubail, developed by a CMS Energy-led consortium. This was financed in July 2003 by Banque Saudi Fransi, Credit Agricole Indosuez, Arab National Bank, Arab Petroleum Investments Corporation, and Riyad Bank.

Until the Sadaf scheme, the government had always provided traditional loan guarantees, especially for EPC-based projects in the petrochemicals sector. But the Jubail plant – which marked the first private independent power plant (IPP) in Saudi Arabia structured under the BOO model – used a complex 20-year energy conversion agreement (ECA), under which Sadaf guaranteed to provide feedstock gas and to make payments to the operator linked to the plant’s capacity and availability.

A similar 20-year ECA agreement will underpin the financing for a BOO-based IPP programme to be developed to serve four of the eastern Saudi Arabian facilities operated by state oil company Saudi Aramco. “Saudi Aramco holds all the country’s oil reserves, so the ECA is really the equivalent to a government guarantee,” said a banker close to the project.

IP starts work

The project calls for the developer, a joint venture of International Power (IP) and Saudi Oger, to install some 1074MW and 4.4m lbs/hr of steam via four cogeneration plants that will cost some SR2bn ($533m) at the Ras Tanurah refinery and loading terminal, the Ju’aymah liquefied petroleum gas and crude loading terminal, and the Shedgum and Uthmaniyah gas processing plants. IP has started work on putting together a project finance package in-house, and aims to complete this work in the first quarter of 2004. It has picked Arab National Bank, Banque Saudi Fransi and Samba as lead arrangers, but would not comment on financing progress.

With the kingdom having to install at least 2000MW a year of new capacity to keep abreast of rising electricity demand, more IWPP tenders are likely to be issued in the second half of 2004.

Saudi Arabian Mining Company (Maaden) has invited developers to submit statements of qualification for its proposed 1500-MW captive IWPP in Jubail, but has yet to decide between a private or EPC project template.

Elsewhere, a RFP will be issued to pre-qualifiers later in 2004 for another IWPP, also in Jubail, planned by the Power and Water Utilities Company for Jubail and Yanbu (Marafiq). With a planned first-phase capacity of 2400MW and 300,000 cubic metres a day of desalination, the project is set to be the largest grassroots IWPP in the Gulf, and will be advised upon by Citigroup.

Political risks

As private sector developments evolve, one area still to be hammered out is how banks and sponsors will approach concerns over political stability and risk.

“We have been pretty bearish on the country risk after the US [military] pulled out,” said the head of project finance at one major European bank. “We have looked at the Saudi Aramco deals and the other IWPPs, but we wouldn’t take want to go any longer than one to two years on Saudi country risk.” He added that in cases where debt finance of $1bn or less was required – such as the Saudi Aramco IWPPs – there was enough local lending capacity. “After that, the debt may become a problem, whatever the margins on offer.”

The key – but often tacit - question now to be addressed is whether political risk insurance (PRI) will be mobilised for the IWPP programme. HSBC has previously indicated that PRI from export credit agencies could be a feature of the Shouaiba financing, although it has also stressed that a PRI lending tranche – and other types of debt such as bonds and Islamic finance - might only be necessary for capacity reasons.

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