Liquidity drives project finance appetite
27 October 2023
This report on project finance and PPP also includes: PPP activity rebounds in 2023
Activity in the Gulf region has triggered a boom in the project finance market, with Saudi Arabia leading the way on the back of schemes linked to its Vision 2030 strategy.
Deals are fanning out from power and water and infrastructure schemes into unexplored territory: hydrogen projects and ever-larger solar power plants have opened up opportunities for international and regional banks that are awash with liquidity and looking for long-term means to deploy it.
Deal advisers attest to the vibrancy of Saudi Arabia, the largest regional projects market with $1.2tn-worth of known work in the pipeline. The kingdom has seen the largest project financing this year, a facility worth at least $6bn arranged for the Neom green hydrogen project.
“Saudi Arabia is a market that really is firing on all cylinders,” says Rob Harker, a partner at law firm DLA Piper, which advised Neom Green Hydrogen Company in connection with its green hydrogen and ammonia project in Saudi Arabia.
“That demand is not limited to utility sector projects. In addition to the very large solar and wind projects – including a Saudi solar deal that is 1.1GW – we are also seeing a large volume of social infrastructure projects being procured across the GCC, including in education, healthcare, social accommodation and transport,” he adds.
“Bank debt – both regional and international – is still the principal source of financing for these projects. However, robustly structured projects should also be attractive, particularly on a refinancing, to a capital markets issuance.”
Robust liquidity support
There is increased liquidity in the regional banking market, notes John Dewar, partner in international law firm Milbank’s global project, energy and infrastructure practice, which advised the export credit agencies (ECAs) and commercial banks in connection with Project Lightning, Abu Dhabi National Oil Company’s offshore power transmission project.
“With the bullish medium-term oil price outlook, there is significant liquidity in the Saudi and UAE bank markets, with these banks looking to on-lend their petrodollar deposits on a longer-term basis.”
This still poses some challenges. Analysts note that despite the bountiful credit availability, things can change.
“There is still a lot of liquidity in the system in the GCC, but some have voiced concerns that liquidity in the banking market could dry up in the future if they have to compete with projects that are much larger in scale,” says Christiane Kuti, a director at Fitch Ratings.
“Overall liquidity in the market could get tight at some point, although we are not there at the moment.”
Even then, notes Kuti, a lower oil price could add impetus to the need to develop frameworks to make projects more bankable, and provide an opportunity for the capital market to play a bigger role.
Most of the larger deals are witnessing a heterodox mix of local and international banks participating. For example, a consortium of five local and international banks has agreed to provide $545m of financing for the Rabigh 4 independent water producer project in Saudi Arabia, with Standard Chartered Bank lining up alongside Bank of China and the local trio of Saudi National Bank, Riyad Bank and Saudi Investment Bank.
The Chinese bank presence is a pointer. “We have seen Chinese banks participating in project finance deals, and that is set to continue as they are not as constrained as some of the regional banks in terms of the tenor on which they can lend. Their ability to lend on a longer-term tenor is sometimes attractive for sponsors and developers,” a source tells MEED.
The flipside of this is that Chinese lenders are less knowledgeable about the market.
Global uncertainties
Despite the robust oil price climate, project financings across the Middle East and North Africa (Mena) region have had to cope with a choppy global interest rate environment, with inflationary pressures also impinging.
Higher interest rates have militated against the use of capital market instruments in some regional deals. For Abu Dhabi’s subsea transmission system deal, which reached financial close earlier this year, higher interest rates were responsible for adding $200m to the $3.8bn deal.
This has implications for other projects that are seeking refinancing on the capital market. In Saudi Arabia, BlackRock-led investors in Saudi Aramco’s gas pipeline network attempted early in 2023 to raise $4.5bn from a sale of bonds to refinance a multibillion-dollar loan. The 10-year mature sukuk (Islamic bond) tranche spread placed it about 120 basis points above where Aramco bonds maturing in October 2030 were trading, according to Reuters’ calculations.
Another consortium led by US-based energy infrastructure investment firm EIG Global Energy Partners had also looked to the bond markets to refinance.
“The EIG and BlackRock-led consortiums investing in Saudi Aramco’s oil and gas pipelines infrastructure have been looking to refinance more than $20bn of acquisition debt,” says Dewar.
“Both have been active in the bond market, but the interest rate environment has moved against bonds, so there has been an increasing focus by borrowers on accessing other longer-term liquidity sources, particularly from the highly liquid regional banks.”
Capital market instruments
For the moment, capital market instruments are largely confined to refinancing rather than greenfield projects. However, once some of these projects are financed, it could encourage others to lend on that basis.
“Once a project has been up and running, and it has got consistent revenue from the offtaker of the electricity or the water, and they are paying an index-linked revenue stream that is 100 per cent take or pay and insulated from the erosion of any inflationary pressures, that is very attractive for bondholders, pension funds and other institutions that want stable revenues,” says one industry insider.
Beyond the Gulf, Egypt has managed to attract project finance for its renewable energy schemes, with significant ECA support. In March 2023, a $690m non-recourse financing was arranged for the 500MW Gulf of Suez Wind 2 project in Egypt.
The renewable energy push has continued after Cairo’s hosting of the 2022 Conference of the Parties of the UN Framework Convention on Climate Change (Cop27). The drive has included the Amunet wind and Abydos solar projects closed by Amea Power, as well as the Gulf of Suez Wind 2 project sponsored by Engie, TTC-Eurus and Orascom.
“They are both important deals in a global context because they mark the first occasions on which the Japanese ECAs have co-financed with the International Finance Corporation and the European Bank for Reconstruction & Development, respectively, opening up important new financing opportunities in emerging markets,” says Dewar.
Support from ECAs is particularly valued in Egypt, given the economic challenges the country is facing.
A planned polypropylene complex due to be developed in Egypt’s Suez Canal Economic Zone has been put on hold, with the $1.7bn project developed by Red Sea Refining & Petrochemical Company having been affected by the depreciation of the Egyptian pound.
More regional financing
Another emerging theme will be for the larger Mena banks to play a bigger role in regional project financings.
The likes of First Abu Dhabi Bank have been active across GCC borders, including in Saudi Arabia. Given their healthy liquidity profiles, the biggest banks in the GCC are better positioned for longer-tenor project finance deals than ever before.
Not that it will be plain sailing. Structural impediments will still have to be overcome.
For example, most Saudi banks still need to get consent from the Saudi Arabian Monetary Agency (Sama) to participate in dollar loans. “That can constrain their ability to operate outside the kingdom,” says Dewar.
“There is a regulatory preference for them to make Saudi riyal loans rather than dollars. But because of the increase in dollar liquidity, there is much more availability in the Saudi market than there was a year ago.”
Project finance will remain a critical part of the funding mix in the Mena region. As Fitch Ratings notes, the significant growth needed to achieve the GCC’s investment requirements cannot be attained using traditional financing channels, such as on-balance-sheet funding by governments. Instead, there is a need to broaden the investor base, including through project financing.
The likelihood of a more benign global interest rate environment in 2024 should pave the way for a reassertion of capital market-based deals, making the next few months busy ones for banks and deal-makers across the Mena region.
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Even companies that purchased war-risk or PVT insurance before the US and Israel attacked Iran on 28 February are unlikely to be covered for the full extent of war damage.
War-risk insurance for large assets such as oil refineries or LNG terminals typically carries limits of $200m to $500m.
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One source said: “If you had, for example, an oil refinery that’s worth $8bn, you couldn’t really buy a war insurance policy to cover the price of a complete rebuild.
“There just isn’t enough insurance capacity in the market to buy that level of cover.
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Payout timing
Full insurance settlements for war damage are expected to take significant time – potentially 18 months to two years for some policyholders.
Payments typically begin with an initial payout of around 20%-30% of the total claim. This is followed by a second payment mid-project – usually once engineering is complete – and then a final payment.
In most cases, projects to rebuild and repair damaged oil and gas facilities are not expected to be delayed while owners wait for insurance proceeds.
One source said: “A lot of the owners of these damaged facilities don’t see the current situation as the right time to start rebuilding, but that isn’t because they are waiting for insurance money.
“The risk of new attacks and more damage is still high, and they are going to want to wait for signs of more stability before they start rebuilding.”
Experts believe that once the security environment improves, facility owners will begin tendering repair and reconstruction contracts even if insurers have not settled claims.
“A lot of the companies that operate oil, gas and chemical facilities in the region have access to funds that will allow them to rebuild without being reliant on insurers,” said one source.
“Even if they have a policy that they expect to pay out, it is likely that they will go ahead with the project before receiving full payment if they think it is the right time to rebuild.”
Once the security environment improves, the cost of rebuilding fully destroyed units is expected to be higher than when they were originally constructed, due to multiple rebuild projects progressing in parallel across the region.
This is likely to drive a spike in demand for skilled labour and materials, pushing up costs.
Market impact
Insurers providing this type of cover in the region have generally experienced several years of low payout levels, so they are expected to meet claims with limited financial strain.
However, the volume of claims stemming from the US and Israel’s war with Iran is expected to harden the war-risk and PVT insurance market, increasing premiums for owners of oil and gas facilities for some time.
Ultimately, the limited scope of coverage means the financial burden of the war will fall more heavily on asset owners than on insurers.
Even where cover is in place, policy limits mean insurers will only partially offset the cost of rebuilding large facilities, leaving companies and governments to bridge funding gaps.
The experience is likely to prompt a reassessment of risk across the region’s energy sector, with lenders and investors placing greater emphasis on potential political violence-related damage when evaluating projects.
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