A settled landscape in the Middle East project market should be visible by July. Both the Dolphin pipeline refinancing and Al Dur IWPP in Bahrain should have reached financial close and the fate of the financings for the Ras Al Zour, Salalah and Shuweihat 2 IWPPs should be clearer.

The $3 billion Dolphin refinancing is an operational project backed by strong sponsors – Mubadala, Total and Occidental – so if anything should get away in the current market, Dolphin should. The question remains, at what price? Bank responses on the deal are due back on 30 April. Fees of 200bp are on offer for a $200 million ticket with the model pricing starting at 225bp and rising to 300bp.

Multi-sourced Dolphin

Three sources of funding are competing on price – international bank debt, an Islamic facility and a bond component. The bank tranche will be between $1.5 billion to $1.7 billion, but could be reduced further, and there will be an Islamic tranche of around $500 million. The bank facilities are structured as fully amortizing 10-year debt, with an average life of five years. Sace has increased an untied ECA facility to $400 million, and there is a $1.2 billion sponsor loan from Total and Occidental.

It is likely that the indicative pricing may have to increase by around 20bp-30bp, because according to one participant "there is almost no competitive pressure among banks – they are selectively choosing the deals in which they participate."

As with the Ras Gas II/III financing, the bond and bank debt will close at the same time (financial close is scheduled for May). The omens for the issue are looking good; two GCC sovereign bond auctions held in late March/early April were inundated with orders.

Abu Dhabi's $3 billion five and 10-year issue came in under its guidance price at 400bp over Treasuries for the five-year and 425bp over for the 10. Bookrunners Citi, Deutsche Bank and JP Morgan set price guidance at 425bp over for the five-year and 437.5bp over for the 10-year par, but pared down the pricing after receiving commitments of $11.85 billion.

Qatar's $3 billion 10- and five-year issuance run by Barclays Capital, BNP Paribas, and Goldman Sachs received $12 billion of orders. The issue came inside the guidance of 350bp and 387.5bp over Treasuries and priced at 340bp and 380bp.

While the Dolphin transaction will help settle the Middle East project market, as a strong, operational project asking for an average life of just five years from banks, it is not a typical project. "The capital markets remain the preserve of the few and far between," says one London-based banker. It is unlikely that any greenfield project within the next 12-18 months will look to tap the capital markets. Bond investors are notoriously fickle, and only Qatar has a tried and tested programme of project issuances. Using bond proceeds during construction also poses only-just surmountable structuring and legal challenges, because it is difficult to obtain waivers from bondholders if the project is delayed. Both sponsors and their advisers will only use the capital markets for projects above a critical size, and probably only once other avenues of funding have been exhausted.

According to one source, the maximum achievable international bank tranche in the current environment is around $500 million. That is the suggested ceiling for a bilaterally agreed (one that is not book-built), non-ECA covered tranche. Realistically, this funding gap will be filled by export credit agencies (ECAs) and Islamic banks.

Bookbuilding

For a book-built deal a larger international bank tranche is achievable, but it is not easy. The financing for the Al Dur IWPP in Bahrain is being arranged by Calyon, Mashreq Bank and Standard Chartered. In total a $1.7 billion debt package is being sought for the Suez/GIC-sponsored $2.2 billion project. The debt splits into a $200 million direct loan from US-Exim, (on the back of GE's provision of turbines), a $500 million Kexim export credit facility (Hyundai Heavy Industries together with Degremont are the EPC contractors), a $700 million uncovered commercial bank tranche and a $300 million Islamic tranche.

Illustrating the depth of the Islamic liquidity pool, the Islamic tranche has pre-commitments for the full $300 million, with $100 million each taken by Saudi Fransi, Al Rajhi and IDB. Another two or three banks are looking at coming into the Islamic tranche, which gives the lead arrangers flexibility to pare down the commercial tranche if required.

Pricing starts at 250bp pre-completion, rising to 300bp for the first 2.5 years of operation and then stepping up to 350bp. The average debt service coverage ratio (ADSCR) is 1.25x. Blended commercial and Kexim tickets of $100 million, $75 million and $50 million are on offer, at fees of 275bp, 225bp and 200bp respectively.

Despite the chunky fees and pricing, the deadline for bank submissions was extended and commitments are only slowly materialising.

To extract as much liquidity from the bank market as possible, the debt has an eight-year tenor. There are no sponsor or government guarantees, and the debt is partially amortising, with no more than 80% of the original debt remaining at the end of the term.

While Al Dur IWPP edges toward financial close, the outlook for the financing of the $5.5 billion Ras Al Zour IWPP in Saudi is a lot less certain.

Ras Al Zour IWPP – a mess

The debt backing the Ras Al Zour IWPP deal has already been restructured. It was indicatively underwritten by Citigroup, BTMU, Mizuho, SMBC and RBS, but they reduced their commitments to the deal to $500 million, with the sponsors securing a $1.2 billion Riyal-denominated tranche from Saudi banks Alinma, Riyad Bank and National Commercial Bank and a $2.5 billion JBIC overseas untied loan (OIL). The tenor of the debt is 23 years, with pricing at 260bp over Libor, dropping to 225bp after three years.

However, that package of commitments is thought to have lapsed and the deal is in the balance, although early indications suggest the banks will extend their commitment period. The delay was caused by negotiations over the tariff and returns to equity.

The Sumitomo/Malakoff/Al Jomaih team won preferred bidder status in early October 2008 with a bid of R0.1036 per kWh levelised electricity cost and R4.1384 per m3 levelised water cost. Malakoff has since withdrawn from the group due to falling IRRs and Sumitomo is now looking for a new equity partner. The Acwa/Kepco bid was R0.1013 per kWh and R4.4978 per m3.

Saudi's Water and Electricity Company (WEC) has asked an Acwa Power-Kepco JV whether its reserve bid for the $5.5 billion Ras Al Zour IWPP is still valid, as pressure mounts on Sumitomo's preferred bidder status for the project. Their reserve bidder, Acwa, has responded that its bid, including the tariff it posted, still holds, which places WEC under pressure not to succumb to the demands from the Sumitomo-led consortium.

Sumitomo is hoping to raise the tariff to increase its rate of return, which has been dented by inflated debt pricing, to an internally viable level. In Sumitomo's favour, it already had debt in place, but WEC appears to be swaying toward ejecting Sumitomo because of Acwa's insistence that it can deliver without alteration to its original bid. Even if Sumitomo's debt commitments can be saved, banks will probably ask for a slightly higher margin, which will eat into their equity return even more. Against sticking with Sumitomo, WEC will also be wary of harming its reputation for running fair competitions for the wave of upcoming greenfield power privatisations.

Acwa and Kepco are debating how to proceed and are closely monitoring the situation. Their bid is supported by indicative commitments from Al Rajhi and Samba, but they would probably require at least two months to put a committed financing in place.

Sembcorp is facing a similar fate to Sumitomo over its $1.5 billion Salalah IWPP, with debt pricing forcing it to renegotiate the tariff with the Oman Power and Water Procurement Company. This has piqued the interest of the reserve bidder, International Power, which has strengthened its hand by raising fresh financing commitments from Arab Bank, Natixis, National Bank of Oman and WestLB.

Sembcorp and its financial adviser, Standard Chartered, began sounding out banks in mid-February for a $750 million 17.5-year debt package to fund the project. The deal is also likely to recive strong backing of up to 50% from China Ex-Im.
On Al Dur, the sponsors Suez and GIC sought, and received, an extension to their power and water purchase agreement (PWPA), rather than a tariff increase, to help the sponsors refinance the miniperm.

Saudi strength

As well as trying to oust Sumitomo as preferred bidder for the Ras Al Zour IWPP, Acwa Power is working on the oil-fired 1,200MW Rabigh IPP in Saudi. Al Rajhi, Samba and Alinma have committed to take and hold $900 million of 20-year debt as the deal progresses to close. China Exim Bank will also provide a direct loan of $400 million.

The financing requirement is $1.9 billion with a roughly 80/20 debt/equity ratio, with the sponsors seeking 20-year debt and a likely mix of riyal and dollar funding. Debt margins are between 200-275bp, with upfront fees of around 200-250bp.

The sponsors are now in talks with National Commercial Bank (NCB) and Bank Saudi Fransi (BSF) about joining the deal.
Both NCB and BSF provided indicative support to the losing bidder for the project, a Suez/International Power/ Saudi Oger group. Acwa and Kepco have begun to speak to the international banks which backed that failed bid – Standard Chartered, Calyon and Bayerische LB.

The procuring authority, Saudi Electricity Company (SEC), shrewdly refused to name a reserve bidder when it named Acwa-Kepco preferred bidder on 14 February, releasing the IP-Suez banks to create additional liquidity.
According to the bidding schedule the deadline for financial close is 1 June but realistically close is likely in July. A power purchase agreement is being finalised. Acwa Power and Kepco will each have a 40% stake in the project and SEC will own 20%.

How will deals look in the future?

All of the above-mentioned deals, with the exception of the Dolphin refinancing and Rabigh IPP, can be considered legacy deals, in that the developers' expectation of debt pricing was significantly below the debt pricing achievable in today's market.

The highest profile casualty of the dislocation of the debt markets was the Shuweihat 2 IWPP, illustrative of the consequence of falling rates of return for equity players. Marubeni is expected to buy a 20% equity stake in the project from Suez so that JBIC can come in with a large OIL to take out the bridge financing. Suez and GIC are also courting J-Power and Itochu Corporation to come into the Al Dur IWPP, which will allow JBIC to provide lower-cost debt and improve equity returns.
That is not to say Japanese sponsors have an insurmountable advantage vis-à-vis other developers because they have access to JBIC's generous OIL programme. The Japanese Yen has appreciated around 8% against the dollar since Lehman's collapse, putting Japanese suppliers at a cost disadvantage.

New contractors are starting to win market share, most notably the Chinese engineering, procurement and construction (EPC) contractor SepcoIII, which is on both Acwa's Rabigh IPP and Sembcorp's Salalah IWPP. To allay bank concerns over the Chinese equipment, Acwa is closely monitoring the Chinese plant and is using the site more as an assembly unit to manufacture the items with a detailed list of internationally-sourced components.

Private developers will also push procuring authorities for changes to procurement procedures to remove funding risk, as many have had to shoulder smaller returns. This has been done in the past but requires a sensitively drafted mechanism, or the banks will just push for as much as the tariff-setter is willing to pay.

One way of avoiding funding risk would be to adopt Qatar's Ras Laffan C IWPP model, whereby the government entity raises the financing, and the private developers bid purely on development costs. But there is little motivation among developers to adopt this template to Saudi Arabia, where, they argue, there is sufficient liquidity to persevere with the standard model, though the UAE could feasibly replicate the template.

Developers are also asking the procuring authorities for power plants to accept currency risk. Long term hedging of, for example, Riyals against the dollar to mitigate against a revaluation or de-pegging event is both expensive and difficult. Developers argue the end-user price would be reduced by such an event and the government is better able to accept this risk than the private sector.

Funding reality

Funding structures will also change, beyond the soft-miniperm of Al Dur and the 20-year debt of Rabigh. Rajit Nanda CFO of Acwa Power International, has coined the term 'mid-perm' for a structure he sees becoming prevalent – around 12-14 years debt with a balloon to push out the effective tenor to 20 years. ECAs will once again become the providers of the longest tenors (under OECD guidelines the maximum average life of ECA facilities after construction is 7.25 years).

Islamic financing, which has matured so that there is now cross-border support from banks across the GCC region, and ECA participation will fill the funding gap in the short term. "There is genuine cross-border appetite, and the market is opening up, which is very encouraging," says one adviser about the Islamic banking market.

China Ex-Im Bank has moved into Middle East projects and US Ex-Im has returned to the region with a direct loan to the Al Dur IWPP. Sace and ECGD have also recently relaxed their country content rules, which should boost their participation. JBIC is still the heavyweight – and its OIL programme is the most highly sought. In 2008, anecdotal evidence suggests that JBIC received around 40 times the applications for its facilities than it actually deployed.

In Saudi, PIF and SIDF will continue to be useful sources. PIF has recently formed the Water & Electricity Holding Company (WEHC), which will take over its stakes in the Shuaibah, Jubail and Shuqaiq IWPPs. WEHC will operate on a more commercial basis and will likely float on the Saudi stock exchange. The country is replicating the Abu Dhabi model, whereby ADWEA set up Taqa.

Talk of the international capital markets, sukuks or equity investors stepping in with debt is still premature for 2009, and probably 2010.

Future projects

Beyond the current slew of IWPPs and IPPs in the market, a number of projects continue to progress slowly – Abu Dhabi's PPPs, Landbridge, Jubail and Yanbu refineries and the large petrochemical complexes at Ras Tanura in Saudi Arabia and Chemaweyaat in Abu Dhabi, among others.

These projects – less essential than power and water – could benefit from waiting for EPC costs to fall and the bank market to settle. The Yanbu IWPP and Riyadh PP11 IPP in Saudi are doing just that. The stronger, more established economies will push ahead with their investments, even in petrochemicals, as many take the view that it is best to invest in a downturn because EPC costs are lower and when the projects are finally commissioned the market is invariably in the upswing.

However project capital costs have not fallen as quickly as developers hoped. For example, for a combined-cycle gas-fired plant commodity prices make up around 40-45% of the cost of a plant. Steel, copper, nickel and lead have dropped to around 2004 levels, but the price per kW for power projects has not followed.

For Bahrain's first IPP at Al Ezzel, which was bid in 2003, the cost of power was around $410-$420 per kW, but at the height of the EPC inflation in 2008 the equivalent cost for Shuweihat 2 IWPP was believed to be around $800-$1,000/kW. In the first quarter of 2009 the bid cost, according to one developer, would be around $700-$750/kW. The reason that costs have not fallen as quickly as commodity prices is because contractors have inventory and forward commodity contracts that will only work themselves out after 12 to 18 months.

While forward contracts take some time to unwind, low EPC prices are likely to march side by side with higher debt pricing: EPC and debt pricing are loosely inversely correlated. Developers argue that low EPC costs are the priority – because debt can always be refinanced – whereas bankers argue the financing is the single most important aspect in the current market. Once commodity prices pick up and EPC prices inflate again, competitive pressure should return to the bank market, but to nothing like it was in 2007-8.