The scale of upcoming Saudi project borrowing is vast. At $26 billion the Aramco/Dow Ras Tanura petrochemical project in Saudi Arabia matches Dealogic's US project debt volume for 2007. And it is just one of a number of multi-billion dollar Saudi projects likely to come to market over the next five years.

The mega-projects that have been allocated fuel feedstock by the Ministry of Petroleum will almost certainly get financed. But construction contract inflation across the GCC is placing more stress on constrained project funding markets. For example costs on the Emirates Aluminium project in the UAE have risen $350 million and there is already speculation that Ras Tanura could go up to $30 billion.

The cost of dollar project funding for local banks – now around 150bp – has risen because of speculation over a revaluation of the riyal's peg against the dollar. A committee in the Shura Council is currently recommending to King Abdullah that the authorities revalue the riyal by up to 30%. But the King is unlikely to accede, to protect the value of some $3.5 trillion of dollar assets held by Saudis. Given the uncertainty, local banks are loath to borrow or lend long-term dollars and are factoring in a dollar liquidity risk, margin on top of credit risk or lending below funding costs for key clients with the financial muscle to compel them to do so.

The riyal/dollar peg is also affecting the cost of local debt. As more borrowers tap the riyal lending market, the cost of riyal debt could face upward pressure. Furthermore, with Saudi inflation at 10.5%, and since the peg prevents it from manipulating interest rates, the Saudi Arabian Monetary Agency (Sama) has taken the only inflation control mechanism available to it and increased the cash reserve ratios of local banks from 10% to 12%. If it pursues that policy further it could place constraints on local bank liquidity, which would leave project sponsors stuck between both an illiquid local and international debt market.

The question hanging over the Saudi project market is whether the forthcoming volume can be financed on schedule and how much of that volume can be taken on by local banks or state institutions like the Saudi Industrial Development Fund (SIDF) and Public Investment Fund (PIF).

For now, local liquidity is healthy. Local banks have been frequent buyers over recent months of dollar-denominated project debt in the secondary market, which has traded at discounts to par value as international banks have sought to mend their balance sheets. And on a number of recent project deals local bank commitments have exceeded international ones. For example, Al Rajhi Bank is particularly liquid and is able to underwrite up to $1 billion of Islamic project debt at a time, and hold around $600 million.

Saudi banks are still able to write big dollar cheques for long tenors, but many banks are only providing long-term dollar debt when compelled to by top-tier clients. Banks will be much more selective for lower-tier clients, and it is those projects which will be hardest hit by fallout from the dollar/riyal peg.

To avoid currency mismatches, projects below $3 billion developed by local contractors are likely to be financed in riyals. For instance, the Saudi Electric Company (SEC) recently awarded local firm Bemco a contract to construct the 2,000MW Riyadh P10 power plant. Lead arrangers and bookrunners Banque Saudi Fransi and Samba are out to the domestic bank market with a locally denominated 4.5-year SR8.5 billion ($2.2 billion) facility.

The risk of currency revaluation is less severe on projects where the funding matches revenue streams, such as dollar funding on export-driven oil and gas projects. Riyals are more likely to be used for non-export projects with domestic contractors, although international banks lending into riyal revenue projects would benefit from any de-pegging, since it would mean an aggressive appreciation of the riyal against the dollar.

Diversification of funding resources will be the key to closing the Saudi project pipeline. Ras Tanura is likely to be split into parts – the utilities component alone could be worth up to $3 billion – and tap every available pool of liquidity such as a 144A issue, regional banks, export credit agencies (ECAs), commercial debt, quasi-sovereign support and so on.
And timing could be on the side of some major developments. Ras Tanura is not expected to reach financial close until late 2010, by which time international bank appetite is expected to be on the rebound from the current low.

Patchy syndication

However, projects in the nearer term will be financed against the backdrop of a patchy syndication market and will rely heavily on the strength of the sponsors, or in effect how much banks value a sponsor's long-term business.

The problem for local lenders is that the strongest sponsors expect the pricing levels of the pre-crunch era. The $1.8 billion of commercial financing for the $5 billion National Chevron Phillips (NCP) olefins project, which signed in May, harks back to pre-crunch pricing. The deal had a soft financial close in November 2007, when banks committed before a spike in dollar funding costs. The 14.5-year loan priced at an initial 80bp to 115bp, with an average life of 10 years and fees of 90bp.

But since NCP syndications have closed for Ma'aden Phosphate and Saudi Kayan – both of which were undertaken without market flex and below the cost of funding for some of the banks involved.

Because of low pricing, the deadline for the syndication of the $6 billion project debt backing Sabic's $10 billion Saudi Al Kayan petrochemical project in Jubail was continually put back as the deal struggled to syndicate.

The financing comprised a $1.8 billion bank tranche, of which $1.03 billion is Islamic finance, a $1.5 billion ECA-covered tranche divided equally among ECGD, Sace and KEIC, a $500 million direct Kexim loan, a $1.5 billion tranche from the PIF and $530 million from the SIDF. There is also a $635 million Islamic working capital facility lead arranged by Al Rajhi.

The commercial loan had a 15-year tenor and a margin of 65bp over Libor, rising to 75bp. Fees on the commercial tranche are 100bp and 25bp on the ECA-backed tranche.

The debt backing the $5.6 billion Ma'aden Phosphate integrated fertiliser project – sponsored 70% by Ma'aden and 30% by Sabic – priced at 80-115bp over Libor. The debt comprises a 16-year $2.06 billion syndicated bank loan, of which $1.76 billion is Islamic debt, a $200 million 16-year covered facility from the Korean Export Insurance Corporation (KEIC), a $100 million working capital facility and a $400 million 16-year direct loan from Kexim. The PIF is also lending $1.07 billion, while the SIDF is providing $135 million.

The pricing difference between the commercial/Islamic facilities on both deals and the KEIC tranche on Al Kayan (25bp) compared with Ma'aden (60bp) is a measure of the difference between the standings of Sabic and Ma'aden, with the stronger sponsor a minority partner in Ma'aden Phosphate. Furthermore, compare this pricing to the ECGD tranche on Yansab, an early 2007 deal which priced at 10bp, and the degree of shift in pricing becomes clear.

A consequence of the syndication market is that some GCC procuring authorities are asking bidders, such as those on the Saudi Landbridge tender (see box on p46), to have underwritten bank commitments at final bid, or are even asking financial advisers to state-owned companies to sign preliminary underwriting commitments. This is rumoured to be the case for Ras Tanura. Despite the authorities' intentions for a fast close and successful syndication, banks say that many of these commitments are unrealistic and unenforceable and can cause conflicts for the advisers.

Sipchem rides it out

Enjoying a smoother ride in the syndication market is Sipchem's JAC (Jubail acetyl) project, on which SABB is solely underwriting a $745 million refinancing. SABB is holding a beauty contest of sorts among local banks who wish to participate and has had reverse enquires from banks willing to underwrite half the debt.

Sipchem, with its financial adviser HSBC, first approached the local and regional bank market in late 2005, based on project costs of $1.1 billion. As with all projects in the region the project suffered from capital cost inflation. When nine banks signed a 12-year $564 million financing in December 2006, project costs had risen to $1.4 billion.

As the project developed it became clear that the sponsor would need to go to the bank market again, as costs rose to $1.8 billion. Financial adviser HSBC approached the same bank group in December 2007 with an entirely updated preliminary information memorandum, complete with fresh market reports. Despite the rise in capital costs, the project was significantly less risky, since construction was over 50% complete, all of Sipchem's base equity was in the deal and the original financing had not been drawn.

Despite the credit market conditions, Sipchem had expected improved pricing on the deal, which is financed on a 60/40 debt-equity split. When the other banks dithered, SABB duly decided to underwrite the whole $745 million loan on pricing lower than the 165bp over Libor on the original deal. The loan has an 11-year tenor from commercial operations. The plant is on course to be operating in around 11 months' time.

Both SIDF and PIF will also come into the deal, with PIF's contribution expected to take out half the commercial bank debt (around $325 million).

The deal is syndicating to a limited number of Sipchem's relationship banks, which are keen to appease a sponsor that will go to the bank market again for a $10 billion olefins project (Jubail II) that is likely to close sometime in 2009. Sipchem has intimated it will not use banks again if they do not sign up to the deal. HSBC is advising and is currently concentrating on bringing in other private partners.

Refineries

Before the mega-Ras Tanura project comes to the bank market in 2010, two more petrochemical projects are likely to come to market in late 2008, early 2009.

A final investment decision was made on 14 May for the Total/Aramco 400,000 barrels-per-day (bpd) refinery in Jubail. A joint venture for the refinery will be formed during the third quarter of 2008, in which Saudi Aramco will initially have a 62.5% stake and Total 37.5%. After 25% of the company is floated on the stock exchange, Aramco and Total each will retain a 37.5% shareholding. Calyon and Saudi Fransi have won the advisory mandate on the project, which is expected to require an overall investment of around $15 billion.

A similarly sized and structured Aramco refinery joint venture is also being developed with ConocoPhillips, the Yanbu Export Refinery Project, for which Citigroup is the financial adviser. And, in the longer term, Saudi Petroleum and Mining Ministry has also announced that it will issue requests for proposals for a third refinery: the 250,000-400,000 bpd refinery in Jizan on the Red Sea coast.

The refinery projects will be fed by Arabian heavy crude feedstock, illustrating the country's shift to heavier feedstock. There is some speculation that the Ministry of Petroleum has allocated all of its available ethane, so there is likely to be an emphasis on downstream petrochemical plants such as acrylics and longer polymers which will involve smaller units and a number of private parties. A paucity of ethane is also likely to lead to a tailing off of greenfield activity and a greater emphasis on M&A activity, especially as most firms are cash rich, given the current oil price.

Power and water

Saudi Arabia continues to have a strong appetite for power and water projects. Demand for power in the kingdom is growing at 7% to 8% a year, and the SEC estimates that 35,000MW of new capacity is needed over the next 10 years to cover demand growth and build up 15% reserves, and 70,000MW is needed by 2020.

Bids for the Ras Al Zour independent water and power project (IWPP) went in on 28 June and are currently being considered by the country's water and electricity company. The project had to be reworked once the deal was changed from gas-fired to oil-fired to ensure that engineering procurement and construction contractors could guarantee the project and that there was sufficient competitive pressure among the top players. Three consortiums are in the running with the Sumitomo grouping favourite to succeed.

HSBC is also advising WEC on the Marafiq Yanbu IWPP project. Request for proposals went out to market on 12 March, with bids due back on 27 August. The plant will be at Yanbu and comprises a 1,700MW power plant with 33 million gallons per day of desalination capacity. Prequalifiers include Acwa power with Kepco, Marubeni, Mitsubishi, Mitsui, Powertek, Sembcorp, Suez with Oasis, Tenaga and Union Fenosa.

The deal comes with a slightly different guarantee from The Saudi Ministry of Finance from the original Jubail-Marafiq deal. The Yanbu project will involve credit support to the concession company and in turn Marafiq will get its customers to pay via collection accounts. The Ministry of Finance guarantee is limited to a termination guarantee rather than a full termination and payment guarantee.

Three IPPs are scheduled to be tendered on a build-own-operate basis. The 1,200MW oil-fired Rabigh IPP, SEC's first IPP, is being tendered and is scheduled to come online in 2013. The 2,000MW gas-fired Riyadh P11 IPP will be commissioned in 2014, and the 2,000MW oil-fired Qurayah IPP in 2015. IPPs are technologically easier than IWPPs but they will not feature any MoF guarantees whatsoever.

Mining and minerals

The Saudi authorities are keen to diversify industries beyond the activities of Aramco and Sabic and have made a concerted push into mining and minerals, through the growth of state-owned mining company Ma'aden and by attracting foreign miners to the kingdom.

As well as the recent Ma'aden/Sabic phosphate deal, Ma'aden is planning an aluminium smelter at Ras Al Zour in a joint venture with Rio Tinto-Alcan. It will cost about $7.5 billion and involves building a bauxite mine, refinery, smelter and power station to produce at least 1.4 million tons of alumina per year and 650,000 tonnes of aluminium. Production is scheduled to begin in 2012.

The country will process ore from the Arabian shield mineral deposit and it also plans to become a regional hub for the processing of bauxite shipped in from abroad to benefit from the $4-per-barrel oil feedstock. Future plants will need captive power plants, though, and they will be dependent on feedstock allocation.

Beyond Ma'aden, Chalco and MMC Corporation plan to build a 1 million tonnes-per-year aluminium smelter at Jizan economic city, which will cost in the region of $5 billion and require $4 billion in debt. Negotiations with the Ministry of Petroleum continue over the allocation of fuel for the smelter's captive oil-fired power station. Fuel allocation will also be critical to a domestic firm, Western Way for Industrial Development Company, which is looking to build a second aluminium smelter at the site.

Other projects

The Ministry of Water and Electricity is pushing ahead with its plans to privatise and upgrade its wastewater network. The privatisation will follow the WEC IWPP model, and is likely to split the network into discrete geographical portions with Riyadh, Damman and Jeddah likely to comprise the best assets. A request for proposals is likely to circulate in the third quarter of 2008.

Similarly the Saline Water Conversion Corporation – the largest desalination company in the world – seems likely to be split up and privatised. Privatisation is awaiting high-level government approval.

The highly ambitious plan to develop six standalone economic cities will also provide huge financing opportunities – although the government agency responsible, the Saudi Arabian General Investment Authority (SAGIA), has made slow progress.

The King Abdullah Economic City (KAEC) at Rabigh on the Red Sea coast is being fast-tracked, and could involve investment at the site of over $35 billion in projects such as a port, an aluminium smelter, a Total-sponsored lubricant oil facility and a college.

The five other cities are located at Medina, Hail, Jizan, Tabuk and and Ras al-Zour. SAGIA's plan is that by 2020 the cities contribute $150 billion towards GDP across the petrochemical, steel, glass and ceramic sectors and create 1.3 million jobs.

Saudi Landbridge: Uncertain progress

The tender procedure for the $5 billion-plus, 30-year Saudi Landbridge concession has drawn criticism from some quarters for its lack of transparency. The Saudi Rail Organisation (SRO), advised by UBS, asked for an initial round of bids on the original technical specification, then received and reviewed the proposals before asking bidders to enter a second bid according to strict specifications with fully-underwritten unconditional bank commitments.

The winning Tarabot consortium (led by Acwa Power) is advised by BNP Paribas, which is likely to join as a lead arranger with Saudi Fransi, RBS, Calyon, Samba, Al-Rajhi, Mashreq Bank and Arab Bank. White & Case is providing legal counsel to the banks and Allen & Overy is advising the sponsors. The Saudi Binladin group, advised by Deutsche, is named as the reserve preferred bidder.

The key element of the bids was the level of government subsidy required. Some sources close to the bidding said that the winning bid was around 25% of the subsidy posted by the highest bidder. The divergent bids have left some to consider that the banks are not unconditionally committed and have overestimated the traffic. It is likely the banks will hope for some flexibility in negotiation now that they have their foot in the door. Indeed, one of the banks in the arranger group says that credit committees have yet to be approached because they are waiting on fuller technical due diligence. The tender procedure has also been criticized because the bidders have to price in setting up and operating a passenger traffic concession for five years before handing it back to the SRO to re-tender, an inefficient method of extracting value from the PPP model.

The main contract is a 40-year freight concession. Banks will depend on traffic projections on a greenfield infrastructure project, which are notoriously inaccurate. The freight line is in competition with poorly paid truckers who can fill their trucks with fuel at R1.68 per litre. It is also unclear what competitive measures the haulage industry could take to counter Landbridge.

The King is thought to have grown tired at the progress of SRO and has dropped using a concession model for the Makkah-Medina Rail Link, which will instead be traditionally procured. The project is split into three main contracts: civil engineering and station construction; track and signalling; and operation and procurement of rolling stock.