The growing economies of India and China have had a marked effect on the price of commodities globally. Oil, gas, and natural resources producers have benefited enormously from this demand, and project lenders have experienced increased demand in turn for their services. It has also been a spur to the entry of new lenders into infrastructure finance, particularly in China and India.

But the competition for resources, and the rise in oil prices, have the potential to change the way in which emerging economies – those below the BRIC (Brazil, Russia, India and China) level – finance their infrastructure. The newer sources of financing, including soft loans, domestic capital markets, Asian export credit agencies (ECAs) and straightforward grants, have the potential to sideline the established multilateral and export credit agency lenders, just as they start to demand better environmental and social performance from their clients.

National insecurity

The rise in oil prices, in particular, has sparked a growing assertiveness amongst host countries in emerging markets, which have seen revenues, and their perception of the wealth of their reserves, grow immensely. While no project lender has recently faced a serious loss from expropriation of an oil asset, several are confronting changes in ownership, as well as the diversion of offtake revenues from their intended destination.

A host of governments – in Russia, Venezuela, Ecuador, Kazakhstan, Chad and Bolivia – have enforced changes to the agreements governing oil and gas projects. Some of these have affected both public and private sector lenders, such as the creeping renationalisation of the heavy oil projects in Venezuela. Others, such as the government of Chad's diversion of revenues from the Chad-Cameroon pipeline to non-approved uses, have little impact upon lenders, but offer a rebuke to the idea that multilateral lending can be a spur to greater transparency and better governance.

The Venezuelan heavy oil projects offer the clearest immediate threat to project lenders, and the country's president, Hugo Chavez, offers the most dynamic example of an emerging market taking control of its own oil resources. The country's national oil company, Petroleos de Venezuela, SA (PDVSA), took control of the heavy oil projects – Sincor, Hamac, Cerro Negro and Petrozuata – in June. While many of PDVSA's fellow shareholders settled, ConocoPhillips and ExxonMobil have disputed the move. ExxonMobil launched arbitration proceedings at the International Centre for Settlement of Investment Disputes on 12 September.

The projects are between them subject to roughly $2.9 billion in project debt, including a $628 million US Ex-Im-guaranteed loan to the Hamaca oil project, in which ConocoPhillips had a 40% stake. This debt is still current, although lender protections, including a pledge over the reduced foreign shares in the projects, have been substantially reduced. A similar, only slightly more amicably negotiated, acquisition took place with the Sakhalin II project, where state-linked oil and gas operator Gazprom bought down Shell's stake in the venture in December 2006.

Mega projects and the ECAs that love them

But while such large oil and gas projects have become the mainstay of the export credit agencies, this assertiveness has not yet led to a wholesale reassessment of their lending practices. Says Barbara O'Boyle, vice-president, structured finance, at US Ex-Im "Well, on one level, that's why we're there. There certainly are projects where we've had problems, and we build the potential for such problems into the due diligence. But we were doing deals when oil was at $12 per barrel."

Oil and gas have accounted for a large proportion of US Ex-Im's recent project finance commitments. It provided a $500 million guarantee for Reliance Petroleum's Jamnagar refinery project, which closed earlier this year, although its largest commitment in 2007 was a $610 million loan guarantee for an expansion to Chartered Semiconductor's Fab 7 plant in Singapore.

US Ex-Im might have contributed to Sabic's $10 billion Kayan refinery financing in Saudi Arabia, but, according to O'Boyle, the sponsor decided to scale back Ex-Im's commitment. Ex-Im still has a $587 million commitment outstanding towards Chevron Phillips' latest petrochemicals project in Jubail, on which the sponsor is currently looking for lender commitments.

Ex-Im and its fellow western ECAs are now much more providers of capacity to sponsors of mega-projects than political risk providers, at least for project financings. The size of such deals, as well as their complexity, means that sponsors are much more concerned with lessening the burden on commercial banks, particularly in the Middle East, than mitigating political risk.

The current level of interest in the Gulf region illustrates one of the peculiarities of the export credits system. Export credit agencies of countries that are members of the Organisation for Economic Cooperation and Development adhere to a common set of guidelines and generally, though not exclusively, restrict themselves to working in non-OECD countries. ECAs from outside the OECD, particularly China Exim and Korean Exim, are not bound by the same guidelines.

How next to innovate?

But some ECAs, whether for political or economic reasons, tend to stick more closely to the letter of the guidelines than others. Several export credit agencies offer some kind of support for sponsor equity investments overseas, including Sace and Euler/Hermes, which provide subdebt for such occasions. The German ECA has also been able to offer support for mining projects that provide raw materials to German industry.

But the most aggressive ECA by far in supporting sponsor activities overseas and their pursuit of natural resources is the Japan Bank for International Cooperation (JBIC). JBIC has recently been gaining plaudits for the speed of its decision-making and the lengths to which it will go in support of Japanese companies. Its heavy goods-manufacturing and power generation players have been the big beneficiaries, and it has also extended its interests in Latin American oil and gas.

For instance, in February this year, as negotiations with the US sponsors of the Venezuelan heavy oil projects broke down, Marubeni and Mitsui signed a $3.5 billion prepayment deal with PDVSA for delivery of crude and refined oil to Japan. JBIC provided $1.89 billion of the financing, and guaranteed the remainder, for which Bank of Tokyo-Mitsubishi UFJ, and Mizuho Corporate Bank, as lead arrangers, and SMBC, ABN Amro Bank, ING, Citibank, Deutsche, Société Générale, BNP Paribas, and Calyon were lenders. Three of the above banks – BNP, ING and BTM – had agent titles on the Hamaca financing, while Deutsche is bond trustee for the Cerro Negro bonds, in connection with which role it has issued a letter of default to the project's sponsors.

When signing the loan, JBIC noted that the deal would lessen its dependence on Middle Eastern supplies of oil, although the Japanese ECA has at the same time stayed active in that region. Its attempts to reign in its exposure to the region, in particular to the independent power and water projects there, have been largely fruitless, and this year it contributed $800 million to Marubeni Mesaieed A financing in Qatar and $1.2 billion to Marubeni and International Power's Fujairah 2 project in the UAE, about the same volume of business that US Ex-Im has done globally in 2007.

But the JBIC funding in these markets, which is designed to support Japanese sponsors and extend Japanese influence in the region, does not always support Japanese exporters. While Middle Eastern financings tend to use gas turbines from larger manufacturers in Europe, the US and Japan, they sometimes lean on less well-known contractors to cut the price of EPC costs.

The China margin

In Asia, and particularly in Indonesia, JBIC has increasingly been supporting Japanese sponsors that are installing Chinese coal-fired generating equipment. The low cost of coal in the region, as well as the expertise than Chinese manufacturers have built up, makes Japanese exporters increasingly uncompetitive, even as, with deals like the $3.43 billion acquisition of Mirant's Philippines assets, sponsors like Marubeni and Tepco build up a substantial portfolio.

Even while JBIC unleashes acquisition products that are the envy of the other OECD export credit agencies, it keeps one eye on the other Asian ECAs and banks. According to Ryuichi Kaga, the director-general of JBIC's project finance department, "it is not just Chinese subcontractors that pose a threat, since Chinese banks are becoming very aggressive. Their attitude to security packages is a little different."

This last is much more significant in competing for oil and gas and mining projects. Chinese banks, and China Ex-Im in particular, have been extremely active in Africa. China Ex-Im recently signed an $8.5 billion loan agreement with the Democratic Republic of Congo to support mining project development. Five Chinese banks, including China Ex-Im, participated in Sonangol's $1.4 billion borrowing base from May 2006. According to China Ex-Im, it had signed and approved roughly RMB 100 billion ($13.3 billion) in loans to Africa up to June 2007.

JBIC's Kaga suggests that the ECA is likely to roll out a borrowing base product to stay competitive in riskier countries in South-East Asia, where it is looking to build market share and offer an advantage in structuring. It is also keeping a close eye on Korea, where Korea Ex-Im is now offering substantially similar products to JBIC, and the two agencies have cropped up alongside each other on deals such as the Ambatovy nickel project in Madagascar. However, as the withdrawal of the Chinese banks on the JBIC-supported Tangguh project in Indonesia demonstrates, there is a limit to the depths to which resource projects will drive pricing.

Soft love

The ECA response to resource nationalism depends on a mixture of ingenuity, political will and the strength of its main exporters. For the multilateral lenders, the outlook is less certain. The private sector solutions that have dominated thinking about emerging markets infrastructure face challenges in countries that enjoy oil wealth, or the attentions of oil rich countries.

According to Roberto Vellutini, the manager for infrastructure and the environment in the structured and corporate finance department at the Inter-American Development Bank "We're seeing a division of Latin America into two camps, with countries such as Ecuador and Venezuela pushing a public sector model for infrastructure provision, and others, such as El Salvador, Chile and Argentina relying on the private sector. Brazil is a mixture."

Here, again, the motivating spirit of Hugo Chavez is at work, since the Venezuelan president has long urged Latin American countries to reject the influence of the World Bank and IMF. He has even put forward a new bank, the Banco del Sur, to combine the project lending and emergency lending functions of the two. The bank, which is set to start operations in November, is set to consider Chavez's pet project, an 8,000km gas pipeline linking north and south, for financing.

The bank, to be based in Venezuela's capital has had a mixed reception, since few other Latin American countries are likely to follow his call to withdraw from the IMF. The Andean Development Corporation (CAF), also based Caracas, and with an overlapping remit, could argue that the new body is largely unnecessary. Brazil, moreover, is ambivalent, particularly since it has opened up its oil industry to foreign debt financing, particularly Japanese players. The IDB, for instance, which has long been a mainstay of Brazil's electricity sector, is now considering a loan to an offshore oil project there.

In Brazil, the national development bank, BNDES, enjoys an unusual level of political influence and involvement in the country's economy. Other Latin American economies benefit, at best, from the attentions of other countries' development banks. Japan, in exchange for pro-whaling votes, and China, in exchange for de-recognising Taiwan, are among the best sources. As one multilateral lender laments "I've had countless conversations with one Central American municipal utility about structuring a private sector upgrade project for him. But the chief executive says he's unlikely to move so long as the JBIC funding keeps coming."

Soft money need not entirely be a curse. According to Rashad Kaldany, the director of the infrastructure department at the International Finance Corporation, "I think we might be able to turn these soft money infusions to some sort of good, perhaps by using them to backstop host government availability payments to PPP projects."

Bonds and moans

Multilaterals see more potential for involvement in capital markets debt enhancement, particularly in Latin America and Asia. The IFC has provided partial guarantees to bank loans, while the IDB, through its public sector department, provided a partial guarantee of the government of Peru's obligations to the IIRSA Norte toll concession in Peru. The Multilateral Investment Guarantee Agency provided a $108 million guarantee for part of the international bond debt and equity financing of the Autopistas del Nordeste toll road in the Dominican Republic.

According to Yukiko Omura, executive vice-president of MIGA, "demand for our products is a little cyclical. Until recently, with the recent credit crunch, you had a situation of excess liquidity, and investors moving boldly into emerging markets. Sponsors and banks preferred a partial guarantee because it provided the requisite capital relief at little cost. The appetite for the 100% political risk cover was a little lower, because the premium ate into their returns."

Omura rejects the idea that such guarantees are usually only deployed where robust capital markets already exist. "The Dominican toll road we did absolutely did need it – the banks were struggling to find investors for the B- credit beyond 8 years Repeating it in Asia should be easier, although using it in Africa would be much harder."

Still, the IDB and IFC have enjoyed limited take-up of their guarantee products, with the IFC's partial guarantee facility for the CONIPSA PPP road concession in Mexico unlikely to be repeated. The IDB, likewise, approved a partial guarantee for the FARAC toll road concession, also in Mexico, but ICA and Goldman Sachs, which won the concession, decided against using it.

Multilaterals think that with some improvements, the product might be adapted to emerging project bond markets like Brazil, Peru and India. The IDB's Vellutini thinks that its local currency products could be made more user-friendly, especially if the guarantor can be persuaded to assume a greater level of currency risk. For MIGA's Omura policy definitions will need tightening. "We need to adapt our guarantee offerings to the changing nature of creeping expropriation. We've mostly been looking at breach of contract insurance without looking at non-honouring of a sovereign guarantee."

This thinking suggests that MIGA is looking ahead to the next wave of project difficulties. Political risk insurance, according to one consultant that specialises in arbitration, is designed to deal with the likes of the Indonesian power crisis, which led to the renegotiation of several power purchase agreements, rather than outright renationalisation, as had been the case in the 1960s and 70s. "Political risk insurance and deal structures will need to reflect what has been happening in the oil and gas industry recently," the consultant adds.

More conflict or more reason?

The multilaterals hope that a more stringent worldwide set of environmental regulations for project lending will help to drive business back to such institutions. Says MIGA's Omura, "it's tempting to go to the fastest and easiest source of capital, without taking the time to go through the necessary structural changes." Omura thinks that as host countries and sponsors take a longer-term view of environmental risk, mitigating it will become less burdensome.

The Equator Principles, most agree, have created a genuine improvement in the quality of projects that they receive for approval. While ECAs still occasionally grumble about the gaps between their own guidelines and those of the IFC, on which the Principles are based, they recognise the fact that these have become the de facto standard for the bank market. The IFC, which had faced some criticism for appearing so close to this commercial endeavour, is broadly satisfied. "The adoption of the Equator Principles has been a terrific development from my perspective," says the IFC's Kaldany.

Even an ECA like JBIC, caught in a tension between its aggressive neighbours and the OECD norms, is hopeful that better practice can be exported. "We have not yet been in a position where we competed with another institution on the strength of our environmental due diligence," says Kaga, and we think that by collaborating on financings with less advanced institutions we can have a beneficial effect." Nevertheless, the reports coming out of Chinese contracting practices in Africa, where labour and social practices have attracted widespread criticism, will direct attention towards any institution that co-finances with Chinese lenders.

Multilaterals are torn between praising the recent surge in global liquidity, when it results in greater supply of equity capital, and despairing at its effect on lending standards. For the IDB's Vellutini, a shortage of equity is a very real problem. "Senior debt is not so much of a problem – borrowers can sometimes get 17-year debt in Guatemala, but local contractors are still the mainstay of many markets. Mexico might be the exception, but even there a local player like ICA dominates the market."

But both the IFC's Kaldany and MIGA's Omura think that a return of normalcy to debt markets will benefit their operations. Says Kaldany "because the markets have been so liquid, we've seen lending standards drop, and we've stood aside, but we don't think that this will be healthy in the long term." Kaldany also notes that while some emerging markets, particularly, BRIC, have been successful in attracting capital, the IFC still has a useful role in less frequently visited areas.

India crops up repeatedly in conversations with the ECAs and multilaterals. US Ex-Im's O'Boyle says that it has had initial conversations with the country's government about the slate of Ultra Mega Power Projects. Kaldany thinks that the development of the Indian capital markets would benefit from some kind of guarantee product.

Band of gold

The lenders, now closer than ever in their vulnerability to external threats, seem to recognise the benefits of a common front. Several ECAs have announced reinsurance agreements in the past ten years, although the volumes of business reflect the fact that most ECAs are called upon to provide capacity and offer the fastest execution possible, rather than disperse political risk.

The national development finance institutions, the parallel sources of development capital, recently issued a statement together with the multilaterals that "places corporate governance at the forefront of their sustainable development agenda." The agreement, signed by 31 institutions*, is a declaration that development finance institutions, regardless of the allure of soft money, will try to advance their development goals through the private sector.

It chimes with recent statements from new president of the World Bank Robert Zoellick, who wants more of the bank's activities channelled through private sector bodies and the IFC. But the new stress is also likely to see the IFC tackling countries much further down the developmental scale than the BRIC countries. NGOs have often argued that IFC activities target the more prosperous borrowers.

More exciting is the latest memorandum of understanding (MOU) to carry JBIC's name. Previous JBIC MOUs have focused on sharing expertise with resource-rich countries. The latest, which has yet to be formally announced, concerns the IFC's preferred creditor status. The ECAs and the World Bank, and to a lesser extent other multilaterals, have been limited in the degree to which they can collaborate because both sides want to adopt a lead role as creditor, and be repaid as early as possible. This does not preclude co-financing, but does make the negotiating process very drawn-out. If JBIC and the IFC have come to a suitable arrangement, and details of the mechanism are still scarce, then other ECAs are likely to follow suit rapidly.

*Asian Development Bank, AWS (Austria), African Development Bank, Belgian Investment Bank, The Black Sea Trade and Development Bank, Central American Bank for Economic Integration, CAF, CDC Group (UK), COFIDES (Spain) Development Finance Company of Uganda, Development Bank of Southern Africa, DEG (Germany) East African Development Bank, EBRD, EIB, FINNFUND, FMO (Netherlands), IDB, International Bank for Reconstruction and Development, Industrial Development Corporation of South Africa, IFC, IFU (Denmark), Islamic Development Bank, Norfund (Norway), OPIC, PROPARCO (France), Eastern and Southern African Trade and Development (PTA), SBI (Belgium), Swiss Investment Fund for Emerging Markets, SIMEST (Italy) Swedfund (Sweden)

 ECA and Multilateral efficiency survey

source: Project Finance market survey 2007

ECA and Multilateral supportiveness survey

Source: Project Finance Market Survey 2007