When and if a Gulf project debt facility fails to syndicate and banks are left with a bad asset on their books there is likely to be a celebration in the offices of regional and domestic lenders.

The margin mincing that was a feature of last year – starting with Rabigh at 35bp and then Yansab at 45bp – looks set to continue for the foreseeable future, and consensus among bankers is that it will take a major syndications catastrophe to get debt pricing back up to what constitutes a realistic return in a market where the majority of local and regional lenders cannot raise funding at less than 30bp themselves.

The average pricing for deals has halved in the past three years with government guarantees and solid sponsors pulling around 35bp during construction (Qatargas 4 got as low as 30bp) for roughly 10 or 15-year debt, rising to 65-75bp.

There are already signs that the pricing war may be nearing bottom dollar. For example towards the end of last year Sembcorp's $1.5 billion Fujairah IWPP deal in the UAE struggled in syndication. Launched via bookrunners Barclays and Societe Generale, the fees were upped on the top $75 million take by 20bp to 80bp to get the deal done.

But with the demand for project deals from highly liquid international lenders continuing to rise – only the Chinese banks are missing from the region and that may change this year – and given the semi-sovereign credit status of many deals and the desire to build banking relationships with corporates across MENA, pricing looks set to only reach a static low rather than climb again.

And appetite for debt from the region's sponsors is equally high. In Saudi Arabia alone the debt requirement for 2007 is expected to top the $26 billion of 2006. Qatar has announced $130 billion of project spend by 2015 of which $55 billion will be raised through syndication and $15 billion through bonds, according to forecasts from the Finance Ministry. Qatar Petroleum (QP) alone is looking to close $27 billion of financing by 2009/10.

But with such vast investment planned and almost double the income from oil and gas than would have been forecast three years ago, much of the financial engineering to come will be about maximizing use of corporate capital – in effect sponsors borrowing, not because they need to, but because they can make higher returns investing their money elsewhere whilst using cheap borrowings to fund development or expansion work.

Corporate capital markets entrants

One of the most significant trends in MENA is the entry of major Gulf corporates into the capital markets – either to part finance or refinance acquisitions, or for equivalent pricing to project debt at longer tenors.

Nevertheless, new infrastructure-related issuers in the Gulf last year included Taqa (the Abu Dhabi National Energy Co), Qatar Petroleum, Kipco, Dubai's state-owned DP World and Nakheel, the property arm of DP World.

On the acquisition side DP World's facility backing its buyout of P&O comprised a $3.5 billion pre-IPO convertible sukuk. Lead managers Barclays Capital and Dubai Islamic Bank increased the deal by 25% from the planned $2.8 billion and priced it at 200bp over Libor – the tight end of an already tightened guidance.

The deal was structured to exploit strong appetite for IPOs in the Middle East. Share offers in the region are frequently more than 1,000 times oversubscribed, so the deal was arranged to attract investors by giving them a guaranteed share allocation in the event of an IPO.

But the headline grabbing corporate bond of the year was the $3.5 billion equivalent euro and dollar deal from Abu Dhabi National Energy (Taqa) in October with Goldman Sachs as sole bookrunner.

Investors found Taqa's combination of Aa3/A+ ratings, scarcity value and 75% ownership by the United Arab Emirates government irresistible. The deal drew more than $10bn of orders for its three tranches: a $1.5 billion 30-year marketed at 160bp-165bp over Treasuries, a $1 billion 10-year at 110bp-115bp and a Eu750 million seven year tranche, offered at 45bp-50bp over mid-swaps. All three tranches were priced at the tight end of guidance.

Saudi petrochemical company Sabic joined the trend in November when it issued a Eu750 million seven-year euro benchmark through JP Morgan and HSBC, priced at 68bp over mid-swaps. And Kuwait Projects Co (Kipco), the diversified holding company, opted for the shorter end of the curve when it issued a Eu200 million two year floater through Dresdner Kleinwort and Lehman Brothers.

New issuance will increase. Taqa alone will bring three more deals to the market in the near future. But the beginnings of bond issuance is not going to outstrip project debt – at least not for greenfield projects – given bank tenors of up to 20 years on project finance and the flexibility of dealing with a bank consortium with expertise in projects rather than arms-length bondholders.

Furthermore, despite expectations to the contrary, banks are having no trouble swallowing ballooning project debt volumes which are driven in part by rising EPC costs and in part by the fact that the banks will accept the large volume takes: ABN Amro claims it initially underwrote the whole of the Yansab deal last year on its own.

Many banks are also content to accept low project margin work with a view to future fee income and to further a client relationship – although fee income is also declining and competition for advisory roles and add-ons (interest rate hedging, cash management or foreign exchange) is intense.

More diversification into Islamic facilities

In addition to more corporate bond issuance the diversification into Islamic debt is picking up into a significant part of the market – albeit often driven by commercial banks with Islamic operations rather than the local Islamic lenders.

The forecast $6 billion debt package on the Saudi Kayan Petrochemical Company project in Jubail is just one of a number of deals expected to feature major Islamic tranches in the coming year. Sponsored by Al-Kayan Petrochemical Company and Saudi Basic Industries Corporation (Sabic) the financing will go to market following an initial public offering (IPO) of shares.

The upcoming financing for the Saudi Arabian Mining Company (Maaden) phosphate and aluminium projects (potentially the biggest Saudi project to date) will also have Islamic portions, and several smaller petrochemical financings in the kingdom will include Islamic structured debt.

Already this year the $1.45 billion Shuqaiq IWPP financing has closed with an Islamic tranche. It followed $850 million worth of Islamic financing for Yanbu National Petrochemical Company in 2006 that was almost equivalent to its conventional bank tranche, and the first wholly Islamic project financing – Al Waha (For more details search "Al Waha").

There are strong incentives to explore sharia-compliant deals. The Saudi banks and sponsors prefer to be seen in Islamic deals. The pricing is normally equivalent with commercial debt and much of the negotiation over asset security, caused largely by semantics, has been simplified with standard risk mitigation techniques – although every deals still has to go before a sharia board for approval.

The number of sharia-compliant structures is also expected grow in line with the Saudi requirement that any project that includes a government stake or feedstock allocation must stage an IPO. For the mass of individual investors at whom the share sales are targeted, an Islamic element is a must.

The move to Islamic debt is good for local banks. The $640 million Al Waha financing for Sahara Petrochemical Company featured an entirely regional MLA line-up with four of the banks being local.

That said, bankers do not expect many future deals on a wholly Islamic basis, due to the small capitalisation of regional Islamic banks, which are limited in their ability to lend on large-scale projects over an extended period. And the number of conventional players interested in taking a stake in Islamic tranches puts a tighter squeeze on Islamic banks already hamstrung by the near-invisible secondary market for Islamic debt, which prohibits syndication. Furthermore, in general, Islamic banks have been slow to drive the market, which is now, to a large extent, driven by commercial banks in Islamic guise.

The emphasis on Islamic finance still lies in the debt capital markets, where Islamic bond, or sukuk, issuance is accelerating. What the market now needs is the first real project sukuk.