Sahara Petrochemicals and Basell have completed the $631 million debt financing of the Al Waha polypropylene and propane dehydrogenation project. The financing is notable as one of the largest standalone Islamic financings in the Gulf to date. The Islamic deal was also structured to comply with the shariah regulations of host country Saudi Arabia, one of the most demanding jurisdictions available.

The Al Waha complex is the third of three interconnected petrochemicals projects located in Saudi Arabia's Jubail industrial zone. It will produce 455,000 tonnes per year of propylene, and 450,000 tonnes per year of polypropylene. The project will use ethane from Saudi Aramco to produce the monomer and polymer, and also use ethylene from the Tasnee (SIPP) project, which raised $2 billion from ECAs and local sources in June, to produce related polymers. The third project at Jubail, the Sipchem Acetyls project, mandated several local banks to provide a $550 million 12-year loan in June. This deal is presently in documentation.

HSBC, together with its local affiliate Saudi British Bank (SABB), was the financial adviser on all three schemes, which allowed the sponsors, whose shareholdings overlap, to approach the market in a relatively coordinated fashion. Basell, which owns 25% of both Tasnee and Al Waha, will market the project's output. While the project can use ethylene from Tasnee, this is required only for a secondary process at the site, and if Tasnee is unable to produce ethylene as planned, the project can run, and produce its primary outputs using only Aramco feedstock.

But Sahara, which was established, like Sipchem, by the Al-Zamil holding company and which was floated on the Saudi Stock Exchange in May 2004, led the financing strategy. Domestic equity investors look upon the use of Islamic financing favourably.

Nevertheless, previous uses of Islamic debt have usually been a part of a larger financing package. Many of these deals, however, featured an asset that was up for rehabilitation, and thus could be made the subject of an Islamic lease structure. Rabigh, the sole exception, was a large and sprawling petrochemicals complex and featured discrete segments that could be pledged to Islamic lenders.

But Al Waha is the first time that Islamic financing, and an Islamic security structure, have been front and centre on a project financing. Unlike, say, a power and water project, whose cashflows are a little easier to adapt to an Islamic structure, the revenue volatility associated with selling propylene and polyproylene onto the global spot market is daunting.

The sponsors, however, were able to divide the financing process into the mitigation of structuring risk and the mitigation, where possible, of credit risk. The construction financing is known as an equity co-purchase agreement, whereby construction lenders come in alongside the sponsors as co-investors, and then delegate to the company the procuring of the asset. Structuring the project company's articles to establish, among other provisions, their ability to step in, preserves the rights of the lenders.

Following completion the financing resembles a conventional Ijara, and the project company makes lease payments to the Islamic lenders. The main structuring risk for lenders is that in the event of a dispute the two parties would have to settle matters in a shariah court rather than a banking disputes court. The outcome of such disputes is not as predictable as it might be under a precedent-based or codified system in Europe, but the legal team of the lenders is broadly satisfied that the process would be equitable.

Basell agrees to market a fixed volume of the project's output, but does not provide price support. However, the deferred repayment structures that have been common in jurisdictions such as Oman do not work in the Saudi shariah legal environment. But the use of a cash sweep, which harvests excess cashflow for faster debt repayment works well. The Ijara is structured so that scheduled repayment not only makes lease payments but also pays for the asset in instalments. Prepayments under a cash sweep mechanism simply make this process faster.

The risk profile, then, is that of a commercial debt financing, and the banks that came in as mandated lead arrangers are by and large regional commercial banks with Islamic capabilities. ABC Islamic Bank, Bank Aljazira, Banque Saudi Fransi, GIB, SABB and Saudi Hollandi Bank are providing $525 million in 14-year debt. The Public Investment Fund is also likely to contribute $250 million, which would go towards scaling back the Islamic lenders by just under half. The final element of the debt package is a SR400 million ($106 million) loan from the Saudi Industrial Development Fund.

The deal is priced well above the standar for Saudi petrochemicals deals – at roughly 205bp over Libor equivalent precompletion, 195bp post-completion, 210bp from year seven, and 225bp from year ten. This premium reflects the fact that lenders are exposed to market risk, and that the sponsors are not providing a completion guarantee.

The project has suffered a little from the general regional increase in EPC contract costs. Market rumour has suggested that these might have increased by up to 60%. When the adviser first shortlisted banks, in May, it was looking for $400 million and the project size was put at roughly $940 million. The final price of the project, as per a lump-sum turnkey contract with Technimont and Daelim, is just over $1 billion.

Al Waha will probably not be the ideal template for most cost-conscious sponsors looking to develop a petrochemicals project. But it does demonstrate that Islamic finance is adaptable enough to serve as the main component of a project financing, and that Saudi Arabia's Islamic institutions – at least those attached to commercial banks – can step up for good margins.

Al Waha Petrochemicals
Status: Signed 2 October 2006
Size: $1 billion
Location: Jubail, Saudi Arabia
Description: 455,000 tonne propylene and 450,000 polypropylen project
Sponsors: Sahara Petrochemical (75%), Basell Polyolefins (25%)
Debt: $525 million Islamic tranche, $106 million SIDF tranche. $250 million from PIF to scale down Islamic lenders.
Lead arrangers: ABC Islamic Bank, Bank Aljazira, Banque Saudi Fransi, GIB, SABB and Saudi Hollandi Bank
Financial advisers: HSBC/SABB
Lender legal counsel: Norton Rose
Sponsor legal: Clifford Chance
Market and technical consultant: Jacobs
Lender insurance adviser: Willis
Sponsor insurance adviser: Marsh