Talk to any banker and margins are never high enough. But thinning lending margins in the Middle East are a reality and while that is not good for the banks, it is benefiting borrowers in the emerging markets of North and West Africa.

A number of banks are looking to supplement margins on lower risk Middle East assets with higher risk/reward emerging market deals to balance their portfolios. Furthermore, the Middle East boom is finite and some banks are already giving riskier MENA markets more serious consideration.

Nowhere epitomises the fall in lending margins and bank competition for well-structured deals better than Qatar.

"Pricing on Qatari energy deals reflects the quasi-investment grade nature of the projects," says Robin Baker, head of energy, SG CIB. "The higher spreads are coming down, in a similar manner to the bond market, as risk premiums are diminishing. This will benefit the emerging project markets in Egypt, North Africa, and West Africa. For example, the margins on the projects in Nigeria last year have tightened up considerably compared with previous years."

The vogue sector of the moment is Liquefied Natural Gas (LNG) and banks are following the LNG roadshow from the Middle East to Africa. But the projects are unlikely to offer a significant extra margin because of strong sponsorship and solid structuring – 100% export of the offtake.

Deals in the market include a further two trains for ELNG, for which an advisory mandate is imminent. Similarly, in Nigeria, the $3 billion-plus Brass LNG project – sponsored by NNPC (49%) ConocoPhillips (17%) and Eni (17%) – could be in the market this year despite the withdrawal of Chevron. And the $7 billion Olokulu (OK) LNG – sponsored by NNPC, Shell, BG and ChevronTexaco – which has just appointed RBS as its financial adviser, is due in the middle of 2007.

Some bankers question whether LNG risk is being adequately rewarded. The structuring of LNG deals has become commoditised. As one banker says, "LNG is a good story, but that doesn't mean the risks are diminished – yet the margins are getting leaner. Banks should be considering whether the risks and rewards stack up on backing something like Qatargas 2 or 3 which pays 50bp over 20 years as opposed to, say, a cement or telecoms deal in North Africa paying many multiples of that, 2.5% to 3.5%, over five or seven years."

What risk?

The banks supporting the emerging African markets generally have a cushion of lower risk Middle East or European assets and, therefore, the willingness to book deals in North and West Africa at higher margins. Although borrowers are benefiting from this liquidity, the cost of borrowing is substantially higher than a comparable deal in the GCC.

The OECD's ECA risk classification highlights the leap of faith banks will be asked to take if and when African markets begin to boom. The three major host nations to oil and gas projects in the Middle East – Qatar, Oman and Saudi – have all been reclassified at a lower risk level in the past three years. The level 7 classification, denominating the riskiest places to lend, is given only to Iraq in the gulf region, yet it is predominant in West Africa. The North African countries, excepting Libya at 7, are moderately risky, with Algeria downgraded to level 3 in April 2005.

Country risk classification on officiallly supported export credits

Testing appetite and pricing

The next big test of banking appetite for African risk is the Sonangol-Sinopec joint venture upstream borrowing base facility. Standard Chartered and Calyon are financial advisers to the sponsors and are looking for $1.4 billion in debt.

The $1.4 billion deal will be used to complete development of Sonangol-Sinopec's Block 18 oilfields, off the Angolan Coast in Africa. BP operates Block 18, which contains the Greater Plutonio fields. BP and Sonangol Sinopec International (SSI) share the Block 50/50.

The level of appetite for this latest Sonangol deal will be interesting, because the same sponsor raised a $3 billion facility in December 2005. Originally pitched at $2 billion, the deal was raised to $3 billion at a seven-year tenor. The funds have refinanced a $1.2 billion, 5.5-year secured facility signed by the borrower in 2003 and also for project development.

The current deal is likely the first time a non-recourse borrowing base facility has been raised in Angola. The deal is being very competitively bid with most commercial banks coming in at around 180bp, and one bank, RBS bidding 125bp over Libor.

"Although an attempt at a relationship play cannot be ruled out given the Chinese sponsor, I don't think this is the main driver for the low pricing. Simply, banks have come to divergent views on the project-specific risks and whether they wish to take and hold the debt," says a banker close to the tender.

The advisers approached 10 lenders at the end of January for commitments – ABN Amro, Barclays Capital, BayernLB, BNP Paribas, ING, KBC Bank, Natexis Banques Populaires, Royal Bank of Scotland, SG and Standard Bank. About six international banks are expected to participate, with two or three Chinese banks expected to join the club.

The RBS bid, although low, could be purely symptomatic of the fact that even in African oil and gas, margins have tightened. The recent Satellite Oil Fields financing in Nigeria came in sub-200bp and arguably has more risk than SSI because there are no completion guarantees, looser covenants and it is not a borrowing base facility (search "Satellite Nigeria" at www.projectfinancemagazine.com for details).

A similar deal in Cameroon may be refinanced later this year or in 2007. The Pecten Mokoko project was originally financed in June 1998. An IFC facility of up to $250 million supported its ongoing oil field development in the Lokele and Rio del Rey permit areas. Of the financing, around $60 million of the credit line was for IFC's account, with the remaining $190 million taken by a syndicate of 15 international banks.

Pecten's owners are Shell (80%) and Société Nationale des Hydrocarbures (Cameroon's national oil company, 80%). The original facility was priced at about 3% above Libor, and the refinancing is expected to be around 2%. The deal, to which IFC has preliminarily committed, will be structured based on P1 reserves but with less restricted field-based cover ratios will not be a true borrowing base facility.

North African dealflow

Most commercial banks are likely to be more comfortable backing well-structured deals in less risky countries such as Egypt, where the margins are not dissimilar to oil and gas deals in more politically sensitive regions. Egypt has recently witnessed a spate of fertiliser deals that have been priced at around the 150bp-200bp range, with EBIC, the largest, closing in September last year (search www.projectfinancemagazine.com).

And there are likely to be many more projects in countries with oil and gas reserves that are now looking to monetise returns upstream. "Where once oil and gas was pretty much shipped entirely abroad, the emerging markets of North and West Africa are seeking to keep the value-added of derivative products rather than pass them away to foreigners," says a lawyer busy in the region.

The bottleneck in refinery capacity should also catalyse the development of large refinery projects in the region. It is believed that Taylor-DeJongh has taken over as adviser from Dresdner on the slow-moving Lobito Refinery project (SONAREF) in Angola – a downstream continuation of the joint venture between Sonangol and Sinopec.

An agreement was signed in March, wherein Sinopec accepted responsibility for funding the $3.5 billion project. The 200,000 barrels per day refinery is expected to be online by 2010 and Samsung has been named as principal EPC contractor.

Of the North African countries – Egypt aside – Algeria shows the most promise of immediate dealflow. As well as OCI's CBA investment, in a joint venture with incumbent Sonatrach, OCI is developing a $750 million fertiliser plant. SG has been appointed as the financial advisor and White & Case has been appointed legal adviser.

There has been a lot more project activity since Algeria's OECD reclassification – and the margins are good, although not as rich as Nigeria.

Just after the reclassification in July 2005, Citigroup, FMO, DEG and Proparco provided Wataniya Telecom Algerie, branded as Nedjma, with $490 million in financing. The multi-sourced deal had a 7-year tenor and included an Algerian Dinar facility of $44.5 million equivalent; a Dinar facility of Eu107 million equivalent covered by EKN of Sweden; a further Dinar facility of $22 million equivalent guaranteed by development finance institutions DEG, FMO and Proparco of France; an offshore loan of $110 million featuring cover from Hermes; and dollar debt of $173.5 million from Citigroup, ABC International, HVB, KfW, EDC, BNP Paribas, Arab Bank, Mashreq Bank, SG, The Housing Bank for Trade and Finance, DEG, FMO, and Proparco.

Algeria will also play host to a glut of petrochemical investment. A $15 billion petrochemical development programme, which involves the tender of seven projects by Sonatrach, has been put back to mid-April to attract more bids. The projects include an integrated 4 million tpy catalytic cracker for fuel oil at the Skikda refinery; a world-scale olefins complex at Skikda with three downstream units; a 15 million tpy, world-scale refinery at Tiaret, 200 kilometres west of Algiers; and a de-hydrogenation unit and an integrated stem-cracking ethane complex at Arzew.

Despite the liquidity of the international bank market, most banks are reluctant to lend into template-setting projects in a new market – especially where the revenue stream is local-currency denominated and entirely domestic. The pioneer lenders on these projects are invariably multilaterals, ECAs, and local banks. One drawback for international advisers is the time needed for local banks to get comfortable with new structuring techniques, particularly in Algeria, where 90% of liquidity is controlled by State banks.

Structural templates forged in the Middle East, which at first seem too testing for emerging markets, could be adapted if advisers can sell the idea to lenders. A structure that allows the sponsors to defer principal payments in lean times whilst overpaying in good times through cash sweep mechanisms should provide project borrowers with the necessary flexibility to accommodate cyclical markets whilst maintaining a conventional level of project finance gearing.

"Local banks have the potential to be very important, especially in non-export driven projects," says an international banker active in the market. Multilaterals and ECAs can also help bank an unfamiliar project – this is illustrated by the $330 million debt and equity Tunisiana deal in 2004. The proceeds of the funding were largely used to meet Tunisiana's GSM license payment in May 2002: Tunisiana is a joint venture of Kuwait's Nationale Mobile Telecom (Wataniya) and Egypt's Orascom Telecom.

The original 7.5-year debt used heavy ECA and multilateral backing – $130 million in two tranches, covered by Coface and Euler-Hermes, a structured finance facility of $160 million, and a short-term loan of $20 million. DEG, FMO, the OPEC Fund, and Proparco also contributed $50 million in dedicated tranches. The remaining $130 million was placed with a syndicate of international banks led by Arab Banking Corporation BSC, HVB, KfW-IPEX Bank and Standard Bank.

Now the deal is being refinanced as a Eu350 million ($423 million) loan entirely placed in the international debt markets. Lead arranged by Citi and ABC, the facility is currently in syndication.

Reality check

Excepting the political risk issues in West Africa, particularly the Niger Delta region, the outlook for project dealflow in North and West Africa looks good.

Despite paying higher margins these projects will remain in competition for funding with Middle Eastern projects for some time. And it is a stiff competition: not a single Middle East project has ever defaulted, and according to the International Energy Agency the Middle East will require a further investment to the tune of $40 billion in petrochemicals, $195 billion in the oil and gas sector and $85 billion in the power sector between now and 2010.

Like the Middle East, the emerging markets of Africa are also under pressure from capital cost inflation, so despite low-cost feedstock, less viable projects are likely to fall by the wayside.

Nevertheless, as margins in more developed markets continue to tighten, and bank liquidity continues to grow, African markets present a good option for those banks with a strong MENA regional presence and an appetite for more risk.

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Cementing good income

Outside the oil and gas sector, and following the Obajana cement financing in Nigeria, there are a number of cement deals with far richer margins than the oil and gas sector in the pipeline.

The demand for cement is based on the increased demand from regional economies. The higher lending margins are because of the lower quality sponsors and much less robust output market.

The $479 million Obajana cement financing, which closed in August last year, is split between $320 million of external debt and $160 million of local bank debt. The sponsor, Dangote Industries, and its adviser African Merchant Bank spent time persuading local banks to take project debt onto their books at a reasonable margin. Across the board, the debt pays 4.1% over Libor (or its equivalent in interest plus monetised upfront fees). The $320 million external debt has a tenor of seven years with a one-year grace period and consists of a $150 million EIB facility, a $75 million IFC facility, and a $95 million facility lead arranged by the African Merchant Bank (subsidiary of Banque Belgolaise) and the Netherlands' FMO.

Elsewhere in Nigeria, Citigroup is advising Unicem on a new greenfield plant with an annual production capacity of 2.5 million tonnes. Unicem will be 70% owned by Egyptian Cement Company (ECC), a 53.7% subsidiary of OCI, and 30% by Flour Mills of Nigeria Ltd.

The new plant will be located near the port of Calabar in Cross River State in southeastern Nigeria. Unicem has signed an engineering, procurement and construction (EPC) contract, with an F L Smidth/OCI Nigeria consortium valued at $250 million. Construction work began in February. The total investment cost for the project is estimated to be $330 million, which will be financed using 60% debt. About $200 million of debt will be provided on a project finance basis, most likely by a syndicate of local banks. According to one source, "the margins are expected to be very rich by international bank standards."

Nigeria is the second largest importer of cement in the world, and imported about 7 million tons of cement during 2004, with an average selling price of $120 per ton. Upon completion of the new plant, OCI (Orascom Construction Industries) Cement Group will have a total annual production capacity of 22.5 million tonnes including 8 million tonnes of annual production capacity in Egypt, 5 million tonnes in Algeria, 4.5 million tonnes in Kurdistan (Northern Iraq), and 2.2 million tonnes in Pakistan.

OCI is also looking to tap the non-recourse market for an Algerian cement plant. OCI's subsidiary Ciment Blanc d'Algerie (CBA) has signed an engineering, procurement and construction (EPC) contract valued at $138 million with an F L Smidth (FLS)/ OCI Algeria consortium to construct a greenfield white cement plant with an annual production capacity of 550,000 tonnes.

The plant will be located 380km west of the capital city Algiers. Construction is scheduled to take approximately 21 months. CBA intends to move into Algeria's white cement market, which is currently wholly supplied by imports. The plant's proximity to three major Algerian ports and the national railway network provides strong potential for exports. Citigroup is advising the sponsor, and is likely to tap the local bank market for about $100 million.