The next wave of power projects in the Middle East are currently being assessed by bankers. Saudi Arabia, Oman and Abu Dhabi are all looking for sponsor groups for both Independent Power Projects (IPP) and Independent Water and Power Projects (IWPP).

In spite of the tense political situation across parts of the region, bankers are generally taking a positive view of political risk, and well structured deals are seen as do-able with uncovered bank debt, should Export Credit Agency or multilateral support be either unavailable or too expensive. A combination of this strong appetite from international banks, plus the growing use of sizeable Islamic finance tranches, should in most cases mean that debt is available.

There is also a growing volume of Middle Eastern sourced equity looking at the power sector. But the problem is that, after all the problems at Enron and other US power groups, there is a shortage of potential project sponsors with suitable track records.

European players such as Total, International Power and Tractebel are all looking at projects currently out to bid, and are viewed as attractive sponsors by lending banks. There is also some interest from Japanese players such as Mitsui and Mitsubishi. But the gap left by big US players who have either gone bankrupt or scaled back is a large one, and the issue is whether there will be enough competition in the tendering process to table attractive bids for all the various projects in the pipeline.

"The number of developers who bid on these projects has been reduced post-Enron," comments one advisor following the sector. "A number of players are no longer there, while others are having to shore up their balance sheets and reduce debt. There won't be any shortage of lenders, but the question is, with the US developers on the back foot, are there enough developers to go round?"

This question is of particular interest for Saudi Arabia, which has a sizeable programme of cogen projects coming up. Saudi Arabia has a population of 23 million, and has fast growing requirements for both electricity generation and desalination plants.

The upcoming deals comprise four cogen IPPs and involve Saudi Aramco, which is keen to press ahead quite quickly. As well as supplying the feedstock, Saudi Aramco will be acting as power and steam offtaker. Thus far two consortia have put in bids, one featuring International Power and Mitsui, and the other Mitsubishi and Korea Electric Power.

Offtakers key

As with all IPPs in the region at present, sponsors and lenders are looking towards a single entity with good credit quality to sign a long term Power Purchase Agreement. There are steps being taken towards liberalising electricity markets, but the feeling is that there is quite a long way to go before merchant plants will be able to be financed.

There will however be some deals involving sales into the grid. On some upcoming transactions lenders will likely have to depend upon the creditworthiness of Saudi Electricity Company (SEC) as electricity offtaker, as well as Saline Water Conversion Company (SWCC) for water. And it is possible that players such as SEC and SWCC could put up some equity in projects alongside an experienced international sponsor, with a view to a flotation at a later date.

"The assumption is that the Saudi IPPs and IWPPs should be bankable," comments one Riyadh-based banker. "Lenders have generally taken small exposures to projects elsewhere in the region to gain experience of IPP and IWPP financing, and there is capacity there that has been held back in expectation of the Natural Gas Initiative (NGI) projects, which may now get reconfigured in a different form."

"At the end of the day the ultimate bankability will depend on a combination of cost, offtake arrangements with SEC or SWCC as well, and the feedstock arrangements with Saudi Aramco," he says. "As long as those arrangements are clearly defined, and the revenue potential is there, there is no reason to suppose that projects will not be bankable, though it also depends how quickly the projects come down the pipeline. If there are four in one go each needing a billion dollars it could be a struggle, but if they are properly sequenced there is no reason why the banks cannot build up a power book on that basis."

However he points out that tenors could be an issue. "I think that the Saudi market is a little less able to push out tenors to the 18 years that you see in the Lower Gulf, so you may be looking at 15 years," he says. "But a common sense approach to the structuring of the repayments, potentially including bullets at the end, may effectively give a longer tenor than a simple repayment profile would."

First Saudi IPP

The first ever IPP in Saudi Arabia recently closed its financing, and provides some clues for the probable structures to be used on the upcoming IPPs. The Jubail Energy Company cogen plant, otherwise known as the SADAF cogen project, is an inside the fence deal featuring petrochemical company SADAF as power and steam offtaker.

SADAF is a joint venture between Shell Chemicals and Saudi Basic Industries, and needs the power and steam for its styrene monomer plant located in Jubail industrial city. Siemens Power Generation provided the gas turbines.

The deal took several years to close, being interrupted along the way by a change of lead managers. But once Credit Agricole Indosuez and its local affiliate Banque Saudi Fransi took over the mandate rapid progress was made, and $169 million worth of project debt was put in place.

"ECA cover is helpful at the moment, and most projects are looking for it, but the Jabail financing was closed without cover," notes Tim Arnheim, partner in the banking department at Allen & Overy in London, which acted for the arranging banks.

There were also some interesting structural elements. "The underlying offtake arrangement for Jubail, effectively the tolling contract, was governed by Saudi law," explains Arnheim. "SADAF wanted to rely on Saudi law for its contractual arrangements, so the lending banks had to deal with aspects of Saudi law and Sharia law, and how that was going to impact on the traditional western type financing,"

Core ventures

In addition to the Saudi Aramco cogen plants, there are also some upcoming power deals which had originally been associated with integrated upstream oil and gas operations, power generation and desalination, and downstream petrochemical plants. These so called Core Ventures, part of the Natural Gas Initiative, will not now proceed as originally intended, meaning that some power generation elements will be done separately.

The timing of this switch is not very good with regard to the power projects. The Core Ventures were looking to the major oil companies for equity, with power generation just a small part of a bigger deal, but after being separated out they will now be competing for equity from the specialist IPP sponsors, who are already overstretched.

Preparatory Agreements on the three Core Ventures were signed with much fanfare in summer 2001, with ExxonMobil and ConocoPhillips taking a leading role. But during subsequent negotiations on the exact technical and financial details of the projects the oil companies and the Saudi government failed to reach agreement.

This breakdown also has to be seen in the broader context of the deteriorating political relationship between the US and Saudi governments. At the time the Core Ventures were first discussed, there was an assumption that US oil companies would get the biggest slice of the pie, but nowadays Saudi Arabia is more inclined to favour the European oil majors.

The single of the three Core Ventures which has survived in limited form, CV-3, is being led by Royal Dutch/Shell and TotalFinaElf, which in July of this year signed up for a big upstream gas deal.

The IPP, IWPP and petrochemical components will be dealt with separately, and bankers hope to see some movement during 2004. "The presumption has to be that those power and water projects are still needed, and will happen in some form or other, though now outside of the Core Ventures umbrella," comments one banker.

Elsewhere in the region, the Sultanate of Oman has invited tenders for a second Independent Water and Power project, which it wants to see up and running by mid-2006. The facility will be located at Sohar, and will be connected to the grid in the north of the country. It will produce 500MW of power, plus 30 million gallons per day of water. The Sohar project follows on the heels of the first IWPP in Oman, which was the Barka project.

Across in Abu Dhabi attention is currently fixed on the bidding process for the planned IWPP near the town of Al Mirfa, which is situated on the coast in the western part of the United Arab Emirates.

The project was put out to tender a few months ago by the Abu Dhabi Water and Electricity Authority (Adwea), and HSBC has been appointed financial adviser, with Fichtner of Germany as technical consultant and White & Case as legal consultant.

Bids on the planned 600-700MW Al Mirfa facility have been invited on the basis of the developer taking a 40% stake in a Special Purpose Company. The remaining 60% to be retained by Adwea, which will supply gas to the plant in return for power and water.

The Al Mirfa deal follows the close of $1.8 billion debt financing of the Umm Al-Nar IWPP in July of this year. The financing will help acquire the existing power and desalination facilities, and build 1,550MW and 25 million imperial gallons a day of new capacity.

The financing included a $540 million Islamic tranche, which was the largest Sharia compliant financing ever incorporated into a project loan. The project represented International Power's second major investment in Abu Dhabi's power and water sector, and the first such investment for both Mitsui and Tokyo Electric Power Company (Tepco).

Clearly having Islamic and conventional tranche side by side does raise some structural challenges. "There are issues raised such as how do you put the two on a pari passu basis," says Phill Fletcher, partner at Milbank, Tweed, Hadley & McCloy in London, which acted as counsel to the lenders on Umm Al-Nar. "For example, for a facility which does not have principal and interest how do you calculate outstandings and equate them to principal and interest on a bank facility, in case you need to allocate voting rights?"

Fletcher points to equity as the main constraint on projects at present, rather than debt availability. "With regard to equity, the main issue is that because of the broad deterioration of conditions for power generation companies in Europe and the United States there are far fewer bidders for power projects in the region, though some more players are coming to the fore from Asia right now to fill some of the gap," he says.

"The amount of equity needed is the not the issue per se," he adds. "But what is needed is sponsorship from players who are experienced in the power industry and investing internationally. And it is not just the Middle East where there is a shortage - globally there has been some withdrawal on that front."