Traditional project finance is having a difficult birth in Bahrain ? with the government opting for conventional and sovereign solutions to some key big-ticket industrial and infrastructure schemes.

Bahrain differs from its neighbors ? it has only limited oil reserves, with production having dwindled to a mere 35,000 b/d, compared with the hundreds of thousands of barrels per day churned out by wealthier states nearby. Nonetheless, the oil sector still underpins the economy, accounting for more than 60% of export revenues, and spurred on by last year's upsurge in oil revenues, the country is anxious to move ahead with key projects that have languished for some years due to liquidity constraints.

Smelter logic

Aluminium Bahrain (Alba) will be the biggest project to come to the market over the next year ? its proposed $1.7 billion expansion, which involves the installation of a fifth potline, aims to add 50% to the plant's already formidable capacity of 500,000 t/y. The expansion project will make Alba, with an expected final capacity of 750,000 t/y, the largest aluminium smelter in the world.

The aluminium industry currently accounts for about one-fifth of Bahrain's GDP. It has been at the forefront of the government's diversification drive since the 1960s, and, since the Alba smelter's incorporation in 1968, a range of downstream production and assembly operations have been developed, collectively propelling Bahrain to the major league of aluminium producers. In fact, the state now accounts for 2% of total global output.

Encouragingly for Bahrain, global aluminium demand is inching upwards at about 2.5% a year and the expansion should coincide with an expected upturn in the market. Says Ahmed Al Noaimi, Alba's finance director, ?we are short of metal in both international and local markets. Quite simply, we've been asked us to produce more. Local demand, in particular, is extremely strong.? Indeed, some 56% of output is sold within the GCC.

The major consideration now is financing for the $1.7 billion project. It will likely involve a mixture of corporate and project-style debt ? Alba expects roughly 90% of the total cost of its expansion to come from debt, with the balance paid out through company equity. ?We have a number of options under review, and we haven't closed the doors on any, yet. But the appetite is there from all sources,? says Al Noaimi. ?What we have to do is balance tenors and costs to find the optimal structure, but we don't need the sort of lengthy tenors others might seek ? our shareholders are fairly comfortable.?

Ultimately, says Al Noaimi, initial feedback suggests that ?the market is hungry for this type of project.?

?Alba has an excellent track record,? explains a regional banker familiar with the company, ?it is a world class facility in top notch financial shape. Financing to date has worked as it should, and there shouldn't be any problems in raising the capital for its expansion.?

Although the initial financial advisory phase was recently conlcuded by Taylor DeJongh, there is still some doubt about when the deal will actually come to the market. Speculates another regional banker, ?Alba will clearly require multiple capital market issues ? this is the big one, and I don't expect it to happen before the first half of next year.?

At the same time, there has been some talk of reworking the shareholder structure ? a prospect which could affect how financing takes shape.

Says another banker close to the deal, ?we'll be looking at a straightforward Sabic-style expansion finance. Using ECA funds will probably be cost effective here.?

Kaiser Engineering, the group undertaking the feasibility study, has also sniffed out the possibility of a sixth potline. The infrastructure for a sixth line will exist, since an expansion of Alba's current 1,504-MW generating capacity is set to accompany the building of the fifth potline. Further plans have been drawn up for a power plant generating an additional 630 MW, which will have 100-150 MW reserve capacity after supplying power to the fifth line.

There still remains some concern over possible regional over-capacity, given the recent capacity increases at nearby Dubai Aluminium Company (Dubal). But these worries are dismissed by those familiar with the relevant industrial dynamics. Says one, ?the two facilities sell to largely different markets so, if anything, there's no competition between the two.?

Bapco bop

As headline grabbing project financing goes in Bahrain ? Alba is about it. The other major Bahraini deal yet to be etched ? the $800 million upgrade and expansion at Bahrain Petroleum Company (Bapco) ? will not take a project finance approach.

Project financing for the deal, to have been backed by a Bahraini government guarantee, had initially solicited sizeable interest from the banking community ? 19 banks were poised to bid for the mandate. But this option has been scrapped in favour of a corporate facility with a state guarantee.

Mandated adviser Citibank is structuring the package. Sources close to the deal suggest that the advisory team ?is looking at more interesting structures than traditional project finance facilities, which make more sense from the perspective of corporate risk.?

Project or corporate debt, either way capacity limits are of concern to many. ?There's finite capacity out there, particularly when you're looking to raise $2 billion,? notes a regional banker, ?and accordingly, Alba and Bapco financings will have to be sufficiently spread apart.?

Sources suggest that the Ministry of Finance and National Economy is looking to fast-track the Bapco project ahead of the Alba expansion. The market, meanwhile, eagerly awaits a final announcement on the matter.

Bapco is not a large regional player, but wants to upgrade the slightly aging 250,000 b/d to produce higher quality petrol. Local demand for unleaded petrol is on the increase and Bapco aims to reduce the sulphur content in its fuel by around 60%. Roughly three-quarters of the refinery's supply comes from Saudi fields.

Work on the front end engineering and design (FEED) package is expected to be wrapped up by August (pushed back from June) for the low sulphur diesel production (LSDP) project, the largest element in the refinery's upgrade. Bechtel is the contractor on that scheme. The $580 million project is designed in part to keep the facility's sulphur content in line with international standards. Bapco hopes to bring the new plant on stream by the first quarter of 2004. A tender for the engineering, procurement and construction (EPC) is slated to be issued once the FEED is completed.

Bapco has been a central part of the country's hydrocarbons industry ever since the state first struck oil in 1931. Now, maximizing returns is at the heart of the company's expansion program. That, and a forthcoming merger of the country's oil production and marketing companies, should position the company to plump up both productivity and profitability over the coming years.

Indeed, the expansion will be the biggest and most complex project yet for the Bapco refinery, calling for both installation of new facilities and the upgrading of several existing units.

Aside from the LSDP project, other packages in the upgrade program are nearer completion. Among them are the $66 million in-line blending project; a new $27 million keromerox plant to be carried out by JGC; a $31.8 million instrumentation upgrade, by Alstom, at the low sulphur fuel oil and fluid catalytic cracking complexes.

In addition, the proposed merger of Bapco with Bahrain National Oil Company (Banoco), is expected to boost the company's efficiency while also strengthening the government's ability to entice foreign finance for future investment in the refinery. The merger, together with various stages of the expansion plan coming on line, will firmly position Bapco for solid future earnings, and growth.

Easy financing?

Pricing trends, bank appetite for long-term debt and the swiftness and sophistication with which debt facilities can be arranged are issues of ever growing significance for the entire region. And, given the vacillation over appropriate financing structures, these concerns are also patently at play in the Bahraini market.

That traditional project finance techniques have not come to bear across the board, most notably in the case of Bapco and the Hidd power and water project expansion (see box), is simply a reflection, according to one Bahrain-based banker, ?of market reality deciding the optimal solutions.? But regardless, both Bapco and Alba financings, given their size, are likely to test the limits of the commercial bank market.

ECA financing is still likely to play a significant role in the major industrial and infrastructure schemes. ?We're talking about three major projects (including Hidd) coming to the market over the next year,? says one regional banker. ?Generally, where there's large offtake risk you'd want to bring in ECAs, but even with these industrial financings the ECA route is likely to be most cost effective,? he adds.

Adds another international banker, ?it would be very wise for Bahrain to consider the ECA element.? He continues, ?combined with the experience of the top international banks, if they (the state) can bring in one third of the financing from ECA's, they'll get great pricing. That way they could easily get at least three projects wrapped up without drying up liquidity.?

The future of project financing in Bahrain is, of course, linked to the size of the market ? and, in theory, there is no shortage of projects. They could include roads, bridges, power plants, ports and further industrial developments, as well as sewage treatment and airport modernization.

Insists a Manama-based international banker, ?economically Bahrain is a very favorable environment. And, more generally, we've reached a stage where all the GCC countries need to hit top gear. As such, project finance has become one of the main strategic directions for a lot of international banks with established presence in the region.?

Private empowerment? not yet

A shortage of funds, coupled with high demand, makes the privatization of, or at least private involvement in, the Bahraini power sector an attractive prospect. Or so some would argue. But little tangible progress has been made to this end. Instead, the Ministry of Electricity & Water (MEW) is actively fighting to maintain its control over the sector ? with, it maintains, good reason. Stark evidence of this lies in the tendering of the second phase expansion of the Hidd power and water complex (Hidd Phase II).

Simply put, installed capacity is barely sufficient to meet current consumption, with annual demand growing by over 5%. Furthermore, despite rising demand, the government is unlikely to increase tariffs, already reduced in 1992 to alleviate hardship among low-income groups. Further tariff reductions were effective since January and, according to the Ministry of Finance and National Economy (MOFNE), will result in annual lost revenue of around BD6.2 million.

The MEW controls Bahrain's four main power generators: Rifaa, with a capacity of 709MW; Manama with 167MW; Sitra with 126MW; and the existing Hidd plant with 280MW. Total generating capacity pulls in at just over 1,550MW. And the government buys 275MW of this from the Alba smelter which, after expansion, may be unable to continue selling its spare output.

The government, which estimates that Bahrain will need a new power plant every two to three years, set about evaluating the possibility of private sector management of the power sector. And early last year, the Gulf Investment Corporation (GIC) of Kuwait and the Saudi-based Islamic Development Bank (IDB) were asked to submit proposals for running the Hidd complex and expanding its capacity. Tractebel and AES proposals were also seriously considered by the MOFNE.

The expansion itself calls for an extra 630MW ? 750MW of new generating capacity, beyond the two currently operational gas turbines with a combined capacity of 280MW, and four 7.5 million-gallon-a-day (g/d) desalination units.

Hidd Phase II was, as such, initially to have been tendered as an independent water and power project (IWPP) development. But the idea of private involvement was shelved in favor of a traditional turnkey project. The project has thus become another example (besides Bapco) where the Bahraini government had considered project finance solutions but then opted for conventional financing instead.

According to Dr. Nabeel Al Maskati of the MEW, ?if we had tendered it on a private basis, we would have had an unacceptably exaggerated price.? Chase Manhattan was originally adviser on the scheme. According to Al Maskati, Chase was suggesting a levellized price of $0.01722/kWh, based on their privatization assessment. In addition, they claimed that if MEW undertook the project, they would be unable to do better than $0.021/kWh. ?But we managed to get less than $0.01/kWh, levellized for fuel,? rebuts Al Maskati. ?It is our intention, as MEW, to achieve the lowest possible prices ? and we did.?

According to MEW, Chase simply assumed higher capital costs, higher operation and maintenance costs and less fuel efficiency. MEW, however, proved those assumptions wrong.

As for the future of independent power production, ?IPPs will not achieve big savings at this time. And until we have market forces implemented, we won't go for IPPs,? says Al Maskati. More encompassing talk of privatization, which could in theory open the space for such market force development, is also readily pushed aside: ?the level of demand growth is quite natural in Bahrain ? its easy to cope with. Remember that this is a small system in a small geographic area, so not only is it under control, but it doesn't make too much sense to talk of going private, particularly when we can do it cheaper,? he adds.

But the argument is much more acute. The real bickering, it seems, is intra-governmental. According to several sources familiar with the alleged dispute, MOFNE and MEW are at odds over the issue of private power. Says one Manama-based banker, ?there was a healthy debate over private power, triggered by a difference of opinion between the two ministries, and the MEW ultimately won out.?

But another informed source points out that ?time constraints pushed it forward as a government project ? it would have taken far too long as an IPP, and Bahrain needs the power fast ? within the next 14 to 15 months.? Accordingly, claims the source, Hidd Phase II will get financed before the two major industrial deals, Bapco and Alba.

Financing for the $350 million expansion will be a blend of government funding and conventional commercial bank loans, for 15 years. There may also be some ECA involvement.

Nevertheless, MOFNE will ?ultimately be looking to privatize the sector, just not yet,? according to a local lawyer.

The three groups currently bidding for the Hidd Phase II expansion submitted their final prices for the engineering, procurement and construction (EPC) contract to the MEW this spring. Alstom Power, Enelpower with GE Power Systems, and Siemens are also required to submit proposals for a 12-year maintenance contract. MEW expects to award the contract, which is scheduled to take four years to complete, within the next month.

The expansion will be implemented in several phases, with the first 230MW scheduled to come on stream in the summer of 2003. A further 230MW will be commissioned a year later, with the balance coming on stream by the second half of 2005.

The Phase II expansion is needed to produce enough steam for a multi-stage flash (MSF) desalination plant with a capacity of 60 million g/d. The MSF plant will not be commissioned before 2005, and work will not begin on the desalination project until the phase II expansion has been awarded.

Meanwhile, the government has taken steps to renovate and refurbish existing plants. Last year contracts were signed totaling BD16.1 million for the overhauling of the Sitra power and desalination plant.