Oman's long-planned market reforms, spearheaded by a spirited privatization program, are finally rousing more than just interest. Foreign investment and blossoming large-scale private sector growth are pumping fresh life into several key private energy and industrial projects, both domestically and regionally.

Guiding market reform is a largely pragmatic axiom underpinned by the Gulf-wide diversification argument. Oman, like many of its neighbors, has been historically dependent on oil revenues, which presently account for roughly 80% of the country's export earnings and 40% of GDP. Oil price volatility and acutely limited proven reserves are an anxiety for any heavily oil-reliant economy.

Hit hard by the oil price crash of two years ago, Oman's economy is now on a sturdy, oil-price driven rebound. The recovery has sent prices soaring from a low of $9 per barrel to $30-plus highs. But notwithstanding this possibly fleeting respite, the demand for greater investment, faster growth and more jobs remains explicit. The medium term aim is to balance the budget and to maintain a reputation for financial prudence. According to the Central Bank of Oman, the government is focusing on further reducing the budget deficit and increasing deposits in the Reserve Fund.

But Oman, in contrast to some of its Gulf neighbours, first etched its plans to boost investment and promote diversification away from oil a decade ago. Moreover, it has already taken some bold steps towards their implementation. The result, so far, has been one of the most punctual and extensive privatizations of its kind in the Gulf, alongside some landmark industrial project financings, with several more moving forward.

Evidence for these claims is in no short supply. In April this year, the largest industrial project in Oman's history began commercial operations ? the Oman Liquefied Natural Gas (LNG) venture. It comprises, according to the government, the cornerstone of the diversification drive. The project, which reached financial close in late 1997, commanded a formidable $2.5 billion, and demonstrated to the international community ample potential for successfully pulling off big-ticket infrastructure projects in Oman.

In practice, the project has met all the criteria drawn up by years of theory and planning- it rakes in massive foreign investment, provides a long term revenue stream and employs natural resources and, eventually, even local Omanis.

Oman LNG sent off its first export cargo to Korea Gas Corporation (Kogas) in April, and the company is currently considering a 50% expansion of its twin train, 9.9 million t/year plant. Other confirmed buyers are Japan and India.

Last year's Salalah container port project represents another historically momentous project, also responsible for stirring up investor comfort. The container terminal is a $260 million joint venture between Omani public and private companies, and Maersk Sealand, which signed in April, 1998. It is already ranked among the top ten most efficient shipping terminals in the world and is currently seeking expansion.

Both projects are indispensable elements of foreign investment and diversification plans, and the government has set about passionately nurturing the momentum they have created. This momentum is supposed to ripple through to a pool of projects designed to harness the sultanate's newly discovered gas reserves, and stimulate even further diversification and investment. After years of delays, this is finally beginning to happen.

The recent closure of $442 million in financing for two Oman Gas Company pipeline projects is the first paragraph of this new chapter. One pipeline will supply gas to Salalah to supply fuel to a related independent power plant development. The second pipeline will provide gas to the northern region of Sohar, where the government hopes to attract a host of gas-based downstream companies in an industrial zone, thus expanding activity away from Muscat.

The project had been in various stages of gestation over the last few years, and, as such, the final deal reflects vastly refitted local circumstances. In an interesting shift, full commercial financing was ultimately taken out rather than the requirement for export credits, as originally planned.

Says HSBC's Richard Grantley: ?Sentiment in the commercial bank market had changed dramatically. As a result, by the end of 1999, we began a cost comparison between the two and the ECA financing option was dropped in favour of commercial bank debt.? The final mandate was awarded to Arab Banking Corporation, BNP Paribas and Industrial Bank of Japan to act as coordinating banks and lead arrangers on the deal.

A tenor of 12 years makes the deal by far the longest for a non-export based quasi- sovereign guaranteed project in the state ? both availability payments, the chief risk to the banks, and termination payments are backed by the government. And the banking market swallowed what was until then an unthinkable maturity, with sell-down following swiftly thereafter. The response of both local markets and international investors involved in the deal has been, by all accounts, invigorating, with debt facilities closing oversubscribed at the end of October.

Shift to natural gas

So ambitious is Oman that it plans to invest at least $7 billion in non-energy related industry over the next 10 years. The slew of remaining drawing-board industrial projects, though having languished for some time in tune to the prevailing economic climate, are, according to one engrossed gulf-based banker, likely to become ever more tangible in light of the recent project boon.

Part of the reason is gas. With the Omani government proclaiming its fundamental commitment to diversification, with the discovery of substantial proven reserves, and with the success of the Sohar and Salalah pipelines, the infrastructure needed to serve the industrial schemes is largely locked in place. ?There will be, with the gas pipeline projects, an increase in the speed with which some of the industrial projects will come on line. The gas will be delivered to Sohar and Salalah and there'll need to be something for the gas to be supplied to,? explains a Muscat-based lawyer.

The hope is that major industrial projects based on gas resources will spell new investment inflows and faster job creation. Senior government officials pick out five or six schemes which they hope will emerge favorably. Among them are the Sohar industrial estate, the Oman-India Fertilizer Scheme, and the Aluminium Smelter project. These two biggest project proposals are apparently being given a new push this year.

?The thrust of our work is to make these projects bankable,? explains Denton Wilde Sapte's Alistair Jeffrey, managing partner at the firm's Muscat office. ?There will have to be a lot of co-ordination between all parties before this happens.? For example, government guarantees on gas and water supply still need to be addressed, possibly in the form of direct agreements between the governments and the lenders.

?One of the major things being considered by the project companies is how they can park risk allocation. At the moment they can't park it with the government, or the construction companies, who can't handle it. But it has been dealt with in the documentation for the electricity projects,? he adds.

Nevertheless, the scenario plaguing planners is the allocation of valuable, and by regional standards scarce, gas reserves to industrial projects which may never acquire material dimensions. With an expansion of LNG under consideration, it is as yet unclear what will prove more profitable. There is no doubt, however, that some movement on the industrial project front will happen soon.

The government last year signed a memorandum of understanding with the vast Dolphin gas project, which aims to pipe gas from Qatar throughout the Gulf and, in one sub-sea vision, ultimately to Pakistan. In any event, future additions to current gas reserves are inevitable.

Official projections call for gas to contribute around 15% of Oman's GDP by 2002. Through its extensive exploration program, the sultanate has more than doubled its natural gas reserves over the last decade, with estimates of its proven reserves hovering about 28 trillion cubic feet (tcf).

But perhaps most visibly charismatic and, of late, effective, effort is Oman's privatization program.

Privatization

The first strains of privatization filtered into the Oman frame in 1994 with proposals for the small but promising 90MW, combined cycle gas-fired Al Manah independent power project (IPP), finally commisioned in May, 1996, to the Tractebel-led United Power Company ? a first, indeed, for the entire Middle East. For years, as proposals for a comprehensive privatization framework continued to flounder, it has remained an isolated example of a privatized utility ? until now.

In the intervening years, the Ministry of National Economy has drawn up a substantial list of infrastructure to be privatized. Forthcoming privatizations include Omantel, the state telecommunications operator, and Seeb International Airport.

?The government realized that they had to mend their reputation internationally as regards privatization,? explains a foreign lawyer. ?The drop in oil prices was a good push for them to wake up and realize that one way of solving the problem was a revised privatization program. And this time they realized that it had to be done successfully, to give the right message internationally.?

Oman is apparently making all the right moves to cultivate local and foreign private investment. This is particularly evident after last year's appointment of a special consortium, consisting of ABN Amro, Denton Wilde Sapte and Mott Mcdonald, to help facilitate the job. Since it began work, several projects are noticeably coming to the fore, especially in the power and water sectors, which arguably represent test cases for the program.

Legal sophistication

A critical component of this effort is the sophistication of the Omani legal framework, and the government's openness to private sector reform. ?Omani law is the most advanced of GCC legal systems by far,? explains Denton Wilde Sapte's Jeffrey. ?But of course with these new privatizations and projects, the law is being tested to see whether it really is sufficient to handle the changes. And so far, it seems thoroughly robust.?

There is always room for development. And the law is certainly being refined. Legislation was introduced this year to establish administrative courts to provide a remedy similar to judicial review of ministerial decisions. The framework is in place for it to be set up. Explains a local lawyer, ?it really is an encouraging development. It points a finger at Oman saying you do have an independent judiciary and that sends out quite a strong message.?

?For international investors,? explains Roger Clarke, lawyer at the international firm Trowers & Hamlins, ?the doors are open and are being pushed further and further apart. On the project side, clearly the government wants to make the environment as investor friendly as possible.?

One of the more substantial changes was the government's announcement in August to increase the permitted level of foreign ownership in local companies from 49% to 65%, with rumors of a further increase to 70% soon. Officials suggest that this level may be raised to a full 100% within two years (although, in theory, applications for100% ownership are currently acceptable, though rarely awarded).

Accompanying this announcement are other recent amendments, by way of Royal Decrees, to tax laws, which have considerably softened the tax regime applicable to foreign investors, reflecting what appears to be the government's attitude towards greater ease of access for the international community.

Of particular consequence is the stipulation that companies with foreign participation of up to 65% will be taxed only at the rate applicable to Omani companies, namely 12% ? clearly a source of deeper international allure. Other changes include reducing the applicable maximum tax rate for foreign companies with Omani branch offices from 50% to 30%, and, in a separate clause, treating mixed ownership (foreign and local) companies as if they were branches of a foreign corporation, thus reducing their tax rate by the same amount.

Agency laws have also been relaxed recently. Furthermore, despite foreign companies being subject to local governing law, there is, in the case of dispute, recourse to common law.

More reforms are expected, including a relaxation of the Foreign Capital Investment Law, to allow for foreign ownership of up to 65% of the issued capital of Omani companies, on a more streamlined basis.

In another crucial development for private projects, company ownership terms have been revamped. Companies now have four years to float a 35% equity stake to the local market through an IPO ? this spells a loosening of prior legislation, which required 40% to be floated on the stock market almost immediately.

Other investment advantages include the provision of soft loans with low interest rates and easy repayment periods, exemption from custom duty on equipment, relief from customs duty on raw materials for up to 10 years, corporate tax holidays of up to 10 years, full repatriation of capital, net profits and royalties, and export credit insurance through the Export Guarantee & Financing Agency.

With these and numerous other incentives in place, and with Oman's recent entrance to the WTO ? with its liberalizing membership conditions ? the Sultanate's private sector push is ever more vigorously under way.

Power and water

Throughout the Gulf, population growth continues at rates well above the world average. Providing additional electricity and drinking water means more private investment and harnessing private sector efficiency.

In Oman, the problem is amplified by a burgeoning downstream industrial base. But the recent developments in the Omani power and water sectors can be thought of as encouraging not only for further domestic private development, but for the development of entire Gulf (even, arguably, Middle East) region as well.

After the initial Al Manah success, UPC moved last year to triple its generating capacity to 270MW. The $183 million Al Manah expansion project signed in December 1999, having secured $60.5 million in debt. The loans were arranged by ABN Amro and BNP Paribas, with Coface covering purchaser credit. The long term power purchase agreements with the Ministry of Electricity and Water were altered to take account of the new generation facilities. The project was devised according to the traditional build, own and transfer (BOT) model.

The Al Manah scheme, and its expansion, have provided the impetus for four new power projects, approved over the last year, plus recommendations for further IPPs in the future.

The first of these is the 240MW Al Kamil IPP, awarded in July to a consortium led by the UK's International Power. The project, tendered on a build, own and operate (BOO) basis, is the first of the newly implemented ?fast track,? meaning it is scheduled for commission between 2002 and 2003. The IPP was devised on the BOO model, some argue, to fit with a more thorough evaluation of the aims of the privatization program. Says the government, ?the BOO model has been adopted because it is regarded as achieving the best value for money while being consistent with our wider privatization objectives.?

Curiously, in its early stages the project seems to have been dogged by some lender discomfort. The $100 million project financing for the IPP was to have been led by HSBC, following Citibank's pricing inspired withdrawal. It now appears that SG has taken over from HSBC, apparently again due to pricing concerns. HSBC was said to be offering a fairly lengthy tenor on the deal, with pricing between 150bp and 200bp. It is not yet clear what the SG package will involve. International Power is drawing up $30 million in equity. Another concern is the apparently dubious credit quality of turnkey contractor Hyundai.

In the bid phase, International Power was battling the regional muscle of Tractebel, AES, Enron and PSEG. Explains IPower's Tom Mackaye, ?We've been in the Middle East, in some form, for almost two decades, but with Al Kamil, we now have a firm foothold which allows us to develop a regionally.? The company, like most of its major competitors, is scrambling to put together bid documents for the forthcoming Shuweihat IWPP in Abu Dhabi.

Moreover, he adds, ?Al Kamil is especially important because it shows how transparent the whole process can be.? He continues, ?the government was very clear that price was its primary criterion.?

The second recently awarded fast track project is the 427MW power and 3800 cu meters desalination plant, Barka, won in November by AES. This is only the second independent power and water project (IWPP) to have been awarded in the world, the first being in Abu Dhabi.

Project cost is said to be around $450 million, with a 20-25% equity commitment. AES is advised by ANZ.

Interestingly, price was apparently not the only criterion for this bid. A TotalFinaElf/Tractebel consortium, bidding aggressively, is rumored to have submitted the most competitive price, but the contract was awarded to AES. The government explains that ?AES's bid accepted the draft project agreements without requiring any material changes to be made, enabling rapid evaluation and progression.?

But all is far from over for Barka. Proposals for phase 2 and phase 3 expansions are expected over the next few years.

In any event, explains another foreign developer, ?although there was a lot of doubt about Oman after the first phase of Al Manah, there is no doubt now that this new process has put the Oman squarely on the map. The new IPPs, and the privatizations, have all fit into an outstanding package offered by the government, which is, above all, very transparent.?

In the south western region of the country lies Salalah, recently notable for its industrial developments. Another independent power scheme has been put together for the port city, although it falls outside the fast-track scheme. The Salalah IPP is a 200MW project which covers the construction of the plant and the operation of two existing gas turbine units, in addition to the operation of existing distribution and transmission networks.

PSEG, advised by BNP Paribas, picked up the contract last year, and has finally begun talking to several banks about project financing the $234 million transaction. The loan tenor is said to be 16.5 years ? particularly lengthy for Oman. Bankers, however, remain confident about such maturities for Omani power deals, partly owing to the success of neighboring Abu Dhabi's Al Taweelah projects, which, in the words of many, set the benchmark for regional power transactions. PSEG is expected not to take volume risk, and will be paid one combined availability and capacity payment linked to operational costs.

Italy's Enel and Japan's Hitachi Zosen won the engineering, procurement and construction (EPC) contract for the plant which is expected to achieve commercial operations by early 2003.

Unlike the other IPPs, there will be a termination payment mechanism, since the company will be the sole generator, distributor and transmitter in the region.

PSEG is said to be in talks with the government over a possible integration of Salalah with the northern grid, which encompasses the other power projects.

The most likely of the government owned generating assets to be privatized is the Rusail plant. Ghubrah and Wadi Jizzi are other likely short term candidates.

A new Sector Law is currently being drafted to cover electricity sector which, according to Mohammed Al Mahrouqi, Director of the Privatization Program, should be finalized by the end of next year. The possible form of an independent regulator is now being considered. Ultimately, the regulatory framework is expected to look something like the UK model.

A bankable risk

On the whole, explains a local financial lawyer, there is strong domestic and international appetite for Omani risk. ?This is an eminently stable environment with a prudently managed economy. A lot of international players that haven't been here before are beginning to realize this,? contends the lawyer.

At the forefront of the local banking community is Oman's strongest player, Bank Muscat, partially owned by SG. The bank recently merged with Commercial Bank of Oman, creating the Sultanate's biggest bank. Its project finance team, having targeted a potential for significant project activity early on, followed up a strategy of participation on the bulk of significant transactions.

?Risk profiles have improved and comfort levels have increased,? says an executive at Bank Muscat. Accordingly, he explains, longer tenors are more feasible.

He adds, ?we are well placed to understand the market, the local banking and regulatory issues,? a point which bodes well for the bank and its steadily broadening project financing role.

The legal lending limit, based on net worth, confines local banks to, at present, a participatory level. ?The desire among local banks for projects is there,? explains an executive at National Bank of Oman, ?but it will be dealt with on a case by case basis, and how much we can contribute will depend on our own books.? The lack of long term instruments obviously restricts appetite.

But at the same time, margins have shrunk, a fact which plausibly causes some degree consternation for local lenders. Regulatory control of the local sector is tight, as the Central Bank exercised more stringent controls on bank borrowing.

No doubt this is something the local banks fully understand. But an often cited potential issue is tax regulation discrepancy. More specifically, given the absence of withholding tax, foreign banks can lend into Oman with effective impunity. Pressure on margins for the locals continues, however, with a 12% tax on net profits.

The Central Bank explains its tactics, saying that strict limits on, for example, personal loans are meant to indirectly encourage lending to the project sector. Moreover, the constraints on local banks are essential, the argument goes, to mitigate against liquidity risk. ?One has to take an objective view,? explains a Central Bank official.

It is important to note, though, that project lending is still in its infancy. And, as such, local expertise is limited, though growing.

The international syndicated loan market, however, has been noticeably keen about the bulk of Omani projects ? a fact which has lengthened loan tenors considerably. At the same time, pricing for long maturity loans, particularly in the power sector, has been surprisingly low.

The development of local capital markets is one of the corollaries of privatization. Indeed, there has been a lot of interest from locals investors, particularly to participate in power, where significant future revenue streams are assured.

But the local capital market is still in its youth ? a limited market with a small infrastructure base. According to a local banker, ?it cannot be justifiably correlated or compared to a larger, more developed capital markets. So it has to be viewed on its own merits, and it will be some time before it broadens into not simply an equity market but also a debt market.? He adds, ?but the government is already thinking in the debt market direction. Its taking time because they don't want to get it wrong. A debt market would itself lend some depth to the market which is missing at the present point. To that extent, the regulators are all talking together, which is a good sign.?

As for tapping the international debt markets, ?it will take time for, say, the bond market to prop up projects, partly because it will be more expensive to do it that way,? claims a local banker. ?Of course, this also comes down to the rating on the individual projects. But it is something we expect to see eventually.?