What Gulf?
Although sitting on one-tenth of the world's proven oil reserves,
Abu Dhabi has moved swiftly ahead of its diversified and
less-wealthy neighbor, Dubai, in tapping private investors for its
power generation sector. With a profound commitment to overhauling
its own regulatory structure, privatizing utilities and luring
foreign investment, the Emirate is now dubbed by many bankers as a
template for utility restructuring and project financing throughout
the Gulf.
Nevertheless, a once dismissed theory about the Gulf has moved beyond any reasonable doubt ? the reliance on oil wealth has left most Gulf countries without the economic dynamics that can cope with the needs of rapidly swelling populations. Abu Dhabi was one of the first to recognize these inherent dangers and others are waking to them.
With the average crude price increasing by almost 40%, and filtering across all UAE business sectors, past UAE lethargy is expected to be replaced by radical reform Abu Dhabi-style. This year, oil revenues will have generated a windfall of around $7 billion. Confidence in private sector reform, briefly unsettled by recent economic exigencies, is back full force.
The economic downturn of the late 1990s forced the UAE into a more pensive disposition. But the result of these collective musings has been divergent. This is most readily borne out by the different attitudes of the two largest emirates, Dubai and Abu Dhabi, towards utility privatization. The former stubbornly refuses to accept the private route, citing enough know how. The latter has inspired a pioneering restructuring of its utility sector, for electricity and water.
Nonetheless, both emirates have undertaken several projects to diversify their economies, and to reduce dependence on oil. The non-oil sectors of the UAE's economy currently contribute to more than two-thirds of its total GDP, and about 30% of its total exports.
Still, on the macro side, the UAE government is trying to reduce its budget deficit, cut spending, and put its fiscal house in order. Part of greater fiscal discipline is opening up infrastructure to private participation, thereby forcing, in theory, the appropriate pricing of output.
The Abu Dhabi government is in no need of foreign capital, with reserves of well over $100 billion. But it believes privatization will inject some market discipline into its utilities, rather than letting them become extensions of the welfare state, as providers of services and employers. So it has begun by privatizing electricity generation.
But before market models can be achieved, many more issues need tackling.
As in any freshly privatizing state, various problems persist. Currently, the cost of power is being subsidized by the government. If market discipline really is the aim, this will have to change. With citizens all at once having to pay for what has historically been a ?free? service, or at least one whose nominal charge has been way below production costs, some annoyance is perhaps inevitable. ?It's a question of ideology as much as it is of economics,? contends a local banker.
But there have already been some increases in the charges for utilities. Over-dependence on the state is being slowly, but perceptibly, peeled back. With it should also come a stronger work ethic. Cuts in government employment will need to be replaced by greater private sector employment responsibility, to ease the inevitable transition.
These concerns aside, the fact remains that with no foreign debt, some of the highest standards of living in the world, and one of the most diversified and sturdy economies in the region, the UAE has had, and will continue to have, little problem attracting more foreign cash to shore up, among other things, its utility efficiencies. This applies to Abu Dhabi as much as to Dubai, if the latter ever sees the need to go the private sector distance.
A Private Picture
A closer look at the Abu Dhabi utility sectors yields a more thorough explanation.
Its recent history is a familiar story. With soaring demand for electricity, coupled with volatile swings in peak loads, the Emirates set up in 1996 a privatization committee for the water and electricity sector, with the principal aims of improving the security and efficiency of the sector, promoting local and foreign private participation and maximizing revenue from asset sales. The work resulted in the passage of a key piece of legislation, Law No. 2, which set out the regulation of the sector. It also triggered the vertical and horizontal demise of the former Water and Electricity department (WED) and the conception, in 1998, of the Abu Dhabi Water and Electricity Authority (ADWEA).
Urging ADWEA's birth, however, was more than the simple realization of long-term demand crunch. According to one local lawyer, ?the WED was notoriously corrupt and inefficient. It buckled under bureaucratic strain.? With all its assets subsequently transferred to ADWEA, the infant company found itself wielding full independent control of the sector, with even the Ministry of Electricity and Water (MEW) playing, some contend, a marginal, albeit strategic, role.
WED's assets have since been divided among nine new companies spread across generation, distribution, transmission and procurement, all licensed and highly regulated. Planning and contracting for new generating capacity became the responsibility of a ?single buyer?, the Abu Dhabi Water and Electrcity Company (ADWEC).
So far so good. The question, however, was how and when to privatize, rather than just restructure. Enter White & Case, Credit Suisse First Boston, and Fichtner, as legal, financial and technical consultants to ADWEA for the first flutters of private activity in the sector: power generation.
The subsequent teamwork gave rise to the first independent water and power project (IWPP) in the world, the $596 million Al Taweelah A2 710MW/50 million gallon desalination project, commissioned by the US company CMS Energy. The tender was issued to eight prequalified international consortia, with subsequent evaluation based primarily on price, calculated as the levelised average over the 20-year life of the power and water purchase agreement (PWPA). Encouragingly, CMS' price was one-third the government's pre-privatization price
Mandated in September 1998, it took sponsor CMS less than 12 months to attract an international team of lenders and reach financial close on April 27, 1999.
The financing serves as ample proof of the government's commitment to opening the emirate to foreign investors. Speaking from the London office in an earlier interview, Amjad Ghori, senior director of global finance at CMS Energy says: ?The authorities in Abu Dhabi gave a tremendous boost to the project and provided the right environment for foreign investors.?
The Al Taweelah A2 transaction (winner of Project Finance's Water/Power Deal of the Year Award, 1999) has since resounded throughout the international lender community as has having set the precedent, in terms of tenor and pricing, for independent power deals in the Gulf region.
Lead arranged by Barclays Capital, the deal flaunts a number of interesting structural features. Priced at 105bp over Libor during construction, the margin drops to 80bp post completion, and then steps up to 120bp and, finally, 150bp throughout the term of the loan. The 17-year tenor is particularly noteworthy ? notwithstanding Abu Dhabi's AAA credit rating.
The project involves the construction of a gas-fired 710MW plant combined with a desalination unit facility with an ultimate capacity of 50 million gallons of water a day. Construction, carried out by a joint venture between Germany's Siemens and South Korea's Hanjung, is nearing completion, with generation already well under way. The plant will be fully operational by August 2001.
Abu Dhabi's restructuring and privatizing efforts were, in part, inspired by a neighboring success: Oman's Tractebel-led Al Manah IPP, the first such undertaking in the entire Middle East. But although Oman got there first, Abu Dhabi has overtaken the eager Sultanate, especially as concerns regulatory overhauling for power and water. One area where the emirate lags, however, is wide-scale legal reform.
Legalities
The essential challenge, explains a prominent local lawyer, is ?to put modern legislative documents into a legal system that's fifty years out of date.? He adds, ?there's no legal protection, for example, against developers being booted out by the majority shareholders.? Namely, the government.
One unambiguous advantage has arisen for project companies. ?The government previously had been in total control of all contracts and there was very little room for dispute resolution. But with the introduction of Law No. 2, certain aspects of ADWEA were placed beyond the purview of Abu Dhabi law.? More specifically, he continues, ? to privatize, what's needed is legislative relief ? and this was granted to power and water companies.? But, he claims, legislative relief has not been taken full advantage of, particularly for real estate, which can only be owned by Abu Dhabi nationals.
Other issues underscored include problems posed by local law that affect project and finance documents, namely, what law actually governs the documents. Presently, this is not as explicit as perhaps desired by more exacting international standards, though consensus is nonetheless typically reached.
Non-issues for the emirates are labor laws, customs regulations, and, significantly, tax.
Security structures evidently cause concern, according to another foreign lawyer, since they are still not sufficiently codified. ?Taweelah A2 was the first time anyone had registered a commercial project. A commercial mortgage was taken out, but it was a painful process to get the key security document.? Nonetheless, he insists, ?you do in theory get a structure that works but nothing has actually been put to the test yet? ? perhaps thankfully.
According to another advisor, Al Taweelah A2 moved so fast that the project actually got ahead of the legislative framework, ?but still worked out.? Nevertheless, he cautions, ?so far this is the only project to have been completed, so let's not get carried away.?
Power project pipeline
ADWEA plans to increase electricity output from the present level of 2,500MW to 7,356MW by 2010. At the same time, desalinated water production is set to rise from 262million g/d to 573 million g/d over the same period. All this to meet a budding downstream industrial base and a fast growing population.
With a highly successful project in hand, then, Abu Dhabi has moved forward full steam with its privately imbued restructuring program. Witness the second smoothly tendered IWPP, the Al Taweelah A1, awarded to a TotalFinaElf/Tractebel consortium earlier this year.
At $1.3 billion, the deal is the largest yet. It comes backed by a $1 billion loan, currently in syndication, and set to close soon. As with its predecessor, the deal is notable for its tenor (18.5 years), which received strong bank backing. BNP Paribas and Citibank co-lead the deal, though the former also supported the consortium during the bid phase, before bringing Citibank into the deal.
Pricing, also said to be comfortable enough for a smooth sell down, is 110bp during construction and notches up to 125bp-145bp during operation.
The progress of the project, however, has not always been as smooth. The selection process was first extended by government demands for refurbished bid documents: the project initially entailed the rehabilitation of an existing 255MW cogeneration facility, but ADWEA asked for modified bids to be submitted for the reconceived, larger project, on a build, own, operate (BOO) basis. The revision instead called for an upgrade of the existing facility to 1,350MW, and the expansion of water capacity from 29 million g/day to 40 million g/day. Bidders were asked to match prices for the previous project ? $0.224/kWh.
TotalFinaElf/Tractebel finally won against the other final listed bidder, CMS, on the basis of pricing. As with the A2, 60% of the project goes to ADWEA, with the consortium picking up a 40% stake.
When the plant reaches full commercial operation, by early 2003, it is expected to supply about 25% of the emirate's power and water needs.
The transparency of the tender process is a feature which warrants significant attention. ?The Taweelah case is by no means the only way regional projects get done,? argues an executive at a foreign power company. ?In that instance, all the players knew exactly what they were facing. The tariff was set, and the rate of return was established. Moreover, the government tried to make it easier for investors to come in and do the work with the result that now, whoever can do it more competitively will win.? He is underscoring the benefits of clear and distinct guidelines in which ?all the assumptions are in place before the bid,? such that there is little room for deviating interpretations and where ?everyone plays by the same set of rules?.
?The tendering process is as transparent as it can be ? Abu Dhabi has effectively showed the Middle East how to bring in IPPs,? says an executive at International Power.
So vaunted is Abu Dhabi's clarity in this regard investor appetite is deep and fierce. Ultimately, though, ?the golden rule for IPPs is that the person who can best manage the risks must take it.?
This truism will certainly play itself out in the next round of Abu Dhabi's IWPP mania. By far the most ambitious power and water project (for the entire gulf) is yet to surface: the 1,500MW and 100 million g/d Shuweihat project, prequalification bids for which will be received by January 15, 2001. To be tendered by June 2000, prequalified companies will be invited to submit proposals for a similar 40% stake for this greenfield BOO scheme. The plan is to notch up capacity in stages to an ultimate 5000MW and 300million g/d.
The first phase is expected to cost around $400 million, and should, it is hoped, come on stream in 2004. If the current schedule is maintained, financial close should come by the end of 2001. The deal is likely to be structured in much the same way as the Taweelah projects.
ADWEA has retained its previous legal counsel, White & Case, for this project. However, Deutsche Bank and Lahmeyer International replace the former consultants as financial and technical advisers respectively.
?This is certain to be one of the biggest deals of next year,? exclaims a foreign developer. It will also be one of the most competitive, with all the regional power players positioning themselves for a piece of profit. With no dearth of money for such deals, bankers are already gearing up for the fervent months ahead.
Also scrambling to plump up their bids are the following consortia: Tractebel/Mitsui, CMS/International Power, PSEG/ Marubeni, with AES attacking alone.
?We don't build power plants unless there's a demand for them,? explains Abdullah Al Neaimi, director of IWPP's at ADWEA. ?The problem is, we need water more than we need power, partly because water is a requirement to build the power plants in the first place,? he adds, ? but it's not always feasible to build a water plant as a stand alone, so we opted for our IWPP system.?
Next in line for possible privatization, in no particular order, are several other government owned generating assets. Umm al Nar Power company, with 1148MW/92 million g/d; Bainounah Power company, with 1201MW/44 million g/d; Al Mirfa Power Company, with 311MW/16million g/d; and, finally, another Al Taweelah Power company, with 1069MW/95 million g/d.
The question remains how far the privatization drive will go. ?Distribution could be privatized, but its not currently under formal scrutiny,? says Neaimi. The two possible candidates for such a move would be the Abu Dhabi Distribution Company, and the Al Ain Distribution Company. Transmission, he says, is unlikely to be privatized in the short term.
Careful regulation
The Abu Dhabi success story, still only in its first draft, owes much to its preemptive regulatory restructuring. Law No. 2 set out in great detail the sector's regulatory environment, and established the Regulation and Supervision bureau, the first independent regulator in the Middle East. The bureau, often likened in function to the UK's independent regulator, undertakes standard regulatory activities, mitigating against monopolistic deviancy, for example, by restricting companies to no more than 25% market share without explicit consent. Indeed, this function is part of its licensing activities, which cover the entire power structure. Of course, the privatization and restructuring process is in early stages yet, with only two consortia owning private shareholdings (CMS and TotalFinaElf/Tractebel). But with the planned future privatizations, this will change.
Deregulation, of course, is a still distant concept. Says Neaimi, ?the regulatory body will of necessity have to be tightly controlled until the market reaches equilibrium.?
But some still raise questions about the nature of the privatization process itself, particularly given that the state still plays such a dominant role in the emirate's utility sector, with the government retaining 60% stake in the projects. As one local banker puts it, ?the main worry is whether this is privatization or something else ? that is, a form of subsidy.? He continues, ?How far can privatization really go??
Counters Neaimi, ?it takes time to privatize effectively. Right now we're not working with fully real market models, but we're working towards them.? As such, the current situation, in which the government still maintains control over ownership and pricing of electricity and water, will likely change over the next few years. How fast this occurs, however, is down to the pace of privatization.
Dubai
The region's commercial and trading center, Dubai, on the other hand, is proving to be an exception to the Gulf rule. It has no immediate plans for unbundling its utility sectors. By all accounts, the emirate's government intends to keep the sector under public control through the rigorous guidance of state-owned Dubai Electricity and Water Authority (DEWA).
Last year, Dubai saw demand rise 13% for water and 16.3% for electricity, with annual increases forecast at an average of 10% over the next decade. Despite its steadfast opposition to privatization, the utility is nonetheless considering commercial financing for some of its large scale projects. Its proposals include the expansion of its Jebel Ali K2 station, with a suggested 400MW/5.72 million g/d boost in capacity, with a view to even more expansion in the long term.
?Dubai is attempting to be so many things at the same time,? says a foreign banker. ?Without privatizing, it's the most more privatized than any gulf state.? He is referring to the unmatched private activity in the emirate's commercial zones, where the government has emphasized creating an environment to allow private capital to work effectively.
DEWA still argues that it can do things cheaper, more efficiently, and to the greater advantage of the public consumer than any private hand. But Abu Dhabi's story admits a contrary conclusion. Some rebut that this boils down to the latter's previously flawed system. This may be so. But another argument crops up which may, in the long run, upset, or at least shift, DEWA's balances.
One of the biggest challenges facing all utilities and suppliers worldwide, insists one foreign power executive, is digitization ? global reliance on advanced computing technologies ? in so far as such developments require not only power but flawless, higher efficiency ?quality power,? the technologies and skills for which are in private clutches.
Dubai, for example, recently embarked upon a high-profile information technology (IT) drive, the Dubai Internet City free zone, marking the IT sector as its main priority. At the same time, it has announced an e-government initiative, aimed at improving government services and setting up public accessibility. The question to be asked, stresses the executive, is whether DEWA can supply quality power: ?this is an issue that Dubai, like California, will face when its digitized developments grow, and it discovers it lacks the technical know-how for guaranteed flawless power.? He adds, ?no one is really thinking in terms of quality power, but we need to ask whether DEWA will be able to muster the type of investment needed for such seamless supply as is necessary for, say, e-transactions.? He is referring to an alleged power quality assurance that guarantees 99.9999% reliability, or 32 seconds of annual disruption, as opposed to the current level of 99.99% reliability, or 53 minutes of annual disruption. ?Any disruption could prove fatal to a digitized community,? he submits.
DEWA's options, he argues, are either to let in private investors with the requisite expertise, or to go at it themselves, when capacities warrant. About the latter option, he remains skeptical.
Notwithstanding the possible merits of this argument, others insist that DEWA, despite its fiery rhetoric, will ultimately have to open its arms to the private sector embrace, for standard reasons of efficiency and economics. No conclusion on this matter is forthcoming, however, though sponsors and lenders are certainly prepared to pounce if and when necessary.
But, of course, another way of providing security of supply, beyond the theory of ?quality power?, is interconnection, something which is already under consideration.
Local, Regional Grids
An initiative has been launched, by the MEW, for the interconnection of Abu Dhabi, Dubai, Sharjah and the Northern Emirates into a single grid. Transco has been discussing the issue of integrating the UAE electricity systems, and the regulatory bureau has been following the matter closely, offering advice on potential legal and regulatory issues, it reports.
But beyond the UAE, an exciting prospect is the interconnection of the systems of all six GCC states. This is nothing new. In fact, the topic has been discussed for years, although concrete steps have been taken only recently. The most probable scenario for the UAE is an initial link with Oman, before a possible further link to a more extensive GCC-wide grid. The combined generating capacity of the GCC states currently totals around 40GW. Interconnection would likely bring significant benefits in terms of cost and enhanced security of supply. But politics govern the course of any such development. Once set up, such a grid could, in theory, wheel extra capacity to Europe during winter months, when Gulf plants mostly run at half capacity. For now, however, this remains strictly theory.
Gas
Rising gas demand has been one of the most striking feature of the UAE energy scene for the past decade. The last few years have witnessed the UAE embark on a massive multi-billion dollar program of investment in its gas sector, vital for the introduction of gas-fired plants and the transformation of the Taweelah commercial district into a gas-based industrial zone.
But possibly the most ambitious of the current gas projects is the immense Dolphin Project, which involves piping natural gas from Qatar's offshore North Field undersea to Abu Dhabi for subsequent delivery to Dubai and Oman, with a possible future link to Pakistan. The United Arab Emirates Offsets Group (UOG) and the Qatar General Petroleum Corporation (QGPC) signed a statement of principles for the project in March of last year.
So far, Enron and TotalFinaElf have signed project development agreements with UOG. UOG has also signed a preliminary agreement with Mobil Oil Qatar for the supply of 300 million to 500 million cu ft/day.
As the plan stands, UOG and Abu Dhabi National Oil Company (ADNOC) have also issued a joint declaration dividing up gas distribution between them. Gas from the Dolphin project will be the exclusive supply for gas fired plants, except in the western region of Abu Dhabi, and will also supply gas for ADNOC contracts with Dubai.
But the $8-10 billion project is currently languishing due to disagreements over gas pricing. UOG and QGPC have spent the last few weeks negotiating price, but a difference remains between Qatar's proposal and what the UAE wants to pay.
Says a senior official at UOG: ?we're in the final negotiation stages with Qatar. We're absolutely immersed in it ? its critical for the emirates, let alone the rest of the region, since there's such a huge need for gas right now.? In Dubai alone, the largest call on gas will come from industry, which is forecast to double its consumption in the next five years. Throughout the UAE, demand from the power sector is projected to surge some 60% in that time.
The UOG itself is becoming somewhat of a mainstay in the domestic energy sector. It helped devise the ?Taweelah solution,? the pioneering privatization and restructuring program, and, with the probability of Dolphin, now has ?the capacity not only to initiate but to implement as well.? Continues the official, ?we're looking to become a major regional player in developing energy and infrastructure projects.? UOG is currently helping to restructure water desalination and distribution in the Northern Emirates, a prospect which demands power. Accordingly, the company is allegedly moving ahead with plans to set up IPPs in the emirate of Fujairah.
As for future project developments, most contend that Abu Dhabi's IPPs are the ?first wave. Then, you're likely to see many petrochemical projects as the second wave, with the gas coming on line. It makes economic sense for fuel intensive industries to set up here, where its cheaper. So we'll no doubt see more industrial projects coming on line in the near future.?
Islamic facilities
?Abu Dhabi's power sector has been so successful because it provided sovereign guarantees backstopping power purchase agreements. Moreover, if a project falters, the government will be there to bail it out, unflinchingly,? maintains a Gulf-based foreign banker.
True, Abu Dhabi, with all its wealth, has had an easy time bringing private cash to bear.
That alone gives great comfort to lenders, and partially explains their willingness to invest.
But, as importantly, the perception of credit quality for regional power transactions is, arguably, stronger than for petrochemical and industrial projects, as far as local and foreign commercial banks are concerned. A major result of this has been the extension of substantial tenors for power financings (compared to petrochemical financings), a fact nicely illustrated by the Taweelah deals. Equally, pricing on long maturity loans has been especially low.
Many regional banks are also in healthy shape, experiencing vast capital surpluses, partly due to oil price rises. Add the fact that the UAE lacks stringent controls on capital, allowing banks almost untrammeled access to liquidity. Most banks have vast appetite and as yet untapped lines.
But with a glut of bulky projects coming to the region in the short term, alternative sources of funding, beyond the syndicated loan market, may gain appeal. And there is no doubt that an increasingly enthusiastic role will be played by the heavyweight GCC banks, such as ABC and GIB, in many large regional project financings. Domestic banks, like National Bank of Abu Dhabi, Abu Dhabi Commercial Bank, and Mashreq Bank, are all expected to fine tune their project capacities in coming years, in line with the region-wide shift to longer term money.
So far, the only project bond to be issued in the Gulf was the $1.2 billion issue in 1997 which fed Qatar's RasGas, a liquefied natural gas (LNG) export project. Though forecasts at the time were upbeat ? even proclaiming the eve of a new financing era ? the reality has been different. But interest in project bonds is still palpably there. In neighboring Oman, one of the banks bidding for the arranger mandate for the Oman Gas Company pipeline projects put forth a long term bond solution. The bid failed, but nonetheless demonstrates that talk has moved beyond theory.
One regional banker construes the major hurdle to potential bond issues to be pricing, explaining that commercial borrowing is still typically cheaper. But the trends are shifting, and bond solutions may yet command more credibility, particularly for LNG and power projects.
The Islamic finance market is another area that has drawn much attention in the project sector recently, especially in light of the recent Thuraya Satellite Telecommunications project, backed in part by Abu Dhabi Islamic Bank (ADIB). Abdul Rahman Abdul Malik, CEO of ADIB, explains that ?Islamic banking is investment banking by structure. It is development banking, not consumer banking. And with projects, our instruments become more workable.? The benefit of Islamic banks, he insists, is ?their high availability of liquidity.? He expects an increased project role for Islamic banks, which, he claims, are comfortable with long tenors. ADIB is rumored to be advising an established player in its forthcoming bid for the Shuweihat deal, suggesting, perhaps, a possible chunk of Islamic debt in what will be the Gulf's biggest independent power project to date.
Others, however, are less convinced about the Islamic Finance Market. ?People will tap Islamic financing only if commercial financing is unavailable. It brings a very complex element to the financing structure because of the requirement to hold collateral on the instruments being financed. We try to avoid this,? says a regional banker.
Governor of the UAE Central Bank, H.E. Sultan Bin Nasser Al Suwaidi, presents a more even-minded view: ?Islamic banking concepts are new to the international community, so its natural that they're in this controversial stage. But at the end of the day, it's down to supply and demand. If there's demand, the Islamic banks will grow.?
A major concern raised by many bankers is the development of regional capital markets.
?The development of the capital markets will not come without the government creating the right infrastructure for it,? explains H.E. Al Suwaidi. ?We, as the Central Bank, have come far in paving the way, by way of regulation on debt instruments, for long term debt. We are now encouraging banks to offer long term deposits, to establish a market for long term financing,? he adds.
As one banker puts it, rhetorically, ?the question we should still be asking is how do we properly introduce capital markets to the Middle Eat?? His answer: ?when structuring projects, banks should be allowed the option to refinance the debt at, say, year twelve. The simple fact of a refinancing trigger is a direct way to stimulate capital market development, through the creation of project bonds.? ?This,? he concludes, ?needs to be done to bring more sophistication and liquidity to the Middle East.?
Nevertheless, a once dismissed theory about the Gulf has moved beyond any reasonable doubt ? the reliance on oil wealth has left most Gulf countries without the economic dynamics that can cope with the needs of rapidly swelling populations. Abu Dhabi was one of the first to recognize these inherent dangers and others are waking to them.
With the average crude price increasing by almost 40%, and filtering across all UAE business sectors, past UAE lethargy is expected to be replaced by radical reform Abu Dhabi-style. This year, oil revenues will have generated a windfall of around $7 billion. Confidence in private sector reform, briefly unsettled by recent economic exigencies, is back full force.
The economic downturn of the late 1990s forced the UAE into a more pensive disposition. But the result of these collective musings has been divergent. This is most readily borne out by the different attitudes of the two largest emirates, Dubai and Abu Dhabi, towards utility privatization. The former stubbornly refuses to accept the private route, citing enough know how. The latter has inspired a pioneering restructuring of its utility sector, for electricity and water.
Nonetheless, both emirates have undertaken several projects to diversify their economies, and to reduce dependence on oil. The non-oil sectors of the UAE's economy currently contribute to more than two-thirds of its total GDP, and about 30% of its total exports.
Still, on the macro side, the UAE government is trying to reduce its budget deficit, cut spending, and put its fiscal house in order. Part of greater fiscal discipline is opening up infrastructure to private participation, thereby forcing, in theory, the appropriate pricing of output.
The Abu Dhabi government is in no need of foreign capital, with reserves of well over $100 billion. But it believes privatization will inject some market discipline into its utilities, rather than letting them become extensions of the welfare state, as providers of services and employers. So it has begun by privatizing electricity generation.
But before market models can be achieved, many more issues need tackling.
As in any freshly privatizing state, various problems persist. Currently, the cost of power is being subsidized by the government. If market discipline really is the aim, this will have to change. With citizens all at once having to pay for what has historically been a ?free? service, or at least one whose nominal charge has been way below production costs, some annoyance is perhaps inevitable. ?It's a question of ideology as much as it is of economics,? contends a local banker.
But there have already been some increases in the charges for utilities. Over-dependence on the state is being slowly, but perceptibly, peeled back. With it should also come a stronger work ethic. Cuts in government employment will need to be replaced by greater private sector employment responsibility, to ease the inevitable transition.
These concerns aside, the fact remains that with no foreign debt, some of the highest standards of living in the world, and one of the most diversified and sturdy economies in the region, the UAE has had, and will continue to have, little problem attracting more foreign cash to shore up, among other things, its utility efficiencies. This applies to Abu Dhabi as much as to Dubai, if the latter ever sees the need to go the private sector distance.
A Private Picture
A closer look at the Abu Dhabi utility sectors yields a more thorough explanation.
Its recent history is a familiar story. With soaring demand for electricity, coupled with volatile swings in peak loads, the Emirates set up in 1996 a privatization committee for the water and electricity sector, with the principal aims of improving the security and efficiency of the sector, promoting local and foreign private participation and maximizing revenue from asset sales. The work resulted in the passage of a key piece of legislation, Law No. 2, which set out the regulation of the sector. It also triggered the vertical and horizontal demise of the former Water and Electricity department (WED) and the conception, in 1998, of the Abu Dhabi Water and Electricity Authority (ADWEA).
Urging ADWEA's birth, however, was more than the simple realization of long-term demand crunch. According to one local lawyer, ?the WED was notoriously corrupt and inefficient. It buckled under bureaucratic strain.? With all its assets subsequently transferred to ADWEA, the infant company found itself wielding full independent control of the sector, with even the Ministry of Electricity and Water (MEW) playing, some contend, a marginal, albeit strategic, role.
WED's assets have since been divided among nine new companies spread across generation, distribution, transmission and procurement, all licensed and highly regulated. Planning and contracting for new generating capacity became the responsibility of a ?single buyer?, the Abu Dhabi Water and Electrcity Company (ADWEC).
So far so good. The question, however, was how and when to privatize, rather than just restructure. Enter White & Case, Credit Suisse First Boston, and Fichtner, as legal, financial and technical consultants to ADWEA for the first flutters of private activity in the sector: power generation.
The subsequent teamwork gave rise to the first independent water and power project (IWPP) in the world, the $596 million Al Taweelah A2 710MW/50 million gallon desalination project, commissioned by the US company CMS Energy. The tender was issued to eight prequalified international consortia, with subsequent evaluation based primarily on price, calculated as the levelised average over the 20-year life of the power and water purchase agreement (PWPA). Encouragingly, CMS' price was one-third the government's pre-privatization price
Mandated in September 1998, it took sponsor CMS less than 12 months to attract an international team of lenders and reach financial close on April 27, 1999.
The financing serves as ample proof of the government's commitment to opening the emirate to foreign investors. Speaking from the London office in an earlier interview, Amjad Ghori, senior director of global finance at CMS Energy says: ?The authorities in Abu Dhabi gave a tremendous boost to the project and provided the right environment for foreign investors.?
The Al Taweelah A2 transaction (winner of Project Finance's Water/Power Deal of the Year Award, 1999) has since resounded throughout the international lender community as has having set the precedent, in terms of tenor and pricing, for independent power deals in the Gulf region.
Lead arranged by Barclays Capital, the deal flaunts a number of interesting structural features. Priced at 105bp over Libor during construction, the margin drops to 80bp post completion, and then steps up to 120bp and, finally, 150bp throughout the term of the loan. The 17-year tenor is particularly noteworthy ? notwithstanding Abu Dhabi's AAA credit rating.
The project involves the construction of a gas-fired 710MW plant combined with a desalination unit facility with an ultimate capacity of 50 million gallons of water a day. Construction, carried out by a joint venture between Germany's Siemens and South Korea's Hanjung, is nearing completion, with generation already well under way. The plant will be fully operational by August 2001.
Abu Dhabi's restructuring and privatizing efforts were, in part, inspired by a neighboring success: Oman's Tractebel-led Al Manah IPP, the first such undertaking in the entire Middle East. But although Oman got there first, Abu Dhabi has overtaken the eager Sultanate, especially as concerns regulatory overhauling for power and water. One area where the emirate lags, however, is wide-scale legal reform.
Legalities
The essential challenge, explains a prominent local lawyer, is ?to put modern legislative documents into a legal system that's fifty years out of date.? He adds, ?there's no legal protection, for example, against developers being booted out by the majority shareholders.? Namely, the government.
One unambiguous advantage has arisen for project companies. ?The government previously had been in total control of all contracts and there was very little room for dispute resolution. But with the introduction of Law No. 2, certain aspects of ADWEA were placed beyond the purview of Abu Dhabi law.? More specifically, he continues, ? to privatize, what's needed is legislative relief ? and this was granted to power and water companies.? But, he claims, legislative relief has not been taken full advantage of, particularly for real estate, which can only be owned by Abu Dhabi nationals.
Other issues underscored include problems posed by local law that affect project and finance documents, namely, what law actually governs the documents. Presently, this is not as explicit as perhaps desired by more exacting international standards, though consensus is nonetheless typically reached.
Non-issues for the emirates are labor laws, customs regulations, and, significantly, tax.
Security structures evidently cause concern, according to another foreign lawyer, since they are still not sufficiently codified. ?Taweelah A2 was the first time anyone had registered a commercial project. A commercial mortgage was taken out, but it was a painful process to get the key security document.? Nonetheless, he insists, ?you do in theory get a structure that works but nothing has actually been put to the test yet? ? perhaps thankfully.
According to another advisor, Al Taweelah A2 moved so fast that the project actually got ahead of the legislative framework, ?but still worked out.? Nevertheless, he cautions, ?so far this is the only project to have been completed, so let's not get carried away.?
Power project pipeline
ADWEA plans to increase electricity output from the present level of 2,500MW to 7,356MW by 2010. At the same time, desalinated water production is set to rise from 262million g/d to 573 million g/d over the same period. All this to meet a budding downstream industrial base and a fast growing population.
With a highly successful project in hand, then, Abu Dhabi has moved forward full steam with its privately imbued restructuring program. Witness the second smoothly tendered IWPP, the Al Taweelah A1, awarded to a TotalFinaElf/Tractebel consortium earlier this year.
At $1.3 billion, the deal is the largest yet. It comes backed by a $1 billion loan, currently in syndication, and set to close soon. As with its predecessor, the deal is notable for its tenor (18.5 years), which received strong bank backing. BNP Paribas and Citibank co-lead the deal, though the former also supported the consortium during the bid phase, before bringing Citibank into the deal.
Pricing, also said to be comfortable enough for a smooth sell down, is 110bp during construction and notches up to 125bp-145bp during operation.
The progress of the project, however, has not always been as smooth. The selection process was first extended by government demands for refurbished bid documents: the project initially entailed the rehabilitation of an existing 255MW cogeneration facility, but ADWEA asked for modified bids to be submitted for the reconceived, larger project, on a build, own, operate (BOO) basis. The revision instead called for an upgrade of the existing facility to 1,350MW, and the expansion of water capacity from 29 million g/day to 40 million g/day. Bidders were asked to match prices for the previous project ? $0.224/kWh.
TotalFinaElf/Tractebel finally won against the other final listed bidder, CMS, on the basis of pricing. As with the A2, 60% of the project goes to ADWEA, with the consortium picking up a 40% stake.
When the plant reaches full commercial operation, by early 2003, it is expected to supply about 25% of the emirate's power and water needs.
The transparency of the tender process is a feature which warrants significant attention. ?The Taweelah case is by no means the only way regional projects get done,? argues an executive at a foreign power company. ?In that instance, all the players knew exactly what they were facing. The tariff was set, and the rate of return was established. Moreover, the government tried to make it easier for investors to come in and do the work with the result that now, whoever can do it more competitively will win.? He is underscoring the benefits of clear and distinct guidelines in which ?all the assumptions are in place before the bid,? such that there is little room for deviating interpretations and where ?everyone plays by the same set of rules?.
?The tendering process is as transparent as it can be ? Abu Dhabi has effectively showed the Middle East how to bring in IPPs,? says an executive at International Power.
So vaunted is Abu Dhabi's clarity in this regard investor appetite is deep and fierce. Ultimately, though, ?the golden rule for IPPs is that the person who can best manage the risks must take it.?
This truism will certainly play itself out in the next round of Abu Dhabi's IWPP mania. By far the most ambitious power and water project (for the entire gulf) is yet to surface: the 1,500MW and 100 million g/d Shuweihat project, prequalification bids for which will be received by January 15, 2001. To be tendered by June 2000, prequalified companies will be invited to submit proposals for a similar 40% stake for this greenfield BOO scheme. The plan is to notch up capacity in stages to an ultimate 5000MW and 300million g/d.
The first phase is expected to cost around $400 million, and should, it is hoped, come on stream in 2004. If the current schedule is maintained, financial close should come by the end of 2001. The deal is likely to be structured in much the same way as the Taweelah projects.
ADWEA has retained its previous legal counsel, White & Case, for this project. However, Deutsche Bank and Lahmeyer International replace the former consultants as financial and technical advisers respectively.
?This is certain to be one of the biggest deals of next year,? exclaims a foreign developer. It will also be one of the most competitive, with all the regional power players positioning themselves for a piece of profit. With no dearth of money for such deals, bankers are already gearing up for the fervent months ahead.
Also scrambling to plump up their bids are the following consortia: Tractebel/Mitsui, CMS/International Power, PSEG/ Marubeni, with AES attacking alone.
?We don't build power plants unless there's a demand for them,? explains Abdullah Al Neaimi, director of IWPP's at ADWEA. ?The problem is, we need water more than we need power, partly because water is a requirement to build the power plants in the first place,? he adds, ? but it's not always feasible to build a water plant as a stand alone, so we opted for our IWPP system.?
Next in line for possible privatization, in no particular order, are several other government owned generating assets. Umm al Nar Power company, with 1148MW/92 million g/d; Bainounah Power company, with 1201MW/44 million g/d; Al Mirfa Power Company, with 311MW/16million g/d; and, finally, another Al Taweelah Power company, with 1069MW/95 million g/d.
The question remains how far the privatization drive will go. ?Distribution could be privatized, but its not currently under formal scrutiny,? says Neaimi. The two possible candidates for such a move would be the Abu Dhabi Distribution Company, and the Al Ain Distribution Company. Transmission, he says, is unlikely to be privatized in the short term.
Careful regulation
The Abu Dhabi success story, still only in its first draft, owes much to its preemptive regulatory restructuring. Law No. 2 set out in great detail the sector's regulatory environment, and established the Regulation and Supervision bureau, the first independent regulator in the Middle East. The bureau, often likened in function to the UK's independent regulator, undertakes standard regulatory activities, mitigating against monopolistic deviancy, for example, by restricting companies to no more than 25% market share without explicit consent. Indeed, this function is part of its licensing activities, which cover the entire power structure. Of course, the privatization and restructuring process is in early stages yet, with only two consortia owning private shareholdings (CMS and TotalFinaElf/Tractebel). But with the planned future privatizations, this will change.
Deregulation, of course, is a still distant concept. Says Neaimi, ?the regulatory body will of necessity have to be tightly controlled until the market reaches equilibrium.?
But some still raise questions about the nature of the privatization process itself, particularly given that the state still plays such a dominant role in the emirate's utility sector, with the government retaining 60% stake in the projects. As one local banker puts it, ?the main worry is whether this is privatization or something else ? that is, a form of subsidy.? He continues, ?How far can privatization really go??
Counters Neaimi, ?it takes time to privatize effectively. Right now we're not working with fully real market models, but we're working towards them.? As such, the current situation, in which the government still maintains control over ownership and pricing of electricity and water, will likely change over the next few years. How fast this occurs, however, is down to the pace of privatization.
Dubai
The region's commercial and trading center, Dubai, on the other hand, is proving to be an exception to the Gulf rule. It has no immediate plans for unbundling its utility sectors. By all accounts, the emirate's government intends to keep the sector under public control through the rigorous guidance of state-owned Dubai Electricity and Water Authority (DEWA).
Last year, Dubai saw demand rise 13% for water and 16.3% for electricity, with annual increases forecast at an average of 10% over the next decade. Despite its steadfast opposition to privatization, the utility is nonetheless considering commercial financing for some of its large scale projects. Its proposals include the expansion of its Jebel Ali K2 station, with a suggested 400MW/5.72 million g/d boost in capacity, with a view to even more expansion in the long term.
?Dubai is attempting to be so many things at the same time,? says a foreign banker. ?Without privatizing, it's the most more privatized than any gulf state.? He is referring to the unmatched private activity in the emirate's commercial zones, where the government has emphasized creating an environment to allow private capital to work effectively.
DEWA still argues that it can do things cheaper, more efficiently, and to the greater advantage of the public consumer than any private hand. But Abu Dhabi's story admits a contrary conclusion. Some rebut that this boils down to the latter's previously flawed system. This may be so. But another argument crops up which may, in the long run, upset, or at least shift, DEWA's balances.
One of the biggest challenges facing all utilities and suppliers worldwide, insists one foreign power executive, is digitization ? global reliance on advanced computing technologies ? in so far as such developments require not only power but flawless, higher efficiency ?quality power,? the technologies and skills for which are in private clutches.
Dubai, for example, recently embarked upon a high-profile information technology (IT) drive, the Dubai Internet City free zone, marking the IT sector as its main priority. At the same time, it has announced an e-government initiative, aimed at improving government services and setting up public accessibility. The question to be asked, stresses the executive, is whether DEWA can supply quality power: ?this is an issue that Dubai, like California, will face when its digitized developments grow, and it discovers it lacks the technical know-how for guaranteed flawless power.? He adds, ?no one is really thinking in terms of quality power, but we need to ask whether DEWA will be able to muster the type of investment needed for such seamless supply as is necessary for, say, e-transactions.? He is referring to an alleged power quality assurance that guarantees 99.9999% reliability, or 32 seconds of annual disruption, as opposed to the current level of 99.99% reliability, or 53 minutes of annual disruption. ?Any disruption could prove fatal to a digitized community,? he submits.
DEWA's options, he argues, are either to let in private investors with the requisite expertise, or to go at it themselves, when capacities warrant. About the latter option, he remains skeptical.
Notwithstanding the possible merits of this argument, others insist that DEWA, despite its fiery rhetoric, will ultimately have to open its arms to the private sector embrace, for standard reasons of efficiency and economics. No conclusion on this matter is forthcoming, however, though sponsors and lenders are certainly prepared to pounce if and when necessary.
But, of course, another way of providing security of supply, beyond the theory of ?quality power?, is interconnection, something which is already under consideration.
Local, Regional Grids
An initiative has been launched, by the MEW, for the interconnection of Abu Dhabi, Dubai, Sharjah and the Northern Emirates into a single grid. Transco has been discussing the issue of integrating the UAE electricity systems, and the regulatory bureau has been following the matter closely, offering advice on potential legal and regulatory issues, it reports.
But beyond the UAE, an exciting prospect is the interconnection of the systems of all six GCC states. This is nothing new. In fact, the topic has been discussed for years, although concrete steps have been taken only recently. The most probable scenario for the UAE is an initial link with Oman, before a possible further link to a more extensive GCC-wide grid. The combined generating capacity of the GCC states currently totals around 40GW. Interconnection would likely bring significant benefits in terms of cost and enhanced security of supply. But politics govern the course of any such development. Once set up, such a grid could, in theory, wheel extra capacity to Europe during winter months, when Gulf plants mostly run at half capacity. For now, however, this remains strictly theory.
Gas
Rising gas demand has been one of the most striking feature of the UAE energy scene for the past decade. The last few years have witnessed the UAE embark on a massive multi-billion dollar program of investment in its gas sector, vital for the introduction of gas-fired plants and the transformation of the Taweelah commercial district into a gas-based industrial zone.
But possibly the most ambitious of the current gas projects is the immense Dolphin Project, which involves piping natural gas from Qatar's offshore North Field undersea to Abu Dhabi for subsequent delivery to Dubai and Oman, with a possible future link to Pakistan. The United Arab Emirates Offsets Group (UOG) and the Qatar General Petroleum Corporation (QGPC) signed a statement of principles for the project in March of last year.
So far, Enron and TotalFinaElf have signed project development agreements with UOG. UOG has also signed a preliminary agreement with Mobil Oil Qatar for the supply of 300 million to 500 million cu ft/day.
As the plan stands, UOG and Abu Dhabi National Oil Company (ADNOC) have also issued a joint declaration dividing up gas distribution between them. Gas from the Dolphin project will be the exclusive supply for gas fired plants, except in the western region of Abu Dhabi, and will also supply gas for ADNOC contracts with Dubai.
But the $8-10 billion project is currently languishing due to disagreements over gas pricing. UOG and QGPC have spent the last few weeks negotiating price, but a difference remains between Qatar's proposal and what the UAE wants to pay.
Says a senior official at UOG: ?we're in the final negotiation stages with Qatar. We're absolutely immersed in it ? its critical for the emirates, let alone the rest of the region, since there's such a huge need for gas right now.? In Dubai alone, the largest call on gas will come from industry, which is forecast to double its consumption in the next five years. Throughout the UAE, demand from the power sector is projected to surge some 60% in that time.
The UOG itself is becoming somewhat of a mainstay in the domestic energy sector. It helped devise the ?Taweelah solution,? the pioneering privatization and restructuring program, and, with the probability of Dolphin, now has ?the capacity not only to initiate but to implement as well.? Continues the official, ?we're looking to become a major regional player in developing energy and infrastructure projects.? UOG is currently helping to restructure water desalination and distribution in the Northern Emirates, a prospect which demands power. Accordingly, the company is allegedly moving ahead with plans to set up IPPs in the emirate of Fujairah.
As for future project developments, most contend that Abu Dhabi's IPPs are the ?first wave. Then, you're likely to see many petrochemical projects as the second wave, with the gas coming on line. It makes economic sense for fuel intensive industries to set up here, where its cheaper. So we'll no doubt see more industrial projects coming on line in the near future.?
Islamic facilities
?Abu Dhabi's power sector has been so successful because it provided sovereign guarantees backstopping power purchase agreements. Moreover, if a project falters, the government will be there to bail it out, unflinchingly,? maintains a Gulf-based foreign banker.
True, Abu Dhabi, with all its wealth, has had an easy time bringing private cash to bear.
That alone gives great comfort to lenders, and partially explains their willingness to invest.
But, as importantly, the perception of credit quality for regional power transactions is, arguably, stronger than for petrochemical and industrial projects, as far as local and foreign commercial banks are concerned. A major result of this has been the extension of substantial tenors for power financings (compared to petrochemical financings), a fact nicely illustrated by the Taweelah deals. Equally, pricing on long maturity loans has been especially low.
Many regional banks are also in healthy shape, experiencing vast capital surpluses, partly due to oil price rises. Add the fact that the UAE lacks stringent controls on capital, allowing banks almost untrammeled access to liquidity. Most banks have vast appetite and as yet untapped lines.
But with a glut of bulky projects coming to the region in the short term, alternative sources of funding, beyond the syndicated loan market, may gain appeal. And there is no doubt that an increasingly enthusiastic role will be played by the heavyweight GCC banks, such as ABC and GIB, in many large regional project financings. Domestic banks, like National Bank of Abu Dhabi, Abu Dhabi Commercial Bank, and Mashreq Bank, are all expected to fine tune their project capacities in coming years, in line with the region-wide shift to longer term money.
So far, the only project bond to be issued in the Gulf was the $1.2 billion issue in 1997 which fed Qatar's RasGas, a liquefied natural gas (LNG) export project. Though forecasts at the time were upbeat ? even proclaiming the eve of a new financing era ? the reality has been different. But interest in project bonds is still palpably there. In neighboring Oman, one of the banks bidding for the arranger mandate for the Oman Gas Company pipeline projects put forth a long term bond solution. The bid failed, but nonetheless demonstrates that talk has moved beyond theory.
One regional banker construes the major hurdle to potential bond issues to be pricing, explaining that commercial borrowing is still typically cheaper. But the trends are shifting, and bond solutions may yet command more credibility, particularly for LNG and power projects.
The Islamic finance market is another area that has drawn much attention in the project sector recently, especially in light of the recent Thuraya Satellite Telecommunications project, backed in part by Abu Dhabi Islamic Bank (ADIB). Abdul Rahman Abdul Malik, CEO of ADIB, explains that ?Islamic banking is investment banking by structure. It is development banking, not consumer banking. And with projects, our instruments become more workable.? The benefit of Islamic banks, he insists, is ?their high availability of liquidity.? He expects an increased project role for Islamic banks, which, he claims, are comfortable with long tenors. ADIB is rumored to be advising an established player in its forthcoming bid for the Shuweihat deal, suggesting, perhaps, a possible chunk of Islamic debt in what will be the Gulf's biggest independent power project to date.
Others, however, are less convinced about the Islamic Finance Market. ?People will tap Islamic financing only if commercial financing is unavailable. It brings a very complex element to the financing structure because of the requirement to hold collateral on the instruments being financed. We try to avoid this,? says a regional banker.
Governor of the UAE Central Bank, H.E. Sultan Bin Nasser Al Suwaidi, presents a more even-minded view: ?Islamic banking concepts are new to the international community, so its natural that they're in this controversial stage. But at the end of the day, it's down to supply and demand. If there's demand, the Islamic banks will grow.?
A major concern raised by many bankers is the development of regional capital markets.
?The development of the capital markets will not come without the government creating the right infrastructure for it,? explains H.E. Al Suwaidi. ?We, as the Central Bank, have come far in paving the way, by way of regulation on debt instruments, for long term debt. We are now encouraging banks to offer long term deposits, to establish a market for long term financing,? he adds.
As one banker puts it, rhetorically, ?the question we should still be asking is how do we properly introduce capital markets to the Middle Eat?? His answer: ?when structuring projects, banks should be allowed the option to refinance the debt at, say, year twelve. The simple fact of a refinancing trigger is a direct way to stimulate capital market development, through the creation of project bonds.? ?This,? he concludes, ?needs to be done to bring more sophistication and liquidity to the Middle East.?
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