The GCC developer market has become very competitive and a number of new entrants are trying to usurp the hegemony of GDF SUEZ, International Power (IP), Marubeni, Sumitomo and ACWA. They face a tough task. “GCC is one of the global growth markets for power projects, with long off-take contracts with government assimilated credit risk and good risk allocation,” says Gijs Olbrechts, director acquisitions, investments & financial advisory at GDF SUEZ Energy MENA. “The appetite is very strong among private equity players through to industrial players.”

“To compete with the established developers, you need to know the market and how it works. For a successful project you need to attract all the best parties: equity partners, EPC contractors, equipment suppliers and banks. So balance sheet, relationships, track record and experience are key factors – but being innovative is also an important factor.”

Developers ogling Oman

A record eight consortiums posted bids for the 650MW Barka 3 and 650MW Sohar 2 gas-fired IPPs in Oman at the end of 2009. The next closest project in terms of bidding groups is the 950MW Bahraini Al Ezzel IPP in 2004, which was contested by five bidders. The bidding groups comprised:

• Suez, Sojitz, Ministry of Defence Pension Fund, Shikoku Electric (Yonden), Bhawan Engineering, Siemens (equipment) and GS (EPC)

• International Power, Mubadala and Alstom (equipment and EPC)

• Acwapower International, Sogex, Mitsubishi Heavy Industries (equipment), Hyundai E&C (EPC)

• Marubeni, Chubu Electric, QEWC, QP and GE (equipment and EPC)

• Kepco, Saudi Oger, Siemens (equipment), Daewoo E&C (EPC)

• India’s Lanco Group and KPS

• US/Ghana-based Balkan Energy

• Iran’s Mapna Energy (bid for the Sohar plant only)

“None of these new entrants should be underestimated. Most come from a utility background – such as Powertek, Tenaga, Malakoff and Tepco – and have an excellent track record in their own countries,” says Rajit Nanda, CFO of ACWA Power International. “The barriers to entry are not very high in this business. It only takes a couple of bids to learn rapidly. The Indians are bidding by themselves, which is a big mistake. The Koreans and Malaysians have come in on a low profile and have teamed up with more experienced regional players and have learned for themselves.”

Patience and continually refining bid strategy can pay off. Both Sumitomo and Kepco – recent winners of the Shuweihat 3 (S3) IPP tender – have been in the region for several years without success. Sumitomo first entered the GCC in 2003 and endured three years of failure until it paired up with Suez and IP and won Al Hidd IWPP in Bahrain in 2006. Sumitomo was also close to lead developing the Ras Al Zour IWPP in Saudi Arabia before a dislocation in the credit markets, the withdrawal of partner Malakoff and the Saudi authorities’ eventual decision to directly procure the project.

Similarly Kepco has been active in the region since 2004 when it bid with Saudi’s Xenel but failed to win Bahrain’s first IPP, Al Ezzel, and bid but failed on Saudi’s Marafiq IWPP with NPC. However, in the space of the last 18 months Kepco has had success after success. It reached financial close with Xenel for the 373MW Al Qatrana IPP in Jordan, followed by financial close for the Rabigh IPP in Saudi with ACWA, and has now been awarded Shuweihat 3 along with Sumitomo.

However, the scope for new bidders is likely to be reduced in the next Omani power project, the 1,500MW gas-fired Sur project. Oman Power and Water Procurement company (OPWP) has placed further conditions on the bidders, which are likely to reduce the number of offers at the final stage. Most notably state-owned entities are limited to 15% of the equity of the bidding consortiums. OPWP appears to be aiming for a shortlist of three serious bidders, says a banker close to the grantor.

The aim of precluding state-owned entities from large stakes is to safeguard security of supply and to ensure that the domestic power market does not become dominated by the interests of foreign states. For example, ACWA’s attempt to participate in the Shuweihat 3 IPP in Abu Dhabi failed because Abu Dhabi’s privatisation law prohibits companies from other GCC countries taking stakes in projects.

A new tender – Sur

OPWP is using a reworked tender procedure for Sur dubbed the “consolidated procedure”. Like the Barka 3/ Sohar 2 tenders, Oman continues to keep the bid tariffs private. Publicly opening the bids is the most transparent way of running tenders – as adopted by Saudi Arabia and Abu Dhabi – and could have avoided the animosity between GDF SUEZ and ACWA on the Barka 3/Sohar 2 bids.

Requests for qualification on Sur went in on the 18 October. Shortlisted bidders will receive mark ups on their bids by 30 November and each bidder will receive a standard set of project documents – the power purchase agreement, the land lease and supply fuel agreement – on 5 February 2011, before final bids are due in 5 March.

This new tender process aims to streamline the procedure and place all bidders on an equal footing before final bid, with none of the project documentation released on 5 February expected to be marked up by bidders.

The groups forming for Sur are thought to include: AES/Hyundai Engineering & Contracting Company/WestLB, Marubeni/Doosan, Saudi Oger/Kepco/Siemens, Sembcorp/ OIC, Tepco/Mitsui and ACWA, so far on its own.

Notable is the inclusion of AES and Tepco, neither of which bid on Barka 3/Sohar 2. AES is re-emerging as a serious contender for greenfield IPPs in the region after several years of consolidation and asset sales. AES won the Omani Barka 1 IWPP in 2000 and as well as Sur, it is participating in the Dairut tender in Egypt and the Qurrayyah IPP in Saudi.

Tokyo Electric Power Company (Tepco) is a new and emerging contender for gas-fired plant in the region, having teamed up with ACWA and Mitsubishi for a failed bid on PP11. Tepco also partnered IP unsuccessfully on Abu Dhabi’s S3 IPP.

GDF Suez has applied to the Omani Authority for Electricity Regulation (AER) to participate in the Sur tender and is believed to have committed to sell either Barka 3 or Sohar 2 plants at the end of construction if it wins Sur without the IP merger going through. If the IP merger goes ahead as planned, because of IP’s Al Kamil IPP in Oman, Suez has committed to sell both Barka 3 and Sohar 2 after construction.

Managing bank liquidity

The Sur RFP also differs from previous Omani tenders and is moving toward the Saudi and Abu Dhabi models by asking for bidders to provide committed financing for the first time. And the bidders do not have any requirement to share future refinancing gains. The RFQ states: “Bidders will be expected to consider any potential refinancing gains and terminal values of the project when calculating their tariffs. This offers much greater commercial and financial flexibility which OPWP is seeking to capture through competitive tariffs.”

There are no rules on enforcing exclusivity on banks or actively managing bank liquidity, although this has been a recent trend in the Shuweihat 3 IPP and Qurayyah IPP tenders.

For Abu Dhabi’s Shuweihat 3 IPP tender, ADWEA stipulated that each bidder must have two pathfinder international banks, each committing $125 million, with ADWEA sourcing another $250 million from two banks – National Bank of Abu Dhabi and adviser HSBC.

“Abu Dhabi has really moved and cornered the bank market into what it should be doing,” says Nanda. “Limiting banks per bid prevents banks from forming cartels and pushing prices up. Why should competitive pressure only apply to EPC contractors, which are acting on an exclusive basis, and not the financing? On a club, banks end up speaking to each other informally, and the range of prices they enter are very close to each other.”

Olbrechts adds: “We get the sense that some banks could be more aggressive but are looking at where the market is and following in behind. By drawing banks out of club deals and non-exclusivity you can create more competitive tension and push down pricing.”

ADWEA named the Sumitomo/Kepco consortium preferred bidder for S3. BNP Paribas and Mizuho are backing the financing and the EPC contractors are Siemens and Daewoo. ADWEA will own 60% of the project. BNP Paribas and Mizuho have each committed at least $125 million and NBAD and HSBC have each contributed $125 million. The cost, including debt interest, of the project is around $1.9 billion.

The debt financing requirement of around $1.6 billion over 20 years is expected to be met by an $800 million JBIC direct loan, a $400 million Kexim direct loan and a commercial bank facility of around $400 million. Financial close is scheduled for April 2011.

“The Abu Dhabi S3 model could not have happened in the second half of 2008 and most of 2009,” says Nanda. “But now there are 11 to 13 banks back in the project market with strong appetite, and there is an established trend of various ECAs being able to meet the timelines of the procurement templates.”

Two by two

ADWEA has a successful track record and is probably the most banker-friendly grantor in the region, given that the Abu Dhabi government provides a direct guarantee to ADWEA for termination payments. Conversely, for the Saudi Electricity Company (SEC) deals, international banks have become comfortable lending without a Ministry of Finance guarantee of the offtake contract, following the Rabigh and PP11 deals.

Like ADWEA, the SEC is actively managing the bank market to avoid oligopolistic bank pricing behaviour.

The SEC recently launched an RFP for the 1,800MW-2,000MW Qurayyah project stipulating that each bid can have a maximum of two Saudi banks per bid and each Saudi bank can back a maximum of two bids. This stipulation is to avoid the situation in PP11, when Alinma and Samba backed four bidding groups creating large potential conflicts of interest. The debt requirement will be around $1.5-$1.8 billion which could be entirely placed with local banks.

The deadline for bids is 28 February 2011, with a minimum of 50% of the debt requirement covered by underwriting commitments. International banks are not prohibited from backing multiple bids as first thought.

“For the Qurayyah IPP I think the SEC and its advisers have done a good job in thinking through in a rational manner the application of Saudi bank liquidity using the ‘2 by 2’ rule,” says Nanda. “It’s a progressive step and pretty close to being a truly competitive landscape for local banks. But they have not done justice with the international banks which are allowed but not obliged to back bidders on an exclusive basis. The ideal structure would have been for the 2 by 2 rule for Saudi banks and enforced exclusivity for international banks.”

For the S3 tender limiting the number of MLAs per bidding consortium to two was a sensible choice because it created a lot of competitive tension while making sure that each bidding consortium could find sufficient funding support to meet the bid requirements. For the Qurayyah RFP there seems to be a balance between limiting the number of banks and letting the banks bid on a free non-exclusive basis.

International banks prefer to back bids on a non-exclusive basis because the expense of backing losing bids means they like to hedge their bets. This is especially little room for failure in the Saudi deals for international banks because of the liquidity of local banks. If an international bank backs a losing bidder there is no room in the financing for it to come back in. In Abu Dhabi and Oman the ECAs have left little room for extra banks to join after the bid stage, with the one exception of Standard Chartered joining at the eleventh hour on GDF Suez’s Barka/Sohar deal.

“In an ideal world financial institutions would prefer to be allowed to enter non-exclusive bids,” says Guillaume de Luze, deputy head of power project finance EMEA at Société Générale. “There is a trend toward non-exclusivity and that trend should remain.”

Another banker tersely says: “It should be up to the market to decide what banks back which bidders – not the grantors.”

While the upside of strictly apportioning banks to bidders is that developers are placed on a relatively even footing and that oligopolistic bank behaviour is curbed, the drawbacks are that the most creditworthy sponsors may not secure the cheapest debt possible because they are unable to obtain full commitments for their bids.

“If a club is not in place at the award of the project, then commitments may be subject to some pricing flex,” adds de Luze. “Club deals effectively kill underwriting risk at inception, but a balance has to be struck between ensuring competitive tension between bidders and certainty of financing.”

If fully committed deals are not returning anytime soon, who should shoulder the price flex risk? Traditionally it has been equity, but with some compromises, as in the Shuweihat 2 financing, in which ADWEA made concessions to lengthen the PPA and provide a government guarantee, and once without compromise as in Sumitomo’s moribund bid for Ras Al Zour IWPP.

“This is a safe time to have uncommitted financing,” argues Nanda. “Grantors should actively encourage this model and take the price flex risk. The chances of this risk actually materialising is very limited. Grantors of IPPs are already comfortable taking interest rate risk for highly leverage transactions between bid submission and PPA signing, with tariffs changed in step with swap rates.”

Bank strain

With fewer than 15 active international lead arrangers in the market there is demand on these banks to take larger take-and-hold tickets. “By imposing exclusivity and a maximum number of banks there is an emphasis on banks’ ability to take and hold, which is a constraint as there are currently few opportunities to recycle capital,” adds de Luze. “The CLO market is closed and the syndication market less liquid. In these situations bidders are looking to maximise support from export credit agencies.”

“There has been a slight rebound in bank liquidity. But certain sponsors recognise the constraints on banks, because of the take and hold tickets on these deals, and prefer to use a club rather than an underwriting.”

Banks have different strategies and credit analyses based on jurisdiction, the sponsor and internal exposure limits. Particularly topical is bank treatment and weighting of government guarantees for offtake obligations and termination liabilities. Both Saudi Arabia and Oman, perhaps for strategy and enforcing credit discipline on quasi-state entities, have removed direct government guarantees from offtake contracts. Given the importance and size of the Saudi pipeline of deals and local bank liquidity, international banks are likely to have to take a softer stance on the credit risk for Saudi offtake contracts and country exposure if they wish to remain an active player in the region.

Further ahead, the structuring of Hassyan IWPP – Dubai’s first – will be challenging, given Dubai’s parlous finances. It is likely that a Federal Emirates guarantee effectively backstopped by the Abu Dhabi government will be required to make the project viable, or failing that some substantial and humbling multilateral support.

On a pan-regional basis, the continuing successes of Korean EPC contractors and developers have left international banks close to their internal Korean agency limits. It is rumoured that the Shuweihat 3 deal was won by the aggressive stance of the Korean government and the fact that both Kepco and Sumitomo are making single-digit internal rates of return supported by heavily JBIC- and Kexim-subsidised financing.

“I don’t think bank exposure to Korean agencies is a significant issue, and sponsors are continuing to pursue Korean EPC solutions,” says one developer. “Project finance banks aren’t funding the EPC directly but are rather taking default protection on project risk. Banks hitting Korean limits it is not something that should affect our plans. Also in my opinion, KEIC (K-Sure) and KEXIM will continue to provide important covered tranches or direct loans to projects.”

Macro force

In the absence of underwriting, debt financing will continue to be defined by the local Saudi banks and the export credit agencies. Almost all of the S3 bidders had access to JBIC direct loan funding by virtue of a Japanese equity partner. US Ex-Im recently reported in its annual report that it disbursed its largest ever amount of capital and is actively backing GE turbines in the region once again for Al Dur IWPP in Bahrain and PP11 in Saudi. Hermes is also back in the region with ECA cover for facilities worth $650 million for Oman’s Barka 3/Sohar 2 projects. The deals mark the first time since Saudi Arabia’s first IWPP – the $2.45 billion Shuaibah project that closed in December 2005 – that Hermes has had a role in a power financing in the region. The Korean agencies are also very aggressive and appear to be copying JBIC’s use of direct loans to strongly support Korean developers and EPC contractors.

“ECAs are a function of the size of these deals,” says de Luze. “When total project costs exceed $1-$1.5 billion they exceed the current capacity of the international bank market so other sources are needed.”

The active role of ECAs has filled in the gap left by international banks; but they are also an increasingly vital way of bolstering exports. The uptick in ECA activity can be set against global trade imbalances and the currency war being played out by further round of US quantitative easing, the unwillingness of the Chinese to allow the renminbi to appreciate and the forlorn attempts by the Bank of Japan to weaken the yen. The increased use of direct loans is a useful low visibility tool in an export war, given that they are not subject to the same OECD guidelines that prevent unfair subsidies of exports on export credit agency facilities. This race to the bottom on direct loans is clearly being won by JBIC and the Korean agencies.

However, the ability of JBIC to sway project awards is partially counterbalanced by the yen’s strength. Major currency trends would appear to favour a developer-EPC contractor-equipment supplier solution that is US dollar-denominated because they naturally match GCC offtake contracts, which are pegged to the dollar (with the exception of Kuwait, which is not pegged). Developers are most exposed to currency risk between final bid date and bid award. The Sumitomo/Kepco S3 bid was thought to be under FX pressure as it had a provisional EPC contract with Siemens and Daewoo with a large euro-denominated component to pay for the Siemens turbines. In the weeks leading up to final bid the Euro appreciated around 18% against the dollar.

The major EPC contractors and equipment suppliers can normally hedge this risk internally. “Private bidders have always tried to allocate FX risk on to the procurer but they have always ducked out,” says Nanda. “EPC contractors and equipment suppliers are usually able to manage currency risk within their portfolios of global business.” As most of the large equipment supply contracts are made up of dollar-denominated commodity inputs, all major EPC contractors should have an inbuilt natural hedge for most of their costs.

Another developer says: “You have to make a bet on the currency movement, attempt to pre-hedge or negotiate with the EPC contractor to set a price. It is one component when choosing an EPC solution, but by far the most important is to obtain the best technical solution, and if that means using a European EPC so be it.”