Kurdistan’s infrastructure has been neglected in recent years as the region coped with the threat of the so-called Islamic State, an influx of refugees and the low price of oil. There are now some signs that much-needed funding could return to the sector, writes Rebecca Spong.


Summer nights in the city of Erbil in Kurdistan are warm, sticky and – for many inhabitants – tinged with the sickly sweet smell of sewage. Despite being the capital of the semi-autonomous region of Iraq and home to approximately 1.5 million residents, the city has a completely inadequate sewage treatment system to cope with its growing population.

Drinkable water is also in short supply, due to declining yields from current wells and the limited capacity of existing water treatment plants. The recent influx of refugees and internally displaced people escaping conflict in Syria and Iraq has increased the city and the wider region’s population, which has only further exacerbated the pressure on water reserves.

In 2015, a step was taken towards remedying this problem, with the Kurdistan Regional Government (KRG) signing a US$1.2bn contract with UK engineering company Biwater to manage a water and wastewater project, which includes the construction of a 600,000m3 per day water treatment plant in Erbil as well as upgrades to water treatment plants in Sulaimani. At the end of last year, the KRG secured a US$34.8mn loan provided under UK Export Finance’s (UKEF) direct lending scheme to finance the project’s early scoping phase.

The financing was raised independently from Baghdad, and considered a ‘landmark’ deal by some, as it is the first of its kind to be concluded under the KRG’s debt law, which was enacted in 2015. Many of those who worked on the deal predict it will spark renewed interest in Kurdistan, a region that in recent years has struggled to cope with the threat of so-called Islamic State, the refugee crisis and the collapse in oil prices.

Kilian Balz, partner at law firm Amereller, which advised UKEF on aspects of Iraqi law on the deal, is one of those who has high hopes for Kurdistan and the impact the Biwater deal will make on investor appetite for the region.

“Sovereign lenders, export credit agencies (ECAs) and development banks are looking at the Kurdistan region at the moment. There is a political consensus that stability must be brought back to the region – particularly the Kurdistan region. There are many development banks that are willing to assist the Kurdistan region, so this will be the first of a number of transactions,” he says.


Depleted finances

The Kurdistan region of Iraq has not always been considered as risky or unstable as it has been in the last two to three years. In the years following the 2003 Iraq war, investors had increasing appetite for the oil-rich region, despite the violence and political instability in other areas of Iraq. There were also concerted efforts to improve the region’s non-oil industries, with the KRG publishing its Kurdistan Region of Iraq 2020: A Vision for the Future document in 2013, which set out targets for the power, water, transport and housing sectors.

The situation changed as the war in Syria became more entrenched and Islamic State forces began to gain ground in the past few years. As a result, the KRG was forced to ramp up its security spending. Refugees also began pouring into the region, placing pressure on infrastructure. Then, in 2014, the global slump in oil prices began, and with oil being the region’s main export, this hit the KRG’s finances hard.

Inevitably, the region’s infrastructure needs fell off the government’s priority list. According to data from the Kurdistan Board of Investment, there were 51 licensed projects under implementation with capital investment of US$3.8bn in 2007. This rose to 122 projects in 2013, with a total capital investment of US$12.3bn. Then the numbers dropped off to 34 projects in 2015 and 2016 with capital investment of US$3.9bn and US$2bn respectively. These figures include foreign and national investment as well as joint ventures.

The low oil price also led to flare-ups between the KRG and Baghdad between 2015 and 2016 over delayed payments from the federal government budget to the Kurdistan region. Baghdad said payments were first cut and then subsequently delayed because the Kurds had not transferred the agreed amount of oil to the central government. Without receiving its share of the country’s oil revenues, the KRG became even more cash-strapped and struggled to pay its own debts to oil producers.

Efforts are now being made to repair relations between the KRG and Baghdad, but there’s still much work to be done, says Bryan Plamondon, director, Middle East and Africa at IHS Markit.

“They’ve [the Iraqi government] backtracked from complete stoppage of transfers, but we are still noticing some delays in debts. There is still a bit of mending to do in terms of political relationships – but there have been promises in terms of being more positive about channelling investment into the Kurdistan region,” he says.

The KRG has also looked to develop other revenue streams that are not so reliant on Baghdad. In February, Russian oil company Rosneft signed a pre-financing agreement with the KRG for the purchase of oil exports between 2017 and 2019. “When we see financing such as the deal with Rosneft, in terms of KRG oil exports, that’s a big plus, as that provides the government with a pretty steady stream of cashflow,” Plamondon says.

Rosneft is potentially one of many companies taking a fresh look at Kurdistan. “There are signs that it [Kurdistan] is starting to be more stable. There are signs of the first steps toward improving security, the first steps in terms of KRG’s oil exports getting a bit of a lift now that prices are nearer the US$50-55 per barrel mark. These are all signs that we are seeing a greater interest and refocus on Iraq and the KRG, but it is still an uphill battle,” he adds.

Looking at Iraq as a whole, GDP growth is also expected to recover. IHS Markit currently forecasts 1.9% GDP growth in 2017, rising to 5% in 2018. The consultancy also forecasts global oil prices remaining at a healthier level than in recent years, rising to just above US$60 by 2019.


Infrastructure needs

It is not just the oil sector that is tentatively attracting attention again. Almost a year before UKEF finalised its facility with Biwater, another ECA, France’s Coface, signed a deal to support the supply of gas turbines to Kurdistan’s Bazian power plant. In contrast to the UKEF deal, in this instance Coface provided a guarantee rather than a direct loan.

The deal marked the first time the French ECA closed a deal in the region. It was also the first corporate debt raised by the borrower – privately-owned Kurdistan firm Qaiwan Group. Qaiwan also operates the Bazian refinery, one of the two main refineries in Kurdistan.

Deutsche Bank and Lebanon’s BankMed (via its Dubai branch) arranged the US$75mn refinancing, which was guaranteed by Coface – now known as Bpifrance. Deutsche Bank funded the larger share of the facility (US$50mn), with BankMed picking up US$25mn.

The lenders viewed Qaiwan as an oil and gas corporate with a robust credit profile, says Brian Scheidt, structured trade and export finance at Deutsche Bank. “At the time, the company had very little debt and, given its historical profitability, visibility on cash flows, and the availability of ECA support, we were able to do this transaction. If you removed the political risk from the equation, you would see a company with a very strong balance sheet operating
in a strategic industry.”

The power plant – which remains under construction – will have an initial capacity of 442MW in simple-cycle mode, with the potential to increase to 662MW in combined-cycle mode. Turkish firm ENKA has the engineering, procurement and construction (EPC) contract for the project.

While this deal suggests there is some appetite to work with Kurdistan corporates, Scheidt takes a measured view on the outlook for the region.

“For Iraq, including the Iraqi Kurdistan region, the big issue is allocation of budget to projects and prioritisation of these projects. The government would most likely prioritise essential infrastructure such as water treatment, power generation and projects in the oil and gas sector,” he says.

He adds that it is unlikely there will be many billion-dollar deals in the region in the immediate future, and that most lending would need the support of ECAs, supranational entities and development banks. “The region continues to see major challenges, such as the oil price and the war. It will likely remain complicated for some time – but there are obviously bright spots.”


Inspiring activity

For some, one of those bright spots is last year’s US$34.8mn UKEF loan provided to the KRG under its direct lending facility.

“The deal was a double first – in terms of the use of the KRG debt law and a landmark loan agreement with UKEF – demonstrating the support of the international financial community in the region and laying a foundation for potential future Kurdish projects,” says Richard Wilkins, executive director in the export finance team at JP Morgan in Emea. JP Morgan was the mandated lead arranger on the deal.

The deal marked the first time the UK agency has supported the KRG, and may well be the first of a number of UK-backed deals in the region. “We are happy to explore similar support in future provided a project meets all of our normal UKEF minimum risk standards and satisfies other due diligence,” says Richard Simon-Lewis, head of civil, infrastructure and energy and business development at UKEF.

Indeed, this transaction is only the start of a much broader financing package to support UK firm Biwater’s water and wastewater project. Mark Robinson, project finance director at Biwater, says that the company’s project finance teams are already working with a number of ECAs, including UKEF, as well as banks to arrange suitable finance to fund the construction phase.

He tells GTR that the pressure of the rising number of refugees in the region on the water system has meant that the project’s original schedule will be sped up to deliver water supplies as soon as possible. “All parties are adapting to the requested alterations to reach completion of the scoping works and reach financial close of the loan required for construction to commence this year,” he explains.

The deal was also a test run for the KRG’s new debt law and according to a client note published by law firm Amereller, the deal has demonstrated that “the new Kurdistan debt law provides a workable basis for sovereign borrowing by the Kurdistan region”.

Before the law, there had been concerns about whether the KRG was allowed to raise money under bilateral loan agreements or on the capital markets without authorisation from Baghdad. In 2015, KRG had selected two banks to help it issue a bond on the capital markets in an attempt to gain greater financial independence from Baghdad. Although the bond issuance never took place, it did spark the need to establish a legal framework for the Kurdistan region to be able to raise sovereign debt.

“This piece of legislation provides the authority for KRG to borrow funds from the international market in its own right,” says Biwater’s Robinson, adding that the company will be working within this same legislation for the construction phase of the project.

Amereller’s Balz adds: “Lenders have been looking at sovereign debt in the Kurdistan region for a couple of years. It is a milestone transaction – the market has been waiting for this to happen.”