Signals coming through indicate that the hydrocarbons financing market in the Middle East may be reviving again, writes Kevin Godier.

After many months in the doldrums, the hydrocarbons market exploded into life again in late April, when 23 banks committed to a 10-year, US$2.6bn commercial loan for the Dolphin gas pipeline connecting Qatar to the United Arab Emirates (UAE), with five of these also signing a 10-year, US$400mn loan tranche guaranteed by Italian export credit agency Sace. The sponsoring Dolphin Energy (DEL) had been targeting just US$1.5bn of debt from banks in a quest to refinance existing project debt that expired in June. This placed DEL in the enviable position where it had already raised more money than needed, even before a proposed bond financing tranche was launched.

The news came as a shot in the arm to participants in the Middle East’s oil and gas sector, which, like so many other sectors over the past nine months, has stumbled across a range of difficulties in accessing new finance. Two years ago, appetite for the assets among banks and other financing sources was ravenous, as demonstrated when Qatar Petroleum (QP) and Royal Dutch Shell seamlessly concluded the ground-breaking 15.5-year, US$4bn project financing required for their Qatargas 4 liquefied natural gas (LNG) scheme.

But in 2008 the picture began to change, driven by the spread of banking losses in the US real estate markets across into global banking markets, which pulled down international liquidity levels. This happened at the same time that rising commodity costs pushed up the price of project development, most notably for massive oil refinery complexes proposed in Kuwait and Saudi Arabia.

As many global and regional banks dropped out of what was formerly the world’s most thriving project finance market, and oil prices plummeted from a July 2008 high of US$147/barrel, Middle East oil and gas financing specialists have been forced to sit on their hands and watch lowered oil prices put pressure on state budgets across the region that in turn have negatively impacted on the liquidity and investment capacity of Saudi Aramco and other national oil companies.

And for smaller independent oil explorers, “practically all markets have been closed for the past nine months and many of their investment plans are delayed”, says Keith O’Donnell, head of natural resources in KBC’s structured finance unit based in Dublin, which is “active but selective in oil and gas structured finance in the Middle East”.

O’Donnell adds that, except for a few of the strongest names, the reserve-based lending (RBL) market has been closed and low oil prices have restrained free cashflow for the independent sector that uses RBL. “The result has been a dash to cut capex plans,” he comments.

“As for the banks, how many are really active in the market now?” asks one project financier. “Citi is scarcely seen, Fortis is gone and ING is on the fringes. Barclays is not there, and RBS (Royal Bank of Scotland) has stopped most project lending. In the GCC, Gulf International Bank is ditching its project finance team in Bahrain, and while other regional banks will do local currency tranches, they have been hurt by the cost of dollars.”

He highlights that the regional market was in any case “fairly content to be a secondary market for syndications, which was reliable for small tickets, aside from players such as Qatar National Bank and Bank Muscat, which have strongly supported the major sponsoring names in their markets – QP and Oman Oil”.

Among those banks that remain, “there is far more selectivity”, underlines Jonathan King, London-based head of structured and project finance at Europe Arab Bank (EAB). “Banks are not pursuing balance sheet or asset growth now, but focusing on relationships. With liquidity still so tight, banks are even looking to say no to well-structured deals where these fail to tick the relationship box.”

Juxtaposed against this situation is a potential list of hydrocarbons projects that remains huge, and will require some enormous sums of debt if sponsors are to push ahead as envisaged. According to consultancy firm Oxford Analytica, in oil, gas and energy alone, a massive US$520bn worth of projects are still planned across the GCC in the 2009-13 period.

A good sign for the oil and gas industry came on June 6, when oil prices broke through the US$70/barrel barrier again, boosting cashflow prospects and encouraging hopes of even higher prices through the rest of the year.

Dolphin morale boost
Probably the most positive signal of all has been the headfirst plunge by banks into the Dolphin refinancing, in a transaction that has been anticipated as the depressed market’s first litmus test of 2009.

The project’s existing cashflow and strong sponsor group were seen by financiers as key underpinnings for the very liquid bank commitments, which included two individual bank offers of US$300mn and US$250mn. The Dolphin scheme – officially inaugurated in May 2008 – currently pumps around 2 billion cubic metres of gas a year to seven emirates within the UAE and to Oman. The Abu Dhabi government-owned Mubadala Development Company owns 51%, and Total and Occidental Petroleum the remaining equity.

“Dolphin is a quality deal, with a good sponsor,” claims Nigel Reed, London-based head of project finance at Bayerische Landesbank, which was a participant in the Dolphin deal.
“The infrastructure is all completed apart from a last spur, and it is priced about right.” Another banker confirms that a reported 275-350 basis points (bp) over Libor interest rate is “pretty near” to what participants will receive.

According to Jonathan Robinson, managing director, head of project finance, Mena, at another participant, HSBC Bank, “the commercial bank oversubscription was a very good sign for the wider market”.

Set to be one of the more interesting deal features is a capital markets tranche earmarked at anywhere between US$500mn-$750mn. DEL’s financial adviser RBS issued a request for proposals to banks for the targeted bond in mid-April, and was awaiting the result as GTR went to press at the end of June. “The intention is to issue a bond, and then scale back the bank facility. The bond market likes deals where there is no construction risk, and if this goes through, it will replicate the bond issue for the RasGas 2-3 project financing,” says a source close to the deal.

He adds that “bonds and capital markets could show more momentum this year – the bond market has been quite strong for new Middle East corporate issuers recently, and there is talk of a new bond issue for the RasGas 2-3”.

Next project wave
So will the Dolphin deal presage a spate of further new Middle East transactions in 2009, as private sector majors and national oil companies re-address their investment requirements? “Dolphin says that ‘where there is a will, there is a way,” observes KBC’s Keith O’Donnell. “The sponsors made the financing attractive and used relationships to ensure it is a success,” he stresses.

“The recent market conditions mean that risk returns for high quality transactions are very attractive – pricing is up significantly globally and the Middle East is no different,” says O’Donnell, pointing to new opportunities for the market “in Egypt, Qatar and Saudi Arabia that may close this year”.

At Sace, head of oil, gas and infrastructure department Ivan Giacoppo says the Italian agency is “currently working on several oil and gas projects in the area, some of which may be finalised by the end of 2009”.

He continues: “The energy sector, and especially the oil and gas industry, is likely to continue to represent an important portion of our portfolio in the next years,” pinpointing Saudi Arabia, Qatar and UAE as the most active markets.

Of further encouragement for the banks that have poured untold billions into Qatar is talk that the tiny but wealthy emirate has begun to discuss lifting the embargo on further developing the world’s largest gas field – the North Field – by 2011, two years earlier than previously envisaged. And in Yemen, the country’s first LNG plant was finally set to commence production in June 2009, underpinned by the US$2.8bn limited recourse financing that was closed for the sponsors in the first half of 2008.

However, what must be faced by hydrocarbons project developers looking to tap financing markets is “a significant re-gearing of the project finance market in the Middle East, with substantially altered terms and conditions, in particular shorter loan maturities and higher pricing”, says King at EAB, another participant in the Dolphin commercial bank tranche.
Because Dolphin and Qatar Gas Transport Company (Nakilat) possess exceptional credentials, the way forward for most sponsors, runs the market consensus, will be to use export credit agencies (ECAs) and some bilateral financing to deliver extra liquidity. “ECAs will be the lead factor in nearly all of the large-scale, upcoming Middle East deals,” indicates HSBC’s Robinson.

This was the case even in late 2008, when LNG transportation specialist Nakilat closed a US$1.5bn vessel financing, combining a 17-year commercial tranche and a 12-year export credit-covered portion. Nakilat closed a further US$1bn facility in late May 2009, without ECA support, to fund payments required between October 2009 and July 2010 under an US$8bn debt programme to buy 25 LNG carriers under construction in South Korea. The latest deal was split into Islamic and commercial components, advised by BNP Paribas and SMBC.

Saudi refineries
Probably the largest user of ECA market money in the medium term will be Saudi Arabia, where a huge debt financing is to be sought for the 400,000 barrels/day Jubail export refinery, sponsored by Saudi Aramco and Total. Initially earmarked to come to market in June 2009, the financing has been delayed as Saudi Aramco has sought a reduction in the proposed cost to below US$10bn, from an original estimate of as much as US$12bn. “This is a genuine mega-deal, where, whatever the overall costs, they will still need US$7-8bn in debt,” emphasises Robinson.

Although Saudi banks are among the strongest in the region, the Jubail scheme is also likely to tap ECA-backed money plus the generous lending liquidity available from Saudi state entities which specialise in project financing, such as the Public Investment Fund and the Saudi Industrial Development Fund. Beyond Jubail, a refinery at Yanbu of the same size as Jubail, to be built by Aramco in partnership with ConocoPhillips, will not come on line until 2014, after the two companies decided to restart the bidding process on the project.

Mega-bucks will also be needed when Aramco’s plans for the massive Ras Tanura refining and petrochemicals complex in Saudi Arabia – already tagged as the world’s largest project with costs that could reach US$25bn or more – finally comes to market. “Ras Tanura is in gestation at present and is not for this year,” says a project source. “The first set of approaches will be to ECAs, as the project will have a very large ECA component. We will take it out to the banks and capital markets after that.”

Adds EAB’s King: “The numbers in Saudi are so big for the refineries, and liquidity is short, that the Saudis are looking both to ECAs and bilateral money.” According to Reed, “nothing is advanced in Saudi at the moment, and the refineries will have to take price risk on the oil”. Bayern LB has “done six or seven deals there”, and is comfortable with Saudi projects, he adds.

Egyptian deal
ECAs – alongside the European Investment Bank and development finance institutions – are also set to provide the bulk of project finance for the estimated US$3.5bn Egyptian Refining Company (ERC) Project, which is set to create a new financing milestone for an Egyptian project. Financing is “back on track” after delays mainly linked to the global credit crisis, says Katan Hirachand, director, energy project finance at Société Générale (SG), the project’s financial adviser.

Financial closure of a US$2bn-plus debt facility covering about 65% of the project costs is planned “by year-end”, he adds, noting that the ECA involvement – either through direct loans or guarantees – will come from Japan and Korea, aligning with a construction consortium comprising South Korea’s GS Engineering & Construction and Japan’s Mitsui & Company.

The sponsors of the plant, being built at the Mostorod refining complex, some 10km from Cairo, have already signed a 25-year take-or-pay agreement with the project’s 15% shareholder, state-owned Egyptian General Petroleum Corporation (EGPC), to purchase the refinery’s entire distillate output at international prices. “The economics of the project are strong, and based around import substitution, so it remains very much a viable project,” says Hirachand.

Iran and Iraq prospects
Looking across the region, one banker moots that Dubai could be a potential borrowing market. “There is a possible deal brewing, to cover the cost of converting a ship at a Dubai jetty into a regasification facility to convert LNG from Qatar. Even with Dolphin, Dubai will be short of gas in the summer,” he explains.

Two of the biggest potential sources of new borrowing, notwithstanding existing political risk concerns, would be Iran and Iraq, both of which possess massive unexploited reserves under the ground that would allow them to push past current oil production levels sitting just below 2.5 million barrels/day.

International banks currently kept out of the Iranian market by sanctions are well versed in structured medium-term lending to the Islamic Republic, which was one of the largest markets globally for European ECAs at the turn of the 21st century, when the National Iranian Oil Company and the National Petrochemical Company were major obligors.
Iran’s financing needs were summarised in mid-May by Parviz Davoudi, the country’s first vice-president, who said the Islamic Republic’s hydrocarbon sector needed to attract US$200bn over the next five years, and US$500bn over the next 10 years.

“Sanctions will keep banks out of Iran for the time being although there are signs that the US is softening its stance,” says KBC’s O’Donnell. He notes that Iraq, by contrast, “has reached agreement with the EU and exports have started from Kurdistan, so it is making progress”. Any initial financings “will be led by multilaterals and bilaterals”, he forecasts.
Among ECAs, Sace is open in both Iraq and in Iran “within country ceiling and operating on a case by case basis”, says Giacoppo.

A key requirement, observes Robinson, will be for Iraq to put in place over the next few years the building blocks that will permit large-scale financings. “This would include factors such as a robust regulatory and legal framework, transparent financial reporting, and a clear and concise government approvals processes, as well as an improvement in the physical security element that would let insurers take risks on physical assets,” he explains.

A start is being made via Iraq’s first oil licensing round, through which the government is aiming to bring production capacity up to 4 million barrels/day, but the country’s long-awaited hydrocarbons law has yet to materialise.

Jordan – where oil shale projects are being discussed again, despite production costs estimated at US$75/barrel – represents another potential financing market, argue bankers. As with all Middle East countries outside the GCC, this would probably necessitate banks buying PRI market facilities, says one banker. “Jordan is a difficult country as it is small in size and population, and is a neighbour to some difficult countries,” he concludes.