Despite the financing success enjoyed by the Barzan project in Qatar last year, a key shift in the funding sources for oil and gas project sponsors in the Middle East may be underway, writes Kevin Godier.


Qatar Petroleum’s (QP) December 2011 financial closure for its US$10bn-plus Barzan gas project, which saw a debt package totalling some US$7.2bn put in place, made project finance headlines. This was as a result of its massive US$3.34bn tranche of uninsured commercial bank lending, claimed as the biggest uncovered debt amount ever raised for a Qatar project.

“Despite the challenging market conditions, we were able to bring a large number of commercial banks into the deal with big ticket sizes,” affirmed QP finance director Abdulrahman Al-Shaibi when the deal was concluded.

Of the 31 lending institutions drawn into the deal, nine were from Europe: Barclays Capital, Credit Suisse, DNB Nord, HSBC, KfW, Royal Bank of Scotland, Siemens Financial Services, Standard Chartered and WestLB. However none hailed from France, where banks have been hard hit to the extent that their role as lending stalwarts for GCC projects appears to be over, for the time being at least.

“Barzan marks a turning point in the market – there has been a change in the risk matrix because a number of European banks are no longer lending money down there,” says a French project financier based in the GCC, who prefers anonymity. He contends that Barzan succeeded in raising the required level of debt “purely because QP brought in a record US$850mn worth of Islamic funding to fill a gap in the commercial banking market”, adding that more and more European banks outside of the French market can be expected to pull back from the Middle East and North Africa (Mena) region due to problems in their home continent.

“Eastern Asian export credit agencies and export financing institutions – particularly from Japan and Korea – will increasingly become a key source of financing in the GCC region,” he predicts. “Saudi banks will maintain their robust support for the many upstream and downstream projects domiciled within the Kingdom, but cannot be guaranteed to be so active elsewhere in the region,” he cautions.


Crisis fallout

“There is now a smaller audience of banks for this market as a result of the eurozone crisis, which has caused banks to make deal choices and often refocus,” underlines Andy Brown, London-based head of project finance, energy, in Bayern LB’s Emea structured finance unit.

“Not only are French banks pulling back because of their exposure to European sovereign debt, but European banks as a whole are generally less able to obtain well-priced dollar funding. They are having to focus on boosting their capital ratios due to internal rating criteria and sovereign events in southern Europe, and are more and more reluctant to lend over the long tenors required for projects. That said, ECA-backed lending tranches remain attractive especially as some banks, like ourselves, can then use the assets to raise dedicated funding at attractive rates,” he explains.

Brown points out: “EU-based banks are now not inclined to take underwriting risk, are already taking smaller positions in GCC project financings and will increasingly be stepping back from their generally much higher level of involvement seen in the years before the 2007-08 financial market crashes.” He stresses that European banks are now forced to look for higher returns when they do lend, at a time when many Middle East deals continue to be financed with “margins lower than most banks seek in order to achieve their return hurdles”.

The pricing on the 16-year Barzan deal was pitched at a relatively low 130-200 basis points over Libor. This spread was possible only because “there is not a better project credit in the GCC, in terms of the country, sponsor and structure, so no questions were asked about the quality of the deal”, says the first banker.

Another energy financier, based in Dubai, stresses that some project sponsors operating in the Middle East will increasingly be forced to pay higher pricing than the margins that prevailed up to 2007-08. “International banks will still be heavily attracted to the deals that carry the sponsorship clout of a QP, an ADNOC or a Saudi Aramco, but lesser-rated sponsors in the region will undoubtedly end up paying a higher price for their borrowing,” he predicts.

There was little mention among bankers of any spreading impact from the Arab Spring, which led to the ousting of three North African leaders in 2011. “The biggest impact has been in Egypt, where there has been some stepping back,” says Phillip Fletcher, a London-based partner at law firm Milbank Tweed, which is involved in projects across the Mena region.

One major effect in Egypt has been the prolonged postponement of equity financing for the Egyptian Refinery Company (ERC), which tapped North Africa’s largest ever debt financing in the second half of 2010, worth US$2.6bn. This was nevertheless expected to conclude in early 2012, GTR was told by a project financing source.

Beyond Egypt, “there was never that much going on in Syria, and Libya wasn’t a project finance market”, stresses Fletcher. “Bahrain deals have gone forward again, despite a fall in the country’s investment grade. Saudi Arabia is the market leader and the Arab Spring has not affected that country’s financing prospects, as it focuses on building its downstream assets.”

Signals in the political risk insurance (PRI) market have indicated that the Mena operating environment is improving for oil companies inside and outside of Arab Spring countries, says Thomas Holmes at Miller Insurance Services. He notes that as Libya’s oil markets head back towards full momentum, PRI has now begun to be extended for short-term refined fuels import financing. “People are still cautious in the post-Gaddafi environment, and insurers have to juggle high rates against recent potential claims,” he says.

Among other higher-risk Middle East countries, PRI is also available to back western majors involved with Sonatrach Petroleum in Algeria, and for import financing for Iraq’s State Oil Marketing Organisation (Somo), notes Holmes. “However Iraq is still not seen as very secure, and Kurdistan deals are hampered by uncertainty over its legal status,” he points out.


Eastern money

Notwithstanding the greater hesitancy among eurozone banks and the ramifications of the Arab Spring, there is now an increasing raft of money available for GCC hydrocarbons projects from Japanese and Korean financing institutions, and a growing possibility that China may be poised to latch onto this trend, bankers believe.

Bayern LB’s Brown comments: “Many Middle East deals now have a local or Eastern orientation. If you have a Japanese entity in the consortium developing the project, then credits from the Japan Bank for International Cooperation (JBIC) can be tied in, covering up to 50% of the project costs. A sponsor can often halve the quantity of lending required from the bank market place in this manner. This allows for sponsors to close deals with a small number of banks who are willing to absorb their pricing ambitions.”

The ERC deal in Egypt, for example, has been backed predominantly by direct Japanese and Korean lending from JBIC and the Export-Import Bank of Korea (Kexim), in addition to debt guarantees from Nippon Export and Investment Insurance.

Adds the Bahrain-based banker: “You would not bet against the involvement of Chinese contractors and finance in the future. It takes time to sell your credentials in the Middle East, because the area’s rulers are traditional and cautious. But just look at the model where Chinese finance has been deployed hugely across Africa’s oil and gas markets.”

Both Japan and Korea – the latter through Kexim and the national ECA, K-Sure – will be involved in financing the giant Sadara Chemicals Company petrochemicals project planned in Jubail by Saudi Aramco and Dow. Some major contracts for this have already been awarded to low-bidding Korean companies, while other backers will include ECAs from North America, France and Germany, as well as Saudi Arabia’s Public Investment Fund. The financing package is expected to cover between 60% and 70% of capital costs which have been cited at anywhere between US$15bn and US$20bn. “When scale outstrips lending liquidity, the ECAs will continue to step up, because every country wants to grow its exports,” observes Fletcher at Milbank Tweed.


Future projects

So which oil and gas-linked financings should Middle East players expect to see conclude in 2012? “We see many refining projects in the area, but are not aware of new LNG project finance transactions coming along the pipeline in the Mena region,” says Ivan Giacoppo, head of oil and gas, infrastructure and steel at Sace, which was involved in the Barzan project.

Fletcher highlights that “national oil companies in the Middle East don’t need project finance for extraction”, but predicts that both Iraq and Libya will eventually become project finance markets for downstream activity. If and when project financiers move their focus to hydrocarbons-based projects in these two markets, “they will need techniques to factor in political risk factors”, he says.

The Bahrain-based financier says that the oil and gas pipeline in the GCC should include an extension of the Bapco refinery complex in Bahrain, “this year or next”. “More project financing will also be required in Oman, as the sultanate looks to develop around refining and petrochemicals,” he adds. Other projects to watch out for include petrochemical projects in Qatar, “worth around US$4-6bn each”, involving ExxonMobil, Shell and Total. “Shell will probably go first,” says the banker, adding that there will be more use of capital market bonds by project sponsors in both Qatar and Abu Dhabi, following the project sukuk by the Satorp refinery in Saudi Arabia in October 2011.


Saudi market

GTR’s anonymous source in Bahrain goes on to predict that a significant amount of the GCC project activity in the next 24 months will take place in Saudi Arabia, particularly in the petrochemicals sector as the two key parastatals, SABIC and Aramco, look to tie up financing for several multi-billion dollar schemes involving overseas majors such as ExxonMobil and Sinopec. “Saudi projects will be able to tap into high levels of local bank liquidity as Saudi banks tend to stick with their own market,” he underscores.

The Kingdom is one of four GCC countries – alongside Abu Dhabi, Kuwait and Qatar – that are perceived by project financiers as top quality credit risks. With the price of crude holding up at around US$100 or so, well above the base case and breakeven scenarios needed by international lenders and most GCC governments, oil and gas loans can currently be repaid more rapidly than stipulated under loan agreements. This leaves political risk as the most unpredictable factor that could modify perceptions of these markets.

Exactly how things can change is illustrated by the shift in perceptions of nearby Egypt, where only a decade or so ago commercial banks showed a willingness to provide uncovered 15-year money for power and petrochemical sector schemes.

Sace’s Giacoppo suggests that deals in North Africa’s oil and gas sectors now generally require multilateral development banks to participate and mitigate political risks, and that “legal and regulatory frameworks in some Mena countries still present some vulnerabilities”.