Markets are digesting several huge deals raised for Saudi Arabian borrowers over the past nine months, which have shown that financiers have few reservations about Saudi project risk, writes Kevin Godier.


With its oil revenues flowing in unabated, Saudi Arabia enjoyed an upgrade on March 7 courtesy of Fitch Ratings, which forecasts that Brent crude will continue to average US$100 a barrel in both 2014 and 2015. Fitch pointed out that the net creditor position of the world’s biggest oil exporter “is the strongest of all Fitch-rated sovereigns bar Macau”, illustrating perfectly why the Kingdom is so effortlessly able to forge ahead with massive new projects.

According to Middle East regional lender Apicorp, Saudi Arabia will spend US$173bn on energy projects through to 2018, heading the investment in the sector by the oil-producing nations of Mena. Apicorp predicts that most of this investment will be “engendered by Saudi Aramco, Sabic and its affiliates, as well as the Saudi Electricity Company”.

“There is a strong project pipeline in the Kingdom, with a number of new projects planned or in various stages of execution across different sectors. This includes conventional power generation, renewable energy, petrochemicals, metals and mining and transport infrastructure,” says Klau Sander, director at the Abu Dhabi representative office of KfW Ipex, which has participated in several Saudi deals.

One of these was the huge US$19.3bn Sadara Integrated Chemical project, where the sponsoring Saudi Aramco and Dow Chemicals tapped the biggest-ever project financing in the Middle East. A massive US$10.5bn project financing package closed in June, shortly on the tail of a US$2bn sukuk issuance, helping to fund the scheme in Jubail Industrial City II, in Saudi Arabia’s Eastern Province.

The deal’s highlights included the presence of seven export credit agencies (ECAs), led by US Exim, whose massive US$4.975bn direct loan is the largest extended by the Washington-based agency to a single project. Other commentators focused on the issuance of the US$2bn shariah-compliant Islamic bond, which was the first project sukuk issued in Saudi Arabia.

“Within the Saudi market, if a project is well-structured and the participants have strong reputations, liquidity is not a problem,” notes Phillip Fletcher, partner at law firm Milbank Tweed, which acted as a legal adviser to the lenders in the Sadara deal.

The Sadara financing boosted regional project finance lending to a record US$87.6bn in 2013, according to Standard Chartered. The bank’s head of project and export finance for Europe, the Middle East, Africa and South Asia, Ravi Suri, said in Dubai in January that “some of the monster deals that were done in 2013 are not anticipated this year”.

But that’s not to say there aren’t large deals in the market. Commitments worth over US$7bn have been pledged for Saudi Arabian Mining Company’s (Ma’aden) US$9.5bn Waad Al Shamal phosphate development, touted as the world’s largest mining project. Ma’aden said in late-December that it has received financing commitment letters from local, regional and international banks and financial institutions for up to SAR15.75bn (about US$4.2bn) in 17-year lending for what will, in effect, be a new industrial city in the Northern Borders region. Ma’aden said that another US$3bn will come from a combination of ECAs, plus the Kingdom’s Public Investment Fund (PIF) and the Saudi Industrial Development Fund (SIDF).

“PIF and SIDF have a regular part to play in large Saudi deals, not only in providing capacity, but in helping international institutions to get comfortable,” says Fletcher. The Waad Al Shamal partners – which include Sabic and US phosphate and potash producer Mosaic – expect to sign definitive financing agreements in the second half of 2014.


Power sector draw

Several other deals concluded in late-2013 illustrate how the Saudi power sector is also pulling in funding. Led by Saudi-based water and power project developer ACWA Power, the US$1.36bn Rabigh 2 project tapped a senior debt package of about US$1bn from banks including Standard Chartered, KfW-Ipex and Mizuho, as well as local lenders Banque Saudi Fransi, Al Rajhi Bank, National Commercial Bank, Samba Financial Group and Al-Inma. ACWA said in late-November that the remainder of the 2,060MW project – which is supported by a power purchase agreement with the Saudi Electricity Company (SEC) – would be financed with equity bridge loans.

The project, to be developed on a build-own-operate basis, will be located in Rabigh, 130km north of Jeddah and adjacent to SEC’s Rabigh 1 independent power project (IPP).

At around the same time, Japanese lenders issued a smaller US$366mn loan in support of an equipment supply contract won by Mitsubishi Heavy Industries for the construction of a 2,640MW heavy oil-fired power plant being developed by SEC in Jeddah. The 14-year loan for the Jeddah South scheme was arranged by BTMU and Mizuho, which provided a combined US$183mn, insured by Japan’s Nexi, while JBIC weighed-in with US$183mn in buyer’s credit, through which JBIC “took the corporate risk of SEC”, says spokeswoman Erika Nakahara.

SEC followed up the loan with a much larger US$1.6bn debt package from South Korea in support of Hyundai Heavy Industries’ EPC contract for the plant. This involved a direct loan from Kexim and insurance from K-sure, supporting commercial bank lending.

“We have received similar loans from export banks in the US and Europe before and this reflects the confidence of investors in the Kingdom,” says SEC’s chief executive Ali bin Saleh Al-Barrak.

Nexi was also involved in a deal concluded in early-2014, providing overseas untied loan insurance to cover the political risk attached to part of a US$530mn financing package for three co-generation plants in the country’s Eastern Province, where Marubeni Corporation is participating as an investor and operator alongside Saudi Aramco. The 876MW project, sponsored by the Power Co-generation Plant Company, tapped debt from US Exim for GE turbines, as well as Saudi riyal and US dollar commercial facilities and a local Islamic finance facility.


2014 slowdown

Antoine Cousin, a partner at White & Case, which advised Saudi Aramco on both Sadara and the co-generation plants, suggests that there may be a fallback in financing activity through the remainder of 2014. “Bankers and sponsors involved in the sector have told us that their teams need to digest the recent spate of transactions, such as Sadara, which reduces any immediate focus on new projects,” he says. “From a macro view, the reality is also that the gas allocations are very tight on a series of specific projects, which limits new options.”

The biggest deal on the near horizon concerns a US$7bn expansion of the PetroRabigh petrochemical project, for which 37.5% shareholders Aramco and Sumitomo Chemical Company expect to win project finance approval “in the first half” of 2014, according to Sumitomo Chemical president Masakazu Tokura. “Until the project finance is ready, parent companies will be providing money needed to proceed with the Rabigh II project [not to be confused with the aforementioned Rabigh 2],” he told a December 2013 news conference. Financial adviser HSBC did not comment, but one observer based outside the country suggests that “JBIC is likely to provide long-tenor overseas investment lending”.

“There is substantial liquidity in Saudi riyals,” observes Cousin. “But the local lenders lack US dollars, so they cannot do very long-term maturities. Foreign funding is needed to bridge that financing gap. ECAs such as JBIC and US Exim stepped-up some years ago, with guarantees giving way to real debt financing.” The implication from Cousin is that ECAs are lending directly because the commercial finance just isn’t there to guarantee.


Slowing pace?

However, Fletcher is positive on the overall market trend, suggesting that we are more likely to see a realignment of capital going into projects, rather than an actual slowdown. “Aramco, Ma’aden and Sabic are all continuing to invest, the financing is getting more sophisticated, and international financiers are becoming more comfortable on the legal questions. Perhaps the question to ask is whether the pace of individual deals will slow as the projects get bigger and more ambitious? However, the aggregate amount of dollars being invested is likely to remain significant.”

The next large IPP planned in Saudi Arabia is SEC’s proposed 550MW plant at Duba, near Tabuk on the Red Sea coast. The plant – which is scheduled to begin with an initial 550MW of generation capacity – would be the first power facility in the country to be fed by both fossil fuels and solar power. “There are plans to follow up with a further 2,000MW of capacity,” says Paul Mansouri, an Abu Dhabi-based partner at Norton Rose Fulbright, which is among law firms pitching for involvement in the scheme.

Mansouri also notes that 54GW of renewable energy capacity is eventually planned within the Kingdom. “41GW of this will be solar power, and will require over US$100bn in investment over a 15 to 20-year period. Project finance will be the preferred route, with the first projects likely to go ahead on an EPC basis.”
Looking ahead, Cousin highlights huge gaps in Saudi Arabia’s social infrastructure, in areas such as housing, education and healthcare. “Transportation sector deals have been successfully closed – for example Medina airport was funded in mid-2012 entirely on the back of traffic revenues. There is an expectation that the project finance market will be increasingly involved on the infrastructure side, because public procurement schemes do not cover a project’s operation and maintenance requirements.”

The Saudi government is launching few PPPs, with the current emphasis being on public procurement. But Cousin says that as the project sector progresses, it might become more of an option: “Authorities are able to use their own funds for traditional procurement, and there is a perception that PPPs can be difficult to structure. However, all the new design-build projects will need to be completed on time and then operated; and then the authorities may realise that in terms of delivery time and quality of operation and maintenance through incentivisation of the private sector, the PPP model ticks more boxes.”
He anticipates that if the Saudi government were to deploy PPPs for social infrastructure [such as healthcare, education or housing projects], “a PFI or European PPP financing structure would be used, based on availability payments and limited or no demand [or ‘volume’] risk asked of sponsors and lenders”.


Islamic finance solutions

Market observers do see an increasing role for Islamic financing in the construction sector, while stressing that more innovation is required when it comes to the security options available to lenders. Mansouri says that the aforementioned US$1.2bn Medina airport financing from mid-2012 was a fully-Islamic solution, on which Norton Rose Fulbright advised the borrower. “The assets that underpinned the financing were concession rights extended by the government. That template can be used again in the transportation sector, whereas other infrastructure projects remain something of a testing ground,” he says.

Two of the key names in the Saudi energy sector have recently used Islamic finance. SEC said in late-January that it had completed a SR4.5bn (US$1.2bn), 10-year floating-rate sukuk offer, pricing the deal at 70 basis points over the Saudi Interbank Offered Rate.

The deal – which followed up a US$2bn dual-tranche sukuk issued by SEC in January 2013 – was managed by Banque Saudi Fransi, Crédit Agricole and HSBC Saudi Arabia.

In December 2013, ACWA Power raised a SAR1.77bn (about US$471.9mn) Islamic loan from Banque Saudi Fransi, National Commercial Bank, Saudi British Bank and Samba Financial Group to help finance investments.

Could another project-specific sukuk be used? “It is difficult to know,” says Robin Balmer, counsel at Norton Rose Fulbright. “They do act to dilute the concentration risk of Saudi banks, which have significant exposure on names such as Aramco, Sabic and Ma’aden. But they do not represent an underlying asset that can be traded. Most Saudi sukuks are privately-placed.”

In an interesting twist on Islamic financing, shariah-compliant debt was insured by two European ECAs in 2013, when EKN and Finland’s Finnvera each guaranteed 50% of a 10-year, US$650mn commodity murabaha financing for Mobily. Victor Carstenius, country analyst at EKN, stresses that the lending was structured on a corporate basis, with no government guarantee. It marked the first time Finnvera had participated on a shariah-compliant loan. “The use of Islamic law and Islamic finance offers challenges in terms of understanding its implications and ensuring accordance with the OECD requirements for ECA financing,” Balmer concludes.