The Middle East is now the world’s largest energy project finance market. The recent trends in the financing of independent water and power projects in the region, with a particular focus on the involvement of the Japan Bank for International Cooperation in support of Japanese sponsors and contractors are explored.

Driven by high oil prices and the increasing global demand for oil, natural gas and their derivative products, the governments of the Middle East, and especially the states of the Gulf Cooperation Council (GCC) – Saudi Arabia, UAE, Kuwait, Qatar, Oman and Bahrain, are looking to capitalize massively on the investment and development opportunities arising from their large fiscal and external account surpluses in recent years.

Rapid economic growth, suppleented by a forecast increase in the region’s population from 377 million to a staggering 524 million by 2030 has, however, inevitably put significant pressure on the existing infrastructure and water supplies and has strained electricity capacity.

Source: JBIC
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Demand growth for electricity in the region is in fact running at two or three times the international average and in some parts of the UAE is growing at 15 per cent. The GCC States are expected to experience an increase in the installed generating capacity from approximately 40 GW to between 65-70 GW within the next seven years.

Accordingly, the Middle East is now the world’s largest energy project finance market, with the independent water and power project (IWPP) market accounting for $20 billion in debt raised since 1999, and has attracted significant attention from international developers.

Japan and the Middle East

The political and economic situation in Japan has changed substantially in the last two or three years. Furthermore, the major trading houses have repaired their balance sheets, and are now actively looking to expand their businesses and are aggressively looking at overseas opportunities. They are seeking to acquire both greenfield and existing assets across the globe, and in the power and water sectors all of the trading houses have significant acquisition plans.

Japan, which depends heavily on the Middle East for crude oil, is also very conscious of the need to secure its supplies of energy (LNG, natural gas and oil) and the government has been encouraging trading houses to invest in oil and gas projects with a view to securing security of supply. Developing stronger economic and political relations with Middle Eastern energy producing states is therefore an imperative for Japan.

In support of these initiatives, The Japan Bank for International Co-operation (JBIC) plays a crucial role. JBIC as a government institution is primarily concerned with the development of the Japanese economy, and therefore undertakes lending and other operations for the promotion of Japanese exports, imports and economic activities overseas.

The schematic above outlines both a typical IWPP legal contractual structure in the Middle East, as well as indicating the forms of possible JBIC finance and support. In the context of an IWPP in the Middle East, JBIC typically helps in two ways:

(1) by providing cover and/or loans to support the acquisition of Japanese engineering and procurement equipment, and
(2) by providing overseas investment loans to help finance the development of an IWPP, which has a Japanese trading house as an equity investor.

The Middle East has been a significant benefactor of JBIC’s commercially attractive overseas investment loans. As regards IWPPs in this region, JBIC’s first major loan came in 2005 when it supported the winning bid consortium including Marubeni Corporation and JGC Corporation, with a $1.2 billion loan for the Taweelah B IWPP in UAE.

That was followed in 2006 when it extended its biggest ever loan to the region, $2.5 billion to the power component of the $9.9 billion Petro-Rabigh project in Saudi Arabia (including Marubeni Corporation, JGC Corporation and Itochu Corporation as sponsors).

Bahrain’s Al Hidd IWPP was part-financed by Sumitomo
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JBIC has also recently extended $600 million to the Al Hidd IPP in Bahrain, which includes Sumitomo Corporation as a sponsor. Financial close is also expected very shortly on the Mesaieed IPP in Qatar, where JBIC is again supporting the winning consortium that includes Marubeni Corporation.

Furthermore, the preferred bidder announcement is due shortly on the Fujairah 2 IWPP in UAE, the latest IWPP to come to market in the region, and the lending proposal of the current first placed bidder, comprising Marubeni Corporation and International Power, includes a JBIC tranche. Indeed, three out of the four bidders for this project included a JBIC tranche in their debt financing packages.

JBIC’s willingness to provide such large loans has directly assisted Japanese sponsor and EPC contractor activity and involvement in power projects across the region.

In a further statement of their intent to build further and stronger ties in the region, JBIC opened representative offices in Jordan and Dubai in January 2005 and in November 2006, respectively.

As noted above, of all the Japanese trading houses Marubeni Corporation has in particular enjoyed considerable recent success. In terms of a ranking for successful developers (found by totalling the equity investments of the winning sponsors of the 20 or so IWPPs/IPPS that have reached financial close in the Middle East since the first in 1998), then after taking into account the Mesaieed IPP in Qatar, Marubeni Corporation are placed third for power development with 1260 MW and are ranked sixth on desalination.

The first and second ranked developers are International Power with over 2200 MW and Suez Energy International with over 1300 MW.

Bridging funding gap

Considering the number and size of forthcoming IWPP projects in the Middle East and their large debt funding requirements – averaging more than $1.5 billion, JBIC is also undertaking another crucial role in the market for such projects – bridging the funding gap.

Historically, conventional debt finance institutions such as western and regional banks have been the greatest contributors to debt funding for project financings in the Middle East.

While it is likely they will continue to form the bedrock of funding such projects in the region, they do have constraints that include:

  • Country/sector limits – most credit committees will have limits for exposure to particular countries or sectors, and given the amount of financing likely to be required in the future, many banks and financial institutions will be reaching those limits.
  • Political risk – some banks will be concerned about the political risk of the region.
  • Capacity – the amount of funds available in the bank market that can be lent.

In the past, export credit agency (ECA) finance and cover (including JBIC) was considered expensive and not necessary because of the liquidity in the conventional debt finance markets and because the projects were located in countries where ECA finance was thought to add little value. For the reasons above, this is not the view today and ECA finance and cover is becoming more attractive to sponsors looking at diversifying their reliance on conventional debt finance. While there can be some drawbacks in using ECA finance, including, documentation and timing related issues, some of the key benefits of ECA finance:

  • Competitive commercial terms – quite often the involvement of an ECA will enable bidders for projects to get better financing terms, and therefore provide more competitive bids.
  • Enhanced bankability – the presence of an ECA tranche or support in many projects will be a comfort to lenders.
  • Political risk – ECA involvement can cover political risk in countries where bank credit committees have either real or perceived concerns.

Debt financing restraints

The access to local bank debt finance has also become more restrictive primarily because to the competition from the international debt finance banks and the resulting lower margins on offer. The local GCC banks have further structural constraints as their balance sheets are built on short-term deposits, which can hamper their ability to provide long-term debt.

This constraint becomes a particular problem for transactions in the power and water desalinisation sector where the nature of off-take and supply deals necessitates longer loan tenors.

Islamic finance tranches have become increasingly common in IWPPs and other energy projects – for example, the Shoaibah IWPP in Saudi Arabia, Aluminium Bahrain and Bahrain Petroleum Company structured financings and the Qatargas II LNG transaction. While the use of Islamic finance tranches will inevitably become more prevalent in the next few years as the market develops, for now such tranches are relatively few.

While capital markets structures, such as bond issues have appeared in some regional energy projects – primarily in Qatar – they have yet to feature in the Middle East IWPP market. Instead, there is little current interest because apart from offering less flexibility for sponsors, the conventional debt finance institutions combined with the ECAs have shown they have the appetite to finance the very large amounts required.

The ECAs, and in particular JBIC’s involvement in the IWPPs and other energy projects are crucial from the perspective of contributing large amounts of debt finance for the ever increasing amounts required. The Marafiq IWPP in Saudi Arabia, which reached commercial close on 19 January 2007, is currently the largest IWPP in the world (2750 MW and 176 million gallons of desalinated water a day). The funding requirement of $3.2 billion comprises $500 million for equity and $2.7 billion for debt.

Booming market

The growth rate in the Middle East IWPP market continues to rise significantly in 2007. This year the Fujairah 2 IWPP has already come to the market and recently the request for proposals was released for Ras Laffan C in Qatar. Further projects expected include Raz Azzour and Yanbu in Saudi Arabia and Addur in Bahrain.

With the steady stream of these large-scale projects, the construction companies are able to charge large premiums, mainly due to supply constraints. This has led to a significant escalation in recent years in the constructions costs, which in turn have impacted on the overall project costs.

With the market forecast to grow at the same impressive rates then the interest and involvement of the Japanese trading houses are expected to intensify, and so likewise will the contributions by JBIC in the funding of those projects.

The author would like to express his thanks to Jason Comrie-Taylor for his assistance with the article.