Ravi Suri: To your question, can you raise US$15bn to US$20bn of finance in the next year? The answer is, yes. How? Basically three good things have happened to project finance. The first thing is that in the 2005/2006 period project finance risk was completely skewed. And we had the EPC contractors taking the least amount of risk and getting the best terms because of the shortage of EPC contractors.
You had bankers being squeezed down with their pricing and you had the sponsor having a nice day, and it couldn’t last long. Now the risk return has come in the right place, EPC contractors are taking more risk, they are not commanding that kind of a negotiating like they used to, the project finance pricing for bankers has gone up and there is good risk-return sharing between the sponsors and the banks.
So that’s very good for the project finance market. Also, at the end of the day the debt is not costing more to sponsors because though the margins have gone up, the actual Libor rates are down. So net-net, the costs are more or less where they were but the risk has come back in the right form.
The second thing that has happened is that people have realised that during the financial crisis the loss default ratios in project finance have been very low.
And really it is, rating agencies have come forward and shown that, and the project finance deals are well structured, you can see the cashflow, you can even see - you do a really good amount of due diligence and not many banks have lost money on project finance, at best they get restructured and even on restructurings, they get them back.
So all that is good for the market and then with capital adequacy norms being needed with Basel II and Basel III coming on board, a judicious mix of the models has been done to ensure that adequate capital is being used. So this is good for project finance; so you will find for well-structured projects in good countries commercial banks coming forward and financing projects.
The other thing is that it’s very important to get the right liquidity pool. Many financings fail because they’re using the wrong liquidity pool and you’ve got to see which country you’re operating in with that.
For example, if you’re in Saudi Arabia in a project you’ve got to back the local pool, you’ve got to back the Islamic pool because that’s very deep. And so if you do that right, you can get these projects financed. And yes, ECAs will continue to play a big role, they are playing an even bigger role because the funds are larger, and they’ll be there and many new ECAs are coming in, like you’ve seen US Ex-Im coming in in Saudi Arabia.
So there’s going to be a good co-existence between ECAs and the commercial banks. And on the bond market, this region is not new to bonds. Bonds have been done in the past and done very successfully for petrochemical projects and there will be some financing from the bond market once construction is over, and some of the projects where construction risk is over you can refinance it in the bond market.
Over time it should develop. So I’m very confident that there will be a good amount of liquidity for this, particularly in a lot of the projects next year in the power sector.
Sachin Karia: From where we’re sitting on the liquidity side there seems to be more liquidity in the debt markets. What we are seeing, it’s a divided liquidity; there are certain countries that have no commercial banks with any sort of decent limit to fund projects, and so they have to go to the multilaterals, the IFCs, the EIBs of the world in order to get debt because the commercial banks don’t have sufficient limits to lend in countries like Jordan.
It’s an interesting opportunity for some banks that, if they feel that they are getting squeezed out of certain countries where the bigger guys are getting much more of the pie, then there are countries where they could look where there are interesting opportunities in the IPP sector.
I think part of the question, which we haven’t focused on yet, is equity. Will equity be able to cope? There’s way too much equity in the market already. There’s probably more appetite for IPP assets and I’m sure Pascal and his friends are finding infrastructure funds knocking on their door all the time saying “Please take us with you on your next bid.” And certainly we advised on a massive asset disposal, we were advising AES and the IPP infrastructure fund. There were assets in Oman and Pakistan and elsewhere and the appetite for these assets are absolutely enormous.
And all the funds are looking for these things and I think over time what we’ve heard some sponsors say is actually: “We will come in at the early end, use our resources to develop these things and take our upside out by selling down to a fund and then move on to the next project.” And this is where I think things will become more interesting with infrastructure funds, pension funds stepping in and holding these, which are pretty good assets when you compare them with what else is around, long-term, sovereign-backed.
Rod Morrison: It is surprising, isn’t it, that there haven’t been many M&A deals have there really.
Sachin Karia: Yeah. But it’s not for the lack of buyers. People don’t want to sell because they still think there’s a lot of growth in this market and they want to have the credential and the references and the credibility to go out and bid for other projects and continued government relationships to be front-runners for some of these projects. They’re not under a lot of pressure to sell. But going forward certain sponsors have already told us: “Look, we’re now rethinking whether we need to hold these in the long term when we could be making much higher IRRs by exiting at least part of our stake at an earlier stage.”
Charlie Seymour: Yes, I mean in the last couple of years since the global financial crisis, and I’m speaking from ADWEA, we’ve seen a number of things. We closed a deal S2 right in the heart of the crisis, we raised US$1.5bn of commercial bank debt for 22 years; some of it was reluctant but it came through in the end. For our projects that’s ongoing S3, we received five offers from consortia with very competitive finance, you know, more competitive finance than elsewhere in the market, which is good news for Abu Dhabi, the tariff has been very keen and good news for us.
So I think - and we’ve seen ECA involvement, the direct loans from the Asian ECAs outside the consensus scheme and the region is awash with equity, as Sachin was saying. So there’s a sense of things getting back to normal and I think it’s tempting to think that this crisis will lead to, you know, from crisis to normality in a quick time.
I’m less optimistic, I think we need to be careful but is the ECA stopgap sustainable? ECAs are now different creatures, as David mentioned, I think they are a lot more commercial now than they have been, JBIC, Kexim, etc. But their role has changed; they’re now looking at strong credit jurisdictions whereas previously they were looking at weaker credit jurisdictions, their liquidity stopgap is in the better credit jurisdictions now. So they’re changing and I would question whether that’s sustainable.
I think refinancing the ECAs from the markets when prices reduce is an issue. I think also I just don’t see the demand, looking at 12 months ahead. But looking further ahead, I don’t see the enormous demand for liquidity being net buyers for 13 to 15 international banks.
David made a very good point; for the power sector we want long-term finance against long life assets. The buyer credit product is a shorter maturity product; it can compete as Suez showed. But going forward, I question whether the ECA involvement in these projects is sustainable.
So you’ve got a regional bank market, apart from Saudi Arabia, that’s not particularly liquid in US dollars; it’s recovering but it will take time. We’ve got an Islamic market that again is recovering and raising monies in the markets - in the bond markets - and will lend that money but not long term at competitive prices.
So you’re left with the good old commercial banks and from ADWEA’s perspective we’re getting very, very strong interest from all the top banks that are right in the market, but I think that’s a facet of what’s happening. The banks are looking to PF loans from certified, very strong companies like GDF Suez, Aramco, ADWEA. I think they sort of view it as a quasi-corporate opportunity.
And so I think liquidity is pouring into the strong sponsored projects. But we’re all, I think, everyone’s fighting for tapping liquidity across all the sectors. Again, David is absolutely correct that I think that power is at the top of the pyramid, so that’s good news. But I don’t think it’s all going to be roses and back to normal, I’m sure shocks will happen as all these countries try to delever and cut their budget deficits.
So I think we do need to look at new liquidity and I think the bond markets have changed actually quite dramatically. I take the point around the table that for greenfield bond financing is some way to go. The issues and the problems are well known and are debated at conferences from time to time.
But certainly in the US markets; interest rates are low, bond investors have changed there - I think they’re looking for yield and diversification. They’re actually getting more and more familiar with the Middle East and there is an enormous pool of liquidity.
The QE programme in the US has just thrown up an enormous pool of cash looking for a home and that may not last as rates go up going forward. But I think in the short term there’s a big opportunity to educate and to tap into that liquidity before we finance things in the first instance, and speaking from that perspective we will be looking at the bond markets. These are doing some refinancings, as an option not as preferred marketable execution but we will certainly be looking at it.
I think also that with these direct loan products from the ECAs again, JBIC and Kexim, have led the field. From ADWEA and Abu Dhabi’s perspective the relationship with JBIC is excellent, we’ve built up strong links. Question marks? in the long term whether it’s sustainable because I think procuring authorities, if this product’s going to be the stopgap, then we’re looking at Korean and Japanese investors.
I think procuring authorities want a wider geographical spread of investors and also I think there will be increasing pressures on the host governments of these countries to look at these products closely, they’re outside the consensus but they are playing a very key role in the award of contracts to consortia.
Duncan Allison: I think I would respond to this by saying I am confident, but we need to be quite skilled for how we play it. There are a lot of factors at work here. And I think the mantra for a while is going to remain “size your projects right”.
And it’s not for nothing that your projects are coming to the market at 1,500MW/1,600MW, not at 2,000MW/2,500MW at the moment; it’s because that’s where the liquidity is at. I think where I see it today, and I would agree totally with Charlie; the main players are back, there are about 13 to 15 of them.
I think the secondary players are still not there. I mean they’re still very limited, leaving aside Saudi, I think there is still very limited appetite at the less specialised players, which means that you are still relying on the prime players. And I think raising the project debt size to US$1.5bn is probably quite realistic.
I think the challenge that may face us a little bit in the future is when we switch possibly to alternative technology, which is going to push the capex up quite considerably and that’s one or two of the reasons why some of the larger projects have been slightly delayed, because it’s a sensible thing to do.
I think generally JBIC and Kexim have played a very important role and so they’re basically providing significant liquidity. I think that will continue for a period of time. I agree with Charlie that this may not go on forever and I think there may well come a point where they’re going to start saying: “Well we’ve primed the UAE for long enough and we’ve primed various markets.”
And they are very, very interested. You know, it’s more challenging when you move into slightly less mainstream markets when looking and not sourcing. We talked about - I suppose on the sizing thing, the other thing that’s slightly curious at the moment is we’re just seeing a return of bids going out with fully underwritten requirements.
Well we can finance a project once; we might be able to finance it one and a half times. Trying to get five bids fully financed, well the market isn’t there and I can tell you as an institution, being approached by seven syndicates to lend on the same project is challenging, purely from a resourcing point of view.
The banks have far more stringent credit approval processes than we had two or three years ago and the resourcing is an issue. And I think the fully underwritten is a challenge because we can’t support everybody, we don’t have the resources to do it.
Rod Morrison: Should Charlie do a staple?
Duncan Allison: Well no, I don’t think you have to go fully underwritten, I think quite sensibly he’s been looking at doing a partial underwrite. We know when we’ve got all the bids together we’re more than underwritten anyway from all the tenders across. So I think that very much is a much more interesting strategy.
Charlie Seymour: And I think just to make a point, Duncan made exactly the right point that, particularly in our recent tender on S3, we required exclusive finance of a limited committed amount, as against some jurisdictions looking on exclusive, and I think the tariffs and the financing terms achieved, yet to close admittedly but achieved at bid stage, vindicate that decision we took with our advisers to go that route.
And we’ve certainly got real competition in the debt, whereas, and I’ll probably be shot down by some bankers around the table, but when you are a non-exclusive it leads to a lowest common denominator on the price in terms of perspective, so underwrite is not quite there yet.
Duncan Allison: Project bonds are a very live debate and I think there are again two strands here. I think where project bonds are very much likely to come to the market are in two contexts. One is to release liquidity for projects nearly completed, and I’m absolutely sure that a number of projects that have recently that are looking to refinance will probably seek to do the refinancing for the deck out of the markets rather than through tying up bank liquidity.
Bank liquidity can cope with the complexities and the difficulties of greenfield, so don’t tie up the same pool of liquidity necessarily on the refinancing. I think the other area where project bonds may come in, and I don’t think the major procurers will want to go this way until they have to, is possibly in the area of staple facilities. Now that may arise when the project sizes get large because we do have some potentially very, very large projects around and I’m realistic as to where the debt market is at the moment.
Conventional power projects, I think, will continue to be done in the manner they are being done at the moment, which is largely a mix of commercial debt and the direct lenders and some ECA debt. But if the project sizes start getting much larger, and some of them will if we switch to alternative technologies, then once you start building coal and when you start building dual fuel plants and you start pushing up the size of these plants, then we are going to have to start to think creatively. And that may not be a debate for the next 12 months but if you’re looking ahead two years or three years then I think it may be an unanswered question.
Rod Morrison: On refinancing. Given that a lot of deals were done pre-crunch and they were quite cheaply priced, is the response that they don’t need to?
Duncan Allison: Well there’s some that have been done fairly recently that weren’t in that luxury position. I can assure you that people who have got debt priced two or three years ago aren’t going to touch it. But there are some, not so fortunate, who have done fairly recently. There may well be potential in 18 months time to see some liquidity improvement, once they’ve reached completion.
Gijs Olbrechts: When you consider that in the aftermath of the financial crisis, projects like S2, Al Dur, Salalah and Rabigh, requiring debt for an amount of around US$6bn to US$7bn, have been financially closed, we can conclude that there was even during the height of the crisis liquidity available in the market. However, it must been said that there was a lot of pressure from developers and offtakers on the remaining banks to deliver the necessary commitments.
These projects got in first instance financed due to the support of ECAs like JBIC, KEIC, Sinosure and US Ex-Im. ECAs have taken US$2.5bn of the required debt, of which 50% was on a direct loan basis and 50% on a covered basis. US$2bn of the required debt has been taken by Saudi banks and the remaining US$2bn by commercial banks on an uncovered basis.
This was at the height of the crisis and we believe that sufficient liquidity for projects should be available in the market, assuming that the pipeline of projects for 2011 is a peak. Of course, the available liquidity for individual projects will continue to remain dependent on local liquidity and/or funding that the developers, EPC contractor and equipment suppliers can bring along.
Regarding ECAs, we believe most will be likely to continue supporting projects, up to the moment that the commercial lending market is restored at pre-crisis levels. Countries, like Germany, Japan, South Korea and US, are stimulating through their ECA programmes the domestic employment, which is a key political agenda point in the current economical climate. We note that ECAs are also adopting a more commercial and flexible attitude regarding structuring and are reducing the required time to complete their due diligence and documentation than pre-crisis.
In the beginning you also questioned the use of multilaterals in GCC financings. I think multilaterals will be more difficult to integrate in the GCC template in view of the aggressive time tables for the IPP programmes and the likelihood that high creditworthy GCC countries will fall outside their scope.
Regarding the potential of the bond market, I believe that such instruments are difficult to finance greenfield projects, but could be a potential liquidity source for projects out of construction. A number of GDF Suez projects are structured to be refinanced. For example, the Al Dur project features a hard mini-perm and would result in an event of default in case the debt is not refinanced within six years. For such refinancing transactions, the bond market is one of the liquidity pools to be explored.
Another trend we’re seeing is that Chinese contractors and financiers are getting more and more involved in the GCC region. Chinese contractors have been successful in a number of recent transactions, such as Salalah, Ras al Zour and Rabigh, and have brought Chinese financing with them. Chinese liquidity is likely to become an important liquidity source in the short to medium term.
Rod Morrison: You don’t, as a sponsor, tend to sell?
Gijs Olbrechts: No, in most of the transactions, the sponsor consortium is formed at the pre-bid stage and the consortium is chosen based on its merits and to prepare the most competitive bid. This largely reduces the need to sell down.
The different stakeholders in the projects tie up in a long-term relationship with the developer and require the developer to commit to the project for the long run. This is not only the case for the relationship with the offtakers, co-shareholders, but also for the relationship banks. Some of the relationship banks are in our projects because of GDF Suez. In addition, GDF Suez is an owner and operator of power plants and holding on to its assets in the GCC region is part of that strategy.
Pascal Martese: I concur with Gijs in terms of developers in this region holding on to the assets. First, it is not an easy undertaking and Sachin can comment on the kind of consent that you need to go through with the governments and with your lenders in order to get a transaction through, and it can be very long and very painful.
It’s also from the developer’s perspective we come and even though we just have a contract with the government and the ownership is not tied, it’s really a partnership between the developers and the governments that they’re going to be here in the long run to run the assets.
And if tomorrow we want to sell an asset, we’re just sending the wrong message to the government because we have a long-term relationship, not only because of that deal but because there are so many other deals coming in the pipeline. And in a world where liquidity is not constrained, I don’t think GDF Suez has difficulties in raising capital to fund these projects and we don’t have either.
That is part of the reason for them to put these assets on to them. Now there are other sorts of players who probably will churn their capital faster, I mean the typical financial investors coming up at pre-bid or at financial close time. But yeah, the governments or the partners are going to just prevent you from doing it. There are several reason also, I am not sure I can talk about, why some of the AES assets that they were initially expected to last year were not sold. So it’s not that easy.
Rod Morrison: And you’ve been on the buyer side?
Pascal Martese: That’s right.
Rod Morrison: You managed to get it in the end…
Pascal Martese: Well it took six months to eventually close the transaction that was on paper a pretty straightforward asset. So six months ago is a long time.
David Wadham: The other point is that for the major players the assets out here have a long-term contracted capacity that offsets their exposure to merchant markets elsewhere. So my former employer International Power, you know, they had assets in the States and the UK, which were very much merchant markets. Having a long-term portfolio of contracted assets here was a very neat sort of counterweight in terms of the risk profile of the overall company.
Sachin Karia: It’s interesting how when you look at utility companies or developers and assets, you see that the strategy that a number of the missed identities follow is dependent on what the then perceived best strategy is, which is a combination of what the banks are telling their investors, their shareholders are telling them and sometimes it’s divest, divest, divest, sometimes it’s go for the biggest returns.
And over time that changes. You saw it when Enron collapsed and every developer suddenly rushed for the door in Eastern Europe and so on and so forth, and so you’ve got Asian developers pouring in and they’re all pouring out or you’ve got lots of new ones and over time it kind of all evens itself out.
But in the medium term you will see strategies change as you have mergers like the GDF/IP, which will force some strategic changes in terms of divestments and all the rest and others where particularly what we are seeing now is national champions emerging where governments in the Middle East and elsewhere are supporting particular state-owned, quasi-state owned entities to be particularly assertive in acquiring assets and bidding for greenfield IPPs, both within this region and outside it.
So the game certainly is not the same game that was here five years ago. I think we’ve got lots of new players and lots of much more interesting jostling going on currently.
Harold Fairfull: I think there’s a clear consensus around the table that there is going to be sufficient liquidity in the next 12 to 18 months to meet the finance requirements of the power project market in the Middle East. But I think we need to question beyond that looking into the future. Clearly, the market has been sustained over the last four to five years, even before the crunch, with a lot of liquidity from the likes of JBIC, and Kexim coming in as well now.
I would have to question whether they’re going to have that appetite in the long term for both the reasons that Charlie mentioned that they were; we need to get these markets started, they should be providing long-term funding to well established markets, but also secondly from a sheer concentration risk point of view.
They’re clearly putting in a lot of exposure to certain procurers within this region. Do traditionally ECAs have more exposure in the future? Frankly, I don’t think they are the answer to it, clearly with consensus rules for short-term repayment profiles the only impact they’re going to have is to push up tariffs, which is certainly not what producers are looking for.
I think, though, they clearly played the role over the last couple of years simply because there was a deficit in liquidity within the commercial banking market, and they were just to step in and get projects closed that had been put on hold for a number of years.
I do think that we need to consider Chinese funding going forward. I think China probably has a very large role to play in this region in the coming decade, whether it’s in the next two or three years or five years and beyond it’s hard to say. But they’re clearly going to be an equal party both from a finance liquidity point of view, from a contracting point of view, although that’s probably longer term, and also from an equity investment point of view.
We’ve long talked about project finance bonds for power stations and it never really has taken from Europe. So I think everyone hopes that eventually that market will open up, it’s a natural source of liquidity post-construction. What we really need to see is one of the major procurers within the region taking the bull by the horns and leading that process forward, refinancing an existing project. And I have no doubt that there’s sufficient appetite out there if the bond can be properly structured and if the credit rating agencies can be brought on board to give the appropriate ratings.
Setting liquidity aside there, I think a more interesting issue, which Charlie and Duncan have partially hit upon, is the procurement structures that procurers within the GCC are going to adopt going forward. Clearly, if we go back to 2007 before there were a lot of banks playing in this market and now the number has severely contracted, certainly from my perspective there are probably no more than eight what I would call tier one project finance banks playing in the power market in the Middle East, probably no more than half a dozen in the tier two category.
And if procurers are looking to go back to the previous standard model of 2,000MW and 100MIPD, and we assume that JBIC and Kexim are going to be taking a small role, I think it’s going to be very difficult to get those deals done. So size is going to be one important component for procurers to consider.
But the other is the whole approach to bid finance. We have seen a marked shift in this clearly in previous transactions that ADWEA undertook; they were looking for fully underwritten finance, they changed the requirements for the S3 bid and hopefully it’s been a very successful exercise. But there are other models as well that would certainly be considered in keeping stable finance. And I suspect that we’re going to see procurers looking quite clearly and hard at their policies over the coming two to three years as liquidity becomes more constrained.
Rod Morrison: Harold, you advised the successful Japanese/Korean consortium on S3. Will JBIC always be around? I mean they never seem to make that decision to reduce their exposure?
Harold Fairfull: Well, the decision never seems to come, there’s always a lot of discussion going on about that. But certainly if I were sitting in the seat of a procurer I would have big questions as to whether they would be there in three to five years. And even if they were still available, whether they’d be putting the amount of liquidity on the table as they have historically done.
Rod Morrison: Do you think that’s the same for the Koreans?
Harold Fairfull: No, I think the Koreans clearly are a number of years behind. They’ve only just started providing their equipment for the OIL programme, which is in the Middle East region. But at the same time they don’t have the same excess of liquidity in US dollars within their financial system as the Japanese do. So they have another constraint entirely.
Rod Morrison: Will the EPC contracting still be able to cope with this US$15bn to US$20bn next year? Will new suppliers need to come in? Will the Koreans continue to dominate? Will the Chinese become a factor?
David Wadham: I think the short-term answer to whether EPC contractors are going to be a constraint on a number of projects and the speed with which projects get executed is, no. I think we’ve seen a fairly robust return to the previous period where there was plentiful EPC supply.
I think if you look back a couple of years you had sort of a perfect storm really of a very tight contracting market, 2007 early part of 2008, contractors were almost beauty parading sponsors on projects, and why should I go with you guys, are you really going to win this project? And you had the unfolding credit crisis at the same time.
We’ve talked about the financial angle but I think in terms of the EPC angle, from what we’re seeing the conditions of have eased and I think the obvious benchmark is what’s happening to construction costs, and construction costs have clearly come down.
I don’t know quite where they go to but they got to US$1.500 a kilo. I mean, prices have got very, very high indeed for the greenfield plant. If you were to look now the EPC pricing on S3, I’m sure you’d find it’s actually much, much lower, so prices have dropped significantly from their peak.
It’s for a number of reasons I’m sure; a lot of it’s got to do with the appetite of the individual contractors, but all in terms of the IPPs, in terms of particularly the desal components, are very intensive on some of the metals products, so the prices of those commodities have dropped. So there’s a number of factors, but there’s no doubt in my mind that the prices have come back down again and at the moment I’d say it’s a competitive EPC market.
In terms of the new players, well they come up on the debt side already, as you said. The Chinese clearly have a role to play, they made a breakthrough in relation to the Rabigh project, in relation to the Salalah project, so the Chinese contractors have very much become a feature of the landscape here, I think.
A number of the sponsors, Acwa is one, have worked very hard to develop their links with the Chinese contractors and I think to try and reassure some in the bank market as to the quality that can be obtained from a Chinese EPC. I think there’s still some way to go on that as far as some banks are possibly concerned when it comes to the sort of high-end gas turbine products.
But I think it’s undeniable that the Chinese are going to play a very, very important role going forward because, as has been highlighted already, they can put the finance in. I don’t know the exact figure for the Salalah, but I think it’s about US$350m or so of Sinosure debt, so that is a fairly significant portion.
Ravi Suri: For the right projects, the right sponsors and the right country, EPC contract, there’s absolutely no doubt in my mind they are there for that US$15bn to US$20bn. Chinese, anybody who’s not believing in the Chinese EPC contractors is living in the past. They are here to stay and they will be very competitive and the Chinese financing will play a big role going forward.
It’s already started; Salalah set the trend and it’s just a leaning of a larger basket of liquidity to come. I think going forward it will be the Chinese, the Japanese and the Koreans who will dominate EPC. And along with them they will bring their liquidity along, the Chinese liquidity will be big and I’m fairly confident that these projects will get done. In the countries that are the peer countries, which are basically Qatar, Oman, Abu Dhabi, Qatar, Kuwait and Saudi, they’ll be contracting capacity.
Harold Fairfull: We have been interested in your reference to the Japanese because clearly the trading houses have pulled back substantially from the EPC business in the power sector, and currently and for the foreseeable future, with the yen where it is, Japanese manufacturers are not really going to be competitive against, certainly, US manufacturers and more likely as well, European manufacturers.
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