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The Impact Of The Credit Crunch On Energy Project

Finance

By Melanie Lovatt, Finance Editor,

Middle East Economic Survey

The Credit Crisis

• Triggered by the collapse of US subprime mortgages, which were securitized & spread across the financial market

• This had a ‘house of cards’ effect on financial institutions (Bear Stearns, Lehman)

It’s impact on all bank lending, and even on energy project finance, is profound.

But why can dodgy US home loans impact an energy project in, for example, Saudi Arabia?

Especially if some of the failed institutions were not big

project finance providers in MENA?

The Impact

Global interbank lending ground to a halt driving up interbank offered rates (Libor, etc). This cut complex links between chains of banks.

Banks became reticent to lend because they faced losses or feared their fellow banks would fail

Customers took deposits out of banks, further reducing the amount they are able to loan – laws govern percent of deposits that can be loaned.

This Impacted Banks In All Regions

• Including MENA where the bulk of energy projects are being planned.

• Here domestic banks rely on credit lines from international banks to fund loans with long payback periods (15+) typical of project finance. (international banks by contrast finance through long term debt instruments).

• But the region’s banks had not, to date, provided the dominant share of funding to project finance…

…International banks have

These banks (mostly European and Japanese, with a few notable US players like Citibank) have provided the bulk of energy project finance over the last decade…

…Awash with liquidity (2004-early 07), they were aggressively competing for business

Gulf PF 2004-07

• After the 9/11 shock, the market gradually improved, with bank pricing (margins) on projects reaching record lows in 2004-early 07

• The number of banks involved in PF shot up from just over a dozen to over 40.

Gulf PF 2004-07

• Bank pricing (margins) on project financing was in a downtrend. Top sponsors saw record lows:

• Qatargas 4 30-60 bps in 2006• Qatargas 3 45-70 bps in 2005• RasGas 2/3 45-65 bps in 2005• Qatargas 2 50-125 bps in 2004• Qatargas 165 bps, RasGas 95-200 bps – 95, 96

Gulf PF 2004-07• Prices also reached record lows on Saudi

Arabia petrochemicals projects:

• PetroRabigh (Aramco/Sumitomo) 35-65 bps

• Sharq (SABIC/Mitsubishi) 50 bps

As bankers were eager to take on Gulf risk due to the climbing oil prices and strong economic outlook for the region

By early 07…

Margins were so thin that some bankers were shunning deals citing low returns that even undercut corporate financings (which have shorter pay back period).

They also complained about reduction in covenants (completion guarantees, etc).

And the ‘commoditization’ of deals – sign the term sheet, turn it around, onto the next one…

Hiccups

• There were problems, and one particular deal (Qatar Steel Co), flopped, but it was a result of poor market approach.

• Syndications for a few had to be reevaluated simply because sponsors were pushing banks too hard for lower prices.

Bankers wished for higher margins…

…but the old axiom – to be careful what you wishes for – is applicable here.

Higher margins were on the horizon, but so was the credit crunch.

As the crisis unfolded margins started to rise

But in late summer 07-early 08 Gulf project finance appeared shielded as financings proceeded in orderly manner:

Oman – Sohar/ORC $1.37bn from banksSaudi – NCP petchem project $1.8bn, $10bn Kayan

petchem project was closed. Qatar – Qafco 5 fertilizer project $1.6bnAnd Emirates Aluminum, Fujairah 2 IWPP were

funded

Rising margins were accompanied by other changes

• Market flex – made its first major reappearance since 9/11

• Reduction of international banks participation on some deals (ie Qafco 5)

But there were hopes that with high crude prices, energy project sponsors would continue to attract funding

In March the crisis worsened

With Bear Stearns’ (founded 1923) collapse and fire sale to JP Morgan.

But deals continued to get done, Yemen LNG secured funding, QP completed financing for Ras Laffan C power project at (100-160 bps), also Nakilat LNG ships (110-125 bps).

Margins had edged up and ‘Clubs’ were favored over underwrite/syndicate.

In September everything changed

• With the collapse of 158-year old Lehman Brothers, confidence nosedived. Other banks and financial institutions collapsed or needed lifelines and rescue packages (including $700bn in US) were vital

Anyone who had thought energy companies would ride out the ‘hiccup’ had to admit that the impact would be far-reaching and ALL COMPANIES looking for a loans would be impacted by crisis, which was now stifling global economic growth.

The PF market is LARGELY CLOSED

Abu Dhabi Water & Electricity Co (ADWEA) $2bn Shuweihat S2 underwriting morphed into 20-plus year loan to a 10-month $1bn bridge loan.

Hasdrubal (gas – Tunisia) using Afr. Devel Bank, local banks, international bank component reduced

Market events led to material adverse change clause (MAC) and market disruption clause (MDC) discussions.

For short term loans, banks are servicing regular customers, but taking on little new business

The Outlook

With capital injections around world, Libor rates (and Gulf interbank rates) had eased slightly from record highs seen in Sept.

But changes this month to the Bush Administration’s plan to buy distressed assets caused more nervousness, and rates had stopped declining.

When will PF market reopen?

Depends on how much more money banks lose, success of bailouts and capital injections. And the impact this has on confidence.

Confidence may be helped if Hasdrubal, Shuweihat, get their financings completed.

But there will be some important changes…

Changes

A smaller bank group will emerge, with increased government ownership, strategy may be different.

ECAs & multilaterals will be increasing providers of PF (ie JBIC can provide up to $3bn on Ras Azur IWPP, provided $2.5bn to PetroRabigh)

Local banks, Islamic banks relatively unaffected (exceptions GIB, ABC) but they are small compared to internationals

Margins higher, tenors shorter, fine print scrutinizedSponsors will need to increase equity investmentCapital market funding, when markets reopen, will increase

Equity Investment

• Where large sponsors can, they will finance projects via their balance sheets. This is already seen in upstream oil investment

• But oil and gas sponsors NEED project finance for joint ventures due to contingent liabilities. Anything needing external funding will be impacted.

• And smaller project sponsors NEED PF loans

Finance problems already triggering delays:

Aforementioned Hasdrubal, Shuweihat S2 delayed, also:

Bids for Saudi IWPPs (SEC Rabigh, Marafiq Yanbu)Bids for multi-billion ($15bn) Saudi oil refineries

(JVs Saudi Aramco, ConocoPhillips and Total) Where possible sponsors are deferring projects, and

refinancings. Although regional gas project – Dolphin must refinance $3.5bn bridge loan in 09

The crisis is a problem for MENA

66% world’s crude oil, only produces 37%

46% of natural gas, only produces 17%, and was counting on new projects.

For 2009-13 MENA proposed energy capital investment is $650mn. Partly due to credit crunch projects in progress are now 80% of this ($520bn), according to APICORP.

MENA Energy Spending

Investment Distribution

Saudi was proposing ($163bn) but 13% have been shelved mostly in the petchem sector

Iran needs $96bn but 30% postponed due to sanctions

Qatar was expected to need $76bn, but due to moratorium on North Field shelved projects (ie GTL) are now up to 37%

Of $520bn For MENA in 2009-13:

Oil investment will be:Upstream $79bn, midstream $11bn, downstream $153bn

Gas investment will be:Upstream $62bn, midstream $24bn, downstream $79bn

Power generation $112bn

Source: APICORP

But…

This investment could fall dramatically:

If banks restrict lending over a long period

If the economic downturn is severe and lengthy (affecting oil consumption)

If oil prices continue downwards, and stay low for a protracted period

The good news…

…Prices of raw materials used to construct these projects, such as steel, copper, concrete have fallen dramatically.

Project sponsors are already haggling with contractors for a reduction in price, and this could have a big impact on viability and help to counterbalance rising bank costs.

Uncertainty remains

The interplay between the bank crisis, volatile crude oil price (which dropped by over half since it hit $147/B in July) and the shift in construction materials prices makes it very difficult to assess the outlook for energy projects in the years ahead.

There have been calls to hike infrastructure spending to reinvigorate economies, and have them better poised when they emerge from crisis, but it remains to be seen if GCC governments take on board this advice.