Academic year 2002-2003

UNIVERSITY PARIS X- NANTERRE

_________________________________

D.E.S.S. Right of the International Trade

Debbie Danoffre

Development of the Financing of Project and Privatization in the Arab Peninsula

MR PATRICK BLANCHARD,

Financing of Project

Privatization is defined as the transfer of the goods, or the responsibility of a service, governmental control towards the private company. Primarily, it is acted well in fact of transferring the commercial risk towards the private sector. The consequence of such a transfer is that it is accompanied by a symmetrical transfer by control and decision-making towards private organizations. Political perceptions, as much as the inescapable consequences in social and economic terms bring the governments to a great prudence before slackening their control completely. This is why, with the Middle-East, privatization is carried out only by stages during which, at least at the beginning, the government maintains a level of undeniable framing in the catch of the decisions.

Project Financing, or financing of project, is generally included/understood as being the financing of a project in which the financial organizations are based on the incomes generated by the exploitation of the project for « to guarantee » the refunding of their loans^1(*). Without being unaware of the identity of the future shareholders (sponsors), one can say that the organizations lenders are based much more on the economic and industrial feasibility of the project that on the assessment or the merits of the aforesaid shareholders.

Since the middle of the Nineties, the Middle-East opened in the world of the financing of project. Insofar as the legal environment and the rules governing the creation of companies evolve/move and improve, the banking world more was interested in this type of financing in the area. Indeed, the States started to show a keen desire to draw aside their assessments certain great projects of public interest, and the Middle-East at once became the favorite hunting ground of the international financial organizations. Between the financings of already closed projects and those which are under development, the work-in-progress Project Financing rises today with nearly 90 billion dollars US.

This is particularly true in the fields of oil, gas, and electricity. The governments are increasingly reticent to engage the mobilizing government stocks in great projects of heavy capital, particularly because of the variations of the price of the oil barrel, and thus of the incomes coming from oil. They thus launched out in the search for private means of financing. It does not have them escaped that the financing of project makes it possible to the sponsors to decrease their general exposure by transferring certain project risks towards other parts.

This memory concentrates more particularly on the privatization and the development of the financing of project to the Middle-East in the field of the production of electricity. In the years which come, one expects in this sector has a growth without precedent, and with corresponding investments in all the area, because the governments try to diversify and relieve an economy primarily based on oil. The need for power electric is the determining factor of the evolution towards the privatization of the manufacturing units and the intervention of producers independent of electricity (IP^2(*)) and water (IPWP^3(*)).

The programmes of privatization under development to the Middle-East proceed in general of a common strategy. It is characterized by a progressive transition from a monopoly of state (often heavily subsidized) towards the private property (and thus hoped profitable) of the means of production. The best means of illustrating the evolution of the financing of the IP to the Middle-East consists in examining the efforts made in the direction of privatization by Abou Dhabi, Jordan and Saudi Arabia.

Abou Dhabi : the regional leader for the privatization of electricity

Abou Dhabi, the main thing of the seven emirates^4(*) which constitute the United Arab Emirates, continues to be the regional leader for the reorganization and the privatization of the sector of the production of electricity. It is Giat Industries which, during its work to try to discharge Offset obligation contracted at the time of the sale of 436 Leclerc tanks to the Emirates, (but, as would say Kipling, this is another history), proposed the idea of privatization, carried out feasibility studies thorough on the Mirfa power stations then of Taweelah B, and produced in 1994 and 1995 of and the text draft agreements of law allowing the installation of such a privatization. The business was alas without a future for Giat Industries, but colossal produced work constitutes still today the base of the programme of privatization in the emirate.

Indeed, in 1996, Abou Dhabi began its program by the publication from the Decision N° 1, which created the Committee of Privatization of the Sector of Water and Electricity. After completion of work of the Committee, Deputy Ruler, Sheik Khalifa bin Zayed Al Nahyan, enacted the Decree of the Emir N°. 7 of 1997 which establishes the idea of operation of the government to arrive at the reorganization and privatization. It was about :

1. To then share the properties of the organization of state in load, the Toilets and Electricity Department (WED) between separate and distinct entities, this being accompanied by the transfer of some of the interests of these entities towards private investors,

2. To into force develop and put a new legal and lawful framework,

3. To satisfy the needs envisaged in terms for water and electricity through projects in form IPWP. ^5(*)

In February 1998, the WED was replaced by ADWEA (Abu Dhabi Water and Electricity Authority). The flow chart of ADWEA is shown in the following page. ADWEA immediately created a subsidiary company, ADWEC (Abu Dhabi Water and Electricity Company), which remains the exclusive supplier/purchasing of produced water and electricity. ADWEC is also responsible to establish projections in terms of need for output, which matches of a responsibility in the establishment of the invitations to tender allowing creation for new IPWP. Lastly, ADWEC is the central merchandizing of gas necessary to the operation of the electricity/manufacturing units water.

The role of ADWEC consists in buying water and electricity at certain independent companies (of which the IPWP) through in the long run called contracts of purchase PWPA (Power and Water Purchase Agreement). ADWEC then sells water and electricity at two distributive firms through TRANSCO, governmental company of transmission of water and energy.

This sale is carried out according to a tariff « in bulk and wholesale », but which includes/understands the cost of the generation, the operating costs of ADWEC, and the cost of the transmission. The companies of distribution must then establish a tariff (not subsidized) applicable to the end-user, tariff which must be based on « economic cost », which includes the price invoiced by ADWEC, increased cost of the distribution.

D. Danoffre 1999

In theory, the subsidies granted by the government are carried out only through one refunding poured directly by the State with certain groups of customers. A company of independent regulation supervises the correct operation of the companies lately create and the calculation of the tariffs.

Since 1998, competition was actually introduced into the activities of production of water and electricity. Three projects IPWP up to now reached the installation of Project Financing : Taweelah A2 in 1999 (CMS), Taweelah A1 in 2000 (TOTAL & Tractebel) and Shuweihat 1 in 2001 (CMS & International Power).

Although ENRON and consortium TRACTEBEL/TOTAL, led by the Belgian group, were a long time in the group of head, it is with American group CMS Energy Corporation that Taweelah A2 was allotted in October 1998. It was about first project IWPP in the world, which represented an amount of about 760 million dollars^6(*). The financing, assembled under the leadership of the leader BARCLAYS BANK, was accomplished with a delay, considered acceptable, six months compared to the initial objectives. It was about one « dry credit », i.e. without participation of the agencies of credit export, one 17 years duration (a record for L `time^7(*)). It did not comprise cash a sweep^8(*) (mechanism outrageusement favorable for the lenders) and thus excluded the risks from obligation of refinancing or not-payment of dividends, because the government wished to draw up a new point of long-term reference for the attribution of loans in the country. On the other hand, the system included/understood one « security package » resting mainly on the goods and incomes of the company-project, like on direct agreements signed by the bankers with the Joint Venture selected to build the factory turn-key^9(*) and with the company in charge of the exploitation of this one^10(*).

But it is well following privatization, Taweelah A1, gained this time in May 2000 by consortium TOTALFINAELF/TRACTEBEL, led by Middle East Management of the French tanker, which opened new grounds with the Middle-East for the financing of project. It was about a project of the form build-own-operate, or BOO, which included/understood the restoration, the handing-over with technical height and the extension of an existing factory producing of electricity and water freed of salt in order to obtain an installation able to produce at least 1430 MW and 84 MIGD^11(*) (approximately 25% of the needs for the emirate in terms of water and electricity).

The transaction contained gravitational financial terms equivalent to those which could have been found in Europe for a business of the same type, which means that they were quite higher than those available at the time on the American money market. For one « deal » total of 1,4 billion dollar, the financing amounted to 1,015 billion (ration debt/equity 75 : 25), for the one duration of 18 years and half, longest in the area. There still, the agencies of credit export missed device, which was, him also, a first with the Middle-East : the banks (leaders : BNP Paribas and CITYBANK) admire that the shareholders pour their contribution in own capital stocks only after the complete pulling of the banking commercial debt^12(*). The conditions were so interesting that the loan was sursouscrit with 250% at the time of the international syndication. Several local banks took part in this syndication, and in particular National Bank off Abu Dhabi and Abu Dhabi Investment Corporation. The fact deserves to be announced as a mark of progress of the financing of project to the Emirates because, before, the local banks agreed of the loans only in exchange of personal guarantees provided on their own goods by the borrowers. To also note that it is the project Taweelah A1 which set up the contractual system of escrow account^13(*) (for the payment of the price authorized for the purchase of the existing factory), which functioned so that it became one of the contractual bases in the book of invitation to tender emitted for the fourth privatization, Umm Al Nar. The financial engineering of Total Fina Elf for the project Taweelah A1obtint six international prices, decreed by the financial press, whose «Project Finances Deal off the Year» (Euroweek), «Power Deal off the Year» (International Project Finance), «Middle East and Africa Deal off the Year» (Project Finance Magazine), «Emerging Markets Deal off the Year» (Euromoney).

It is in December 2001 that the financing of following privatization, Shuweihat 1, goal definitively « buckled ». It was about a factory grassroot BOO of 1500 MW and 100 MIGD to be built in the extreme West of the emirate, with 250 kilometers of the capital, which was allotted to the consortium between CMS Energy (the USA) and International Power (the U.K.). At an overall cost of about 1,6 billion dollar, the financing to be obtained rose at 1,285 billion over one duration 20 years. Its syndication, impetus says one the day before September 11, 2001, was largely disturbed by the events which one knows. However, thanks to the more or less underground support provided by the ADWEA, and to the appearance of a substantial portion of Islamic financing, the banks^14(*) ended up following. The project obtained even the prices « Project off the Year » (MEED) and « Middle East Power and Deal Toilets off the Year » (Euromoney Project Finances).

In these three cases, the government retained the majority to a total value of 60% of the shareholding, and hears privatiser gradually this share by offers of sale (IPO, or « Initial Offerings Public ») reserved to the citizens of the E.A.U.

While at the same time the duration of the loans authorized for these businesses was greeted like a mark of the maturity reached by the market, about many financial organizations are worried by the growing appetite of the area for so long terms. Indeed, this appetite could more be able to be satisfied, taking into account the number of the transactions until one waits in a future close relation. A British leader of one of the large banks of the Golf observes that if one continues with « to push » of the businesses in financing « without envisaging a refinancing at the end of ten or twelve years, the building will break down ». ^15(*)

Currently, Abou Dhabi is in the last phase of privatization of the factory Umm Al Nar (« Mother of Fire ») including/understanding the repurchase of certain existing units for an amount which, according to International Power, would exceed the billion dollar, while at the same time the estimate of its competitor TOTALFINAELF would show a clear residual value of about 670 million dollars...

TOTALFINAELF proposes a financing, completely subscribed^16(*), of a traditional type from now on : 1,35 redeemable billion dollar over 20 years as from the commercial starting of the factory, ratio debt/equity 75 : 25 being able to reach 80 : 20 if the real costs of the project are reasonable. It is in fact the first offer with the complete financing received until now by ADWEA. Moreover, the Islamic financing could be actuated with height of 200 million dollars by Abu Dhabi Islamic Bank and 300 million per National Bank off Abu Dhabi.

International Power has a more complex structure, but also more « fuzzy » in the duration. It includes/understands :

1. a facility of short-term, to allow the payment of the existing installations, redeemable treasury from June 2006 to June 2008,

2. A bridge loan for the share normally to pay in own capital stocks, refinançable in June 2008,

3. A 20 years loan (not subscribed) redeemable as from December 2008.

The decision of ADWEA should intervene during March 2003... if the Iraqi question allows it.

The privatization of the distribution and the transmission is much less advanced. The regional companies of distribution are authorized to practice only one very limited competition and until now no private investor was solicited. As for the transmission, it remains, at least for the moment, the monopoly « naturalness » of the state. Because it is well this monopolistic position of the government which allows him to be established like the intermediary of right between the firms of production and the companies of distribution, and also to preserve a narrow control on the level of the granted subsidies, not to even say on their existence.

Jordan : establishment of the foundations allowing the reform of the structures

The programme of privatization of Jordan, much less mature than that of Abou Dhabi, follows from there less one very similar model : the government remains exclusive purchaser of energy, the transmission falls on companies of state, but the production and the distribution must be gradually privatisées.

Being more particularly the field of the production of electrical energy, Jordan Electricity Sector Report published in January 2001 estimated that Jordan would need more than 10.000 GWh to satisfy the electric demand for 2005, and 12.500 GWh around 2010, is respective increases in 34% and 65% compared to the production of 2000.

In 1999, in order to prepare privatization, the government replaced the law of 1996 by the news General Electricity Law n° 13. The same year, the national company in load of the production of electricity NEPCO (National Electric Power Company) was separate into three : NEPCO, CEGCO (Central Electric Generating Company) and EDCO (Electric Company Distribution).

NEPCO, which remains state-owned property, deals of the direction, the exploitation and the development of the distribution network high voltage, the control system and the regional grid. It is this entity which is the single purchaser.

CEGCO is the principal company of Jordanian production ; it should be privatisée in the short run. EDCO should follow the same way ; it is responsible for the distribution of electricity outside the concessions granted to Jordan Electric Power Company (JEPCO) and Irbid Distribution Company (IDECO). The process of privatization of CEGCO and EDCO timidly started with semi-2002, whereas it began in 2001 for IDECO, whose government wishes to give up 55 to 70%. It should be noted that the privatization of these companies is a condition posed by the International Monetary International Monetary Fund with the extension of the facilities granted to Jordan.

The tariffs of electricity were fixed in May 1996, but taking into account the trend of the price of the oil barrel, the government had to re-examine them since 2001. The tariff applicable to the distributive firms should increase, and be reflected then towards the end-user.

The bases were thus thrown. In May 2000, the Jordanian government chooses as a preferred bidder for the development and construction in BOO of the first IP of the country. The negotiations with the Belgian group had already trailed during years, primarily because of uncertainties related to the origin of gas necessary to the production. Located with Kherbet-Al-Samra, the factory was to have a capacity of 450 MW. Until 2002, the Jordanian government and TRACTEBEL negotiated certain aspects of the project, including the terms of financing, in the hope to concretize it during 2003. The business, in any event, could hardly progress without the construction of a suitable pipeline. Unfortunately, on the instructions of its SUEZ shareholder, TRACTEBEL, which had already given up depositing an offer for the business of Umm Al Nar in Abu Dhabi a few hours before the opening of the folds, gave up the Jordanian business abruptly.

In addition to the vexations of SUEZ because of hazardous investments in the field of the water treatment, one can guarantee, there still, that the situation in Iraq is not foreign with this withdrawal. All this of course has very negative effects on the credibility of Jordan and discourages the financial organizations which, otherwise, could have invested in the sector, which shows, but this time in a negative way, the close connection which exists between the privatization of the sector and the development of the financing of project.

Saudi Arabia : a step front, two steps behind !

The electric developers of projects constantly scan the efforts made laboriously by Saudi Arabia (KSA) to reform the sector in question. The country presents great potentialities for the blooming of the IP : it is estimated that, if KSA wishes not to be overflowed by the increase in the electric request in the country, its need for investment on the matter will reach the 117 billion dollars in the twenty years to come. This represents an increase in the working installed capacity of the order 50.000 Megawatts. The electric policy of KSA is far from being as well defined as that of Abou Dhabi, but it does not present of it less the budding of the same strategy :

1. separation of the goods of the State between generation, transmission and distribution

2. adherence with the concept of the government as an exclusive purchaser.

However, certain events which proceeded into 2000 bring to wonder about the sincerity of the Saoudi government (monarchy « lit » ?) in its search of privatization and reform. Indeed, the will of the government appeared to weaken when in October 2000 it succumbed to pressures of the public by cancelling increases in tariff decided by Saudi Electricity Company (SEC) in April. However, this increase in tariff had been decided in order to make it possible future the IP to function with a rate of return reasonable and this without guaranteed governmental subsidies nor dividends.

Moreover, legal environment and « operational » Saoudi is underdeveloped, while at the same time the government feels reluctant to provide guarantees, which presents obstacles more than significant at the development of the privatization of the sector of electricity. The factory of Shuaiba, for example, of a cost of 2,2 billion dollars, owed at the origin being a IP. But the private investors were not interested in it, precisely because of their doubts about the stability of the tariffs and the applicable legal status. Consequently, the project was financed by the government on an Islamic basis provided by Al-Rajhi Banking and Investment Corporation.

In spite of that, KSA continues to push new diagrams of financing for its electric projects. For example, station PP9 (1200MW) in the north of Riyadh was financed by excesses of incomes taken on the large-scale consumers since 1995. The factory Ghazlan II (2400 MW) is financed through a loan of 500 million dollars, trade unionist to the international one, and who gives to his transmitters the right to refund himself if need be on request starting from the incomes of prestigious customers such as Saudi Aramco. Another test tried by KSA to show its sincerity lay in the project of a IP « captive » of 320 MW that Saudi Petrochemical Company envisaged to create to satisfy its own needs. Americans ENRON and CMS Energy had been selected like foreign partners... The scandalous bankruptcy of the first, the failure and the withdrawal of the second, and finally the events of September 11, 2001, were to strike of a fatal blow this attempt, with the remainder not very convincing.

The financial organizations remain in active day before. But nothing will be possible as long as the Saoudi government will not have shown its political capacity to impose not subsidized tariffs and tallies legal and operational transparency. This, without forgetting that the question of the development of the gas fields, necessary to the electrical power, remains outstanding, whereas it is probably the only reason which brings them « large »^17(*) with still considering the subject in Saudi Arabia.

Conclusion

The governments of the Arab peninsula, to differing degree appear to have admitted that their loathing to grant sovereign guarantees moves away the investors who are neither of the agencies of credit export, nor of the multilateral institutions. Although it is exact that privatization implies the creation of independent entities capable of self-sufficiency, it would not be reasonable to expect that the developers enter the eyes closed and without support new companies which do not have any countable history nor operational. So that such a project meets success, it is appropriate that the risks and profits are equitably distributed between the government concerned and the private investors.

The evolution of the structures of financing of the IP in the area shows well the increase in the interest and confidence tested by the financial organizations. The participation of the agencies of credit export is not any more one indispensable condition. Even if privatizations of Abu Dhabi showed that long-term loans can be secured, it does not remain about it less than, so that the financings perdurent, it will be necessary that the area shows its capacity to extend the depth and the diversity of its sources of financing.

Or else, the international banks will end up reaching the limit of their exposure per country, and the developers will have to be addressed elsewhere to finance or refinance the debt of the projects. The solutions of replacement, in terms of financing, will include/understand then, most probably, the capital markets (projects jumps) the Islamic financing and the regional banking market.

But all this will not be able to be carried out, as we believe to have shown it through the example of Abou Dhabi, that if the governments concerned show their adherence with the process of privatization by the setting does not place and in force of transparent lawful structures and disciplined tariffs.

Or else, the process will be put in danger, and the flood of the investments and the financings will be dried up irremediably.

BIBLIOGRAPHY

Ø The Guides To Financing International Oil and gas projects, Milbank, Tweed, Hadley & McCloy- 1996

Ø Project Finances International Yearbook 1999

Ø Particular reports/ratios Electricity, Total 1998, Total Fina Elf 2000/2002.

Ø Middle East Economic Digest, since October 1999

Ø The Website for the Power Industry ( http://www.power-technology.com)

Ø Jordan Electricity Sector Carryforward, January 2001

Ø Website of the embassy of Jordan.

Ø Energy Intelligence Briefing, 18/02/2003

* ¹ Guide for the Financing of the International Projects Oil and Gas, Milbank Tweed

* ² Independent Power Producer

* ³ Independent Power and Producer Toilets

* ⁴ Abu Dhabi, Dubai, Sharjah, Ajman, Fujeirah, Close-cropped Al-Khaimah and Umm Al-Qwain.

* ⁵ MEED, Special Abu Dhabi Carryforward, 20/02/1998

* ⁶ for 710 megawatts (MW) and 50 million Imperial gallons per day (MIGD)

* ⁷ until this moment, one considered that for the area one 12 years duration was extremely ambitious.

* ⁸ as under consideration at the origin in this case  : all the funds of the company are regularly transferred firstly at the organization lender. The possible distribution of dividends is done only then. The requirements in working capital are the subject thus of separate financings.

* ⁹ Siemens/Hanjung  .

* ¹⁰ in fact, a subsidiary company of CMS created of any part to this end, in order to maximize the rate of return of the Americans.

* ¹¹ I.e. 380.000 tons of water per day  !

* ¹² «  back ended equity  »  : this system can be adopted only if the shareholders have a very strong credit.

* ¹³ count of setting in third hand

* ¹⁴ Capital Barclays, Citibank, Bank off Tokyo-Mitsubishi, Kreditanstalt fur Wiederaufbau, Royal Bank off Scotland, National Bank off Abu Dhabi, Abu Dhabi Investment Company, Crédit Lyonnais, HSBC Investment Bank, Sumitomo Mitsui, Abu Dhabi Islamic Bank.

* ¹⁵ Mr. E.E.D, October 2000

* ¹⁶ by ABN Amro, Crédit Lyonnais, Royal Bank off Scotland, etc

* ¹⁷ Exxon Mobil, Shell, TotalFinaElf, etc