A new dawn

As high oil prices continue to entice investors to resource-rich countries in the Middle East, Erika Morphy reports on the region’s deepening liquidity and the challenges and opportunities facing trade and project financiers.

By any industry measure or benchmark, the trade volumes supported by the Trade Bank of Iraq are miniscule at best – and to be accurate, largely aimed at the US and allied contractors involved in the reconstruction. “We can count on the banking system for wire transfers and perhaps setting up a letter of credit to help us with our business,” says Subhi Khudairi, vice president, business development for the Khudairi Group, a Baghdad-based importer with offices in Houston, Texas. Loans, though, are another story.

Despite these obvious growing pains, the simple fact is there is no comparable benchmark to measure the impact the bank has had on the Iraqi economy since it was established in November 2003.

“In 2004 we issued 1,500 letters of credit worth about $3.8bn,” says Hussein Al-Uzri, an executive with the Trade Bank of Iraq. “We expect a 25% increase in volume this year.” Also, he adds, at the end of 2004 the bank began making moves to expand beyond its original scope and offer such services as corporate and commercial banking. It is also talking to institutions – both private banks and export credit agencies – about establishing medium-term finance products.

These developments, he says, have attracted the interest of multinationals that up until now have been less than impressed with Iraq’s financial infrastructure. “Because we had to start up very fast we could not offer everything we wanted right away,” Al-Uzri says. “But with our latest changes we are receiving more expressions of interests and outside contacts.”

It is not surprising. Leaving aside the political differences with the United States and United Kingdom over the invasion, many financiers in the region attribute the current glut of projects in large part to the sense that the Middle East might, just might, be poised to enter a new era of development.

Not that Iraq is stabilised – far from it, as anyone who watches CNN can tell you. Indeed Al-Uzri hesitates to discuss the Trade Bank’s plans for anything but the immediate term. “In Iraq, we take things one day at a time,” he says.

Then there is the big question mark about Iran and what may happen if the Europeans and Americans are not satisfied that its nuclear development activities are benign. “There is no way to predict the future,” one banker at a regional trade and project finance institution, says. “So that is what is hanging over our heads now.”

But he adds these worries are not enough to curtail the current activity.

Right now, the banker says, “the project finance market is more buoyant than any other time in the past since 1997”, a peak year in which $12bn in project financing was closed.

“The war removed a significant political risk to commerce in the Middle East,” he concluded. And of course, there is the $50 per barrel of oil price point that does not appear likely to budge any time soon.

Beyond borders

These trends have resulted in new investment patterns, impacting both banks in the region and on trade and commodity financiers outside of the Middle East. The latter – primarily Asian and European banks – are finding themselves financing projects that were once the purview of Middle East finance houses. At the same time Islamic institutions are providing new competition for these banks in commodity finance. In short, Islamic funds are finding their way into the international commodity market as its banking sector becomes more and more international.

“There is a considerable amount of untapped liquidity in the Islamic finance market, much of it the result of the price of oil,” explains Fritz vom Scheidt, managing director of the WestLB-Tricon Forfaiting Fund.

“At the same time, there is a need for diversification of Islamic banking portfolios into more non-traditional products to blend risk and diversify geographically.”

Perhaps the best illustration of these trends is the Qatargas II mega project, based in Qatar, which has the world’s third largest reserve of gas. At $12bn with some 57 lenders participating, it is the largest project financing in the Middle East to date.

A 70-30 joint venture between Qatar Petroleum and Exxon Mobil, respectively, the two conglomerates are in the process of building two 7.8 million tonne/yr liquefaction trains – the largest, in fact, built to date – as well as a receiving terminal in the United Kingdom, in order to transport LNG shipped from Qatar to Milford Haven, South Wales. Upstream financing has also been arranged to cover gas production facilities in Qatar’s North Field, as well as supporting pipelines and liquefaction facilities.

But if one wants to examine a transaction that is illustrative of the growing flexibility and ever deepening liquidity of trade and project finance in the region, a better example would be another recent record setter, albeit not on the scale of Qatargas II: the Al Taweelah A2 power and water project in Abu Dhabi.

Al Taweelah A2 is the first asset-backed securitisation executed for an infrastructure-related project in the Gulf co-operative countries region. Of course, if the entire amount of the project had been financed in the bond market, that would have rivaled Qatargas II in newsworthiness. In this transaction, only part of it was (see below). But give it time, observers say. The liquidity in the region – thanks to sky high oil prices – will no doubt continue to fuel such innovation and drive banks and project sponsors to push the financial envelope.

In short, the lines between project finance loans and bonds are blurring in the Middle East. The traditional view has been that loans would finance up to ten years and bonds were to finance any time period beyond that. Now, as can be seen with Al Taweelah, there is a greater choice and trade off in pricing and flexibility between the bond and loan solution for sponsors of Middle Eastern projects.

At the other end of the investment spectrum from Qatargas II and Al Taweelah A2 are funds such as WestLB-Tricon.

WestLB-Tricon’s activities are a mere drop in the bucket in the face of the growing demand for investment vehicles in the Middle East, not to mention the region’s liquidity, vom Scheidt says. However what it lacks in scale it makes up for in innovation. WestLB is the first – if not only—Islamic forfaiting fund.

According to the laws of Shariah, selling debt at a discount is forbidden. However WestLB-Tricon, established two years ago, structured the fund to match up the maturing of forfaiting assets with metal futures. Investors earn a trading profit, which they are allowed to do, through future purchases. The transactions are overseen by Islamic scholars to ensure they remain true to the tenants of Shariah.

Al Taweelah A2

The transaction securitises a long-term project finance loan provided by National Bank of Abu Dhabi to the Emirates CMS Power Company for the purpose of financing the Al Taweelah A2 power and water project.

It consists of $23m floating rate loan participation notes due 2008, $21.5m floating rate loan participation notes due 2011, and $89.25m floating rate loan participation notes due 2014. The Bank of New York Europe will provide Luxembourg listing services, and the Bank of New York (Luxembourg) will provide Luxembourg paying agent services.