The population of the Middle East has exploded from just 132 million in 1990 to 212 million in 2010. This is a 61% growth rate in 20 years, one of the highest in the world with 30% of Saudis under 14 years of age. Applying the same constant growth rate, the predicted population in the Middle East in 2030 is over 340 million. A number of countries are looking again at their big projects in the light of the Arab Spring, and the global financial downturn, but while some projects have changed their structure, with growing populations local governments are forced to press ahead with new infrastructure.
The Middle East region is hungry for electrical power. It is projected that 100GW of new energy capacity will be needed in the region in the next 20 years.
The region has access to fossil fuels to convert into power. The capital costs associated with each new power plant are huge but international lenders are comfortable with the mature technology of power generation and the risks associated with long term power purchase. Originally all power projects in the region were solely government owned but over the last 20 years independently owned and financed power projects (IPPs) have been a great success and have led the project financing of infrastructure in the region.
More than two dozen IPPs and Independent Water and Power Projects (IWPPs), are currently in operation. The first IPP in the region was Manah in Oman, which achieved financial close in 1995, with the first IWPP in 2002. IPPs are projected to be 34% of regional capacity by 2015, and as these IPPs are normally base load plants, this could be up to 60% of the electricity generated in the region.
The procurement process for a new IPP or IWPP begins with the government deciding that it requires additional generation capacity and inviting competitive bids from interested project developers. There is a pre-qualification stage and then a full tender with developers bidding an electricity tariff (and in IWPPs, a water tariff) based upon their financial modelling of costs over the project term, key elements being: the lump sum turnkey engineering, procurement and construction contract (EPC); the operation and maintenance (O&M) over the term and the cost of finance. The developers will each select EPC and O&M contractors; consider Export Credit Agency support and negotiate with lenders for limited recourse project finance. Developers may also put in place a long term service agreement with the supplier of the turbines.
Once selected, the project developer will sign key project agreements with the host government or its relevant public authority. For an IPP the most important document is the power purchase agreement (PPA), to sell electricity from the project to a public sector off-taker. The obligations of the offtaker are normally backed by a sovereign guarantee to enhance the creditworthiness of the project and thereby assist in attracting finance (which is why finance for power in Kurdistan is problematic as no sovereign guarantee is available). Two slightly different approaches have been applied in the Middle East: the Oman model (also applied in Bahrain and Jordan) and the Abu Dhabi model (also applied in Saudi Arabia).
An implementation agreement (IA) will feature in the Oman model approach providing some details of local project support. The terms of an IA will vary from state to state, but they often cover the following issues:
• taxation and customs incentives;
• specific exemptions which have been granted to the project, or exempt the project developer from the effect of certain local laws or certain changes of law (or compensate the project developer from adverse change);
• confirmation of the right to exchange local currency and transfer monies overseas and hold accounts overseas; and
• conditional rights to be granted necessary permits, subject to proper application.
In the Abu Dhabi model the host government participates with a minority shareholding in the project company and a shareholders agreement forms part of the bid documents. A land lease agreement or usufruct will apply to the site. A fuel supply agreement may be required but fuel is a pass through and the project company is paid effectively on a tolling basis for conversion of energy.
The project developer will take revenue from the project as a share dividend and may have some participation in the operation and management charges. The project company will, under the power purchase agreement, receive a regular capacity payment for the available electricity generating capacityof the power plant for the duration of the power purchase agreement and an energy payment which covers variable costs.
For the Manah project in the early 1990s we negotiated long and hard over the structure of the PPA and IA. With the implementation of first in country projects around the region: Taweelah A2 in Abu Dhabi and Shuaibah in Saudi Arabia we also had scope for extensive negotiation of the key project agreements. The market has now been established. Fully drafted PPA, IA or shareholders' agreement, land lease or usufruct agreement and other supporting documents are provided in the Request for Proposals, or Invitation to Bid and developers provide a mark-up of provisions with their bids. The scope for successful amendment of the key project agreements is now slight because the models are well-established and have been proven to be financeable. If governments deviate from past forms, questions arise but otherwise they can find developers ready to take established risks.
The key advantage for the host government of an IPP or an IWPP is that they do not have to find the money for the construction costs up front and are able to defer the payment of such costs over a period of up to 20 years, to be paid as part of the capacity charge. As IPPs are subject to competitive bidding, they are normally reasonably cost efficient, but the finance costs are significant and more expensive than sovereign debt (so risk transfer is the explanation for the preference for IPPs). The modest risk profile of IPPs, with a government guarantee, and single government owned offtaker,means that they can have a debt to equity ratio of as much as 85%/15%, requiring little initial capital investment from the project developer (who may also be able to negotiate bridging finance for equity contributions).
The power generation market is constantly developing, and the new Rabigh IPP in Saudi Arabia is a good example of how governments in the region may seek to structure projects in the future. The Rabigh plant has recently reached its commercial operation date on schedule and is the first project to reach financial close after the global financial downturn. The project, which had significant involvement of Saudi banks lending on an Islamic finance basis, is notable as the first project in the region to be financed without a sovereign guarantee.
In Jordan we are seeing the development of a variation from the traditional scheme of IPPs. Jordan has huge reserves of oil shale and the Jordanian government is keen to exploit this resource which looks attractive at high international prices for crude oil. Jordan has already awarded three oil shale concessions for exploration and development. One of these concessions is with Enefit of Estonia, who has experience of direct burning. Enefit and the National Electric Power Company of Jordan (the government owned public sector offtaker of power from generators) have executed anMoU and negotiated project agreements for an IPP located next to the oil shale mine that will be fuelled by direct burning of oil shale. At the present time Enefit and the government have still to finalise key details such as the agreed tariff based upon an analysis of the substantial construction costs (and other costs), but it is hoped that this project will move forward shortly. It is an example of a negotiated agreement for a difficult commodity that may open the door for other developers to bring similar direct burning oil shale proposals.
In places hungry for power but with difficulty in raising finance suchas Kurdistan, Governments are more likely to respond to a negotiated package.Kurdistan cannot offer a sovereign guarantee which means that international lenders are unlikely to be ready to offer pure project finance. A negotiated package that incorporates feedstock from existing gas producers, construction, equipment and engineering and brings its own financial solution is likely to find favour. Turkish interest in the region may possibly open doors and is worth investigation.
The onshore concessions in Abu Dhabi expire in 2014, with the offshore concessions expiring in 2018. The first concessions were granted to the Trucial Coast Development Company in 1939, which was a joint venture between BP, ExxonMobil, Shell and Total.
Today, the state owned Abu Dhabi Company for Onshore Oil Operations is the concession holder and is majority owned by the national oil company, Abu Dhabi National Oil Company, with minority shares held by BP, ExxonMobil, Shell, Total, and Partex Oil and Gas.
Abu Dhabi is looking to invest in increased production, but requires additional investment in technology to ensure that it gets the best possible returns from its mature fields. New bidders for the concession will be expected to provide technology, financial support and project management expertise.
ADNOC will look towards its previous partners for bids, but it has also invited participation from Occidental Petroleum and Statoil. The bidding process has been notable by the initial absence of BP, which was only invited to participate at a late stage following UK Prime Minister's recent trip to the Middle East.
The concession is not a massive income stream for the current parties, with BP only making around USD $50 million a year (equivalent to USD $1 a barrel) from the existing concession, but the bidders see it as strategically important, and it will be interesting to see who is successful. Below the lead international oil company level, sub-contract opportunities will exist. Companies wishing to participate will need to develop links with the key international oil companies to provide services.