The following is the text of the presentation made by Michael Hamilton, Senior Manager, Projects and Trade Finance, The Arab Petroleum Investments Corporation (APICORP), at the Joint OPEC-IEA Workshop on “Oil Investments Prospects” held in Vienna on 25 June. The focus of APICORP is very much the Arab world and I am especially grateful to have this opportunity to talk on “financing options” in connection with the financing of projects in the hydrocarbon sector, because they are becoming increasingly important. For us in APICORP, based in the region and very active in the financing of hydrocarbon projects, financing options are indeed now a critical matter. Over the last two decades projects in the hydrocarbon sector have been moved ahead very successfully, without the adequacy of finance hindering their implementation. Now, however, there are signs that the presumption of financing availability in future may be inappropriate. What I propose to do is to attempt to define the size of the issue for the region, comment on the existing financing sources – the traditional sources that appear to be reducing – and highlight some options. You will see that for some of these options to be progressed, there is a need for governments to accelerate the capital market reforms many have now started to bring into effect. It will be noted that about 60% of the world's proven oil reserves of roughly 1,048bn barrels and nearly 26% of proven gas reserves of 155 tera cu ms are located in the Arab world. Although, the share of production outside the Arab world is significantly greater at the moment, this is expected to reduce as the world depends more on the oil and gas reserves of the Arab world. So, too, the trade (exports), from the Arab world is expected to increase. After a dip in the mid 1980s, when demand fell and oil exports from the region declined, Arab producers have managed to regain a share of nearly 30% of world oil demand. In other words, the Arab world now supplies approximately 22mn b/d out of 74mn b/d of crude oil consumed globally. The growth of gas demand has been more dramatic over the last two decades. Arab participation in the supply of gas has grown steadily; the region now supplies about 11% of world demand (2,530bn cu ms), amounting to a total of 280bn cu ms per year. Investment Needs – Oil And Gas Assuming a pattern of growth similar to last decade, for the next five years, we in APICORP calculate that the total investments of the region may amount to as much as $24bn each year. This conservatively excludes any allowance for the Saudi gas initiatives, which we still expect to move forward in one form or another. We expect the major expenditures which include maintenance expenditures – mainly in the oil sector – to take place in Saudi Arabia, Qatar, Algeria, Libya, Egypt and the UAE, some easier to finance than others: they represent some 75% of total investment. With regard to Iraq, we expect a very moderate amount of expenditure on maintenance of approximately $2.5bn. This is mainly to restore production to its prewar level of approximately 2.5mn b/ d of crude oil and to sustain it throughout 2004. To increase production to a level similar to that of Iran, ie approximately 3.7mn b/d, we assume about $7bn will be spent over the period to 2007. This of course is on the basis that an appropriate legal infrastructure will by then have been established. A third phase beyond 2007 may bring production progressively to the much quoted 6mn b/d, supposed to reflect better the potential of Iraq. More generally within the region, in addition to substantial export pipeline investment, from Algeria and more recently Libya, notable is the investment in LNG production capacity. In the 1970s and 1980s, Algeria and the UAE were the main producers. In the 1990s, production increased significantly with Qatar, Oman and now Egypt investing in LNG production heavily. Regional LNG investment alone in the last six or seven years has exceeded $10bn, with regional capacity now around 65bn cu ms/yr. We expect the rate of investment in LNG in the medium term to increase, to raise production capacity to about 90bn cu ms by 2008. A much newer development is the progress being made with gas to liquids projects. Qatar Petroleum, with Sasol of South Africa, have led the way in this and we anticipate further GTL investment in the region over the next two to three years. The Power Factor A word on the power sector, principally because of the competition it will create for long term bank funding. Those banks active in the financing of Arab hydrocarbon projects have also been active in the recent spate of power financings. Although the amount of debt raised for power projects only amounted to approximately $1.5bn in each of the last two years, this amount is expected to increase as the Arab governments increase involvement of the private sector in power. Investment Needs in the Power Sector Based on various reports on demand for power in the region, which suggest an additional 30 GW capacity may be required, there is competing for funds for a total of $40bn of investment. I feel rather dizzy when I see these indications of demand, as they may be somewhat voluntarist and exaggerated, but the investment program over the next five years does give an idea of the magnitude of possible expenditure on power, with investment in Saudi Arabia, which is trying to catch up with its capacity shortfall and Egypt, with its large population, notably heavy. Resulting Equity And Debt Requirements On the basis of the analyses referred to, we thus derive some quantification of the monies needed over the next five years, for hydrocarbon and for power, in term of equity and debt For the hydrocarbon projects, given their nature, with a significant portion upstream, we calculate that roughly $70bn equity / internal financing will be required and $50bn external, mainly bank, financing will be required. The competing power sector will require rather less but still a significant $35bn in total, of which $20bn will be in the form of debt. In other words, on average, it is possible that the Arab energy sector will seek to raise from the debt markets each year a total of $14bn. For the hydrocarbon sector alone, up to $10bn each year may need to be raised. Financing The Gap For The Hydrocarbon Sector On average over recent years the total amounts raised for hydrocarbon and petrochemical projects in the region has averaged $5-6bn/yr. As APICORP has itself been much involved in the arrangement of this financing, we can place a good degree of reliability on this. The issue for project sponsors is essential ly from where the balance of up to $4bn is to be sourced. This is to be considered against a background where equity requirements themselves are now straining the foreign currency resources of certain countries. Indeed, we are now seeing requests for equity funding being more common place. The issue for many of the banks in the region is not simply the volume of funding required but the maturity of the facilities and currency availability. Particularly for banks in North Africa, dollars are in short supply. The banks in the region have risen to this challenge as much as they can. It is however unfair to put such a burden entirely on them. Let us have a look at the characteristics of some major recent financings. Financing Constraints The bar chart in Figure 1 shows (with the exception of the last column) the final take in some of the largest financings in the hydrocarbon sector in recent years. These financings were arranged for prime borrowers in the GCC and most were deemed successful. This however was due much to the participation of banks in the region. The amount of black on the chart reflects the increasing share taken by local and regional banks. White reflects the foreign bank final participation. It is relevant to highlight that the 3rd-6th financing on the chart were without Export Credit Agency (ECA) cover, and the lenders therefore took on the associated political risk. Or to put this another way, foreign banks appear to be less inclined to take regional political risk. Other factors which are impacting on the level of foreign bank participation include: a) Mergers – there are fewer major banks around; b) Foreign bank strategies – diversification away from project finance due to perceptions of inadequate risk returns; c) Provisioning requirements set by regulatory authorities The last column, which reflects underwriting exposure of the lead arrangers rather than final take, does not indicate a complete reversal. It so happens the financing, which is still in fact being progressed, has the significant benefit of the European Investment Bank (EIB) support, which leads us to the discussion of financing options. Financing Options I propose to discuss first the “bank” options, ie financing options; and then, secondly, discuss the “non-bank”, capital market options. Bank Options Figure 2 shows the tier 1 capital of the top 15 Arab Banks in the region. The largest bank in the region is the rehabilitated and now active National Commercial Bank in Saudi Arabia, with a capital of SR8.9bn ($2.4bn) as at 31 December last year. The 15th largest is the National Bank of Egypt with a net worth of approximately $1bn. Together the combined capital of these 15 banks, mostly in the GCC, amounts to approximately $23bn, very roughly equivalent to that of Barclays Bank in the UK. In the scale of things, although their average capital adequacy ratio is around 12%, their lending capacity is thus quite limited, even in Saudi Arabia, which has by far the highest bank lending capacity. As a rule of thumb, in Saudi Arabia, one can count on the local banks to provide $ 500-600mn for a major hydrocarbon project. Outside Saudi Arabia, and to some extent, Kuwait and the UAE, the amount of indigenous lending capacity within any country falls away sharply. There is thus a high dependence upon external banks and other sources for funding. Throughout the Arab world there are relatively few local funds to assist with the funding of projects in their countries. The principal exception to this is in Saudi Arabia, where the Saudi Industrial Development Fund (SIDF) and, more recently the Public Investment Fund (PIF) both provide considerable long term funding at concessionary rates. More generally, however, for the hydrocarbon sector, a heavy reliance has been placed instead on banks for funding. The regional agencies such as the Arab Fund for Economic and Social Development (AFESD) in Kuwait tend to focus on infrastructure, and to date have been little involved in the funding of the hydrocarbon sector. All in all, local funds and regional agencies do not play a major part in the funding of oil and gas projects (except in Saudi Arabia, where the SIDF provides an average about $500mn each year) and are thus not a major financing option. Similarly the World Bank and the IFC are not so active in the funding of the regions hydrocarbon development. They have instead concentrated their focus on the poorer countries of the world. On the other hand, the EIB is taking on a pivotal role in regional finance, especially around the Mediterranean within the framework of the Barcelona process. Through the recent creation of the Facility for Euro- Mediterranean Investment and Partnership (FEMIP) we are hopeful that we will see increasing involvement of the EIB in hydrocarbon financing in the region. There is no doubt that the EIB support for the Egypt LNG financing now in progress, amounting in total to $1.15bn, encouraged the international banks to participate in the $1bn “international tranche”. In addition to providing long term loans for the LNG project at concession rates, the EIB effectively guarantees up to $225mn of the $1bn tranche in so far as political risk is concerned. The political risks absorbed by the EIB cover expropriation, war and civil disturbance, including sabotage and terrorism and non-transfer of currency. Also of importance, the EIB is acting as a lender of record: the different tranches of the financing have cross default clauses which provide substantial additional support to the banks. The financing for Egypt LNG is the largest project financing ever undertaken in North Africa. Over the next two years further heavy investment is expected in LNG, not only in Egypt but possibly also in Algeria and Libya. As a corporation which is keen to act as a catalyst to progress financings for the region, we in APICORP very much hope to see the EIB active in these other projects. Certainly the EIB is providing an important financing option. Stock Markets Moving to the capital markets, as yet the stock markets of the region provide little in the way of support for projects in the hydrocarbon sector. Upstream investment is largely funded by sponsors from their internal cash flows. Downstream, where risks may be more acceptable to investors, investment is still funded by a combination of sponsor cash flows and bank borrowing. Recently in Saudi Arabia, in March this year, the Saudi Council of Ministers approved the establishment of the Industrialization and Energy Services Corporation as a joint stock company with a capital of SR533mn ($140mn). PIF will own 40% of the equity and the remaining 60% was offered for cash through a private placement. This new company will be involved in service industries for the oil, petrochemicals, power and water industries. It is hoped that in two years or so the company will be listed on the new Riyadh stock market. This is a small company but it is indicative of the growing interest in the potential use of the stock market in Saudi Arabia. The Saudi Government has recently approved new capital market legislation and there now appears to be a genuine commitment to establish a more sophisticated capital market in the country. The stock exchange in Saudi Arabia, which is enjoying a remarkable upward movement, in part due to privatization, currently has a capitalization of approximately the equivalent of $120bn. It is interesting to note however that about 80% of this is accounted for by the shares of Saudi Telecom, SEC, SABIC and nine listed banks. The only major listing of any hydrocarbon company is SABIC. Saudi Aramco continues to be 100% owned by the government. IPOs So far there has been only limited use of the IPO market, ie by governments wishing to free up hydrocarbon equity. The largest placement in the hydrocarbon sector has been that of SABIC when the Saudi Government decided to sell 30% of its share of SABIC. In line with the growing recognition of the benefits of the capital markets, an interesting development has been the recent floatation of Industries of Qatar, aptly referred to as IQ (MEES, 28 April). IPOs: The IQ Case IQ is a very interesting case and is receiving considerable attention throughout the region. It has in effect provided a viable way for Qatar Petroleum (QP) to raise approximately $350mn and, at the same time, reorganize the chemical industries of Qatar in a more efficient manner. Essentially QP has consolidated some of its holdings in existing, profitable petrochemical companies into IQ and then sold 15% of the equity of IQ to the local market, mostly to Qatar nationals: an effective privatization and, indeed, a timely way of taking up some of the abundant private sector liquidity. This notwithstanding, the stock market in Qatar remains relatively small and as yet has not been accessed to fund any major hydrocarbon project or company in the sector. Qatar has however been the most successful country in the region in making use of the bond market for its hydrocarbon sector. Bond Issuance Generally speaking the international bond market has been a disappointment for the region. Only for one borrower, Ras Laffan LNG, has it been a success. This was in 1996 when Ras Laffan managed to raise approximately $1.2bn from the bond market to fund almost 50% of the Ras Laffan LNG project costs. Goldman Sachs, who, together with CSFB, arranged the issue were themselves surprised at its success, having anticipated a much lesser amount would be raised. This gave hope to many prospective borrowers in the region, that a significant, new source of funds was available to them. In the event, however, this proved short lived. Even Oman LNG, with the Oman Government and Shell right behind it, has been unable to tap the bond market, notwithstanding their rating last year of A- from Standard & Poors. Net FDI To The Region Foreign direct investment (FDI) into the region also has been a disappointment. Various analyses of FDI flows indicate the Arab world attracts less than most other emerging markets: in total last year the FDI reported as being invested in Singapore was apparently greater than the foreign equity investment in the whole region. This however is somewhat misleading in that much of the investment made by foreign oil companies into the Arab world is invested through production sharing arrangements, which do not come within the definition of FDI: (at least 10% of equity issued by a project company). In Algeria, for example, BPs investments in the gas sector do not get reported as FDI. The largest foreign direct investment possibility in the region, the Saudi gas initiatives have not progressed as was envisaged. It is known that the IOCs were prepared to invest billions of dollars in the gas projects so the potential for large foreign investment has been established. More generally FDI flows have been concentrated in a few countries only: 75% of total flows, as defined, have been to Saudi Arabia, Egypt, Bahrain, Morocco and Tunisia. Concluding Remarks In conclusion the oil and gas investments in the Arab world over the next five years will likely exceed those of the last five years. Total investment in the sector may amount to as much as $120bn or $24bn/yr. This assumes that all the serious projects now on the drawing board are implemented according to schedule. Even if three quarters of this amount is invested, the demands of the region on financing institutions will remain very heavy indeed. The capital markets and the bond markets have not yet become a major source of funding for the region. Some of the governments in the region are at least now making considerable strides to develop the local capital markets and we in APICORP are hopeful that within the next few years there will be the emergence of a strong regional bond market. For the moment there continues to be a heavy reliance on financing institutions; and as foreign banks merge and perhaps curtail their lending, the dependence on financial institutions in the region is likely to increase. A topic I have not touched on is the possibility of using Islamic funding. Somehow the now vast resources of the Islamic banks have to be effectively harnessed for project finance. So far, with some exceptions, Islamic funds have largely been used to finance short term needs. As yet they do not provide a major viable option. Courtesy MEES, July 14, 2003