Market intelligence: Middle East petchems may be hit by credit crisis

Credit crisis to hit Middle East?

07 July 2008 00:00  [Source: ICB]

Malini Hariharan/Mumbai

THE GLOBAL credit crunch raises questions on the future of petrochemical projects in the Middle East. Financing costs have risen, challenging project planners who are already grappling with a shortage of ethane and record high construction costs.

Those at risk include projects led by private firms that are relatively new to the industry and the very large projects that have financing requirements of $10bn (€6.3bn) or more.

Globally, there is less money available, said Darren Davis, managing director and head of project and export finance at HSBC Bank Middle East, at MEED's Middle East Petrochemicals 2008 conference in Bahrain.

The lending availability of international banks has been hit. And the bad news extends to regional banks.

There was a feeling last year that banks in the region would be immune to the global credit crisis, as they did not have much exposure to subprime-mortgage-linked derivatives. However, there is exposure at another level, as these banks have to rely on the international markets for funding.

An additional problem has been the weakening of the US dollar. Most of the Gulf Cooperation Council (GCC) countries peg their currency against the dollar, and companies usually secure project funding in the same currency.

But currency volatility seen during the last six months has prompted some Saudi firms to seek financing in riyals rather than in dollars, said Zahoor Khan, vice president, Gulf Investment Corporation (GIC).

"This is an important trend. More and more banks locally will be able to lend in the local currency," he added.

Khan also highlighted the questions being raised about the accuracy of LIBOR (London InterBank Offered Rate), the global borrowing benchmark.

The controversy arose last year when losses from subprime securities made banks cautious of lending to each other.

This led to the belief that some members of the British Bankers' Association (BBA), which sets the LIBOR, may have understated the rate at which money was being borrowed by banks, to avoid being seen as seen as having problems in securing finance.

Interest rates for project-related loans have been set against the LIBOR, but regional banks are finding that it is not representative of what they are paying for their own funds, said a source from a Saudi bank.

Tim Holder, director at international merchant banking firm Taylor DeJongh, highlighted yet another problem - the ­competition that petrochemical projects face in an overheated construction market.

"There is an inherent risk in petrochemicals. Lenders are more comfortable lending to power projects. Petrochemicals are vying for a limited pool of funding," he said.

And the risks for new petrochemical projects are increasing. The Middle East is the costliest place in the world to build a new plant, and construction costs have shown no signs of easing.

Cost-advantaged ethane is short, and many of the recent cracker projects have turned to naphtha. For example, South Korea's Honam Petrochemical's joint venture cracker project with Qatar Petroleum will use a combination of naphtha and ethane as feedstock.

"The real concern now is economics. There is no economic advantage of making petrochemicals from naphtha in the Middle East and shipping out product. We will see projects coming when markets turn. We might see projects struggling to give returns to sponsors," said Davis.

The consensus is that well-structured projects with strong promoters, such as state-owned companies or international chemical majors are unlikely to face problems.

This includes the $20bn-plus Ras Tanura project promoted by Saudi Aramco and US-based Dow Chemical.

"The mega projects are in a class of their own. The regional bankers can't handle them on their own. These projects will see mega sponsors and raise debt through them," said Khan.

But even big projects will face some challenges. "In two to three years, Ras Tanura will come to the market. It is possible this will need additional equity. Then we are back to the question: what return will you get on equity from these projects?" said Nicolas Thevenot, senior manager, project and trade finance at Arab Petroleum Investments.

Given the limited liquidity globally, what are the financing options?

"A big pool of liquidity that is not tapped is retail [financing]. There is a lot of money with individuals that can be channeled through convertible bonds," said Davis.

The initial public offering (IPO) route is already popular in Saudi Arabia. Both Saudi Kayan Petrochemical and Rabigh Refining and Petrochemical (PetroRabigh) have successfully secured funds through IPOs for their cracker and derivative projects.

Bankers expect a sizeable government element in funding of projects. There is also likely to be increased participation by export credit agencies.

"We may also see private equity funding, which is trying to find a home in lucrative projects," said Holder.

And it is not all gloom and doom.

"There is a flight to quality, with banks moving away from exotic products. So there is interest in project finance," said Davis.

But given rising costs, companies probably need to evaluate if it would be better to buy rather than build assets.

ICIS Copyright © Reed Business Information 2009

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