S3 navigates the gap
The Shuweihat 3 deal – a return to normality in the Gulf IPP finance market or a brief respite? By Harold Fairfull, managing director, Consilium.
The request for proposals (RFP) for the 1,500MW Shuweihat S3 IPP (S3) in Abu Dhabi was issued by ADWEA in March 2010, some five months following the delayed financial close of the Shuweihat S2 IPP in October 2009. The finance bid requirements for the new project were, therefore, always likely to reflect lessons learned from the difficult Shuweihat S2 IWPP (S2) process and prevailing concerns about continued liquidity in the commercial bank market.
The RFP for S2 had been published in November 2007, just ahead of the successful financial close of the Fujairah F2 IWPP the following month and, more pertinently, in advance of the start of the credit crunch that engulfed global capital markets in 2008.
The S2 RFP continued the structure adopted on recent previous ADWEA IWPPs and required bidders to provide commitments for 100% of all equity and debt required for the project. During the course of 2008 it became clear that the banks supporting Suez, the winning bidder, were not willing to countenance the underwriting risk attached to their commitments of approximately US$2bn of debt.
An interim solution comprising a US$900m bridge facility to allow the project to commence construction was closed in December 2008. There then followed the introduction of Marubeni into the international sponsor group to permit access to JBIC funding and an eventual full financial close 10 months later as each of ADWEA, Suez and Marubeni used their relationships with commercial banks to fill out the syndicate.
The bid requirements
The bid requirements in the S3 RFP therefore differed remarkably from previous ADWEA projects. While responsibility for and the risk of raising finance remained with the successful bidder as in all previous transactions, significant qualifications were made to ensure sufficient liquidity for multiple bidders as well as sufficient later liquidity for a bookbuilding exercise to be undertaken by the successful bidder with co-operation from ADWEA.
To achieve this ADWEA required each bidder to have exactly two international commercial banks supporting its bid, with a minimum commitment of US$125m for each bank. Non-exclusive commitments or letters of support were not permitted and local and regional banks were not to be approached to support a bid.
To partly compensate for the restriction on the number of committed banks each bidder was allowed to secure prior to the bid date, ADWEA offered to undertake to arrange a US$250m facility from local UAE banks and bidders were free to assume that the terms and cost of such funding would be pari passu with the terms and costs of their committed banks.
Equally, however, bidders were required to assume that the terms and cost of uncommitted funding to be sourced from non-local institutions would be pari passu with the committed funding and to provide evidence to show that there would be sufficient market liquidity to source such funds on these terms.
Also, as in previous ADWEA transactions, bidders were permitted to include government supported debt with only outline term sheets and/or preliminary commitment letters but with suitable acknowledgements that the structure of the proposed transaction, including the mark-up of the project documents and the insurance arrangements, were acceptable to the government institution.
Early on in the bid process the consortium of Sumitomo Corporation (Sumitomo) and Korea Electric Power Company (Kepco) (together the consortium, advised by Consilium) formed a view that minimising the risk of raising additional funding post-bid was both efficacious to the consortium, since finance risk under the ADWEA model rests solely with the successful bidder, and likely to be a competitive advantage, since it would permit ADWEA to place a greater degree of certainty on the consortium’s financial assumptions and therefore on the levellised tariff included in its bid.
The cornerstone of the finance plan adopted by the consortium was therefore JBIC, which since its first involvement in the Taweelah B IWPP in 2005 had acted as the largest lender to all subsequent ADWEA I(W)PPs with the exception of Fujairah F1 for a total of more than US$4bn of committed funding under its Overseas Investment Loan facility.
The inclusion of Kepco in the consortium permitted access to Kexim’s similar Overseas Investment Credit facility. However, while Kepco had experience of Middle East IPPs through its pivotal role in the financing of the Al Quatrana IPP in Jordan, S3 was its first project opportunity within the UAE. However, JBIC and KEXIM have built a good working relationship through teaming together on other projects in the Asia-Pacific region and this allowed the knowledge and experience previously built up by JBIC to be efficiently transferred to KEXIM.
The final element of the finance plan was also to bring in NEXI, the Japanese overseas investment insurance agency. This allowed the proportion of the approximately US$1.1bn of debt required to be raised from commercial lenders on an uncovered basis to be substantially reduced to between 10% and 15% of the total requirement.
The combination of the low amount of uncovered commercial debt and the very attractive sweet:sour ratio with the covered tranche allowed the two supporting banks, BNP Paribas and Mizuho, to provide total commitments in excess of the minimum amount of US$125m each set out in the RFP while also providing competitive pricing.
The consortium wins
The consortium was successful in submitting the lowest levellised tariff at the end of July 2010 and was invited to commence negotiations with ADWEA. While the details of such discussions must remain commercially confidential it can be noted that the covered tranche was not included in the final financing and also that the pricing of the commercial debt was reduced between the bid submission date and financial close.
The fact that the two run counter to each other (in that increasing uncovered risk would generally lead to high commercial bank margins) reflects the improving market conditions during the negotiations as well as the fact that ADWEA was able to bring to the table an offer of a substantial committed facility from a regional bank in addition to the US$250m local facility it had undertaken in the RFP to arrange. The higher uncovered commercial bank debt facility was syndicated by the two lead banks prior to financial close so that a total of seven banks signed the common terms agreement alongside JBIC and KEXIM in May 2011.
While the finance package cannot claim to have been the sole determinant in ensuring that the consortium’s bid was successful, it did provide the sponsors with greater comfort on the risks associated with their bid bond and, following commercial close, development security. Moreover it provided ADWEA with greater certainty of the consortium’s ability to raise the necessary debt finance on terms consistent with or better than the bid assumptions.
Maximising the sources of government-supported funding allowed the consortium to circumvent the combination of (i) the limited underwriting appetite available in the prevailing commercial bank market at the time of the bid and (ii) the RFP restriction of only having two supporting commercial banks. Additionally, it provided a smooth transition from commercial close to financial close and favourable terms and conditions of finance not seen on an ADWEA I(W)PP since prior to the credit crunch of 2008.
The market going forward
However, this strategy was only available due to the composition of the consortium and its access to both JBIC and KEXIM funding. It does not, therefore, provide a ready template that can be adopted by all bidders on future transactions since it is predicated on being able to source a significant proportion of debt from outside of the commercial banking market. Equally, since financial close of the S3 project in May 2011 the bank funding market has reacted adversely to the growing crisis within the eurozone as well as continuing concerns about the health of the global economy.
There are already signs that a number of leading players in the Middle East project finance bank market are looking to reduce assets on their balance sheet in preparation for expected losses on peripheral eurozone government debt and are therefore taking a more cautious approach to underwriting exposure and scaling back appetite for new assets.
If this trend continues then it is likely that aggregate overall lending and underwriting appetite will reduce further. Procurers within the Middle East will need to mindful of potential market developments when structuring future project opportunities, both in terms of the overall size of projects, and therefore debt funding requirements, as well as any restrictions to be placed on the number of exclusive commercial banks each bidder is required to have and the level of committed finance they are expected to provide.