Trends of Project Finance in the World Market and in Arab Countries

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Trends of Project Finance in the World Market and in Arab Countries

M. K. Mohammadia

Damascus University, Syria; Saint-Petersburg State University, Saint-Petersburg, Russia

ABSTRACT

Over the years, project finance has proved to be one of the innovative techniques in bridging the resource constraints faced by most governments in financing Large developmental investments. In this regard, the current state and dynamics of indicators of the world project finance market, as well as the role and place of the Arab economy in this global phenomenon, are interesting. The aim of the article is to review the features of project financing in the world and in Arab countries, mainly in the GCC region. The article employed the methods of statistical analysis, regression modelling. The author analysed historical data on the volume, dynamics, and structure of project financing in the GCC countries. The study revealed the use of project finance in 18 Arab countries, primarily concentrated in three areas: energy and water supply, petrochemicals, and the oil and gas industry. The author concluded that there is a growing tendency to use Islamic project finance structure.

Keywords:project finance; Islamic project finance; Gulf Cooperation Council (GCC)

Тенденции проектного финансирования на мировом рынке и в арабских странах

М. К. Мохаммадия

УниверситетДамаска, Дамаск, Сирия; Санкт-Петербургскийгосударственныйуниверситет, Санкт-Петербург, Россия

АННОТАЦИЯ

Проектное финансирование на протяжении многих лет стало одним из инновационных методов преодоления ресурсных ограничений, с которымисталкиваетсябольшинствоправительствприфинансированиикрупны инвестиций в развитие. В связи с этим интересны текущее состояние и динамика показателей мирового рынка проектного финансирования, а также роль и место арабской экономики в этом глобальном явлении. Цель статьи - обзор особенностей проектного финансирования в мире и особенно в арабских странах, в основном в регионе GCC. Использованы методы статистического анализа, построения регрессии. Автор проанализировал исторические данные об объеме, динамике и структуре проектного финансирования в странах GCC.Результаты исследования показали, что проектное финансирование использовалось в 18 арабских странах. В основном оно сосредоточено в трех областях: энергетике и водоснабжении, нефтехимии и нефтегазовой промышленности. Сделан вывод, что наблюдается растущая тенденция использования исламской структуры финансирования проекта.

Ключевые слова:проектноефинансирование; исламскоепроектноефинансирование; Советсотрудничестваараб скихгосударствПерсидскогозалива (ССАГПЗ)

INTRODUCTION

Project finance has over the years proved to be one of the innovative techniques in bridging the re source constraints faced by most governments in financing large developmental investments, it is an efficient way to fund capital-intensive and strate gically important projects such as long-term infra structure, industrial, or public services.

Despite the increasing trend in using project finance in the world, published empirical studies on the topic are limited [1]. The majority of these published articles and working papers are theoreti cal rather than practical studies, focusing primarily on a detailed examination of individual narrow as pects such as risk management, types of interaction schemes used between participants, contractual framework, and credit structure. funding arab region regression

P. Nevitt [2] was one of the first authors who justified the concept of project financing, present ing the general theory of project financing. Many texts (S. Gatti, F. Fabozzi, A. Fight, M. Khan, R. Parra, M. Morrison) [3-7] contain detailed descriptions, analyses, and examples of project financing. The works by B. Esti [8, 9] are highly specialized and mainly devoted to risk analysis. While the materials published by international financial organizations, such as the World Bank [10], are mostly presented in the form of databases, which should be analyzed by the reader.

Kleimeier and Megginson [11] indicated that project finance is mainly used in infrastructure and the utilities sector, where it is easy to create project structures with clearly identified cash flow streams. Kleimeier and Versteeg [12] argued that project finance can offset the lack of institutional and finan cial development and it can be well adapted to the least developed countries. Based on empirical data analysis of data from 90 countries, they found that project finance was a powerful driver of economic growth in low-income countries.

The work by H. Davis [13] consists of 38 case studies of project financing covering energy, water, resources and infrastructure projects in a variety of countries, which illustrate different aspects of project finance across the world.

Among the works devoted to project finance in Russia, it is necessary to note the works by I. Nikono va, A. Smirnov, G. Kalmykova, V. Kasatonov, D. Mo rozov, Eh. Fait, V. Fauzer, I. Rodionov, etc [14-19]. They examined the main features of project financing, presented practical examples of project financing in the CIS and abroad. The modern tools for manag ing risks arising from the implementation of large investment projects, and ways to minimize them are described.

Existing literature suggests many definitions of project finance. Triantis defines project finance as the art and skill of piecing together new busi ness development elements, financial engineering techniques, and a web of contractual agreements to develop competitive projects and make the right decisions to raise funding for industrial or infra structure projects on a limited/nonrecourse basis where lenders look to the cash flow for loan re payment and the project assets for collateral [20]. While Finnerty contends that project finance may be defined as the raising of funds on a limited- recourse or nonrecourse basis to finance an eco nomically separable capital investment project in which the providers of the funds look primarily to the cash flow from the project as the source of funds to service their loans and provide the return of and the return on their equity invested in the project [21].

So, the principles of project finance can be sum marized as [22]:

• The project usually relates to major infra structure with a long construction period and long operating life. Therefore, the financing must also be for a long term (typically 15-25 years).

• Lenders rely on the future cash flow projected to be generated by the project to pay their interest and fees, and repay their debt.

• There is a high ratio of debt to equity (`lev erage' or `gearing') -- roughly speaking, project fi nance debt may cover 70-90% of the capital cost of a project.

• The Project Company's physical assets are likely to be worth much less than the debt if they are sold off after a default on the financing, and in projects involving public infrastructure they can not be sold anyway.

• The project has a finite life, based on such factors as the length of the contracts or licenses, or reserves of natural resources. So, the project- finance debt must be fully repaid by the end of the project's life.

• There are no guarantees from the investors in the Project Company for the project-finance debt. This is `non-recourse' finance.

The synthesis and analysis of data on project financing is significantly complicated due to the difficulty of identifying compliance with the above characteristics. In fact, the only formalized source of information on a systematic basis is data on loans attracted for project purposes.

THE DEVELOPMENT OF PROJECT FINANCING IN THE WORLD

The analysis of the state of the global market for project finance allows us to state that in recent years there has been a clear trend of growth in the use of this type of financing.

The synthesis and analysis of data on project financing is significantly complicated due to the difficulty of identifying compliance with the above characteristics. In fact, the only systematic source of information that can be formalized is data on loans attracted for project finance purposes, which are often classified according to the purposes of obtaining a loan declared by the borrower. This in formation on transactions is available at several organizations including Thompson Reuters and Dealogic, which publish regular information of deal activity and compile league tables summarising the activities of the key players in the market. Table 1 summarises the project finance market information for 1995-2018 from Thompson Reuters.

The analysis of the volume dynamics of project finance transactions in the global market allows us to state that in recent years, the use of project finance has grown dramatically from $ 23.33 bn per annum in 1995 to reach a peak of $ 282.7 bn in 2018, financing around 11000 transactions in 158 coun tries, with a total amount of project finance raised between 1995 and 2018 amounting to $ 3771 bn. The USA with $ 578.7 bn accounts for most project finance (followed by Australia $ 370.2 bn and the UK $ 313.3 bn).

The project finance market before the financial crisis from 2000 to 2008 can be characterized based on the following data:

• total project finance loans amounted to $ 1259 bn;

• a total of 4325 loans were granted to finance projects;

• the average annual growth rate of financing was 19.2%.

Using this type of financing had been a clear trend of growth until 2008, when this sector of the

international financial market reached $ 250.6 bn. However, in 2009 the volume of project finance in the world fell back to the 2005 level, decreasing by 44% compared to 2008 due to the global financial crisis, amounted to $ 139.2 bn which was the lowest figure in the last 15 years.

The project finance market after the financial crisis from 2010 to 2018 can be characterized based on the following data:

• total project finance loans amounted to $ 2210.2 bn;

• a total of 6262 loans were granted to finance projects;

• the average annual growth rate of financing was 9.7%

This form of financing has also been used ex tensively in emerging economies such as in China ($ 34.7 bn) and India ($ 274.8 bn). Since 2005, India has been among the top ten countries attracting project finance. India ranked on top in the global project finance market in 2009, 2010 and 2011, ac counting for 21.5%, 26.3%, 21.05% of the global project finance market respectively, ahead of the UK, Australia, and the USA.

According to Thomson Reuters, from an industry perspective on the international project finance market, the energy sector has been the leading sector in applying project finance since 1995. It has accu mulated at least 30%, reaching a maximum of 53.5% in 2017, except 1997, when the telecommunication sector took first place (27.6%) ahead of the energy

sector (24.9%). While in recent years, the oil and gas industry and the transport sector have shared the second place with an average value of 20% for both industries from 2009 to 2018.

In 2018, the main industries that used transac tions involving project financing were the energy (48.7%, $ 137.63 bn), oil and gas (19.1%, $ 54.07 bn), and transport (17.9%) ones, as shown in Fig. 1. These fairly capital-intensive sectors form a significant part of the national infrastructure, have predictable sources of income, which makes them suitable for project financing [23].

On a regional basis, the distribution of the trans actions by region is shown in Fig. 2 for the period of 2007-2018. The market is divided into the Americas, EMEA (Europa, Middle East and Africa) and Asia Pa cific. Until 2009, EMEA was the leader in the number and volume of project finance transactions followed by the Asia-Pacific region. Asian project finance ac tivity has been particularly driven by infrastructure finance in India and the natural resources sector in Australia [24]. In 2011, India and Australia made up one-third of the project loans market. When the global financial crisis happened, the reduction in the volume of transactions in the European region and the Asia-Pacific region took the first place for the years from 2010 to 2012.

However, since 2013 and today, the sector of the EMEA region has again dominated, with an average of 41.19% of the global market for 2013-2018. The majority of transactions are conducted in UK, France, acteristics. Such a study will allow us to establish a relationship between the growth of project financing and global GDP.

Sizeandnumberofprojectfinancetransactionsin 1995-2018

Table 1

Source: author's calculations according to the PFI League Tables. URL: http://www.pfie.com/ (accessed on 05.12.2019).

Fig. 1.Sectoralstructureoftheglobalmarketforprojectfinancein 2018

Source: author's calculations according to the PFI League Tables. URL: http://www.pfie.com/ (accessed on 05.12.2019).

It can be assumed that the relationship between global GDP and project finance is direct, which can be described by the equation of the line. To establish the parameters of the linear regression equation y= a + b * x, we used the built-in statistical function (linear), which allowed us to establish the value of coefficient b, coef ficient a, determination coefficient R².

Fig. 2. The distribution of project finance transactions by region for the period of 2007-2018 ($ bn)

Source: author's calculations according to the PFI League Tables. URL: http://www.pfie.com/

Y= 209 * X + 23508.

R² is 0.78, which is fairly good. It means that 91% of our values fit the regression analysis model.

Global GDP from 2001 to 2018 ($ bn)

Source: World Bank data. URL: https://data.worldbank.org/indicator/NY.GDP.MKTP.CD (accessed on 05.12.2019).

Table 3

The annual volume and number of transactions of project finance in the Arab world from 1995 to 2018

THE DEVELOPMENT OF PROJECT FINANCING IN THE ARAB World

Arab countries are not the most developed markets considering the examples of project financing com pared to European countries or the USA. However, the Gulf countries stand apart. They have become a popular investment destination, given their exten sive energy resources and rapidly growing popula tion. There is still a huge need for infrastructure (including energy, water treatment and sewage) throughout the region.

Table 3 illustrates the evolution in the volume of transactions carried out in all Arab countries from 1995 to 2018 and their share in the global volume. The project finance market boomed in 1996 and rose from virtually nothing to about $ 5 bn with 11.5% of the global market. Then, the market stayed almost stable with less than 10% of the global market share until 2004, when the project finance loan market increased by 134% compared to 2003 and jumped to $ 18.25 bn which was 15.7% of the global market. The volume oftransactions continued growing in Arab countries until 2008. The 2008-2009 financial crisis had a sizeable impact on energy prices and, by association, on the development of energy and non-energy infrastructure where volumes decreased dramatically from about $ 40 bn in 2007 to just below $ 26 bn in 2008. A similar fall occurred in 2009, when the loan volumes dropped to about $ 12 bn. The volume of transactions fluctuated significantly in the last decade dropping off to 9.13 bn in 2012 and peaking at $ 27.51 bn in 2016. Fig. 3 lists the total volume of project finance for each Arabic country from 1995 to 2018.

Project financing is booming in Saudi Arabia, leading Arab countries to transactions. About 32% of the projects took place in the Kingdom of Saudi Arabia, the largest economy in the region with 85 transactions worth more than $ 104 bn, followed by Qatar (17%), the United Arab Emirates (16%) and Oman (12.5%). Together, the Gulf Co-operation Council (GCC) account for 86% of the total Arabic project finance market.

Numberofprojectsbyindustryandcountryfrom 1995 to 2018 (sizein $ bn /numberoffinancedprojects)

Table 4

Source: author's calculations according to the PFI League Tables. URL: http://www.pfie.com/ (accessed on 05.12.2019).

Project financing in Oman has emerged as the preferred alternative to conventional methods of financing infrastructure and other large-scale pro jects in the field of oil and gas pipelines, refineries, electricity generating facilities and water and de salination projects.

Islamic finance made up nearly 40% of the total project finance market in the GCC in 2015 compared to just over 12.5% in 2006 [27]. Islamic project fi nance is basically the same as project finance -- it is a financial technique that involves financing of the entire or partial capital needed to fund a project. However, Islamic project finance requires that the purpose of the project and the financial schemes are consistent with Sharia. For instance, investment objectives must not be related to gambling or sale of pork or spirits, which are prohibited by Sharia law. Also, financial schemes cannot involve interest-based lending, and cannot include unclear terms of contract

Islamic financial institutions therefore have to design their financial structure so that profit is generated from commissions and rental fees through actual trading, without collecting interest [28].

CONCLUSIONS

In light of the above analysis, the world market reflects wide variations in the field of project fi nancing. The article sheds light on the Arabic experience in the project finance market. This mechanism has been used in 18 Arab countries, the member states of the Gulf Cooperation Coun cil (GCC), given its extensive energy resources to be actively engaged in project finance transactions, enhancing their role in the global economy. The transactions have primarily been used in three ar eas: energy and water supply, petrochemicals, and the oil and gas industry. Moreover, one can notice that project finance in the GCC region is witness ing a growing trend of using Islamic project finance structure.

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