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APICORP’s review of MENA energy investment for the five-year period 2014-18 has estimated total capital requirements at about $765bn (see box, p20). Concurrently, the review has established that, among the major issues facing investors and policymakers in this respect, financing remains the most challenging. To explore this question further and provide new insight, this commentary discusses in three parts current trends and patterns in financing large-scale projects along the main links in the oil, gas, and power supply chains. The first part outlines the normative and conceptual underpinning of the approach. The second tests the aggregate leverage assumption in the context of a negative loan supply shock, while the third part discusses some of the resulting financing issues and challenges.
NORMATIVE AND CONCEPTUAL UNDERPINNING
Financing is at the core of corporate strategies and investment decisions. It is essentially determined by the structure of capital requirements. Using normative leverages, or debt-to-equity ratios, for the main links in the energy supply chain, we have established that to finance MENA current five-year investment a mix of external and internal capital sources in a proportion of 33% and 67% respectively will be needed. The normative and conceptual underpinning of this structure is illustrated in Figure 1.
Equity is a dominant feature of the oil and gas upstream and midstream industry as well as the power transmission and distribution systems. As easily inferred from Figure 1, equity amounts to $103bn per year. It is sourced internally through companies’ retained earnings and complemented in a significant manner by state budget allocations to national oil companies (NOCs) and public power utilities.
In contrast to equity, debt is a dominant part of the downstream industry, which has been extended beyond refining to include petrochemicals, LNG, GTL, and power generation. As similarly inferred for equity, debt amounts to $50bn per year. It is sourced externally mainly from the loan market (credits from domestic, regional and international banks, multilateral institutions and export credit agencies or ECAs), as well as from the capital markets (bonds and sukuk).
Whenever possible and affordable, MENA energy corporations and their international partners would consider using the full range of financing options available to them in the different markets. Before addressing the issues and challenges this raises, it is worth examining how far our normative aggregate leverage ratio departs from the empirical reality, and then justifying it.
LEVERAGE AND THE LOAN SUPPLY SHOCK
The aggregate normative debt-to-equity ratio of 33:67 for the MENA energy sector as a whole differs somewhat from recently observed capital structure patterns. As shown in Table 1, while it is comparable to the current global ratio of 32:68 for all enterprises of economic sectors, it is relatively high compared to the actual ratio for MENA all enterprises of 20:80, and much higher than the 18:82 realized within MENA energy sector.
One explanation for this deviation is that, the region’s internal financing (from retained earnings and state budget allocations) has been more easily available than external financing, particularly loans. It is worth noting in this regard that while MENA energy investment represents more than 10% of global energy investment, loans to the energy sector, the bulk of which in the GCC area, represented only 2.2% of the total loans extended to the world’s energy industries. It so happens that this pattern is similar to that observed in all industry groups in the region (Table 2).
The limited availability of loans to the MENA region begs an immediate explanation. Suffice to say that since the onset o20the global financial crisis, loan supply has been markedly restricted. While central banks’ ultra-loose monetary policies have helped stabilize the money markets, their impact on the real economy has rather been limited. Indeed, commercial banks, through which monetary policies are implemented, have largely failed to support growth by providing much needed credit. Instead, they have focused efforts on rebuilding their capital reserves to mitigate persistent financial market uncertainty and prepare for the stricter Basel III capital requirements. Those involved in MENA have further been facing adverse political developments and geopolitical tensions, which have dampened their appetite for risk. In this context, loans to the region have collapsed after banks significantly reduced their exposure or completely pulled out from several countries. Accordingly, loans to all MENA economic sectors nearly halved from $101bn in 2010 to $55bn in 2012. They recovered slightly to reach $72bn for 2013, due to the increasing involvement of domestic and regional banks as well as ECAs.
Looking ahead, we expect to see actual MENA leverage increasing for two main reasons. The first, developed more fully in the next section, is that the leverage could rise in the likely instance of internal financing tightening as a result of oil prices falling below current OPEC fiscal break-even levels for a sustained period. The second reason is that a higher leverage could be held as there are now signs that international commercial banks are becoming active again in the region’s syndicated loan market.
Table 1: Recent Surveys on Access to Financing
|. Banks and ECAs||22||11.4||13.7|
|. Stock sales||5.2||2.8||0.1|
Table 2: Global and MENA Loan Financing in 2013
|All industry groups||Energy' group|
|World corporate volume*||3,332.30||100.00%||982||100.00%||29.50%|
|MENA within World||72.4||2.20%||21.2||2.20%||29.30%|
|GCC within MENA||69.7||96.30%||19.5||92.00%||28.00%|
*Out of a global syndicated volume of $4,251 bn. APICORP Research, using Dealogic database.
CRITICAL FINANCING ISSUES AND CHALLENGES
Having put the normative leverage assumption into perspective and justifying its high level, we now provide a more thorough discussion of the issues and challenges associated with funding the resulting internal and external financing needs. As far as internal financing is concerned, we have already noted that it has so far been easily provided for through corporate retained earnings and state budget allocations. In particular, oil and gas exporting countries have been able to extend such financing as long as world oil market prices remained above their fiscal break-even levels (see Figure 2 and MEES, 26 July 2013). The likelihood in this regard is that oil prices risk receding on lower demand for OPEC oil and resulting higher spare capacity. Even so, however, the funding risks facing these countries will differ depending on their relative position on the fiscal cost curve. The higher above market price their fiscal cost will be, the more funding requirements will have to be met by external financing instead.
Internal financing shortfalls will lend more support to the assumption of an annual level of $50bn debt requirements and make external financing more challenging. As shown in Figure 3, this amount was met only once, in 2010, when the debt market was at its apex. With still limited opportunities for raising funds via the capital markets and further inadequacies of the private equity funds industry, external financing has mainly been provided through the loan market whose performance has recently been improved thanks to the involvement of ECAs.
Obviously, the challenge is very manageable in countries that have relatively easy access to bank credits as is the case with the GCC countries. Figure 4 shows that on an accumulated basis, between 2010 and 2013, the GCC countries accounted for 82% of total loans to the region’s energy sector, with Saudi Arabia alone, representing 37% of MENA total. As suggested by Table 2, in most recent years these shares were even higher.
As a matter of fact only Saudi Arabia, the UAE and Kuwait can be said to have not experienced any serious loan problems, neither on the demand side, nor on the supply side. Conversely, among the countries whose energy sector has virtually been absent from the loan market are the notable cases of Qatar, Egypt and Iran, each for a different reason. Reduced loan demand in Qatar stems from the shrinkage of investment in its natural gas industry in line with a long-standing policy moratorium on further development of its super-giant North Field. In Egypt – as in other countries seriously affected by the Arab uprisings – the supply of credit has dried up due to heightened country risk. In Iran stricter sanctions targeting primarily the energy sector have completely blocked access to the international financial system.
Although less important than the loan market as a source of external financing, the bond and sukuk markets continue to mainly serve the government sector and the financial industry. Otherwise, only a group of relatively large energy corporations, mostly based in the high sovereign-credit-rated UAE, Saudi Arabia and Qatar, can appeal to the risk-averse domestic and foreign investors (Figure 4). At the end of 2013, the dozen or so corporations forming this group represented about 10% of the region’s nearly $250bn corporate bond/sukuk outstanding (according to a Markaz Research study), with the UAE accounting for the lion’s share.
The next alternative is financing energy investments through private equity funds. The few such partnerships that ventured into MENA energy business have mostly avoided the cyclical segments of the oil and gas industry focusing instead on energy services, utilities and most recently renewables. Both their number and investment size remain too small to make any significant contribution at the aggregate level.
Last, and unfortunately least among all alternative sources, is external equity financing. Regrettably, only a small number of energy corporations are listed on the stock market and among them, less than a handful have been involved in selling stock to raise funds for expansion, mostly in the Saudi market. Accordingly, the portion of rights issue in funding MENA total energy investment has been less than one percent, too low to be of statistical significance or to constitute a pattern worth probing in the context of this commentary.
To highlight some of the critical issues and challenges involved in financing current MENA energy investment programs of some $765bn, an aggregate capital structure of 33% debt and 67% equity has been normatively defined and assumed to be valid in the medium term. Although this level of leverage is higher than that empirically observed since the onset of the financial crisis, it can be justified by the prospect of internal financing tightening as a result of market oil prices declining durably below current OPEC fiscal break-even levels. It is also likely to be held in the wake of a revival of the regional syndicated loan market.
In such a case the burden of financing would fall increasingly more on the debt market. To be sure, the steady growth of the bond and sukuk markets in the region has somewhat reduced constraints on debt supply and lessened sourcing efforts particularly in key GCC countries. However, in nearly all other countries, the supply of debt could fall short of demand if the region’s loan market does not fully recover and/or access to the bond/sukuk markets is not assured. The challenge will be even more daunting when considering anticipated higher future costs of debt. Hence, in the face of increasing aggregate capital requirements, funding availability, accessibility and affordability will hardly be achieved without a larger and sustainable fiscal space as well as deeper regional capital markets.
*Ali Aissaoui is Senior Consultant at the Arab Petroleum Investments Corporation (APICORP). This article is published concurrently in APICORP’s Economic Commentary dated March 2014. The views expressed are those of the author only. Comments and feedback may be sent to: [email protected]