March of Progress:The evolution of global transaction banking

LIWA PLASTICS • COMMODITIES • SUPPLY CHAIN FINANCE

Volume 21 • Issue 3 • April/May 2016

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Feature: Middle East commodities

It is no secret that international oil exploration and production has

signi�cantly declined as a result of tumbling commodity prices. �is has in turn led to huge reductions in capital expenditure, and job layo�s reaching into the tens of thousands.

But oil production in the Middle East has continued at pace thanks to dramatically lower production costs compared to the rest of the world.

Lance Kawaguchi, Managing Director, Global Sector Head - Resources and Energy Group, Payments and Cash Management, HSBC, told Trade Finance that “the larger Gulf Cooperation Council (GCC) oil companies are not feeling the pain as much as reports suggest”.

He added: “It is true that the impact of lower commodities prices is being felt in the region, but not as much as in other regions. Outside of the Middle East, investment in oil has all but dried up and there is very little exploration activity taking place.

“�ere are two main factors behind this, the �rst being that their cost of production is a lot lower than the majority of their competitors, at around $8-9 per barrel. �e second is that these companies are making a conscious e�ort to maintain market share.”

While this has been bene�cial for corporates working in the region, it has also been welcome news for trade �nance providers.

Marco Ferioli, Italian export credit agency (ECA) SACE’s Middle East and North Africa area manager and head of the Dubai o�ce, said: “�e commodities downswing caused a progressive shift to �nancing tools not usually used by local �rms.”

Some companies have turned to the debt capital market to raise funds, said Ferioli. “Many of [these companies] don’t really have speci�c liquidity constraints or a lack of their own resources to �nance their business, but in a context of lower returns they decided to better manage their assets and use �scal leverage.”

As a result, banks and ECAs are seeing an uptick in interest for trade �nance from oil companies as cash-�ows dwindle. Trade �nance can be used to provide working capital to both producers and traders as well as enabling them to borrow against the value of future output.

Tahir Amed, head of Civil Defence Business at UK Export Finance (UKEF), told Trade Finance that “international oil companies that wouldn’t have worked with ECAs in the past are now looking for support”.

UKEF is seeing a tremendous amount of activity in the Middle East. 46% of the business it supported in FY 2014/15 was in that region, amounting to around £1.25 billion ($1.78 billion*).

Furthermore, a survey conducted by the International Chamber of Commerce (ICC)

Banking Commission in September last year highlighted that, while global trade has slowed, trade �nance has grown.

Vincent O’Brien, chairman of the ICC Banking Commission Education and Market Intelligence Group, said the increase was driven by risk. “�e perception of risk is going up. When there is an increase in the perception of risk, there is an increase in demand for the core trade �nance products – letters of credit, standby letters of credit and guarantees,” reported Middle East news provider, �e National.

�e total value of trade �nance transactions closed in the Middle East reached $42.2 billion during 2015, according to the Trade Finance Analytics league tables. Around 42.6% of this total was attributed to the energy sector, while 4.3% was in the metals and non-metallic minerals sector. A selection of commodities deals closed last year can be seen in Table 1.

While deals are clearly going ahead as a result of continued oil production in the Middle East, there has been an impact on the market dimensions.

Slick business: why the Middle East is key for trade financeWhile the international oil markets slump along with commodity prices, corporates in the Middle East have ploughed ahead with production. Concurrently, the requirement for trade finance is on the rise as governments look to diversify the economy and companies seek alternative forms of funding.

Emma Hughes, Executive Editor

Borrower Transaction Country Transaction Value (USDm)

Nogaholding Bahrain 570Qaiwan Group United Arab Emirates 105Kurdistan Regional Government Iraq 300Emirates Global Aluminium United Arab Emirates 4,900Abu Dhabi National Oil United Arab Emirates 3,300Attarat Power Company Jordan 1,623Jazan Air Separation Facility Saudi Arabia 1,700Emirates National Oil Company United Arab Emirates 1,500Dalma Energy Oman 78ORPIC Oman 909

Table 1: A selection of Middle East commodities deals closed in FY2015

Source: Trade Finance Analytics

Lance Kawaguchi, Managing Director, Global Sector Head - Resources and Energy Group, Payments and Cash Management, HSBC

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Feature: Middle East commodities

Rassem Zok, CEO, Middle East and North Africa, Standard Bank, told Trade Finance: “Falling commodity prices have impacted the dynamics of the trade �nance as some banks have been experiencing delays in repayments/recoveries under the usual trade �nance tools.

“Occasional delays in letter of credit payments have somehow altered the appetite, and rising awareness amongst the Middle East banks. It has certainly changed the market dimensions; trade �nance is going through an interesting path where new innovative techniques are being explored to safeguard interests of concerned parties.”

Zok also touched on how this is a�ecting the cost of funding and pricing of deals in the Middle East, telling Trade Finance that low commodity prices and its trailing e�ects have pushed the cost of funding upward.

“Impact of Basel III has added additional costs on capital allocation. In addition to these, with delayed payments, irregular or non-payment of obligation and skips by small and medium-sized enterprises (SMEs) has impacted the pricing and pushed it up compared to recent years, but there’s nothing dramatic in that,” Zok explained.

Shehzad Sharjeel, head, Global Trade Finance Program, IFC, told Trade Finance that, “�e oil price drop had left a positive impact on most of the oil importing countries in the region with reduced import bill and hence supporting their current account de�cit.”

“In terms of trade �nance, this price reduction resulted into reduced ticket size of underlying trade at banks’ end which resulted into higher limits availability for LC con�rmations. In some markets, we observed this excess limit availability translating into competition among banks, ultimately compressing the margins for LC con�rmations downwards,” Sharjeel added.

Anand Pande, product council head, Supply Chain and Trade Finance, iGTB, added: “It is the Middle East’s “real economy” corporations that will su�er the most from the knock-on impact – from the drying up of liquidity, as banks tighten up, as well as the widespread removal or reduction of government subsidies around oil, gas and electricity.

“�e facilitation of trade – as always – will be key to rejuvenating the economy. �at said, conventional trade �nance has become relatively stagnant in the Middle East. And while there is much discussion around supply chain �nancing, there is very little actual action – something we hope will change as banks become better equipped to educate their clients as to its application, and continue to leverage new technology to improve the overall customer experience.

Diversifying the economy�e increased requirement for trade �nance in the region does not just apply to the oil sector. Non-oil trade has also increased as a result of depressed commodities prices.

Countries in the Middle East have for centuries relied on oil as a major economic contributor. Indeed, the Middle East and North Africa leads the list of top 10 oil producers globally.

Saudi Arabia, the United Arab Emirates (UAE) and Kuwait hold approximately 460 billion barrels of crude oil reserves and produce more than 15 million barrels per day, according to a recently-published article by HSBC’s Kawaguchi.

But because of the decreased pro�t being made as a result of lower selling prices, governments in these – and other Middle Eastern countries – are now looking to diversify the economy in a bid to counteract sole reliance on oil.

Infrastructure & energyMajor investment is now being made in areas including transport, ports, power and desalination. �ese new areas of development are providing international companies – particularly those in Europe – with opportunities to export, which is in turn boosting the requirement for trade �nance.

More open deals made progress towards �nancial close in Africa and the Middle East during the �rst quarter than in any other region. �e biggest was the Kuwait National Petroleum Company’s $10 billion, seven-year loan to upgrade and expand the Mina Abdullah and Mina Al Ahmadi re�neries. In mid-March the company was nearing close on the local funding portion of the loan.

�e Middle East plays an increasingly important role for European companies as they look to expand their business and as the region looks to diversify its economy. �e export of European goods and direct investments in the region have continually increased over the past 10 years, according to Paolo Daino, a partner at BonelliErede.

“For instance, while European exports to the UAE and Saudi Arabia were worth €18.912 billion and €12.680 billion respectively in 2004; they amounted to €42.756 billion and €35.073 billion in 2014 (making the UAE and Saudi Arabia Europe’s principal export markets in the entire MENA region),” Daino told the International Chamber of Commerce ahead of its MENA conference on International Arbitration.

“More recently, the drop in oil prices has also a�ected the balance in the energy industry in the Middle East. Our lawyers have therefore been very active in supporting our clients in renegotiating a variety of contracts, ranging from supply and transportation of oil and gas, to the construction of energy projects,” he said.

In Dubai, this increase in non-oil project development has been particularly prevalent over the past 12 months. As a result, several trade �nance players have moved into the area, with SACE and the International Islamic Trade Finance Corporation (ITFC) both opening o�ces in the country this year. HSBC’s Louis Robinson, former trade sales head for corporate key account clients, has also relocated from London to Dubai in order to head the bank’s regional business development for UAE and MENA global trade and receivables �nance.

Ferioli told Trade Finance that “despite the challenges posed by the declining commodity prices, the Middle East – and the GCCs in particular – are likely to be one of the most signi�cant pools for exports and investments in the medium-long term for various Italian industrial sectors and consumer products”.

Ferioli said the company’s Dubai o�ce was managing a more-than €5 billion portfolio of insured transactions and guaranteed

Middle East oilDespite a more-than 60% drop in pro�t

since the oil price tumbled from over $100 per barrel in the �rst half of 2014 to around $40 per barrel by December that year, countries in the Middle East have been ramping up activities in areas of both production and e�ciency.

�e simplest explanation behind this stark contrast with the rest of the world’s reaction to crashing commodities prices is the cost of crude oil production in the Middle East.

Corporates in the Middle East are producing oil at around $8-9 per barrel, whereas countries such as the US produce at around $36 per barrel, Russia at around $20 per barrel and the UK as high as $52 per barrel, according to �gures from Rystad Energy.

In areas outside the Middle East, these production costs were sustainable when oil

prices were as high as $100 per barrel sold. However, when the commodities slump occurred in the second half of 2014, things began to get tough. Since then, prices have �uctuated but remain around the $40-50 per barrel mark, leading to the drying up of international investment and production.

�e low costs of production in the Middle East mean that there is still pro�t to be made. �ese low costs can be attributed to the fact that wells are mostly onshore, which means the drilling, transportation and maintenance costs are far cheaper.

Reserves are also large and have good �ow rates, meaning that little or no new exploration is required. In addition, the oil produced is often high quality and, owing to many government-owned operations, royalties do not need to be paid.

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Feature: Middle East commodities

investments – over 70% of which are concentrated in Gulf countries.

As well as considering projects in oil and gas, chemicals, petrochemicals, tourism, fashion, agro-foods, home furnishings and various industrial technologies, SACE is paying particular attention to infrastructure investments in Dubai.

In October last year, the Italian ECA signed two agreements in the UAE that will boost exports to the country.

�e �rst included a €1 billion line of credit, earmarked for the purchase of goods and services from Italian companies. It was signed with the Dubai Aviation City Council (DACC) and will sustain the exports and investments of Italian companies involved in the Dubai South projects, which comprise of an airport, aviation hub and commercial districts.

Ferioli told Trade Finance that SACE had also signed a memorandum of understanding with Abu Dhabi Ports, which provides for the assessment of major projects for Italian companies, particularly of those related to development of the Khalifa Port, the port of Abu Dhabi, and the free zone of Kizad.

UKEF is also seeing a “tremendous amount” of activity across the Middle East – in particular in Kuwait and Iran, the latter of which has opened up since sanctions were lifted. European companies are well positioned to take advantage of these new investment opportunities as the EU has historically been one of Iran’s key trading partners.

One such trade �nance deal was the UKEF-supported $913 million, 10-year, Sukuk (Islamic bond) signed with Emirates Airline last year. �is was the �rst ever Sukuk guaranteed by an ECA. �e deal was also the largest ECA-wrapped debt capital markets transaction in the aviation sector in 2015 and the �rst pre-funded trade with a UKEF guarantee.

Tahir Ahmed, head of Civil & Defence Business, UKEF, told Trade Finance that this project received signi�cant interest and was oversubscribed. �e ECA is open to considering further Islamic �nance products, he explained.

�e proceeds from the issuance were used to fund the acquisition of four Airbus A380-800 aircraft, which were delivered in April, May, June and July 2015. �e aircraft has been leased to and operated by Emirates.

“UKEF is now receiving queries for projects in the real estate and infrastructure sectors as governments in the Middle East look to diversify their economy,” Ahmed added.

For Atradius Dutch State Business, which o�ers export credit insurance and guarantees, the situation has changed over the past two years. Vinco David, head of international relations, development & marketing, told Trade Finance that back in 2014, Atradius had a long pipeline of oil and gas projects.

“Now it is considerably smaller, although we are still seeing new projects,” he said.

One of these projects is the $3.8 billion Liwa Plastics project debt facility (p13), which was signed with Oman Oil Re�neries and Petroleum Corp (Orpic) on March 2. �e deal comprises a $1.4 billion 15-year commercial facility and $2.38 billion of 16-year ECA-covered and direct loans.

Along with six other ECAs on the deal, which are providing varying amounts of funding, Atradius is providing $586 million. Nineteen commercial banks have also joined the deal, despite relatively tight pricing (between 200-250bp over Libor during the construction period. �e deal has an all-in price of around 300bp over Libor).

David explained that Atradius had to invest a lot in due diligence for the project owing to the low oil price situation.

“[We] had to take a view on the oil price in �ve years’ time when the project comes on stream. We have come to the conclusion that we can cover the project,” he said.

Alternative energy projects are also on the rise in the Middle East as a result of this need to diversify the economy, in particular in the renewables sector.

Karim Nassif, associate director at Standard & Poor’s, said: “Historically, subsidised fuel prices in the Gulf have put renewables projects – be it wind or solar among others – at an economic disadvantage compared with projects for fossil fuel plants. “However, lower government revenues stemming from falling commodities prices have prompted governments to tackle energy subsidy reform.

“Any reduction in energy subsidies to the power sector resulting in more cost-re�ective tari�s could improve the market for renewable �nancing, in our view,” he added.

Examples of such project deals closed in 2015 include the $800 million �nancing for the Negev Energy solar power project in Israel, $100 million �nancing for Scatec Solar in Jordan and the $129m �nancing of the Shams Ma’an photovoltaic solar power generating project, also in Jordan. All of these projects took advantage of trade �nance products.

It is true that governments in the Middle East are making a signi�cant e�ort to diversify away from oil, but the commodity remains important to the region. A willingness to invest in new infrastructure also applies to oil production. �is, in turn, boosts the requirement for trade �nance.

“For instance (…) UAE is pushing ahead with a plan to raise its oil production capacity to 3.5 million barrels per day within the next two to three years, plus make an investment of $25 billion in o�shore exploration,” HSBC’s Kawaguchi reports in a recently-published article.

Kawaguchi also references Saudi Aramco’s plans to continue with investments and avoid reducing upstream spending for at least the

next few years. He also mentions Project Kuwait, which will encompass production and export infrastructure upgrades, exploration expansion and new downstream facilities – both domestically and abroad.

“Collectively this e�ort is expected to boost the Emirate’s total oil production capacity to 4 million barrels per day by 2020,” Kawaguchi adds. �e commodity price slump has also enabled other commodity producers to progress operations that were previously deemed too expensive.

Metallic and non-metallic miners, for example, are taking advantage of the low oil price as logistics, re�neries and chemicals production are cheaper, Kawaguchi said.

The future�ere is clearly a ripe market for trade �nance in the Middle East as a result of increased export opportunities for new energy projects, combined with governments and corporates looking at alternative forms of lending to progress oil production.

In regard to future projects, SACE’s Ferioli told Trade Finance that “appetite for investments and more broadly on Gulf economies will depend on how long the prices remain depressed. Such a situation makes the role of �nance even more strategic”.

Standard Bank’s Zok, meanwhile, said: “�e Gulf region and the UAE in particular has really established itself as such an important corridor for trade �ows that recent commodity price declines will not a�ect volume and transactions to a very large degree.

“�is is certainly true for the India to Africa corridor as well as the Asia to Africa in general, plus all the inter-regional trade �nance �ows. �e outlook remains positive.”

Atradius told Trade Finance that it was not negative about the Gulf area – in fact, it is active across the region.

“We are taking a cautiously optimistic approach,” David said.

In general, the trade �nance market concedes that the commodity price drop has been an important lesson for the Middle East.

HSBC’s Kawaguchi concluded that the current situation is opening the eyes of many companies and has encouraged them to take advantage of technology and liquidity solutions to automate processes and improve their e�ciency.

�e upside is, he explained, that once these systems are in place, and an uptick in commodity prices eventually occurs, corporates will be much better equipped.

In partnership with Euromoney Seminars, Trade Finance will host the inaugural Middle East Export & Agency Finance Conference in Dubai on June 1-2 2016. For more information, or to book your place, please visit tradefinanceanalytics.com/events.

*Conversion made in April 2016