Almost all of these deals were in the utilities space and, as one would expect, the payment structure was different from what would typically be seen in a PPP project. Payments were generally structured on the basis of a capacity payment and output payment. Capacity payments were linked to the availability of the asset. In the case of an independent power project, the power plant would be tested and if the capacity was found to be less than the agreed “contracted capacity,” a financial penalty would be assessed resulting in a reduction of the tariff payments. As far as output payments were concerned, payments would be made in respect of the actual services delivered. For example, in the case of an independent water project, payments were made by reference to the volume of water produced and supplied.
In contrast, the payment structure under a typical PPP project is predicated on the basis of a unitary charge. A unitary charge is the periodic amount payable to a project company in exchange for the performance of its full obligations under the PPP Agreement. Full performance can be determined by reference to availability, and in this respect it is conceptually similar to capacity payments under a BOO or BOT project. Where there is sub-standard performance or a lack of availability, deductions are made depending on the level of failure. The meaning of availability will depend on the nature of the PPP project. In some sectors, the services are broken down into units. Availability is then applied to each unit and payment of the unitary charge will fluctuate as the availability of each unit fluctuates. If some units are more critical than others, the deductions or penalties can be weighted to reflect the criticality of the unit.
Although there are differences between the payment arrangement under a PPP project and the deals listed above, the question is whether those deals are the right starting point for structuring a PPP deal in Saudi Arabia. There is no shortage of PPP deals around the globe that could conceivably be used as a precedent. For example, in the UK, the Treasury Department has developed a very detailed set of guidelines and principles for PPP projects that have been used as a template by governments around the world.
A risk of introducing a new model to Saudi Arabia is that the local banks, and perhaps also the international banks, may not be familiar with how that model would work in the context of the Kingdom, particularly against the backdrop of Sharia law. In that context, it would seem prudent to use some of the above Saudi precedent deals as a starting point, with necessary modifications.
Regulatory Regime
If the private sector is to be encouraged to invest in PPP projects, it will want sufficient comfort that the relevant sectors will be subject to proper regulation. The issue, however, will be one of timing. Establishing a regulatory regime for each of the relevant sectors will take time – possibly years. The private sector consultation process alone would create unexpected issues that would have to be thought through carefully. Only once the regime is in place, would one expect to see the first project floated.
Nevertheless, there is precedent in Saudi Arabia for the regulatory regime to be fully installed after the first deal achieves financial close. This was the case in the independent power and water sectors, in which regulations for the Electricity and Cogeneration Regulatory Authority were issued after the first IWPP (Shuaibah) closed. In that case, interim measures that served as a quasi-form of regulation provided sufficient comfort to the private sector and international banks that the government fully supported the project.
Given the current desire to cut public spending and float the first PPP projects in the very near future, it will be interesting to see if the government takes the same regulatory approach as under the Shuaibah IWPP.
Credit-Worthy Off-Taker
It is not yet clear how the PPP projects will be structured and, in particular, the identity of the off-takers. In nearly all of the projects mentioned above, there was either a credit-worthy off-taker or a sovereign guarantee provided by the government. In the case of Saudi Aramco projects, the lenders took comfort from the strength of Saudi Aramco's balance sheet. The same applied to Saudi Electricity Company independent power projects where several billion dollars of deals have been project financed. In the Shuaibah and Shuqaiq independent power and water projects, a sovereign provided the guarantee.
There have been exceptions to the general rule. In one of the deals mentioned above, there was neither a financially robust off-taker nor a sovereign guarantee. However, when the request for proposals was issued for that project, the documentation envisaged that the off-taker and project company would enter into an escrow agreement. The intention was for the off-taker to deposit a sum of money into an escrow account. This essentially meant that if the off-taker failed to make a payment that was contractually due and owing under the off-take agreement, the project company would be entitled to draw down on the escrow account without any objection from the off-taker. The off-taker would then have to replenish the escrow account. Failure to do so would trigger an entitlement on the part of the project company to terminate the off-take agreement. This essentially provides comfort to the banks where the off-taker fails to make a periodic tariff payment. What it does not address, however, is the failure of the off-taker to pay out the lenders for any outstanding debt in the event of the termination of the off-take agreement. Nonetheless, the deal in question was successfully banked.
In a very small number of cases, deals were closed with an off-taker that was not considered to be financially robust and where there was no sovereign guarantee or escrow account. In many respects, these deals contained a number of unique features that helped facilitate the viability of the structure and the achievement of financial close.
Conclusion
The Kingdom clearly has a big challenge. However, there appears to be full support for the privatization program from the highest levels within the Kingdom, which is encouraging.
There are a number of key threshold issues that must be addressed, most notably the model to be adopted, the regulatory regime and the identity of the off-takers. Despite the challenges, it is an inescapable fact that Saudi Arabia has an impressive track record of structuring and closing multi-billion dollar financings, quite often involving international banks. The current sentiment is that there are no reasons why the PPP program will not succeed, provided these threshold issues are properly addressed.
