Credit rating agencies at war

Ratings analysts wield remarkable power in the Gulf. On the back of their opinions, international banks give the green light - or not - to the region's multibillion-dollar construction projects. These ventures are the lifeblood of the regional economy, so the thumbs down from ratings analysts can have a devastating impact on an entire country.

Normally, it's a straightforward process. Analysts at rival agencies crunch the same numbers, throw in the same political risk analysis and come up with more or less identical ratings. When one agency changes a rating, the others almost always follow suit (witness the virtual simultaneous downgrades by agencies during the recent Bahrain International Bank crisis). For lenders and investors, it's easy to know what to do when all the analysts agree.

But what should they do when one analyst says 'stick' and the other says 'twist'? Investors have wrestling with this dilemma since rivals Moody's Investors Service and Standard & Poor's (S&P) issued conflicting advice on Qatar's prominent RasGas LNG plant.

In February, Moody's downgraded RasGas after the plant's insurers slashed its terrorism cover in the face of mounting regional tension. Moody's cut its RasGas' rating to Baa3, from Baa2.

'While [RasGas] maintains significant liquidity including a six-month debt service reserve, the combination of this liquidity plus any proceeds from insurance may not fully cover the estimated maximum loss that could arise from a terrorist attack,' said Moody's. (Since RasGas renewed its insurance policies late last year, terrorism cover has been just $100 million. That is tiny compared to the book value of its onshore assets, which Moody's puts at about $1.6 billion.)

Standard & Poor's took the opposite view. Like Moody's, S&P reviewed its RasGas rating in the light of the insurance development. But S&P analysts decided that nothing much had changed. 'Standard & Poor's has concluded that the replacement insurance policies will provide adequate coverage,' said a statement. S&P maintained its BBB+ rating, with a stable outlook.

What does all this mean for RasGas, and other megaprojects in the Gulf's investment pipeline? If banks take the Moody's line, the consequences could be dire. Downgrades make projects more expensive to finance, as banks demand higher interest rates to offset the increased risk. And that could lead to some regional projects being shelved. Western and Japanese banks that finance most Gulf projects are already jittery about the threat of war in Iraq on the doorstep. A high-profile rating downgrade will have done little to lift their mood.

'The [banks] are taking a pretty cautious approach,' says Darren Stubing, chief bank analyst at ratings agency Capital Intelligence (CI). 'At the moment, any project looking for funding will have to pay slightly more.' CI does not rate RasGas, but the Cyprus-based niche operator is a major player in the Middle East ratings world.

As result of this caution, sources in the Gulf say some projects are being unofficially put on ice. Project managers fear that if they negotiate loan terms now, they may be stuck with high interest rates for years. The difference may only by 10 or 15 basis points (0.1 percent or 0.15 percent), but on a 20-year loan for $1 billion, that makes a big difference.

'Some project managers are holding back,' says Stubing. 'And those that are committed are seeing a slight increase in their funding costs.'

Qatar alone has a host of projects that could fall victim to an interest rate hike. RasGas - 70 percent owned by state-owned Qatar Petroleum (QP), 30 percent by ExxonMobil - is planning to more than double output capacity over the next four years. Sister LNG operator QatarGas has similar aspirations.

Major investments are also on the cards in gas-to-liquids, petrochemicals, oil production and the Dolphin gas export pipeline to the UAE and beyond. Together, the finance bill is estimated at close to $10 billion.

Clearly, Qatar is not the only country affected - although the government's ambitious development of its gas industry makes it the most active borrower on the international markets. And the effect is not uniform across the Gulf - Moody's left its A3 rating of Oman LNG unchanged following the review that led to the RasGas downgrade.

But even in Oman, raising project finance is increasingly difficult. 'It is not a good time now to raise finance for projects because everybody is concerned about the war,' Abdul Kader Askalan, chief executive of Oman Arab Bank, said in mid-February. Omani projects currently seeking funding include the Sohar Refinery, which is looking to raise $1 billion to build a plant in the northeast of the country.

A sharp slowdown in the development of megaprojects like Sohar and RasGas would have serious implications for the Gulf economy. Multibillion-dollar energy and infrastructure projects are the main engines of growth in most Gulf states, and any delay will hit local contractors hard.

So will investors write off 2003 altogether? Far from it. War fears - epitomized by the Moody's downgrade of RasGas - will certainly have an impact, but they will not bring investment to a halt. Especially if lenders and investors take the more optimistic S&P line.

Fitch Ratings - the fourth significant player in the Middle East ratings arena - is also bullish. In late February, Fitch published a report stressing that it was leaving its Middle East sovereign ratings unchanged, despite the looming threat of conflict in Iraq. 'A war in Iraq, if it were short and did not spill over into neighboring states, would not result in rating changes for sovereigns in the Middle East,' said a spokesperson.

Perhaps the most significant bellwether of investor confidence is the market for regional bonds. The secondary market for internationally traded Middle East bonds remains buoyant - there has been no mass sell-off in the face of possible war.

'There has been talk [of war] in the market for five or six months now,' says Salem Saadeh, head of debt asset management at Dubai-based investment bank Shuaa Capital. 'At the beginning there was some weakness in the market. However, since then [bond prices] have been holding these levels. At the moment, all of the debt issues are range bound.'

A number of factors underpin this confidence. First, high oil prices since 2000 have supported strong economic growth throughout the Gulf - in sharp contrast to the West. Partly as a result, regional banks are stronger than ever.

One or two institutions have come under pressure after major Western lenders cut vital credit lines. But by and large, the sector is in a much stronger position than during the Gulf War 12 years ago, when local banks were forced to sell their bond portfolios. 'Most of the banks in the region are highly liquid - much more so than in 1990,' says Saadeh.

Three Middle East governments have successfully sold new bond issues in recent months. Iran placed a bond in December, with Bahrain and Tunisia raising money in the debt markets in early 2003. Together, the three issues raised more than $1 billion from international investors.

It is clear that both bulls and bears can call on evidence to back up their positions. But it would be wrong to overstate the extent of their differences. Moody's only downgraded RasGas by one notch, and acknowledges that the company still has much to offer.

Ultimately, investors must back their own judgement in the face of such uncertainty. In doing so, one crucial distinction they must make is between lending to individual projects - such as RasGas - and to governments. 'When evaluating project finance it is different from evaluating a whole country,' stresses Saadeh. 'For a project, if it is hit by a missile the whole project would go down the drain. The risk is higher.'

Some investors choose to ignore ratings analysts altogether - some bankers have privately dismissed the Moody's RasGas downgrade as irrelevant. Partly, this is because analysts' status within the financial world has taken a battering since the late 1990s.

Some Wall Street banks have been hit by huge fines because their analysts were less than honest in their assessment of stocks during the technology boom. On a different level, ratings analysts have been criticized for failing to spot the holes in Enron's accounts.

Even the analysts admit they are far from infallible. The Fitch report, defending the agency's decision to keep Middle East sovereign ratings unchanged, carried significant caveats. 'Fitch recognized that, if its assumptions about the war are proven incorrect, and it is more protracted and/or spills over into neighboring states, the negative regional economic effects could be much more severe.'

If ratings agencies continue to disagree - or sit on the fence - their powerful grip on the fate of Middle East project finance may not last long.