Global investment banks swoop on regional project finance

The booming Middle East oil economies are attracting investment banks like flies to a honey pot. However, in this oil boom the flow of funds is two-way and not just about selling Western assets to the Arabs. For the new stress on inward investment means that regional projects now have huge financing requirements.

Only last week the Dubai Government announced that its development company Nakheel will borrow $6.5 billion over the next few months to fund projects. Nakheel is currently negotiating a $1.5 billion bridging loan, likely to be followed by two $2.5 billion syndicated loans.

P&O refinancing

The Dubai Government is also rumored to be intending to refinance its recent purchase of the P&O group with an $11 billion initial public offering as early as this autumn that will also include Dubai assets like the Jebel Ali Free Zone. Deutsche Bank, advisors to the government on the P&O acquisition, and Merrill Lynch have been appointed to run the IPO.

It is not only in Dubai that investment bankers are having a field day. Qatar has created the Qatar Financial Centre to regulate financial institutions looking to participate in an estimated $70 billion project finance bonanza over the next few years. Abu Dhabi also intends to gear its local investments to maximize returns.

Of course, borrowing money using any kind of financial instrument is not the same as using your own equity. Money borrowed has to be paid back, and any interruption to the flow of funds back to the lender generally carries harsh penalties that can impoverish the borrower.

International banks are not always the best judges of overseas lending risk either. They suffer from a herd mentality and have a tendency to pile into the same emerging markets at the same time, over-inflating these markets and partly contributing to the subsequent market correction.

Indeed, the list of emerging markets where investment banks have got their fingers burnt in the past is easy to draw up as it comprises all of them.

Different this time?

However, there is an argument that this time it is different in the Middle East. The outlook for energy prices is excellent with high demand from emerging economies like China and India and constraints on supply expansion from refinery capacity to ageing oilfields. And so long as there is a health flow of money then investment banks can gear it up for expansion and investment.

Where things usually go wrong for investment banks, and they ought to know better, is that they put their money into projects that have no realistic long-term chance of repaying the principle.

In the past oil booms of the Middle East such 'white elephant' projects mattered less because squandering cash in a boom hurts nobody. This is not the case for highly-leveraged projects, but doubtless the investment banks now working in the region are fully aware of the risks that they are undertaking and have worked this out.