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Sunday, 22 October 2017

Muharraq - Middle East pathfinder

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The Muharraq wastewater project reached close in September 2011, more than two years after the RFP was released to bidders. By David Wadham, partner in the energy, transport and infrastructure group, Ashurst LLP.

Hailed not only as a pathfinder deal for PPP in Bahrain but also for the wastewater sector in the Middle East more generally, the Muharraq project has achieved close against the backdrop of the recent unrest in Bahrain and the continuing difficulties in the banking sector.

Launched to the market with the full RFP in May 2009, the project involves the construction, ownership, operation and maintenance of a new 100,000m3/day wastewater treatment plant at Muharraq in Bahrain. The project will deliver critical new infrastructure for Bahrain, reducing the influent to and outflows from the ageing Tubli plant.

In addition to the plant itself, the project requires the construction, ownership, operation and maintenance of a new 15.9km deep gravity sewer trunk main (STM), as well as an associated wastewater collection network (WWCN). Construction of the plant and the STM is scheduled to be completed in 32 months, with the WWCN, which replaces certain existing wastewater pumping stations that are to be decommissioned, to be completed 12 months later.

Influent will be conveyed to the plant by the new STM and WWCN and/or by tanker. All treated sewage effluent (TSE) is delivered to the MoW at the plant boundary, with sludge being incinerated at the on-site sludge incineration plant and transported by the project company to a site in Bahrain to be made available by the MoW.

After re-issue of the RFP documentation, binding bids were received in February 2010 from five consortia. After an initial technical evaluation, in July 2010 a consortium led by Samsung Engineering was declared preferred bidder and negotiations commenced. The consortium had submitted a levellised tariff of 0.550 BHD/m3, some 10% lower than the closest other bidder. The Sewage Treatment Agreement (STA) with the Ministry of Works of the Government of Bahrain (MoW) was signed in February 2011.

Project structure

The project is being undertaken by Muharraq STP Company, a Bahraini joint stock company owned 45% by Samsung, 35% by Invest AD and 20% by United Utilities. The documentation for the project comprises the STA, which is a 29-year concession to build, own and operate the facilities, supported by a land lease agreement for the project site and other land documents for the pipeline corridor (see below), together with a Shareholders’ Undertaking Agreement (essentially a share retention agreement with the Government) and a government guarantee for the project from the Ministry of Finance.

Construction of the facilities is being undertaken by Samsung as turnkey EPC contractor. The project will be operated and maintained by Muharraq Wastewater Services Company, a Bahraini limited liability company owned by Samsung and United Utilities.

While the documentation draws heavily on the prior Bahraini I(W)PP documentation for the Al Ezzel, Hidd and Al Dur projects, there are still some notable differences. Some of these differences are not industry-specific. However, the different nature of the underlying Project nonetheless necessitated a number of departures from the Bahrain I(W)PP model, the most significant of which are explored below.

Pipeline corridor and land issues

One of the most challenging aspects of the project is that part relating to the STM and the associated WWCN. On almost all IPPs and PPPs undertaken to date in the region, the project company has exclusive possession of a clearly defined plant site, plus possibly some limited easements for access or utilities over adjacent land. The inclusion within the project scope of a 15.9km deep gravity sewer trunk main and WWCN passing through Muharraq town to be constructed, owned and operated by the project company entailed additional technical and legal challenges.

From a technical perspective, it was reported that some potential bidders were discouraged by the inclusion of the STM and WWCN, as the tunnelling skills required were not core competencies for some of the bidders and therefore represented a risk they were not keen to wrap. From a legal perspective, MoW has responsibility under the STA for procuring all land rights necessary for the project (including the STM and the sea outfall). However, in practice, identifying, procuring, documenting, and granting security over the land rights for such an extensive pipeline corridor proved time-consuming.

Helpfully, due diligence revealed that the majority of the pipeline corridor ran through unregistered public (government-owned) land, along existing road corridors. Usage of public land in Bahrain is regulated under contractual arrangements administered by the Central Planning Office (CPO) via a system of planning permissions and no objection certificates. In addition to the public land, there was a small number of plots of registered land owned or being transferred to Government-related parties.

Ultimately licence and easement agreements were entered into covering the entire pipeline corridor and a lease granted in respect of the site for the intermediate lifting station. The parties were able to use the slippage in the overall project timetable (see below) to ensure that all necessary land rights were granted prior to financial close, alleviating one of the lenders’ key concerns.

Tariff

The tariff is a standard three-part tariff, comprising a capacity payment, an output payment and various supplemental payments. However, the deduction regime is complex: depending on the facilities’ performance, the project company can potentially suffer deductions for delivery of off-specification TSE or various by-pass events, environmental deductions and infiltration deductions (based on infiltration into the STM).

There was considerable discussion around the carve-outs and tolerances on the various deductions. The TSE specification in the STA is detailed, requiring the testing of in excess of 20 different parameters on a daily basis. The parties needed to balance the sponsors’ desire for a deduction regime that would not result in an unacceptable level of deductions for sporadic and trivial breaches with MoW’s requirement to maintain strict water quality criteria permitting re-use of the TSE.

Plant expansion and standby facility

The STA contains a flexibility for the MoW as procurer with regard to additional capital expenditure and future plant expansions. It is anticipated that the plant may be expanded by another 60,000m3/day to a total of 160,000 m3/day. These so-called expansion works can be undertaken in one or two phases, subject to a minimum volume for any single expansion.

The STA contains a mechanism for the tendering by the project company of that expansion and agreement of a supplemental STA for those facilities. There is corresponding provision in the financing documents for the incurrence of additional indebtedness to finance any such plant expansion, subject to certain conditions.

In addition, MoW wanted the flexibility to potentially instruct variations during plant construction. The project’s standby facilities are sized to take this requirement into account (in addition to the usual cost overrun/revenue shortfall risks).

Availability testing

Capacity payments are based on the available influent treatment capacity of the facilities. Unlike a power plant, where availability can be expected to fluctuate on a daily basis and daily declarations of available capacity are required, the available capacity of a plant like this is essentially the tested capacity, which is set/confirmed by annual testing of “availability”.

The facilities, however, comprise in essence three separate parts: the STM/WWCN, the plant and the sludge incineration plant, and this led to discussions as to how availability could meaningfully be tested and applied across the facilities as a whole. Sponsors and lenders were keen to ensure that it was clear how available capacity was determined and that if, for example, the STM failed the availability test but the plant did not, then this would not lead to an available capacity (and thus capacity payments) of zero. Eventually, a testing regime was crafted that sees each of the three sections tested and the availability of each then aggregated on a weighted basis according to capital cost.

STM and WWCN buy-out

The STA provides for the handover of the STM and WWCN at the expiry of the STA term. In addition, the MoW has the ability to purchase these elements of the project at any stage during commercial operation and can elect to purchase such assets either on the basis of a lump sum payment or via an adjustment to service payments, and the STA contains provisions regulating the tariff recalculation.

Financing

At the bid stage, given both the number of bidders and the timing of the bid phase in 2009, sponsors elected to bid with no committed commercial banks but with support from K-EXIM, confident that they could finalise a bank group if they were selected as preferred bidder. So it proved and over the summer of 2010 a commercial bank group comprising CA-CIB, Natixis and SMBC was assembled to work alongside K-EXIM.

The STA was signed on February 2 this year, backed by credit committee-approved commitments from the supporting banks. Sponsors and banks had been expecting financial close around April of this year. However, the financing phase of the project became more protracted than expected, based on events in Bahrain.

Beginning in mid-February and shortly after STA signature, Bahrain suffered a series of civil disturbances and saw its long-term ratings downgraded to BBB by S&P and Baa1 by Moody’s. The effects of these events on the project were twofold, having both an impact on construction activities on the ground in Bahrain, as well as on the financing.

Work on the financing continued as sponsors discussed the impact of the events on the project with the Government on the one hand and with the lenders on the other, and the parties waited for the situation to stabilise. In early July, it was agreed to extend the construction period by two months and the concession term by just over two years, allowing the project to absorb the impact of the events. Financing documents were signed on July 19.

The financing comprises a US$120m direct facility provided by K-EXIM, a US$80m K-EXIM-covered facility and a US$43m commercial (uncovered) facility. The commercial banks are participating in the covered and uncovered facilities pro rata. Leverage is around 80:20. The facilities have a tenor of 22 years with margins starting at 225bp rising to 275bp on the uncovered tranche.

These non-recourse facilities are backed by a comprehensive package of onshore and offshore security agreements and direct agreements. The project also benefits from standby equity and debt commitments, sufficient to cover not only the usual cost overrun and revenue shortfall risks but also potentially any MoW-requested variations (see above).

Conclusion

The closing of a pathfinder wastewater PPP would be a significant event in its own right but is all the more remarkable given the continuing uncertainties in the bank market and recent events on the ground in Bahrain. At the time of writing, it is not clear whether the Government will choose to use the Muharraq PPP model for its next wastewater project at Tubli, or will revert to more traditional government procurement.

It is inevitable that “first of a kind” deals take longer to structure and implement: significant work has been undertaken by the Government of Bahrain, sponsors and lenders in developing a commercially reasonable and bankable framework for private sector participation in the wastewater sector. Even if Bahrain chooses not to follow the Muharraq model, the project will undoubtedly prove a valuable benchmark for the wastewater sector elsewhere in the Middle East, such as the upcoming Umm Al-Hayman project in Kuwait.

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