Kuwait: The BOT Market Reopens

Author: Keith Martin Publication | February 14, 2014

Global interest in undertaking development projects in Kuwait has never been greater. A significant milestone in the evolution of project finance in Kuwait was achieved in early January with the financial close of the Az-Zour North IWPP phase I project.

This article describes the legal framework in Kuwait for undertaking projects, examines the Az-Zour North IWPP phase I project and describes the upcoming opportunities.

Kuwait has undertaken few projects to date on a public-private partnership basis.

It used a build-operate-transfer or BOT model in 2002 to build the US$377 million Sulaibiya wastewater and reclamation project. The sponsors of that project were able to put together a 25-year regionally-funded debt package for a 27-year concession from the Ministry of Public Works. Since then, private infrastructure projects have been sparse, with the focus on tendering projects using the EPC procurement method; that is, until the Az-Zour North IWPP phase I project reached financial close.

Re-enter BOT projects.

The Az-Zour North IWPP phase I project was procured under a framework established by two pieces of legislation. The BOT law, passed in 2008, and the IWPP law, enacted in 2010 and amended in 2012.

For IWPP (independent water and power producer) projects, the IWPP law prevails over the BOT law. However, where the IWPP law is silent on any matter, then the BOT law applies. Therefore, Kuwaiti projects procured as public-private partnerships are undertaken within the framework established by the BOT law and, for certain projects, supplemented by additional legislation.

The BOT law is Law No. 7/2008. Regulations issued by the executive to implement it can be found in Law No. 256/2008. The two together provide the framework for PPP projects in Kuwait and the role of government institutions such as the Council of Ministers, the Higher Committee, Partnerships Technical Bureau, the State Audit Bureau, public entities and private investors. At the core is a steering committee that is responsible for studying and approving projects involving state-owned real estate and putting them out for public tender. Amendments to the BOT law are currently being considered by the government.

Key Agencies

The steering committee or “Higher Committee” goes by the formal name “High Committee for Projects on State-owned Real Estate.” It is presided over by the Minister of Finance and also includes the Ministers of Municipality, Public Works and Commerce and Industry. Other members are the President of the Partnerships Technical Bureau, the Undersecretary of the Ministry of Electricity and Water, the Director-General of the Public Authority of the Environment and two experienced specialists named by the Council of Ministers from civil servants.

The Higher Committee is responsible for developing general policies and approving detailed documents for projects and initiatives (including unsolicited proposals) of strategic importance to the national economy of Kuwait. It refers projects to the Partnerships Technical Bureau for study so that decisions are taken in accordance with the BOT law. It selects the relevant public entity to participate in the project and sign the PPP contract and to monitor the project’s implementation and operation. It also must authorize any termination of a PPP contract determined to be in the public interest.

No public entity or company is permitted to enter into a contract with any investor for a project that involves state-owned real estate under BOT or similar models until the project has been reviewed and approved by the Higher Committee.

While the Higher Committee has broad responsibilities, the Partnerships Technical Bureau handles the day-to-day administration and management of the procurement process and the monitoring of project implementation.

The Partnerships Technical Bureau reports to the Minister of Finance. Its duties include undertaking surveys to identify potential development projects, making a technical evaluation of projects and unsolicited proposals that are referred to it by the Higher Committee, developing a guidebook and forms of contracts for use in projects and following up on projects to ensure they are properly implemented.

The projects that are tendered by the Partnerships Technical Bureau follow a road map that tracks the Kuwaiti national development plan.

National Development Plan

Kuwait has 10% of the world’s oil reserves, giving it tremendous economic and development potential. Its GDP per capita is far higher than the OECD average, and it runs a trade and budget surplus that is 20% to 30% higher than the OECD average. Nevertheless, it has proven to be somewhat of a challenge for the country to translate its substantial wealth into domestic infrastructure. Kuwait ranks 52 in the infrastructure band of the global competitiveness index (2012 to 2013), which ranks investment by different countries in physical capital and infrastructure.

The framework for Kuwait’s economic development is laid out in a four-year development plan that was approved by the Kuwaiti parliament in 2010. The plan sets a goal of turning Kuwait into a Middle Eastern trade and financial hub with approximately US$104 billion set aside for this purpose. Significant investment is intended to come through implementation of the PPP model and private-sector participation.

A goal of the PPP program is to attract private investors and capital to Kuwait by developing the capital market, writing a PPP guidebook based on international standards, guaranteeing impartial treatment of foreign and local investors, and promising an efficient licensing process where all required approvals are provided to the investor in a timely manner.

A total of eight priority non-oil sectors have been identified by the Partnerships Technical Bureau for private-sector participation, all within Kuwait’s wider development objectives. These sectors are power, water and wastewater, communications, health care, education, real estate development, transport and solid waste management.

The PPP model has been tested and proven in several countries in the Gulf region, including Saudi Arabia and Abu Dhabi. Both managed to meet the strong growth in power and water demand through large IWPP and independent power projects that attracted international developers in addition to international banks that financed the bulk of these projects. For instance, Abu Dhabi IWPPs provide more than 10,600 megawatts of power and 750,000,000 gallons per day of desalinated water. Over the last five years, Abu Dhabi has added on average 900 megawatts per year of power generating capacity solely through IWPPs that have enabled the country to keep up with a demand growth exceeding 10% per year. Recent regional experiences show that once the market has closed on the first IWPP or IPP project in a country, then the implementation process for future projects was streamlined.

The closing on the financing for the Az-Zour North IWPP phase I project should have the same effect in Kuwait.

Lessons From Az-Zour North

The project has considerable history attached to it. There were several unsuccessful attempts made by Kuwait to develop the project using the EPC procurement method. During 2008 and 2009 there were plans to develop four phases at the Az-Zour North site, south of Kuwait City. Each phase was to be procured by the Ministry of Electricity and Water with costs for the development met through budget allocations from the Ministry of Finance.

There are few vacant sites in Kuwait that can support a power generation and water desalination project. Finding a viable site is a challenge given the location of existing plants and other domestic and commercial infrastructure that is already in existence along the shoreline. As such land is scarce, it is not surprising that the Ministry of Electricity and Water requested the Partnerships Technical Bureau to run a competitive tender for the phase I project once it converted to a BOT project. This small but very significant step signaled the shift in procurement policy away from the traditional EPC model to the new but unchartered territory of IWPPs in Kuwait. Under the IWPP law, the government retains the right to tender renewable energy projects as EPC contracts, and EPC contracts for power plants with capacities of below five hundred megawatts may continue to be tendered by the Ministry of Electricity and Water, subject to the approval of the Council of Ministers.

The table below lists key features of Az-Zour North IWPP phase I.

Az-Zour North IWPP Phase I : Key Features

Project

Development of a new combined independent power generation and seawater desalination station with a net dependable power capacity of at least 1,500 megawatts and a net dependable water capacity of between 102 and 107 million imperial gallons per day on a build-operate-transfer basis

Offtaker

Ministry of Electricity and Water of Kuwait

Term

40-year energy conversion and water purchase agreement

Shareholders
in the Project Company

GDF-Suez, Sumitomo Corporation and Abdullah Hamad Al Sagar & Brothers Co (together, 40%)

The Public Institution For Social Security (5%)

Kuwait Investment Authority (5%)

Partnerships Technical Bureau (50% shareholding on behalf of Kuwaiti citizens)

Project Cost

Approximately US$1.8 billion

Lenders

Commercial lenders are National Bank of Kuwait, Bank of Tokyo-Mitsubishi, Sumitomo Mitsui Banking Corporation and Standard Chartered Bank. Additional loans provided under Nippon Export and Investment Insurance (NEXI) cover and export credit agency funding provided by the Japan Bank for International Cooperation (JBIC)

Full Commercial Operation

Q4 2016

The request for proposals was issued in March 2011. For the first-ever IWPP project in a country with no history or track record in this sector, the result was impressive. The Partnerships Technical Bureau received bids from five strong consortia in September 2011. The consortia were led by ACWA Power International, GDF-Suez, Malakoff, Marubeni Corporation and Mitsui, with each bid supported by at least a 50% commitment of financing. This can be contrasted, for example, with the first-ever IPP project in Saudi Arabia that attracted only one bidder.

The consortium led by GDF-Suez was selected as the preferred bidder in February 2012. The project agreements were finalized and agreed in December 2012. The incorporation of the Kuwaiti holding company for the purpose of taking up shares in the project company was completed during early 2013, and the project company itself was established a few months later. The incorporation coincided with sweeping reforms to the commercial companies law that streamlined the process. The project agreements and financing agreements were signed in December 2013. Financial close was achieved in January 2014.

The main project agreement is an “Energy Conversion and Water Purchase Agreement” or “ECWPA” for the sale of capacity, electricity and water. As the use of “energy conversion” in the name implies, fuel is supplied by the Ministry of Electricity and Water and converted to electricity. The other project agreements include land lease agreements and a shareholders agreement. No sovereign or other form of payment guarantee was provided by the government.

The risk allocation in the ECWPA is largely consistent with regional precedent, but adjustments were made to ensure compliance with Kuwaiti law and general policies of Kuwait. The project agreements are governed by Kuwaiti law, but they provide for offshore dispute resolution in accordance with ICC rules.

A unique feature of the transaction is the shareholder arrangements and the issues that arise from the requirement of Kuwaiti law that the contract must be entered into by a public joint stock company. This requirement is a significant departure from regional precedent. Oman is the only jurisdiction in the region that requires an initial public offering of the shares in the project company, but it does not require the IPO to have occurred before entering into the project agreements. By contrast to the position in Oman, Kuwaiti law requires the IPO to have occurred before the project agreements are executed.

This raises a number of unique challenges, the main one being how to conduct an IPO for a greenfield project at its inception and manage a call on equity where a significant proportion of shares in the project company is held by Kuwaiti citizens.

As is typical for project finance, equity commitments were provided by all shareholders to the lenders. For those shares held by the government, the commitment came in the form of cash contributions.

Shareholding Structure

Kuwaiti law is prescriptive as to the shareholding requirements. There is a clear public policy objective of ensuring participation in projects by Kuwaiti shareholders as a means of wealth sharing between the state and its citizens. Under the BOT law, for projects whose value is over KWD 250 million and for most projects whose value is over KWD 60 million, 50% of the shares in a project company must be placed for public subscription through an IPO. For projects between KWD 60 million and KWD 250 million, the Higher Committee can designate the project as being of a “special nature.” Special nature projects do not require the formation of a public joint stock company and do not require an IPO. The new Physical Medicine Rehabilitation Hospital was designated a special interest project.

The IPO requirement before completion is unique to Kuwait’s legal framework and has not been experienced in previous IWPP or IPP projects elsewhere in the region. Hence, there were developer and lender concerns over the risk. Completion of the IPO was a condition for the full incorporation of the project company. This meant the IPO process had to be undertaken in parallel with the negotiation and finalization of the project and financing documents with the preferred bidder and its lenders. This added a significant layer of complexity especially since investors and lenders prefer certainty as to the number of shares being subscribed for, the price of those shares and the timing of the subscription.

In the Az-Zour North IWPP phase I, a structure was developed to mitigate construction risk exposure for Kuwaiti nationals and for lenders. The amendments to the IWPP law subsequently enshrined this structure by permitting the Partnerships Technical Bureau to subscribe for the capital of the shares allocated for public subscription. The PTB will hold these shares until the project is operational at which time a distribution will occur during which Kuwaiti citizens will be invited to pay for subscriptions at the same price paid by the PTB. The Council of Ministers has reserved the right to exempt citizens from paying the subscription price.

The remaining shares are held by investors and Kuwaiti public entities.

Under the BOT law, 40% of the shares in the Kuwaiti public joint stock company that will serve as the project company must be offered by way of public auction to investors, with a further 10% offered to the successful bidder after award at a discount.

For IWPP and IPP projects to which the IWPP law applies, the share allocation can vary in that the sponsoring public entity is permitted to subscribe to shares not exceeding 24% with the investor subscribing to shares not less than 26% and with no change to the allocation for public subscription to Kuwaiti nationals. While 26% is a floor, investors are wary of investing in a company in which they only own 26% of the shares. Indeed, investors and lenders inevitably require control at the management and board level, and the application of Kuwaiti law can make this process challenging. For the Az-Zour North IWPP phase I, 40% of the shares in the project company were offered to investors with 10% taken by government sovereign wealth funds.

All shares whose capital is either not paid for within a prescribed period or that remain unsubscribed by the Kuwaiti nationals may, under the IWPP law, be transferred to the developer at the government’s discretion within a period not exceeding one year from the date of distribution to Kuwaiti citizens. Alternatively, the government may choose to keep these shares within the percentage allocated to it, i.e., not more than 24%. The key issue for developers is the uncertainty of ascertaining the ultimate shareholding. Kuwait’s record of implementing government-sponsored IPOs is so far very good and the proposed investment returns, together with the fact that the IPO is being implemented without construction risk attached, should ensure the distribution is a success.

Additional Key Features

The IWPP law specifies that the number of Kuwaitis employed by the project company must not be less than 70% of the total workforce, and their aggregate remuneration must not be less than 70% of the total remuneration of the workforce. These requirements seem high, but they are comparable with indigenous employment targets in the market.

The Partnerships Technical Bureau evaluates bids for PPP projects through a two-step process: a technical bid evaluation followed by financial bid evaluation. Under the BOT law, in evaluating financial bids, the highest score is awarded to the bidder providing the highest price for the proposed shares of the project company.

While this may be consistent in models where governments are trying to extract value for existing assets in a sales process, it does not sit comfortably for a greenfield project. In the context of a greenfield IWPP project, this requirement raises complex issues in terms of bidding process: bidding on a share price requires fixing the various components of power and water tariffs in the request for proposals that would constrain developers in optimizing project costs and could limit the competition. The bidder offering the highest share price is not necessarily the bidder with the best offer. This creates uncertainty in terms of bidding evaluation compared to international best practices and regional precedents. Fortunately, the IWPP law favors an evaluation methodology that balances the tariff and the share price bid by the investor.

Projects tendered under the BOT law and the IWPP law are subject to a multi-layered approvals process. Approvals at various steps in the procurement process are required from the government department for legal advice and legislation (Fatwa Tashrea), the State Audit Bureau and the Higher Committee.

Opportunities for Future Deals

The Partnerships Technical Bureau has commenced the feasibility process for around 20 projects. The following are the current active projects listed on the PTB website, with some more advanced than others:

Upcoming Projects

Power

Az-Zour North IWPP phase 1

Financial close

Power

Az-Zour North IWPP phase 2

Pre-request for qualifications

Power

Al Khairan IWPP

Expressions of interest expected shortly

Power

Al Abdaliyah ISCC

Pre-expressions of interest

Water and
Wastewater
Management

Umm Al Hayman

Request for proposals expected shortly

Solid Waste
Management

Municipal solid waste treatment facility – Al Kabd

Pre-request for qualification

Communications

Kuwait public post office

Request for qualifications (standstill)

Communications

Communications network and telecommunications services

Request for qualifications (standstill)

Real Estate
Development

South Al-Jahra Labor City

Request for qualifications

Real Estate
Development

Rest houses and Doha Chalet’s service centers

Request for proposals

Real Estate
Development

Kuwait Failaka Island development

Pre-expressions of interest

Real Estate
Development

Commercial, education, cultural and entertainment center in Abdulla Alahmad Street

Expressions of interest

Real Estate
Development

Expired contracts of properties established on state-owned real estate

Post-bid
submission

Health

New Physical Medicine and Rehabilitation Hospital

Pre-request for proposals (standstill)

Education

Kuwait schools development program

Pre-expressions of interest

The BOT law also allows the submission by a developer of an unsolicited proposal with respect to a project proposed to be developed in Kuwait under the PPP model. However, an unsolicited proposal cannot be submitted if a request for proposals has already been issued for a similar project. The advantage to the developer in submitting an unsolicited proposal is that, if the project is ultimately offered for public bidding or competition, the developer is entitled to a “preference margin” upon evaluation of the proposals submitted to the PTB, not exceeding 5% of the value of the lowest price proposal that fulfills all the terms and requirements of the request for proposals.

The Al-Abdaliyah integrated solar combined-cycle project is currently in the tendering phase and was initiated as an unsolicited proposal.

  Kuwait has come a long way since Sulaibiya. There is now a new legal framework for undertaking projects. There is a now a banked and project-financed transaction. There is a long line of deals that are waiting to come to the market. There is an excitement about Kuwait. There is a buzz surrounding the potential that it represents for investors, developers and lenders. There is strong political determination for increased private-sector participation, for increasing technology transfer, for know-how, for creating investment opportunities and for employment and training of its citizens. Az-Zour North IWPP phase I has been described as the trailblazer.

Sohail Barkatali
Derek Kirton

 


Originally prepared by Chadbourne & Parke. Chadbourne & Parke combined with Norton Rose Fulbright US LLP on June 30, 2017 and is now known as Norton Rose Fulbright US LLP.

Contacts

Keith Martin

Keith Martin

Washington, DC