Welcome to the latest episode of Gowling WLG's Listen Up podcast where we look at a range of topics trending in the legal and commercial landscapes.
Imran Mufti: Hello and welcome to our Gowling WLG in the Gulf podcast series. I am Imran Mufti, project finance lawyer at Gowling WLG. Having spent over 20 years in the region and witnessing its tremendous growth, I am excited to bring you a new episode every month focusing on the latest developments and topics in the GCC . We will be in conversation with a different guest each episode. Today I am joined by my partner, Andrew Newbery, to discuss opportunities in the water sector in the Middle East and North Africa region. Andrew has been heavily involved in major water and utility projects in Saudi, the UAE and elsewhere in MENA since the 1990s and he has been based in the region for a number of years. Andrew's focus remains on working alongside me, Jonathan Brufal and the rest of our GCC -based team on successfully delivering projects, including water projects, in the MENA region. Since joining Gowling WLG in 2016, he and the firm have consistently been ranked Tier 1 by legal publications in the water sector.
Andrew, welcome, and thanks a lot for being the first guest on this opening podcast. Remind me, I think you have been involved in all sorts of water sector projects for over 25 years, is that right?
Andrew Newbery: Yep, thank you Imran, yes that is right. I have advised on most sorts of water projects I think; desalination, wastewater treatments, storage and transmission. I was even client side for a while as Head of Commercial to Thames Water on the procurement of what I think is probably the largest single water asset, the £4.2 billion Thames Tideway Waste Water Transmission Project. I think I have seen most models of water projects in the last quarter century and more from PPP and BOT wastewater projects in Scotland and in Ajman through to the delivery of various desalination technologies across MENA under various delivery models.
Imran: Thanks. Can you tell me a bit about the opportunities that you see for growth in the MENA water sector?
Andrew: Let's start with a few figures just to get to grips with the nature and extent of the opportunity. Bahrain, Oman, Qatar, Kuwait, Saudi, UAE and Egypt were all recently included in the ten countries worldwide most likely to be facing extremely high water stress and that means where 80% or more of all available surface and ground water on average year is at risk of being consumed. So water insecurity is at the very top of the agenda for all of those countries and all the MENA countries. 57% of the world's desalination plants can already be found in the GCC with a pipeline of projects expected to be added to at least another 40% of additional capacity by just a few number of years away, 2025. I do not have the figures for the broader MENA region but clearly even focusing on more restricted GCC figures would suggest that the region will remain the priority area for most water developers and technology suppliers. MEED – Middle East Economic Digest – recently reported that contracts worth 115 billion US dollars were being placed in the MENA water sector, or had been placed in the last ten years, with that accelerating to 14 billion in the last nine months alone and MEED has identified a pipeline of at least another 77 billion already for the coming years.
With reference specifically to Saudi Arabia, Arab news recently reported that Saudi desalination output will need to double by 2040 from its 2021 production levels, and given that Crown Prince Mohammed Bin Salman is targeting a near trebling of population by 2040, I think it is around about 36 million today, perhaps the mere doubling of water capacity might seem conservative. And then perhaps more tangibly, the Saudi Deputy Minister for Water at the Ministry of Environment, Water and Agriculture, Dr Abdulaziz Alshaibani, recently confirmed that the Kingdom of Saudi Arabia is on track to achieve the UN's sustainable development goals by 2030 thanks to the restructuring of the water sector in that country and the development of the national water strategy. He said that the KSA has allocated 80 billion US dollars for water projects within the coming years as part of Saudi's efforts to achieve universal and equitable access to safe and affordable drinking water for all. I think all this underscores that MENA is already the number one investment region for the global water sector, so that is number one in the whole world, and is set to continue to be so. The opportunity for further material growth in MENA is quite obvious to me, Imran.
Imran: Thank you Andrew, that is very helpful. We will come back to that a bit later but if we get down in the weeds a little bit more, which of the subsectors in the water sector do you think will present the most opportunities in the MENA region?
Andrew: Yeah, MEED recently identified that water transmission has represented the biggest subsector opportunity over the last ten years, some 43 billion US dollars, with Saudi Arabia just pipped to being the second biggest market. Broadly, the expectations are that Saudi, the UAE and Egypt will be the three biggest markets in the coming years. In desalination, Saudi has planned and awarded desalination projects of about 8.3 billion, which is over 40% of MENA's market. Egypt and the UAE come next with an overall pipeline for desalination projects of about 20 US billion. Egypt alone is planning 100 desalination plants with the tender for its first batch of IWPs being launched later this year. Saudi, the UAE and Egypt are also planning the most wastewater projects with an overall MENA pipeline for wastewater of over 21 billion. Transmission probably has the biggest pipeline for planned and awarded projects at over 25 billion with the UAE and then Saudi taking the top slots. MEED recently estimated that planned and un-awarded projects for water storage at nearly 10 billion US with Saudi and Qatar taking top dibs there. So, Imran, in answer to your question, I would say transmission, wastewater, desalination present the biggest opportunities in MENA with meaningful opportunities for storage in some countries too, and overall the three top countries would probably be Saudi, UAE and Egypt.
Imran: Thanks Andrew. Now let me take you back a little bit into the history of the private sector involvement in the delivery of water projects in the UAE. What was the very first water project on which you advised in the region?
Andrew: I gave some advice to a bank on the very first independent water project in Abu Dhabi back in 1999, and then the following year I was heavily involved for lenders in the negotiation and documentation of the Taweelah A1 IWPP acting for Citi and BNP Paribas. A few things stand out in that deal for me. First, at the turn of the millennium desalination then stood at only about 216 million gallons a day and, as we know, one single project can easily eat that up today, and today, Abu Dhabi's installed capacity is about four times that figure. It is amusing to me because back in '99, 2000, there were bankability concerns raised by some of the banks as to whether the expansion in the water production forecast for the Emirate would actually be needed. That was a big concern at the time. And, as we know, since then there have been numerous IWPPs and standalone IWPs in Abu Dhabi so those forecasts way back in 2000 were evidently actually quite conservative. The other thing is that back in 2000, all of the desalination projects were focusing on thermal technologies, multi-effect distillation (MED), and multi-stage flash (MSF), rather than the reverse osmosis (RO) technology that we more often see today.
Imran: Thanks Andrew. You are using very technical language here and I am going to ask you to delve into that a bit more. What does MED, MSF, reverse osmosis, what do these terms mean, particularly in the context of the region?
Andrew: Well, I will try and put it back in historical context and at the turn of the millennium the reverse osmosis was, let's say, the holy grail of the desalination subsector. Reverse osmosis was much lower – or held out the opportunity for much lower – energy consumption than the two thermal technologies, MED and MSF. In addition, standalone reverse osmosis projects provided an opportunity to use excess base load electricity generation which was not otherwise being used. So it is great to have RO in the mix, particularly in a country like the UAE, which now has a large amount of Musk-run nuclear baseload. RO can also be easily coupled with low-carbon forms of renewable energy such as solar, and with this in mind, I think I see a continuing boom in the reverse osmosis space.
Imran: You describe it as the holy grail. Why do you use that term?
Andrew: Well it was the holy grail because, for a long time, the reverse osmosis membrane technology promised much for the region but could not be made to work, particularly, I understand, because of the technological and ecological challenges for deploying such technology in the warm and rather brackish waters of the region, particularly around the Gulf. Remember, quite recently the 2019 Aqua Taweelah reverse osmosis project, which reached financial close. What you might not remember is the somewhat smaller, 50 MIGD reverse osmosis project that had been tendered also at Taweelah back in 2004, which was at that time won by Mitsui and Veolia. I advised the bank supporting that winning bid. Sometime later though, the 2004 project was discontinued, largely I think it was reported because of membrane issues. Thankfully now as long as long-term membrane risk is appropriately allocated, issues relating to membrane technology are now totally surmountable and bankable.
Imran: Is there any other innovation on the desalination side that you can talk about?
Andrew: Thanks for the reminder on that. I think it is worth pointing out NEOM's zero-liquid discharge policy. That means that NEOM over in Saudi Arabia will only allow technology, which results in no brine being discharged back into the Red Sea. Increasing salinity in the Red Sea and the Gulf, in part, let's face it, resulting from the implementation of previous desalination technologies has been an ecological challenge on this, and in response to NEOM's zero-liquid discharge policy, it is particularly heartening to see that Veolia and Itochu's project for NEOM would deploy the principles of circularity ensuring that the brine is harvested or monetised, rather than just being poured back into the Red Sea.
Imran: Can you describe that term, what does it mean to harvest brine? And what does it mean to monetise it?
Andrew: Well, as I understand it, Veolia and Itochu have found a way to economically mine magnesium and other minerals from the brine, which will then be used in industrial processes in NEOM's oxygen industrial zone; hence, desalination is now becoming part of the circular economy.
Imran: Thanks Andrew. What other water sector projects have you seen deployed in MENA, and what sort of project risks have you seen them raise?
Andrew: Well, as I mentioned, I worked in-house on a major wastewater transmission project, that one was in Europe, but I had been working on MENA projects in the wastewater sector too. Indeed, back in 2003, I acted alongside Standard Chartered advising Thames Water, then under the ownership of RWE on its 60% investment in the Ajman sewerage PPP alongside a 10% investment by Black & Veatch. The Ajman project is well remembered for several things, including the rather unusual risk allocation that sort of sat with the project in collecting tariffs from the end-consumer. And, it was widely reported at the time this collection risk, that being the end-users refusing to pay for their connections to the new wastewater system almost came home to roost and resulted in a fundamental restructuring of the deal, then a refinancing later in the decade. I think the 2006 refinancing was also the first example of the monoline rat-financing in the Middle East and, of course, actually, that Ajman project opened the doors for subsequent sewerage projects in the region such as ADSSC's project financings, Veolia and B6 in Abu Dhabi, and much more recently the wastewater treatment PPPs in Qatar.
Imran: Are there any other subsector examples that you can talk about in MENA?
Andrew: Yeah, of course, I guess Cobra's recent win as the preferred bidder for Saudi Arabia's Rayis-Rabigh independent water transmission pipeline project is another example in a different subsector, they are water transmission. Saudi Water Partnership Company's (SWPC) tender for the Juranah Independent Water Reservoir is another example, and this time on the storage side. As mentioned earlier, the pipeline in the region for transmission, desalination, wastewater treatment and storage, all those elements is huge and by far the biggest regional opportunity in the water sector, probably on the planet.
Imran: And do you see any consistent themes across the subsectors?
Andrew: I guess the key theme is that successful privately financed projects have generally been structured with a long-term availability payment commitment from a strong off-taker, parking back those earlier successful projects such as the Taweelah A1 project that I mentioned.
Imran: Thanks, Andrew. Talking a little bit about financing now. Can you tell me a little bit about the evolution of project financing structures for water projects in the region?
Andrew: The first water project financing in the region was probably those in the UAE kicking off with the Taweelah project at the end of 1999. The Saudi pipeline of projects started a handful of years later with the Shuaibah IWPP. The Shuaibah project is often said to have established the repeatable delivery model for water and power deals in the kingdom. The Shuaibah project and I think the Rabigh IWSP project, around about the same time, were also the first projects I think that the newly‑formed Aqua Power successfully, a name of course which has become ubiquitous in regional water and utility projects from then on in.
Imran: Yeah, indeed. And what about Islamic finance structures in those early water sector deals?
Andrew: Well, Imran, as you know probably even better than I do, Islamic finance is a main feature of the Saudi water deals, and even going back to those early water deals in the kingdom there were Islamic finance tranches, that are in Shuaibah and Rabigh that I just mentioned. Been a little bit less regular in the UAE but it has remained an important tool in the box and probably is becoming more important. But if you go back even to Al Murunah in 2003, that was probably the first water project to have Islamic tranches, albeit that the Shuweihat S1 power deal had had an Islamic tranche a few years earlier, and I think Al Murunah had Muharabah on the equity bridge finance side which, again, we have seen become ubiquitous and that had an ijarah lease for some of the Al Murunah existing assets and a forward lease for the new assets that were being procured at Al Murunah.
Imran: And what were the project finance features involved in those early water sector deals?
Andrew: The earliest water sector deals in the region were probably the earliest ones to involve a sort of hybrid acquisition project finance model. So Taweelah A1 was I think the first deal to adopt that sort of hybrid financing model and, as mentioned, the Al Murunah then followed that similar structure with the existing assets and day-one revenue streams providing a useful way of integrating Islamic tranches into the overall deal. I suppose another area that is becoming ubiquitous across not only the water sector but all sectors, is equity bridge loans and those earliest water deals in Abu Dhabi saw the first use of subordinated equity bridge loan structures that we have seen adopted and, indeed, RFP‑mandated on nearly all regional deals including those in other infra-sectors. It is worth remembering that prior to 2000 the typical project finance requirement was real equity to be injected by the sponsors upfront, but that is meaning ahead of all the base senior debt or perhaps if you were pushing the envelope a bit pro-rata alongside the debt. So Taweelah A1 definitely broke the mould there. In that deal, the equity was back-ended and then right after that the equity bridge loan structures that we see today became prevalent.
Imran: Thanks Andrew. Moving now from the transactional side of a water deal to the disputes. What are you seeing from the perspective of Gowling WLG in terms of disputes arising from water projects?
Andrew: Yeah, there are disputes. Our international construction arbitration team see quite a few disputes in the water sector in the MENA region. These often arise in desalination and wastewater treatment plants and the disputes tend to focus on two areas. First what I would call classic construction law issues. That is disputes over variations, extensions of time, prolongation costs. Secondly, we often see contractors struggling to achieve the output specification. Very often in desalination plants, for example, it can be hard to achieve the precise output spec specified by the projects and as the water projects get bigger and even more complex, I can see the scope for major disputes getting greater too. The implementation of new technology such as the brine mining perhaps in NEOM, I can speculate, could be ripe for disputes too. Most of the water contracts that we see in the GCC are bespoke EPC arrangements with arbitration clauses although where a multi-lateral funding agency is involved they might use a FIDIC arrangement and often make provision for a dispute board as a precursor to arbitration.
Imran: Thanks Andrew. Finally, big picture, looking forward, what do you see as the future for water projects in the region?
Andrew: As I have already said, the commercial opportunities for the deployment of water technology in MENA are demonstrably greater than anywhere else in the world and are likely to be even greater than we are imagining today. So why do I say even greater? Well, let's look at the production of green hydrogen in the region, for example, and that is happening in an adjacent sector, big plans for green hydrogen production in NEOM and Saudi Arabia. Now if green hydrogen becomes a big thing in the region, then there is going to be a great demand for purified water as input into electrolysis so, I think some of these modelling figures on the need for water do not take these other factors fully into account yet. I think as well as development opportunities in the water sector there will also be increasing secondary market equity deals. I mean, this has been going on so long that those initial deals are maturing and there is a depth in the market and we have seen the secondary market starting to become more important. We saw, for example, when Mubadala Infrastructure Partners divested its 35% stake in the Muharraq wastewater treatment plant. Of course, Jonathan was heavily involved in and divested it to Abdul Latif Jameel Energy's subsidiary Almar Water Solutions.
As to specific upcoming opportunities, the upcoming pipeline of renewable powered IWPs to be tendered in Egypt reportedly later this year, I think will be one to watch and, as already mentioned the pipeline of desalination wastewater and transmission projects across Saudi, UAE and Egypt in particular will be occupying investment boards for the next generation I think, and I expect the circular economy, the decarbonisation idea is being addressed, for example, at NEOM, to become more prevalent across the region and for those to be factored in increasingly to the evaluation criteria of the MENA procurers, as well as, of course, the investment criteria of the developer boards themselves and their banks, and I also expect to see opportunities for MENA-based developers getting involved in other markets and one that immediately comes to mind is South Africa's new water partnership office which is anticipating a slew of public tenders for desalination and reuse projects funded by the private sector hoping, I think, to follow the success of South Africa's greenfield renewable energy projects which I think attracted over 10 billion US dollars of private sector investment. So, I think, as the title of this podcast says, I think MENA is awash with opportunities in the water sector.
Imran: Great. Andrew, thank you very much for talking with me today. Really enjoyed it. I think the key takeaways that we can decipher from all of this is that number one, water, the sector as a whole is clearly a key sector for the Middle East, particularly when it comes to investment and lending from banks and other investors looking to make money out of the sector, but also I suppose it is also the subsectors associated with water transmission, wastewater, storage, desalination that you have described during the course of this podcast. The other key thing I think going forward is going to be the ecological and environmental considerations that will need to be fed into any kind of project associated with water and its subsectors and that is going to be a key part, not just for the sponsors but for lenders as well. And then you have talked about finally the expansion of opportunities for developers in the region across other geographies so, for example, Africa, South Africa. So, overall, looks like the opportunities are vast and they are only going to get bigger so look forward to hopefully working on these projects as advisors at Gowling WLG with yourself and the wider projects group in the firm.
Andrew: Thank you, Imran.
Imran: Thank you everybody for listening, and that is the end of the first podcast.
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