When Bahrain-based First Energy Bank “FEB” was conceived in early 2008, it wasn’t exactly the most auspicious time to be launching the world’s first energy-dedicated Islamic investor. As chief executive Vahan Zanoyan, long an authority on the sector, admits, the debut happened at the wrong end of the cycle. “We were establishing the bank at the peak of the energy market, probably the worst time to enter because of the downside risk,” he recalls.
So make that four months an eternity. The price of assets collapsed, although not right across the board as we shall see, and the newborn institution’s medium-term prospects immediately looked much brighter. “Suddenly, First Energy Bank made a lot more sense for counter-cyclical reasons,” Zanoyan says. “Now we’re very much on the right side of the curve.”
Having said that, he was never worried about the big picture: “The bank always made sense for conceptual reasons and that’s never changed.” That concept was based on highly targeted equity in a region bursting with potential, both in conventional energy and in renewables, as becomes more receptive for private equity.
Unique solar resources
The region’s potential for absorbing disciplined energy investment has never been in doubt. As a World Bank report noted in September: “The Middle East and North Africa (MENA) region has about 57 percent of the world’s proven oil reserves and 41 percent of proven natural gas resources. MENA is also endowed with unique solar resources. ”
The World Bank’s timely survey also identifies a pent-up need for the implementation of industry-wide efficiencies through judicious doses of private-sector equity. “In many MENA countries, petroleum product prices are distorted, cost recovery in electricity is low, efficiency of supply leaves a lot to be desired and energy intensity is relatively high. Carbon intensity is, on average, higher than in industrialised countries, and the potential for renewable energy is under-explored,” the report summarises. “The region is lagging behind in implementing reforms in the electricity sector and lacks private sector investment.”
Which is where the world’s first Islamic energy bank comes in, First Energy Bank’s latest deal – and its biggest to date – provides a fair illustration of how the picture is changing. In November, FEB announced a partnership with Saudi’s Project Management and Development (PMD) to build a USD 1bn polysilicon plant that is slated to meet fast-rising demand for solar power, not just in the region but globally. (Polysilicon is a vital component in the production of solar panels.)
On a start-up schedule of 2013, the partners have already signed with US-based Vinmar International to buy most of the plant’s annual production of 7,500 tonnes of high-quality polysilicon. Down the track, the venture plans to invest more deeply in solar power by manufacturing solar wafers and modules which many see as the sector’s version of killer apps.
At roughly 40 percent equity, 60 percent debt, the project looks conservatively financed. This reflects First Energy Bank’s, well, first principles. The general parameters, explains Zanoyan, is a judicious split of the bank’s resources along the lines of 40 percent equity investments, 40 percent Islamic debt finance and 20 percent Treasury investments. (As of September 30, 2009, the bank had total assets of USD 1.3bn and liabilities of USD 240m).
More than an investor
Also reflecting the way the bank intends to operate in future, its role in the project is more than that of investor. A subsidiary of First Energy Bank, Cosmos Industrial Investment, will manage and develop the plant, working alongside PMD, as it takes shape at Al Jubail industrial city, one of the most important manufacturing hubs in the Gulf.
With the cycle now working very much in First Energy Bank’s favour, it’s hunting for similarly promising deals and not just on its own patch. “Our mandate is global. The Board has put no limits on where we can invest,” Zanoyan explains. “Right now we’re looking at projects beyond the MENA region.” Nor, for that matter, is First Energy Bank confining itself to its sector of choice when it comes to other operations of the Bank. “Treasury is not limited to taking stakes in the energy sector,” he adds.
The institution’s prime mandate however is clearly the sector where the chief executive has spent more than a quarter century. From the outset First Energy Bank was set up to invest in profitable niches of the hydrocarbons industry – development, production, transportation, storage, refining and distribution – as well as in oilfield services and exciting technologies in power generation and renewables.
The choice of chief executive was clearly critical to that mission and Vahan Zanoyan seems to have arrived ready-made for the job. A pioneer in applied analysis of the political economies of oil-producing nations, a frequent speaker at energy conferences and a member of the Council on Foreign Relations, he joined the bank after ten years as president and CEO of global energy advisor PFC Energy.
With that mandate and its chief executive in place, First Energy Bank had little trouble attracting shareholders. Starting out with central bank approval for USD 750m in capital, it had to go back and request a higher ceiling of USD 1bn because of the pressure of investor demand. As Zanoyan recalls, “the extra USD 250m was filled almost overnight and we had complaints when we had to close it off.”
With authorised capital of USD 2bn, First Energy Bank started slowly largely because of the inflated state of the market but still found attractive projects. “We invested USD 250m – USD 300m in the first year, more than I thought we would because market conditions were not very favourable.”
Not that First Energy Bank is a soft touch. The projects that land on its doorstep are subjected to some of the hardest-headed analysis in the Gulf. One of the chief executive’s top initial priorities was to create a team of not just bankers but bankers who are very much at home in the complexities of the energy sector. That is, people who could drill down, if you like, into the fine detail of proposals.
“There’s a lot of banking expertise in the Middle East but not much energy-sector expertise,” says Zanoyan. “First EnergyBank’s ability to combine pure banking skills with sector-analysis skills is worth a lot more to us than the USD 1bn.”
His immediate executives appear to be similarly steeped in the industry. Before joining First Energy Bank, joint deputy chief executive Mohamed Shurki Ghanem who has overall responsibility for investment, originated advisory assignments for Arab Banking Corporation right across the energy market and worked in a senior research role for Opec in Vienna. His fellow deputy CEO Mohammed H. Al-Nusuf combines the roles of marketing private equity to institutional investors with unsentimental analysis. Ramzi Al Sewaidi, Head of Investment Banking, has experience with multi-billion dollar energy projects in the region. Between them, they run opportunities through a fine tooth comb.
They’re so hard-headed, in fact, that Zanoyan told the magazine that only five of the projects presented to his team of analysts have been put before the board. That’s five out of 70 proposals they have evaluated to date.
Typically, the polysilicon project got the full treatment before a proposal went upstairs. Already in the planning before it was presented to Zanoyan’s analysts, the project had already cleared most of the hurdles but that wasn’t good enough for the investigative team and the recommendation did not go before the directors until all the boxes were well and truly ticked.
In practical terms, this meant that the essential power supply agreement was signed with Saudi Electricity Company. Tenure on the industrial land was wrapped up. The all-important off-take agreement with Vinmar International was settled. And all this was preceded by a full range of market and technical studies that ended up by establishing the project’s viability.
Needless to say, if any part of the world is ripe for the mass-production of solar power, it’s got to be the Middle East and North Africa (MENA) region with its consistently high temperatures. No wonder many commentators on MENA energy are bullish on renewables, including the polysilicon industry.
Meantime the plant certainly seems to meet the competitive criteria. Not only will it be the biggest of its kind in the region, its technology is leading-edge and, reflecting recent progress in solar-powered research, will produce much more affordable energy than would have been the case even three years ago before a massive influx of R&D capital, especially in the US where much of the technology has been developed.
“It will be one of the lowest cost polysilicon producers in the world, “ summarises partner PMD. Indeed costs have collapsed in the last few years in the solar energy industry, which is now on the brink of competing in price with conventional forms of power.
Late last year, as investment conditions improved with the decline in inflated asset prices, Zanoyan promised “a rich pipeline of projects”. The polysilicon plant fulfilled that promise, but a few earlier projects also survived his team’s rigorous process and First Energy Bank, dipping its toes in the water, has made other relatively modest investments.
Last September it bought a nine per cent stake, costing USD 50m, in a USD 2.2bn water and power project run by Al Dur, the largest of its kind in Bahrain. First Energy Bank also has a positive outlook toward the oilfield services industry, especially drilling. Although most industry segments face a downturn at the moment, crude oil prices have not remained depressed which bodes well for the drilling industry. So First Energy Bank recently finalised the purchase of 40 percent of Arab Drilling and Workover Company (ADWOC) from Transocean, in addition to its investment in Menadrill, an offshore drilling venture.
Still hungry for hydrocarbons
Although the trend toward renewables is here to stay, hydrocarbons will continue to attract a lot of investment and provide a major part of the world’s energy needs. “There are no rapid and consequential substitutes to hydrocarbons,” says Zanoyan. “Renewables will certainly be a priority for many governments, but it will take a long time for them to occupy a material share in the global energy slate.”
Although First Energy Bank’s capital is modest by the standards of the giants of the sector, appearances in this case deceive. The register counts a number of deep-pocketed, blue-chip regional shareholders who have the desire, capacity and know-how to invest in those projects that make it through the eagle-eyed analysts and appear before the board. They include North African sovereign wealth funds such as the Libyan Investment Authority, government and quasi-government organizations like the Abu Dhabi water and Electricity Authority, financial institutions and wealthy individuals from across the Gulf.
The advantages of this depth of capital are clear. “They give us a very diverse regional group of potential co-investors and much deeper pockets than we otherwise would have,” explains Zanoyan.
And although he doesn’t say so, shareholders’ deep pockets and Gulf-wide stature also lend credibility to First Energy Bank. If the institution, with its rigorous processes, has identified a project as a suitable location for its capital, then it implies a certain seal of approval.
Also, shareholders of this caliber have the capacity to stay in for the long haul. While as a bank, First Energy Bank is careful to plot an exit strategy if needs be, it’s also in a position to exercise what’s known as investment longevity and stay in for many years if the returns justify it. Explains Zanoyan: “Most of our investments have very different exit strategies within a two or three-year period, but if we choose we can stay in for the long-term. Some projects we have no intention of exiting because they are important for our portfolio. We are investors, not financiers.”
With that attitude, First Energy Bank could end up giving private equity a good name.
After so many years of experience in consulting across the globe, First Energy Bank’s chief executive is by no means Pollyannaish about the sector, especially in his home base. He understands its idiosyncrasies, tensions and pitfalls.
Some countries are, for instance, effectively closed to outside equity investors in certain kinds of activities, notably Kuwait and Saudi Arabia, while some of those that are open may be overcrowded and highly competitive.
“But opportunities are available elsewhere in the region,” he points out. “And there’s no reason why we should be tied down just to the MENA region just because we know it better.”
Having said that, First Energy Bank is dedicated to a diversified portfolio of projects but remains cautious of investing in upstream projects such as exploration, which is a notoriously heavy consumer of revenue and capital with dismayingly long lead times. “No financial institution should take exploration risk,” he says flatly.
Meantime according to a groundswell of independent commentators, all the indications are that First Energy Bank and its partners have ended up with their timing right, even if a little fortuitously. At a November energy summit in Riyadh, economist Dr John Sfakianakis of Banque Saud Fransi, citing the recovery in oil prices over the last few months and the “cautious global recovery”, was unapologetically up-beat. “Even as the MENA region gradually recovers, investment opportunities abound [as they do] after any crisis,” he said.
Recent reports highlight the vacuum of private equity for MENA projects, which are typically large, complex and capital-hungry. Similarly, there’s said to be an even greater dearth of Islamic financing whose time-frames neatly match the long-term requirements of the sector. Although the underlying value of many Islamic-financed projects has reportedly declined in the last year, so have many conventionally-financed energy assets. Nothing has happened, say economists, that might shed doubt on the importance of Islamic finance, which in principle pursues investments in project development, joint ventures, M&A, and the purchase of assets.
In short, guided by Sharia’a scholars, First Energy Bank is seeking various forms of partnership rather than a narrow role as a mere financier.
The current hunger for capital can only intensify, according to the World Bank. Citing rapid population growth, urbanisation and economic development that, combined, are putting pressure on existing infrastructure, its latest report predicts that the region will need energy investment alone of around USD 30bn a year for the next 30 years, or nearly USD 1trn altogether. This is equivalent to about three percent of the region’s total projected GDP and is about three times higher than the world’s average.
As the bank points out, the main problem is that the usual sources of capital simply won’t be able to keep up the required rate of investment: “The continued high and volatile prices of fuels are straining the finances of many net importing countries, both at the government and the utility level, and increasing costs of subsidised energy at home for the oil exporters.”
All up, it looks like a good case for “highly targeted private equity” if the region is serious about providing affordable, clean and reliable energy for its people.