Iraq Energy and Infrastructure Finance Discussion

1. Iraq Energy and Infrastructure Finance Discussion Iraq Refinery 2012 Conference 18 April 2012 Strictly Private and Confidential

2. The Government of Iraq has embarked on an ambitious program of reconstructing its energy infrastructure Background • Iraq’s energy and infrastructure investment requirements run into the hundreds of billions of dollars • The Government of Iraq (GOI) made public ambitious plans to attract foreign direct investors into energy infrastructure • According to Iraq’s Electricity Master Plan, over the next 20 years, Iraq will need to invest more than $55bn in its power sector, $29bn of which would be in generation alone • In 2010-2011 the GOI announced plans for attracting FDI into the first four Independent Power Producers (IPP) in Basra, Maysan, Diwaniyya and Samawa • In 2011 Iraq has announced plans to attract $30 billion of investments to build five oil refineries in Karbala, Kikkuk, Maysan, Nasirriyah and Nineveh • These ambitious investment plans are constrained by four main factors: • A limited (although expanding) GOI budget (~US$100 Billion in 2012) still mainly reliant on the ebbs and flows of oil revenue • A dysfunctional and illiquid local banking sector dominated by state-owned banks and small and fragmented private sector banks • Limited liquidity in the global financial system with on-going sovereign debt challenges • High political risk costs coupled with the untested creditworthiness of the GOI

3. Appetite for Iraq credit risk in the international capital markets is available with robust political and credit risk mitigants Iraq Risk Appetite • Local credit support in the form of Iraqi lending institutions and investors is very limited • Global debt markets are constrained and therefore challenging for Iraq to source traditional debt financing • Increasingly as Iraq integrates into the global lender and investor market, there are requirements about political security and assurances of payments • The US$2.7 billion issue of the Iraq sovereign bond, the Iraq 2028s in 2006 provides a price mark and some, if limited, liquidity if Iraq chooses to tap the international capital markets • Export Credit Agency financing (ECA) is the last and deepest pool of capital available • And while unsecured ECA financing may be available for smaller US$20-50 trades, large scale energy and infrastructure project in the hundreds of billions of dollars will require banks to take out ECA insurance against credit risk of payer and political risk • Therefore the ECAs will require sovereign guarantee or some form of forward sale of commodities will be required

4. Under the Iraq’s Debt Law, there are clear legal requirements for the provision of an Iraq sovereign guarantee The (Elusive) Sovereign Guarantee • The Iraq Financial Management Law and Public Debt Law of 2004 (CPA Order 95) “establishes a comprehensive framework for the conduct of fiscal and budgetary policy” • This Public Debt Law “authorizes the Ministry of Finance to issue and pay debt securities guaranteed by the Government… for the purposes of financing Government operations and promoting a stable Iraqi economy” • The Public Debt Law stipulates “The budget deficit shall be financed by cash balances of the federal government, short-term borrowings, domestic and external loans, or by the issuance of government debt securities.” • Under the law, the Minister of Finance must submit the annual draft budget as approved by the Council of Ministers, including any requests for domestic and external loans or guarantees to fund the deficit, to the Iraqi Parliament for approval. • Order 95, Section 6, Paragraph 10, then gives the Minister of Finance authority “to sign the borrowing and guarantee contracts of the federal government” • Before 2012, successive energy and infrastructure investment announcements have failed to take into account the requirements of the Public Debt Law

5. The draft 2012 budget included language allowing the GOI to fund the budget deficit for infrastructure projects The 2012 Budget and Finance Infrastructure Projects • Article 36 of the proposed draft budget in 2012 allowed the GOI to borrow specifically to fund infrastructure projects “not to exceed 18 trillion Iraqi dinars (~US$ 15 billion)” • Article 36 proposed the Ministries of Finance and Planning, would review the financing terms of the proposed projects and submit their recommendation to the Council of Ministers. • The Council of Ministers according to recommendations from the two Federal ministries, Finance and Planning, would then approve the projects • The Ministry of Finance was then given the authority to ratify all the debts and guarantees incurred on the State due to the programs in question (i.e. the infrastructure projects) according to the provisions of Paragraph (6) from Section (10) of the Financial Management and Public Debt Law number (95) of 2004. • Lastly the borrowing was to be paid in installments in a period of not less than (5) year from the project completion date. • What happened? Article 36 was struck down by parliament during the final voting on the budget…

6. Competition is global and the GOI will have to “de-risk” their energy and infrastructure projects and lay out a framework that will attract developers and their financiers to Iraq Financing Challenges • There is only a select number of reputable international energy and infrastructure developers with the expertise of doing business in Iraq and a finite pool of capital with appetite for the country • To pull these developers away from more attractive markets, the GOI must offer incentives commensurate with the added risk of doing business in Iraq • Until it establishes a track record of closing deals, honoring commitments and thereby building trust with equity investors and lenders, the GOI will have to concede more to developers and lenders than it probably wants or expects. Leave some money on the table to your international partners willing to take Iraq risk at this juncture • Iraq has no sovereign credit rating and except for the IPPs in the Kurdistan Regional Government no real track record of closing private-public energy and infrastructure transactions • Instead there is a recent history of botched attempts in the power sector through the IPP program. Compounding this are the serious on-the-ground security risks and political instability. • Furthermore, Iraq was recently ranked number 175 out of 184 in Transparency International’s Corruption Perceptions Index, somewhere between Sudan and Somalia.

7. Competition is global and the GOI will have to “de-risk” their energy and infrastructure projects and lay out a framework that will attract developers and their financiers to Iraq Recommendations • Offer long term guarantees – Given the uncertainties surrounding access to fuel supplies in Iraq, this risk must be borne by the GOI. Without fuel supply guarantees from the GOI, developers will be unable to secure financing from even the most motivated of institutions, such as the export credit agencies. • GOI financial flexibility –The GOI needs to negotiate and secure more flexible borrowing terms with the IMF and other creditors. The current IMF-imposed limitation on non-concessional indebtedness is a significant constraint on Iraq’s ability to mobilize private investment in the energy and infrastructure sectors. • Credit quality – The revenue stream and the credit quality of the obligor underpins infrastructure projects. Given the lack of creditworthiness of Iraqi Federal Ministries, a sovereign guarantee from the GOI is critical. Letters of credit or guarantees from state banks that have been offered, are inadequate substitutes given the size of the exposure that needs to be guaranteed for large scale energy and infrastructure projects • Sequential approach – start off small. As opposed to the ambitious attempts so far the GOI may consider to start small and deliver on one successful deal early on. Success breeds more success, and building a track record with lenders and developers on an initial deal will allow GOI to increase its leverage in subsequent negotiations, and deliver more favorable terms for the country. ~US$50 billion required – prioritize. • Political support – need for unanimous political backing. To further de-risk the opportunity and provide additional comfort to investors, the GOI needs to demonstrate unanimous political support for their infrastructure programs. Coordination between the Ministry of Oil and the Ministry of Finance and other federal ministries are critical preambles to the success of energy and infrastructure projects in Iraq.

8. Questions?

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