For the last decade, liquefied natural gas (LNG) mega-projects have dominated the Gulf project finance market. The 'Qatargas Four' project may mark the end of the current phase of LNG development in the Gulf, which started just over 10 years ago with the Qatargas One and Oman LNG projects. However, there is no sign of large-scale project activity diminishing in the near future, with high oil prices and increasing competition to secure energy resources.

The project finance market in the Middle East has evolved significantly during the last decade, as the markets have become more confident and, in turn, sponsors have become more ambitious and confident in their dealings with them.

The evolutionary lessons of the LNG megaprojects in Oman and Qatar are now finding expression in other leviathan projects elsewhere in the region. Project finance debt terms are now commonly a blend of project finance and corporate concepts driven by sponsor requirements for future flexibility. The market has also seen the beginnings of greater involvement of new domestic funding sources.

Significant petrochemical projects have been developed and financed to date in Kuwait, Qatar and the United Arab Emirates. Now a wave of new projects, rivalling the size and complexity of the LNG deals, is beginning to reach the market. More will do so during the coming years.

Petrochemical production is migrating from North America and Europe to the Gulf. For an industry in which 60% of the integrated cost of production is represented by the hydrocarbons, the Gulf has enormous attractions. The national oil companies in the Gulf have the reserves and the international oil companies are keen to tap into them, bringing technology, expertise and capital. Dow, Chevron Phillips, Total and Borealis are all in some way involved in plans in the Gulf.

"The petrochemical industry in the Gulf Cooperation Council countries together with Iran will be as big or bigger than the industry in Europe by 2010 – and bigger than North America by 2015," says petrochemical consultant Pat Rooney, managing director of Chemical Market Associates' operations in the Middle East.

Earlier this month, the project finance market saw the long-awaited debut of Saudi Aramco. On 2 March this year, PetroRabigh (a 50/50 venture between Saudi Aramco and Japanese petrochemical company Sumitomo Chemical) signed the $5.8bn (£3.3bn) financing for a $9.9bn (£5.7bn) world-scale refining and petrochemical project. The financing package includes a $2.5bn (£1.4bn) tranche from the Japan Bank for International Cooperation (the largest to date for the institution anywhere in the world), a $1bn (£577m) Saudi Public Investment Fund tranche, a $1.7bn (£980m) commercial debt tranche and, significantly, a $600m (£346m) Islamic financing (including international Islamic finance participants, the Islamic Development Bank and new Saudi Islamic bank, Bank Al Bilad). The Islamic tranche is the largest long-term Islamic project financing to date in the Middle East. Having made its first foray into the project finance market, there is now much speculation in the market as to how Saudi Aramco will finance future schemes.

With high demand for capital in the Middle East being driven by these large projects, diverse financing sources are required. The $600m Islamic tranche in the PetroRabigh financing was a first in a multi-sourced project financing in Saudi Arabia. We have also seen Islamic tranche firsts in Qatargas II (2004) and in the Oman Sohar Smelter project (2005). Although the presence of Islamic tranches in these projects is a significant move forward, further development is needed to increase the depth of the Islamic finance sector for future projects. The tenor of deals and pricing (currently at historic lows) makes it difficult for Islamic institutions to take and digest their positions in the larger deals. Thus, to date there has been little involvement of independent Islamic institutions in large transactions. Developments in the regional capital markets, including the evolution of the sukuk (Islamic bond) market, may make it possible for Islamic institutions to free up capacity for future projects.

The increasing confidence of sponsors and the markets can be seen in the ability of sponsors to access the global capital markets. In 2005, the RasGas projects in Qatar raised a significant sum in the capital markets. As sponsors gain increasing comfort with the capital markets, it is expected that they will turn to them, rather than traditional bank debt, to finance future plans or refinance operating assets.

Beyond LNG and petrochemical project development, the Gulf market remains strong with independent water, steam and power plant activity, as well as projects aimed at extracting high value from hydrocarbon assets, being a prevalent feature.

In particular, the thirst for cheap energy has made the Middle East an increasingly attractive location for the establishment of new aluminium smelting capacity. The $2.4bn (£1.4bn) Sohar smelter project in Oman is one such example.

The Sohar smelter project, the financing for which closed in December 2004 and is sponsored by Oman Oil, ADWEA and Alcan, involves the construction of a 350,000 tonne per annum aluminium smelter and power plant in Sohar, Oman. Neighbouring countries have also announced similar major plans. Qatar Petroleum and Norsk Hydro have announced a smelter development in Abu Dhabi, Dubai Aluminium Co and Mudabala (the Abu Dhabi investment vehicle) are planning to build a 1.2 million tonne per year aluminium smelter, while in Saudi Arabia, Ma'aden (the Saudi mining company) is involved in plans for a 620,000 tonne per annum aluminium smelter and 1.4 million tonne per annum alumina refinery. All of these are major projects that will require multi-sourced funding.

Project finance activity in the Gulf is reported to have reached $30bn (£17.3bn) in 2005 (following on from $18.5bn (£10.7bn) in 2004). As LNG development tails off, other large plans chasing competitive energy supplies are taking root and interesting new sources of funds are emerging. With sustained high oil prices driving high liquidity, law firms will be involved in mega-sized project finance work in the Gulf for some time to come.

Craig Nethercott and Christopher Cross are partners at White & Case.