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8/7/2019 Infrastructure Finance - The changing landscape in SA
1/12
March 2010
Infrastructure Finance
The changing landscapein South Africa
8/7/2019 Infrastructure Finance - The changing landscape in SA
2/12
Stimulus packages in many countries, including
South Arica, are being used to redress part o the
inrastructure gap, which in addition to achieving the
short-term goals o creating employment and ostering
spending, should create a good platorm or increased
economic eciencies going orward.
Governments need to look beyond short-term objectives
and articulate a much broader vision or enhancinginrastructure as measured, not just by jobs created, but
by enhanced productive capacity or the uture.
Funding is still a problem in the current constrained
credit environment, and although the stimulus
packages address some o the shortalls, market
conditions are making it hard to und the balance o
required projects in the private debt capital markets.
Budgetary constraints and reduced taxation collections
are impacting the States ability to und large projects
beyond the stimulus packages, which have placed
urther strain on national nances.
As a result, new and innovative Public-Private
Partnership (PPP) structures are needed to make projects
work. This article looks at how to structure a unique
and optimal partnership solution or each project.
The degree o risk sharing between the public and
private sectors needs to be fexible, and optimised on a
case by case basis to ensure that projects can become
a reality.
Synopsis
The political landscape has changed;infrastructure is top of mind and there isrecognition of the large infrastructure
shortfalls locally and around the world.
8/7/2019 Infrastructure Finance - The changing landscape in SA
3/12The changing landscape o inrastructure nance in South Arica 1
Ater decades o neglect, and despite many other
distractions in the global economy, inrastructure has
nally made it to the top o the political agenda, not
only in South Arica, with its new ocus on service
delivery and job creation, but in many other countries as
well. According to a recent survey, 77 percent o senior
global business executives believe that the current level
o public inrastructure is inadequate to support their
companies long-term growth. These executives believe
that over the next ve years, inrastructure will become
a more important actor in determining where theylocate their operations.1
The public has awakened to the consequences o our
neglected roads, bridges, public transport, electricity
grid and other social inrastructure such as hospitals
and schools. The recent wave o service delivery unrest,
Eskoms load-shedding and media exposs o the
countrys crumbling water and sewage treatment
inrastructure, have ensured that inrastructure delivery
remains top o mind. This is not purely a South Arican
phenomenon. According to a recent poll, 94 percent o
Americans are concerned about the condition o their
countrys inrastructure.2
Thanks to the stimulus packages unveiled in many
countries (see table 1), public inrastructure is receiving
long overdue attention and a signicant inusion o
public unds. While these are welcomed developments,
the level o direct government unding proposed will
meet only a tiny raction o inrastructure needs. In
the United States, according to the American Society
o Civil Engineers, there is a $2.2 trillion gap between
the supply and demand or roads, bridges, water and
sewage systems, public transit systems and other public
inrastructure.3
The inrastructure stimulus money romthe 2009 American Recovery and Reinvestment Act
(ARRA) addresses less than 5 percent o this need.
The current confuence o events presents government
leaders with a unique opportunity to make a timely
and economically productive down-payment towards
closing the global inrastructure gap. Funding
is however, not the only challenge. The current
inadequate state o certain inrastructure demands
innovative thinking in order to speed its improvement.
This means using the ull complement o innovative
inrastructure nancing and delivery solutions available,
while developing new approaches to address todays
challenging market conditions.
The landscape or public and private inrastructure
nancing has changed dramatically since the nancial
crisis began (see table 2). Tightened credit markets
pose as an obstacle to raising debt nance or public
and private inrastructure delivery models. This depends
on high levels o up-ront capital repaid over the long
term through user ees or general taxation. Just as
governments are strapped or cash, private rms ace
diculty raising capital in constricted nancial markets.
However, this does not mean that private involvementis o the table. Governments can make limited public
unds go urther by leveraging the $180 bil lion in private
equity that has been raised by inrastructure unds over
the past ew years.
Introduction
Table 1 Stimulus packages announced across the globe
Australia Around AUD 28 billion
Canada CAD 12 billion
China Around USD 438 billion
European Union Around EUR 173 billion
France Upward o EUR 10.5 billion
Germany Around EUR 19 billion
Japan Around JPY 2.6 trillion
India Around USD 33.5 billion
Sweden SEK 1 billion
United Kingdom GBP 3 billion (in capital spending brought orward)
United States Around USD 113 billion
8/7/2019 Infrastructure Finance - The changing landscape in SA
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Table 2 - How the infrastructure landscape has changed in the wake of the credit crisis
Pre-crisis Demand
Limitedpublicmoneyforinfrastructure
Highconstructioncosts
Fiscaldynamicsencouraginggovernmentsto
explore alternative delivery models
Supply
Well-functioningdebtcapitalmarketsand
international project nance loan market
Highlygearedcapitalstructuresandattractive
equity returns
Dominanceofactiveequityinvestorsand
emergence o inrastructure unds
Post-crisis Demand
Infusionofpublicmoneyforinfrastructure
Fallingconstructioncosts
Fiscaldistresssolidifyinginterestinalternative
delivery models
Supply
Challengeddebtcapitalmarkets,butaidedbynew
borrowing instruments
Priceandtenorconstraintsininternationalproject
nance loan market
Variabilityinequityreturns
Impairmentofsomeactiveequityplayers,balanced
by continued growth in inrastructure unds
8/7/2019 Infrastructure Finance - The changing landscape in SA
5/12The changing landscape o inrastructure nance in South Arica 3
Inusion o public money or inrastructure
Ater a long period o underinvestment in public
inrastructure, the South Arican Government in 2008
announced a range o inrastructure investment projects
aimed at increasing the productivity o the South Arican
economy and creating much needed employment.
These projects are estimated to total some R785 billion
over three years (see breakdown in table 3).
Investing in public works to stimulate economic activity
is hardly a South Arican phenomenon. The 2009 ARRA
directs substantial public unding to transportation,
energy and IT inrastructure, schools and ederal
building modernisation, among other areas. Around
the world, inrastructure investment has become a
signicant component o a number o the economic
stimulus packages developed to respond to the global
recession. The European Union has committed upward
o $200 billion to inrastructure. Further east, India is
investing around $30 billion in upgrading the countrys
inrastructure, while China has announced that hal o its$585 billion stimulus package will go to inrastructure.
While the sizable infux o government stimulus dollars
will not come anywhere close to eliminating the
inrastructure decit, stimulus unds should certainly
help improve the condition o inrastructure which has
been badly neglected over the past ew decades.
Falling construction costs
As o March 2009, investment spending (which includes
construction) was down 12 percent in the United States,
and over 20 percent in several Asian and Middle East
markets, with worldwide construction activity levels
not expected to return to their 2008 peak until at least
2011. Due to diminished global demand (or both
residential and non-residential construction), commodity
prices have allen globally, and other construction prices
have allen in some jurisdictions. With new stimulus
unds now available or inrastructure, government
leaders can take advantage o lower construction
costs while providing a needed boost to employment.
An estimated $50 million project at Baltimores BWI
Airport, or example, will be built or $8 million less
than originally estimated, partly because o increased
competition among contractors.
According to the BER 2009 Building and Construction
report, the BER South Arican Construction Cost index
ell by 4.3 percent in 2009, the rst annual decline inthe index since its inception in 1962. Industry players
have suggested that Eskom should consider breaking
the earlier contracts or the construction o the planned
Kusile power station, and re-bidding or these at current
lower construction prices, since the original construction
contracts were contracted when global construction
prices were at a peak beore the recession.
On the demand side
Table 3 Large South African infrastructure projects
Power Madupe R102 billion
Kusile R142 billionOther Eskom projects R96 billion
Transport Gautrain R25 billion
Bus Rapid Transit System R25 billion
Gauteng Freeway Improvement Project R11 billion
Durban Harbour Widening R3.2 billion
New locomotives R12 billion
Multi-products pipeline (Dur-JHB) R10 billion
New Durban Int airport R7.4 billion
Extensions to JHB & CT Int airports R14.6 billion
Fuel New Coega renery R102 billion
Water inrastructure LesothoHighlandsPhase2 R7.3 billion
Berg River dam R1.5 billion
Other Stadiums or 2010 R8.4 billion
Other R217.6 billion
8/7/2019 Infrastructure Finance - The changing landscape in SA
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A possible risk is that contractors could adopt a
low-bid strategy and subsequently recoup the
discount through change orders. Governments
should be aware o these risks and develop strategies
to mitigate them through careul staging o capital
programmes and aggressive contract management.
The changing shape o the demand or PPPs
It is too early to tell or certain whether the inusion o
public money will dampen or stimulate governments
demand or PPPs or other creative nancing solutions.
More public subsidy does not necessarily mean less
private capital. In act, it could actually oster the
reverse: better project economics, better credit and
more private capital put to work. I the hundreds
o billions in planned inrastructure spending in the
stimulus packages can be leveraged with private unds,
then stimulus dollars can generate an even more
proound impact on nations economies. There are
many viable options or integrating stimulus unds into
PPP project structures.
In many countries, PPPs have been successully executed
or projects that required public subsidy to be viable. In
these cases, government unding was used to write
down particular project costs (capital and/or operating)
or risk elements either up ront or over the entire project
lie cycle. Such an approach could be used to leverage
stimulus unding.
The South Arican government appears to be making
increasing use o PPPs and other public-private
investment structures to achieve its inrastructure aims.
For example, the N4 highway rom Johannesburg to
Maputo was concessioned, the Gautrain project was
structured as a PPP, Eskom is currently seeking a private
investor to take a stake in the Kusile plant, and there
are tenders out or PPPs across a range o other asset
classes. The PPP website maintained by the PPP unit in
National Treasury, lists 11 PPP projects active in South
Arica as at February 2010. William Dax, who heads the
PPP unit, has said that 25 PPPs with a private investment
value o R13.8 billion have been completed to date and
an additional R29 billion o private capital is committed
to new PPP projects.
In addition to writing down particular project costs,
jurisdictions are increasingly looking or innovative ways
to make projects viable by involving multiple public
sector entities, both within and across jurisdictions.
Public-public-private-partnerships (PPPPs) are startingto emerge as a way to get projects o the ground
by combining multiple levels o public support. For
example, a new energy-rom-waste project being
developed in Staordshire in the United Kingdom is a
collaborative eort o a number o local governments
that are banding together to achieve economies o scale
that will make the project viable.
8/7/2019 Infrastructure Finance - The changing landscape in SA
7/12The changing landscape o inrastructure nance in South Arica 5
On the supply side
Tightened credit markets
Financing markets are improving, but they may remain
less attractive than usual or the near term. In this
context, nancing markets include both government
bond markets and the international project nance loan
markets that provide capital or many PPPs. While many
market participants view inrastructure as an attractive
deensive asset class during this recessionary period, the
dynamics o the credit markets, particularly with respect
to the tenor o debt, have moved in the opposite
direction. As a result, deal volume is down. Transactions
that are being executed are taking more time, incurring
higher costs and relying more heavily on ocial unding
rom institutions like the European Investment Bank.
A number o governments are proactively trying to
ensure that the credit crisis does not stall needed
inrastructure projects. The UK government has decided
it is better to provide additional government-backed
debt nance than to delay projects or restructure scores
o scheduled PPP transactions. Toward this end, the UKTreasury announced in February 2009 that it will lend
directly to those Private Finance Initiative (PFI) projects
that cannot on their own raise sucient debt nance
on acceptable terms. Across the EU, the European
Investment Bank has increased lending to ensure that
signicant deals are executed.
Variability in equity returns
In principle, the great variety o PPP structures makes
it dicult to generalise about equity returns in the
inrastructure market. For example, in some PPP
structures, reduced gearing can lead to lower equity
returns. In others, it can have the opposite eect. The
dierence lies in the nature o the revenue supporting
the structure. For example, in availability payment style
structures where debt costs are passed through to a
government payor, equity returns are stable or rising; in
availability payment style structures where revenues are
xed, equity returns are stable or declining.
Potential fight to quality
On the positive side o the equity equation, there is
likely to be an eventual fight to quality, with investors
seeking sound prospects in the inrastructure sector,
particularly i other asset classes remain severely
impaired (see table 4). This is particularly relevant or
pension unds, since long-term inrastructure projects
are a good t or pension und liabil ities. Over thepast several years, billions o dollars have migrated to
inrastructure unds - the total value o which now ar
exceeds the likely equity component o PPP projects in
the pipeline. There are over 10 inrastructure unds and
provincial growth unds active in Southern Arica.
Table 4 - Infrastructure investors
Strategic buyers/concessionaires
Traditionally,operators,developersorcontractorsintheinfrastructuresector
Oftenbenetfromsectoroperationalexpertise,whichenhancesvalueadd
Long-terminvestmentstrategy
Inrastructure
unds
Privateorlistedequityfundsfocusedoninfrastructureinvestments
Strongliquidityawaitinginvestmentopportunities
Lowerequityreturnsthanfornancialsponsors
Typicallylooktotakepartinaconsortium
Medium-tolong-terminvestmentstrategy
Fundsizesaresmallerthanfornancialsponsors
Financial sponsors Privateequityfundswithshorterexitstrategy
Highequityreturns(+20percent)maylimitabilitytobidcompetitively,buthavebeenachievableincertain
opportunities
Normallylookforshort-terminvestmentswithaclearexitstrategy
Typicallylooktotakepartinaconsortium
Fundsizesrangefrom$6billionto$16billion
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Structuring effective PPPsfor infrastructure
With a greater number o priorities (and industries)
competing or public unds in the wake o the credit
crisis, governments are under more pressure than ever
to be creative about how inrastructure needs are met.
I inrastructure gaps are to be narrowed, the traditional
models o nancing and delivering inrastructure must
give way to new, innovative models and a portolio
o hybrid approaches. The structure and nancing
o inrastructure projects involving both the public
and private sectors will need to evolve in response
to changing conditions in the nancial markets. In
countries around the world, we are starting to see the
outlines o what such innovations may entail.
Inearly2009,theFloridaDepartmentofTransportation
entered into a $1.8 billion 35-year concession with a
private consortium, headed by the Spanish rm ACS
Inrastructure Development, to build and operate
highoccupancytolllanesnearFortLauderdale.
The nancing includes more than $200 million in
equity, $750 million in commercial bank debt anda $603 million loan rom the ederal Transportation
Inrastructure Finance and Innovation Act (TIFIA)
programme.4 In this PPP, the Florida Department o
Transportation will set toll rates, retain all revenues
and make availability payments to the private
concessionaire annually out o all o its revenues
(including state appropriations, tax revenues and tolls).
The project is the rst US toll road PPP structured with
perormance based availability payments.
TheUnitedKingdomisinthemidstofthenations
largest-ever school buildings investment programme,with a goal o rebuilding or renewing nearly every
secondary school in England. To realise this ambitious
goal, the central government has created a PPP model
calledLocalEducationPartnership(LEP),aprivate
sector consortium working in ormal partnership with
local authorities and the central government. Certain
LEPprojectsarebeingdeliveredthroughconventional
capital unding and design-build contracts, while
others employ PPP models. The programme is
designed to capture economies o scale in delivery by
bundling multiple acilities into a single procurement.
Otherinnovativestructuresemergingaroundthe
world include combining multiple public authorities
(such as neighbouring local government entities) to
procure a single project or service. The improved
project economics can attract a broader array
o bidders to the procurement, resulting in cost
eciencies or the local authorities.
These projects, each with its own distinct mix o public
and private participation, demonstrate the diversity o
delivery models available today. There is no longer a
binary decision between public and private. In reality,
nearly every public inrastructure project involves a
large degree o private sector participation through the
normal channels o a market economy. Most PPP models
simply represent a way o deepening and/or broadening
the private sectors engagement in delivery in exchange
or sharing in the associated risks and rewards. The
question policymakers need to answer is: What is the
optimal mixture o public and private sector participationin the project to maximise public value?
This is the central question acing inrastructure
policymakers today. And theres no one-size-ts-all
answer or every situation. Most inrastructure
projects are composed o ve elements or which
responsibility must be assigned: design, construction,
service operation, ongoing maintenance and nance.
Theoretically, any o these elements and their related
risks can be allocated to either the public sector or the
private sector. The shape o that allocation determines
the structure o the partnership.
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9/12The changing landscape o inrastructure nance in South Arica 7
Determining the right mix o public and
private involvement in inrastructure nancing
and delivery
The ollowing three steps should be considered
when determining the right mix o public and private
involvement in inrastructure nancing and delivery.
Step 1: Determine public authority - What am I
allowed to do?
What laws and policies exist regarding the delivery o
inrastructure and the potential involvement o private
nance? Are there political, legal or policy constraints
that would make it dicult to use certain partnership
structures? These questions are among the rst that
need to be answered beore a public sector entity gets
too ar ahead o itsel. The legal and policy ramework
in place, in addition to the temperament o the
electorate, will automatically narrow the pool o possible
partnership options. Most public sector entities ace
restricted choice in partnership arrangements.
Recently, several governments have improved upon
their existing PPP legislation. The State o Caliornia
has adopted a new legal ramework or transportation
PPPs that authorises regional transportation agencies
and Caltrans to enter into an unlimited number o
PPPs through 2017, removing earlier restrictions on
the number and type o projects they may undertake.
The South Arican PPP guidelines, as issued by the PPP
unit in national treasury, have been similarly relaxed
post the credit crisis, permitting government to retain
higher levels o risk in order to make proposed projects
undable by private sector bidders.
In addition to legislative constraints, political actors
oten determine the extent or nature o private sector
involvement. For example, in Canada and elsewhere,
core services (such as teaching, health care and prison
guards) are distinguished rom non-core services (such
as janitorial services, ood services and transportation),
and the public sector generally retains the ormer. In
the South Arican context, the resistance o trade union
bodies to perceived privatisation o essential services is
well documented. In addition, concerns have been raised
around the possibility o privatising Eskoms generating
capacity, which is seen as a strategic national asset.
Step 2: Defne project needs and objectives - What
do you want to do?
Once a public sector entity has determined what it is
permitted to do, the next step is to dene the project
goals. First, dene the need. For example, it could be
decongesting a certain corridor by 15 percent over the
next three years. The next step is to dene the service
solution and associated assets to meet that need. In this
case, the solution might be to deliver a new toll road
with specic capacity within a specied time period.
Lastly,policymakersmustdeterminehowthesolution
will be delivered and unded. Can tolls or congestion
charges be introduced, or must public unds rom
general (or special) taxation be made available?
Four o the most common variables that governments
should consider when dening the need that must be
ullled are speed, eciency, degree o certainty about
needs and innovation.
Step 3: Determine the best owner or each projectcomponent - Who can and should do what?
Determining what you have authority to do and then
what you want to do will begin to narrow the options
or structuring the relationship with the private sector.
The next step is sorting out who can and should
do what. The sorting process has three principal
components: capabilities, nance and risk.
Capabilities - What capabilities do we have in-house
to deliver and/or manage the project?
In what areas o project delivery does the public
sector project sponsor excel: design, operations,maintenance or nancing? What capabilities are
present in the market? For example, i a government
excels at road maintenance but is weak in
construction (cost or timing), it might decide to bear
responsibility or long-term asset condition, but allow
a private partner to add value at the ront end o
theproject.Thesamegoesformanagement.Large
capital projects are complex and require a great deal
o experience to manage successully. Partnerships
add another layer o complexity, and institutional
capacity building must be a core element o any PPP
programme. Eective project management is essential
to limit risk and cost overruns and streamline delivery,
so the presence o competent sta is o particular
importance when unding is tight.
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Financial - How are we going to pay or the
inrastructure?
An important, but oten conused distinction to
draw when considering the nancial elements o an
inrastructure project, is that between unding and
nancing. The unding or a project is its long-term
source o support. In the case o public inrastructure,
this may be revenues generated by the project,
dedicated tax revenues or general resources o the
sponsoring public sector entity. The nancing o a
project is the means by which the unding is leveraged
to provide enough upront cash to purchase, construct
or adapt the project. While there may be many
creative nancing vehicles available, once the unding
structure is established, all o these nancing vehicles
will be securitising the same project economics.
In the current tight monetary environment,
partnership structures may prove appealing or many
public sector entities. They may consider partnership
structures that reduce the public sectors capitalpayments over the lietime o the asset (or contract),
monetising existing assets to pay or new ones (or
example, Eskom could sell one o its existing operating
power stations, or example, Majuba, to raise cash to
und the construction o Kusile) or allow or nancing
by the private sector that does not eat into public debt
capacity. Using PPPs to raise private capital or public
projects can help to spur job creation when projects
would otherwise be put on hold.
Risk transer - How much risk should be transerred?
Answering this question correctly and allocatingrisks accordingly maximises public value. There are
several risk allocation conventions, or example, a
private contractor is naturally positioned to eciently
manage construction risks, and a government is
better positioned to control and absorb regulatory
risk. However, every partnership is unique and
careully negotiated.
As partnership models prolierate around the world,
risk allocation principals are becoming increasingly
sophisticated and the parties are becoming more
adept at crating structural solutions to risk capacity
constraints. For example, many PPPs have been
structured to isolate discrete and identiable chunks
o risk (such as tunnelling) to avoid contaminating the
overall risk-sharing approach with inecient pricing.
The public sector has discovered ecient ways to
write down those elements and still achieve value.
The key is to optimise, rather than maximise, the level
o risk transer.
One o the core tools being used in international
PPPsisthePublicSectorComparatororValuefor
Money analysis. The term Public Sector Comparator
(PSC) reers to the risk-adjusted whole-o-lie cost
o procuring an asset or service through whatever
is considered the conventional public procurement
method.ThetermValueforMoney(VFM)refersto
the result o a comparison between the PSC andthe risk-adjusted whole-o-lie cost o procuring
the same asset or service rom a private party. The
PSC/VFManalysisisusedtodescribethedifference
in risk-adjusted cost to the public sector between
conventional procurement and PPP procurement. In a
direct comparison, whichever model produces a lower
cost is said to provide value or money.
The practice in many countries is to perorm
this analysis as part o the approval process or
undertaking a project as a PPP. In those cases, unless
VFMcanbeproven,theprojectiseitherabortedor pursued by conventional procurement means.
The South Arican Municipal Services Act provides
or a similar comparison to be perormed by any
municipality wishing to outsource any aspect o
service delivery. The act requires the municipality to
rst calculate the cost and capacity o providing the
service in-house, to provide a benchmark against
which to compare the proposed costing or any
outside service provider to provide the same service.
8/7/2019 Infrastructure Finance - The changing landscape in SA
11/12
In these challenging times, governments are coping with
the normal course o scal stress overlaid with a new
set o extraordinary demands on their resources. At the
same time, it is clear that reverting to a deault setting o
earlier times - putting inrastructure investment on hold
until the economy has recovered - will put economies
in an ever more precarious position going orward.
I inrastructure gaps are to be narrowed, the public
sector must respond with creative and fexible solutions
that evolve with the changing environment. Too oten,
public sector entities are unaware o the alternativesavailable to them or o the considerations involved in
selecting the most appropriate delivery models or their
capital projects. By applying a bottom-up approach to
the development o a partnership structure, the public
sector can deliver projects in a way that most closely
approximates the optimal solution within the connes o
what is possible.
Conclusion
Contact
Andr Pottas
Partner
Tel: 031 560 7033
E-mail: [email protected]
Reerences
1 Top Executives Say Current Inrastructure Investment Wont Support Business Growth, Says KPMG
Study, PRNewswire, January 14, 2009
.
2 Building Americas Future, Building Americas Future Releases New Poll: Majority o Americans Ready
to Pay or Better Inrastructure but Demand Accountability, press release issued on January 8, 2009
.
3 American Society o Civil Engineers, 2009 Report Card or Americas Inrastructure, January 2009.
4 Federal Highway Administration, US Department o Transportation, USDOT Approves $603 Million
LoantoBuildNewExpressLanesInFlorida:SunshineStateLandsNationsFirstTIFIALoanof2009,
March 4, 2009
.
8/7/2019 Infrastructure Finance - The changing landscape in SA
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