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Product Details
| ISBN-13: | 9781787420847 |
|---|---|
| Publisher: | Globe Law and Business |
| Publication date: | 08/01/2017 |
| Sold by: | Barnes & Noble |
| Format: | eBook |
| Pages: | 297 |
| File size: | 9 MB |
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CHAPTER 1
What is infrastructure?
1. Introduction and context
'Infrastructure' can have a number of definitions and interpretations.
In the context of this book, 'infrastructure' has been assumed to mean the underlying framework of fixed assets required to deliver a public service.
Within that interpretation, however, exist a number of grey areas, in particular with regard to what constitutes a 'public service'.
In most economies, services such as power, transportation, water, health, education, and municipal and governmental administration are seen as essential public services which the economy and population require for sustaining economic growth and development.
As these services are key to the well-being of the economy, a public interest requirement will inevitably underpin them such that they must, at least, achieve acceptable standards and quality of service, and represent value for money.
Alternatively, if the public are paying directly for the service provided (eg, for a toll road), the tariffs charged must represent acceptable value to users, otherwise users will go elsewhere. In this context, such services are usually controlled by the imposition of a regulatory regime under which service providers are licensed, and tariff levels are determined by a regulator which monitors and ensures that the standard and quality of service are maintained.
It is thus immediately apparent that the delivery of public services, whatever the boundaries of one's definition, will always be made against the backdrop of subjective, and not solely objective, criteria and judgements. Political influence and, possibly, interference is never far away.
In addition, some services may be deemed marginal in some countries and essential in others (eg, tourism facilities or sports stadiums). Similarly, in some sectors, such as telecommunications, the mode, or technology, of delivery of a specific public service (eg, for mobile phones) may change so rapidly that investment in fixed assets is very short term and could be deemed as a 'current', as opposed to 'capital', expenditure. By contrast, some components of the delivery of such services may be deemed as arguably 'long term' (eg, mobile phone masts) and therefore investment in such assets is treated as 'infrastructure'.
A third marginal infrastructure project type can be found in pipelines, which may be both constructed and operated for one dedicated user or beneficiary, or alternatively built and operated with open access – that is, available for use by thirdparty customers or beneficiaries. Pipeline financing, therefore, has many of the characteristics of infrastructure project funding, whichever its type, and therefore has been included here in the definition of 'infrastructure'.
In the table below, project investments are identified either as regulated (ie public services) or non-regulated (ie projects operating in open and competitive markets).
The prime focus of this book is on the regulated projects listed above, which embrace infrastructure assets for whatever public service. Often such projects may, in the event, be in the form of public-private partnerships (PPP), but the underlying aim of the venture will be the same – namely, the creation of public service assets and delivery of a public service. On occasion, reference will be made in this book to projects in the non-regulated sector, when lessons can be learnt.
The fact is that the underlying financing structures for projects of both generic types, regulated and non-regulated, are largely similar. It is purely the internal balances within those structures that differ.
2. Recent history
Infrastructure project financing and PPP are, in essence, no recent phenomena. In the early 1800s a number of toll roads, turnpikes, railways and canals were funded as PPP-type concessions through the issue of shares to the public.
In 1854–59, the Suez Canal was funded using equity/shareholder funds, raised through a public issue to cover 51% of the costs, the balance coming primarily from the Egyptian government. This was then followed by a similar funding mechanism for the Panama Canal in 1878, although that project was overtaken by technical and environmental problems, leading to eventual completion being achieved only with the help of US government money. Similarly, many railway companies funded developments throughout Europe and North America by raising funds – debt or bonds, and equity – from investors.
Unfortunately, by the early 20th century many such projects had cost the investors dearly, so governments had to step in to fill the breach for investment in essential transportation infrastructure.
For the first part of the 20th century, infrastructure projects were largely funded by governments, or by public utilities as corporate financings. Developments thereafter in the second half of the 20th century followed differing paths in North America, and Europe and the rest of the world (see Figure 1.2).
3. History – Europe and the rest of the world (excluding North America)
In the first half of the 20th century, infrastructure projects outside North America were funded either using funds directly from the government's budget, or using loans raised against government guarantees. This process was seen as quick and straightforward. Even today, a large portion of investment in infrastructure is still funded this way.
The same applies to the industrial and commercial sectors, too. Much of the investment in capital assets by the large multinationals was funded through balance sheet or corporate debt financings, rather than using complex cash flow-based mechanisms. Indeed, this characteristic still applies today.
By the mid-1960s, North Sea oil and gas resources were beginning to be found and developed. Initially, the developers of such projects were large multinational oil companies, which funded these projects using the strength of their balance sheets (ie 'on balance sheet'). Over time, the governments around the North Sea wished to introduce competition, so licences were offered to smaller companies, often in consortium with the larger developers. However, the smaller companies did not necessarily have the balance sheet strength enjoyed by their partners, so struggled to raise their portion of the project funding required.
Faced with this problem, City bankers came up with the concept of raising the debt required against the security provided by the cash flows that the projects were going to generate. After all:
• the demand and price for oil and gas in the European market were relatively stable and predictable;
• the technology of extracting oil and gas from under the sea was well understood and within experience;
• the companies involved with constructing, completing and operating the projects were substantial and experienced; and
• lenders could take security not only over the project assets (ie drilling and production rigs) during the period when their loans were outstanding (ie not fully repaid), but also over the oil and gas reserves in the ground which as yet had not been extracted.
Cash flow financing was reborn!
Before long, as more deals were implemented as above, the same technique was applied to natural resources – namely, iron ore, zinc or copper mines. Furthermore, not only were commercial banks involved as lenders, but also, in time, development banks (international financial institutions or IFIs) and export credit agencies (ECAs) were prepared to lend on such terms too. However, such deals were between private sector industrial companies and their bankers, so quite often the terms and conditions remained confidential to the parties.
After some years, particularly in the United Kingdom, government policies were moving towards more private sector participation in the delivery of public services. Margaret Thatcher's government privatised the telecoms, power, water, airports and ports sectors, so that any new investment in these sectors had to be undertaken as private sector deals. Projects such as the Channel Tunnel (Eurotunnel), the Dartford Bridge and others were brought forward. In Southeast Asia a number of toll roads were promoted as build, operate and transfer (BOT) or build, operate, own and transfer (BOOT) projects, with others also following suit, for instance in Turkey and Mexico, with mixed success.
By the early 1990s over 20 countries were considering the use of private capital for investment in public service assets, but there remained many question marks over the value for money generated by such deals and their public acceptability.
In the United Kingdom, such deals were often termed as 'private finance initiatives' (PFIs) – which today might be described as PPPs – and a specialised unit in Her Majesty's Treasury was set up to pioneer and sponsor the mechanism throughout government. Indeed, for any investment over a specific value (eg, £20 million), the privately funded or PFI route had to be considered by all UK government ministries or agencies against the alternative of using public money (see further the chapter on government options).
There was an added potential advantage of such PFI-type deals in that, suitably structured, the financial obligations for the host government could be kept 'off balance sheet', which offered some attraction for those responsible for government budgets. However, such off balance sheet funding is tantamount, in effect, to using a credit card – and we all know how easy it is to overspend on credit cards.
When the Labour party came to power in the United Kingdom in 1997, a number of PFI-type deals were either operational or in the pipeline. While the new government was attracted by this concept for the procurement of public service assets, it felt that a name change was needed and the term 'public-private partnership', or 'PPP', emerged.
Taken literally, this is, however, a misnomer. The underlying framework of any PPP transaction is contractual: when there is a dispute, usually under such a framework there is a winner and a loser, with not much sharing or 'partnering' in the outcomes. Nevertheless, the term 'PPP' remains fixed and, superficially at least, the name and concept are very attractive for politicians.
Now between 80 and 90 countries worldwide are developing, implementing and operating PPP-type deals for capital investment in assets for the delivery of public services, some with more success than others. In the United Kingdom, PPP deals are still often referred to as 'PFIs', but the differentiation between acronyms and types is often blurred. Other countries now use different acronyms, such as 'P3' or '3P' in North America and 'PSP' in Southeast Asia. Generically, all these structures, however, are PPPs.
The PPP concept has taken hold not only in developed economies, but also in emerging markets, sometimes with negative effects. After nearly 25 years of global experience of the mechanism, one can arrive at two key conclusions:
• Infrastructure PPP deals are not free – their cost is merely delayed. Like credit cards, they allow the beneficiary – the government or taxpayers – to pay for the investment in public service assets at a later date. Unfortunately, as the financial obligations for PPP-type transactions can be kept off balance sheet, outside the watchful eyes of the International Monetary Fund (IMF), some emerging markets' governments have overspent on their PPP credit card. Regrettably, too, the guidelines as to whether any specific PPP is on or off balance sheet are somewhat imprecise and open to abuse, although in recent times the authorities have been tightening up on the interpretation; and
• Those countries which have been using the PPP mechanism as one option for investing in public service assets and have achieved the greatest success are those with either a long-term local capital market or an indigenous raw material (eg, oil or gas) which they can export for hard currency revenues, thereby providing a foreign exchange hedge against revaluations or devaluations of the domestic currency versus world markets.
This conclusion should come as no surprise as:
• PPP infrastructure concessions typically have a lifespan of 20 to 30 years. They are long-term deals;
• the underlying capital assets require a long cost recovery period and need to be funded with long-term debt and equity funding;
• much of the capital cost and, probably, much of the operating costs too, will be denominated in local currency. After all, such PPP concessions are delivering a public service locally; and
• in emerging markets in particular, the only source of long-term funds which can justify and support financial viability of the PPP will be denominated in hard currency.
Hence, any possible foreign currency fluctuation between the local currency and world markets for dollars, euros or yen can have a very significant impact on the PPP project's sustainability and ability to service its debts, in particular.
The conclusion, therefore, is that the development of PPP in any national environment ideally should proceed hand-in-hand with the development of local capital markets – that is, pensions funds and life insurance, among others.
Alternatively, if the country has a hard currency-generating export, then such revenues, often via some form of sovereign wealth fund, can be used as a foreign exchange hedge or buffer against such currency fluctuations, in support of PPP developments.
Here are two examples:
• As mentioned earlier, in the 1990s a number of Southeast Asian countries (eg, Malaysia, Indonesia and Thailand) embarked on PPP-type deals, often called BOOT in those days, particularly for toll highways and power projects. Such PPP projects were built and operated, for a time, quite satisfactorily.
In the late 1990s recession hit the region. The Thai baht and Indonesian rupiah devalued sharply, putting their PPP deals into jeopardy, in some cases terminally, as it was impossible to increase tariffs to compensate for the devaluation. Malaysia, for its part, weathered the storm thanks to its oil and gas exports, which cushioned the Malaysian ringgit from significant devaluation, thereby protecting PPP-type revenues.
Similar events have hit PPP-type deals in Argentina, Mexico and some Central European countries, too, over the years. Whereas the underlying PPP concession contracts may include clauses requiring tariff changes in the event of devaluation of the underlying currency, bolstered by international arbitration proceedings to enforce them, it can be politically unacceptable for host governments to impose such tariff rises on their populations.
• By contrast, countries such as South Africa and Chile have enjoyed the benefit of sizeable and long-term local capital markets, which have been available to fund most of such PPP-type deals, thereby avoiding the foreign exchange risks inherent in such funding structures.
4. History – North America
In the early days of the 20th century, the United States was in a similar position to Europe concerning the state and development of its infrastructure services.
After the depression of the 1930s, however, suddenly the demand for investment in new roads, bridges, rail connections, etc, flourished, not least because of the success of the mass-produced cars made by Ford and General Motors. Unfortunately, the municipalities and individual states sponsoring such infrastructure projects were short of funds to build the assets.
In response, the federal government recognised that the potential support for financing such assets over the long term would require participation from the private sector and, in particular, from the life insurance and pension fund industries, where fund managers took both a long- and short-term investment perspective and were seeking profitable, but low risk, investments for their funds.
(Continues…)
Excerpted from "Infrastructure Finance"
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