April 18, 2017

What can the developing world do to get the most out of public-private finance?

Written by  Andrew Buisson
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While public-private partnerships (PPP) are used extensively as a delivery model for major infrastructure projects, there are still only limited examples of successful railway PPPs in emerging markets. Andrew Buisson, a partner with global law company Norton Rose Fulbright, looks at some of the risks involved and what steps can be taken to improve the viability of these projects.

RAILWAY public-private partnerships (PPP) in emerging markets can broadly be divided into three main categories: network rehabilitation, mine to port schemes, and urban rail projects.

Kenya Photo 02Rehabilitation projects involve taking existing railways, which may be in generally poor condition, and upgrading infrastructure and rolling stock, as well as extending lines, to adequately meet freight and passenger demand.

Traffic may have moved away from the railway due to long-term lack of investment leading to unreliable or non-existent services. The Rift Valley Railway project in Kenya and Uganda is a good example of this type of project, albeit one which has been beset by a series of problems over the years. The proposed concession of the existing narrow-gauge network in Nigeria would be a project of a similar scale and nature.

Mine to port projects are mostly driven by mining companies or specialist logistics providers, and often involve the construction of new lines and associated port infrastructure to access landlocked natural resources.
A good example is Vale’s Nacala project, linking its Moatize coal mine to a new port, via a combination of new and upgraded railways through Malawi and Mozambique. Other planned projects include the new railway and port infrastructure developments required for Sundance’s Mbalam/Nabeba iron ore mines in Cameroon/Congo-Brazzaville and for Rio Tinto’s Simandou iron ore scheme in Guinea.

Urban rail projects are more likely to be greenfield in nature, and therefore will be less at risk from existing asset conditions; but these projects are likely to have greater technical complexity due to their close interaction with the urban environment and the greater safety requirements for rapid passenger movement.

To date, there are limited examples of existing urban rail or metro projects in Africa. Gautrain in South Africa provides a good example of a greenfield inter-urban railway. Addis Ababa’s new light rail system which opened in 2015 was conceived with the assistance of Chinese export finance, but not structured as a long-term PPP concession. A less-successful example is the Blue Line metro project in Lagos, Nigeria, with its repeatedly postponed opening dates and consequential uncertainty over the operational concession arrangements.

Difficult

While a PPP procurement model may be regarded as a necessary step to bring in much-needed private finance, it cannot create an affordable project where none fundamentally exists. It is very difficult to make greenfield metro projects self-funding, even in developed countries, and virtually all demand-risk passenger rail projects have failed to meet their original traffic projections.

“Decision makers are well advised to take with a grain of salt any traffic forecast that does not explicitly take into account the risk of being very wrong,” says Professor Bent Flyvbjerg, professor of major programme management at Oxford University’s Saïd Business School. “For rail passenger forecasts, and especially for urban rail, a grain of salt may not be enough.”

Nevertheless, this assumption could be challenged by developments in some cities in Africa, where an urban metro scheme would offer significant time benefits against chronic congestion, and where passenger numbers may be high enough to secure appropriate financing even with relatively low fares.

For projects underwritten by freight and commodity projections, the structuring must take into account their sensitivity to changes in market movements and the ability of the project participants to pass on these costs to users.

In the case of a new line serving an iron ore mine, the cost of the infrastructure is likely to represent a large proportion of the final sale cost of the product, which is at the mercy of global price setting. Similarly, with a new or expanded freight service, investors should not underestimate the ability of road hauliers to vigorously compete or lobby against it.

As noted by Pozzo di Borgo (2010), there may also be an inherent imbalance “where governments saddle concessionaires with both the cost of rail maintenance and rehabilitation, while road users should pay no more than a mere portion of the cost of road maintenance.” Accordingly, governments may have to look more broadly at how they can support these projects to make them successful through taxation, subsidies, or other measures.

It is possible to mitigate project demand risk by giving a level of guaranteed return of capital investment. The Rift Valley Railway project, for example, achieves this to a degree by running a notional asset value account and providing for a guaranteed payout of unamortised expenditure at the point of termination.

Many other emerging-market projects across different infrastructure sectors also recognise that a guarantee of senior debt is required for bankability purposes. Examples can be seen in Global Infrastructure Hub’s PPP Risk Allocation Matrices published last year. Sadly, there is little consensus as to how many other important key risks are allocated, such as political force majeure events and changes in law, and even within a single jurisdiction one can find as many different formulations as signed projects. This increases the time taken for due diligence and negotiation which hinders the orderly development of new projects.

A PPP in an emerging market is also likely to create a “new” type of project for that country, where the government’s role and mind-set will need to change from being an operator and self-regulator to become an independent regulator of user pricing, safety and operations. Without a track record of managing long-term PPPs or acting as an independent regulator, any bankability review will need to take into account the risk of government interfering in, or simply mismanaging, the intended operation of the contract.

Inexperienced

The private sector should not be given a free ride either; part of the problems on the Rift Valley Railway concession were attributable to inexperienced management on the concessionaire’s part. If a project is not well-structured by the government, it may find it is unable to attract the most suitable operators for what is likely to be an extremely challenging endeavour.

Even where a project is well-structured, the risk of political fall-out and lack of support looms large. Prospective PPP investors in Nigeria, for example, may see the lengthy legal disputes on the Lagos Airport domestic terminal as a warning that even where a binding court judgment is achieved, it does not quickly translate into redress if the government party is not willing to pay. It is also a stark reminder of the value of political risk insurance. A better solution will of course be part prevention and part cure.

Finally, a project’s sponsors have a key role to ensure that politically sensitive issues such as increased tariffs, and potentially necessary hardships such as re-settlement of people and redundancy of inefficient staff, are handled with tact and transparency to maximise the chance of long-term acceptance and stability of the project.

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