Interest returns in private financing

11 October 2015

Public-private partnership programmes have yet to establish a firm foothold in the region, but change is on the horizon

Special Report Contents

The use of the public-private partnership (PPP) model in major projects is back on the agenda, fuelled by the collapse in oil prices that has forced governments to rethink how they push ahead with critical planned infrastructure spending.

While there are examples of successful use of the PPP model in the region, particularly in some major power and water schemes, it has continued to suffer from a perception of simply being more trouble than it is worth to set up.  

PPPs are a more complex and often more expensive option to traditional procurement and this threatens to be the biggest roadblock for its acceptance as a viable instrument in the procurement of projects.

This means to push ahead with a PPP, government entities need to have the right motivation to engage private partners.

Planned PPP projects in Mena region*
ProjectCountrySectorStatusStart of project study
Taif International airport Saudi ArabiaAirportPrequalification of developers and investors2015
Union Oasis UAEMixed-UsePrequalification of developers and investors2015
Kuwait National Rail Road KuwaitRailStudy2010
Kuwait Metropolitan Rapid TransitKuwaitRailStudy2010
Contact Centres Park (Al-Maadi, Cairo)EgyptCommercialBid evaluation2010
Operation and Maintenance for King Abdulaziz International Airport (Mecca)Saudi ArabiaAirportBid evaluation2014
Cairo Metro extensionEgyptRailStudy2015
The VillagesUAEConstructionDesign2015
Rehabilitation of two airports and construction of one new airportJordanAirportStudy2015
Nile River Bus Scheme (rehabilitation of 16 berths/construction of 12 new  berths)EgyptTransportStudy2015
Automation for 400 notarisation offices EgyptITStudy2015
Rehabilitation of Safaga Industrial PortEgyptPortsStudy2015
Four  river transport schemes (3 in southern Nile, 1 in Delta) EgyptTransportPre-feasibility 2015
Four stadiums (Luxor, Mersa Matruh, Hurghada, Sharm el-Sheikh)EgyptConstructionPre-feasibility 2015
*=Excludes power and water projects. Sources: MEED; MEED Projects

Barriers to acceptance

One of the barriers that have made PPPs historically less attractive is the government’s ability to get credit cheaper than private companies.

“Sovereigns can borrow money more cheaply than project companies. But this brings us back squarely to the question of what motivates them to consider PPPs, which should be efficiency generating overall cost savings rather than the cost of financing,” says Douglas Segars, UK-based associate managing director at Moody’s Project Infrastructure Finance Group.

Shifting mindsets from acquisition cost to life cycle costs orientation is also a major leap for most procurement authorities. A PPP contract typically takes into consideration long-term services and operational life-cycle costs such as energy consumption, system upgrades and maintenance, and environmental impact mitigation, where necessary. These items, which usually end up costing far more than the acquisition cost, do not feature in most engineering, procurement and construction (EPC) contracts.

The complexity involved in drafting PPP contracts is another barrier. A PPP project typically involves extended and expensive feasibility and contract negotiations. Lead and technical advisors, banks and equity investors usually conduct their own due diligence, especially for projects whose life cycles often span 30 years or more.

“The financiers do not wish to take risks… they conduct very, very thorough and independent due diligence on every project and time scales to establish their viability and robustness,” explains Alistair Dormer, group CEO for rail of Japan’s Hitachi.

Such arduous processes, along with negotiations facilitated by legal and technical advisors, usually precede the signing of each PPP contract.

This complicated and often expensive process, however, is the only route that could ensure procurement authorites that the project they want to buy will be delivered according to agreed specifications and timeline over a very long period. “The banks, for instance, will only release funds once evidence of real progress as specified in the timeline is presented by the private project company,” explains Dormer.

This procedure effectively ensures the efficiency of the model once a project gets off the ground, primarily with the government or service offtaker dealing only with the project company or the special purpose vehicle (SPV), which takes responsibility for the project throughout the agreed life cycle of the contract. “For one, the lenders will only deal directly with the private entity throughout the project’s life cycle,” adds Dormer.

Another false dawn for PPPs?

Interest in PPPs tends to rise and fall with oil prices. In protracted periods of low oil prices, governments look to PPPs as a way of easing pressure on their budgets.

“The risk that interest in PPPs will wane when the oil price recovers is present, but I would guess the risk is lower for geographies that are less hydrocarbon reliant, like Dubai,”explains Trevor Butcher, partner and head of finance and projects at DLA Piper Middle East.

Dubai has recently introduced a new PPP law, which is expected to come into effect in November once the implementing regulations are released.

Unlike an earlier PPP law that covered only power and water, the new law applies to all sectors and is considered by experts as an important first step towards future use of PPP, as it means the government is considering the model as a procurement option. It also improves confidence among private investors that there is enough regulatory framework in place to guide future projects.

“This is a good start towards having a more developed understanding of PPPs. The key message being brought forward is that the government will take hold of it as a procurement option,” says Butcher.

PPP projects, completed and underway*
ProjectCountry StatusContract period (years)Credit providers
Prince Mohammad bin Abdulaziz airport  - MedinaSaudi ArabiaOperational25 National Commercial Bank, Sabb, Arab National Bank
Mowassat Specialist Hospital (224 beds)EgyptConstruction na
Smouha Maternity HospitalEgyptConstruction na
Shakara for Housing project (Naseej)  Bahrain Construction5Ithmar Bank
*=Excludes power and water projects. Sources: MEED; MEED Projects

Risks and options

The laws however do not completely eliminate the technical and financial risks that go with each planned PPP project. Or the length of time it can take to finalise a deal.

The sizeable investments required by projects such as the Kuwait rail and metro, which have undergone two prequalification rounds show how daunting such schemes can be.

The Kuwait schemes are estimated to be worth $17bn. UK firm EY (formerly Ernst & Young), along with UK’s Atkins and Ashurst, was awarded the advisory contract for the metro project in 2010 by Partnerships Technical Bureau (PTB). Following a review of all PPP schemes in 2013, the procurement was transferred to the Communications Ministry, which decided that EPC was the preferred route. The second prequalification round was then conducted in late 2013, but subsequently stalled.

The projects were resurrected this year, with EY, along with Trowers and Hamlins and Ashurst, asked to review and update the initial feasibility studies for the rail road and metro projects, respectively, that were completed and approved by the PTB’s Higher Committee in 2011.

“[Such projects] take a lot of investment from the private sector, which they won’t do for free, and the public sector needs to be ready,” says Khaled Amri, a director at EY. 

To make these projects more appealing to investors and creditors, public entities could take one of several options in approaching their PPP projects

PPP models

The first is the adoption of an availability-payment model.

Unlike the typical PPP concession route, where the private company collects fees from users for the provision of a service like electricity, the availability payment option requires the government to assume the demand risk by providing sovereign guarantees to the private company.

This model allows the private company to recover its capital investment revenues as long as the services are delivered or the equipment or vehicles are in good condition, especially in PPP schemes like rail, where the number of customers can be difficult to forecast or impossible to guarantee.

Another option is be to break down a big scheme into smaller more manageable packages. This can be particularly good for rail projects, for example, by tendering the civils, rolling stock, systems and operations separately.

Alternatively, PPP could be used only for the rolling stock and systems, services and maintenance, leaving the civils package as a separate contract altogether.

The hidden complexity of EPC contracts

Major PPP projects that were converted into EPC 
ProjectCountryBudget ($m)Cause of PPP cancellation
Mafraq Ghuweifat HighwayUAE3,000Abu Dhabi Executive Council and Finance Department deemed financial offer by developers too high
Saudi LandbridgeSaudi Arabia7,000Failure of Saudi Railway Company and preferred bidder (Tarabot consortium) to agree on financial terms of the proposed 50-year concession agreement
Abu Dhabi Airport Midfield Terminal ComplexUAE6,000Project structure was changed to traditional procurement at an early phase
New York University UAE1,500No clear reason reported
Sources: MEED; MEED Projects

In many respects, the PPP process is the inverse of securing an EPC contract, where the front end is relatively straightforward.

However unlike in a PPP contract, once an EPC contract is signed, and the work completed and handed over, any future upgrades would require a renewed round of contract negotiations, either with the same entity that built it or new bidders.

It also means that a separate or new operations and maintenance contract needs to be negotiated.

A poster child for the hidden complexity that EPC contracts can entail is the pilgrim metro in Mecca.

The metro, which operates only seven days a year, during the hajj pilgrimage, requires 5,000 staff to operate, and was procured via an EPC deal with a three-year operation and maintenance contract. 

Beijing-based China Railway Construction Corporation (CRCC) operated the rail between 2010 and 2013 as part of a $1.77bn deal. CRCC is understood to have incurred losses in excess of $600m during the three- year period.

To make matters worse, the rolling stock and systems used are understood to be legacy systems and cannot interconnect with the rest of Mecca’s metro network.

Such cases highlight the risks that are often not factored in by the public sector, say PPP advocates.

PPP case study: Prince Mohammad bin Abdulaziz International airport

Full-fledged PPP projects outside the power and water sector are an exception in the Middle East.

The most talked about is the $1.2bn Prince Mohammad bin Abdulaziz International airport in Medina, Saudi Arabia, whose 25-year contract was won by local/Turkey Tibah Airports Development in 2011.

Tibah is a special purpose vehicle (SPV) formed by Turkey’s TAV Airports and local contractors Saudi Oger and Al-Rajhi.

The International Finance Corporation (IFC) was lead advisor for the project and funding was provided by the National Commercial Bank (NCB), Saudi British Bank (Sabb) and Arab National Bank.

Development on the airport was completed on time and within budget and it entered operations in June 2015, as scheduled.

But other big-budget PPP projects have struggled.

Mafraq-Ghweifat road

Source: Alamy

The Mafraq-Ghweifat road was originally considered a test case for PPP deals in the region

These include the $3bn Mafraq Ghuweifat Highway in the UAE and the $7bn Saudi Landbridge railway line.

Both projects defaulted to traditional procurement, due primarily to the failure of the government entity and the private partner to agree on financial terms.

 

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