PPP financing demands a flexible approach

19 April 2020
Finance agreements could be restructured to accommodate the new realities of the Covid-19 pandemic, says Sudarshan TM from Deloitte Middle East

In order to curb fiscal deficits caused by low oil prices and diversify economies to reduce reliance on hydrocarbons, Gulf nations have turned to public-private partnership (PPP) models to develop crucial infrastructure. This move has been outlined in national vision statements, and has led to the completion of projects in sectors such as power and utilities, accommodation, transport and social infrastructure.

Most have been executed on typical long-term project finance solutions based on a ‘whole life costing’ assessment and an integrated approach across the full scope of construction, maintenance, operations, debt and equity financing.

Major GCC infrastructure projects are not immune to the impacts of the Covid-19 pandemic. Companies and sponsors need to consider the implications for continuing development and operations of projects and their associated payments and debt servicing capacities.

Project companies need to first assess if the ongoing situation may constitute a force majeure event. This may depend on whether the impact of Covid-19 is foreseeable – so parties entering into contracts after the pandemic may not get the benefit of force majeure relief. ‘Epidemic or plague’, commonly seen in PPP contracts, is typically drafted as a natural force majeure event, as it is considered to be insurable. 

In most regional PPP contracts, to the extent natural force majeure events impact a party’s obligations, they may result in schedule extension or relief from obligations, but not be eligible for financial compensation, which is supposed to be dealt with through the insurance. For such relief to apply, the event would have to directly impact the obligations in question.

Under pressure 

Major impacts on operational infrastructure projects around the GCC include:

  • Transport infrastructure, such as metros and buses, are experiencing reduced patronage;
  • Accommodation facilities may suffer reduced occupancies especially in the hospitality sector;
  • Contractors may need to introduce onsite facilities such as disinfection units and isolation rooms to prevent the spread of Covid-19;
  • Electricity, water, district cooling and telecoms remain key services, but the impact of the shift to remote working for much of the population is yet to be assessed;
  • Availability of assets could be impacted by reduced manpower onsite for asset maintenance;
  • Airports could face loss in revenues from gate fees, refuelling charges and service fees.
Impact areas

All of these situations could impact payments to the developer or contractor, which would affect debt servicing, equity returns etc. Some of the potential impact areas are:

Determination of payment charges:
Payments can be structured as fixed amounts for services provided over a period of time, or as fixed and variable payments depending on usage or output. In either case, enhancement or addition of services and/or variations in usage or output would impact the payment profile. The computation of payment is typically part of the project agreements and could potentially not include mechanisms to catch additional/reduced services or asset conditions in the current situation.
Delays in service payments from the offtaker:
Government spending may be redirected to urgent, humanitarian needs, which could delay payments to project firms. There may be logistical challenges for receiving and approving invoices.
Project insurance:
Insurance typically taken out by project companies could see an uplift in premiums to deal with the pandemic situation, leading to questions on project affordability and bankability. Insurance companies/advisers should be consulted further on this matter.
Mini-perms are common in GCC power and utility bids. The region has also seen a few refinancing transactions (Al-Dur, Shuweihat S2). Investors could commence early discussions with procuring agencies and lenders and consider partial refinancing if the agreements allow this.
Financing covenants:
As part of the financing, agreements need to be carefully monitored by project sponsors and lenders, with particular focus on debt service cover ratio and the levels at which default, cash sweep, lock up and drawing of debt service reserve accounts are triggered.
Disputes and delays

All of the potential impacts listed may filter down to affect the equity returns of the project company and payments to subcontractors, which could result in claims or defaults.

Projects in the development stage are facing the impacts of Covid-19 through contractors being affected by global restrictions on travel. There is also the potential for delays in construction due to affected global supply chains, ranging from extended customs clearance times to unavailability of parts or equipment due to shutdown of manufacturing facilities.

For delays or increased costs incurred prior to completion, it may be possible for the project company to agree an extension to the commercial operations date and tariff adjustment with the offtaker. This may result in additional financing costs, which would necessitate further discussions with lenders and shareholders. 

The project company would require the financial model to be updated to reflect the revised position.

Procurers may need to consider designing contracts where not just force majeure may apply, but with additional provisions for back-up obligations in order to mitigate the effect of any future epidemics, and mechanisms to enable the developer to recoup lost service payments as a result of reduced availability due to a force majeure event. 

Given that the ongoing scenario is unprecedented in scale, the project stakeholders need to be pragmatic and sensitive in the handling of these issues, should they arise.

Project and finance arrangements/agreements could see changes in structuring to accommodate the new realities. This would provide comfort to developers and lenders, enhancing project bankability and providing a clear way for GCC countries to realise their national visions, even in these testing times. 

About the author

Sudarshan TM is assistant director, Government & Infrastructure, Deloitte Middle East

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