AFTER years of delay, Turkey has finally got its first privately-financed water supply project under way. Such schemes are seen as a way of transferring risk and costs from the hard-pressed state to the private sector, and of raising private capital to pay for public infrastructure. If this first scheme at Izmit and a second at Birecik are successful, they could revolutionise the way future water projects are developed in Turkey.

The first water scheme dates back to 1987 when the Turkish State Water Company ran out of money in the middle

of building a dam outside Izmit, a coastal town 100 kilometres southeast of Istanbul on the Sea of Marmara. The then president, Turgut Ozal, suggested to the Turkish contractor on the dam, Gama Endustri, that it should form a consortium to complete the work on a build-operate-transfer (BOT) basis. To be built at a cost of $860 million, the Izmit domestic and industrial water supply project would be the largest privately-financed water supply scheme in the world, delivering water to 1.5 million domestic and industrial consumers.

This was a huge undertaking. A Turkish registered company, Izmit Su, was duly formed under law 6224 which covers all BOT projects. The shareholders are Izmit municipality, the UK's Thames Water, Gama Endustri and Guris Insaat & Muhendislik, both local, and Mitsui & Company and Sumitomo Corporation, both of Japan.

Izmit Su awarded two contracts. Construction was let to a joint venture of Gama and Guris with PWT Projects, a wholly-owned subsidiary of Thames Water. The contract for the operation and maintenance of the plant over a 15-year period was awarded to Thames Water. Thames will also act as a consultant to Izmit municipality, which will eventually take charge

of the network, providing training and advice.

Gama is completing the construction of the dam, which it began in the 1980s and will lay the pipelines. Guris is building the water treatment plant and pumping stations. PWT is supplying the designs for the treatment plant and pipelines and bringing in materials from France and the UK. The Japanese involvement is mainly as shareholders in Izmit Su, providing 15 per cent of the equity.

The Izmit water supply project reached financial close on 18 April 1996. It is one of two BOT schemes under way in Turkey. Gama is also a major partner in the second big BOT project to reach financial close, a hydroelectric dam at Birecik on the river Euphrates. Birecik is a larger scheme than Izmit and will take longer to complete. The negotiations for the two projects ran in parallel for many years and both reached financial close within a month of each other.

The delays to the Izmit project can be blamed on a series of financial hitches over the sourcing of funds, repayment guarantees and a variety of legal obstacles. The developers were exploring uncharted territory as there was previously no clear legal or constitutional framework for BOT projects in Turkey.

There were problems over subordinated debt, which is a means of financing the consequences of disastrous events. Another critical issue was whether BOT contracts constituted concessions or commercial contracts - important when it comes to international arbitration in the event of a dispute. In the end, the project was able to go ahead without the provision of subordinated debt and on the understanding that it is a commercial contract.

Legal fees have proved to be the largest single cost in developing the scheme. All the parties are being advised by Turkish lawyers. Thames Water, which is the major investor, is philosophical about the expense and complexity. It says the lessons learned in setting up the Izmit water supply project will become standard procedure for Turkish BOT projects and should keep costs down in future.

At the signing in April, the project was estimated to be worth $860 million, but an additional $60 million has been made available to cover contingencies. The financial package was arranged by Chase Investment Bank, which is also involved in the Birecik scheme.

Finance

The funding breaks down into $580 million in export credits, mainly from France and the UK, $130 million in shareholders' equity - Thames Water owns 35 per cent - and a $130 million commercial loan.

The commercial lenders were encouraged by the provision of export credits and by the commitment of the shareholders, but they also needed reassurances from the Turkish government, which played a key role throughout the negotiations.

The Turkish treasury has guaranteed the obligations of Izmit municipality to the project. If the municipality is unable or unwilling to take the water and pay the price agreed with Izmit Su, the Turkish treasury will cover the municipality's obligations. The treasury is also guaranteeing to service the debt if Izmit Su cannot. Since international lenders remain cautious about Turkey, because of the perceived political and economic risks, such guarantees were essential if sufficient funds were to be raised.

Costs have risen far above original estimates, but Thames Water says it remains confident that the consumers will be charged a fair tariff, the investment can be recouped and the whole venture will turn out to be profitable. As part of the feasibility study for the project, Thames Water took water charges in Istanbul as a benchmark and concluded that Izmit consumers could be supplied at a lower price.

Izmit Su will service its borrowings with the proceeds of the sale of water to the municipality, which will collect the water charges from consumers. The municipality will also be able to sell water on to outlying areas, which could even include the city of Istanbul where the population is growing by about 500,000 a year.

Demand for new water in the Izmit region is also rising rapidly. Izmit and the nearby industrial town of Gebze currently rely on groundwater which is being extracted from nearby lakes. The Izmit Su project will help to reduce this reliance and stop the environmental degradation that drawing water from the lakes is causing. When the Izmit Su water project is up and running, ground extensions should stop.

All the parties involved in the Izmit project hope it will firmly establish the BOT model for future water projects in Turkey. The legal precedents set by the scheme could certainly make any future projects easier to negotiate.