Financing of large infrastructure projects

Typically, the financing of large infrastructure projects is on a what is known as, 'non-recourse' or 'limited recourse' basis, that is, non-recourse to the project sponsors or to the host government. Recourse is limited to the project company and its assets including plants and equipments, buildings, lands, performance bonds, insurance, contractual rights and government guarantees obtained by the company. The lending for the project generally is based upon the anticipated revenue of the project rather than the general assets or credit of the project sponsors and the collateral for such lending is comprised of the assets of the project facility including all contractual rights and cash flow of the project. This approach to financing the large infrastructure projects is known as 'Project Finance' approach. The project company owns and operates the facility for a period of time which is sufficient to pay off the debt and a reasonable return on equity. The project company, at the end of the period, transfers the ownership of the facility to the host government.
 In recent years, however, we have seen many variations on this theme, which have spawned a (sometimes bewildering) variety of acronyms. BOT is perhaps the most familiar form of PPP and the basic concept has been employed (with some variations) in many different ways, including:
Build, Own and Operate (BOO);
Build, Own, Operate and Transfer (BOOT);
Build, Lease and Transfer (BLT);
Build, Rent and Transfer (BRT);
Build, Transfer and Operate (BTO);
Design, Build, Finance and Operate (DBFO) and
Design, Construct, Manage and Finance (DCMF).
The way in which risks, responsibilities and powers are allocated between the public and private sectors will vary enormously from structure to structure across this spectrum. There is now a growing tendency to categorise all these terms together as 'Public-Private Partnerships' or 'PPPs'.
In recent years, the Build-Operate-Transfer (BOT) method of financing large infrastructure projects has found widespread applications around the globe, specially in the Asia-Pacific region. The BOT concept was first coined in 1984 by the then Turkish Prime Minister Turgut Ozal within the framework of the privatisation of Turkey's public sector projects to designate a "build, own and transfer" or a "build, operate and transfer" project (the terms are used interchangeably). The structure requires the private sector to finance, design, build, operate and manage the facility and then transfer the asset free of charge to the government after a specified concession period. The idea immediately captured the world's attention, specially in developing countries such as Malaysia, the Philippines and Thailand which see BOT as a way of reducing public sector debt while promoting foreign direct investment in the infrastructure sector. The success of Eurotunnel in raising $ 1.72 billion equity for the Channel Tunnel project further inspired worldwide interests in the BOT schemes.
In emerging economies the sectors including highways, expressways, roads, bridges, tunnels and related facilities are being increasingly considered as potential areas for the promotion, construction, rehabilitation, improvement, expansion, modernisation, operation, financing and maintenance of projects under Public-Private Partnership method. These are:
a. Railways or rail-based projects.
b. Non-rail-based mass transit facilities, navigable inland waterways and related facilities.
c. Port infrastructure like piers, wharves, quays, storage, handling, ferry services and related facilities.
d. Airports, air navigation and related facilities.
e. Power generation, transmission, distribution and related facilities.
f. Telecommunications, satellite facilities and related service facilities.
g. Information technology and database infrastructure.
h. Irrigation and related facilities.
i. Water supply, Sewerage drainage and related facilities.
j. Education and health infrastructure.
k. Land reclamation, dredging and related facilities.
l. Industrial and tourism estates/ parks.
m. Government buildings and housing projects.
n. Markets, slaughter houses and related facilities.
o. Warehouses and post-harvest facilities.
p. Public fish ports and fishponds including storage and processing facilities.
q. Environmental and solid waste management related facilities.
 DISADVANTAGES OF PPP/BOT MODEL:  Though PPP/BOT model of infrastructure project development is being hailed in many countries around the world, the ground realities demonstrate that the supposed benefits of the model are based more on free market ideology than on empirical evidence or fact. The concept in its present form and structure is relatively a new development and is gaining popularity for the last two decades or so. With long concession periods usually ranging from 15 to 30 years, not many such projects have to-date completed all the stages of project cycle-build, operate and transfer as planned. Experience shows that many of the projects have run into problems and has led to legal disputes between the private sector operators and the host government. Several such projects have faced problems mainly because of the time over-runs, cost over-runs, unrealistic price and revenue projections. Virtually in all such cases, it is the users/general public and the host government, not the private sector investors, who had to bear the cost of failure.
Empirical evidence suggests that the benefits of BOT model of infrastructure project development is not always unmixed and may have undesirable consequences. Despite wishful arguments and promises of the proponents of the model, the ground realities warrant that the premises and assumptions behind the model need critical re-examination on rigorous economic terms. In assessing whether such a project can be considered viable, due attention need to be given to the inherent disadvantages of a BOT infrastructure project.
n PPP/BOT model of infrastructure project involve a complicated process that require money,time, patience and sophistication to negotiate and bring it to fruition.Experience suggests that the lost opportunity costs of such time consuming exercise could sometimes be substantial.In many developing countries, the bureaucratic bottlenecks and inefficiencies in dealing with the PPP projects cause inordinate delay in project negotiation and development and the process may sometimes drag on so long that it may even lead to abandonment of the project.The very complex nature of the PPP/BOT project typically involves time consuming exercises thereby requiring the host country to suffer severely in terms of lost opportunity costs.
n In many BOT projects the host government or its entities are contractually bound to supply natural resources (raw materials) for use in the project. In such cases, the private sector may ask for treating the cost of raw materials as informal equity or the price of raw materials may be linked to the price of the product of the project. Typically, the government is more likely to get a price lower than the fair international market price for the raw materials supplied.
n In BOT projects where the government is the sole buyer/user of the project's output, the price paid and the payments made by the government to the project company need to cover not only the financing costs of the project but also adequate return on investment of the sponsors in the project. Thus the cost of product/service is higher in a BOT project than in a government-owned project. The notion that under BOT a public infrastructure is created without having to spend little or no public money, is nothing but wishful thinking. There is 'no free lunch' and nobody does anything for nothing, least of all the private sector. The private sector will be willing to invest in a project only if there is reasonable degree of certainty that they will be able to recoup their investment and also earn adequate profit on the investment made. Under any circumstances, it is the users - the tax-payers and/or the government who ultimately have to bear the cost of the project.
THE PROJECT AGREEMENTS:  BOT is a complex structure and is organised through a host of agreements among the parties involved. Major agreements that typically bind the participants in a BOT project are:
a.  Shareholders' agreement
b. Implementation agreement
c. Output sales/off-take agreement
d. Engineering, Procurement and Construction contract
e. Operation and Maintenance agreement
f. Fuel supply agreement
g. Equipment and essential supply agreement
h. Loan agreements
i. Insurance agreement.
j. Escrow agreement
k. Land lease agreement
 The project agreements among the various participants are the major instruments based on which a project is developed and financing is arranged. The inherent value of the agreements in the project development process is that these agreements
a. Reflect that the pricing and negotiations are real and controlled
b. Establish credibility of the project
c. Provide a basis for authorities to monitor progress of the project
d. Provide lenders with documentation for assessing attractiveness of investment opportunity
e. Document the allocation and assignment of risk inherent in any project
The commercial agreements are the key elements in a BOT project deal fundamentally because:
 The sponsors/developers want-
- To specify the responsibilities and obligations of each party
- To specify the cost of service to the buyer
- To specify the guarantees/warranties of the seller
- To specify the penalties to be paid in the event of default by either
 party and the lenders want-
- To secure investment
- To specify contingency plans for handling all transactions if  unexpected events occur.
THE PROJECT PARTICIPANTS: BOT/BOO projects have a characteristic corporate structure that is different from the methods normally used to procure infrastructure assets. In general, any major BOT/BOO project involves at least the following parties:
Host government (usually a government agency)
Sponsors
The project company
The Constructor
The operator
Off-takers
Suppliers
Lenders
Insurers
Advisers
Independent Engineers
Structures differ between projects and are influenced by different factors. The following considerations are important in determining the form and structures of the projects:
a. What project is being planned (e.g. Power Project)
What technology is being planned
How will fuel be supplied
How will the project be constructed and operated
b. Who will be the project's sponsors
What financial assets and professional capabilities do they bring to the project
How do they plan to share ownership and finance the project
c. Where is the project being planned
Specific site/ownership/status
d. How will the output be sold
How and to whom will the plants' output be sold
What is the credit worthiness of purchaser, amount and currency of the tariff.
e. The country environment
Economic and commercial considerations.
Political conditions
Legal aspects/country laws
Policy and regulatory environment
Institutional capabilities
Infrastructural constraints/capabilities.
The writer is a former Secretary, Ministry of Health and Family Welfare, Energy and Mineral Resources Division and Ministry of Information. [email protected]