Infrastructure: building and financing the future
The first question is what is infrastructure?
It is best defined as the basic systems and services -such as transport and power supplies- a country/organisation uses in order to work effectively. It is commonly described as something less shared.
It is generally broadened down to be community infrastructure or business infrastructure. For the purposes of this discussion we will focus on investable assets.
Infrastructure funding remains one of the greatest challenges in the world of finance.
Debates include private versus public, who should pay and when, intergenerational equity and how to share the risk.
In developing countries, it is the greatest single challenge.
Whether you are talking about the Sydney Harbour Bridge, the Roman roads or the Three Gorges Dam you are speaking about infrastructure which will change the lives of people and will survive for more than one lifetime.
Projects RH, and its sister company Tabatinga, at the time of writing are working across a broad range of infrastructure projects in the energy area including Australian solar power generation, thermal coal assets, port assets in Colombia and refining assets in Sri Lanka.
Community Infrastructure:
Generally, most communities work together to establish core assets which enable the society to function.
Historically, these have included foot paths, local roads, water supply, defence establishments, dams, power transmission lines, railways networks, community hospitals and ports, but to name a few.
What interests many in the community is that government, like many private sector companies, lease space in buildings and choose not to own them even in the national capital.
We are talking of assets which no individual could hope to provide for themselves yet collectively help us to enjoy a high quality of life and increase our economic productivity as measured in GDP per capita.
Private infrastructure:
Is generally considered to be the things built to enable the company to do its business.
A steel manufacturing group will build a steel manufacturing plant and an oil group will generally have an oil refinery or storage facilities.
As the private sector has grown in most Western societies, private infrastructure has included assets such as power stations. As our economies have grown some things previously thought of as strictly public infrastructure have become replaced with specialised private infrastructure.
Examples of the above, in Australia, include cement plants, brickworks, ports and railways associated with coal and iron ore exports. Steel mills. Plants for converting gas into liquids.
In the USA
The USA has long had a history where many community infrastructure assets are provided by corporations, some who act like cooperatives and others who do not.
Whilst their existence and operation were important in forming the thinking behind PPPs, further discussion of the unique features the US economy, its tax regime for utilities, etc. are not merited in this paper.
Government cannot pay
One of the great challenges in dealing with the building of countries is who should own and pay for the infrastructure.
There are clearly many examples were grossly inefficient and totally impractical for each person to have their own infrastructure.
The glaring examples are roads, power networks water systems.
In many countries government does not have a choice but to accept private ownership and generally this is foreign direct investment (FDI).
The largest FDI provider today is China under its “One Belt, One Road” program. Many countries have concessional treatment for investment in less-developed countries.
A number of specialised banks assist in the funding of these projects including the Asian Development Bank, the World Bank and the Latin American Development Bank.
In most countries, with the notable exception of the United States of America, much of the community infrastructure has been developed and owned by community, owned corporations or government. For the point of this paper there is little purpose in distinguishing between GOC’s and government themselves.
In many countries where community infrastructure had been built by government it now appears it is inefficient, not maintained or cannot be funded by government for the required upgrading.
On the other side, as developed economies communities build large asset bases to fund their pension commitments is often seen that some of these funds are available to finance community infrastructure whether it be roads, airports, dams, power stations…
Since the Thatcher years in the United Kingdom, hybrid model has developed, with standardised approaches to sharing risk and revenue, called public-private partnerships (PPP).
Under PPP government and the private sector share some of the risks associated with projects.
It must always be remembered that certain of the risk cannot be shared because they are solely within the realm of government.
Equally, as we go through the Covid 19 pandemic there are clearly risks that no private-sector investor could have contemplated or taken into account in preparing a private public partnership.
Today around the world PPP exist in huge amounts of infrastructure ranging from hospitals, prisons, water systems, toll roads and ports.
One of the “smarts” of PPP is the allocation of who pays for what and how risk is priced, at one extreme you have prisons who in the end must be paid for by government and the other extreme is bypass expressways which parties take only if they wish to.
In the middle are examples like gas pipelines -not all parties use gas and may choose not to and say operate solely using electricity or most toll roads where community members can choose to travel on old roads.
The payment for infrastructure is commonly a mix of availability and usage.
Availability is often charged as a connection fee and usage can be charged not only for the amount that is used/consumed but when it is chewed it is used. And a good example of charging for availability and usage is electricity in most countries.
There are cases where government will not pay and this is considered fair by the community.
Many private sector projects are by their nature infrastructure intensive.
Most major resources projects involve significant amount of infrastructure. For example, an aluminium smelter needs available power and transmission lines. It is not uncommon for it to be required to pay for the transmission lines.
How to finance infrastructure
Given that linking good projects with money is the essence of what Project RH does, this is the part of the business that interests us the most. T
here is not, and there should not be one answer. Much infrastructure is for the community’s use and not that of one corporate group alone.
It is normal for governments to supply and finance infrastructure such as a military base. They are generally designed and built for a specific purpose and do not have a great deal of flexibility about the four other parties.
A second group of community assets exists where what happens inside them is far more important than the physical shell.
These types of assets have been viewed as primary candidates for PPP funding.
An example is a community hospital. The physical building is required but what is far more important are the people professionals and technicians and machinery inside and their medical outcomes.
It is common in Australia and the United Kingdom for hospitals to be financed PPP projects. In this the buildings are funded and the provider is also required to undertake certain maintenance cleaning and security.
Under this model the provider is given a 30-year concession to provide and maintain the building, engage cleaning staff and security staff. Payment is made for the building, and services, and subject to performance. So, for example cleaning is not done properly or a ward of the hospital is not available the provider will be penalised.
A third group of community assets is one where government wishes to outsource the patronage risk – usage.
We have seen this example applied to stadiums and toll roads.
The investors normally form a consortium and are awarded the concession for say 30 years but they bear the risk that the facilities will be used. They have an obligation to build and maintain according to agreed standards and if the facilities are not available when required they can be subject to penalties. Again, they may be paid a provision fee and availability fee.
Funding community infrastructure
The Australian government has recently been able to fund government securities with a 30-year lifespan at 1.94% per annum.
This is the first time Australia has had a government security which would have the financial same life as most PPPs. The issue becomes:
- is government the best party to own build and operate the proposed asset?
- Is government likely to negotiate the best price on the construction of the asset?
- is government able to manage the costs of the asset on an ongoing basis?
- Is government the right party to take patronage risk on the asset?
- Is government able to return to the market fund and upgrade the asset if that is what the community needs?
- Will government collect fees / tolls for the asset?
- Should government be using its money in other ways including providing current services to the community?
In most things there is not one right answer and it does depend where we are in the economic and interest-rate cycles.
Equally, some parties simply are better at building and operating things, especially in controlling costs than government.
The corporate infrastructure model
Generally large companies require substantial facilities for doing what they do. Equally it is common that such facilities need to be specialised to meet their requirements.
An oil company will want to build an oil refinery that meets the specifications of the products that needs to supply to the available markets, local environmental requirements and their patented systems. They generally want to own a substantial amount of the refinery and will borrow against. This is simply asset financing and the corporation is liable for the performance and must pay its loans regardless of the performance.
This model is generally applied also in multi-user facilities where each of the participants is responsible for their share.
Infrastructure in the global setting
The separation of commercial and public infrastructure assets is a matter of concern normally to democratic countries where there is a concept of private property.
In countries where everything is provided or undertaken by the state, the state provides the funding regardless of which entity it owns or does for itself.
In democratic countries where there is a separation between government and private property there is an important philosophical discussion to be held as to what assets the government should and should not have. What assets it should build and when.
Governments generally have a limited budget so they need to decide what they will spend on assets and what they will spend on what we call recurrent expenditure.
They also need to decide how much they can borrow and what for.
It is generally considered unwise to borrow from recurrent expenditure including interest payments. Recurrent expenditure includes payments of Social Security, provision of health services, childcare services and defence. If the government borrows to build assets it will build a forward commitment in its budget to pay interest.
Importantly, however, if it provides community service obligation (payments) to a PPP to provide a road is somewhat like borrowing money and making a commitment to maintain the road.
What is broadly agreed is most PPPs create a new revenue stream, like building an expressway, people will pay for saving their time and will use expressway. This new revenue would not have been generated by government.
Government may make an initial payment and/or an annual payment for the provision of the expressway, but the parties operating the expressway would expect to get the majority of their revenue from users.
They are taking a commercial risk that users will drive along the motorway. The builder operator of the motorway must maintain the motorway and generally at the end of their concession, commonly 30 years, the motorway or other assets will revert to the state or national government.
They will make their profits from having invested in the motorway and from having received revenue from both the private sector and potentially from government. It is generally treated as an amortising asset.
At the end of the concession period, with the reversion of the asset to the government, community wins as this asset now belongs to them and in theory should be provided freely.
Having looked at a number of these projects around the world, we do note that, whilst the assets may have been returned, governments tend to continue to levy tolls or charges on these assets.
They also tend to be less well-maintained when in the hands of government than they were previously in the hands of the private sector, who would lose part of the revenue stream if facilities were not available as required.
The outcome of direct foreign investment in enabling infrastructure has been positive in some countries and negative in others.
The investments and their outcomes in Colombia for the G4 roads are by all accounts excellent but port developments in some African countries have not reached expectations and effectively the loans are being called in and the ports are controlled by foreign government lenders.
Most countries, on balance, seem to get economic benefit from direct foreign investment into their infrastructure.
Conclusion
Infrastructure is essential for how we live whether it be built and owned by government, created by the private sector for its own commercial uses or is built as a concession by the private sector and/or government.
What we are seeing in our community is the need for infrastructure whether that be telecommunications, public transport, water systems or ports.
Generally, infrastructure implies big dollars and these dollars lead to jobs and stimulate the economy.
The ability to finance infrastructure, whether for the private or public sector, is essential for building the economy.
Governments, with their existing commitments to recurrent expenditure (education, social welfare, public sector salaries …) cannot commit to the level of investment required to meet the infrastructure requirements set by the community – new hospitals, new roads, new airports- so they mobilise capital from the private sector for roads, etc. and we pay for them on a usage basis via tolls etc.
As we prepare to exit from Covid 19 we can expect to hear a lot of debate about building infrastructure and creating jobs.
What is critical is that the infrastructure creates business activity or efficiencies not just in its construction phase but over its economic life. It is clear that major roads, ports and power stations meet these criteria.
As a community, in each part of the world we must listen and understand what our leaders are proposing and ensure we can afford to pay what they are committing us to.
We need to ensure we have the appropriate mix of infrastructure and financial obligations to support it.
By Paul Raftery, Director Projects RH
