Project financing continues to be used extensively in Australia.
Since the GFC, the use of capital markets as a funding source for "greenfield" projects in Australia has all but dried up. The funding void in Australia has been filled by the traditional bank debt market and, at least in the case of some very large projects, also through loans from Export Credit Agencies which have become an increasingly important funding source.
The bank debt market continues to be dominated by the "big four" Australian trading banks but there are a significant number of foreign banks now active in the PF market. Most recently, we have seen an increased interest in and participation by China banks in the PF market, the return of a number of European banks to the PF market and regular participation in the PF market by several major superannuation funds as lenders alongside banks.
The US capital markets have recently become an attractive source of funding for mature infrastructure assets (such as airports, ports and toll roads) which have an investment grade credit rating. The US Private Placement (USPP) market and the Reg 144A market have both been accessed by a number of Australian issuers in the infrastructure sector. These markets are attractive from both a pricing perspective (compared to the pricing of bank loans in the Australian market) and tenor (issuances in these markets can be for term 10-15 years compared to a maximum tenor in the Australian markets of five years for bank loans (with some limited lender appetite for seven years)). These issuances will often require the issuer to execute a cross-currency swap to convert the USD into AUD – however, even with swap costs included, the pricing remains attractive to issuers.
Export Credit Agencies
Export Credit Agencies (ECAs) have played an increasingly important role in the funding of major projects. Recently, we have seen an increasing willingness for ECAs to provide "untied" support and substantial ECA participation in project finance "mega" deals that have come to market. This is illustrated by ECA support for:
- the PNG LNG project (2010), a large scale Liquefied Natural Gas project in PNG. ECA support totalled US$8.3bn in direct loans and guarantee insurance cover for commercial debt, representing 59% of the US $14bn project finance package;
- Ichthys LNG project (2012), development of on-shore and off-shore facilities for the Ichthys gas field located in the Browse Basin off the coast of Western Australia. ECA support totalled US$1.2bn in direct loans and guarantee/insurance cover for commercial debt, representing 56% of the US $20bn project finance package; and
- Roy Hill Iron ore project (2014) iron ore mining, rail and port project to be developed in the Pilbara region in Western Australia. ECA support totalled US$4.435bn of direct loans and guarantee/insurance cover for commercial debt, representing 62% of the US$7.2bn project finance package.
There has been a trend for particular ECAs to favour specific sectors of the Australian PF market. Examples include the Canadian EDC regularly participating in privatisation bids alongside bank debt and the Denmark EKF's activity in the renewables space.
Northern Australia Infrastructure Facility ('NAIF')
An interesting recent development is the decision by the Federal Government to fund an initiative intended to promote and support investment in infrastructure in Northern Australia.
The NAIF was established by the Federal Government in 2016 to offer up to $5 billion in concessional finance for infrastructure projects which benefit Northern Australia. The NAIF will be seeking to fund so called "economic infrastructure", such as roads, rail, ports, and telecommunications. These projects will need to generate jobs and taxes, but must also create broader benefits for the North Australian community, such as via an indigenous engagement strategy. The expectation is that debt finance provided by the NAIF will generally be in the range of $200m per project.
Whilst loans can be provided by NAIF on a concessional basis (e.g. an amortisation "holiday" for a period) and possibly over an extended tenor, the NAIF will be run as a commercial concern and will expect its loan to be fully repaid on each project.
NAIF has its own Board of Directors and CEO but is administered by EFIC, the Australian Export Credit Agency. Loans will in fact be made by NAIF to the relevant State or Territory which in turn will make a back-to back concessional loan to the relevant project
No appetite for patronage risk
There have been several spectacular examples of patronage based projects failing in Australia in recent times, particularly in the toll road sector. As a result, there is a high degree of reluctance from equity investors and lenders to take significant patronage risk on major infrastructure projects in Australia. This has led to the development of new financing models for major infrastructure projects particularly road and rail projects. In particular, State governments have adopted the public/private partnership ('PPP") model to fund major road and rail projects – under this model, the patronage risk remains with the government and the private sector is paid an "availability" payment for building and operating and maintaining the infrastructure.
Political risk in Australia
Historically, Australia has been regarded as a place of low political risk because Australia's federal system of parliamentary democracy has provided stable and largely predictable governments at both the State and Commonwealth level. However, in recent times Australia's reputation as a place of low political risk has been "muddied" by legislation such as the Clean Energy Act 2011 (Cth) which implemented a carbon pricing scheme. This legislation was repealed with effect from 1 July 2014 but it signalled to the global market that there can be an element of political risk in Australia through government intervention for policy reasons in various industries. Most recently, the newly elected labour government in Victoria cancelled the concession arrangements for the East West Link PPP (an availability based road project) which had been entered into by the previous Liberal government. The cancellation involved the payment of compensation to the winning consortium for costs incurred and also payment of bank fees. This has elevated the level of political risk in Australia in the eyes of international investors.
Foreign investors have recently focused their attention on developments surrounding the Foreign Investment Review Board ('FIRB'). FIRB's veto of bids by a Chinese and Hong Kong consortia for the estimated $10 billion partial sale of Ausgrid (the largest of the New South Wales electricity distribution networks) have highlighted the difficulties for offshore investors in sectors which are strategically sensitive (particularly from a national security perspective). In January 2017, the Federal Government announced the creation of a Critical Infrastructure Centre to maintain a register of critical infrastructure assets (e.g., airports, ports, electricity, gas, roads, nuclear plants). The register, which is not currently publicly available, will identify critical assets and set out how to mitigate national security concerns in the context of a sale of those assets. This will allow FIRB to provide guidance at an early stage regarding national interest concerns and promote a dialogue between FIRB and the private sector.
FIRB will also be of continuing importance even for investment in Government-owned assets following changes in March 2016 to the Foreign Acquisition and Takeovers Regulation. These amendments mean that FIRB approval is now also required for foreign investors to acquire land or assets from government entities where the interests comprise critical infrastructure assets or an Australian business which holds critical infrastructure assets.
The PPP model continues to be used by the Australian states and territories to fund major social and transport infrastructure. These projects are usually exclusively funded (at least initially) by the bank debt market. Recent PPPs include:
- light rail projects in Queensland (Gold Coast Rapid Transit), New South Wales (Sydney Light Rail) and the ACT (Canberra Metro);
- passenger rail rolling stock procurement in Queensland, New South Wales (Reliance Rail) and Victoria (High Capacity Metro trains);
- prisons, hospitals and social housing in New South Wales and a major hospital in South Australia; and
- transport projects in Victoria (High Capacity Metro Trains, Melbourne Metro – Tunnels and Stations and OSARS).
Several PPPs have suffered financial distress during the construction phase of the project (Ararat Prison, Reliance Rail and New Royal Adelaide Hospital). Interestingly, in none of these cases has the State terminated the project agreement but rather has entered into an informal process with the project sponsors and financiers which has led to the private sector developing ways of recapitalising the relevant project. .
Recently there has been a significant increase in the number of, and interest in, unsolicited proposals (termed "market led proposals" in Victoria). Unsolicited proposals for PPPs are proposals initiated by a private sector proponent as an alternative to the traditional PPP model which is generally initiated by the government and requires the private sector to participate in a competitive bid process. A number of states have now issued guidelines for unsolicited bid processes (e.g. Queensland, New South Wales and Victoria).
A key feature of the unsolicited bid process is that, if the relevant assessment criteria are met, the government may enter into direct negotiations with a private sector proponent to avoid the costs and uncertainty involved for the private sector in a competitive bid process. Unsolicited proposals also encourage innovative private sector ideas about how to improve the delivery of infrastructure projects and public services.
The NorthConnex toll road project involved a successful unsolicited proposal by a private motorway group to construct a tunnel between the M1 and M2 motorways in Sydney. The $2.9bn project reached contractual close in January 2015 and it is expected that construction of the tunnel will be completed in late 2019. Another example is the Western Distributor project in Victoria.
We are likely to see a renewed focus on energy-related project financing as attention again turns to sources other than coal-fired generation. Despite an 88% fall in in spending on large-scale renewable projects in 2014, recent headline energy issues in Australia are pushing energy back onto the political agenda. These include State-wide blackouts in South Australia, an increasing reliance on renewable energy, and a shift away from traditional coal-fired power stations, as seen in the upcoming closure of the brown coal-fired Hazelwood Power Station in Victoria.
The creation of new renewable projects will be driven by the federally legislated Renewable Energy Target (RET) to supply 20% of Australia's electricity with renewable sources by 2020. While the RET was revised down by the Coalition government in 2015, it is still expected to drive approximately $10 billion of investment. In the near future, we can also expect to see State based renewable targets and initiatives to facilitate new investment in solar projects, as well as continuing investment in wind projects.
There is also continuing privatisations of 'poles and wires' businesses in New South Wales (and potentially Western Australia and Queensland) and possibly a new interconnector project between New South Wales and South Australia to help deal with South Australia's chronic energy crisis.
State governments throughout Australia have continued to sell assets to finance their infrastructure programmes or reduce public sector debt. Notable examples have included the sale of major ports in New South Wales and Victoria and the sale of electricity transmission and distribution assets and Land & Property Information services in New South Wales. It is also anticipated that the New South Wales government will shortly commence a competitive process to sell its interest in the large WestConnex motorway project – this project comprises 3 stages, and stages 1 and 2 are likely to be sold with the Government retaining a shareholding interest (possibly up to 50%). An additional harbour tunnel and link to the Northern Beaches are other "greenfield" toll road developments under consideration by the New South Wales Government. Following the very recent outcome of the Western Australian election where a new Labour Government was elected, anticipated privatisation initiatives in that State are unlikely to be pursued.