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  • Project finance 2015 – understanding the infrastructure cycle

    By David Rose / 9 September 2015 / Comments

    Project finance, in the form we currently recognise it, has been around for about 25 years. For most of that time it has been closely linked to the fate of infrastructure investment. Whether in times of economic prosperity or austerity, infrastructure is a constant concern in some form or another for governments around the world. This means that when we talk of trends in project finance, we’re often, in fact, referring to the prevailing infrastructure priorities – which tend to move through reasonably predictable patterns.

    Having supported the development of infrastructure models and investment around the world, we see that there are three major classes of infrastructure investment: social infrastructure (schools, hospitals and other bricks and mortar facilities), economic infrastructure (often focussed on transportation, ports and industry) and a grouping of energy and utilities (which can bridge the two, featuring both networks and discrete power or water treatment plans).

    The UK, following the recent election, is entering a new stage in the infrastructure cycle. Below we’re providing a ‘traffic light’ indicator for each area and what prevailing trends mean for the project finance industry.

    Social Infrastructure – Red (Low activity)

    Only 10 years ago, under the then Labour government, social infrastructure was the booming trend in the UK. A large movement towards the development and construction of schools created significant demand among construction companies, ICT experts and others. Because social infrastructure often deals with discrete, bricks and mortar buildings and shorter timescales, the modelling required to secure and approve finance during this time was less complex.

    As so many schools were looking to be procured over a relatively short period in England, the Department for Education and Partnerships UK developed the Local Education Partnership or (LEP) structure. This involved a delivery partner appointed by a Local Authority on the basis of the design for one or two ‘sample schools’ and then retained exclusivity to redevelop the remainder of that Authority’s secondary school estate, subject to performance against a number of predetermined KPIs.

    Since then, however, social infrastructure investment has taken a backseat, as there’s now a much greater focus on using the limited funds that are available on measures that will boost productivity and help to return the economy to growth in the short to medium term. This emphasis can be seen from the projects that are currently being put forward in the National Infrastructure Plan.

    Economic Infrastructure & Transportation – Green (High Activity)

    Economic infrastructure is very much on the agenda at the moment, and is a major component of both George Osborne’s plans for revitalising the ‘Northern Powerhouse’ and improving Britain’s economic productivity. Despite the ever present challenges and long timescales required, economic infrastructure is expected to create the majority of opportunities, especially over the course of the next 5 years.

    These projects tend to be more complicated and present more risks than straightforward social infrastructure deals. Lenders to the projects will need to carefully consider how these risks might crystallise and what impact this might have on returns, cover ratios and other financial covenants.

    From the perspective of an advisory firm such as Operis, this can lead to detailed sensitivity analysis to help all lenders achieve credit and investment committee approvals to invest in these projects.

    Power, energy infrastructure and utilities – Amber (Medium Activity)

    Power and utilities infrastructure is on uneven ground at the moment. While it’s expected that renewable infrastructure spending will be stalled, similar challenges abound for alternative sources like shale gas, or improvements to water treatment facilities.

    It was hoped that investment in renewable energy would fall within the government’s mandate to improve the country’s economic infrastructure. However, recent subsidy cuts and policy announcements in the onshore wind, solar and biomass sectors have led to a raft of projects being cancelled or delayed whilst restructuring can take place.

    On the other hand, mega-projects such as the Thames Tideway ‘super sewer’ and the new nuclear power plant at Hinkley Point C are proceeding so there will certainly be activity in these areas.

    What to take away

    Many of the key investors and firms operating in infrastructure investment are active across all of these areas – and have been around for long enough to move with the various trends and cycles of the infrastructure market. However, some valid lessons can be learned from recognising which areas of infrastructure are in ascendancy and which may be slowing down.

    The shifting landscape demonstrates the danger to infrastructure firms (and individuals) of becoming too specialised in one particular area. It is a mistake to focus solely on the areas requiring investment today – the key is to also anticipate future trends to see what is round the corner. As a leading participant in the infrastructure and project finance market for 25 years, Operis has been through many of these cycles and we hope to still be going strong when sectors where investment is currently scarce make a comeback.

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