Australian infrastructure potential shines amidst GFC chaos By Dan Stojanovich

By Dan Stojanovich

Images at top L-R: Aerial view of site with artist’s impression of plant; Victorian water Minister, Tim Holding, inspecting a section of pipe; close up of completed plant – artist’s impression. The GFC put a few people and institutions to the test, including Australian infrastructure projects. Securing fi nance for Victoria’s new desalination plant to help ‘droughtproof’ Melbourne was a case study in how the funding could be achieved in a very negative climate by a well structured and argued business case.

Receiving the ‘Financial Excellence’ award* at the Australian National Infrastructure Awards in March 2010 was due recognition for a lot of clever work done by the AquaSure Consortium and colleagues to get over the line.

“The sheer size and complexity of this landmark transaction (close to $4 billion of debt and $800 million of equity) made it noteworthy,” said Chris Herbert, CEO of the AquaSure consortium that included Thiess and Degrémont, fi nancial adviser Macquarie Capital, and the Department of Sustainability and Environment (DSE) Capital Projects division on behalf of the State of Victoria. “But the big unknown challenge was the extraordinarily diffi cult market conditions at the time.”

The start of the transaction in September 2008 was less than fortuitously timed - coinciding with the collapse of Lehman Brothers and the ensuing big chill across international debt and equity markets. To raise the bar just a little higher, the fi rst bid had to be submitted in March 2009 – pretty well the height of the GFC.

Despite these unprecedented diffi culties, consortium members worked collaboratively with the DSE and State Treasury offi cials to arrange a competitive fi nancing package for not only one of the world’s largest desalination plants, but also the largest PPP fi nancing and PPP debt package in the world since the start of the GFC in August 2007. To add extra context, there was also competition from signifi cant projects in India and China for rapidly diminishing funds.

No one knew where it was all headed. According to Jim Miller, executive director, head of infrastructure and utilities, Australia and NZ, Macquarie Capital Advisers Limited, “Financial markets signifi cantly deteriorated as the bid progressed, with debt spreads and equity premiums increasing signifi cantly and liquidity evaporating as every week went by”.

International fi nanciers started favouring projects ‘back home’ with more and more of them retreating from the Australian market, increasing the likelihood of there being a potential funding gap for the project.

Macquarie had foreseen the potential downturn and acted early to access a large and diverse bank and equity group, an approach which helped AquaSure maintain a strong investor base despite many original fi nanciers dropping out during the course of the bid.

A crucial part of the success of the package was the very close working relationship AquaSure enjoyed with the State of Victoria. The State provided a vital contingent guarantee to act in the role of ‘lender of last resort’ to ensure the project did not stall.

According to Mr Miller, “There was simply not enough liquidity in the market at the time to fi nance two competitive bids, which resulted in the possibility of the State acting as potential lender of last resort. The State of Victoria was very responsive and was able to not only read the markets and competitive bid dynamics, but adapt well to the changing market conditions. As a result, the state was able to provide a contingent facility in case not all of the debt underwritten by AquaSure was syndicated.”

The state’s lender of last resort status did not have to be called. Shortly after fi nancial close, the combined efforts of Macquarie Capital, the book runners (National Australia Bank and Westpac), the DSE as the state’s representative and other project sponsors, resulted in oversubscriptions of more than 50 per cent.

This was a signifi cant step towards improving market sentiment in Australia and overseas for infrastructure fi nancing and renewing confi dence in the private sector’s ability to complete large transactions. The intention had always been to structure a fi nancing package with project risks allocated to the private sector, while seeking an interim solution to address the liquidity gap during the bid phase.

“We saw oversubscription in the syndication process as a strong market testament to a sound infrastructure initiative and a vote of confi dence in a project with experienced sponsors and a fundamentally strong fi nancial proposition underpinned by availability payments from a AAA-rated government entity,” said Mr Miller.

The role of the Victorian Government was critical. While its guarantee was not actually called upon, the fi nancial confi dence it created in the project was fundamental. “This allowed us to get a head-start on the project despite the tough conditions of the GFC,” said AquaSure’s chairman, Chloe Munro. “The remarkable success of the syndication process showed both the strength and soundness of the project and great investor confi dence in the Victorian economy and the PPP model adopted by the Victorian Government.”

The successful outcome refuted claims by opponents of the modern PPP procurement approach that the model would be rendered unviable by changes in global capital markets. The success of this fi nancing arrangement should give other Australian states confi dence that they can go to the market to deliver their backlog of infrastructure projects.

“The successful selection of a preferred tenderer shows governments in NSW, Queensland and South Australia that they too can continue to deliver projects in the aftermath of the GFC,” says Infrastructure Partnerships Australia’s executive director, Brendan Lyon.

In his keynote speech at the National Infrastructure Awards, Sir Rod Eddington said underlying changes to the demands on government revenues meant that the infrastructure investment landscape was permanently changed away from fi nancing from government revenue or government debt. He said that it has become increasingly diffi cult for state and federal governments to pay for ‘hard infrastructure’, as ‘soft infrastructure’ - such as health and education – is taking up a larger share of the budget. In 1972, social infrastructure was just under 30 per cent of total government spending - it is now 60 per cent. He added that the private sector needed to take a larger role in building infrastructure.

The use of the PPP model is therefore likely to become an enduring mechanism for infrastructure investment in the coming decades. According to Mr Lyon, “Wonthaggi was the world’s largest PPP since the GFC and the successful partnership between the Victorian Government and the private sector showed the maturity and world class skills operating in the Australian public and private sectors. The use of a PPP allows Victoria to transfer signifi cant risk away from taxpayers, protecting the state against cost and time blowouts.

Australian infrastructure potential shines amidst GFC chaos

“Independent research has shown that PPPs save governments more than 11 per cent in cost blow outs, because of the discipline and risk transfer delivered by PPPs. On a project with an initial spend of $3.5 billion, the potential cost saving is very signifi cant,” he says.

Perhaps another appealing feature about the Wonthaggi project, as far as its ability to attract investment is concerned, is that it is based on a sound underlying need – the requirement to guarantee water supplies to a major city. Traditional water supplies – land capture in dams – are now no longer reliable given the uncertainties about climate change.

The Wonthaggi plant will come onstream by the end of 2011, providing an important new source of water not dependent on variable rainfall for Australia’s second-largest city. This will droughtproof Melbourne.

The success of the plan was aided by the consortium’s attention to other considerations such as sustainability concerns, for example energy usage. The use of wind power to fully offset the plant’s fossil fuel footprint was important in addressing this and gaining community acceptance.

AquaSure’s Chris Herbert concludes, “The fact that we were able to succeed in putting together the fi nancing arrangements at the time that we did - to secure one of the largest PPP projects in the world – is testimony to DSE’s ability to structure a sound economic infrastructure project. It also says a lot about global confi dence in Victorian and Australian infrastructure, and the ongoing relevance of and appetite for PPPs regardless of the fi nancial climate.”

Perhaps another appealing feature about the Wonthaggi project, as far as its ability to attract investment is concerned, is that it is based on a sound underlying need – the requirement to guarantee water supplies to a major city.

* The ‘Financial Excellence’ award recognises the distinct efforts, achievements and collaborative approach of the AquaSure consortium members (Thiess and Degrémont, and its fi nancial adviser Macquarie Capital) and the Department of Sustainability and Environment (DSE) Capital Projects division on behalf of the State of Victoria.

Australian infrastructure potential shines amidst GFC chaos

Project snapshot

Construction commenced:

Late August 2009.

Projected completion date: “Desalinated water by the end of 2011,” says Chris Herbert, chief executive of AquaSure

Project cost: Initial cost - $3.5 billion. Net cost over the contract term of 30 years is $5.7 billion.

Capacity: Planned at 150 billion litres pa over 27.75 years. The inlet and outlet marine structures and the underground pipeline and power cable have all been developed to accommodate a rapid expansion to 200 billion litres annually.

Pipeline: The water will be delivered to Melbourne via an 84 kilometre underground pipeline.

Power requirements: The plant will use 90 megawatts of power when operating at capacity. The cables to supply the power will be underground adjacent to the water transfer pipeline.

Carbon credits: To be achieved with 100 per cent renewable energy credits.

Site preparation: The construction plan requires earthworks involving 1.1 million cubic metres of earth.

Footprint: The plant itself takes up 32 hectares of a 263-hectare site. The remaining 225 hectares will be used in an environmental restoration program. Three million indigenous plants and shrubs, including 150,000 trees, will be planted to restore natural vegetation cleared in the earthmoving and construction process.

AquaSure: AquaSure is the project’s private investor. AquaSure’s members include Suez Environnement, Degrémont, Thiess, Macquarie Capital and 20 international investors.

Central reasons for success

A range of key factors contributed to the success of the package, including: - Quality sponsors with extensive PPP experience meant that the consortium was able to adapt to the needs of the State and changing markets to deliver a competitive bid - Best-of-breed contractors with a strong track record in large-scale civil and desalination projects gave fi nanciers confi dence around the tight construction timeframe - The responsiveness and interactive approach with the State to implement the contingent support to address the fi nancial crisis impact on market liquidity - The diverse and global relationships of Macquarie, and project co-sponsors Degrémont/Suez Environnement and Thiess, which proved vital in arranging the wide investor group - Robust contractual framework and fi nancing documents to ensure best practice in corporate governance, equilibrium of power, and risk allocation appropriate for the environment meant fi nanciers were comfortable that material risk was appropriately managed and mitigated during the bid process - Strong project fundamentals, with availability based payments from a AAA-rated government entity - Macquarie Capital’s extensive experience in arranging large infrastructure fi nancing packages, deep understanding of the PPP framework, strong reading of global fi nancial markets trends and variables, extensive and global pool of resources and key debt and equity investor relationships worldwide was central to the success of the consortium’s fi nance arrangements.

Infrastructure fl ow-on from Wonthaggi

One hundred per cent of the energy used by the Wonthaggi plant and pipeline will be offset through the purchase of renewable energy credits via a competitive 30-year fi xed price agreement with AGL. To help fulfi l this commitment, AGL will be constructing a new wind farm at Oaklands Hills in southwest Victoria

“The wind farm project alone will create some 200 jobs,” says Chris Herbert. “It will consist of 32 turbines at a total development cost of approximately $200 million.”

Of course the economic fl ow-on effects will go a long way further than just the construction of the wind farm. In addition to approximately 1,700 onsite jobs that will be created during the plant’s construction, it is anticipated that local industry and jobs will be further boosted by a commitment to a high level of local industry participation. “It has been estimated that some 4,750 full time equivalent jobs, both direct and indirect, will be created during the construction of the project,” says Herbert. “The infrastructure fl ow-on effects will not be confi ned to just the capacity of the plant we are currently building,” he says. “If, at some stage in the future, the fresh water production of the plant is increased, our renewable energy contract requires AGL to lift its renewable energy production as well.” Both sides of the contract are scalable.