20 Dec 2012

Infrastructure at Christmas, past, present and future

by Brad Vann, Bruce Cooper

It's certainly not all gloom and doom in the Australian infrastructure sector, but we also shouldn't be looking at the market through rose-coloured glasses either.

At this time of year it is useful to lift our heads out of the trenches and consider what has happened over the year. We shouldn't let the somewhat dismal gloom over the global economy distract us from what has happened in Australia, and the current trends and opportunities.

Infrastructure projects

While current bids involve prisons such as Eastern Goldfields in Western Australia and Ravenhall in Victoria, healthcare, including Bendigo Hospital in Victoria, and a convention centre in Sydney, the most significant opportunities in Australia are currently in the transport sector. Brisbane, Melbourne and Sydney are each currently planning or investigating multi-billion dollar projects in rail and road to cope with population growth, and much needed improvements to enhance the productivity of the economy. Over the last few years there has been a significant PPP pipeline in health and water, but this is now tailing off.

Although there has been a recent slow-down in mining infrastructure investment, it still represents a major part of the Australian projects industry.

Project finance

The appetite to lend in the social infrastructure PPP market remains healthy. Exposure to government revenue streams backed by strong and experienced contractors compare favourably to some other market risk-based projects. Many projects now also include a significant government contribution that reduces the debt amount substantially, leading to most sponsors having an excess of lenders/funding options. Recent difficulties with one project in Victoria – Ararat prison – have caused financiers to more closely interrogate the technical and financial standing of contractors, but at this stage we have not seen significant increases in pricing or other covenant tightening.

Infrastructure Australia Report on Infrastructure Financing

Infrastructure Australia, through its Infrastructure Finance Working Group, published a detailed report on infrastructure financing. The release accompanying the report, which was prepared by leaders in the finance sector and government after extensive industry consultation, noted that it "argues the private sector is a willing infrastructure partner but a lack of projects is impeding greater private sector involvement in infrastructure investment. It points to the need for a sustained period of reform by all levels of government, to encourage the spend on infrastructure that this country needs in order to meet future challenges.

The report calls for a three-pronged approach: major reform of infrastructure funding, improved infrastructure planning to provide a deep pipeline of projects that give industry certainty, and steps to encourage more flexible and efficient markets that attract private investment." While there has been extensive coverage of the debate, it is yet to be seen what impact the report will have as governments plan the next round of significant transport infrastructure projects.

The importance of delivering projects on time and on budget

Delivering projects on time and on budget is now a real focus given governments are potentially facing some significant claims on existing projects. This is in part of function of the dramatic turnaround in climatic conditions over the last few years. Projects built during the early part of the 21st century experienced relatively mild weather conditions, with the prolonged drought that covered most of eastern Australia. However, with the breaking of the drought and some rare rainfall patterns being experienced there has been a keen focus on the risk allocation in contracts to see where the delay costs associated with those events should lie. Another cause has been the complexity of some of the remarkably large projects (in the AUD multi-billions) that have been delivered over the last few years. Industry has found itself challenged in managing the interfaces created by this complexity.

The importance of due diligence when executing infrastructure deals

Due diligence remains a critical part of the analysis undertaken by financiers and equity providers on infrastructure deals. Due diligence reports are invariably obtained in the key areas of technical, tax and accounting, legal and insurance. Reliance terms continue to be a matter of interest and concern for financiers where experts are engaged by project sponsors rather than by the financiers themselves. In the social infrastructure PPP market we have seen some relaxation in that some reports, such as legal, will only be required as a condition to financial close, but not necessarily required for the initial bid. This is generally where a project is a ‘standard’ type of facility on a greenfields site.

Looking ahead: expected key trends in infrastructure and project finance

A pipeline of privatisation and PPP proposals is looking most secure in New South Wales. Examples include the Port of Botany/Port Kembla privatisation, the Sydney Convention Centre, the Northern Suburbs Hospital and the North West Rail projects. The increasing reliance on pension funds as active equity – and in some cases debt – participants will continue, with the expectation that more offshore pension funds will become active. The growing importance of longer-tenor and fixed rate ECA loans will become more pronounced as mega deals such as the US$8.5bn Australia-Pacific LNG project are closed with significant ECA funding.

The dominance of Australian banks in domestic projects will not wane, but we still expect well-structured deals to benefit from participation by increasingly selective offshore financial institutions. The attractiveness of Australian infrastructure assets to offshore investment – non-pension – funds will continue to be an issue: the balance between the stability of Australia as an investment destination versus the need to overcome the investment return hurdles of such funds will continue to test those funds' appetite for Australian infrastructure investment. The strength of the Australian dollar and the increasing capital costs for Australian projects will also remain a critical factor for the attractiveness of Australian deals.

Hopefully this brief run through 2012 shows that all is not gloom and doom, but we also shouldn't be looking at the market through rose-coloured glasses either.

Season's greetings to all those who spend their time in infrastructure, making Australia a better, more productive place to live and work.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.