Using Project Finance to Fund Infrastructure Investments

Inhaltsverzeichnis

Register of Illustrations

1. Introduction
1.1 Objective of this work

2. Definitions
2.1 Definition of Infrastructure Investments.
2.2 Definition of project finance.
2.2.1 PPP Arrangements.

3. Project Finance
3.1 Principles of project finance
3.2 Importance and difficulties of project finance

4. The construct of project finance
4.1 The main parties involved
4.2 Contractual framework in project finance

5. Conclusions

Literature.

Register of Illustrations

Figure 1: Overview: Forms of Infrastructure Finance

Figure 2: Parties to Project Financing

1. Introduction

The competitiveness and the ability of economic growth and the local living standards are closely related a country’s infrastructure quality and volume.¹ After World War II, in Europe huge investments in infrastructure, such as roads, railways or hospitals were traditionally financed by public sources, such as tax revenues, over-printing of money or borrowings.² Today, especially in the developing countries there is a huge demand for infrastructure investments. There exist so-called “infrastructure gaps”: In order to improve the standard of living and the attractiveness of a country and econ- omy, the segments of transport, electricity generation, transmission as well as water and telecommunications are essential. The main problem for governments is that Infrastructure projects within these segments usually have a huge extent and require a lot of capital, which often is not available. The OECD estimates that there exists a global infrastructure investment requirement of 71 trillion dollars by the year 2030 only to improve the basic infrastructure.³ But also in Europe there is an important demand for infrastructure investments. Today, post financial crisis, the TEN-T pro- gram which started in 2014 and also the energy distribution networks or the power plants will require very huge amounts of capital in the coming years and decades, while the political and economic situation is rather uncertain.

The forms of financing projects like the above mentioned have changed substantially: Over the past years and decades, severe budget constraints and inefficient manage- ment of infrastructure projects by public entities have led to an increased involvement of private investors in the business of infrastructure financing. This development has attached more and more importance to concrete strategies of private financing forms or partnerships. In recent years this private funding has increasingly taken the form of project finance. So there are basically the following questions: What exactly is project finance, how can a partnership between a public and a private entity be es- tablished and how can this construct help to solve the problem of the mentioned infrastructure gap? The scope of project finance, the different forms and the critical success factors and the meaning for infrastructure finance are the subject of this assignment.

1.1 Objective of this work

The purpose of this work is to provide an insight into the financing form of project finance, laying the concrete focus on infrastructure investments. It shall list and explain the main parties involved, the mechanics and the different sources of capital that are available. This work shall help to understand this form of financing by contrasting the risks with the opportunities it is related to. Furthermore the author intends to explain the importance of an appropriate contractual framework. Combining all the single elements the assignment provides the answer on the question how to use project finance to fund infrastructure investments.

2. Definitions

In order to understand the scope of this assignment, in this chapter the central terms are explained.

2.1 Definition of Infrastructure Investments

The assignment is supposed to provide an answer on the question how project fi- nanced can be used to fund infrastructure investments. Therefore, one essential question to this assignment is the definition of Infrastructure investments. Alfen and Weber use the following definition: “Infrastructure generally describes all physical assets, equipment and facilities of interrelated systems and the necessary service providers, together with the underlying structures, organizations, business models and rules and regulations, which are used to offer certain sector-specific commodi- ties and services (e.g. transport, energy and water supply, waste water and waste disposal) to individual economic entities or the wider public to enable, sustain or en- hance social living conditions.”⁴ Basically there are two forms of Infrastructure invest- ments: The public financed investments and the private financed investments. The following graph provides a detailed overview of the different forms of infrastructure finance:

illustration not visible in this excerpt

Fig. 2: Overview: Forms of Infrastructure Finance

As one can see there are Infrastructure finance projects in which public authorities are involved and those, in which private institutions, such as companies are involved. Both, the public and the private entities can either finance a certain project on their own or they join forces. When both work together, it is called PPP, Public Private Partnership. The concrete explanation of this term follows in chapter 2.1. In recent years and decades, the governmental expenses for infrastructure investments have been decreasing. Since the 1970s it fell from about 5% to about 2.5% of GDP in the 2000s⁵. Therefore the private financed investments become increasingly relevant. In this assignment the Infrastructure finance method of project finance will be explained.

2.2 Definition of project finance

What is “project finance”? Simplifying the meaning you can say that project finance is one of the mechanisms of the capital markets and the purpose is to provide finance to large-scale projects. Going more into detail you can say that the term project fi- nance describes a non-recourse or limited recourse financing structure. This struc- ture combines debt, equity and credit enhancement for the construction, operation or the refinancing of a certain capital-intensive project⁶, such as an infrastructure

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¹ Cf. Alfen et al. (2010) p. 1.

² Cf. Tan, W. (2007), p. 4.

³ Ahead Investment Magazine (2007), p. 5.

⁴ Cf. Alfen et al. (2010), pp. 2-3.

⁵ Cf. Inderst, G. (2013), p. 5.

⁶ Cf. A. Fight (2006), p. 1.