The New Face of Project Finance

Bank and government infrastructure funding cutbacks are forcing projects to be financed differently.

A large power company recently had to scramble for new sources of funding after its government financing was abruptly halved in the middle of a 20-year power plant upgrade and investment program. Executives examined alternative financing sources ranging from a private placement to a loan fund. They even considered changing how they were paying their suppliers. The loss of funding had put much more than the project in jeopardy: the company itself was suddenly at risk of reduced profits and threatened by a credit rating downgrade.

These are tough times for infrastructure projects. Until recently, banks and governments gladly financed the roads, bridges, and power plants needed globally. Now, they are pulling back their financial support in reaction to regulatory reforms and increasingly severe budget deficits.

These cutbacks could not have come at a worse time. The burden of maintaining roads, water systems, and other facilities in Europe and North America, many built in the 1950’s, is becoming difficult for governments to bear. Meanwhile, emerging countries are struggling with infrastructure that is proving to be insufficient to support their economies. India, for example, is facing an energy crisis because of its inability to supply enough electricity to keep the lights on at corporate office towers and to provide enough fuel for 1.5 million new vehicles added to the roads each month.

The decline of traditional infrastructure financing is introducing a whole new set of risks to infrastructure projects and triggering a sweeping change in how developers, and other companies, will need to manage projects. Moving forward, infrastructure sponsors will need to embrace unfamiliar long-term financing schemes that rely, at least in part, on public capital markets. This will require them to address a much wider investor group than they previously have, and to engage in investor relations much more proactively. Developers will need to demonstrate to new investors a detailed understanding of their projects’ risks and future cash flows, in part by documenting a track record of previous successes.

Equally important, infrastructure sponsors will have to adopt a two-tiered approach to financing their projects – simultaneously addressing both their larger long-term needs and the health of the many small and midsized suppliers that every project’s success depends on. Indeed, some developers have already begun to extend their own short-term financing to suppliers who are struggling to deliver critical equipment because they are experiencing financial difficulties or teetering on the edge of bankruptcy.

The infrastructure players who first develop the capability to come up with innovative financing solutions will have a significant competitive advantage for several reasons. First, they will benefit from cheaper and more stable financing. Second, they will suffer from fewer delays by avoiding searches for new suppliers. Third, they will be able to tap a potentially huge untouched amount of alternative infrastructure funding available. Consider: less than one percent of pension funds, which have an estimated total of $65 trillion in assets, invest in energy infrastructure today, according to a recent study by the Organisation for Economic Co-operation and Development sponsored by Oliver Wyman’s Global Risk Center.

The New Face of Project Finance