CALIDAD DEL SERVICIO PRESTADO

Drawing on the West Delta case, the following model of a concession-based irrigation project can be derived.

Table 5.4 Full Cost Recovery Irrigation Concession, with Sovereign-Mobilised Capital

PFI Component Characteristics

Strategic Purpose ‰ Higher and sustained economic growth of market-orientated crops. ‰ Reduce environmental pressure on groundwater aquifers.

‰ Concurrently achieve (i) full capital and operational cost recovery, and (ii) acceptable tariffs to farmers.

Infrastructure

Coordination ‰ Intended economic ‘spillover’ benefits for agricultural services (locally produced fertilisers, packing, market information, technical advice, logistics). ‰ Support to small and medium-size growers, traders, exporters and food processors

across value chain.

Organisation ‰ SPV (private operator) established with private equity (highly leveraged 1:10 debt equity ratio).

‰ Debt-mobilisation for capital costs taken by sovereign party.

‰ Relevant ministry establishes a dedicated project management to supervise compliance to technical standards and authorise disbursal of funds from relevant ministry.

‰ Dedicated regulator.

Resourcing ‰ Equity from private operator combined with farmers security deposits.

‰ Credit risk retained by state, enabling (i) concessional donor finance, (ii) avoidance of costly third-party credit guarantees, and (iii) zero capital or tariff subsidy.

‰ Initial years of farmers’ service fee (during loan grace period) used to offset operator’s start-up costs.

Cost Recovery ‰ Fixed user service charge to pay for the public surface water irrigation infrastructure and debt servicing, based on farm area; and (ii) a variable volumetric charge to recover operations and maintenance expenses related to actual usage of water for irrigation.

‰ Project operator pays ministry ‘concession fee’ derived from ‘irrigation service charge’, which then pays interest and principal on loan.

Contractual

Arrangement ‰

Competitive bidding among prospective operators, including bid on required tariff rates.

‰ DBO ‘contract’ concession with state.

‰ Project operator completes final design based on subscription of farmers. ‰ Disbursement of funds by state based on outputs/milestones.

‰ DBO contract offers two types of incentives: (i) profit on construction portion of the contract (enabling lowering of initial cash outlay, and (ii) expanded coverage up to the limit of water allocation (similar to normal concession).

Risk ‰ Number of prospective bidders may be too few (mitigated through expansion flexibility).

‰ Demand risk – farmers fail to purchase contracted amounts, reducing the commercial viability of the project (mitigated by adopting a demand-driven design).

‰ Regulator at MWRI subject to coercion.

‰ Foreign exchange rate risk mitigated by sovereign party assuming debt.

Regulatory

Framework ‰

Regulatory framework that allows operator to: (i) require security deposits from farmers, (ii) disconnect in event of non payment; (iii) expand service if demand not fulfilled.

‰ Splitting key functions, with regulation, monitoring and conflict resolution between farmers and operator assigned to a dedicated regulator; and contract management, approval of funding disbursements and technical oversight assigned to a PMU. ‰ Single Water User Council manages potential conflicts between competing farmers,

5.2.3 Lessons

Financial Modelling

The West Delta case and the derived model seek to achieve two key financial sustainability objectives: zero subsidies (capital and operational) and affordable tariffs. This shows the importance of using financial modelling, where the main variables – equity, debt, debt financing terms, tariff (fixed and variable), demand, credit risk guarantees, other quantified risks and their mitigation – can be shifted around, and tested with prospective private investors and the government, until the two objectives are met. Financial modelling informs infrastructure planners whether it is the private party or the state that will need to bear the majority of the capital costs, as well as whether capital or consumption-based subsidies are inevitable.

Subsidy vs Credit Retention

Above all, this model highlights the stark choice of public sector concession planners between subsidies and credit risk retention. A conventional BOT concession transfers the liabilities for credit risk to private investors. This increases the cost of borrowing in many respects (repayment rate, grace period, tenor, cost of credit risk guarantees), pushes up the required ratio of equity to debt and depresses the overall attraction of the project to investors. For example, the West Delta project secured a 20-year maturity, with a four-year grace period, and quite likely a below-market rate of interest, financing terms unavailable on the commercial markets for such a high-risk project.

The obvious solution when transferring credit risk to private investors is for the state to provide capital or consumption-based subsidies, either negotiated or administered as a competitive auction. The alternative is for the state to raise the loan capital itself at rates preferential to the commercial market or to DFIs, and retain the repayment risk. This the state can do either by securing concessional loans from donors such as the World Bank or specialist loan facilities including the LDC Infrastructure Fund of the Dutch Government, or by using its sovereign status investment rating on the capital markets, or both. With the state retaining the risk of default on debt servicing, debt equity ratios can be highly leveraged and the cost burden of securing repayments through third parties reduced, making the project more attractive to the private sector.

Further analytical research is needed to determine the comparative ‘value for money’ of the two approaches to the public sector (subsidies vs credit risk retention), and their comparative attractiveness to private investors and prospective operators.

In the West Delta project, it was noted that the BOT/concession option would not have worked. Such models have ‘fallen out of favor among private sponsors and financiers largely because of the significant losses experienced in the past’130_{. The DBO model works because it retains credit risks}

associated with a lack of user demand with the state. It also avoids transferring exchange rate risk to the private sector. In the West Delta project, government financial support can also be solicited in operational occurrences where cash flow positions fail to meet ongoing expenses.

Preparatory Work

A number of technical studies were undertaken to develop the West Delta project, demonstrating the importance of using donor funds to support this. In addition, the two secondary components of the project show the value of thinking beyond the irrigation infrastructure itself, and looking at the wider value chain and institutional framework.

Technical Assistance

Providing technical assistance to small and medium size growers, traders, exporters and food processors that is market-orientated increases the economic value contributed to the national economy.

Further research would be needed on the expected returns of this TA, but at around 1% of total project costs it has the prospects of being significant.

Fiduciary Risk

Feasibility studies for the West Delta project identified fiduciary risks in public procurement of irrigation construction and maintenance service. The tendering of a single large DBO contract to implement all activities (procurement of subcontractors, engineering services, construction works, operations and maintenance), as well as an experienced team of engineers and transaction advisors on hand up to financial closure, mitigated these risks. The latter included technical assistance from the World Bank PPIAF facility.

NGO Participation

In the West Delta case, to avoid potential marginalisation of poorer stakeholders, an NGO – the Egyptian Water Partnership – undertook an information campaign and survey to identify farmers’ needs, to be reflected in the design. A Private Growers Advisory Council was also formed, and the project itself is to establish a Water Users Council to provide a voice for users. There is, however, no formal role at present for NGOs in the operation of the project. Given the risk of conflict inherent in irrigation schemes (and in the case of the West Delta project the shift from groundwater to surface conveyanced water), a variant of the model would be to include a representative NGO and the WUC and WUAs more formally, for example, affording them a right to consultation on the operator’s final design and permanent representation in the regulatory authority.