DMC

Water

Water Projects Development

DMC‘s project finance structure allows water projects with attractive cash flows and risk profiles to secure long-term private capital. This structure provides a direct link between a project’s cash flow and its funding to give project sponsors, investors, and lenders strong incentives to ensure that projects are structured and operated to generate stable revenue streams. But even in industrialised countries the credit strength of off-taking municipal governments and the sector’s traditional monopoly structure expose lenders to potentially significant credit, regulatory, and political risks. These risks, combined with the sunk, highly specific, and non-redeployable nature of water investments, mean that lenders and investors are vulnerable to government opportunism and expropriation.

Worldwide, the public sector finances, builds, operates, and owns most of the assets in the water and sanitation sector; facilities are often inefficient, service coverage and quality are inadequate, and cost recovery is poor. To extend coverage and improve the quality of service provided, municipalities around the world are turning to the private sector to rehabilitate and expand existing systems and build and operate new ones.

Private sector participation in water and sanitation has often taken the form of special-purpose build-operate- transfer (BOT) projects following the project finance or limited recourse model. These are self-contained projects that address the need for more water and sanitation. Although these bulk suppliers can alleviate immediate shortages, they have virtually no effect on system wide revenue problems (for example, leakage and tax collection) or labour cost problems. These long-term problems are sometimes tackled incrementally through leases and management contracts. An increasing number of countries have gone further by awarding operating concessions for entire systems, which require investment commitments from the concessionaire. Beyond such concessions lies full privatisation of assets, which facilitates financing by creating collateral. The promise of steady—if not growing- -long-term future cash flows is the basis of the private sector’s interest in financing these ventures. As one of the last monopoly utility sectors, water and sanitation can be especially attractive to long-term private investors. But financing water and sanitation projects has been a special challenge because of their unique risks:

• Expensive to transport but cheap to store, water is essentially a local service and subject to control by local government, which can be more politicised and have weaker credit than state or federal government.
• With most of the assets underground, their condition is hard to assess. That makes investment planning difficult, posing risks for contract renegotiations.
• Inadequate provision is associated with health and environmental risks, so government has a strong interest in extending access to service, regardless of ability to pay.
• Significant currency risk arises because customers pay in domestic currency that does not match the currency of international debt and equity financing.

Significant currency risk arises because customers pay in domestic currency that does not match the currency of international debt and equity financing.

The risk profile of a project is also influenced by its type and by its stage of development. Greenfield projects with a build-operate-transfer or build-own-operate (BOO) structure, because they involve a period of construction before revenues are generated, generally expose lenders to greater credit, political, and regulatory risks than concessions for infrastructure services that are up and running. Similarly, older and more efficiently run systems with longer operating histories tend to have more secure and predictable cash flows and mature investment profiles, and thus expose lenders and investors to fewer risks.

The experience of the private sector in the water and sanitation sector has been a positive one, in which the private sector has successfully demonstrated its ability to provide water and sanitation services with increased efficiency and at affordable rates within different country, regulatory, and contractual contexts. The growing worldwide shortage of water, serious problems with access to clean drinking water, and the escalating requirements for waste treatment can be expected to prompt increasingly bold experiments with private involvement in the water and sanitation sector.

While firm conclusions are premature in what is yet an incipient movement, certain lessons emerge for successful private sector involvement in the water and sanitation sector.