Project Finance 2017: Q&A with Phillip Cornwell
Project Finance 2017: Q&A with Phillip Cornwell
Phillip Cornwell, Allens
In an exclusive interview with Who’s Who Legal, Phillip Cornwell at Allens discusses recent trends in the field including the effects of continuing low commodity prices on the project finance market, the development of infrastructure finance and alternative sources of financing.
Which areas have seen an uptick in activity over the past 12 months? What is driving this?
Australia is in its 26th year of economic expansion, without a recession. The outlook for the Australian economy remains positive. Real GDP continues to grow at above the Organisation for Economic Co-operation and Development average. This growth is being achieved even while the Australian economy transitions from strong resource investment-led growth to broader-based drivers of activity. A key driver of growth has been net immigration, and in recent years Australia’s population growth has been among the fastest in the developed world. Naturally this puts pressure on infrastructure.
So it should be no surprise that the Australian infrastructure sector dominated project financing deals in 2016 as politicians “got religion” on the need for infrastructure funding. Large economic infrastructure projects continue to be a focus, partly driven by the disposal of public assets by state governments encouraged by the federal government’s asset recycling programme, including the Victorian government’s long term lease of Port of Melbourne and the long term leases of interests in the New South Wales energy transmission and distribution businesses. IFM Investors and Australian Super paid A$16.8 billion for the Ausgrid distribution network following a successful bid under the NSW unsolicited proposal framework. The initial preferred bid, with majority foreign investors, could not obtain Foreign Investment Review Board approval (discussed further below). The disposal of Endeavour Energy, the third and final piece of the NSW energy transmission and distribution network, is now under way and Allens has once again been busy advising the NSW government on the transaction. Proceeds, along with the Commonwealth asset recycling payments, have been directed towards new infrastructure projects, including the A$11 billion Melbourne Metro rail project in Victoria and the Sydney Metro rail project in NSW.
In April 2017, the NSW government announced it will lease the state’s Land and Property Information titling and registry services to a consortium, advised by Allens, called Australian Registry Investments, made up of First State Super, Hastings Funds Management and the Royal Bank of Scotland Group’s pension fund. A$1.6 billion of debt funding was provided by a club of bank lenders, split as usual between three-year and five-year tranches. The state government will receive A$2.6 billion for the 35-year concession. The government had announced last year that part of the proceeds would be used to upgrade sports stadia, and now a further A$1.6 billion of the proceeds will be invested in other infrastructure projects through the Restart NSW fund (with at least 30 per cent of the total proceeds to be spent in regional NSW). There is already a strong pipeline of infrastructure projects for 2017, such as the Melbourne Metro PPP, the second Sydney Harbour Tunnel, the third stage of the WestConnex Motorway and a number of smaller social infrastructure PPPs.
Following a trend which began to emerge in 2015, after the settling of the revised Mandatory Renewable Energy Target, we have also seen a strong uptick in deal activity in the renewables sector, boosted by the signing of the Paris Agreement on climate change by the Australian federal government in April 2016. Last year saw the sale of a number of renewable assets including the Pacific Hydro sale by IFM Investors to China’s State Power Investment Corporation and the Cullerin Range wind farm, as well as a spate of new renewable projects. The establishment by AGL and QIC of the Powering Australian Renewables Fund targeting approximately 1,000 MW of large-scale renewable generation, with a total investment of A$2 billion–3 billion, captured market attention during 2016. Two operating solar plants (the Broken Hill solar farm and Nyngan solar farm, each in NSW) formed the seed assets of the fund, with the A$450 million 198MW Silverton wind farm which closed earlier this year becoming the first greenfield project to be developed by the fund. Other wind projects to be developed during 2017 and 2018. Allens is delighted to have assisted AGL in establishing the fund, and has advised the fund on the project financing of each of its projects.
While wind projects have dominated activity in the renewables sector, the development of large-scale solar projects in 2016 was stimulated by the federal government’s Australian Renewable Energy Agency awarding A$1 billion in grants to 12 solar projects. It is inevitable that 2017 will see an increased level of activity in large-scale solar project development and recent power outages in South Australia mean we will also see combined large-scale solar and battery (or pumped hydro) storage projects in the near term. Conergy is currently developing the Lakeland combined solar and battery project in northern Queensland. Transactions such as Wirsol and Edify Energy’s portfolio project financing of three solar farms with a combined output of almost 200MW (Whitsunday, Hamilton and Gannawarra), which reached financial close a short time ago, will provide a likely blueprint for future solar development in Australia. Allens advised the financiers on that transaction. The states are actively pushing renewable energy projects now; eg, Queensland has just called for expressions of interest to develop a 450MW renewable energy generation facility at a site near Gladstone.
How has the continuing low commodity price affected the sector over the past 12 months?
Mining related investment remains very low – for the December 2016 quarter it was 94 per cent below the long-run average. Although there has been some recovery in commodity prices, the greenfields resources sector generally has remained quiet, with very little new project finance. High Australian-dollar gold prices have triggered funding for new gold projects on a modest scale but there has been more action in the mergers and acquisitions sector, such as Evolution Mining’s acquisition of an economic interest in the Ernest Henry Mine in Queensland from Glencore, with which our firm was pleased to assist.
Similarly, there were a number of divestment processes conducted in the coal sector, although complicated by a spike in the coal price in November 2016. Allens advised Rio Tinto on its recently announced agreement to sell its stake in the Hunter Valley Operations mining complex in New South Wales as well as Rio’s interests in the Mt Thorley Warkworth mine to Yancoal, recently approved by the Foreign Investment Review Board (FIRB). This is the latest in a number of sales processes conducted by Rio for its Australian coal assets. Wesfarmers is also reported to be preparing its coal assets for sale.
Although coal prices have recovered somewhat, funding for new coal projects remains difficult for Australian and international commercial banks, many of whom have policies restricting support for coal or fossil fuel projects, and all of whom are coming under intense lobbying pressure from the likes of Market Forces and local environmental organisations. Those same policy concerns are raising issues around the long term funding for the coal fired power generators. The market is watching with interest the progress of Adani’s Carmichael Coal Project and the proposed sale of a major brown coal (lignite) fired generator, Loy Yang B.
In the shorter term, we expect that M&A activity will continue with certain of the sales processes commenced in 2016 yet to close, such as Barrick’s sale of its interest in the Kalgoorlie Super Pit, Australia’s second largest open cut gold mine. Origin Energy recently commenced a process for the IPO or sale of its upstream gas assets. The longer term will depend on commodities markets, and especially the level of demand from China.
Many practitioners spoke of the continuing trend for alternative financing for projects – for example, from private equity funds and capital markets, etc. What implications does this trend have for law firms providing services to the project finance sector?
Project finance in Australia is dominated by the banks, but their reluctance to lend at longer tenors does leave a major opportunity for both private equity funds as alt lenders and for debt capital markets, particularly for refinancings. We are certainly seeing private equity funds more engaged with the sector; and funds acting as lenders. Large M&A deals, such as TransGrid (a NSW privatisation), often incorporate bridge tranches earmarked for takeout in the capital markets. Further, bridge facility tenors have extended beyond the traditional 6-12 months, as observed in the A$3.5 billion AusGrid bridge facility. Domestic pension and superannuation funds have also emerged as sources of alternative debt financing for infrastructure projects on a primary basis in selected deals.
While debt financing for construction of new infrastructure projects has been dominated by bank debt, diversification of funding sources continues to improve for operating projects. US private placements in particular were popular, with examples including the bank debt for TransGrid being partially refinanced with a US$775 million US private placement issue and Sydney Airport turning to the US private bond market for a US$900 million financing. Transurban Queensland again tapped the US private placement market while also issuing in the European medium-term note market and Swiss markets. The Australian corporate bond market was less active but WestLink M7 (a tollroad in western Sydney owned by Transurban, QIC and Intoll) was able to raise A$500 million in July 2016.
Domestic pension funds, institutional investors and offshore funds continue to circle the Australian market for debt funding opportunities in operating projects but remain selective. Transurban was able to refinance its Lane Cove Tunnel project in June 2016 with a combination of bank funding and long term debt placements from IFM managed funds, REST Super and Prudential. Expect to see such funds playing a greater role in debt funding of operating projects in 2017.
Are you seeing greater government support for infrastructure finance?
Both the federal and state governments regularly profess enthusiasm for stimulating private sector investment in infrastructure, though the actions of some jurisdictions have cast doubt on the sincerity of this sentiment. Australia’s complex political landscape is the biggest challenge that our clients presently face in the infrastructure sector. Changes to state governments have led to revised priorities among, or the abandonment of, major infrastructure projects. The cancellation of Victoria’s A$6.8 billion East West Link project by a new incoming government has recently been followed by the newly elected WA state government’s suspension of the Perth Freight Link project. That same WA election result knocked a huge hole in the privatisation pipeline, with the sales of Western Power (A$10 billion-plus) and the Port of Fremantle (around A$1.5 billion) being put on hold. The opposition party in the Australian Capital Territory was threatening to axe the Capital Metro light rail PPP should it gain power, but that threat has evaporated with the re-election of the governing party.
Subtler political obstacles have emerged. The uncertainty of the federal government’s position on national security has caused Chinese state owned entities difficulties, highlighted by the federal government’s unexpected intervention to prevent China’s State Grid and Cheung Kong Infrastructure from acquiring the Ausgrid network on national interest grounds. As an attempt to give investors more certainty around the rules that would apply to future asset sales, the Foreign Investment Review Board clarified the foreign investment rules late last year, but in the meantime the federal government has announced the creation of a Critical Infrastructure Centre (CIC) within the Attorney-General’s Department, signalling a continuing concern with foreign control of critical infrastructure. It is hoped that the CIC will be able to provide expedited national security risk clearances at an early stage, to avoid late surprises like that for AusGrid. The Australian Taxation Office’s recent alert flagging a crackdown on tax effective stapled structures, widely used for investments in infrastructure, has also given rise to structuring issues and tax risks which could particularly impact the renewables sector.
We have moved into an era of government intervention and support, with waning confidence in the market. The cynical would say that populist impulses are supplanting well considered long term policy development. Power outages in South Australia, the leading state for renewable energy, have triggered both blame exchanges and the announcement of federal and state government interventions in the energy sector. The most notable being the federal government’s proposals of a A$2 billion expansion of the Snowy Mountains Hydro scheme to expand its 4,000MW capacity by 50 per cent by introducing pumped hydro and the addition of 2,500MW of pumped hydro and wind capacity in Tasmania (with a second undersea cable crossing), and the South Australian government’s proposal to build a new gas-fired power station for “emergency generation” and to mandate large-scale battery storage projects. At the same time, both the Australian and the Western Australian energy market regulations are under review.
Just as Australia is poised to become the largest exporter of LNG in the world, high domestic gas prices have meant that the federal government appears poised to intervene, raising the threat of the use of export controls to mandate a domestic gas reservation policy if current jawboning does not work.
These developments have cast a pall of uncertainty over the east coast merchant power markets for the private sector.
On, possibly, a more positive note, the federal government has embraced the use of ‘off-budget’ loans and investments (held as assets, in place of, or to supplement, grant funding which is an expense) as co-finance mechanisms to stimulate and foster the co-financing of infrastructure projects with the private sector. The model is that of the US TIFIA-style loans, long-term, cheap (“concessional”) and patient funding, well suited to long-life infrastructure.
In November 2016 the government noted that “it is increasingly seeking to employ innovative financing solutions including public-private partnerships, balance sheet leveraging and alternative revenue streams such as value capture for major projects”. It has already used innovative solutions to support key projects including WestConnex (via a concessional loan for stage 2) and the Moorebank Intermodal Terminal (equity injection). This commitment was strengthened in February 2016, when the government released its Principles for Innovative Financing, which set out the government’s expectations for state and territory governments on when and how innovative financing should be used.’ The government has also established the $5 billion Northern Australia Infrastructure Facility (NAIF) and the $500 million National Water Infrastructure Development Fund, as well as the $2 billion National Water Infrastructure Loan Facility.
The NAIF will provide concessional finance to encourage and complement private sector investment in economic infrastructure that benefits Northern Australia and that otherwise would not be built or would not be built for some time. The water initiatives will provide a mix of finance options to accelerate the identification and construction of economically viable water infrastructure. These initiatives are being supported by the establishment of an Infrastructure Financing Unit within the Commonwealth bureaucracy to work with the private sector in developing financing solutions to fund key government projects. This approach has its critics, notably Infrastructure Partnerships Australia which argues that funding not finance is government’s role, that there is no shortage of private sector finance and that the NAIF and like bodies will be treading an impossibly fine line between on the one hand crowding out the private sector and on the other wasting government funds by supporting non-viable projects.
The government launched last year its Smart Cities Plan, intended to maximise the potential of Australia’s cities through better investment, policy and technology. In relation to infrastructure the Plan signals the government’s commitment to the use of value capture as a means of promoting increased investment in productive infrastructure. According to the Plan, all levels of government can do more to realise the potential benefits of value capture, so that value capture is not just as an alternative infrastructure funding source, but has the potential to bring forward investment in projects that might otherwise be delayed.
Of course, the Australian government is not a major player when it comes to direct infrastructure investment (contributing no more than 20 per cent of the total) – this is primarily the responsibility of state and Territory governments. Nevertheless it has the capacity to exert considerable influence through its decisions around Commonwealth funding contributions, which often determine whether and when a project proceeds. The government’s value capture policy commitment is reflected in a requirement that value capture mechanisms be addressed early in all business cases seeking Commonwealth funding for infrastructure. The states are also promoting value capture (or ‘value sharing’), and we are seeing one example in the packaging of commercial development opportunities within the Melbourne Metro PPP.
To conclude on a bright note, the federal government has referred to the recently released Australia and New Zealand Infrastructure Pipeline (ANZIP), established by Infrastructure Partnerships Australia in collaboration with the Australian and New Zealand governments, as evidence of the commitment to adopt a more considered and transparent approach to infrastructure. In February 2017 Infrastructure Australia published a revised Infrastructure Priority List identifying no less than 100 major proposals for infrastructure that Australia needs over the next 15 years.