“Investing in badly-needed, but well-designed, infrastructure is an obvious area of great potential”- Christine Lagarde, President, European Central Bank
Over the years, there has been a rapid increase in the rate at which capital intensive and high risks projects of governments and corporations have been funded through the concept called Project financing. To put the concept into context, take for example if the government has plans to embark on capital projects such as railway construction, bridges, energy projects, airports, power generation facilities, seaports, roads, and telecommunications networks.
These projects require humongous amounts of funding to embark upon, coupled with the fact that they are fraught with high risks. These risks might be in the form of construction risks, operational risks, economic risks, environmental risks, maintenance risks amongst others which the government or the corporation might not be able to bear alone. The solution to this in most cases is project finance.
Stefano Gatti defines the concept as “the structured financing of a specific economic entity—the SPV, or special-purpose vehicle, also known as the project company—created by sponsors using equity or mezzanine debt and for which the lender considers cash flows as being the primary source of loan reimbursement, whereas assets represent only collateral.”
Hence, a project finance deal involves the government or corporation borrowing funds for a capital project through the formation of a specific economic entity known as the Special Purpose Vehicle company or project company. The project company is legally independent of the project sponsor and the repayment of the funds injected into the project is solely based on the economic returns and assets of the project itself and not the balance sheet of the project sponsor.
It is noteworthy to mention that a project finance deal is incomplete without the presence of these key players. These are the: Project Sponsor(s) which can be single company or consortium who are the equity financiers in the company; Project company which is the entity that will own, operate, and ensure the maintenance of the project; Lender(s) which might be a commercial bank, a multilateral economic agency or even an investment bank and lastly, the host government. Asides from these key players, other participants in a project finance deal are the construction companies, suppliers of resources needed for construction, off-takers, insurance firms, law firms and accounting firms.
Infrastructural needs: Nigeria’s experience
The infrastructural needs in Nigeria are quite uncountable. The Nigerian Government over the years has failed to meet these needs. Even when efforts are made to embark on a capital project that can impact lives and ease the burden its citizens go through, these efforts are often sabotaged by cases of misappropriation of funds, lack of political will, use of substandard construction materials, nepotism over meritocracy while awarding contracts amongst other issues. Thus, external loans and internally generated revenue of the government have been wasted in time past. This has made it more difficult for the country to bridge the gap in infrastructural development.
In 2019, the Chairman of the Nigerian Economic Summit Group, Mr Asue Ighodalo stated that the country needs about $100billion to address its infrastructural deficit. According to a report published by Moody’s Investors Services in November 2020, Nigeria needs to invest about $3 trillion in the next 30 years to close the infrastructural gap and accelerate economic growth. Since the government does not have this large amount of money, the project finance mechanism should be one of the means through which the government can uplift the burden of bearing these heavy costs alone.
Azurra Independent Power Project, Egina Oil Project and Lekki Toll Gate Project are good examples of Project financing deals in Nigeria and how they played out. Thus, project finance is a way out for the government to get the private sector and multilateral institutions onboard. Investments from these parties can help ensure the financing, completion, and effective management of these infrastructural facilities. This offers the country a better chance of having an enabling environment for businesses to thrive.
Furthermore, project finance offers a transparent and better-managed structure for capital intensive projects, and through careful attention to potential risks, it can help increase new investments and improve economic growth. There are many examples of projects that were left abandoned by the government and contractors. This sort of scenario is nearly nonexistent where project financing mechanism are in place as there is a contractual structure with strict adherence to corporate governance; thus, creating a transparent process in the project execution.
On a final note, the fact that project finance is a mechanism that can be used to solve the infrastructural needs of a developing country like Nigeria has been acknowledged by development finance experts and development banks across the world. Despite the complexities attached to these project finance transactions, it has proven to be a means through which governments can achieve economic transformation in their countries.
Dr. Ngozi Okonjo Iweala once stated that “without infrastructure, it is very difficult to attract private investment. Private investors need supportive infrastructures like industrial parks, electricity and access roads.” It is therefore expedient for the government to implement economic friendly policies; grant waivers and incentives to companies; solve the security challenges in the country; adopt a sustainable financing mechanism and regulatory framework to attract increased funding in capital projects.
Written by Peter Arojojoye