INFRASTRUCTURE PROJECT DEVELOPMENT 101
The project development environment is an extremely difficult environment to operate within. Having a number of people running around claiming to be project developers but when asked how many projects they have developed, they always have many stories but not a lot of projects that have been completed.
This phenomenon gives project development a bad name and many project houses do not want to work for project developers as they feel the risks associated with non-payment and projects not proceeding to the execution phases are too high.
Having worked with a number of project developers as well as developing projects in Africa and internationally, the following project development model was developed. By following the steps outlined below, project developers can improve their chances of closing projects, spend less money and time in developing the projects and improve the perception of project development.
BUSINESS CASE
Before anything gets done on a project, ensure that your project has a real business case. This does not mean building excel spreadsheets or writing long documents. It means do one A4 page business case for your project. A project is like a business, you have some input, a process and output. Start by who wants to buy or pay or lease the product or infrastructure you are planning to develop. Once you identify the potential parties, understand what inputs you need to produce the outcome. Do high level calculations of the economics for your project and ensure it makes sense. Work out what your turnover, profit and payback period is for a budgetary capex. This should all fit on one A4 paper and give you an answer to proceed with the next step or not.
OFFTAKE
Once you understand your business case for your project and feel comfortable that you can pay the capital required back in a certain number of years, you need to sign up your offtake term sheet. This should be the first step before you start spending money on developing your project. You won’t know exactly what to charge for your product or service at this stage, but you will have a feel and agree on certain terms with your offtake. This will be done on a term sheet basis.
FEASIBILITY STUDY
If you feel confident that you have somebody willing to buy your product or service and you have some form of document signed that they are willing to pursue the project further, you can start looking at a feasibility study for your project. You will encounter a number of consultants wanting to do the feasibility study for you at enormous prices and all of them will claim that they know exactly what to do. But in reality, the experience for project development from African consultants are very limited. You also do not need a massive feasibility study to show your project works or not. The term bankable feasibility study is used, but not a lot of people understand what bankable feasibility study is. What you really need is an engineering study that gives you a +-10% capex for the infrastructure with a financial model that shows the project makes sense.
IRR
The project development world is all about IRR, this is the internal rate of return. In layman terms, it takes a number of factors into consideration and works out what the hurdle rate of return is for the investors and bankers. A typical dollar-based IRR in the range of 10% to 20% would be sufficient to most investors, depending on their risk appetite in Africa. This IRR should tell you if your project makes sense or not and also give you a firm indication what you can sell your product or service for. Once you get these results, you need to revisit your offtaker and discuss the price you can offer the service or product to them. If they are still happy to proceed and sign up for this price, you can proceed. If you don’t get the buy-in from your offtaker, you need to stop, look for different offtakers or remodel your project to get your offtaker signed up. Many developers make the mistake that they proceed after this point not having anybody that’s willing to take their product or service. This only leads to a lot of money being spent on the development without any real prospect in the future.
LOCATION
Proceeding to the next phase, you need to find a facility where you will place your infrastructure. This process takes time and finding the correct piece of land is very important. This also comes with a big cost, as you need to purchase the land or sign a long-term lease. Many land owners are willing to negotiate with you, but they also want answers and cannot necessarily wait for your project to work before they get commitment from you. Some land owners might be interested in providing their land as equity into the project, but this does not often happen and if you have a real solid project, it’s a very expensive way of purchasing land. Things that should be considered during land negotiations is the environmental approvals and rezoning of the property.
ENVIRONMENTAL
In South Africa, you basically get two types of EIA’s (Environmental Impact Assessments). The first is called a basic assessment, this usually takes about 6 months to complete and it’s not very expensive. The other type of EIA is called a full EIA and can take anything from 12 to 18 months to get approved. Different infrastructure would require different type of EIA’s, it would thus be very important to understand what type of EIA needs to get done early on and get the process moving as soon as possible. The environmental process will also need technical inputs from your engineering consultants and getting a group that understands and have experience in the infrastructure you are planning to develop would help a lot. African EIA’s can get done in shorter timeframes, but investors usually want international standards, and this will add a lot of extra requirements.
REZONING
During the land purchase, the zoning plays a major role. If for instance, the land is still zoned for agricultural use, it will be a lot cheaper than industrially zoned but will take a long time to rezone. Rezoning can take anything up to 3 years and it’s thus very important that you understand what zoning classification your project would require. Any good town planning outfit that knows the area, would be able to assist with the zoning of the land and the required zoning for the typical infrastructure you plan to erect. Bulk contributions also have a major impact on the development costs for a project and should not be underestimated. If a property does not have enough power or water for the development, the upgrades are very expensive and takes a lot of time.
REGULATORY FRAMEWORK
The biggest stumbling block after all the issues associated with land acquisition, is the regulation in the country the project is planned for. Depending on the project, there are a number of bodies that regulate the infrastructure and you will have to apply for the correct licenses to operate the infrastructure. The licensing process can also take a long time and the earlier you identify the required licenses, the better chance you have in securing it in the shortest amount of time.
SOCIAL IMPACT
Something that’s often overlooked is the social impact a project can have on the communities around it. This can have both positive and negative impacts on the community, but the most important is to understand the existing social environment and measure the impact the project will have on this environment. Most of the financial institutions would require a thorough social impact assessment before investing into a your project.
DEVELOPMENT FINANCE
A number of places in South Africa and abroad offer development finance as part of their suite. In reality, development finance is almost impossible to access. Some parties offer grant funding especially when it’s a green and environmentally friendly project. Other institutions like the DBSA (Development Bank of South Africa) and PIC (Public Investment Corporation) would offer development funding in South Africa and Africa, but they are very selective, and you usually need all the boxes ticked in terms of EIA’s, land and a bankable feasibility study. The PIC would be willing to fund 50% of the development in some instances especially in Africa, but you will have to provide the other half in cash before their funding takes effect. If you find somebody willing to provide development funding, it will be very expensive, or they would want a large part of the equity in the project. The best way to overcome development funding is to keep the upfront costs as low as possible. You will however need some money for the upfront developments and this can be funded from previous savings, leveraging off existing assets or selling equity in the project. Some project developers raise development funding on the stock markets but take not that listing a company on the stock exchange is expensive and a big administrative burden.
PROJECT FINANCE
Once your bankable feasibility is done, your EIA is approved, land rezoned and purchased, all regulatory requirements have been adhered to, offtake and supply agreements have been signed, you are ready to approach institutions for project finance. Project finance is a specialty finance that caters for projects and uses the project itself as a ring-fenced business. Project finance is usually broken into two components, debt and equity. You will often hear the term debt equity ratio. It basically means the percentage debt and equity the project would attract.
DEBT
Most of the commercial banks would be willing to provide up to 70% of the value of the project in the form of debt. This would usually be done at a relatively good interest rate depending on the type of project and the location. Banks will have a very stringent due diligence process and usually appoint technical and commercial advisors to evaluate the viability of the project. The rest of the money would have to come from private equity investors or the project developer itself.
PRIVATE EQUITY
There are a number of private equity investors in Africa and abroad all willing to invest money into projects. Some funds focus on Africa, other funds focus on certain types of infrastructure. All of them have the same model, they get funds from individuals, pension funds or businesses to invest and need to optimize their return on investment for their investors. Private equity investors usually want to optimize the IRR on the project and they base their offers on the IRR the project makes. In layman terms, the higher the IRR of your project that you are busy developing, the more interest you would get from private equity and the stronger negotiating position you will have. It’s usually good to speak to a number of the private equity funds until you find the fund that works for you. If you develop multiple projects, building a strong relationship with a fund or two also works well.
OTHER TYPES OF FUNDING
A number of other options to fund projects exist and many projects find ways to secure funding in alternative ways. This article will not go into the detail of each option, but only mention some of them. Export credit is a good way to secure funding from certain countries if the equipment is sourced from that country. Crowd funding is also becoming popular to fund certain projects but is still in its infancy. Venture capital has become very strong in America and even in South Africa SARS has established the 12j vehicle to encourage venture capital in the country. These offerings can all be tapped into to fund projects and also optimize project funding.
OWNERS ENGINEERS
After project funding strategies are determined, it’s a good time to appoint owners’ engineers to the project. The company that provided the feasibility study services is usually favored for this role, as they already understand the project dynamics, but it’s not essential that this company is appointed for the owners engineer role. The owners engineer would usually be responsible to develop the scope of work for the EPC-and-O&M Contractor and manage them during the execution phase of the project. It’s thus important that the owners engineer understands the type of infrastructure involved as well at the experienced and bank approved EPC and O&M contractors.
EPC CONTRACTOR
Selecting the correct contractor and engaging with them early, will increase the likelihood of making a success with the project. Many contractors encourage early engagement with developers and even help them with certain items at risk to secure the downstream work. It should however be noted that at the end of the day, the banks make the decision on the contracting strategy and the type of contractor selected. If the project finance route is selected, the banks want the main contractor to be appointed on a EPC basis with a single point of responsibility. They also want the contractor to have a balance sheet that is equal to or more than the project value. This is very important to them and they see it as a means to reduce the risk in the project. Having experience in the type of infrastructure to be erected, also plays a big role.
OPERATIONS AND MAINTENANCE CONTRACTOR
It’s also very important that the asset gets operated and maintained correctly to ensure the returns are realized over the total life cycle of the project. This is usually done by a separate contractor that specializes in this scope of work. Project finance will also not be released until the O&M contractor is approved and appointed.
PROJECT EXECUTION
By the time all the contracts have been signed with contractors and offtakers and all the environmental and regulatory conditions have been met, you are finally ready to execute the project. The process from starting a development to being in a position to start building takes a number of years to complete. During execution both cost and schedule are very important to the developer as they have built both those items into their economic models. If one of those items slip, they have severe impacts on their payback periods to the lenders and private equity investors. They usually also ensure against cost overruns and slippages on projects like these. Once the EPC contractor has completed the execution phase of the project, the developer usually gets the contractor to commission the infrastructure with support from the client and owners engineer as required.
OPERATIONS
Once the asset is live, the O&M contractor will take over the asset and ensure it performs as expected. The EPC contractor usually has a 52-week defects liability period where they will repair any defective works. Once this period is over, the O&M contractor will continue with maintenance and repairs as needed.
CONCLUSION
Although project development takes a long time and faces many burdens during the development phases, it can really pay off in the long run. It also gets easier once you have developed one project as you build credibility and equity to fund future developments. It also happens often that once a team develops a project together, they stick with the same team for many years and develop a number of projects together. This leads to sustainable work for all the parties involved.