• Rural NZ
• Adverse Events
• People issues
• Profitability
• Research
• Rural Proofing
• SLM Hill Country Erosion Programme
• Community Irrigation Fund
• Stats & forecasts
• Sustainability
  • Best practices
  • Biodiversity
  • Climate
  • Irrigation
  • Land
  • Native forests
  • Organics
  • Resources
  • Water
• Legislation
• Media Centre
• Publications
• What's New

1. Executive Summary

1.1 Introduction

The objective of this study is to identify the range of feasible funding options and likely fund providers available for financing large-scale water enhancement projects, determine which is the most appropriate funding structure for these developments, identify the key risks for potential funding providers and possible risk management strategies to assist in reducing the impact of these risks.

1.2 Funding water enhancement schemes

The greatest barrier to funding large-scale water enhancement development is accessing finance (under reasonable terms) for the feasibility and construction phases of the project. During these phases the risk of financial loss is significant for potential investors and financiers.

The common risk profile of an irrigation scheme is as follows:

An ‘established’ large-scale water enhancement scheme (i.e. where start-up, development and take-up risks have been overcome) is an attractive investment for those looking for stable longer-term low risk investments. Risk is low and returns are generally fixed given that schemes have high-income certainty (take or pay contracts and a monopoly over supply of water to landowners in the region) and the majority of operating costs are fixed.

1.3 Phases of Development

A water enhancement project progresses through five distinct development phases.

• Phase 1 - Pre-feasibility/feasibility
• Phase 2 - Resource consent
• Phase 3 - Marketing and pre-sale
• Phase 4 - Design and Construction
• Phase 5 - Operating and maintenance

Each phase has a very different risk profile (as outlined in the diagram above) with different funding requirements and is therefore likely to require different funding providers/financiers throughout the development process.

1.4 Seed capital funding

Seed capital funding relates to the monies required to complete the feasibility and resource consent phases of the development. This funding is considered seed capital as it is essentially funding research and development with a high chance that funds will not be recoverable.

As a rule, the private sector (excluding water users) will not provide seed funding to an irrigation development, as the absolute risk of the investment is too high. The granting of resource consent is a key milestone and essentially a prerequisite for attracting private sector funding. If a scheme is to proceed, this funding must be sourced from other providers i.e. Government (Central and/or local), water users or other related parties.

The providers of seed funding (including Government) to a scheme that ultimately proceeds, should expect to recover this investment including a return commensurate to the level of risk undertaken.

If Government is the provider of seed capital, the level and type of return generated from the investment will be dependant on the agreed funding instrument (debt or equity). Converting the seed capital to debt is the simplest and lowest risk method for Government to recover the investment and return i.e. fixed repayment terms and returns are set upfront. Where Government chose to convert the seed capital to equity the risk increases given that the timing of Government exit or the return on the investment is not fixed. There may also be complications with take or pay requirements fixed to some classes of equity (water rights).

1.5 Design and construction funding options

Subsequent to accessing seed capital for the completion of feasibility studies and granting of resource consent there are broadly three options available to a scheme when accessing funding for the design and construction phases:

• Business Finance 
• High equity requirement (50 percent+), security required, medium lending terms.
• Project finance
• Lower equity requirement (20 percent - 50 percent), security secondary, longer lending terms, secure long-term customer contracts required.
• Build Own Operate Transfer (BOOT)

• No equity requirement, external scheme ownership for a period, secure long-term customer contracts required.

Given the characteristics and key issues faced by water enhancement schemes, project financing is the funding option most closely aligned with scheme needs. However, in-order to qualify for project financing there are stringent income certainty requirements that must be satisfied by the scheme.

The ability to secure ‘project finance’ funding is largely dependant upon the investors’ assessment of the schemes revenue certainty and credibility. For a water enhancement scheme to be eligible for such funding, the minimum requirements would include:

• securing long-term take-or-pay supply contracts with all customers and/or the availability of a credible external underwriter to guarantee revenue capacity;
• documented proof of the long term affordability of water users in the region to meet the required take or pay commitment; and
• the security over long-term access to water.

The BOOT concept has been used successfully in Australia for funding the development of large-scale infrastructure projects, primarily related to development of core Government infrastructure e.g. hospitals, prisons and roads. Application of this model to the New Zealand environment, and more specifically to irrigation - a non-core Government service - will require further investigation before it can be recommend as a viable source of funding.

1.6 Debt Funding Providers

There are a number of potential providers of debt funding for water enhancement schemes. These include standard bank debt, institutional debt (e.g. superannuation funds, insurance companies, other managed funds), public debt (e.g. bonds and debentures issued to the public market), Government debt and off-shore/foreign debt.

The debt providers that most appropriately match the requirements of water enhancement schemes are banks, Government (Central or local) and institutional investors.

Arguments relating to the justification of Government funding are outlined in a study on the role of Central Government and the role of Local Government.

Foreign and public debt investors generally require strong independent credit ratings and a recognisable company or brand name before they are prepared to commit funds. Water enhancement schemes are not likely to meet either of these criteria, and therefore would find it difficult to raise funds in these markets.

1.7 Equity Funding Providers

Possible equity funding providers fall into two categories, private equity and Government equity. Private equity encompasses water uses (e.g. farmers, electricity generation companies and other industry users) and other non-participating private investors.

The equity providers that most closely match the requirements of a water enhancement scheme are water users and Government (Central or local). This is primarily because water users and, to a certain degree, Government are able to generate returns on their investment outside of the financial performance of the scheme e.g. capital growth in land prices, more efficient use of natural resources and provision of social and community benefit.

Schemes may access some non-participating private equity investment but as these investors require a return generated primarily from scheme operating profits, it is unlikely that the necessary return will be available if these investors provide a significant portion of funding.

1.8 Other funding support

Other methods of support are critical to ensuring a scheme is able to access the most efficient funding structure. Provision of guarantees can assist a scheme to overcome the issue of inadequate security while underwriting revenue take-up can allow a scheme to better manage the water user take-up issue.

Guarantees from a credible source will be required for security over debt provided under a business financing option. The party with the greatest credibility and capacity to provide this guarantee is Government. These guarantees should be able to be limited to an initial scheme operating period of three to five years.

Where it is not viable for a scheme to stage the development in line with customer demand, there may be a role for a third party underwriter e.g. Government (Central or local) to guarantee the revenue capacity of a scheme where water user commitment is less than the scheme requires. There are significant risks in providing this underwriting role. It is critical that a detail risk assessment is completed and management strategies developed before this role is considered.

1.9 Corporate structure

The corporate structure selected will impact on a schemes’ ability to access debt and equity funding from various parties. The structure selected will be largely determined by the requirements of prospective investors.

Equity Investors

Where a scheme is expecting to receive equity from a combination of water users, non participating private investors and Government, the scheme must structure share capital in-order to meet the specific needs of each investor.

• A water users primary requirement is access to water rights from the network. The holder of these rights will have a contracted financial take or pay commitment to service.
• Non-participating private investors do not want access to water, and certainly do not want to be committed to a take or pay liability.
• Government may want to access some water e.g. for domestic supply purposes, but is not proportionate to the level of equity investment made.

A scheme can manage these investor preferences by issuing different classes of shares, e.g. Class A has water rights attached and Class B does not. The number of share classes, the proportion of shares in each class and differential in pricing between classes will be specific to each individual schemes and investors.

Debt Financiers

Different legal structures can provide different levels of risk for financiers. Under project financing and BOOT funding, long-term certainty of revenue is the critical element that debt providers will focus on. Therefore the legal structure of the scheme must support long-term certainty of revenue. For example, Co-operative companies may not provide the level of long-term commitment required given that Co-operative Company legislation allows shareholders, under certain conditions, to force the Company to repurchase shares.

1.10 BOOT Model

The Build Own Operate Transfer (BOOT) funding model essentially has water users buying water under a supply agreement (typically for 25 years) from a private party who has funded, built, owns and operates the scheme for a defined period of time. At the end of the contracted period the scheme is transferred to an agreed party.

There are two key advantages to funding a scheme using a BOOT model. Firstly, there is no upfront financial commitment required from water users, the scheme is funded 100 percent by the BOOT company. Secondly, water users are able to transfer the majority of risk relating to construction and operating and maintenance costs to the BOOT operating company for the term of the contract. The water users pay a fixed price for a service regardless of the operating and maintenance costs incurred by the BOOT operator.

The applicability of private BOOT funding to large-scale water enhancement schemes in New Zealand requires further investigation. Some of the key unanswered questions include:

• Is BOOT is an affordable means of funding a water enhancement scheme? What will be the cost of water at the farm gate?
• Do BOOT operators consider water users to be sufficiently credit worthy to undertake a BOOT development? Is the risk too high? Will additional security/guarantees be required?
• Does the RMA provide secure enough access to water?
• Is the New Zealand legislative and control environment appropriate and attractive for BOOT operators?
• Can all parties be appropriately protected (water users, BOOT operators, Government, environmentalist) if one of the parties is not able to meet commitments into the future?

BOOT operators have shown interest in the New Zealand water enhancement market.

1.11 Legislative Constraints

There are some legislative constraints impacting private investment in water enhancement schemes in New Zealand. The key Acts include:

Resource Management Act (RMA)

Under the Act there is a general lack of security over long-term access to water. While the Act does not allow cancellation of a granted resource consent, it does provide for additional conditions to be imposed throughout the consent period that may make it prohibitive to access water under the consent. Certainty of water supply is a key issue for funding providers.

Comments have also been made suggesting that the process of applying for resource consent is prohibitive for private investment. The process is time consuming, cumbersome and heavily weighted towards the concerns of individual members of the public.

Electricity Industry Reform Act

This Act prevents significant investment from electricity lines companies into water enhancement schemes with hydro generation capability.

Tax Depreciation Rates

New Zealand tax depreciation rates for water enhancement development are not as favourable for investors as they are in other similar countries.

Contact for Enquiries

MAF Information Services
Pastoral House
25 The Terrace
PO Box 2526
Wellington, NEW ZEALAND

Fax: +64 4 894 0721
Contact this person