The Role of the Private Sector
- The primary responsibility for initiating, promoting, and developing communal irrigation schemes lies with the private sector, and in particular with the proponents who are normally the direct beneficiaries, directed by a lead agent and/or "champion(s)". For example, with the Opuha proposal there were nine subgroups within the region, each with a "champion" leading support for their area of the scheme.
- While the scheme proponents will initially be a relatively informal group of interested parties (commonly through a committee), the need for greater formality and structure increases once the development process proceeds past the first stage. This is particularly true at the stage when contracts for investigations need to be let and monies raised (often from the community of interest, and from special purpose funds), and a range of possible legal/business structures need to be considered including (i) partnerships; (ii) co-operative companies; (iii) limited companies; (iv) trusts; and (v) unincorporated associations. Different structures may be appropriate in different circumstances – for example, the Opuha development involves a partnership structure owning the assets, with limited liability companies separating each investor from the partnership. Conversely, Waimakariri is a co-operative company. In addition, the structure selected as most appropriate for the initial stages may not be the same as the structure that is ultimately seen as the most appropriate ownership vehicle for the scheme. Key factors to be considered in any structure include issues of continuity of existence, shareholder/member protection, access to funding, flexibility of capital contributions and transferability of interest, control, restrictive provisions, and taxation implications. A recent report10 canvassing these issues, concluded that while each scheme will need to assess its own situation before deciding on an appropriate structure, company structures (limited and co-operative) generally provide the best match of requirements11. Limited company structures offer shareholder protection, transferability of interest, and access to public and private capital, with co-operative companies maximising asset control. Early taxation losses, however, are best captured through a partnership structure.
- Another major issue that is faced by scheme proponents is how to finance the capital requirements involved in the development process, since these are typically beyond the financial resources of the direct beneficiaries (particularly when farmers need to meet on-farm capital development requirements). This raises the issues of equity and debt options, including private equity through BOOT type implementation arrangements, as well as PPP.
- Funding alternatives are closely tied to considerations of risk, and different funding arrangements are suited to different stages of the development process since each stage has a different perceived risk profile. As noted above, access to private sector funding beyond direct beneficiaries is unlikely before resource consents are granted, largely because of the perceived high risk associated with the consent process. However, after the resource consents are confirmed, a range of options emerges including business finance, project finance, as well as BOOT variants. Business finance, which was adopted in the Opuha and Waimakariri cases, involves high equity requirements (typically over 50 percent), with security and medium-term lending. Project finance involves lower equity (in the range of 20-50 percent), lower security and longer lending terms, but relies on secure long-term customer supply contracts12. BOOT type options require no equity, but involve external ownership of the project for a specified period, coupled with secure, long-term customer supply contracts. The difficulty in securing long-term supply contracts through the initial take-up period has, to date, been one major reason why project finance and BOOT options have not been utilised in the irrigation sector, and is one of the reasons why irrigation groups have approached Government to underwrite large scale water supply projects13. For this reason, a scheme may need to access business finance over the take-up period (with the assistance of guarantees), and look to refinance using project finance after the take-up risks have been mitigated14. Generally, project finance will be the funding option most closely aligned with scheme needs, but this does involve a relatively high level of certainty of cash flows. Over time, it is likely that BOOT/PPP funding models, once applied more frequently in New Zealand infrastructure, may become more common in irrigation projects although the applicability of PPP models to large-scale water enhancement projects is yet to be assessed in detail15.
- Critical to accessing suitable finance is a clear and well-presented analysis of project risk, since debt/equity providers will wish to carefully evaluate risk profiles as part of their evaluation process. Risks will vary in type and incidence at all stages of the development process, and early identification and appropriate mitigation measures will ensure appropriate management procedures are in place – for example, there are inherent risks involved for debt providers which vary with the ownership structure involved with the scheme, so it is important to formulate the ownership structure to minimise direct risk exposure for potential debt and equity providers. Similarly, consideration of the extent to which shares can be traded, including amongst non-users, and the manner in which water entitlements are transferred/traded are all important considerations when the risk profile of the project is being assessed.
- There are a number of potential providers of debt funding for water enhancement schemes, including standard bank debt, institutional debt16, public debt17, Government debt and off-shore/foreign debt. In assessing the merits of debt funding, these institutions will consider a wide range of issues including supply risk, construction risk, sales/revenue risk, insurance, ownership structure and security. However, the study on equity investment options concluded that an established water enhancement scheme is an attractive investment for those looking for stable, longer term, low risk investments, but this relies on the resource consent to be in place and a high level uptake commitment from potential scheme users. On balance, the debt providers that most match the requirements of water enhancement schemes are banks, government (central and local), and institutional investors, and experience with the Opuha and Waimakariri schemes indicates that with sufficient equity and security levels, business finance through banks will not be a constraint.
- Possible equity providers include private equity and government equity. Private equity (farmers, electricity generation companies, other water users) are the most common sources since they directly benefit from the scheme, although the issue of whether another potential source of private equity finance, "outside" investors18, should be permitted can be contentious. These investors may be somewhat philanthropic and keen to support the local community, but if they see their investment in purely commercial terms, access to this pool of finance will depend on the returns being available commensurate with the risk exposure.19
- The form of equity structure is therefore of critical importance, and requires detailed consideration. Issues include eligibility criteria, tradability of shares, third party access, and voting rights. Generally, structures will opt for issuing different classes of shares - e.g. Class A may have water rights attached, and Class B has no water rights – but the number of shares classes, the proportions of shares in each, and pricing differential will be specific to each scheme.
- Other methods of funding support that need to be considered include the provision of guarantees, with underwriting often critical to ensuring a scheme is able to access the most efficient funding structure20. In such cases, however, there should be a specific time limit to the guarantee (say 3-5 years)21, and an appropriate return built-in to compensate for the risks involved. There is no doubt, however, that the presence of a key institution such as local government as part of the funding structure is helpful in accessing other avenues of debt and equity capital.
10 Deloitte Touche Tohmatsu 2001 referred to in footnote 4.
11 Multiple ownership structure should also be considered in some circumstances - for example, where resource consents are "owned" by a community trust, and the infrastructure assets are owned and operated by a company or companies.
12 Generally, providers of business finance have a lower reliance on the certainty of business cashflows and a higher reliance on the ability to recover funds through the salvage value of the asset and/or access to monies from guarantors should the business fail. Project finance, on the other hand, relies heavily on the certainty of cashflows, and is less focused on security/recovery.
13 The involvement of local government in underwriting has been the most common response to the issue of increasing the security attached to project financing - for example, bank debt for the Waimakariri Scheme was guaranteed by the local council for the first five years of the project.
14 This would allow the guarantee risk to be minimized.
15 Overseas experience indicates that PPP can be a cost effective modality, ensure on-time delivery, provide access to innovation and effective/efficient project management skills, and be cost-effective. However, NZ experience with PPP is very limited to date.
16 Such as superannuation funds, insurance companies, other managed funds
17 Such as bonds or debentures issued to the public market
18 "Outside" investors are those who do not directly purchase the products of the scheme (such as water or electricity).
19 Returns generated will be a combination of operating profits and capital gains, and it is therefore important to structure the scheme in such a way as to maximise capital growth opportunities available to shareholders. The issue of whether water rights are tradeable may therefore have a bearing on how the private sector views the potential returns from its investment.
20 Underwriting by Local Government occurred with the Waimakariri scheme - see para 20.
21 To enable the scheme to build up operating credibility and maximize take-up.
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