The easy answer would be: “it depends”. It depends on the country, it depends on the sector, it depends on the project, the developer and so on and so forth. However looking at the forecast spend it is possible to make general observations to start understanding how and, more importantly, who will meet this value.
Of the US$2.8 trillion, roughly 40% relates to residential, leisure and hospitality buildings and mixed use developments. These projects are driven by market supply and demand, developers and investors armed with feasibility studies, raising finance, for such projects typically on-balance sheet through a combination of debt and equity.
For example, a villa development, even a large scale one, can be seen as a private-to-private transaction between the developer and buyer. The developer will sell units to the buyer with little funding required from the public sector. Although, as in the example of Mohammed bin Rashid City in Dubai, the public sector may take the initiative and facilitate the mixed use development, but the construction, and financing of construction, of hotels, residential accommodation and leisure complexes are likely to be met by private companies.
Taking the 40% out of the equation, how about the remaining 60%? Who is putting up the money for the other sectors? A huge amount of funding, just under US$ 1 trillion, is required to cover the power, water, chemical, oil and gas sectors (“Utilities and Petchems”) and such projects can be on a massive scale.
It is no surprise then that these sectors are a proven ground for non-limited recourse financing, also known as project finance, with mammoth capital projects underpinned by long term purchase agreements or production sharing arrangements. Oman is a good example of where the public sector has established a pipeline of power and water generating projects which is typically funded through a project finance style structure. For such projects, there is no direct funding from the government although, provided the private parties deliver, a public entity is liable for revenues under a long term agreement, against which the private sector raises finance.
Nonetheless even the project finance market would be challenged to find funding for US$ 1 trillion in one shot but on the positive side, the projects in the region have been phased and packaged so as not to present an extreme issue (reinforced by the fact that across all sectors only c. US$ 170 billion contracts were awarded in 2014). It should also be noted that the Middle East project finance market has yet to fully access the wider liquidity pools available amongst the capital markets/institutional investors, as is the situation in more mature markets. As the need arises and the market matures, one expects platforms to be developed such that these pools of capital will become accessible in the region.
Having considered the above categories, which rely on minimal direct funding from the government, we have not yet looked at the group of “problem child” capital projects that are the large capital projects that provide a “social” benefit. This “soft” or “social” infrastructure includes projects such as affordable housing, public education and public healthcare facilities from which the private sector may struggle to generate a commercial return without additional incentives. These projects are often difficult to measure in terms of financial benefit but are socially and/or politically necessary. Here the onus on funding these projects typically falls on the government. Unfortunately not all countries in the region have the budgets to directly fund this “social” infrastructure, and when funding is not available projects are delayed.
With constraints on government budgets, how can social infrastructure be funded? This is usually where Public-Private Partnerships (PPPs) are touted as a solution, formulating long term infrastructure contracts with risk allocation that is acceptable to developers, investors and lenders to leverage private finance.
This has been used successfully throughout the world, and is in effect a variation of the model successfully deployed in Utilities and Petchems in the region. Accordingly, it should be considered carefully in the context of value for money for the public sector particularly in light of the ever-changing dynamics in the region. The key is to recognize that PPP is a term used to cover all sorts of contracting styles, it is not black or white public versus private funding but rather shades in between.
One lesson from PPPs that can be applied immediately in the region to help bridge the funding gap is the idea of “capital recycling”. When projects are operational, demand is proven and early stage risks such as commissioning are minimized – the government should assess whether raising capital against the asset. This capital can then be used to develop other projects and is similar to how investors will roll their equity out of one project and into the next.
Having gone through the various sectors, discussing potential sources of funding from corporate finance, project finance/PPPs and direct government funding, one circles back to the original question – how will the region fund US$2.8 trillion for capex? The only reasonable answer I can give succinctly is: it depends.
By: Vishal Rander, Assistant Director, Corporate Finance Advisory, Deloitte Corporate Finance Limited (regulated by the Dubai Financial Services Authority)
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