Managing the money gap

With little money available for the vast investments required to deliver infrastructure renewal and the energy transition, can the wider world of project finance breathe life back into PPPs?

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How do you build infrastructure when the public sector has no money? Just over 30 years ago, that question led UK politicians to look at how the private sector managed to finance major investments without necessarily having the capital readily available or wanting to take on the full risk of the investment operation.

The answer in the private sector was (and still is) project finance. In the public sector, this was translated into PFI.

Many in the infrastructure community believe the UK’s experiment with PFI should not have stopped - especially given its continued use under various guises in other parts of the world. Some still remain hopeful that a future Labour government planning new investments might be tempted to dust off some of the old contracting models to create a programme of investment reminiscent of the mid-to-late 2010s.

That, though, seems to be little more than wishful thinking. Not only would it be extremely difficult from a political standpoint (Conservatives still use ‘PFI’ as a stick with which to beat Labour’s economic credentials), it would also be answering different problems to the ones facing the country - and indeed the world - today.

As one public sector official puts it, there is no money in the public sector - not capital or (unlike in the late 1990s and 2000s) future revenue.

And the same is true on the private sector side. “Funds are struggling to raise cash at the moment because interest rates mean investors are better off putting money in the bank rather than infrastructure,” says one lawyer.

That view is backed up by one fund manager, who admits that it is difficult to make the case for investing in infrastructure when inflation remains high, interest rates have risen, and supply chain issues mean labour is tight and difficult to secure.

Nonetheless, there remains interest from the private sector in investing in public infrastructure. For all the negativity, some investors are keen to point out that infrastructure can offer a natural safe harbour at a time of volatile stock markets, providing long-term, stable returns.

The A9, in Scotland, is perhaps a good example of this. A section of that route has been waiting to be tendered under the mutual investment model (MIM) for several years now, but sources have repeatedly insisted that a number of bidders are primed and ready to throw their hats in the ring for that deal when it does come to market.

“If there was more flexibility for PFI-style projects, that would unlock investment without the government having to put more money in,” suggests one financial advisor.

While PFI and its ilk are largely off the agenda for UK central and devolved governments (the A9 MIM scheme is just about the only PFI-style project in the pipeline at present), project finance more broadly is seeing plenty of activity in the private sector - and not just in the UK.

“We are seeing more project finance deals being done,” says one official at a multilateral. “Particularly for some of the energy projects, where the corporates want to keep the projects off their balance sheet because the size of the investment is so big.”

This is also the case in the UK. “The government’s energy transition policy - whether by accident or design - is creating more project finance projects between private partners,” says one investor.

These could be considered a new way of thinking about PPP: private partnerships for public benefit.

Project finance has been given a “new lease of life in offshore energy” and other areas, agrees procurement expert Dennis O’Keeffe.

The investor suggests that Grid connection issues are helping to drive this trend. “We are seeing industrial manufacturers wanting to use a green energy resource, but ensuring that specific resource is available to them is difficult, so they’re looking to partner with, for example, an energy-from-waste producer.”

A special purpose vehicle (SPV) can sit in the middle of this structure to design, build, finance, operate and maintain that infrastructure.

“If you have a long term offtake arrangement on a take or pay basis, there is a good fixed revenue line for the SPV, and that allows investors like us, and lenders, to invest in them,” the investor continues. “The principle is the same as a PPP, the difference is that the revenue comes from the private sector instead of the government.

“It goes back to the principle that risk lies with those best placed to manage it.”

However, while this has worked for the private sector, the public sector is currently more restricted when it comes to balance sheet issues. Bodies such as Eurostat have traditionally seen efforts by the public sector to take greater shares in projects effectively as attempts to benefit from the rewards without taking on the risks. As a result, they have been quick to clamp down and insist that many of these structures still require the public sector to keep the costs on their own balance sheets.

This, in turn, significantly reduced the benefit of delivering projects under these models, because the public sector could no longer ignore the capital costs and consider them to be on the private sector’s books.

Nonetheless, if public authorities (at a local, national and even international level) are serious about transforming their infrastructure and delivering the energy transition that many have promised, ways to manage this issue will need to be found.

Some suggest that the arguments around balance sheet treatment and a lack of public money are dancing around the issue. “Something has to give,” says Mark Williams, senior advisor to the Chartered Institute of Public Finance and Accountancy (CIPFA). “Whether capital, or revenue, or a mix of both, unless money is available for building and maintaining infrastructure, it becomes a downward spiral.”

As O’Keeffe points out, MIM has successfully negotiated the balance sheet treatment question - although it has been used sparingly with only three projects in Wales (plus potentially the aforementioned A9 in Scotland) having gone down that route.

He argues that authorities need to be more bold in their plans. “Are you prepared to be vulnerable and compromise to come up with a solution?” he asks. “The prize is the innovation that can be unleashed.”

Williams points to areas such as the Net Zero challenge, where investments can result in public authorities saving money over the long term. “The Mayor of London’s Energy Efficiency Fund is a great example of that,” he says. “The message we always give is for authorities to explore a range of models. There are always different pots of money available; there is a mixed economy of money available.”

It is not just in energy where other potential models can be explored. “You could create a social housing model that is similar to PRS or student accommodation; where the public sector takes the risk on the market, but the private sector builds out and is paid for on the basis of rental income - but where the public sector guarantees to pay for a certain number of units,” suggests one financial advisor.

“That would be on the government’s balance sheet, but it would have private expertise in the build-out and managing of it.”

There is certainly a need to be bold: whether it’s using PPPs to secure the energy transition in the UK and other places or the levelling up the country’s town centres, there is no doubt that a significant gap currently exists between what is needed and what public authorities have available to them to pay for those requirements. As ever, though, such initiatives demand political will and a commonality of purpose. Whether such commitment can be found today remains to be seen.