UK project bonds part 1: Scotland pwns

The start of the M74 motorway in Glasgow. This bit is already built and will be maintained under the new £500 million contract

The start of the M74 motorway in Glasgow. This bit is already built and will be maintained under the new £500 million contract, which will see new works undertaken elsewhere on the M74 as well as on the M73 and expansion of the M8 (CC pic: MMcQuade, Flickr)

Alex Salmond, omnifighting first minister of Scotland, may take heart from what his transport authority has achieved in signing contracts for the upgrade of motorways in the central belt last week. They’ve cut the project’s budget, achieved a notable first, and best of all, have made his current bête noire George Osborne look bad (if you know where to look).

My old employer Infrastructure Journal reports that the private financing has been signed on the clumsily named M8, M73 and M74 motorway improvements project, meaning that design and construction can now get underway. Construction is expected to cost £310 million, compared to a capital cost estimate of £415 million when the procurement process began in 2012. That means a saving of up to* £105 million.

True, the cost estimate went up (from £320 million in 2011 to £415 million in 2012) before it went down. However, a banker who’d looked at the project confided in me two years ago that they expected construction to cost even more than the larger amount. The total upfront private investment being made is about £388 million and the total amount Transport Scotland, i.e. the taxpayer, will have to pay out to the private investors over the contract’s 33.5-year life is about £500 million; the difference between the two has to cover not only profit margins for the project sponsors** but also debt interest, transaction fees, swap fees and all the costs associated with looking after three motorways for 30 years. That’s not a bad price for the taxpayer by the standards of these sorts of private finance projects. After doing a rough-and-ready comparison with a similar Scottish road project financed in 2009, the M80 Stepps to Haggs PFI, I guesstimate that this latest one has a margin between investment and revenues roughly 43 per cent lower***.

Part of the reason for this reduced cost most likely lies in the fact that debt is being provided by a loan from the European Investment Bank and a bond from insurer Allianz, instead of commercial banks. The EIB, whose cost of funding is much lower than a commercial bank’s, doesn’t seek to undercut them, but Allianz was obviously able to offer cheaper financing than the banks (else it wouldn’t have been chosen) and the EIB was able to offer something similar. This is in fact the first bond-financed road in the UK since the global financial crisis of 2008 swept away the monoline insurers that previously provided insurance for such deals. The project appears to have been done without a monoline, and is therefore quite important for the UK market.

Given its pathfinder status, it is therefore remarkable that the project managed to complete its procurement and financing phase in less than two years (procurement began in March 2012). Believe me, that’s not bad even for a plain vanilla public-private partnership project of this size – without the extra complication added by a novel financing mechanism. That M80 project, with simpler financing, took two years and four months (although the financial crisis struck during that period, which would have slowed things down).

So why does the project make George Osborne look bad? Because it has been done rather quicker than his pet project, the Mersey Gateway bridge PFI. This project’s procurement began five months before its Scottish counterpart in October 2011, still hasn’t been financed, and is coincidentally five months behind schedule. Exactly why that has happened will be discussed in a future blog – suffice to say for now, I think Osborne’s Treasury may need to take some of the blame.

*Capital costs cover items other than construction, so, depending on how exact Transport Scotland’s press office and its procurement department were being in January 2014 and March 2012 respectively, the two figures may or may not be directly comparable. Even if they aren’t, construction still accounts for the vast majority of the capital costs. A Transport Scotland spokesperson confirmed to me that the £105 million saving related to the £415 million estimate, so they *should* be comparable.

**Note for geeks: normally ‘sponsors’ would mean equity investors. In this case they are actually subordinated debt investors, as this project was procured using the non-profit distributing model developed by the Scottish Government.

***Even geekier note: I arrived at this by doing the following: adding up unitary charges for the M80 Stepps to Haggs PFI (total: £917.6 million over 30 years) and then applying a discount rate of 1.875 per cent, assuming 2.5 per cent indexation on 75 per cent of the unitary charge, following the example for Scottish PFI projects set out in this report. That yielded a figure of £525.56 million revenue on an investment of £320 million, compared to about £500 million on an investment of about £388 million for the M8-M73-M74. The latter margin is about 22.4 per cent of contract value compared to 39.1 per cent. That doesn’t necessarily make it 43 per cent better value, but it’s one indicator. This is only an educated guess, admittedly…


About René Lavanchy

You can contact me at rene dot lavanchy at googlemail dot com.
This entry was posted in Institutional investors, Roads and tagged , . Bookmark the permalink.

One Response to UK project bonds part 1: Scotland pwns

  1. Pingback: The Commonwealth Games 2014 and infrastructure (but mostly infrastructure) | Infrastructure Punk – René Lavanchy's infrastructure blog

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