1
Infrastructure economics & finance
in the (very) long run
ICEA - 17.05.2017 Hugh Goldsmith
2
Infrastructure challenges
• Engineering - how to build it?
• Economic - whether to build it?
• Finance - how to pay for it?
What can we learn from history about the
long run sustainability of infrastructure
projects and how to finance them?
3
Topics
1. Personal perspective
2. Ancient world
3. Pre-modern world
4. Modern world
5. Big picture
6. Are we learning?
Infrastructure investment …
a personal story (Punjab circa 1988)
Does lining
canals make
sense?
4 4
5
Delfland Wastewater DBFO
Delfland
Water Board
(founded 1289)
5
6
Project Financing Complex contractual structure:
EPC; O&M; Shareholder agreements
Common Terms Agreement (CTA)
Commercial Facility Bank Agreement
EIB Facility Agreement
Interest Swap Contracts
Total financing for € 362,5 million
Main Loan Facility M€ 166,4 46%
EIB Guaranteed Facility M€ 132,5 37%
Shareholder funding/Junior Facility M€ 43,6 12%
Stand-by Facilities M€ 20,0 5%
6
Operations and
Maintenance
(O&M)
Delfluent Services b.v.
• Heijmans
• Strukton
BAHR Consortium v.o.f
(Beouw Afvalwater Haagse
Regio v.o.f.)
• Group Veolia
- Veolia Environnement
- OTV
- CGE
- Rossmark
• WBE
• Delta
• Rabobank
• Heijmans
• Strukton
• Dexia
• Rabobank
• EIB
Engineer, Procure, Construct
(EPC)
ORAHR v.o.f
• OTV
• Rossmark
(previously USF
Benelux)
Het
Hoogheemraadschap
van Delfland(Delfland Water
Authority)
Equity Shareholders
Lenders
HSAHR v.o.f
Delfluent
b.v.
• CGE
• Delta
• WBECivil Engineering
and Construction
Process, Mechanical,
Electrical Engineering
and Construction
Won Project Finance Deal of Year 2003
Project Delivery
Harnaschpolder WWTP - September 2009
Houtrust WWTP - September 2008
Completed: On time, on budget
and performing well!
7
Public-Public knowledge
sharing about how to
contract a private sector
solution
7
8
Water supply to Seville In 1882, Seville granted a 99 year Concession to the Seville Water
Works Company Ltd (la Compañía de los Ingleses). Floated on
London Stock Exchange in 1883. Concession given up in 1957.
9
EIBURS 2011-2013 A History of European Infrastructure Finance
+
+
+ =
+
The First PPP Contract - Eretria (~318BC)
Contract between City and foreign contractor
Chairephanes to drain lake Ptekhae:
all expenses paid by the contractor plus lump
sum of 30 talents paid to the City
contractor granted exclusive right to cultivate
and retain the products of the reclaimed land
for 10 years
exemption of local taxes and some laws
4 year schedule, extended in case of war
obligation on Chairephanēs heirs/collaborators
to complete works in case of death
contract was "signed" by 230 citizens with six
named Eretria-citizens as guarantors
extreme sanctions against anyone attempting
to cancel the contract (copy in Delphi)
Stele from Eretria
10
Roman Empire 44BC – 476AD
Infrastructure = Civilisation
• Adapted and improved
technology and engineering
practices from Greeks,
Etruscans, Persians etc.
• Concessions for exploiting
infrastructure: postal services,
river transport
• Public and Private Legal
systems established
• Infra Finance: State; Local;
Donations; Taxes; Tolls;
Slaves/Military/Contractors
Roman Major
Road Network
11
What did the Ancients do for us?
Infrastructure:
• Temples
• Canals
• Cities
• Postal system
• Water supply
• Sanitation/Public
baths
• Roads
• Ports
Finance/Resources:
• Slave labour
• Military labour
• Forced labour (corvée)
• Paid labour
• Public funding “fiscus”
• Private gifts
• Modest concessions
• Taxes
• User charges/Tolls 12
Infrastructure
network
Early
Date Pathfinder project
Lead
country Early adopters
Water supply 1582 London Bridge Co. UK France; Belgium
Roads (turnpikes) 1663 Great North Road UK USA; Alps
Canals 1761 Duke of Bridgewater canal UK France; USA
Gas lighting 1810 London Light & Coke Co. UK France; Belgium
Railways 1830 Liverpool & Manchester UK Belgium; USA
Telegraph 1846 Electric Telegraph Co. UK / USA France
Telephone 1878 Bell Telephone Company USA Scandinavia
Tramways 1881 Berlin Germany Belgium
Electricity 1882 Pearl Street USA Germany; UK
Motorways 1924 Autostrade dei laghi IT Germany
13
Private infrastructure revolutions From projects to networks
14
1582 – First Private Water Supply • Letters Patent granted by Elizabeth I
in 1578 to Peter Morris to erect a
water lifting device in the north arch of
old London Bridge and sell water to
houses nearby (at £1 per year).
• Finance: ₤2,500 cost of works –
20% personal equity;
40% grant from the City Sergeant;
40% short term loan from City
• 500 year lease granted for the bridge
arch - remained a profitable, family
owned business for 120 years
• Purchased by private equity in 1701
for ₤38,000
• Eventually sold out to the New River
Co. in 1822 just before old London
Bridge demolished
New River Company • Originally proposed to Elizabeth I, but
approved by James 1st in 1603,
restarted works 1609 completed 1613.
• 65km, 3m wide artificial canal from
Hertfordshire to Clerkenwell cistern:
Cost £19,200 (~ £750m today)
• Financed by 32 “Adventurers” shares.
King James I had to step in for
additional 50% of capital due to cost
overrun. Granted 500 year rights.
• First dividend paid in 1622. Myddelton
later bought out the King’s shares just
before he died in 1631.
• 1888: “The most remunerative and
successful of all trading
corporations of the world”
• Many shareholder perks
Sir Hugh
Myddelton
• Orig £100 share sold for
£125,500 in 1897!
• Over 270 years: Labour wages
x4; New River dividend x200
• Bonds issued in 1860s as
speculation over compensation
• 1904: Municipalized as part of
Metropolitan Water Board
15
16
Competition for water supply London c1856
8 Main Companies (date founded)
• New River Company (1613)
• Chelsea Waterworks (1723)
• Southwark Waterworks (1760)
• Lambeth Waterworks (1785)
• South London Company (1805)
• West Middlesex Company (1806)
• East London Waterworks (1807)
• Kent Waterworks (1809)
• Grand Junction Waterworks (1811)
1817: Secret deal for local
monopoly & transfer of assets
across boundaries at 4-5%
Return on Capital
• 29 private companies
consolidated into 8
17
Economic & Quality Regulation
Waterworks Clauses Act, 1847
Profits of the undertakers to be limited.
Article 75. The profits of the undertaking to be divided among
the undertakers in any year shall not exceed the prescribed rate,
or where no rate is prescribed they shall not exceed the rate of
ten pounds in the hundred by the year on the paid-up capital
in the undertaking, which in such case shall be deemed the
prescribed rate, unless a larger dividend be at any time necessary
to make up the deficiency of any previous dividend which shall
have fallen short of the said yearly rate.
Metropolis Water Acts of 1852 & 1871:
• Appointed a “Water Examiner” – Continuous supply &
quality standards plus financial reporting to Parliament
18
Back to the future
EQUITY
DEBT
The magic of
leverage/gearing
Changing capital structure of New River Co
DEBT
EQUITY
19
Pink wedge of “avoidable costs”
20
London’s water services
Services Year Events / Company founded Finance
100 Roman bucket-and-chain water wheel Taxes (+ Slavery)
1237 Great Conduit (King + Grants + Bequests) Grants
1582 London Bridge Waterworks Co. (private) Equity + grant
1613 New River Company (private) Equity
1723 Chelsea Waterworks Company (private) Equity
1904 Re-municipalisation as Metropolitan Water Board Bonds
1975 Thames Water Authority Debt
1989 Privatisation – Thames Water PLC IPO Equity
1990s Thames Water WASC Debt
2011 Maquarie Infra Fund purchase Private Equity
2015 Thames Tideway Project PF + Guarantee
Railways changed everything …
Length railways in km
Virtually all forms of modern finance were developed in the
context of global railway investment with English, Dutch,
French, German and US capital attracted around the world
by a wide range of subsidy & guarantee mechanisms
21
22
Blending mechanisms
London Stock Exchange Year Book 1883
“… deprived of the power in most cases of issuing direct
loans, several foreign governments have given
guarantees for railways and other national works, and in
this way means have been obtained.”
Examples of foreign investment incentives:
• Principle and interest guarantees on bonds
• Payment per km constructed
• Land grants & land value capture
• Very long concessions
• Upfront grants
Leaders and followers had different
financing strategies
Railway Manias: 1835-38 & 1942-47 Infrastructure bubble finance
The biggest bubble
in history?
24
A slow roller coaster journey
PRIVATE COMPETITION PRIVATE
CORPORATE
CONSOLIDATION
STATE NATIONAL
MONOPOLY
WAR
REGULATED
PRIVATE MONOPOLY
NOT FOR PROFIT
PRIVATE/
PUBLIC
Pa
ss
en
ger
jou
rneys
(m
illi
on
)
25
26
The Electrickery Model
• 1879 - Edison's patent for an “economic” electric generation and lighting system to compete with gas utilities. JP Morgan is main financial backer.
• 1892 - Edison global patents held by complex web of companies. 1000+ small lighting utility companies with business model: Gain concession and pay for equipment in utility shares.
• 1892 - JP Morgan engineers split-off of General Electric, which rapidly became world’s largest electrical equipment manufacturer
• 1893 - Westinghouse develops combined light & power AC system based on Tesla’s patents. US Financial crash almost bankrupts Edison
• 1895 – Westinghouse’s Niagara Power Project demonstrates viability of long distance transmission
• 1920s - Samuel Insull pushes financially complex/opaque utility holding company structure to limits ($27m equity controls $500m)
• 1932 - Insull Bankruptcy. Private utilities fail to serve poor rural areas.
• 1930s – Roosevelt’s New Deal policies promote public utilities (PWA, REA and TVA)
Edison Illuminating Company to Insull utility holdings
27
Project finance continues
• 1876 - Colombia grants 99-year concession
to private syndicate which sell on to
Ferdinand de Lesseps (who built Suez canal)
• 1879 – Lesseps forms Compagnie
Universelle du Canal Interocéanique de
Panama SA with 2m francs in Founder
shares. Then Ordinary shares and debt
raised, including lottery bonds.
• 1880s - Huge technical problems, cost
overruns and delays (landslides, 20,000
malaria deaths)
• 1889 – with project 40% complete and 80%
debt funded becomes largest corporate
bankruptcy in history at the time ($332m)
• 1894 - New company (Compagnie Nouvelle
du Canal de Panama) set up with a capital of
60m francs and opening delayed to 1904.
New company is eventually bought out by US
Govt for $40m.
• 1903 - Newly independent Panama
grants perpetual sovereign rights over
Canal to US.
• 1914 - US Govt completes project
• Ex-post Social Rate of Return
estimated as 6.6 to 9.6% only to
1937 (Maurer & Yu 2006).
28
Laissez-faire: supply-side finance
1900:
UK, FR, BE
CAPITAL
1960:
US
CAPITAL
2000:
GLOBAL
CAPITAL
1800:
NL, UK, FR
CAPITAL
Global Market:
LOCAL
SAVERS
LOCAL
PROJECT
FINANCIAL
RISK
LOCAL
BENEFITS
Local Market:
SAVERS
PROJECT → CORPORATE
RISK
FINANCIAL
INTERMEDIARY
National Market:
Post WWII: new technology, old dilemmas
Institutions/Finance: 1946 Creation of World Bank (IBRD)
1947 $13bn Marshall Plan
1958 Creation EEC and EIB
1963 First Eurodollar bond Autostrade
1970s Restart global project finance
1986 UK Utility privatisations start
1991 First Infrastructure Fund
1992 Launch of UK PFI programme
1990s Blended PPPs
2007 Start global financial crisis
2010 UK National Infrastructure Plan
2015 New guarantee instruments
Technology: 1950s First Nuclear power stations
1960s Motorway programmes
1980s Internet commercialized
1983 1G GSM launched
1991 First offshore windfarm (DK)
1996 Start Broadband
1996 GPS declassified for commerce
Increasingly regulation
drives old technologies,
markets drive new ones.
Re-emergence global finance
Multinationals & Multilaterals
29
30
Eurotunnel
ARTICLE I - Object and Definitions
The High Contracting Parties
undertake to permit the construction
and operation by private
concessionaires (hereinafter referred
to as "the Concessionaires ") of a
Channel fixed link … financed
without recourse to government
funds or to government guarantees of
a financial or commercial nature.
31
-100% 0% 100% 200%
COSTS Actual (May 1994) v Forecast (1987)
Financing & corporate costs (+220%)
Other (contingency, direct works etc) (-38%)
Rolling stock (+188%)
Fixed equipment (+74%)
Terminals (+23%)
Tunnelling (+59%)
TOTAL Project costs (+122%)
TOTAL Works only (+64%)
DEMAND Actual (2003) v Forecast (1987)
Passengers Eurostar no. (-70%)
Shuttle no. Vehicles no. (-89%)
Total passengers no. (-63%)
Freight tonnes (-37%)
Forecast Errors (%)
0
2,000
4,000
6,000
8,000
10,000
12,000
Forecast (Nov 87) Actual (May 94)
£ m Forecast v outturn costs
Eurotunnel - risks and realities
Cost of private finance - the main risk!
Economics OK in the long run Economic return
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
1.0 1.5 2.0
ER
R
Revenue Multiplier
40 yrs (to 2034)
92 yrs (to 2086)
Financial return (real)
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
0.0% 1.0% 2.0%
FIR
R
Revenue Growth after 2020
3 bn £
9 bn £
Economic life: Renewal investment:
32 Source: Goldsmith & Boeuf (2015)
33
• Public Water Companies
• Private DBFOs for bulk
wastewater treatment
• Fully Privatized Regulated
Utility Companies WASCs
and WOCs
• International ownership
• Public Water Service
• Private DBFOs for
bulk wastewater
treatment and bulk
water supply
• Since 2001 a “not-
for-profit” Water
Company
• Private outsourcing
contracts for O&M
and capital
programs
UK Water … many financing models
33
• Plus 13 water
only companies:
34
Globally, water sector risky
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
Energy Transport ICT Water andsewerage
All sectors
PPI projects cancelled or in distress with financial close 1992-2012
total investment
no projects
Source: data from PPIAF PPI database
Total: 9108 contracts
Excludes: Divestitures + Lease/management contracts
China + Brazil
The infrastructure investment cycle
0
100%
Potentially disruptive
innovation in technology,
finance or institutions
Universal
service
gap
Sat
ura
tion
%
of
max
imu
m e
xte
nt
Efficiency v Equity
drivers
Innovation
adoption
drivers
Regulation &
standardisation
drivers
Consolidation
drivers
Competition
drivers
Next wave of
innovation
Complementary or
Competitive
Systems?
Old
Technology
Dy
na
mic
ten
sio
n:
old
v n
ew
Peak financial demand
may drive a private
investment "mania"
Re-use?
Decline?
Source: Goldsmith (2015)
35
Source: Fouquet (2014)
Economic impact
The key impact of
infrastructure is to
reduce economy-
wide transaction
costs over the
very long term.
Long run price trends: lighting, heating, transport
36
UK transport
1700-1870
equivalent to
annual TFP >2%
37
Affordability of water services
Affordability
benchmark
Source: Goldsmith & Carter (2016)
London household water supply typical costs
Technological progress,
efficiency and regulation
lead to high quality
services being available
and affordable to all
38
Long term cost of capital
38
“If any one store corn in another man’s house he shall pay him
storage at the rate of one gur for every five ka of corn per year”
– Code of Hammurabi (1790BC)
Source: Bank of England (2014) based on Homer & Sylla
Source: Smithers (2015) - FT
Debt – Benchmark interest rates
Equity Returns over previous 30 years
Debt: 3 - 6%
Equity: 4 - 8%
UK Railways 1830-1920 average
WACC (stocks & shares): 4.39%
39
Synthesis v Themes - Complexity
Infrastructure services evolve in technical/economic/social context:
• Labour v capital (slavery → labour markets → mechanisation)
• Demand v Pricing policy (free → user charges → tariff structure)
• Competition v Contract v Regulation (natural consolidation trend)
• Actors (Public → Private → Partnership → Not-for-Profit)
• Capital (Domestic → FDI → Domestic)
• Financial instruments (Grant → Debt → Equity → Guarantees)
• Subsidy mechanisms (Land grants/per km/soft loans/guarantees)
• Institutions v Governance (Legal frameworks/Corruption/Politics)
• Invisible hand v Hidden hand
40
History is not a deterministic
journey
State led Private led State led Private led Partnership
local national inter
national global
?
?
40
41
Lessons … or learning how to learn?
• Organizational learning (project
reviews; ex-post evaluation; audit)
• Peer-to-peer support (learning from
others)
• Explicit knowledge (courses; books;
papers; case studies)
• Knowledge networks and platforms
(EPEC; PPIAF; WB)
• Learn by doing (and failing!)
All you needed to know
… in 1912
42
What can we learn from history?
• Economic fundamentals matter
• Infrastructure pay-offs are long term &
systemic
• History (and economics) not deterministic
→ path dependency & context matter
• Many paths: UK v Europe v US v China
• Projects rhyme through time
• Recurrent risks:
• Optimism bias
• Events
• Politics
43
Balancing risks
Good governance
helps balance
risks to society
44
Read some history
Try to learn
Make some mistakes
Learn from your mistakes
Learn from others
Make more mistakes
Write some history
45
References Cassis, Y., De Luca G., & Florio M. (Eds) (2016). Infrastructure finance in Europe:
insights into the history of water, transport, and telecommunications. Oxford University
Press.
Goldsmith, H. (2014). The Long-Run Evolution of Infrastructure Services. CESifo Working
Paper Series No. 5073. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2532911
Goldsmith, H. & Carter D. (2015). Financing the Evolution of London’s Water Services:
1582 to 1904. DEMM Working Paper 2015-02.
https://ideas.repec.org/p/mil/wpdepa/2015-02.html
Goldsmith, H. & Boeuf, P. (2016). The Chunnel in History: Breakthrough or Continuity?
Paper presented at the Second International Conference: Twenty years under the
Channel, and beyond: Capital and governance in major infrastructure projects, Institut
français, London, 8 December 2015. http://ssrn.com/abstract=2717012
Millward, R. (2005). Private and public enterprise in Europe: energy, telecommunications
and transport, 1830-1990. Cambridge University Press.
Picot, A., Florio M., Grove N., & Kranz J. (Eds) (2015). The Economics of Infrastructure
Provisioning: The Changing Role of the State. MIT press.
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