Global lessons on financing infrastructure Infrastructure round - - PowerPoint PPT Presentation

Global lessons on financing infrastructure

Lagos, August 5, 2013 Infrastructure round table

CONFIDENTIAL AND PROPRIETARY Any use of this material without specific permission of McKinsey & Company is strictly prohibited

McKinsey & Company | 2 SOURCE: McKinsey

“A multi-trillion dollar game”: We estimate infrastructure

investment requirements (to both cover current gaps and keep up with growth) of ~$60 trillion between now and 2030 – More than estimated value of today’s infrastructure

“Funding facing strong headwinds”: Current funding

context is difficult, with tight lending capacity and increasing fiscal constraints, but still many options exist to overcome them

“Money is not the (main) problem”: Lack of funding and

financing for infrastructure is a symptom of deeper problems that require action at other, more transformational, levels

– Improve infrastructure portfolio/ project selection – Streamlining delivery – Making the most of existing infrastructure

McKinsey & Company | 3 SOURCE: Organisation for Economic Co-Operation and Development (OECD); International Energy Agency (IEA), 2011; International Transport Forum (ITF); Global Water Intelligence (GWI); McKinsey Global Institute analysis

Projection based on external estimates 55 Projection based on ratio of infrastructure stock to GDP 64 Projection based on historical spending 59

Three different methods point to infrastructure investment needs globally

• f $60 trillion through 2030

Estimates of needed core infrastructure investments, 2013–30 $ trillion, constant 2010 dollars

Telecom Water Power Other transport Roads

McKinsey & Company | 4 SOURCE: ITF; GWI; IHS Global Insight; Perpetual inventory method, OECD, 1998; McKinsey Global Institute analysis

Infrastructure investment needs to rise to 4.1 percent of GDP on average worldwide and much more in most developing countries

World 4.1 3.8

1 Estimated need based on projected growth, 2013–30 2 Weighted average annual expenditure over years of available data, 1992–2011

Spending in core infrastructure (to ensure 70% of GDP in 2030) % of GDP Brazil 4.9 1.5 Russia 4.0 3.4 India 6.9 4.7 South Africa 5.1 3.4 Nigeria 7.0 2.5

Actual spend2 Estimated need

8.5 China 6.4 Most developing countries require significant step-up China is a clear outlier

McKinsey & Company | 5 SOURCE: McKinsey

“A multi-trillion dollar game”: We estimate infrastructure

investment requirements (to both cover current gaps and keep up with growth) of ~$60 trillion between now and 2030 – More than estimated value of today’s infrastructure

“Funding facing strong headwinds”: Current funding

context is difficult, with tight lending capacity and increasing fiscal constraints, but still many options exist to overcome them

“Money is not the (main) problem”: Lack of funding and

financing for infrastructure is a symptom of deeper problems that require action at other, more transformational, levels

– Improve infrastructure portfolio/ project selection – Streamlining delivery – Making the most of existing infrastructure

McKinsey & Company | 6

Context for infrastructure funding is very challenging

Long-term debt financing is becoming increasingly costly and difficult to attain Public budgets are tightening up (particularly in the “developed” world) which affects infrastructure spend more than proportionately No improvement expected

Basel III rules Banks exiting the infrastructure

business (e.g., BNP Paribas, West LB) Average interest margins Basis points, transport infrastructure 280 135 +107% 2010 2007 Difficult funding context

McKinsey & Company | 7

Increase in interest rate spreads have particularly hurt developing countries

Loan interest rate spreads1

SOURCE: Public Works Financing database, McKinsey Global Institute 1 Spread over 6month-LIBOR

Brazil, Chile, India, Mexico, Nigeria, Peru’, Thailand Australia, Canada, USA, UK 100 200 300 400 500 600 2013 12 11 10 09 08 07 06 2005 100 200 300 400 500 600 2013 12 11 10 09 08 07 06 05 2004 bps

McKinsey & Company | 8

Pension, insurance and sovereign wealth funds are projected to grow significantly and show increasing appetite for infrastructure assets

SOURCE: McKinsey Global Banking Pools; McKinsey Global Insurance Pools; SWF Institute; TheCity UK; Preqin

1 7 3 SWF Pension fund Life insurance 22 2000 32 05 41 10 83 106 6% p.a. 20 66 15 52 2030 25 5% p.a. 28 12 Private infra- structure Public infra- structure Global funds under management expected to continue to grow … …and there is solid evidence that infrastructure assets can capture some of that growth Average infrastructure allocations by fund type Percent Investors who expect to increase allocations to infrastructure % of total respondents Global pension, life insurance and SWF assets under management US$ trillions

McKinsey & Company | 9

These funds typically prefer less risky assets, but shift towards greenfield projects may signal increasing “aggressiveness”

Breakdown of funds projects and deals in infrastructure. Share of total

1 Includes Secondary stage and Brownfield 2 Includes Greenfield (112) and Expansion (12) 3 Includes Asset Acquisition, M&A, Brownfield, Privatisation 4 Includes all unlisted funds active since 2002. Includes equity invested outside OECD by funds with global scope

SOURCE: Preqin; Infrastructure Journal; Public Works Financing; Infrastructure Investor; Global Insight; McKinsey

Infrastructure fund scope4 Total funds final size, USD bn, Estimates 91 OECD Non-OECD USD 99 bn 8 35 58 65 42 175 722 283 Projects 2005-10 (average p.a.) 711 Infrastructure fund deals 2005-10 (average p.a.) 190 Projects since 2010

Greenfield Mature1

100%=

McKinsey & Company | 10

PPPs can make up 20-25% of infrastructure spend, in both developed and developing countries

35 100 76 100 90 13 7 21 4 11 20 10 118 89 58 56 84 18 96 100 20 36 52 82 9 64 10 28 26 47 4 81 66 16 156 44

SOURCE: HM Treasury, United Kingdom; Planning Commission, India; McKinsey Global Institute analysis

Planned public, PPP, and private investment in core infrastructure Ratio per sector United Kingdom 2011–15 100% = $257 billion India 2007–11 100% = $485 billion Public Public-private partnership (PPP) Private 64% (164) 23% (59) 13% (33) 17% (82) 19% (92) 64% (310) Transport Energy Communications Waste Water Electricity Roads Telecom Rail Water Ports Airports

• Percentage. $ billion

McKinsey & Company | 11

While public purses are tight, there are several funding alternatives available to governments, with some representing unexploited potential

Detail on following pages

SOURCE: McKinsey Global Institute

Public capital Financial instruments Capital recycling Property value capture Divesture Lease Other financial schemes Alternative funding sources Tax User charge Public cash flow sources 1 2 It includes structured instruments like bonds and loans or plain vanilla like simple cash flows Underlying revenue sources to fund the financial instruments

McKinsey & Company | 12 SOURCE: Moody’s Investors Service, Transportation research board, McKinsey Global Institute

Financial instruments: long-term public debt financing can take different forms 1

Revenue bond1 Limited non-system bonds: backed by revenues not originated by the funded infra system System revenue bonds: Backed partially or totally by system user charges NYMTA: In December 1998, issued $317 million in principal amount of Transit Facilities Revenue Bonds New York City MTA: 1998’s $396 million issue supported by the state’s petroleum business tax SFO link: A $500 million issue of grant anticipation bonds to help connect San Francisco to the airport., backed by ability to issue sales tax bonds Financial instrument Examples

1 Can be issued with tax-exempt feature

General

• bligation

bond GO bonds: backed by the full faith and credit of taxing authorities San Francisco BART: $ 413 million general obligation bonds at ‘AA+’ (secured by an unlimited ad valorem tax levied on all taxable property within the BART counties) Secured and un-secured loan agree- ments Commercial Bank Loans: backed by public entity credit capacity + (collateral for secured loans) Ghana Shared Growth Development Agenda (GSGDA): US$3 billion loan from China Development Bank to finance infrastructure projects Loans from construction firms N/A Direct loans from Government Capital providers: backed by public entity credit capacity Missouri Transportation Finance Corporation [MTFC]: Backed by the Missouri Dept Of Transport, aims at providing financial assistance to accelerate or add projects for the State’s transportation system

McKinsey & Company | 13 SOURCE: Moody’s Investors Service, Transportation research board, McKinsey Global Institute

2

Acquisition and sale of excess land: Public sector acquires land around an infrastructure project and sells it at a profit when project completed and land value enhanced Outer-ring highway in Changsha, China: The Ring Road Investment Corporation acquired 200m strips of land on both sides

• f highway and borrowed against anticipated value of improved land

to obtain financing from China Dev. Bank and commercial banks Instruments Examples Impact fees: Developers pay the cost

• f system-wide infrastructure

expansion needed to accommodate growth Phoenix, USA: Impact fees paid when construction permit issued, depending on type of infrastructure, type of land use, building and lot size, water meter size, distance from infrastructure trunk lines, and

• ther locational features.

Options for property capture value

Public-private partnership: Developer installs “public” infrastructure in exchange for land Madinaty real estate project, New Cairo, Egypt: New Urban Communities Authority agreed to supply the developer with free land, in return for the developer’s provision of basic infrastructure. Betterment levies: Public sector taxes away a portion of land-value gain resulting from infrastructure projects Bogotá, Colombia: ~US$1+ billion municipal works (mostly street, bridge, and drainage improvements) financed from 1997–2007 through betterment levies, graded so that betterment levies fall more heavily on commercial-industrial uses than on residential use Developer exactions: Developer installs onsite and neighborhood-scale infrastructure at own expense United Kingdom: City councils empowered to secure contributions from real estate developers to cover services, infrastructure and amenities in a piece of land (Section 106 of the Town and Country Planning Act 1990) Scale of prevalence

McKinsey & Company | 14 SOURCE: McKinsey

“A multi-trillion dollar game”: We estimate infrastructure

investment requirements (to both cover current gaps and keep up with growth) of ~$60 trillion between now and 2030 – More than estimated value of today’s infrastructure

“Funding facing strong headwinds”: Current funding

context is difficult, with tight lending capacity and increasing fiscal constraints, but still many options exist to overcome them

“Money is not the (main) problem”: Lack of funding and

financing for infrastructure is a symptom of deeper problems that require action at other, more transformational, levels

– Improve infrastructure portfolio/ project selection – Streamlining delivery – Making the most of existing infrastructure

McKinsey & Company | 15

SOURCE: McKinsey Global Institute

Several characteristics of infrastructure make it challenging to govern, leading to fundamental productivity issues

Infrastructure characteristics Governance challenges

Long asset life-

time

High capital

intensity, invest- ment complexity

Political interference with

short election cycles and lack

• f technical expertise regularly

leading to bad planning

Network effects

and external spill-overs

Scattered ownership and

governance across regions and asset classes leads to sub-optimum infrastructure systems

Mono-/

• ligopolistic

structure

Badly defined public vs.

private sector interface, incl. market structure, regulatory and pricing framework 1989 90 100 110 120 130

Rest of economy Construction

Evolution of productivity Percent

McKinsey & Company | 16

Three ley levers can result in significant improvements

Making the most of existing assets

Increased asset utilization Reduced transmission and distribution losses Preventive maintenance Demand management

SOURCE: McKinsey Global Institute

Making better decisions about project planning and selection

Clear socio-economic objectives Standard cost-benefit analyses System-wide decision-making

Streamlining delivery

Streamlining approvals and land acquisition Better tendering and procurement Design optimization and planning Application of lean construction techniques Advanced contractor management Construction sector development

1 2 3

Exemplified

McKinsey & Company | 17

1 Private Infrastructure Investment Center of Korea; 2 Public Investment Management Center; 3 Public & Private Infrastructure Management Center

High cost and time overruns… … by establishing PIMAC …reduced…

SOURCE: IEEE Transactions on Engineering Management, KDI, Construction & Economy Research Institute of Korea, APA Journal

Project selection: System wide decision making

Korea enhanced the efficiency and transparency in infrastructure development by establishing an objective supervisory organization

Example: Mega project construction cost $ billion Seoul- Busan high- speed rail Incheon Internation al airport

18 5

7 3 Adjusted Planned Cost overrun Percent

41 After ’99 Before ‘99 122 Overrun

Between 1999 and 2006, ~60 $ billion saved (~1% of GDP) and allocated for

• ther uses

Projects rejected Percent

• Amended infrastructure projects to be assessed

by a central organization for budgetary decisions (PIMAC)

• Developed detailed description of methodology

and procedures of Preliminary Feasibility Study

• Formed multi-disciplinary PFS team that

involves 3 or more organizations to sustain

• bjectivity, consistency, and transparency

97 54 46 After ’99 Before ’99 3 Rejected

1

McKinsey & Company | 18

Sufficient investment in up-front planning and engineering is key to controlling construction cost and schedule

SOURCE: Build India report, based on interviews and McKinsey analysis

5 2 6-9 “In a roads project, a temple was adjacent to the site of a proposed flyover. This aspect was overlooked in the DPR

• phase. The flyover got built,

and subsequently erased due to local pressure” “In a thermal power project, the DPR firm quoted an abnormally low price, then did not deploy enough resources to prepare the DPR. The resulting design & cost estimate was heavily bloated, and the nodal agency saved 10-20% on it by doing the DPR again” Scope changes High project costs Illustrations of impact of bad DPRs in India Relationship between spend incurred on Detailed Project Report (DPR) & cost overruns – roads sector DPR spend As % of project cost Cost overruns Percent 8 6 24

Streamlining delivery: Design optimization and planning

2

McKinsey & Company | 19

0.1 Infrastructure need 2.7 0.61 0.4 0.1 Making the most

• f existing

infrastructure 1.7 Optimized need 0.2 0.2 Improving project selection/ optimizing infrastructure portfolios Streamlining delivery Global infrastructure investment need and how it could be reduced Yearly average, 2013–30 $ trillion

Acting in these three levers can result in a $1 trillion-a-year savings in infrastructure investment

SOURCE: McKinsey Global Institute analysis 1 Telecom investment need beyond the scope of this paper. Demand management Operations and reduction of transmission and distribution losses Optimized maintenance

~$1 trillion/ year saving in infrastructure

McKinsey & Company | 20 SOURCE: McKinsey Global Institute

Good chance of following infrastructure best practices only if the right system, governance, and enablers are in place

Data and accounting Technocrats vs. politicians

Infrastructure balance sheets to

• vercome issues of scattered,

incomplete, and inconsistent data

While politicians need to set the

• bjectives, technocrats need a

level of independence for planning and evaluation Capacity and capability Private sector orchestration

Leadership and vision at the top

and a sufficient number of high- quality project managers and planners below

Opportunities to create more

competitive markets

Private sector can help originate

and improve planning proposals Stakeholder engagement Coordination between institutions

Establish transparency and trust

early on to avoid bad decisions and delays

Orchestration of decision

makers across regions and types of infrastructure

Thank you!

Lagos, August 5, 2013 Infrastructure round table

CONFIDENTIAL AND PROPRIETARY Any use of this material without specific permission of McKinsey & Company is strictly prohibited