Feasibility of an Infrastructure

train infra

A huge part of infrastructure development work upfront is the feasibility study. What exactly goes into a full feasibility study and why is it so important? This article aims to explain that simply and more accessibly to people outside the industry. We’ll focus on the feasibility study rather than any documentation on projects generated prior to that (sometimes called pre-Feasibility Study – which could be considered a ‘lite’ version).

The feasibility study is like a professional evaluation of a business plan. For any infrastructure project, this is a comprehensive look into all the practical, legal, technical and commercial aspects of the project. Often, it will include social and environmental dimensions of the project in order to ensure that the lenders (ie. financial institutions providing debt to the project) is satisfied. In markets where there is significant social and environmental activism, the lenders are also on the receiving end of hate-mail, harassment and boycotts. Major project finance lenders internationally have therefore got together to be involved in The Equator Principles – a risk management framework that banks sign up to abide in assessing the environment, social risks involved in projects.

What then constitutes environment and social risks?

Infrastructure projects are physical, and will almost always require clearing of a piece of land to allow construction to take place. This would mean either resettling villages, people, farms, or redeveloping urban spaces, or even clearing swathe of rainforest. In cases of large hydropower dams, it will involve spaces not only for construction of the dam but also planned floodplains which can include multiple villages, broad swathe of forests. All of these impacts on human lives, biodiversity, alters natural landscapes.

Of course, the banks, developers, and builders care about people and rainforests. But beyond that, they are concerned about being harassed, haunted by NGOs, activist organisations trying to run them down reputationally for having been involved in projects that destroyed natural habitats for endangered species, upsetting livelihoods. These forms the environment and social risks; and the feasibility study tend to cover aspects of the social and environmental impact assessment, as well as to propose means to mitigate. Through that, the developers of the project also forms an idea how much resources they might need to expend to support resettlement, to help rebuild livelihoods destroyed.

How about practical and technical risks?

The feasibility study also goes into the technical and practical aspects of the project, including studying the possible technologies to deploy, the actual site conditions: whether the land can accommodate the infrastructure, whether there is actually sufficient demand for that infrastructure, and if the infrastructure has everything needed to service that demand – this could take the form of water supply pipe network, or an inter-connector to the national grid for a power plant.

The study needs to ensure that the proposed technical solution is able to deal with the problem statement at hand. For example, if we are using incineration for the waste, then we have to ensure that the waste stream is not too moist. If the waste is wet, the incineration system may not perform properly, which leads to potential technical breakdowns or stoppage.

And not forgetting the legal and commercial risks?

At the end of the day, the project will have to comply with the law of the land, and often, there will be a lot of permitting, licensing, government approvals that are needed for various components of the project. The feasibility study will investigate all of these and the developers will also do their best to make sure the requisite approvals and permits are obtain in advanced even often in parallel with the feasibility study just to make sure that the project is progressing in a timely fashion. These documentation will often be studied alongside the feasibility studies by the lenders.

Lots of parameters, and results from various aspects of the feasibility study would be captured into the financial model that is used to work out whether the project is commercially viable – that is, the total revenues/payments expected for the lifetime of the project is able to pay for its total cost over its lifetime. Governments may also undertake an economic cost-benefit analysis, to see if the total economic benefit of the infrastructure project is able to cover the total cost to society (more on this from a previous article I’ve written).

At the end of the day, flagging out, assessing and then measuring these risks enables the developers, lenders, and the government to have a better picture of how viable the project really is, hence its feasibility – from the various risks perspective as well as the resourcing that can be availed to the project. Doing proper feasibility studies can also help government better plan areas surrounding infrastructure, whether it is to mitigate some of the impacts of the infrastructure, but also to see if developments around the infrastructure can help improve its feasibility (eg. a larger substation might have to be built in the area to be able to accommodate a large utility scale solar park which would not have been able to feed power into the national grid).

This article is part of a series I’m working on to make topics in infrastructure a little more accessible to students and people from outside the industry who might want to get involved.

What is Bankability?

infrastructure

I’m hoping to embark on a series of writing that will help the university students and young graduates appreciate the infrastructure industry better. I know this is likely the beginning but I’m not sure when it will end or how frequently I’ll be writing. For now, I thought I just want to get started and eventually when there is critical mass, I’ll be putting it up on a separate website.

For consumers, when we apply for credit cards, the bank taking in the application wants to know our income, our employer, age, and will probably scrub our current track records for payment on our other cards, as well as any outstanding debt we have. For businesses, the process involved in loan applications is somewhat similar. Banks look at the years it has been established, the revenue/sales track records, the profitability of the firm and or sometimes they are financing based on the invoices – payments that the firm will be receiving from its customer for goods sold.

And then there’s infrastructure projects; they are not yet built, there’s no cashflow or payments made to the infrastructure, sometimes the land is not even acquired yet (there’s no one providing funds to acquire the land!). The willingness of a well-established financial institution to lend money to the project at reasonable interest rates (ie. ‘bankability’) will depend a lot on factors that surround the projects which gives good indication of the ability of the project to repay its debt. Like consumer credit, the more data the banks have, about both projects of the type in general, and also specific data about the project to be financed, would help give them a better sense to assess if they should lend to the project.

So what kind of data? I’ll distinguish between the availability of data, and the outcome of the assessment on the data available. The banks need data on the reliability of the sponsors/developers (essentially the equity owners of the project), the engineering-procurement-construction (EPC) firms involved, the government or customer of the project (ie. the one who will be paying for the services the infrastructure provides), as well as the underlying project involved. For each of the entities involved:

  • Previous payment/financial performance – in the form of financial statements, records, etc.
  • For government, often some kind of sovereign rating
  • Track records in project execution (especially in terms of the construction in the case of EPC firms, and operating experience for the developer or whoever they might be appointing to operate the project)

Then for the underlying project, the sources of data that will allow the banks to make the assessment would be:

  • All the contracts involved in the project
  • Feasibility studies involving site survey results, data – independent studies verifying that the proposal is feasible, technical solutions can deliver expected results, etc.
  • Any documentary evidence of support by governments or other development financial institutions towards the project.

In essence, these things are basically like the payslip or appointment letter from your employer which you submit for your credit card application. They give proof that the project is able to be put together and generate the kind of cashflow worthy of the loan that it will be taking out. There will also be sophisticated financial models that are shared across the developers and the banks in order to work out transparently what is the cashflow expected from the project across its lifetime and how these cashflows will be divided amongst the various stakeholders.

Through the information, the bank determines how stable the cashflow is, the level of comfort they have with the creditworthiness of the various parties, and then work out the pricing (ie. interest rates) on the loan, which helps to update the financial models, and provide more clarity to all the parties involved on how the returns from the project are shared. The assessment of risks by the bank (which impacts on pricing and whether they would be interested to finance the project at all) will be based upon their internal due diligence on the various parties involved in the project, as well as the feasibility study, and the set of contracts underlying the project. It often depend critically on the government involvement in the project and how they are involved. Major project finance deals are often achieved with government providing a guarantee on the income stream of the project conditional on the performance of the project based on pre-agreed indicators. Once the bank is satisfied that the operators and developer is able to perform in accordance to the contract, they shift their attention towards the creditworthiness of the government who have promised to pay.

As a result of these complexities, infrastructure transactions themselves are not only big in terms of the investment but they do require big teams to put the transactions together whether it is on the developer side, the financial institutions or the consultancy teams. These teams are all combining various disciplines including accounting, finance, engineering, general management, project management, legal, etc. To that extent, we do think that the industry is a good generator of job opportunities. The challenge is that these projects are typically have activities in starts and stops (extreme busyness in one camp or another in different points of time). The skills required across the sector is quite wide-ranging though the topic tend to be more narrow and focused.

This article is part of a series I’m working on to make topics in infrastructure a little more accessible to students and people from outside the industry who might want to get involved.