A March 7th program hosted by Fraser Milner Casgrain LLP and sponsored by the Association of Corporate Counsel - Greater New York Chapter considered the latest developments in project financing in Canada, with a particular focus on opportunities in energy and infrastructure. The luncheon speaker for the program, which was held at the Rainbow Room, 30 Rockefeller Plaza, New York, New York, was the Hon. Dwight Duncan, Minister of Energy of the Province of Ontario. The program speakers were Duncan Caird, Managing Director, HSBC Securities (U.S.A.) Inc., Ron Stuber, Consultant, Fraser Milner Casgrain, Vancouver, and Douglas J.S. Younger, Partner, Fraser Milner Casgrain, Toronto. They were introduced by Charles R. Spector, Managing Partner of Fraser Milner Casgrain's New York office.
Mr. Caird noted the restraints inherent in large government debt, with a particular focus on infrastructure expenditure. He cited Italy as an example of a country forced to make decisions premised on the national debt. "Italy's national debt is 98 percent of GDP, which means they have effectively stopped developing infrastructure. Last year's cancellation of the Messina Bridge, a $4 billion project to connect Sicily to the mainland, is a prime example of what happens when the government continues to spend without determining where the money is coming from."
He went on to discuss the impact that changing the rules after a project is underway can have on public support. Noting the promise of an earlier British government to make the Thames-M-25 crossing free to users once the project had been paid off - which had occurred - he cited the current debate to increase the charge to use the bridge for the purpose of supporting other transport. Commendable, he noted, but corrosive of the confidence necessary to raise money for future projects.
Mr. Caird indicated the importance of law firms in the infrastructure development process as a way in which to get clients to develop and stick to a set of rules on the disposition of the funds and what would occur once the project was paid off. That, he said, was crucial to engender confidence and support continuing investment in infrastructure and an expanding economic capacity.
After contrasting the quality of the procurement discussion in Canada with the political undercurrents informing that discussion in the U.S., Mr. Caird noted that the price of gasoline was approximately $2.50 a gallon in the U.S. and $6.67 in the UK. He stated that revenue from gasoline taxes in the U.S. were insufficient to maintain the highway system, let alone invest in improving it. He concluded his remarks by saying that depoliticizing investment in infrastructure was important for both the economy and for end-users. A mature debate on this issue, he said - and whether the private sector, government or some public-private partnership arrangement was the most appropriate vehicle - was not underway in the U.S. at the moment. Mr. Stuber introduced his remarks by saying that he was pleased to talk about energy in Canada at a time when international interest in the Canadian energy sector was at an all-time high. "The worldwide demand for energy, which is growing at a rapid pace, the dramatic increase in fuel costs in recent years and the rising concern about climate change are driving a tremendous boom in development projects in Canada's energy sector." He went on to note that while historically much of the sector had been publicly owned and financed, at present deregulation of power generation was underway, albeit at different stages, across the entire industry. This, he said. was creating many project financing opportunities for independent power projects, from conventional fossil fuel resources to emerging renewable resources.
He went on to note that energy projects typically entailed funding requirements, and risks, in excess of what sponsors were willing to assume. The project finance structure was appealing to sponsors because it -
provided financing that was legally non-recourse to the sponsors;
achieved "off balance sheet" accounting treatment of project debt by not showing any borrowing for the project's own borrowings in its consolidated accounts;
allowed highly leveraged structures, which often meant a reduction in the cost of capital by substituting lower cost, tax-deductible interest for higher cost, taxable returns on equity; and
allocated project risks among participants, thereby reducing each participant's risk of loss.
Mr. Stuber cited the impact of the global warming discussion on Canada's energy sector, and he went on to discuss the country's commitment to ensure a secure, reliable supply of affordable energy in an environmentally responsible way. This included, he said, the recently proposed federal Clean Air Act to regulate targets for air pollutants and greenhouse gases from key industrial sectors, including fossil fuel-fired electricity generation, upstream oil and gas, downstream petroleum, base metal smelters, iron and steel, cement, forest products and chemicals production. He pointed, in addition, to the federal government's announcement, in early 2007, of an investment of $1.48 billion in the "ecoEnergy for Renewable Power" program aimed to boost Canada's supply of renewable electricity by 4,000 megawatts over 14 years.
Turning to oil and gas production, Mr. Stuber stated that rising energy prices and increased demand for petroleum production had led to greatly increased interest in Canadian oil and gas resources. He cited Alberta's oil sands as containing one of the largest known proven crude oil reserves in the world, with an estimated 175 billion barrels, and he discussed the construction and development of oil sands projects in the province of unprecedented size and scope in recent years. He noted that Alberta continued to be the Canadian industry leader, but he went on to point to major offshore development projects on the east coast of Newfoundland and Labrador and in the country's far north.
Mr. Stuber stated that Canada was a net exporter of electricity to the U.S. as a consequence of the low cost of its hydroelectric resources. Both countries, he noted, realized commercial benefits and improved electric power reliability through their trade relationship, but he went on to indicate that both projected a need to increase generation of capacity by approximately 25 percent by 2025. This, he said, would result in great opportunities on both sides of the border.
In contrast to the U.S., he said, the dominant generation technology in Canada was hydro-electric power. Interest in wind power, biomass, geothermal energy, solar cells, ocean energy and clean coal as credible sources continued to grow in Canada, he said, driven by concern about adequacy of supply over the long term.
Mr. Stuber also spoke about the restructuring of electricity markets across many North American jurisdictions. He noted the traditional market structure, a vertically integrated utility providing generation, transmission and distribution services to a specified service area and with customers paying regulator-approved prices. The intent of restructuring, he said, was to separate the three functions and to promote competition, leading to lower costs. He noted that wholesale access to transmission grids enabled distribution companies to purchase electricity from the most competitive generation sources, while retail access benefited consumers as a result of having choice among suppliers. He went on to say that Alberta and Ontario had moved the furthest in restructuring their markets, while British Columbia, Saskatchewan, Quebec and New Brunswick allowed wholesale access and retail access to large industrial losers. Manitoba, he noted, allowed wholesale access only. He added that both the federal and provincial governments in Canada had adopted policies to encourage the development of renewable energy, including direct subsidies, tax measures and renewable energy content targets.
Concerning project finance considerations, Mr. Stuber noted that the continuing growth of energy demand in Canada was expect to fuel innovation and growth from both conventional and non-conventional sources. The bankability or financeability of a project tended to be project-specific, he said, but the appropriate allocation of project risk was coming to dominate the discussion, and lenders were looking to the cash flow generated by the project and the project contracts, as opposed to the net realizable value of the secured assets of the project company. He concluded his remarks by stating that these transactions were coming to represent excellent opportunities to develop innovative financing and securitization techniques.
Mr. Younger expressed the view that much of Canada's infrastructure, having been built in the 1950s, was approaching the end of its useful life. He added that steady economic and demographic growth in Canada was also resulting in a need for new infrastructure. He went on to note, that while the infrastructure deficit was substantial and on the increase, governmental funds were not available. "The difficulty is, of course, that as governments face pressing demands for increased spending on the operating side - in particular for schools and healthcare - capital spending priorities tend to take a back seat." One of the options gaining currency as a result of this state of affairs, he said, was the public-private partnership.
He pointed to the fact that only some seven percent of the country's public infrastructure is vested in the federal government, leaving the 93 percent balance in the hands of the provinces and the municipalities. That meant, he said, that the impetus for infrastructure renewal had to come from the provincial and municipal levels of government.
Following a review of a variety of provincial public-private partnership initiatives, Mr. Younger described the design-build-finance-operate project finance model utilized for most Canadian public-private partnerships. This entailed, he said, a concession by the appropriate governmental authority to a private sector entity - normally a special purpose vehicle - which was required to build the relevant infrastructure, finance it, operate and/or maintain it, and, at the end of a specified period, hand it back to the authority in the condition stipulated in the concession agreement. He noted that the agreement contained provisions allowing the authority to intervene and run the project, or terminate the concession, in the event the project company failed to satisfy the requisite standards set forth in the concession agreement.
Mr. Younger went on to address the criticisms that had been leveled against the public-private partnership concept in Canada. To the argument that the private sector's cost of capital was higher that the government's, he pointed out that any differential tended to diminish as the market for public-private partnerships matured. He also noted the fact that governmental responsibility for overall economic stability meant that governments were not able to borrow without restraint. He went on to point out that many public sector services had been contracted out to private sector operators for years, and that the line separating public and private services was itself shifting constantly.
Concluding his remarks, Mr. Younger cited the efficiency and flexibility of the public-private partnership model and its ability to bring the benefits of the private sector into the public arena. "In other words, it's not about ideology; it's about getting assets built quicker and more effectively than if they were procured in the old fashioned way."
Published April 1, 2007.