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

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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

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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

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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.

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-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.