Funding a project using the money it makes is a very attractive proposition. It allows businesses and investors to develop new factories, energy-generating facilities, and other major projects without placing a direct strain on their cash flows. But not all activities are suited to it.
“Project finance is most suitable for large, capital-intensive assets with long operating lives and sufficiently visible cash flows to service debt,” says Robert Costello, partner and leader PwC Ireland’s capital projects and infrastructure group.
Typical sectors include transport, renewable energy, utilities, waste, ports, digital infrastructure and selected industrial facilities.
“Funding normally combines sponsor equity with senior debt from commercial banks, development institutions or export credit agencies. Larger or operational assets may also use project bonds or private placements with pension funds, insurers and asset managers, while subordinated debt, grants or State support can fill specific gaps,” says Costello.
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The choice depends on scale, risk, tenor and flexibility. “Bank debt is generally better suited to construction because it can be drawn progressively, whereas bonds and private placements can provide long-dated, fixed-rate capital once the asset and its revenues are more stable,” he says.
In practical terms, project finance applies where an individual project can generate a dependable income stream, for example through tolls, availability payments, regulated charges or long-term energy contracts.
“Irish examples include road PPPs [public private partnerships], schools, the Dublin waste-to-energy facility and financed wind and solar projects. The M50 is a useful historical example, although its current tolling arrangements differ from the original concession structure,” he says.
The upgrade of the M50 was through an availability-based PPP which involves payments from Transport Infrastructure Ireland to a project company to upgrade and manage the road over a long-term period, he adds.
“The Dublin Port Tunnel is an operator contract as part of the wider roads programme rather than a user-pay project finance model. The approach also has potential for offshore wind, electricity networks, storage, water, district heating and other infrastructure where a credible long-term revenue framework can be established,” says Costello.
All such projects require substantial investment upfront but generate returns over many years.
“Project finance matches the cost of the asset with its future income and brings together investors and lenders around a defined contractual structure,” he says.
“Its principal advantage is disciplined risk allocation – construction, operating, demand and performance risks can be assigned to the parties best placed to manage them. Where the structure is well designed and competitively procured, this can improve delivery certainty and whole life performance and potentially provide better value for money.”
That is not automatic, however, he cautions: “The outcome depends on sound project selection, contracts and governance.”
It is generally a poor fit for small projects, early-stage or unproven technologies, short life assets, or businesses whose revenues are highly volatile or difficult to contract.
The main exposures are construction delay and cost overruns, technical underperformance, operating cost increases, weak demand, counterparty default and changes in law or regulation.
“High leverage can amplify any shortfall. If cash flow falls below the required level, the project may breach its financing terms, require restructuring or face lender intervention. The extensive due diligence and contractual work at the outset are therefore central to identifying, allocating and mitigating these risks,” he adds.
Its central appeal is straightforward, enabling a project to be financed primarily on the strength of its forecast cash flows, rather than by reference to the balance sheet valuation or wider credit standing of the promotors.
“This can enable businesses, investors and public sector bodies to develop assets such as energy facilities, transport infrastructure, data centres, manufacturing plants and social infrastructure without requiring the full capital cost to sit on their balance sheet,” says Keith McDonagh, head of corporate finance at Xeinadin.
“Properly structured, a project’s revenues should fund its operating costs, repay its borrowings and provide investors with a return over the life of the asset.”
However, he cautions, the idea of “making projects pay for themselves” should not be read as eliminating risk.
“Rather, it is about identifying, allocating and managing risks so that lenders and investors can take comfort that the project will generate predictable and recurring cash flows over the investment period. In practice that calls for robust contracts, credible counterparties, clear regulatory conditions and a realistic assessment of construction, operational, market and financing risks,” he cautions.
“Preparation of detailed, robust, tested cash flow forecasts that satisfy a lender’s financial covenants are therefore central. Debt is normally sized conservatively against projected cash flow, with lenders requiring a meaningful buffer between expected project income and scheduled debt obligations.”
There is no one-size-fits-all project finance solution. “Most funders are larger European lenders mixed with institutional or pension funds satisfied to step in to refinance on completion, reducing development or delay risk. The source of capital really depends on the project’s size, sector, maturity, risk profile and contractual structure,” he says.
However it is achieved, Ireland has clear opportunities for project finance, he believes, particularly in renewable generation, grid and storage infrastructure, data centres and digital infrastructure, housing enabling utilities, transport and social infrastructure.
“The transition to a lower carbon economy will require very substantial investment over the coming decade, while continued economic and population growth will place further pressure on energy, water, transport and digital networks,” says McDonagh.
“There is considerable appetite among a range of the above funders for well-structured Irish assets. The challenge is to create investable projects – projects with planning certainty, workable structures and regulatory arrangements, credible construction programmes, bankable revenue models and fair allocation of risk among developers, contractors, customers, the State and financiers.”
