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New arena for the project business
November 2007
Paul Melly, International Trade Today
The project business is not what it was. Rare are the times now when a single big-name British engineering company lands a contract worth hundreds of millions of pounds to build a bridge, an industrial complex, an airport or a power station in its entirety. Rare also are the days when a Western export credit agency (ECA) underwrites almost the whole of such a deal, providing the over-arching protective umbrella under which hundreds of small sub-contractors to the lead contractor can shelter.
Indeed, now it is not uncommon to hear a City financier wonder whether there is any role left for the big ECAs at all, other than as props for the defence and aviation industries.
But if the business has changed, that does not mean it has evaporated. Indeed, demand for infrastructure and technology is as strong as ever. It’s just that these are being provided by a wider range of suppliers, and financed in much more diverse ways.
So this is not a time for nostalgia. But it is a moment to recognise that competition is more intense and diverse, that customers are more demanding and have more choice – and that they have become adept at squeezing costings.
For example, a senior procurement engineer for the Nigerian National Petroleum Corporation (NNPC) explained that his group had moved away from the traditional practice of awarding an entire project to an international contractor on a ‘turnkey’ basis. The Nigerians found that such big project managers would build in a fat profit margin for themselves and charge heavily for the risk attached to operating in a country seen as ‘difficult’.
NNPC now tends to hire one foreign engineering group to design a project and then place separate contracts for the physical construction and erection of the project with other companies that have a long-term presence on the ground, are more comfortable with local risks and will charge a correspondingly lower price.
But if pricing and competitive conditions are getting tougher, the options for financing and risk protection for trade in capital goods have also changed radically – and that is probably to the benefit of smaller specialist engineering, technology or service firms. The tools for funding their deals and covering payment risk have become more varied, and the scope for securing support at an affordable price is consequently greater.
Ten or 15 years ago, the cost of cover from the UK’s Export Credits Guarantee Department (ECGD) was a major concern for British companies, who feared they could be priced out of the race for key deals. However, today they can turn to a host of alternative sources for insurance, even for medium-term exposures of several years for markets that are perceived as fairly high risk.
Traditionally, official ECAs such as ECGD, Coface of France or Germany’s Hermes, were the main source of cover for big project deals that needed a repayment period of more than three years.
The role of private market insurers such as Lloyd’s of London syndicates, AIG or Paris-based Unistrat was mainly to cover the political risks attached to individual contracts with credit periods of up to three years; they were able to back deals in a wide range of difficult markets, but only for this short time span. As an alternative, exporters could turn to forfaiting – a technique under which banks and finance companies buy trade payment paper and the attached risks outright.
This limited range of options has now evolved radically. Forfaiting is still on offer, and for a notably wider range of country exposures than in the past.
But it is in insurance that change has been greatest. Today, there are many more names in the private insurance market, with groups such as Chubb, Sovereign, Ace and Zurich Emerging Markets now well established. And the private underwriters have extended the exposure periods they can accept to five or even, in some cases, 10 years.
Moreover, they are also posing a serious competitive threat to the ECAs as underwriters of the more difficult risks. Some of the official agencies, seeking to balance their books, have become strikingly cautious – and most have reduced their own ability to be flexible by signing up to a common OECD Consensus system for categorising country risks.
Intended to guard against unfair subsidised competition, this has had the incidental effect of blunting agencies’ ability to compete because the country risk grid has taken a strikingly unsubtle and simplistic approach to the grading of more difficult markets. Many countries that are poor but financially stable and well-governed have been placed in the same maximum risk grouping as those that are completely failed states with no credible economic or political structure at all.
In particular, through this simplistic approach, the ECAs have disastrously hamstrung their own ability to cover deals in Africa, just at a time when the private market insurers, forfaiting banks and development financiers are becoming much more positive about the continent.
However, some ECAs have managed to adapt to the shift in the balance of the insurance market, away from official export credit and towards more flexible private market approaches. Coface, for example, continues to act as the official French state ECA under an agreement with the government. But it is, in fact, a private sector company and also provides cover on a purely commercial basis; it now owns Unistrat, one of the most experienced specialist commercial underwriters of emerging market and developing country risks.
Atradius, the former Gerling NCM, has also expanded the range of difficult market deals that it can cover, while also continuing to operate the Dutch official export credit scheme under a contract with the government in The Hague.
Most striking of all, Ducroire Delcredere/ ONDD, the Belgian official ECA, has set up an independent commercial underwriting entity, which caters for clients in any country. The group thus puts its long-developed expertise in insurance of difficult overseas risk both at the service of Belgian exporters using the official export credit scheme and a much wider international client base of commercial insurance clients.
One of the factors that has driven the development of private market insurance is the growing tendency for many projects to be developed on a Build Operate Transfer (BOT) basis. This means that instead of a foreign customer paying a foreign contractor to build a power plant or industrial facility and then hand it over, the customer awards an investor a contract to build and then operate the facility.
The big private market insurers often play a key role in backing such projects. However, the extent to which BOT reduces the risks and financing pressures attached to a project depends on the structure of the deal.
Where the project will subsequently produce hard currency revenues – as in the case of a mine or an oil production platform – the financial risks are clearly reduced. But there is still some political exposure because it is not possible to operate most projects in conditions of instability and violence.
For example, action by local militant groups has disrupted activity at certain oil production facilities in the Niger delta in southern Nigeria. Moreover, the viability of projects also depends on the regulatory and business conditions imposed by the host government.
And some projects, such as power plants, water supply networks or public transport, are, of course, catering for the local market, generating their revenues in local currency, and are thus exposed both to the health of the domestic economy and consumer purchasing power and to the terms of operating and regulatory agreements with host governments.
This presents challenges of its own.
Still, overall, it is probably the case that the shift to BOT, or independent commercial project development, has helped to contain or manage risks.
For UK capital goods exporters life may have become a lot less simple, but the tools available to cope with today’s more complex risk and financing scene have become more flexible and diverse.
