Moving in the right direction

A number of countries in the Middle East are planning to invest heavily in rail infrastructure over the coming years. Most of these developments will be greenfield projects and the first rail infrastructure in those countries.  How do you expect these new rail infrastructures to be built and operated? Will governments want full control over process and assets or will we see a strong involvement of private investors and operators as we have seen in other industry sectors in the region?

Joss Dare. Much of the region's new rail infrastructure will be traditionally procured.  Governments are attracted to the (perceived) benefits this brings: relative simplicity, control and speed of delivery.  However, not all Middle East economies have the wealth to fund this sort of infrastructure, upfront through the public purse.  Even those that do, such Abu Dhabi and KSA, are increasingly concerned with managing their wealth recourses as efficiently as possible and keeping budgets under greater control than was previously seen as necessary. 

It is likely therefore that, in an age of relative fiscal responsibility, the region's governments will sooner or later begin to turn to private finance for these projects.  Inevitably, the region will not be homogenous in this respect, however; some regional Governments are more PPP friendly than others.  Egypt, Jordan and Kuwait, for example, have made it plain that they see PPP as central to their procurement plans across a number of sectors, including rail.  In contrast, a number of KSA projects - such as Saudi Landbridge and Haramain High Speed Link - have been restructured so as not to involve private finance at all. 

Frank Beckers. I expect a combination of different solutions, depending on the nature, size and location of each rail system. The Middle East uses private sector solutions, Public Private Partnerships (PPP), and project finance structures more than other regions, in order to benefit from the long-term experience and specialised know-how of private companies in areas where the government has not been active. PPP structures also bring a certain discipline to financing, construction and operation since private contractors, operators, lenders and investors share the corresponding risks.

However, some rail developments will not be suitable for PPP/project finance. Either because the enormous funding requirements can only be raised at government level or because PPP financing may not provide the operational flexibility to successfully operate the rail system. Thus the operational, commercial and financial solutions available for each rail system need to be carefully analysed. In some cases it may make sense to use different solutions for different parts of a development; for example, while some parts may be eligible for private financing other parts will have to be financed by the government or through government-supported PPPs.

Dr. Said J. Al Qahtani. Railway infrastructure is a legacy that will survive for many years. Hence it must be built on a lowest Total Cost of Ownership (TCO) basis and harmonised with its operating environment. TCO considerations must override short-term CAPEX constraints as the railway track can survive up to 100 years, rolling stock up to 30 years, and signalling up to 30 years. Furthermore the design should harness the natural strengths of the rail mode.

Typically the rail infrastructure of the future should be standard gauge wide, capable of handling freight trains in excess of 200 wagons running up 140km/h, and interleave-able with passenger trains in excess of 250km/h.

In the MENA context the design should favour low maintenance ballast-less track in sandy conditions; be diesel powered as this energy source is regionally if not domestically sourced; most of the electronics should be on-board to minimise maintenance over long distances and to ensure dynamic densification of traffic using moving block signalling principles and greatly enhancing safety; the rail bogies axles should be self-steering to double if not quadruple the rail wheel life; and exploit all electronic means ranging from insulated gate bipolar transistor switchgear to traction control systems so as to maximise traction effort of locomotives.

Safe, scheduled railways with capacity reservation have the best chance of commercial success. Freight services are best operated in block loads with consolidation and road/rail bimodality for heavy palletised consumer packaged goods at selected hubs. Intercity passenger services should be run at sufficient high-speed to conclude the trip in 2 hours to avoid erosion by air travel alternatives.

Eventually all railway companies run out of capital as they aspire to satisfy country-scale transportation challenges with company sized balance sheets. Even vertically integrated state-owned enterprises (China, India) solicit PPP investment, normally starting with perimeter terminals and rolling stock. To ensure alignment of interests and equal exploitation of assets, these PPP's must encompass all the assets, not only new ones.

What are the biggest challenges you expect to face when implementing rail systems in the MENA region, and how can these be overcome?

FB. Most MENA countries have little or no rail infrastructure in place. Therefore, greenfield projects will have to be undertaken in markets with no experience in building and operating rail systems, no historic traffic numbers, and an inadequate regulatory environment.

The ability to design an entire rail system from scratch to suit current as well as future needs is a unique opportunity. But it also presents challenges as numerous developments (freight, passenger, light rail, metro, etc.) must be undertaken in parallel, which requires significant coordination regarding the interfaces between those systems and the country's other transport infrastructure.

To the extent governments want to maximise private financing, all risks will have to analysed be carefully and allocated between the various stakeholders. Private investors and lenders will probably be unwilling to bear the risk of future traffic volumes as those are difficult to forecast in the absence of historic traffic data. At the same time, the private sector is best qualified to manage the operations of a rail company and take the corresponding commercial and technical performance risk. Solutions such as performance-based availability payments are designed to reflect such a risk allocation.

SQ. Advisors brought up with an experiential engineering paradigm. They will at best result in uninteresting returns or a perpetuation of historical engineering challenges. Very few highly successful projects contained zero innovation risk at the time. Most of the success stories include engineering innovations that naysayers decried at the time. Smart capital chases smart ideas.

The promoters of new rail infrastructure must include some level of technical innovation risk to take unfair advantage of the near future of rail technologies. This well considered strategy creates a new genetic base for profitability not previously experienced and of significant value to catapult the rail business forward without re-investment for a long time.

Cultural and language diversity from traditional rail seniors and major suppliers can also present a challenge. In order to overcome this developers can create a regional R&D and Organizational Change Management capability to manage diversity; and architect the rail outcome dispassionately thus removing the post-colonial and neo-colonial political alliances from the vendor base.

In addition, the environment and logistics of the MENA region poses some of the most formidable environmental and logistical challenges for overland rail projects. Adapt the rail solution to cost effectively cope with sand, heat, and wind and set up many and smaller depots along the rail route to concurrently roll out new lines during construction. Install low maintenance rail solutions.

JD. Alongside market capacity constraints, there are two key legal/commercial issues facing the development of the MENA rail market. The first is transparency or deliverability; all bidders (in all sectors, not just rail) want to see a clear, efficient and transparent tender process under a legal system that clearly enables the project at hand.  In this respect, the springing up of central PPP authorities and PPP laws across the region (Jordan, Kuwait, Egypt etc) is a welcome development for the PPP market, but this remains critical for all infrastructure procurement in the region.  It is essential that the market can have confidence that the public sector authorities in question will deliver the projects they say they are going to deliver.

The second is the risk profile for the region's first PPP projects must be made attractive to the private sector.  If Governments seek to transfer unacceptable risks, bids will be few and far between and those that do come will be unnecessarily expensive.  There is often no meaningful historical data of demand for public transport services in the region and this makes volume risk even more unpalatable for the private sector than in other sectors (for example, airports and ports).  A failure to understand this and to structure around this risk will fatally wound many projects (witness Saudi Landbridge).  

Given the current financial climate, do you predict there will be problems finding investors for rail infrastructure projects? Where do you think funding is likely to come from and why?

SQ. Rail infrastructure projects are large-scale investments and very attractive for developmental states, especially in tough economic times. Private capital is less patient and will seek out near term annuity returns. The latter is evidenced by industry driven investments in newly discovered mineral deposits.

The funding paradigm of railways is largely aligned with the governance model of their host countries. Therefore private capital will seek out rail projects in market driven economies where the end-user of the rail service will accept the risk in take and pay type arrangements. Once the governance model indicates developmental objectives private capital steps down and governments are forced to underwrite or make the investment.

In heavy haul mine railings the mineral producers are always interested to invest in the railways as part of their production process and risk management strategy.

JD. Undoubtedly, MENA PF lending was seriously hit by the financial crisis, but the willingness to lend is slowly returning. However, enders are much more conservative than previously, desiring greater levels of equity commitment and better terms generally in order to commit. The dearth of syndication opportunities gives rise to bigger clubs of banks, which can in turn be harder to manage logistically. 

We expect that funding for future MENA rail projects will tap into multiple forms of finance: conventional debt increasingly sitting alongside Islamic and ECA tranches.  JBIC has long been a force in the region, but with the recent rise of Chinese and Korean construction firms, the influence of institutions like Korea Exim and China Exim is likely to grow.  Project bonds (presumably unwrapped) may also play more of a part in the larger projects going forward.

FB. Given the large number of rail and other infrastructure projects planned in the region and the correspondingly vast amounts of financing required, we will undoubtedly face challenges in obtaining funding. Even if governments decide to finance these developments themselves, a carefully defined strategy will be required to protect sovereign ratings and the cost of financing.

It is likely that governments in the Middle East will continue to involve the private sector and aim to maximise private financing. However, the required debt amounts will probably exceed the capacity of the bank loan market, which is the most widely used financing source in the region. Export Credit Agencies will be unable to fill the gap since rail projects are less equipment-based than, for example, refinery or power projects. If governments want to avoid shouldering this burden, upcoming infrastructure projects must be able to access the international bond market, which offers a far greater liquidity pool than the bank loan market. However a bond financing requires careful structuring in order to obtain the requisite credit ratings from international rating agencies. If this is considered from the beginning and the relevant expertise is brought to the table (such as involving financial advisors at an early stage), raising bond financing should neither delay a project nor increase its cost.

Similarly, will local and international contractors, rolling stock suppliers and operators have the capacity to design, build and operate all rail systems planned? Which challenges will contractors and procurement agencies be facing?

FB. I expect some constraints on this side. Not only may excess demand result in price increases and/or delays in construction, these constraints may already become apparent during the procurement process. Any competitive tender process, the aim of which is to obtain the best price and quality (whether for traditional procurement or PPP), requires a certain number of bidders to be meaningful, as well as substantial manpower from governments and bidders. The number of tender processes key players will be able to undertake will also depend on the likelihood of these processes being completed, as well as their duration.

JD. If half of what is currently planned comes to the market at anything like the same time, the market will reach capacity very quickly.  Governments should bear in mind that the market craves a steady and predictable deal pipeline.  The jurisdiction that best provides this - with bankable risk profiles and transparent tender processes - will attract the most market share in the global and regional competition for capital.

Also, the market's capacity is not static.  As more MENA projects are brought to market, regional expertise in the rail sector will grow quickly.  This could be exacerbated if predicted contractions in the European market come to pass, prompting the players in that market to increase their overseas focus still farther.

SQ. Generally speaking, the rail industry in developing economies has suffered from under investment for many years. The rail awakening in China, India, South America, the MENA and sub-Saharan Africa is rapidly stressing a supplier market scaled to business in North America, Europe and Australia. The new age railroads should push the technology envelope to gain the most advantage from an investment in the rail transport mode. This could lead to supplier constraints as conventional and experiential engineering struggles to mobile for innovations. Mitigation in the MENA region could include careful supplier management and competitive supplier development programs with strong local/regional development and content. Caveat emptor! - a multi-national full-import supplier base, who essentially act as agents and who leave no lasting legacies.

Joss Dare is managing partner, Ashurst Dubai and Head of Ashurst MENA Infrastructure and Transport team. With wide ranging experience of infrastructure transactions including landmark PFI/PPP projects Joss has advised public sector clients, sponsors, lenders and sub-contractors across the region and globally.

Frank Beckers, Managing Director and Global Co-Head of Deutsche Bank's Project & Capital Advisory (PCA) franchise, is based in Dubai and responsible for the PCA business in the Middle East, Africa and Asia. Before joining Deutsche Bank in 1998 he worked for five years at DEG (German Investment & Development Company). He holds a Masters in Economics from the University of Cologne, Germany, and a Masters in International Management from the Community of European Management Schools (CEMS).

Dr. Said J. Al Qahtani is Managing Director of Central Mining Company Investment Limited (CMCI), a holding company in Saudi Arabia. By his earnest endeavour, CMCI has successfully formed JV companies in the field of Mineral Processing, Mining Operation and Process Additives with Outotec Germany, Kier UK, Comedat Jordan, Arrmaz USA and Citadel Resources Australia. Dr. Said had recognized the need of Economical Ballast-less Rail Track System to the desert environment and established T-Track Saudi, a joint venture with Tubular Track of South Africa, to provide solution to the Track Challenges in Desert Sand Areas.