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TradeInvest (Nigeria)

Nigeria: Mending Project Finance

Nelly Nyagah
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ANALYSIS

28 September 2010
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Everyone agrees Nigeria is a market that no investor can afford to ignore, yet the federal government is facing a monumental task trying to attract adequate financing that is needed for critical projects particularly in infrastructure. TradeInvestNigeria looks at why most emerging markets investors are reluctant to put their money in Nigeria even though trends show there are considerable potential rewards for investing in the country. Urgent investments in a reliable energy source and infrastructure are the key to unlocking Nigeria's ambitious goal to be among the world's top-20 leading economies by 2020, and to cope with the ever-growing consumer base and unexploited natural resources. This provides profitable opportunities to investors. To meet this goal, Nigeria targets an additional 40 000Mw of electricity, which will require investments in power-generating capacity alone of at least US$3.5-billion per annum for the next 10 years. This is according to the recently launched 'Roadmap for Power Sector Reform'. The paper further states that corresponding large investments will also have to be made in the other parts of the supply chain (the fuel-to-power infrastructure and the power transmission and distribution networks). Launching the power strategy to business leaders and investors in Lagos in August, President Goodluck Jonathan confessed: 'A friend of mine jokingly asked me: Can Nigeria celebrate one day of continuous (uninterrupted) power supply? Then I answered: By God's grace by December 2012, Nigeria will not just celebrate one day, but one week, one month, and even better. It's actually with that vision and mission that we are here today to launch the Roadmap for Power Sector Reform.' This ambitious programme shall require financing. Many foreign investors have shown interest in investing, yet the Nigerian government continues to face an uphill task in trying to draw some of that financing. So why are financiers stuck at 'the mulling stage' despite the considerable potential benefits of investing in the country? 'Inasmuch as Nigeria is replete with investment opportunities, the investment environment needs to be more favourable for potential financiers. Problems associated with infrastructure, power, legal recourse, policy instability, management expertise and integrity all add a considerable risk premium to any potential financier's terms,' says Akinseye Akinola, an analyst with private equity firm Emerging Capital Partners (ECP), a firm that has raised more than $1.8-billion for investment in companies across Africa. There is still a certain level of regulatory and legislative uncertainty in many sectors of the economy. Even the oil and gas industry, which has been the main area of investment, is undergoing a period of uncertainty with the Petroleum Industry Bill in the process of being enacted, and the passage of the Local Content Act. All these issues, in addition to the fact that Nigeria is due to hold a general election next year, worry investors. Should there be change in the political leadership, would the new administration continue with the reforms initiated by the current leadership? The global financial crisis and the crisis in Nigeria's banking industry are also factors that have impacted on the country's undeveloped project finance market. 'One of the effects of the global financial meltdown has been that many financiers are taking a ''wait and see'' stance in relation to projects' financing. The meltdown in the banking and capital- market sectors of the economy has also contributed to the lack of confidence in the market,' says Lawrence Fubara, a managing partner at Nigeria-based law firm Aelex, which has considerable experience in project finance, banking and capital-markets transactions. Periodic sovereign ratings issued by the credit rating agencies are another major influence on the mind of investors. Nigeria was rated a BB- by Fitch and a B+ by Standard and Poor's in April this year. The agencies assess how likely a borrower is able to repay debt and are a reference for investors conducting due diligence on potential projects especially in high risk markets. 'The BB- and B+ ratings fall into the lowest category of sovereign debt ratings and gives Nigeria a ''speculative'' investment grade,' says Fubara. Un-bankable projects Financiers who attended a conference on the continent's power sector in March said red tape and lack of well-structured projects, rather than external funding crimped by the global downturn, are the main hurdles to boosting capacity in Africa's power sector. Like in Nigeria, most of sub-Saharan Africa is battling acute power shortages as governments fail to attract the necessary investment to upgrade grids and build new infrastructure, despite the huge resources of coal, uranium, hydro and other renewable energy sources, which if exploited could see to sustained growth. According to David Donaldson, senior manager for infrastructure at the International Finance Corporation (IFC), the problem isn't and has never been finance. 'If you have a decent, bankable project in the power sector you will be able to get the finance.'

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allAfrica.com: Nigeria: Mending Project Finance

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IFC, the World Bank's private sector lending arm, has committed financing to more than 70 projects in Nigeria, amounting to $3-billion from 1964 up until June 2010. Nigeria is the lender's second-largest portfolio in Africa, after South Africa, and its strategy there is to increase investments and advisory services to promote the real sectors of the economy, with a focus on infrastructure, finance and agribusiness. The World Bank's view that the principal problem when it comes to attracting adequate financing for infrastructure and power projects in Africa is the lack of bankable projects with a world-class regulatory and financial framework, rings true for Nigeria. 'Generally, the bankability of projects is negatively affected by the ''speculative'' investment environment of Nigeria. In particular, the failure of project proponents to demonstrate the requisite expertise and experience to execute the projects and the inability to demonstrate efficient risk -mitigation strategies in the event that any problems arise in the course of executing the project, are all factors that slow down the flow of project finance into the country,' says Fubara. 'One must also consider the weakness of Nigerian banks as a contributing factor to the shortage of bankable projects. The process of developing these kind of projects can be very complex, and the skills required to develop such projects remain in short supply,' concurs Julian Jackson, a co-founder of Africa Legal, the specialised legal division of South African law firm Deneys Reitz. Africa Legal provides an extensive range of legal services to investors in Africa. Nigeria received $11-billion in foreign direct investment in 2009. However, most of it was to the oil, gas and telecommunications sectors, which collectively contribute only a fifth of Nigeria's growth domestic product (GDP). 'Capital is dynamic and will flow to where the best risk-adjusted regional opportunities are. If the environment is not favourable, no matter the potential, capital will not be allocated there. Investors want to be sure that contracts will be honoured, regulations will not be ignored, and policies will not be routinely reversed. The issue of bankability of projects I believe is less with the operational performance of the companies, but more so the operating environment within which they operate,' adds Akinola. Current trends The prevalent trends in the project financing market appear to be financing select deals, with equity capital involved, with various guarantees and off-take revenues mitigating the market risks. Although last year's intervention for the banking sector by the Central Bank of Nigeria (CBN) made Nigerian banks quite risk-adverse, they are beginning to look at new deals, especially where proper risk mitigation can be implemented. 'For equity investors, there are a number of good companies trading at distressed or undervalued prices, but I think the key would be to find opportunities with the right management and market-driven sponsors. Also, there is a measure of caution on the investors' side as they wait for the new reformist policies to take effect, and seek clarity on what the political landscape will be like in the coming year,' says Akinola. The trend in the past has been to lend to 'quick win' sectors such as telecommunications and the downstream oil sector because of the shorter gestation period and potential for quick high yields. A typical power plant or road concession project would on the other hand require a longer period to mature. Another reason telecommunications has attracted financing is because of the deliberate effort to liberalise the sector. The result has been a competitive, efficient and lucrative investing space. Says Fubara: 'The lessons of the market meltdown and the not-too-pleasant experience of the financial institutions have contributed to reverse the trend of lending to the "quick win" sectors in Nigeria. For example, Nigerian banks were reported to have suffered great losses from the meltdown with about N6-billion trapped in margin loans and investments in the downstream oil sector.' According to Aelex, Nigeria is beginning to witness significant activity in sectors such as power and infrastructure. Investors generally appear to be waiting to see a clearer regulatory landscape, and local investors are also waiting to see a stable banking sector, which will be more willing to finance projects. 'The bond issue market is also witnessing increased activity with most state governments resorting to this financial instrument to fund their capital infrastructural projects. According to statistics released by the Nigeria Stock Exchange (NSE), about N108-billion has been raised by the states in the last few years,' adds Fubara. Extending measures that have transformed the telecommunications sector to other sectors of the economy will attract potential financiers to competent players. There are signs the federal government wants to move in this direction going by the recent developments in the power sector. The Roadmap for Power Sector Reform is expected to among other things drive the liberalisation and privatisation of state-run distribution companies, concessioning of the transmission grid and creation of a new grid, establishment of a credit-worthy off-taker, adjustment of the pricing regime to accommodate producer costs and guarantee fiscal incentives to Independent Power Producers (IPPs). The existing low tariffs and enforcing Power Purchase Agreements (PPAs) are thorny issues for investors because they undermine appropriate return on investment, including the cost of the necessary maintenance. 'The fundamental issue remains that if, at the end of the chain, users are paying less for electricity than it can conceivably cost to deliver to them, then that's a problem that can't go away,' says Donaldson. CBN governor Lamido Sanusi is among the vocal advocates calling for a hike in the price of electricity to N22 from the current N7 per kilowatt hour, saying the current pricing is unrealistic and discourages investment. 'If you don't have electricity you cannot attract investors and you cannot improve production. We don't have power because the reforms that ought to have been carried out in four years have not been done. We keep talking and talking and we have not yet created the right environment... The reality is that government is not pursuing the right economic policies and nothing in the banking reform will fix the economy unless you fix policy, and I say this as an adviser to the government,' said Sanusi.

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The power sector has been without a regulator for two years following the suspension of the Nigerian Electricity Regulatory Agency (NERC). 'The absence of a properly constituted regulator is a real problem. The board of the NERC is in the process of being re-constituted and once this process has been completed, it may help eliminate one major source of uncertainty,' says Jackson. While development institutions have their role to play in Nigeria's infrastructure development landscape, they cannot fill the funding gap and in any case such finance does not bring with it the financial discipline to project implementers that private sector capital does. Private investment also ensures complete projects are maintained. Private sector participation The federal government has been very welcoming to the private sector with the aim of building a strong relationship that can anchor the development of among other drivers, a solid public - private partnership (PPP) market. The opportunities for PPPs are enormous and span every sector of the Nigerian economy. The states have employed private finance initiatives in infrastructure development even more than the federal government. 'The Nigerian PPP market could be very attractive and what matters right now is that projects are made attractive to international investors, lenders and construction companies. These international PPP players should be encouraged to regard Nigerian projects as being relatively more attractive than other projects elsewhere in the world,' says Anthony Sykes, a director at the International Project Finance Association (IPFA), in an interview with Nigeria-based Vanguard newspaper. IPFA promotes and represents the interests of private-sector companies involved in project finance and PPPs throughout the world. 'Nigeria faces a big challenge to compete with the rest of the world, to attract the attention of investors, sponsors and lenders and that's where the IPFA is trying to help. We are able to help Nigeria to make its projects more bankable, more suitable and attractive to international investors,' says Sykes.
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