Changing Hands: Large portfolio of brownfield assets available for PPPs

Large portfolio of brownfield assets available for PPPs

While public-private partnerships (PPPs) are certainly needed to leverage operational and cost efficiencies, the view that the private sector is better positioned to work with brownfield assets is gradually gaining acceptance. There has been an increasing trend towards using PPPs to renew/

refurbish existing infrastructure. The risk appetite of private players is appropriate for handling projects where additional investments can yield greater returns and efficiencies. In contrast, creation of greenfield infrastructure, which entails high early-stage risks, is a job that would be better handled by the government.

In recent times, the government has made attempts to monetise its brownfield infrastructure assets to raise funds for the development of greenfield infrastructure. Monetisation of revenue generating road assets under the toll-operate-transfer (TOT) model and the proposed privatisation of six operational airports are a few cases in point. While there are only a few instances of greenfield PPPs in infrastructure, there is a huge potential for brownfield PPPs. That said, for brownfield PPPs to be successful, there has to be a provision for renegotiation of contracts.

A panel discussion was hosted at the India Infrastructure Forum 2019 to assess the potential of brownfield PPPs, discuss the experience so far and the lessons learnt, identify sectors that hold promise, and highlight the pros and cons of brownfield versus greenfield PPPs…

Mixed experience so far

In the case of the port sector, experience with brownfield projects involving the expansion of existing ports was mixed. One of the reasons for the failures was inadequate due diligence before the project started. In contrast, the road sector is a great brownfield success story in the country. Most of the network comprises brownfield roads involving four-lane/six-lane highways. Very few greenfield PPP road projects such as the Yamuna Expressway and the Mumbai-Pune Expressway have come up.

Public sector undertakings have a huge portfolio of infrastructure assets that can be profitably given out on a brownfield PPP basis. For instance, NTPC Limited owns a number of thermal power plants and Power Grid Corporation of India Limited (Powergrid) sets up transmission lines. These can be bid out to private players for operation and maintenance (O&M). However, enough time must be given to private players for bidding. The Delhi electricity privatisation model, a successful example of a PPP, can also be adopted. Apart from thermal power plants and transmission lines, hydel plants and railway godowns can also be given out as brownfield PPPs. Further, oil and gas pipelines, tank farms of oil marketing companies (OMCs) and overhead transmission lines of railways can also be monetised. If OMCs want to protect their stake, they can retain 26 per cent and monetise the remaining 74 per cent to deleverage their balance sheets and undertake capital expenditure for modernisation projects. In fact, the best assets should be monetised to attract investors, who expect an internal rate of return of no more than 13 per cent. These are very sound monetisation opportunities.

In the railway sector, the station redevelopment programme has a component of real estate development. But the real estate sector should be kept out of infrastructure because the dynamics of real estate are quite different from those of infrastructure assets. For any basic PPP to work, the infrastructure asset must have a correlation with GDP. This is fundamental to attracting long-term foreign capital into the sector. There are a number of suggestions for the improvement of the railway sector. First, since Indian Railways (IR) is a monolithic organisation, it needs to be split to solve most of the problems. Second, there is a need for an independent regulator to streamline the tariff structure. Tariffs are low for passengers but enormously high for cargo. This cross subsidisation actually affects freight traffic and makes freight tariffs uncompetitive. Third, slots for cargo trains should be allotted on every route. This will ensure a proper price discovery mechanism. Fourth, it needs to be ensured that IR is not involved in anything except infrastructure creation. This implies that aspects such as track laying, station construction and setting up of signalling systems must be the responsibility of IR, while operations must be left to the private sector.

Key challenges

Brownfield PPPs encounter a unique set of challenges. In developed economies such as the UK, Singapore and Europe, the basic risk in a brownfield project is whether the estimation of an increase in the revenue is accurate. However, in India, the fundamental risk of a completed asset is contract enforcement. Another problem with brownfield PPPs is that even when there is a sound proof of concept (as in the case of the TOT model), there is unnecessary intervention by parties that have vested interests.

Large foreign investors such as pension funds have a much lower cost of capital vis-à-vis Indian corporates. Global investors want a long-term duration for contracts so that there is adequate time to generate stable cash flows. However, corporates want quicker returns in 10-15 years resulting in a very high cost of capital. In fact, domestic developers and global pension funds cannot be weighed on the same scale. Further, from a lender’s point of view, change in the ownership of an asset/company due to a default comes with many hurdles, as the lender is responsible for seeking permissions from various authorities for transfer of assets.

The way forward

An important aspect to be considered is whether the public sector should be allowed to bid for projects that are trying to attract private capital. At present, state-owned entities such as the Airports Authority of India (AAI), Powergrid and the Jawaharlal Nehru Port Trust are allowed to bid for such projects. This is in contrast to the definition of a PPP project which requires funds from sources other than the government. Another issue is conflict of interest. For example, Powergrid lays out the vision for transmission infrastructure for the Ministry of Power. At the same time, if it is allowed to bid for transmission projects, it essentially becomes a case of insider information. Similarly, AAI is responsible for the oversight of private as well as its own airports. However, AAI bidding for an airport leads to a potential conflict of interest due to multiplicity of roles. Another instance of conflict of interest is regarding the role of the National Highways Authority of India (NHAI). The authority prepares the detailed project reports (DPRs) and awards bids for projects. However, in case of a termination of contract, it also performs the role of an adjudicator due to the absence of an independent regulator. So, NHAI’s role in ensuring that the banks and investors get fair compensation comes into question if, say, something goes wrong with the DPR. Therefore, an independent authority must be put in place to administer the contract and act as an adjudicator in case of conflict. Meanwhile, besides raising money, the fundamental factor to consider in case of asset monetisation is increasing the efficiency of the asset. Therefore, only companies with cost efficient business models should win the bid.

For instance, the Delhi Metro Rail Corporation should consider monetising the earlier phases when it is working on a new phase. In case of such brownfield assets, the construction and traffic risk is minimised, and private players can enter the O&M space.

For an investor, the rate of return from a brownfield asset will be lower due to fewer risks involved while the government, having taken the initial risk, will expect to get a higher return out of the investment made. This could lead to a mismatch regarding the expected returns.

For the future, the All India Institute of Medical Sciences is a good brownfield asset that can be given out on a PPP basis and this will result in an increase in efficiency. Garbage handling and waste management systems can also be considered for monetisation to reduce the levels of pollution and improve quality of life. Net, net, in order to create a market for brownfield PPPs, the most crucial step is changing the mindset of all stakeholders. Once an asset is monetised, the proceeds should be ring-fenced to develop new infrastructure projects.