Australian Infrastructure: A guide for investors

In recent years, there has been a renewed focus by federal, state and territory governments on developing infrastructure across Australia. This growing demand is driven by a number of factors, including: (i) Australia has an existing infrastructure deficit estimated at AU$770bn; (ii) Australia is facing sustained population growth driven partly by immigration, particularly in the major cities; and (iii) there has been rapid growth in freight and passenger transport demand and this is expected to continue.

Investment in Australian infrastructure is supported by a favourable (although complex) regulatory environment. It is a relatively mature market, which had its beginnings in the privatisation wave of the 1990s. This contributes to a lower level of risk, obviously an important factor for overseas investors desiring stable cash flows.

Types of assets

Social infrastructure PPPs

Australia has one of the most advanced social infrastructure Public Private Partnership (PPP) regimes in the world, making it an attractive opportunity for foreign companies [1]. Social infrastructure PPPs have been used in Australia to develop facilities such as hospitals, prisons and schools. Generally, investors do not bear any demand risk and returns to the private developer are through availability payments.

Rail

There are a number of forthcoming opportunities in the Australian rail market, driven by two factors:

• the need for the mining sector to find routes from “pit to port” for new and developing mines; and plans for the construction of new
• plans for the construction of new passenger railway infrastructure, acquisition of new rolling stock and the restructuring of existing passenger networks driven largely by patronage growth, increased urbanisation and the need to modernise the network.

Overall, the priority of the federal government appears to be developing freight rail before funding the development of urban rail projects:

• Western Australia: this state has a number of independent railway networks which serve major population, industry, agricultural and mining centres. The Pilbara region in the north- west is dominated by substantial iron ore mines which require heavy haul railway networks to transport iron ore to port for export.The rail industry has become highly regulated, particularly in the area of third party access. Western Australia has been driven to try and ensure rail infrastructure is not wholly controlled by the track owners at the expense of rail operators and their customers.
• Queensland: the coal freight network is operated privately by Aurizon, while the passenger networks and the remainder of the freight network are owned by state-owned Queensland Rail. In 2014, the Queensland Government finalised the “New Generation Rolling Stock” project, a AU$4.4bn PPP for the provision of 75 new six-car trains with a 30-year ongoing maintenance contract. It is expected that Queensland Rail will restructure to franchise the network to take advantage of private sector innovation. Queensland also presents significant opportunities in “pit to port” mining infrastructure.
• New South Wales: much of the rail infrastructure in New South Wales is owned and operated by entities owned by the state government. The main opportunities and changes are likely to be around passenger railways rather than mining railways. Two of the largest PPPs in New South Wales are the North West Rail PPP and the Sydney Light Rail PPP, which were both finalised in 2014.
• Victoria: Victoria has seen the most private sector involvement in the operation, maintenance and development of the passenger rail network. For instance, the train network is currently operated by a consortium led by Hong Kong’s MTR Corporation. New projects for passenger rail lines have recently been announced.

The conclusions which can be drawn are that:

• there are major investment opportunities both in passenger and freight railways;
• in many of the rail sectors, there is a relatively thin market when compared with overseas markets; and
• while the projects are politically, commercially, technically and legally complex, given the desire by all governments for implementation, many of them will be delivered.

Roads

Although the past decade has seen significant investment in the Australian road system, population forecasts and the rising number of cars per household indicate that significant new investment in roads will be needed in the coming years, particularly in high urban growth areas.

Historically, governments have been reluctant to strain their balance sheets with the high levels of debt required to fund significant road assets, and have therefore made use of private financing. In Australia, sourcing revenue through user-pay tolls has been a common funding model, with the private sector taking patronage risk based on traffic forecasts.

However, this funding model, as applied in a number of high-profile projects (such as the Lane Cove Tunnel and the Cross City Tunnel in Sydney, and Airport Link and the Clem Jones Tunnel in Brisbane), has led to financial difficulty for the private operator as a result of the actual road traffic being significantly below forecast levels, on account of an over-allocation of traffic revenue risk to the private developer. Against this backdrop, governments are recognising the need for alternative funding models to be considered, including:

• government contributions;
• shadow tolling (where a toll is paid by the Government);
• payment by government of ongoing availability payments (as used by the Victorian Government in the Peninsula Link road PPP); and
• funding the initial stage of the investment and seeking private sector involvement after traffic usage levels are established (as is being considered by the New South Wales Government in the proposed WestConnex motorway PPPs).

The main types of roads-related transactions include:

• PPP road concessions;
• operation, maintenance and expansion of existing toll roads (including refinancing opportunities);
• large-scale upgrades of non-PPP roads (such as the Pacific Highway upgrade); and
• electronic tolling and associated infrastructure issues.

Ports

Port-related infrastructure projects currently present attractive opportunities to international infrastructure investors. Reflecting the importance of ports in the Australian economy, activity in this sector has been buoyant in recent years. The main types of port-related transactions include:

• privatisations of government interests in ports;
• expansions of existing ports (including new terminals); and
• private-to-private sales of interests in existing ports.

The demand for new infrastructure, coupled with a perceived need by state governments to maintain or regain high credit ratings, has placed pressure on governments to privatise some ports in order to fund vital new projects. Recent port sales in Brisbane, Newcastle and Sydney have been met enthusiastically by the market, with state governments generating serious interest from offshore investors looking to diversify by investing in the Australian economy. Victoria, Western Australia and Queensland have announced plans to privatise other port assets, although these ports predominantly service bulk commodity producers.

Resources-driven activity in Australia is helping to fuel a number of port development projects and there are a number of projects at the planning stage for both bulk commodity and container terminal expansions.

In addition to resources-driven port development, growth in freight to, from, and within Australia’s capital cities is placing increased pressure on existing container handling facilities, forcing a number of state governments to look at new projects. By 2030, the number of container movements through Australia’s ports is expected to be two and a half times that of 2007 [2].

Airports

Australia’s network of airports forms an integral part of the national economic infrastructure. They are largely monopolistic businesses. The Australian Government has identified investment in airports as a key objective. Meeting demand will require significant investment, particularly to upgrade local gateway airports. Almost AU$9bn worth of necessary upgrades and improvements is in the pipeline over the next decade to cope with the predicted increase in airport traffic [3]. In particular, planning has accelerated for a second airport for Sydney at Badgerys Creek to the west of the city.

Between 1997 and 2002, 22 of Australia’s major airports were privatised under 99-year lease arrangements with the federal government. These leases have given control of all airport developments to the private operator and are regulated under the Airport Act 1996.

Water

Involvement in the water sector has been more limited than in other sectors. Despite this, several state governments have procured desalination plants to remove

salt from sea water in order to supplement traditional water supply systems for large urban areas. Desalination plants have been built in Queensland, New South Wales, Victoria, South Australia and Western Australia, with foreign companies involved in these projects.

Private infrastructure for the resources industry

Supporting infrastructure is a critical component of any resource venture. Given the remote locations of some resource projects, this infrastructure is often provided as part of an integrated self-contained development. Any subsequent transfer

of the interests in these projects would include the associated infrastructure. Where infrastructure is developed by a particular resource project, there are legal obligations to allow access to neighbouring resource projects (see “Access regimes” below).

In less remote locations (e.g. Queensland), government-owned and privately owned roads, railways and ports support the resources industry. However, the existing infrastructure is inadequate to accommodate future growth.

Project pipeline

Although it is now more than a year since the Liberal/National Coalition Government was elected, there is still some uncertainty as to how it will prioritise different infrastructure needs. The Government has announced some of its infrastructure priorities and construction timetables and these will be developed in conjunction with state and territory governments. The federal government has also announced an AU$5bn asset recycling initiative to incentivise state governments to sell assets and invest proceeds in new infrastructure.

PPP Model

According to Business Monitor International, “a key factor underpinning [Australia’s] attractive operating market is the strong platform it provides for Public Private Partnerships (PPP). Australia has one of the world’s most mature PPP markets and, over the past two decades, has pioneered the delivery of complex PPP projects, developing a model that other countries, notably Canada, have sought to emulate” [4].

Continuing commitment to the delivery of infrastructure through PPPs is evidenced by work at both the federal level and the state and territory level to streamline the PPP pipeline, and to refine the PPP model so as to maximise its application in a changing economic landscape. Today, the Government’s appetite for PPP remains strong, despite a difficult period in 2008–10 as a result of the global financial crisis. Infrastructure is still a fundamentally attractive asset class from the perspective of the private sector, as it provides a secure investment through a long-term contract with government and, often, a government- backed revenue scheme.

The PPP model has been used to successfully deliver infrastructure across a very broad range of sectors. While the market is currently dominated by large transport (particularly urban road and rail) projects, rolling stock solutions, custodial facilities, schools, hospitals, car parks, court facilities, defence and educational accommodation, convention centres, sports stadiums, social housing, desalination plants and other economic infrastructure have all been delivered on a PPP basis in Australia.

The challenges for Australian PPP

Australia has very large and diverse infrastructure needs but a relatively small pool of contractors able to undertake projects on a PPP basis. This has led to an increased need to attract new contractors into the market, in order to add to market capacity and also to ensure that Australia benefits from global best practice in this area.

New participants face various challenges in entering the Australian PPP market, including:

• perceived lack of certainty over project pipeline;
• a costly bidding process; and
• complex tax-driven investment structures.

Australian governments have been working hard to alleviate these issues in order to attract further players into the market (for example, it has recently become more common for governments to agree to reimburse some bid costs to losing bidders, and governments are conscious of the need to reduce bid timetables and to work with smaller lists of competing bidders).

Australia’s infrastructure needs often involve projects with a very large capital cost. The trend is towards an increasing number of “mega projects”, such as urban tunnel construction, resulting in projects with capital values in excess of AU$5bn. This, coupled with probity and process rules which often mitigate against funding sources being available to multiple bidders for PPP projects, creates financing capacity issues which need to be carefully managed by reference to the timing of bringing PPP projects to market.

An emerging feature of PPPs in Australia is for governments to contribute to the financing of the project. This is most prevalent where the capital costs involved are very high, where there are concerns about financing capacity issues, or when it is considered that government contributions will result in a better value- for-money outcome.

A series of high-profile PPP project failures (particularly in the toll road sector) have made it very difficult to finance projects featuring patronage risk. The market is currently dominated by PPP projects backed by stable government cash flows.

In the aftermath of the global financial crisis, debt financing in Australia is only available for relatively short tenors leading to heightened refinancing risks. The Australian governments are responding to this by drawing on international lessons to introduce structures designed to alleviate this risk.

PPP Guidelines – national framework

Since November 2008, all state and territory government agencies have been influenced by the National Private Partnerships Policy and Guidelines (January 2010) published by Infrastructure Australia (the National PPP Guidelines). The National PPP Guidelines are the agreed policy framework for PPP procurement and apply to most federal, state and territory government departments and agencies. They apply to projects where there is private sector investment or financing and where the private sector is involved in providing public infrastructure (including economic and social infrastructure) or non-core services.

The key objectives of the National PPP Guidelines include: value for money; ensuring projects are delivered in the public interest; optimal risk allocation; output performance specifications and probity; and transparency and accountability of governments. However, the guidelines acknowledge that individual projects will need to address project-specific issues on certain mechanical and risk allocation matters and that individual states may, in some circumstances, wish to approach commercial matters associated with PPPs in different ways. Consequently, the National PPP Guidelines need to be considered in conjunction with policies adopted by individual state governments.

• Victoria: procurement of public infrastructure in Victoria is subject to the policies of Partnerships Victoria, the state body set up to facilitate the procurement of infrastructure in Victoria. The Victorian Government released comprehensive guidance material entitled “Partnerships Victoria Requirements” in May 2013 which, together with the National PPP Guidelines, will apply to the next phase of Victoria PPP projects.
• New South Wales: in New South Wales, the procurement of infrastructure and associated services through PPP by any NSW government agency, including state- owned corporations, needs to comply with the National PPP Guidelines and NSW specific requirements, as set out in the “NSW Public Private Partnerships Guidelines”, published in 2012. NSW has recently established a state body, Infrastructure NSW, to facilitate the procurement of infrastructure and to develop a cohesive long-term strategy for infrastructure in NSW.
• Queensland: in July 2002, Queensland Treasury and Trade established a body, Projects Queensland, to enhance the Queensland Government’s infrastructure delivery capability. Projects Queensland is responsible for the implementation of the Queensland Government’s “Public Private Partnership Policy” (July 2011), which sets out the overall principles governing the Queensland Government’s approach to PPPs in conjunction with the National PPP Guidelines.
• Other states and territories: South Australia, Western Australia and the Northern Territory have each adopted the National PPP Guidelines as their primary PPP policy framework, with various jurisdictional departures. In Tasmania, all PPPs are still run primarily through the Shareholder Policy and Markets Branch of the Department of Treasury and Finance.

Further legal issues to consider

Tax

Infrastructure investment in Australia is affected to a large degree by considerations of Australian tax law. In fact, for some PPPs, generating a tax-efficient outcome is the main driver of the corporate structure of the investment vehicle. Given the complexity of Australian tax law, issues relating to tax and stamp duty throughout the life of the project need to be carefully considered before commencing the project or investment.

Particular issues for investors to note include:

• Investment and development stages: landholder duty (a form of stamp duty) applies to the transfer of “fixtures” to the land which generally include all infrastructure assets, although exemptions may apply depending on the particular rules of the state or territory in which the asset is situated. Normally, payments from a “debt interest” under Australian income tax law are deductible against Australian income and are subject to a lower withholding tax rate than an “equity interest”. However, the thin capitalisation rules limit the tax deductions which may be claimed by non-resident investors – this is important as projects may be highly geared in this initial stage. There may be a need to separate structurally the ownership from the operation of infrastructure assets to retain the “pass-through” benefit of certain trusts (i.e. where the beneficiary of the trust is taxed, rather than the trustee).
• Operation: withholding taxes apply to certain types of income generated by Australian tax non-residents, including a five per cent withholding tax for construction or activities related to construction. The withholding tax rates may be reduced through the application of double taxation treaties. Where an infrastructure project is part of an energy or resources project, investors should also consider the application of petroleum resource rent tax and royalties imposed by state and territory governments on the extraction of minerals.
• Disposal: any gain by a non-resident when disposing of an investment is subject to capital gains tax in Australia if the investment is “Taxable Australian Property”, determined in accordance with the relevant tax legislation.

Access regimes

In Australia, many publicly and privately owned infrastructure facilities are subject to access regulation. There are both Commonwealth and state statutory access regimes, as well as frameworks for infrastructure owners to submit voluntary access undertakings. Access regulation is particularly common for railways and ports.

Access regulation can have very significant consequences. A company investing in affected infrastructure should consider the potential for third parties to utilise an access regime to gain access to the infrastructure. Providing access to third parties under an access regime may significantly affect the commercial returns to a facility owner, as well as limiting the owner’s operational control and flexibility in its use of the infrastructure. Third party access may also impose regulatory and compliance costs, including involvement in expensive disputes. Conversely, an investor interested in using another company’s infrastructure facility may have the option of negotiating access under an existing access regime, or applying to have the infrastructure facility subjected to an access regime.

Part IIIA of the Competition and Consumer Act 2010 (CCA) establishes a national regime for access regulation which can be applied to nationally significant infrastructure. Under the CCA, an infrastructure owner may seek approval from the Australian Competition and Consumer Commission for an access undertaking which is offered on a voluntary basis by the infrastructure owner. This access undertaking is intended to provide a framework for negotiation of the terms and conditions upon which the owner will provide access to third parties.

Other legal issues

There are a number of other legal issues of which participants in the infrastructure sector should be particularly aware, including the foreign investment approval regime, labour relations, environmental law, and the powers and authorisations of the Crown.

To view this article in the full February 2015 Infraread, please click here.