For the next five years, Nigeria is reported to require US$166 billion to provide energy and infrastructure for its growing population. Demand for energy and infrastructure in Nigeria, Africa’s largest economy, is ever increasing as its population grows. Consequently, so has the demand for viable financing solutions to support investment in such infrastructure projects, which according to the African Development Bank has an infrastructure deficit of US$300 billion. In fact, overall infrastructure spending (and in turn demand for financing) in Nigeria is expected to grow from US$23 billion in 2013 to US$77 billion in 2025.
Where will this financing come from? Nigeria has recently attracted Chinese financial and technical support for its ambitious infrastructure plans. This article will look at the role and significance of Chinese investment and key trends relating to how Chinese infrastructure financing transactions are typically structured.
Nigeria’s infrastructure challenges have become protracted due to a number of reasons, which include:
- dwindling oil revenues, which makes up around two third of the country’s revenue due to the fall in global oil prices;
- instability in Nigeria’s oil producing Delta region, due to a series of attacks on oil pipelines in southern Nigeria by militants causing crude output to hit the lowest levels in decades;
- US dollar scarcity; and
- currency exchange risk volatility. According to the Nigerian Bureau of Statistics, these macroeconomic challenges have obstructed infrastructure investment in Nigeria and contributed to Nigeria’s gross domestic product ("GDP") growth rate contracting 13.7% in the first quarter of this year to a 25 year low. Nigeria’s GDP growth is forecasted to be 3.8% in 2016, as investments will seek to somewhat rebound an economy, which has grown around 7% per annum for the past decade.
In light of the challenges, President Muhammadu Buhari’s government intends to address the infrastructure funding gap and support businesses which now need competitive, cheaper and longer term financing to fund infrastructure and other related projects in Nigeria.
China and Nigeria loan commitments
One of the mechanisms to address the infrastructure funding gap has been a US$6 billion loan commitment from China to fund infrastructure projects in Nigeria. It is understood that the Nigerian government can access this credit facility by identifying and putting forward the relevant projects to the Chinese presumably through a series of tranches in respect of each identified project.
The loan commitment coincided with a currency swap deal agreement between the Industrial and Commercial Bank of China Ltd ("ICBC"), which is China and the world’s largest bank, and the Central Bank of Nigeria (“CBN”). The swap deal should facilitate the settlement of Nigeria-China trade by removing the dollar from transactions and trading instead in yuan, whilst in tandem boosting imports from China, whose exports represent some 80 per cent of the total bilateral trade volume. It is anticipated that this in turn should reduce the demand for dollars on the CBN.
The swap deal also fits neatly in CBN’s plans to diversify its foreign exchange reserves away from the dollar by switching a stockpile into yuan. This may accelerate plans by the Nigerian government to issue its first ‘Panda Bond’ (renmibi-denominated bonds sold by overseas entities in mainland China), to plug the current record budget deficit currently standing at approximately US$11.1 billion and assist to improve the value of the naira, which has weakened against other currencies and choked off growth in the economy.
The entry into these two agreements also coincided with the signing of several memoranda of understanding (“MoUs”) and/or definitive agreements for several infrastructure development projects, which reportedly include:
- North South Power Company Limited and Sinohydro Corporation Limited (“SCL”) signing an agreement valued at US$478 million dollars for the construction of a 300MW solar power in Niger State;
- Granite and Marble Nigeria Limited and Shanghai Shibang signing an agreement valued at US$55 million for the construction and equipping of a granite mining plant;
- Infrastructure Bank of Nigeria and SCL signing an agreement for the construction of a greenfield expressway for Abuja-Ibadan-Lagos valued at US$1 billion;
- the signing of a US$2.5 billion agreement for the development of the Lagos Metro Rail Transit Red Line project in Lagos State;
- and the signing of a US$1 billion facility for the establishment of a hi-tech industrial park in Ogun-Guangdong Free Trade Zone in Ogun State.
More recently, the Nigerian National Petroleum Corporation (“NNPC”) arranged an investor roadshow in China with the objective to bridge the funding gap in the country’s oil and gas infrastructure sector, including pipelines, refineries, power facilities and upstream projects. MoUs between NNPC and several Chinese counterparties were signed worth approximately US$80 billion.
Experience of Chinese infrastructure financing transactions
In light of the above, the financing structures for the funding of these projects by Chinese counterparties may not vary too much from western project financings. However, from our extensive experience of advising sponsors, borrowers and lenders on a significant number of China outbound infrastructure financing transactions there are certain dynamics one can expect to encounter.
Historically, Chinese infrastructure financing in Africa was often structured as commodity linked and government to government (“G2G”) transactions. In this instance, the Chinese lenders would extend a loan to the government or the Ministry of Finance (“MoF”) in respect of an infrastructure project to be constructed by a Chinese contractor in exchange for access to a commodity (in the case of Nigeria, crude oil). This G2G loan is then secured by a sovereign guarantee provided by MoF and security is taken over the commodity offtake arrangements.
Whilst in some cases this model may still prevail, going forward, we are also seeing a shift in the funding dynamics from China. Chinese counterparties are in some cases moving away from G2G transactions (not in its entirety) and are willing to engage with private sector sponsors on a business to business (“B2B”) basis. As such, Chinese counterparties (mostly state owned enterprises) with an appetite to operate in Nigeria or lend to Nigerian projects are doing so on an arm’s length basis and paying particular attention to project specific risks and project bankability issues.
The mechanism used to document the obligation of a contractor to construct the infrastructure project is the turnkey contract, which is typically in the form of an Engineering, Procurement and Construction (EPC) contract. Chinese EPC contractors have emerged as serious, technically competent and economically competitive players in the global infrastructure space. What makes Chinese EPC contractors even more competitive now for Nigeria is their ability to procure project financing from their relationship banks (like ICBC), export credit agencies (like China Exim Bank) and development finance institutions (like China Development Bank and China- Africa Development Fund) all supporting the export of the EPC contractor’s services (and any Chinese manufactured equipment). These participants are particularly active on China outbound transactions into Nigeria. In addition, we expect to see the Asian Infrastructure Investment Bank (an international development financial institution that aims to support the building of infrastructure in Asia) feature more on these infrastructure financings after recently confirming that it intends to expand its lending activities beyond Asia and into Africa.
Features of Chinese outbound loan agreements can (but not necessarily always) include relatively longer tenures and at times cheaper margins compared to domestic bank lenders, though much depends on the individual facts, such as the nature of the projects and the domestic risk profile.
In the case of the NNPC related financings, we would expect to see a guarantee from MoF in addition to security over a long term crude offtake arrangement with NNPC. In the case of pure infrastructure financings on a B2B project, we have seen Chinese lenders focus less on the points relating to micro-project risks during the diligence process. This is perhaps because finance from Chinese lenders is typically given on the basis that there are enforceable guarantees (often bank guarantees) in place from various counterparties participating in the project. Project guarantees have formed the basis of the security package that Chinese lenders have sought to have in place. Depending on the nature of the project, guarantees are sought from the following counterparties (amongst others):
- equity providers and sponsors (in proportion to their equity interest in the project);
- feedstock suppliers;
- project offtakers;
- and the EPC contractor.
Therefore, the counterparties providing these project guarantees will also need to get comfortable around the project risks associated with the development.
Human resourcing of Chinese funded and EPC contracted projects has proven to be a controversial issue for stakeholders involved in these infrastructure projects. It goes without saying that one of the political upsides of financing infrastructure projects is the microeconomic benefits that would derive from such projects (i.e. direct and indirect job creation). There is perhaps a misconception (this may be due to historical factors) that Chinese EPCs not only come with their equipment but also with their own human capital. This approach is seen to prevent job creation opportunities for local workers and the negative backlash can often frustrate the progress of infrastructure projects in-country.
Going forward, Nigeria and its Chinese counterparts will need to address up-front the topic of human resourcing of Chinese funded and EPC contracted projects. Whilst it is reasonable to expect that the EPC contractor would want to have its lead engineers and trained workers on the ground to construct the project, this however, needs to be tempered with the needs of the host country in order for its people to benefit from job creation opportunities.
The MoUs signed between Chinese funders/EPC companies and the Nigerian government/indigenous companies marks a new direction towards finding financing solutions that will work for Nigeria. It is important to note that historically, some MoUs have been signed between China and Nigeria with very little progress made or projects financed to completion.
There is still a process of education from both participants in respect of understanding how each counterparty operates, the project risks they are willing to accept and devising/ documenting structures on a project-byproject basis that can work in a Nigerian context, but which also satisfies the funding requirements of Chinese parties.
It goes without saying that collaboration between the two countries in relation to infrastructure projects can work (for Nigeria, it needs to work) and over the coming months King & Wood Mallesons hope to play a significant role in facilitating to financial close projects between China and Nigeria that can bridge the infrastructure gap.