Many subsectors within the food and agribusiness industries are, in one way or another, reliant on process plant infrastructure.
As developing countries start to strengthen their own domestic processing capabilities, the opportunity for investment in their process sectors is likely to grow. Even though there are countless variables relevant to process plant infrastructure delivery across agribusiness subsectors, there are some common issues that investors and developers will face as they become more involved in development of this kind. This article explains the key issues that should underpin any investment decisions.
In issue 4 of Cultivate, we discussed how the financing and development of transport infrastructure in sub- Saharan Africa can unlock agricultural potential. The next step will involve sub-Saharan African countries developing their own processing capabilities, so that they can move up the value chain, increasing internal tax revenues and local employment opportunities.
The means by which this may be achieved will be the subject of a further article but it is clear that policies underpinned by tax incentives and/ or bans or quotas on the export of unprocessed commodities and raw materials are likely to become common across the continent. Critics may argue that such policies will distort global markets, but the value to local communities in developing countries in Africa and elsewhere may be significant, prompting inward investment in the process sectors.
Process plant infrastructure differs from one subsector to the next in terms of complexity, capital value, the feedstock and raw materials used, the mechanical and/or chemical processes adopted and the end product produced. However, there are common issues across all types of process plant infrastructure which investors should have at the forefront of their minds before making any investment decisions.
Careful planning around these issues can often mean the difference between a successful project – and optimal returns for investors – and an expensive failure, anywhere in the world.
Investors should always carry out detailed upfront feasibility analysis. Decisions made at the feasibility stage are often difficult to change later without cost and delay. Factors to consider include:
- the security of feedstock supply, specification risk and options for risk mitigation
- offtake options, likely price movements and the possible risk to operational returns (keeping base case assumptions conservative)
- plant location (labour availability, transport links, access to feedstock and offtake markets)
- financing options (including thirdparty due diligence and lender requirements for project delivery contractual structures and risk allocation)
- contracting options (including the impact on the risk profile assumed by the developer, and pricing)
- local requirements (including tax, permitting and other local law issues).
The feasibility stage is also a good opportunity to develop outline process design, which will give an indication of capital cost and inevitably influence the choice of contract delivery structure. We discuss the link between capital costs and contract structure in further detail below.
There are numerous financing options open to developers (too many to list in this article), but a self-funded project is the best way to maximise autonomy in project delivery options.
Limited recourse third-party financing may limit a developer’s control and flexibility over contracting solutions, but it can also limit their risk exposure to any equity contribution. Where third party finance is used, developers will also benefit from expert third-party due diligence on project deliverability, which will provide assurances on the robustness of the contract delivery structure.
Developers may also consider thirdparty equity, export credit agency options, plant and equipment financings and development finance institution options, as part of the overall financing mix.
Contracting structure and procurement
The aim of the developer will be to secure a contracting solution that is best able to deliver the plant on time, on budget and to the required performance and technical specification.
The full transfer of risk to one financially robust contractor will be attractive to the developer and their backers, but a single-point responsibility ‘engineer, procure and construct’ (EPC) structure of this kind may be prohibitively expensive, since the ‘wrap’ of project delivery risk by the contractor typically comes at a premium. It may also be the case that no contractor may be willing or able to assume project delivery risk on this basis. The contractors available to perform the works may not have the necessary balance sheet to manage the relevant risks or may be less willing to accept this type of risk profile in certain high-risk locations.
Where the developer is more experienced in delivering process plant infrastructure, it may instead adopt a multi-contracting solution. This will include managing the interface between the different contracts and identifying (and managing) residual risks that may not be passed to the supply chain because of the way in which the scope has been developed or because the liability for the relevant contractors is limited in some way or another.
Quite often, employers will manage project-delivery risk under a multicontracting solution through an engineering, procurement and construction management (EPCM) contractor, who aside from developing detailed design and overseeing project procurement (including for the supply chain contracts), will manage delivery of the works and project interfaces on behalf of the developer. While not assuming full risk in this regard like an EPC contractor, an EPCM contractor will typically be incentivised to achieve key programme and budgetary targets through a bonus/penalty structure – often putting some of their own profit at risk.
Most developing countries have tax regimes that seek to control the amount of foreign investment benefits leaving the country. Withholding tax is the most common form of taxation to consider when structuring the construction development stage of any process plant project.
It would be unusual for any contractor to bear withholding tax risk, and if it did it would simply become an extra economic ‘cost’ to the project. It is important therefore:
- to give proper consideration to structuring the construction contracting arrangements very early in the procurement of a project, and
- to obtain early buy-in by local tax authorities (either directly or through local advisers) to those arrangements.
One of the most common means of mitigating withholding tax exposure is to adopt a split ‘on-shore’ and ‘off-shore’ contract structure (that is, two contracts, each entered into by a different contractor entity and each containing a different scope of services). The on-shore contract will cover services that must be performed in the country where the works are taking place (because there will need to be on-the-ground personnel as supervisors) and will typically fall under the local withholding-tax regime. The off-shore contract will cover services taking place outside the country and can be structured to avoid withholding tax.
It is important that these contracts are well drafted and dovetail together. The developer will usually look to limit their exposure to breach by the separate on-shore and off-shore contractors by putting in place further contractual arrangements. These allow for the off-shore contractor entity (or a suitable parent) providing a performance and financial guarantee (backed by indemnities and, possibly, suitable financial security) for the respective and collective obligations of both on-shore and off-shore entities. This guarantee (which could be wrapped into the off-shore contract) is often referred to as an ‘umbrella agreement’.
Clearly any such arrangements will need to be considered in light of the legislative regimes mentioned above that seek to retain and maximise tax revenue in-country.
This article provides a very high level summary of common issues to be considered by those developing process plant infrastructure in the agribusiness sectors. These issues will of course be supplemented by a number of other issues that will arise on a sector and project specific basis. Experience shows that those prepared to plan and formulate a strategy with the right degree of flexibility required to deal with the inevitable ‘left field’ issues that will arise when developing this kind of infrastructure, will be best placed to secure project delivery on time, on budget, to the required specification and generating optimal returns for investors.