Project finance: Eastern assist

Sub-Saharan Africa is ripe for development – and China is making the first moves. By Corinna Mitchell and Michael Foundethakis

Perhaps the last great region requiring intensive infrastructure and resources development is Sub-Saharan Africa. Traditionally perceived to be beset by unpalatable economic and security difficulties, Sub-Saharan Africa has not attracted much by way of project finance investment, other than where Western sponsors were heavily involved and provided some recourse to overcome potential risks.

In the past three years there has been a noticeable trend of non-Western investment, including by way of project finance, in Sub-Saharan Africa. The thirst of sleeping giants such as China and India for natural resources to fuel their booming economies has triggered increased investment in the Africa by these countries.

It is estimated that, by the end of 2006, a total of $11.7bn (£5.76bn) had been invested by China alone in the African continent, with approximately $2bn (£984.78m) more to be invested in 2007. Furthermore, trade between China and the African continent increased by more than 40 per cent in 2006, up to around $55.5bn (£27.33bn), compared with $10bn (£4.92bn) in 2001, making China the third-largest partner of the African continent after the US and France.

Some of the largest projects have involved, or will involve, a significant element of Chinese investment, particularly in the production and export of oil from Angola, Chad, Nigeria and The Sudan. For example, on 9 January 2007 state-owned energy company China National Offshore Oil Corporation announced that it would buy a 45 per cent stake in an offshore oil field in Nigeria for $2.27bn (£1.12bn). Underscoring this trend, this year the African Development Bank held its annual meeting of its board of governors in Shanghai.

So why have Chinese investors (both debt and equity) boldly gone where few have previously? And what does this mean for emerging markets and project finance overall?

Emerging market risks
Bearing in mind that project finance is essentially about identifying, allocating and mitigating risks connected with any particular development project, Sub-Saharan Africa poses similar risks to any other emerging market. Potential risks may include political risk, currency or exchange risk, concerns about the efficacy of local legal structures, marketrelated risks, including price and offtake risks, and general concerns about stability.

None of these is by any means exclusive to Sub-Saharan Africa, but perhaps the combination of risks has been more challenging in this area of the world than in other emerging markets.

In some respects Chinese investors are uniquely placed to bear or mitigate risks on the African continent, for example by the following:

Political risks
Chinese investors, including the major corporations such as PetroChina and Sinosure, are state-owned and accordingly well placed from a policy perspective to get support for their investments. China has recently instituted a programme of aid in Africa, including building hospitals, schools, anti-malaria centres and other similar infrastructure.

A China-Africa Development Fund has been approved with an initial amount of $1bn (£492.39m), increasing to $5bn (£2.46bn). This coordinated approach tends to assist in creating acceptance of large-scale foreign involvement in African countries.

Chinese investors and lenders are not subject to the same trade restrictions that apply in certain other countries, such as the regulations by the US Department of the Treasury’s Office of Foreign Assets Control.

These regulations currently restrict US entities from entering into transactions with certain persons in a number of African countries, including The Sudan and, potentially, Zimbabwe (although PetroChina did experience the wrath of the US in May 2007 when Fidelity Investments was required by the US government to withdraw all investments in PetroChina as a result of the latter’s transactions in The Sudan).

An appetite on the part of Chinese investors for working with suitably well-connected local partners also serves to alleviate projectspecific political concerns.

Market-related risks
Chinese project finance investment tends to be made with the aim of securing the long-term supply of natural resources to satisfy the predicted strong domestic demand in China. Accordingly, long-term, fixed-price and currency-specific offtake contracts signed by offtakers with strong credit positions are available to support most Chinese-involved project finance. Such strong offtake contracts and offtakers also assist in structuring around currency risks, as revenues may be paid offshore.

There is also a large and liquid group of Chinese lenders with the capacity and appetite to either provide fully, or provide a substantial proportion of, debt finance to Sub-Saharan African projects. They are comfortable with the credit and methodologies of Chinese investors and offtakers and are prepared to work in long-term partnerships to deal with risks and ensure success of the relevant project. The National Bank of China has even opened a branch in Zambia to further assist Chinese investors on the ground.

The chicken and egg scenario resolved?
Traditionally, two of the greatest challenges for the development of Sub-Saharan African economies have been the lack of long-term investment and the poor infrastructure in the region. The former disables the long-term expansion of major projects and companies, while the latter increases the performance risk that would encourage the long-term investment required to improve such failing infrastructure.

Enter China. Chinese involvement in the region now allows for longer-term investment, which will give African industry and economies the headroom required for healthy and organic expansion. In addition, for reasons beyond exploiting mere short-term commercial gain, Chinese investment has targeted the improvement of local infrastructure, not only to secure export of much-needed hard commodities, but also as a means of securing the granting of a project in the first place.

What is the point of developing a mine in Zambia or extracting oil from Angola or Nigeria, if safe, effective and efficient means do not exist for transporting such natural resources to the relevant offtakers? In return, is it not also more advantageous for the local authority granting a concession to have its infrastructure improved as an ancillary benefit?The influx of Chinese project finance activity into Sub-Saharan Africa will greatly increase the speed of infrastructure development there. The availability of Chinese investment will in turn serve to allocate and mitigate risks and underscore the benefits to be reaped from such projects, in such a way that increasing numbers of Western and Middle Eastern investors will develop a greater appetite for such projects and will then co-invest alongside Chinese project counterparties, including debt providers.