Castor project sends Project Bonds Initiative shockwaves, taxpayers hit worst
Bankwatch Mail | 2 December 2014
In July 2013, the much-hyped joint European commission/EIB ‘Project Bond Initiative’ (PBI) had scarcely got off the ground – in its pilot phase at least – when unusual natural events took over.
Work at the EUR 1.7 billion Castor underground gas storage plant off the coast of Valencia commenced in summer 2013. But by mid-September the Spanish government was forced to halt work at the plant after 220 mini earthquakes in the area were detected in less than a month. Local residents reported the tremors following injections of natural gas to prepare Castor for operations. Subsequent research has found that the gas injection provoked 1,000 earthquakes in the region.
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Work at the site has not since restarted. So has the Castor project simply been a victim of unforeseen, natural powers? Or might the man-made, financial artifice that provided the basis for pushing the project forward be said to share a certain – even high – degree of responsibility for this debacle?
EUR 1.4 billion worth of project bonds for Castor were issued in conjunction with the EIB, and although they were initially issued with a BBB+ credit rating, ratings agency Fitch ended up putting the bonds on negative watch as a result of the suspension of operations.
As the project’s problems mounted, and the complexity of its financing unravelled, Spain’s beleaguered taxpayers became aware that, under the terms of the project contract and a royal decree arranging the Castor concession, the Spanish government would be obliged to reimburse the operator Escal UGS, owned by Spain’s ACS and Canada’s Dundee Energy. The sum in question is EUR 1.7 billion, and the liability is now to be socialised by an increase in electricity bills in Spain.
This is quite an achievement for a project that was deemed to be a European priority project and which, campaigners maintain, was fundamentally unnecessary due to declining demand for gas in Spain over the last decade. Yet are there lessons to be learned from Castor, lessons related to PBI itself and the suitability of projects it may support? And lessons too for financiers, chiefly the EIB?
The Castor project, on the planners’ table for many years, had simply not been an affordable investment for Spain to progress with due to the acute economic problems the country has faced as a result of the economic crisis and subsequent eurozone crisis. The PBI was thus deemed to be an investment solution – a magic bullet – for the Castor project: another form of supposedly beneficial financial engineering that we are told to take on trust. The issue, the EIB maintains, is not the financing mechanism as such, and the PBI pilot phase is continuing, the bank insists.
However, as disaster has struck the project, the negative consequences – and risks to the public purse – of the project bonds mechanism, and the flawed investment it helped to catalyse in Spain, are becoming apparent.
Major projects can, and often do, go wrong, for a variety of reasons. And the project bonds approach is not set up to insulate unsuspecting Spanish and European taxpayers from picking up the bill for an ill-conceived and badly executed example of fossil fuel infrastructure development. If anything the reverse is true: the balance of financial risk is firmly weighted towards first of all encouraging and, if necessary, protecting private sector project promoters.
While the EIB has sought to deflect attention, not to mention responsibility, away from the PBI, in this case it is unarguable that the presence and issuance of project bonds made the Castor project viable, however briefly.
In spite of the Castor debacle, the EIB’s project bonds pilot phase has continued, playing a key funding role in a UK offshore wind project signed off in late 2013, and in spring 2014 being central to the new 12 kilometre A11 motorway link between the Belgian port of Zeebrugge and the European motorway network – ‘the first greenfield PPP in Europe to benefit from the EC-EIB Project Bond Initiative’, according to the EIB.
The wider finance sector, too, appears to be enthusiastic about and fully behind PBI, if an investment note from Deutsche Bank in spring 2014 is anything to go by.
Deutsche Bank, like many of its competitors, is participating and looking to be further involved in the kinds of multiple investor infrastructure projects that project bonds, in the jargon, are designed to ‘anchor’. The German institution does not, however, appear to have been involved in the Castor project, which it astonishingly describes as “a successful refinancing of a gas storage deal in Spain.”
Nonetheless, the Deutsche Bank investment note does get to the heart of what project bonds are all about: “… project bonds have been used to refinance existing bank debt … Another sign of shifting sentiment is that investors, who no longer have the guarantee of monoline insurers, are prepared to take on construction risk.” Such a frank assessment of the golden opportunity now being established for private sector investors and project promoters invites the observation that they would be foolish not to be optimistic – what’s not to like about project bonds?
Deutsche Bank’s conclusion is also worth quoting in full:
“Long-term investors are eager to match long term assets and liabilities and have the resources to get involved in project bonds, but the infrastructure pipeline is not flowing fast enough, perhaps because of the period of retrenchment inflicted upon European governments over the past few years.
“So far, project bond transactions have been relatively modest in size, but once confidence is fully restored and the European Union becomes more stable, over a longer period, more substantial transactions are likely to become commonplace. How they appeal to investors will depend on the quality of the project, but at the moment, cautious optimism for the future of project bonds is very much the order of the day.”
As we await a rush of these ‘quality’ projects, one immediate conclusion to be drawn is that EIB-backed project bonds, given the extent to which they are set up to not only favour but also cushion major investors, may well – in the short-term – provoke enthusiasm for just about any old project that the EIB opts to favour and prioritise.
And there are a lot of ‘any old projects’ out there right now, clamouring for finance. Have you seen the EU’s current list of ‘Projects of Common Interest’?