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Project Finance:
AQUA$URE
Victorian Desalination Plant
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This case study was written by Jean Wee, Research Associate, under the supervision of Pierre Hillion, professor
of
Finance and the de Picciotto Chaired Professor of Alternative Investments, both at INSEAD. It is intended to be
used as a basis for class discussion rather than to illustrate either effective or ineffective handling of the specific
investment situation,
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Introduction
Over much of the last decade, the state of Victoria, Australia, had experienced drought
conditions which had heavily impacted water reserves. In June 2007, as part of its water
strategy "Our Water, Our Future", the state govemment announced its intention to develop a
seawater reverse osmosis desalination plant to augment Melbourne's water supply, with the
capacity to supply up to one third of the state capital's water needs from a rainfall-
independent sourcs.

On 30 July 2009, AquaSure Pty Ltd (AquaSure) - a consortium comprising Degr6mont,

Thiess and Macquarie - was selected as the preferred bidder, beating out competition from
Bass Water, a consortium led by Veolia Water, to finance, build, maintain and operate the
for period of 30 years and 1 month. n;& 3
A$5.72 billionr Victorian Desalination Project a 9iri i
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From the announcement by the govemment to the financial close, the entire project took place
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against the backdrop of the global financial crisis which rocked financial markets from mid- '6F o
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2007 to 2009. The ensuing tight credit environment made the procurement of 100% .2;
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committed funding prior to the final bidding for such a huge project problematic, requiring O.' d)
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Macquarie to use all of its project finance experience and banking connections to ensure the E+=
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Historically, Victoria's water supply system was entirely dependent on rainfall, but over the
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past 12 years the state had experienced a prolonged drought, causing inflows into F=E
Melboume's water storage to hit record lows (Exhibit 1). At the same time, population growth 6v)
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was increasing pressure on the water supply system, with the city's population expected to : il)*
F!.E
almost double from 3.8 million in 2009 to 6.5 million by 2051. As a result, in 2007 the E&E
3eb
Victoria state govemment called for expressions of interest (EOI) to construct the world's E
Il
largest seawater reverse osmosis desalination plant under a public-private partnership (PPP) to (Li!-.
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supply water to the city.

Public-Private Partnership
The PPP framework generally govemed the partnership between the state and the private
sector in the development and provision of services and facilities, usually in the area of
infrastructure, such as the private finance initiative (PFI) that had originated in the UK in
1992 under John Major's Conservative govemment. Within this framework, the private
operator's role was to design, build and finance construction of the assets, and then maintain
and operate them (known as a build-operate-transfer or BOT scheme). In retum, they received
either contracted payments from the state (budget revenues such as shadow tolls or
availability payments)2 or revenues generated by these assets (user-paid revenues such as tolls

1 Capital cost was A$3.5 billion. Inclusive of construction, financing and operating costs, and using 150
gigalitres of water every year for the next 27 .7 5 years, the total maximum net present cost to the State over
the 30 year contract term ofthe project was $5.72 billion.
2 Service pa).rnents for making the facility "available" for use during the contract term.

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or user fees). The assets were usually held for a finite period under a concession awarded by
the government, after which they reverted to state ownership.

There were many arguments in favour of PPP as a way to provide much needed infrastructure,
especially at a time when govemment budgets were under considerable strain. For example, in
the IIK, the big attraction for the govemrnent of the PFI was that it enabled infrastructure to
be built without it appearing as an increase in the public-sector borrowing requirement
(PSBR), which represented govemment borrowing in the national accounts. Because the
assets were financed by the private sector, they counted as private-sector investment for
national accounting purposes. However, as pointed out by economists like Paul Grout,3 since
the building of the asset was usually accompanied with a public-sector commitment to
purchase a flow of services, the impact on the underlying govemment finance would be the
JE
same. If the public sector owned the asset, there was a commitment to fi.rnd the debt; if the eis g
private sector owned the asset there was a similar commitment, but now in the form of a :N o
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service contract.a o Lc
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Other proponents of PPP pointed out that it encouraged efficiency in the delivery of bu.ij
infrastructure service, as it bundled financing, building and operation under the same frrm. lao
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For many infrastructure projects, operation and maintenance costs depended on investments Jo
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made during the initial construction stage. Since a firm with a PPP contract enjoyed partial or Fr O
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total ownership rights during the contract period and kept most of the gains from cost cufting, o*o
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there were strong incentives to cut life-cycle costs and promote efficiency gains. It had been >s6
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estimated that private operators could cut operating expenditure by 40% and capital 83F
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expenditure by 25% thanks to the cost savings frory consolidating responsibility for Lro
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construction, operation and maintenance in a single entity.5
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The other side to cost savings, however, was a need for tighter monitoring on the part of the
regulating authority to ensure that there was no reduction in the quality of service. There was 4;3
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also the possibility that the private provider could refuse to adopt costlier, better technology in +19 9
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line with environmental or safety concems. Moreover, due to the long-term nature of the 3Bb
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service contracts, which were specified in advance before the asset was built, the service f Y,o
trdH
contract might not prove to be optimal. For example, it was diffrcult to get an idea of what Fl

reasonable standards of quality would be like in 20 or 30 years time, or the state of congestion
on road networks 75 years thereafter. Hence, such concessions, especially the longer-term
ones, were prone to costly re-negotiation.

The provision of infrastructure in an economy is often a monopoly; PPPs had been heralded
as bringing infrastructure provision closer to the advantages of competition through
competitive auctions of the concession to run the monopoly. Competition for the field could
be a close substitute for competition in the fietd6 if, for example, the bidding variable was the

3 Professor of Political Economy at Bristol University, who has written extensively on the tIK's PFI
experience.
4 "The Economics of the Private Finance Initiative", Paul Grout, Oxford Review of Public Policy, Vol. 13
No.4, 1997.
5 As mentioned by Professor Jose Gomez-Ibanez, Professor for Urban Planning and Public Policy, Harvard
University, in his opening remarks at a programme of the Manhattan Institute "The Private Role in Public
Infrastructure", 2 O ct 2008
6 The distinction between the terms competition "for" and "in" the market was first drawn by the Victorian
social reformer Edwin Chalwick (1800-1890) in an article published in 1859. Chadwick argued that in a

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-user fee to be charged during the concession term. A competitive auction achieved second-
best pricing by dissipating ex-ante rents. However, a prerequisite to reap the potential benefits
from auctioning PPPs was that there be real competition for the contract, which was not
always the case (such as in developing countries where companies with political links could
be favoured above companies without). Furthermore, even if there was a truly competitive
process at the time of the auction, due to the immovable nature of infrastructure assets the
relationship tended to become a bilateral monopoly over the life of the contract, and there
were often opporhrnities for hold-ups, either by the govemment or by the firm. For instance,
since the investment was sunk and the firm was unable to take its asset elsewhere, a
govemment could increase its regulatory takings, either by compulsory or unilateral
renegotiation of agreed-upon contract terms. Similarly, a govemment might not have the
wherewithal to take over the infrastructure service without major disruptions to the service,
I
making it difficult to punish non-compliance by the frm. "r&
69:

Nonetheless, PPPs had been useful in re-setting user charges closer to their true economtc :x* o
ee)
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value, although not without raising the ire of the users affected. In many places, due to i€H
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political considerations, user fees for infrastructure had historically been charged below
l-O
marginal costs (e.g. US toll roads like the Indiana Toll Road)7, leading to over-consumption -ii
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and under-investment. By being more insulated from political pressures, PPPs provided the 6?r
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means for such rates to be raised, bringing in much needed investment. o oi
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o'white elephants" and other over-engineered >+6
PPPs were also viewed as potential filters for goF
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projects. White elephants projects with negative social value were often the result of the
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plans of politicians to boost their political capital, which would have otherwise failed the o=d
gEP
process of project evaluation. When such projects were auctioned under a PPP framework
C cc
financed by user fees, those that were not profitable would fail to attract a concessionaire. F>3
Such a filtering effect would be negated when shadow tolls or availability payments were iY)
q=b
used to pay for the project, or when government guarantees were provided to cushion private FgE
interests in the event of a shortfall in demand. EKE
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Despite the advantages highlighted by proponents of PPP, the actual experience with PPPs L iL ..,
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had been mixed. While in some cases expectations were met (see Guasch, 2004), a World
Bank Institute study involving over 1,000 infrastructure concessions granted in Latin America
between 1985 and 2000 found that there were frequent acrimonious disputes over contract
compliance, complaints about excessive tariffs, frequent instances of bankruptcy among the
concessionaires, reports of poor service delivery, and in particular, incidents of opporlunistic
and early renegotiation of contracts (30% of the sample). Renegotiation was common in

wide range of activities, the failure of markets to work effectively could be cured through centrally
administered competitions "for the field". Rival firms, in bidding to secure the market as a whole, would set
prices at cost, while regulation could be used to ensure adequate service quality. Harold Demsetz, in 1968,
revived the argument in "Why Regulate Utilities?" by proposing that formal regulation of utilities would
not be necessary where governments could allow "rivalrous competitors" to bid for the exclusive right to
supply the good or service over some indefinite "contract" period. Source: "Chadwick and Demsetz on
Competition and Regulation", William Mark Crain and Robert B. Ekelund, Jr, Joumal of Law and
Economics, Y o1. 29 No. I (Apr 197 6), pp.l49-162.
7 Where the toll fees have been unchanged for more than20 years under state ownership and management.

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-transportation concessions, occurring in 55%

of cases, and even more so in water and
sanitation concessions, occuring in 7 4o/o.8

Partnerships Victoria

At a time when the public outcry against PPPse (as a result of higher charges for the usage of
public infrastructure by private opemtors) had discouraged use of the model, the state of
Victoria was one of the few to increase government involvement in PPPs. The move to
embrace the public-private partnership model had started in the mid-1990s, when the state
budget was severely under strain and the govemment had little option but to sell off state
assets such as the Loy Yang power station and to privatise state businesses such as Melboume
Water. In 2000, the govemment established a 'Partnerships Victoria' team in the Department
of Treasury and Finance as the centralised authority for PPPs, with the intention of "growing :E
the market" by playing a coordination and enforcement role within the govemment and $!d:
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developing government expertise in assessing projects and making timely decisions. U bTA\
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"Partnerships Victoria is building a private sector market through a critical mass [io u
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of projects with the intention to grow the market," l;o
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One of the key features of the Partnerships Victoria programme was the adoption of a public oo o
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sector comparator (PSC) to provide a benchmark against which to assess bids for a PPP. The -ao=
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PPP option could be pursued only if the private provider's bid was less than the estimated tr- o
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PSC cost, or in other words, provided "value for money" (VFM). (/),8
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Public Sector Comparator (PSC) F>
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The PSC was flrst developed in the UK for the PFI programme, involving a two-step F€E
approach: frstly, estimating the present value of the expected life-cycle costs of the facility E&E
3eE
under traditional public procurement, explicitly including all foreseeable risks; and secondly 9c-o
adjusting the components of the cost estimate for "optimism bias", defined as "the systematic Ldg
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tendency for appraisers to be over-optimistic about key project parameters".t0 However, as
the PSC was difficult to estimate accurately, criticisms were raised against using a single
number to decide whether or not the PPP provided value for money. To head off criticism that
the VFM test was arbitrary or inaccurate, the government in Victoria developed detailed
guidelines for the calculation of the PSC.

Victoria's PSC consisted of four components:t1 1; the raw PSC, comprised of the capital costs
of construction and operating costs of service and maintenance over the facility's life-cycle as
obtained under traditional public procurement; 2) competitive neutrality adiustment, which
referred to the savings derived from public ownership, such as exemption from corporate

8 "Granting and Renegotiation Infrastructure Concession - Doing it Right", J. Luis Guasch, World Bank
Institute, 2004.
9 In the US, for example, the Indiana To11 Road (ITR) drew much flack from the public regarding the sale of
public infrastructure to foreign owners and the resultant higher toll charges. Some ofthe other states in the
US looking to privatise public toll roads had to withdraw privatizationplans due to the political backlash.
10 "Partnerships victoria: The Public Sector Comparator", Kennedy school of Govemment, 2006.
1l Ibid.

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income tax or property tax; 3) transferable risft, which referred to the expected cost of the
risks transferred to the private provider under the PPP option (e.g. construction delays, cost
over-runs); and 4) retained risk, the expected cost of the risk retained by the govemment and
not transferred to the private operator. Items 2-4 would be added to the raw PSC to derive the
final PSC number to allow a fair and equitable comparison of the PSC with the private PPP
bids. (Note: for projects where the retained risk is included in the PSC, the same has to be
added to the private bids for meaningful comparison.)

The Discount Rate - Measuring the Transfer of Risk

Parbrerships Victoria initially followed the British approach of applying the same discount
rate 6Yo realt2 to both the PSC and private options. In 2003, however, the Treasury
- -
decided it would be analytically more correct to calculate and apply different risk premiumsl3 qt q! ii
for the public and private options.
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Victoria's discount rate methodology was based on the core principle that all (or nearly all) >.9 3
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projects had systematic risk, which would be bome by either the public sector, the private bu6
sector or shared between both, and this, and only this, was reflected in the discount rate. i:€
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Project-specific or diversifiable risks would not be taken into account. Where systematic risk ro.4
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was transferred from the govemment to the private sector, the rate used by the govemment to o o!
0-o
discount the PSC and the rate used to discount the PPP bids would differ according to the QN o
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systematic risk bome by each parfy. >q6
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This approach used the Capital Asset Pricing Model (CAPM) to determine the amount of Lgo

systematic risk in the project. Under CAPM, the rate of return from an asset should gEg
compensate owners for risk that cannot be eliminated by diversification - systematic risk -
F> 3
through investing in other assets. Systematic risk was a measure of the extent to which a Xv>
particular asset's retums were likely to vary relative to a portfolio of assets across the market. 4=5
b€E
This measure of systematic risk, known as beta, determined the additional retum that an 8€E
investor would require to compensate them for investing in that project and thereby taking on 33"b
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the systematic risk of that project. Projects which were more risky than the market portfolio
I
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(Lioo
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would have a beta greater than one, with a higher return required for investors to take on the
risk, while projects which were less risky than the market porffolio would have a beta less
than one, with a correspondingly lower retum required. The required retum was given by the
equation:

Ro= Rr + p"(R,- Rr)

where R. was the required return, R1 was the risk-free rate, Fu was the asset beta, and (R.-R1)
the market risk premium.

12 Six percent in real terms was the government's estimate of the retum the private sector required to finance
public projects of 1ow-to-moderate risk.
13 One school of thought was that since the govemment could borrow at the government bond rate (risk-free
rate), then the PSC should always be discounted at that rate. However, the rate did not take into account the
risk of the project - the debt appeared to be risk-free to the lender because the government could always tax
everyone to meet the obligation, but the risk was passed on to the public, who took on the risk through
riskier future tax payments and consumption. Source: "The Economics of the Private Finance Initiative",
Oxford Review of Econornic Policy, Vol. 13 No.4, Paul A Grout.

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-Where no systematic risk was transferred to the private

sector, the discount rate to be used to
calculate the net present cost OIPC) of the private project would be the risk-free rate, while
the discount rate for the PSC (bearing all systematic risk) would be the CAPM-determined
rate of retum required. If all the systematic risk was transferred to the private sector then the
discount rate to be used to calculate the NPC of the private sector altemative would be the rate
determined based on the CAPM approach, known as the 'project rate'. Where the systematic
risk was shared between the public sector and the private sector, then the amount by which the
project rate exceeded the risk-free rate, referred to as the 'systematic risk premium', must be
allocated between the parties. The more the systematic risk transferred to the private sector,
the higher the discount rate should be to evaluate that option.to lExhibit 2 shows the process
for developing the discount rate. Exhibit 3 gives a diagrammatic representation of how the
discount rate was determined based on the transfer of systematic risk from the government to
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One complication regarding the discount rates was the different pattems of cash outlays in the bA\
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PSC option versus the PPP option. The PSC typically required a large capital outlay from ;^c d
govemment for construction in the early years, followed by much smaller outlays for bu6
operations and maintenance over the service life of the facility. In contrast, under PPP, as the f;o o
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private provider financed the construction, the govemment avoided major expenditure in the J o.q
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beginning but had to make larger payments during the service life of the facility (so that the
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private provider would recover the investment costs as well as pay for operations and oo o
maintenance). Given the different patterns of outlays, higher discount rates could make the >$6
private bids appear cheaper relative to the PSC and vice versa. 33F
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Growing Pipeline of PPPs >-t

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Since the start of the decade, Victoria had completed about A$9.5 billion of ppps (in capital oYi
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value),rs which would soon include a proposedA$750 million Peninsula Link road, the A$1
F!E
billion Parkville Cancer Centre, the Ararat prison project, and one of the world's largest Ppp 3< E
projects, the A$5.72 billion Victorian desalination plant. c-q
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The Victorian Desalination Project

The desalination plant, the world's largest PPP project undertaken in2009, would be a vital
piece of Victoria's water infrastrucfure with the capacity to supply up to one third of
Melboume's water demand from a rainfall-independent source (Exhibit 4). Expected to be
operational by December 2011, it would supply up to 150 gigalitres (GL)tu of witer a year to
Melbourne, Geelong and, via other connections, South Gippsland and Westem Port towns.
The project was comprised of the construction of a 150GL desalination plant, tunnels
supplying the plant with seawater ('inlet tunnel') and discharging more concentrated seawater

t4 This methodology is for net cash outflows projects i.e. the government has to make net payments. For net
revenue projects, the PSC is evaluated at the project rate, and the bid revenue streams ofthe PPP at the risk-
free rate.
15 "victoria writes a new chapter", Project Finance International, pFI yearbook 2010.
16 The capacity of the plant could be upgraded to 200GL - the marine intake and outlet tunnels, transfer
pipeline, and the power supply would all be built for 200GL per annum capacity from the outset, so that if
additional capacity was required, only the plant would have to be upgraded.

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-back to the sea ('outlet tunnel'), an 85km pipeline transporting treated water to the Melboume
Water network, and an 88km underground high voltage altemating current (HVAC)
transmission line (to be transferred to the electricity operator on handover). In addition,
AquaSure was responsible for procuring the power supply for the project and ensuring a
100% offset of electricity used in operating both the plant and transfer pipeline with the
purchase of Renewable Energy Certificates (RECs)t7 as required by the state. (Exhibit 5
shows the important milestones for the project). At the end of the project term of 30 years and
I month, the assets were to be handed back to the state, with no additional payment by the
state, and were required to have a specified residual life in order to ensure that they were in
good working condition. Many of the project assets were to have a'design life'longerthan
the project term, such as the tunnels- and pipelines (100 year design life) and the desalination
ptant building (50 year desigrr life).l8
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Water would be ordered annually by the state government, with AquaSure supplying water to 5-R
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the state only when requested to do so. Placed each year on 1 April for the following financial O rE
.>€8o
year (i.e. between I July of that year and 30 June of the following year), orders could be '4.:
bu5
between QGL and l50GL per annum, generally n 25GL increments (0, 50, 75, 100, 125, >d
cr -
150). The state had the flexibility to restrict supply during wet winter months or to increase cJo
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supply (subject to plant capacity) during any year. AquaSure was not entitled to sell water to 5?E
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AquaSure derived its revenue from monthly service paymentsle from the government, made >T6
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up of two key components: E-o 6
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i) Monthly Water Security Payments (MWSP), covering fixed costs (regardless of water =+<
o c.=
volume). MWSP were "availability payments", which were payable whether or not F>=
water was delivered i:< i
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ii) Monthly Water Usage Payments (MW-UP), covering variable costs relating EIE
E&E
specifically to the volume of desalinated water delivered to the state each month. The 3 i'b
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state would not make usage payment for any volume of desalinated water delivered E
f,
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that exceeded the amount ordered, nor for any desalinated water that was ordered but Fl
not received.

l7 Renewable energy certificates, or RECs, represent one megawatt hour @Vfh) of energy generated from a
clean, renewable source, such as wind, solar, hydro, or certain types of renewable biomass, which generate
little to no carbon as they produce energy. They represent an indirect emission reduction, so that a "clean"
energy source "offsets" the use of"dirty''fossil-fuelled energy.
18 The state could require AquaSure to cany outjoint inspections with the state up to three years prior to the
end of the project term (and at 6 monthly intervals until the end of the term). The state and AquaSure also
had to agree (or seek independent determination of) on a schedule of maintenance and repairs (if any)
needed to ensure the desalination plant and associated infrastructure met the required handover conditions
(including residual design lives for particular assets), the cost of any such maintenance and repairs, and a
programme for carry.ing out any works required. As surety, AquaSure had to either deposit funds into an
escrow account or provide the state with a bond, to the value of the estimated cost of maintenance and
repairs.
19 The service payments were said to reflect "what could be expected to be an efficient cost, and therefore it is
a cost that the govemment felt was appropriate and in that competitive process delivered value, and at the
same time it also enables us to stay in business provided we manage our assets efficiently'' according to
AquaSure (see Appendix 8), suggesting that they might include covering operating costs, debt costs and
repalments, and required equity retums.

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In the event that AquaSure's performance did not meet the state's requirements (volume
shortfalls, low operating standard and performance, water quality failures), an abatement
would be made to the monthly service payments according to a prescribed schedule.

Cost pricing
In order to check that the private sector was providing value for money, the state built a public
sector comparator (PSC) which was an estimate of the risk-adjusted, whole-of-life cost of the
project if delivered by the state, using the same output specifications as given to the private
operators. Expressed in terms of the net present cost to the state, calculated using discounted
cash flow analysis, the PSC included amounts to cover both the design and construction costs
and the maintenance, operation and facilities management costs during the project term.
(Exhibit 6 shows the PSC calculations). The PSC cost was ,{$6.656 billion, compared to
AquaSure's cost of A$5.72billion, a saving of L4.l%o.
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To take on the project, the winning consortium set up AquaSure as a separately incorporated laO

special-purpose vehicle, which then contracted with various counterparties for the different 6t3
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services required to get the project off the ground. (Exhibit 7 shows the structure of the 5+E
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project). The key players in the structure were: o-o
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>+6
gdF
AquaSure. Under the contract signed with the Victoria state govemment, AquaSure had to 3.e F
'71-i o
finance and/or procure financing for the project; design, construct and commission the Lgo
desalination plant, transfer the pipeline and HVAC transmission line; operate, maintain and 9EE
repair the desalination plant and transfer pipeline for the project term, and hand over that o P..
cc-

infrastructure to the govemment at the end of the project term; hand over the HVAC 5>
o\li =
transmission line to the govemment upon completion of reliability testing; and offset 100% of 4=b
:9c
rr9 g
the project's energy usage with renewable energy during the O&M phase.
EiE
3eb
c-a
The Sponsors. AquaSure was sponsored by three market leaders: Degr6mont (parent Suez 9c-o
f Y,o
soid
Environment), a world leader in water and desalination technology; Thiess and Thiess F]
civil contractor in the Asia-Pacific region and
Services, a leading engineering, tunnelling and
part of the Leighton group of companies; and Macquarie Capital, a global investment,
advisory and securities firm.

The State of Victoria. The state was the contracting entity for the project, with the Minister
for Water the person empowered to execute the contracts on behalf of the state. As part of its
contribution to the project, the state was responsible for procuring the land for the desalination
plant and related infrastructure, which included obtaining all attendant approvals and dealing
with land acquisition and compensation matters with the land owners. The state also provided
support for the financing of the project through guaranteeing the debts of the project.
Furthermore, to address the adverse effects on debt funding of the global financial crisis, the
state would also share the risk of refinancing losses equally with AquaSure20 and the risk of
funding costs of the senior debt increasing above market rates due to market disruption.2l

20 The state would also share refinancing gains. Source: Project Deed.
21 The state would have the right to recover extra costs through future refinancing gains. Source: Project
Deed.

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Should financial markets be unable to underwrite refinancing of the initial debt at debt
maturity because of significant market dislocation, the state would also provide support by
adopting one of a number of options, which included procuring altemative funding; procuring
a state-supported guarantee for the debt funding; termination of the project and payment of
the relevant termination payment; or pay-out of the balance of any unrefinanced debt, etc. The
state also assumed the risk of higher energy costs through a price-reset mechanism to
compensate AquaSure for any increased energy costs should AGL Energy, the energy
ptouid"r, default or become insolvent after 10 yeurs."

D&C contrscton AqtaSure subcontracted the D&C to Thiess Degrdmont, a joint venture
between Thiess (65%\ and Degr6mont (35oh), to design and construct the desalination plant
and associated infrastructure under a fixed time, fixed price contract. Theiss had coordination
experience in mega-projects, and Degrdmont had 40 years of experience in designing and aiq! 8

operating 250 desalination plants all over the world. Civil, mechanical and electrical design
u biA)
was done by Theiss's long-standing design partners Parsons Brinckerhoff and Beca, using O gf
>.9 8
proven technology, while Degrdmont used a standardised and modular building process, ';iO
Eou
which allowed construction of the various components to be run in parallel to minimise delay.
l^O
In order to avoid undersupply and risk abatement to service payments, the plant would be --o
alo
ro.9
built with redundancy and additional capacity, with the parallel processing and modular 5? E
Er O
design allowing for the repair of components on a segregated basis while the remainder of the o o!
o-o
6N.^
plant ran at firll capacity. The contract was protected through joint and several guarantees c-
GO O
t
from parent companies Leighton Holdings and Suez Environment. >+6
-dE
oo*
sqH
;Fo
Lgo
O&M contractor. O&M was subcontracted to a Degrdmont Thiess joint venture (Degrdmont
AEP
60%, Thiess 40o/o), which would assume operation and maintenance obligations which >-=
o c._L
< cc
included delivery of specified volumes of desalinated water, operation of the plant to produce
5=3
flexible desalinated water requirements, and delivery of a specified quality of desalinated oYi
glb
water. Unavailability of the plant or loss of water quality could lead to an abatement of the .6; 6
service payment. The risk of O&M failures was bome by the O&M contractor as, like the EEE
69
D&C contract, the O&M contract was protected by joint and several guarantees by the parent
!P
c
g
companies. (I.
FJ
Transmission line operator SPI PowerNet. The network construction contract was signed
with SPI PowerNet, a power distribution company, for AquaSure to provide the design and
construction of the HVAC transmission line. Under the agreement SPI PowerNet would pay a
nominated and fixed amount for the delivery of the power transmission infrastructure.

Electricity & REC provider AGL Energy Limited (AGL). AquaSure entered into a fixed price
30-year electricity supply contract with AGL, a major Australian utility with a focus on
renewable energy. AGL would fully offset electricity requirements of the project with
renewable energy sources - such as from a wind farm located in south-west Victoria, with the
balance of renewable power sourced from AGL's other renewable projects. AGL would
supply electricity at a fxed cost per MW over the life of the contract. As the supply of water
that AquaSure would be providing was variable, ranging from OGL to 150GL depending on
the state's order, the contract with AGL allowed for variable volumes.

22 Source: ProjectDeed

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The Business Sch@l
for the Worldo

-Melbourne ll/ater. Melboume Water was the

corporatised state-owned water company paying
for the desalinated water produced by AquaSure.

Equity providers. Equity for the project was sourced from both domestic and international
equity providers.

Debt providers. commercial debt was syndicated amongst a large group of banks.

Financing
Prior to the onset of the global financial crisis, in the Australian infrastructure finance market
which was well supported by both domestic and intemational banks, projects mainly operated .tr
on a full project risk underwrite and syndication model. Accordingly, to "ri
Xo Y
6
maximise xN O
competitive tension among bidders, the Victoria govemment required that banks could not :- o
:E@
provide financial backing to more than one consortium, and the bid, as was customary, was on O Lc
>98
'aE o
a fully funded, limited recourse basis. bv6
.2;.S
l^o o
Equity for the Victorian desalination project was provided by sponsors, suppliers and -ii
@lo
Jo.!4
financial investors, with Macquarie acting as equity arranger, equity investor and equity 6+E
Fr o
underwriter. The size of the equity offering (A$769 million), particularly in a market spooked 6o5
o-o
QN o
by the global financial crisis, meant that equity investors were demanding higher retums as 60 0
>T6
dE
well as a liquidity premium, making Macquarie's job of procuring 100% of committed equity -
6#p
funding prior to the final bid (a requirement of the government) more difficult. Macquarie E-o
L---
leveraged upon its market relationships and transaction experience to line up investors, a.Y o
2-=
initially targeting potential investors who had been involved in previous transactions, or with oLs
Ccr
whom there was an ongoing relationship. It also tapped its global corporate and infrastructure 5>=
arv-l
finance network to gain access to all major international markets. Suez Environment, Thiess 4=5
g)-
-
and Macquarie Capital Group provided alarge portion of the A$800 million (US$670 million) €! "E
8&E
equity component, while Itochu Corp. put up ,4.$100 million. The remaining members of the Plb
equity consortium included HSBC, Australian pension fund UniSuper, anda group of Korean 9c-o
r Y,o
adS
investors comprising Samsung C&T Corporation, the Korea Development Bank, Korea Life Fl

Insurance and the Korean Teachers' Credit Union.

The project required a A$3.7 billion debt financing package on financial close, but in the
liquidity-constrained environment AquaSure had difficulty securing a fully hedged 100%
committed debt financing package from domestic and intemational banks. The consortium
could only secure a A$1.925 billion full project risk seven-year tranche provided as take-and-
hold commitments by 12 domestic and international banks supporting AquaSure NAI!,
Westpac, BBVA, Banco Santander, Bank of Tokyo-Mitsubishi, SMBC, Intesa Sanpaolo,
-
Dexia, HSBC, ICBC, Macquarie Bank and Mizuho. The remaining A$1.746 billion, which
was to be syndicated to a wider group of banks, needed to be supported by a Victorian
government guarantee (State Syndication Guarantee Facility), where the state eflectively
acted as lender-of-last-resort in the syrdication of the debt if it was not completely sold down
by the lead arrangers and bookrunners National Australia Bank Ltd (NAB) and Westpac
Banking Corporation (Westpac) under a best-efforts syndication. The consortium, with

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._
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Macquarie acting as debt ananger,23 targeted committed banks of the losing consortium, Bass
Water, and banks which had fallen out of the bid process to join the AquaSure consortium.

Within two months of the financial close, the mandated lead arrangers successfully syndicated
the .4$1.746 billion state-supported facility. The syndication was 537o oversubscribed,
bringing the total number of institutions involved to more than 30 from the initial 12. The
total A$3.7 billion senior debt was priced at 3.50o/o for years 1 to 5, 3.75% for year 6, and
4.00% for year 7, with upfront fees of I.25% to 2.50%o (based on the size of the commiued
funds and the role of the bank). The debt-to-equity ratio was 80:20, the average debt service
coverage ratio was 1.35x, and the loan life coverage ratio was 1.38x.

A separate A$246 million HVAC financing facility was drawn for the IIVAC transmission
line, which also received state support in the form of a repayment guarantee (IIVAC .:^q
gis
Supported Facility). Interest rate risks were hedged with interest rate derivatives. EN A
:- o
:O E@)
r<
>98
';EO
Post-deal Issues bu6

o
--
oJo
Industrial A,ction r6.Q
6+ -
E- O
o o!
Pipe laying started in February 2010. By October 2010, construction had begun on all29 o-o
oN,^
oo o
buildings that made up the desalination plant, while installation of mechanical process >T6
q oF
components was proceeding rapidly. Local newspapers reported that in order to minimize 8,9 F
'-t-i o
industrial trouble and delays, AquaSure was paying about 25%o more than the industry norm Lcn'
o:6
@E9
to workers.24 However, in November 2010, workers employed by Thiess went on strike
following allegations of workplace spying by strike-breaking operatives at the plant, and only co c.!
cc
went back to work after the company agreed to sack, rather than merely suspend, two 5>=
^v>
managers in the management team. In February and March 2011, strikes again delayed 4;5
F€E
construction at the plant as conflicts continued between site workers and the project EEE
management. 3Ab
-"
I
(L(.
=
r'AWhite Elephant" FJ

Water became a hot-button issue at the November 2010 state elections when the contesting
Baillieu camp accused the then (Labour) Brumby government of overspending on the
Victorian desalination plant after weather pattems reversed and Melboume's water storage
level reached 54.7oh, up from its lowest point of 25.6% in June 2009. Producing figures that
showed that the project would cost Melbourne households ,4.$19.3 billion in nominal terms
even if no water was sent to homes,25 and almost A$24 billion over 28 years if the maximum
150GL of water was ordered,26 the Baillieu govemment called the plant a "white elephant",
and attempted to cancel the contract, but later said it would have to honour it. It also charged
the former Brumby govemment with refusing to release all cost details of the PPP. The
Brumby govemment defended its actions, saying that the A$24 billion nominal figure was

23 and financier with a commitment of A$92 million to the 7 -year senior debt faciliry
24 "Brumby's giant money pit", The Age, 28 Aug 2010
25 "Public will thank us, Labour has no regrets over desal plant", Herald Sun, 2 Mar 11
26 "Victorian Desal Plant Builder has No Grounds to Sue: Minister", Asia Pulse, 12 Apr 11

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-equivalent to the net present value A$5.7 billion that

was publicly disclosed at the start of the
project.

The use of the more expensive option of desalination was also questioned by market
observers, who pointed out that water from the plant had to be pumped 86kms, requiring
approximately 92MW of energy, and the interconnection of Melboume and regional water
suppliers added to energy demands. fusing energy costs would hence feed directly into
desalination costs. Recycling water^from treatment plants closer to the city would be cheaper
and more environmentally friendly.2T Desalination as a method of water procurement received
finther criticism in three reports released over April 2011 by the Australian Productivity
Commission and the key independent advisory body to state and federal governments on
water, the National Water Commission. The Productivity Commission said that too many
.tr
decisions about Australia's urban water supply had been "too political" and not based on HNE
social economics, and concluded that smaller investments in sources other than desalination
x*bJ rl\o
would have been sufficient to maintain water security across Australia's cities. It also u
O Lc
criticized the lack of clarity and transparency around the way decisions about water supplies >98
'a^L a
were made, stating that "poor institutional arrangements" had led to over-investment in bub
desalination and the inability of these arrangements to escape political interference.28 t;o o
-ii
olo
r o.Q
6+E
Escalating Costs and Possible Delay E-_9
o o:
o-o
QN o
oo o
Construction at the Victoria desalination plant was not only delayed by continual industrial >+6
<oF
action, bad weather had also added to the woes. Flooding caused damage to part of the E3F
tr- 6
construction works, and in April 2011 AquaSure notified the Victoria govemment that it ctro
(J)E9
might claim for flood damages under a force majeure clause,2e leading to fears of escalating
oFs
costs for the taxpayer. The plant was due to finish by December 201I, with water delivery due
by 30 June 2012, ?!d the company faced penalties of A$1.8 million for every day the water 5> =
oYi
was not delivered-3o 4=b
. o-
p!E
E&E
As a result of the delays, flood damage and escalating costs, Leighton Holdings, the parent E3s
company of Thiess, announced that it expected to make just ,{$6 million profit from the 9c-o
l g,o
Ldg
project, a fraction of the anticipated 4$288 million. F:

27 "What price water transparency?", The Age, 18 Sep 2010

28 "Wet blanket over desal plants", The Australian, 15 Apr I I
29 "Desal consortium may seek compensation. Government denies escalating costs", Australian Broadcasting
Corporation (ABC) News, 26 Apr 2011
30 "Aust company facing daily penalty on Victoria desal plant", Asia Pulse 7 Apr 2011

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--
ior theWorld@

Gase Questions and Presentation

1. What were the risks associated with the project for all the relevant parties involved, e.g.
state, equity sponsors, other equity providers, debt holders, contractors, financiers, etc.?
What were the residual risks faced by the sponsors?
2. How were the risks mitigated in the structuring of the project?
3. What was the role of the state and how important was it in getting the project going?
4. Does the Victorian desalination plant experience support the practice of PPPs? Was the
transfer of risk reflected in the discount rate used in the public sector comparator (PSC)?

E*q
EN O
:- o
:
oLt
E@)

e€H
Eio
>.6
'=ol
t
:FE
oJ o
ro.q
6+:
cr O
o o=
o*o
QN o
60 0
>$6
* otr
g,? *
i-d
Lro
o;o
anEO

O c.!
ccc
F>=
ivi
9=b
. o*
E.b "U
EKE
3eb
c,-
II
tL.
Fj

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I

INSEAD
ltre Bwiness Schoo]
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-
Exhibit I
Record law Water Inflows
Annual inflows to Melboume's main harvest-ng resewoirs fihomson, Upper Yana, O'Shannassy and Maroondah Resewoirs)

i,r'}].0Ci ,.., .

IflEluicg l:)llo;t
Sg0 GLryear - - /,i 6riiq0 irqd$ 1!ri'20t)$ i00 SLruirr
'r
loc.tloil 1}]q?"-20r8 r$

387 GUyear
,0{X.trtr'

s{)(j.tji,x.)

)
i:jgj.uor
silp
EN Q
obA\
,:ryJ .UI' oLc
>98
H6€
:LlJ.U{ii .>;.9
t^o o
*ii
eJo
lnllow 1006 itlit GL
0
ro.Q
6=EO
FF
o o=
II
91 fi
l. 9 {, q,
^* $ &,{
Ll s c F r i 6 UE
I e o !a Io F * q, r ;o $
E Ii €'; qt si * bt Sr oE b5 $ri ; Iib i{b Ir Fj,a
ji ; ei
"i +--? b d il
i $
5 h As*
F 'i,' 6 S } $6i E; g5 gE t;
S5
o-o
QN o
"r --;:;;::a\:!&!\ oo o
>q6
*oF
Source: Melbourne Water 8.s F
g'+.8
L---
Exhibit 2 oEo
Discount Rate Decision Tree gE+
E>B
4;5
- {D-
Step 1 - What are the Systematic Risks in the project? €!E
E&E
3aE
Oc.\
5 qr6,
): Step 2. Are predominantly all the Systematic Risks
Yes L6i;
F:]
bome by the Government?
IVo

3- Rate

Step 4 - Are predominantly all the systematic Risks

borne by the Private Sector?
Yes No

Slep 5 - Evaluate proportion of systematic risk

transfened by the Govemment

Source: "National Public Private Partnership Guidelines - Volume 5: Discount Rate Methodology Guidance",
Australian Government Infrastructure Australia, Dec 2008
)
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ior the World@

Exhibit 3
De termining the Disc ount Rate Based on Transfer of Systema frc .fusk
z Prqec
rate
Full Risk Transfer
,a
q, !E
l(D
.E
E
4
High Risk Transfer r3
.o,
T+
o l6'
o Mediun RiskTransfer _> t4
.g
o ,*
tE
o
.l'
ra
l=
G lE' EE:
uJ r= ;N O
l^ X- o
Rrsk rJ :E@
O u!
V BflH
Y Risk Transferred By Government Alltransfened bu6
>.6
lAo o
-i(
olo
The more systematic risk that is transferred to the private sector, the higher the discount rate should be Jo.9
6+ E
to evaluate private sector bids. Therefore, if little or no systematic risk is tansferred (i.e. the risk lr O
o o=
remains with the public sector) then the appropriate discount rate is correspondingly lower. If all ovo
QN o
60 0
systematic risk remains with the govemment, the discount rate to evaluate the private-sector bid >s6
-dE
should be the risk-free rate. 83F
Ero
L=o
oA@
Source: "National Public Private Partnership Guidelines - Volume 5: Discount Rate Methodology Guidance", eEe
Aushalian Govemment lnfrastructure Aushalia, Dec 2008 o E.s
E5E
oY?
4=b
. o-
Exhibit 4 EI.E
Plant I'ocation E&E
3eE
c
Plant locetion -Wonthaggi, Victoria Il
(L._
F] -,

.^.-; -

Wonthaggi'
/ .a-

_#
Transfur pipeline / Underground HVAC Transmission Line routes

Source: AquaSure

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--
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Exhibit 5
Project Milestones
Key milastones Datoltarget date
AquaSure narr,ed Preferr+d Bidder 30 July 2OO9

Firrancial Close 2 September ?009

Ccmmencement of Consiruction Octobe!'2OOQ

First Water prefi nrf nary Conrmercral AcceOtance) Noven:ber 2O11

i50GL compldted {Date for Comnrercial Acceptance} 1 I D€cember 201 1

Cor*missioning complet--d iDate for RT Finalisetioni 3O June 2O1 2 .F

"r& 6
Enc of Prgect Ter-n 2 Ociober 2039 E3:
XN o
U b)A\
NB: RT: Reliability Testing. O !c

Source: Project Summary for Victorian Desalination project

.:'g 8o
'6E
bu6

Exhibit 6 oro
J 6.9
Public Sector Comparator (PSC) 6+ E
trF O
o o!
o-o
Components of the Public Seclor Comparator (pSC) QN o
Net Present Cost $m oo o
>ry6
Hypothetical, risk-adjust€d sstimats of lhe mosl (150 GL output per annum) - oF
8.fl F
'd-f
efticient, likely and achievable form ol pubtic sector o
LFo
delivery.
9EP
2-F
Capital Costs J.1I Z C cc

Operating and Asset Replacem€nt Costs (27 years) 5> 3

2.602 oYi
9=b
,9n
Raw PSC 5,874 p!g
BtE
Transferred Risk 782 3;' [
<-
9€o
Competitive Neutrality r 9'o
0 o-d3
F]
PSC 6.656

Note the assumptions used to ealculate the PSC include:

. all numb€rs are expressed in net present values as at 30 June 2009.
. discount rate of 7.3olo {Real) to reflecl the nature of the project
. discounting basis: annual, period end.
' the transferred risk calculation of $782 million refers only to the risks transferred to the privale sector
under the Paftnerships Victoria arrangemenls fi.e. those risks that the State would othenvise assumei
and excludes the State's estimates of its retained risks)

' the competilive neutrality adjustmenl removes any net compelilive advantages thal accrue to a
government business by virtue of its public ownership

Public Sector Comparator AquaSure's Wnning Bid Saving

(Net Present Cost) (Net Presenl Coet)

$6.656 million $5,720 million 14.1V"

Source: Project Summary for Victorian Desalination Plant, Department of Treasury and Finance, Nov 2009

NB: The value of Transfened Risk refers to the cost the govemment is willing to pay to the private sector for
taking on those risks. In this case, market observers believed it referred to thi financing risks of the project,
taken on by AquaSure by procuring 100% committed financing prior to the final bid.

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'_
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Exhibit ?
Project Structure

I.fqff S-ih!
'$6& The $ets $q{4,
'!

;
sts!3trd
l,rssmlM
iJm glwilt 1

*$tGmtr tlltl .-;$ttsl6r

UClsBtrsrffi.rV DsgsnsrlTl6st.tr
{e*COorsrryEr} {&Hkrraq+
E
";N
-Q)*;
t.ra'&C i5flnd{G H&6
Esbfillrl*rr IrIffi*4
1*r4FF
:O EQ)
rC
E6SFrdrFu >98
'6^E O
FEi.:*rtri Ebsi'l. Sq$r t!6*!.1 buE
>.6
:lb a
olo
io-q
3?E
cr O
o oE
o+o
6N ,^
cr g
60 0
>qr6
Source: Project Summary for Victorian Desalination Plant, Department of Treasury and Finance, Nov 2009 -oF
gfiE
E-d
tL--.

ffi
o;o
(/).tr Q
fthttb.dqd' , -
o E.c
Su*uin&i$ty cc<
r*al Sd*in$trFEl 5>=
oYi
**,'*i* Lxngtftr&CF 9;b
. o-
',J,.{{',1:'r.ir *psEli?rai;d{t F *ifli:i FNE
{irrr-**t-:r'rr!y !iU!14n &.i*,"i13 f5ri4 l-in,fdnr}. M'rilfi BTE
irr{i*f!l!fiq$t tf1{-t lil{rpFrr{a*'d t{i{l*rr{l gfld 3eb
c
irlur fr.+*i *,tr {rtf!{rrrir}i#.Fil{Jlttt' I
(Lo-
=
lQUrfunr F=
..crfrF

Sffi:ii1n!&r. 06git!rtr6$l
tl.*-11g, :ir-. :1 l1 *rrirr{t!;dr,
#%
ilsqtei?afi
l:td?aLl'd,
t:

ll
E&is** sr!'!i6es.
[!d fir.*rnta nrrs*e

I
I

4'ffinffip
l"*'ar-r S*ry*m.:{l lttil*;lF
I

l
fHt[ts
Yl!igr$
f,f rmca
Ffrl:ri: t1* l*ffrr$s.hnll' !1efrn
F'rair+e ff C "+'?wtt i:r]a:itr'ite!!ri4 lJ*lr;is Arid Taritf lrt trplriFiJdtb?n ;ri* l"*x*r f*rSF

Source: Office of Water, Austlalia.

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-----
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Exhibit 8
Water Service Payments - Excerpt from Government Hearing

The CHAIR Can I ask you about the structure of the relationship between the state and AquaSure
with respect to- the paynents. There is the water usage payment which we touched on previously and
the water security pa;.ment. What are the factors that drive the amount of the water security paynent?

Ms MUNRO Again, I do not want to interpret the contract and that material is in the public
-
domain, but essentially it is provision that enables us to maintain the plant to a standard where it is
capable of delivering water should that be required. You can think of it as the kind of fixed cost that
you would have in many contracts which have a fixed and variable element. That is the element of it.

The CHAIR Is it a fixed cost or does it reflect your

actual maintenance costs as they vary?
- .tr
Ms MUNRO It does not reflect our actual costs. Clearly this was the core element of the subject of *?s g
the bid, but it -reflects, if you like, what could be expected to be an efficient cost, and therefore it is a
;oc
:N O
cost that the government felt was appropriate and in that competitive process delivered value, and at Fr6
o Lc
the same time it also enables us to stay in business provided we manage our assets efficiently. ;38
'4,! @
bu6
Mr BARBER But it is a fixed cost that varies with the amount of water that the government
-
chooses to order for that year, is that correct?
oJoa
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Ms MUNRO There are two elements. There is the element which is the security payment and there 5? E
is the element -which is the usage payment.
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Let us just focus on the security pa)ment. >Tb
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Mr BARBER But the security payment itself varies, given that it is an annual pal.rnent that is Q.n I
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struck at the beginning of the year when the govemance says how much it is going to order. The fixed
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payment itself is a different payment depending on whether the govemment is ordering 50, 100, 150 et
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Ms MUNRO As you have seen in the => i
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documents, the actual formula there is a complex
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formula to arrive allows for the passage of time and so forth, but my point
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remains that it is not derived from our actual costs and we are not able to pass on cost overruns or any E€E
of those matters to the government, so it is incumbent on us to manage our affairs efficiently to meet oo I
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Source: Inquiry into the business case for water infrastructure Melbourne, Standing Committee on Finance and
Public Administration, 17 June 2010

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