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1	Фамилия, имя, отчество автора (ов)	Алигажы Айжан (Aligazhy Aizhan)
2	Название статьи и количество страниц	The efficiency analysis of the infrastructure investments under Public-Private Partnership: heat energy case-study
3	Название конференции и секции	Инвестиционный анализ, экономика/финансы
4	Место учебы (полное название учреждения, без сокращений),	Казахский Гуманитарно-юридический университет (КазГЮУ) Kazakh Humanitarian Law University (KazGUU)
5	Должность, ученая степень, звание	Магистр, «Финансы», на стадии получения данной степени
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7	E-mail	aizhan11ali@gmail.com
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The efficiency analysis of the infrastructure investments under Public-Private Partnership: heat energy case-study

А. Aligazhy

Kazakh Humanitarian Law University (KAZGUU)

aizhan11ali@gmail.com

Abstract

The scientific article contains quantitative research on financial performance of a potential investment project in heat energy industry under so-called Public-Private-Partnerships (PPP). The research objective is to establish if investments in heat energy industry are financially attractive for private sector. Attractiveness and efficiency of investments in heat energy were measured by one of the most applied financial metrics among business dealers – Net Present Value (NPV). Calculations of NPV was made by using discounted cash flow model. As such infrastructure projects traditionally long-termed with 8-10-year maturity (pay-back period) financial statements for the project with 15 years long forecast model was built. In order to test achieved financial result on sustainability and sensitivity four key assumptions were selected for sensitivity analysis. Results demonstrated that heat energy tariffs are the most influential variable on NPV.

Introduction

Since 80-s governments started actively cooperate with private sector by attracting their resources in infrastructure projects under so-called Public-Private Partnerships (PPP).

In general, PPP is a system of medium- and long-term relationships between the state and the private sector for the provision of business on behalf of the State of design, financing, construction, reconstruction, rehabilitation, operation and maintenance of facilities.

The main objective of launching a public-private partnership is the development of infrastructure in the public interest by bringing together the resources and expertise of government and business on mutually beneficial terms, the realization of socially significant projects at the lowest cost and risk provided that the economic operators of high quality services. 

Investments in infrastructure, especially in energy requires huge financial expenses, while its pay-back period is long-termed as mentioned above. For instance, according to The International Energy Agency (IEA) estimates that globally US$38 trillion must be invested in energy supply infrastructure from 2011 to 2035—with US$17 trillion going just to the power sector. On top of that, enormous sums will be needed in the power sector to handle additional investment needs stemming from the green growth agenda and related policies. [1]

Today Kazakhstan also faces challenges of modernizing infrastructure, building new facilities that require big amount of long-term investments., required capital investment in the generation of heat energy and electricity in Kazakhstan is estimated at more than $ 21 billion. [2]

Currently country’s heat energy infrastructure suffers from physical and moral obsolescence that increase amount of technical heat losses. There are a lot of regulation barriers for new players to enter the market, traditionally low tariffs.

Budget insufficiency pushes governments to involve business sector’s resources to develop infrastructure projects. In this regard, Kazakh government also started to promote this form of partnership by passing new laws, adopting government programs. Among them are the state program "Energy 2020", “Nation’s 100 concrete steps” and the new Law on PPP from November 2015 [3], all of them consider governmental grants, technology business incubation, preferences, tax breaks.

Thus, investments under PPP are becoming a subject of stormy discussions both in private and public circles. There a lot of technical and economic reasons why new investments are not coming to Kazakhstani power sector, business sector still has huge confuses on economic efficiency of such investments despite of provided governmental incentives.

Based on this issue, I tried to analyze financial (quantitative) benefits for private sector applying governmental incentives provided by law. The analysis implies financial performance of a potential investment project under PPP that aimed to modernize infrastructure in heat energy industry.

The research objective is to establish if investments in heat energy industry are financially attractive for private sector. Outcomes of this insight will be applied to analyze what criteria shall be met by government officials who form the policy in PPP sphere to make such investments beneficial in Kazakhstan. Likewise, results of the research might be notable for potential Small Power Producers.

In order to answer this question, I analyzed the following:

· Common conception of PPP and its experience.

· Current problems and potential of power sector in Kazakhstan.

· Sources of financing infrastructure projects.

· Financial statements and their forecast.

· NPV calculated through Discounted Cash Flow Method.

· Key aspects that impact on decision making process through sensitivity test

Methods and models

Valuation analysis is used to evaluate the potential merits of an investment or to objectively assess the value of a business or asset. Valuation analysis is one of the core duties of a fundamental investor, as valuations (along with cash flows) are typically the most important drivers of asset prices over the long term.

Business decisions, and particularly financially related business decisions, depend heavily on forecast of future events. In that fashion, decisions to lend money or borrow money depend on forecasts of future cash flows and expected returns.

Forecasting is central to economic and financial decision-making. Government institutions and
companies in the private sector often base their decisions on forecasts of financial and economic variables.

The efficiency analysis will be conducted by computer simulation of the forecast project in excel using "realistic" scenario for getting the most objective picture of the project.

The modeling is necessary to construct the forecast of financial cash flow statement and income statement. Further received reports will make it possible to build a Free Cash Flow to Firm (FCFF), which the project will generate. The results of financial modeling will be the achievement of such financial metrics as the WACC, cost of equity and cost of debt and NPV.

The evaluation of capital investments is focused on the question whether investing in a certain project makes economic sense. The DCF analysis is, at least when large capital investments (under certainty) are valuated, the most common concept applied today. [4]

The DCF analysis is based on the calculation of the present value of the future cash flows, i.e. the future cash flows are estimated and discounted. The sum of all discounted cash flows, both incoming and outgoing, is the NPV. The basic decision rule underlying the NPV method is going forward with projects that have a positive NPV and rejecting projects with a negative NPV. [5]

The aim of this chapter will be to calculate NPV to the project, and then to come to an analytical advice whether to accept or reject the investment project in heat energy sector based on financial discounted cash flow valuation method.

In order to calculate NPV the following appraisals should be made:

· Cost of equity (CAPM)

· Weighted Average Cost of Capital (WACC);

· Free Cash Flow to Firm (FCFF);

· Enterprise Value (EV).

In order to check the financial stability of the project will be carried out sensitivity analysis and stress test. Through this testing will be determined the maximum allowable tariff price, the volume of sales (heat production), cost of equipment (CAPEX) and raw materials (the OPEX), determined the break-even point for the project.
The basis of modeling techniques formed the scientific work

The scientific works professor of finance at the Stern School of Business in New York University formed the modeling techniques for the research. [6]He is best known as author of several widely used academic and practitioner texts on Valuation, Corporate Finance and Investment Management. Damodaran is widely quoted on the subject of valuation, with "a great reputation as a teacher and authority". He is also known as being a resource on valuation and analysis to investment banks on Wall Street. [7]

Data for forecasting and modeling is based on assumptions.

RESULTS

Sum of project’s all present values is equal 2 221 378 thousand tenge, which is the project’s NPV (see Annex 1). According to NPV rule that project is recommended to accept it. Moreover, the project’s NPV is completely for from being zero and this interprets the project has a good level of financial reserves.

From calculations made in this chapter it is determined that project in heat energy industry under small generation facilities might have NPV more than 2 trillion tenge.

In order to test NPV on sustainability it was relevant to apply sensitivity analysis on key economic metrics of the project.

For a sensitivity analysis, were chosen such parameters as:

· Tariff price on generation, transmission & distribution of the heat energy;

· Number of heating objects;

· Capital expenditures;

· Interest rate.

Tariff and number of heating objects

Таблица 1 Sensitivity test on tariff and number of heating objects

NPV, 000 KZT 2 221 378		№ of heating objects, units	№ of heating objects, units	№ of heating objects, units	№ of heating objects, units	№ of heating objects, units	№ of heating objects, units
		480	560	640	720	800	880
Tariff,	Scenario 1	-3 719 759	-4 330 879	-4 941 999	-5 553 119	-6 164 239	-6 775 359
Tariff,	Scenario 2	-2 310 788	-2 687 080	-3 063 371	-3 439 663	-3 815 954	-4 192 246
Tariff,	Scenario 3	-984 143	-1 140 519	-1 296 891	-1 453 271	-1 609 638	-1 766 010
Tariff,	Scenario 4	187 483	225 883	264 288	302 683	341094	379 500
Tariff,	Scenario 5	1 316 006	1 542 345	1 768 691	1 995 026	2 221 378	2 447 724
Tariff,	Scenario 6	2 441 507	2 855 411	3 269 321	3 683 220	4 097 136	4 511 046
Tariff,	Scenario 7	3 566 920	4 168 392	4 769 871	5 371 339	5 972 824	6 574 303

As can be clearly seen from the above sensitivity analysis, a 10% decrease in the initial rate (at constant amount of 800 units of objects) has led to a reduction in the NPV of almost 7 times from 2,221,378 thousands KZT to 341 147 thousands KZT. At 20% reduction in the cost of heat energy NPV is negative and declining a hundred times with the previous indicator - 1,609,582 thousands KZT. On the contrary, 10% increase in the rate led to an increase in NPV almost doubled, amounting to 4 billion KZT.

NPV is less sensitive to changes in the number of objects compared with the change in the cost of payment for the same interest. For example, a 10% reduction in heating buildings decreases NPV for a number - 10%, respectively 20% reduction results in a corresponding change in the NPV

CAPEX and interest rate

As mentioned earlier, infrastructure projects are usually very expensive due to the high capital costs. In this connection, payback period of these projects have been delayed for 8-10 years. Accordingly, the loan funds for infrastructure projects are taken on the purchase of capital assets.

In this project, it was assumed that the rate of interest is expected to be 9%. However, the financial world is so dynamic and integrated that banks often can change this rate depending on both the internal and external factors. Therefore, the rate of interest may be uncertain and volatile variable. Also, as we know from the course of Finance, rather than risk a project, the greater the premium demanded by investors projects. This sensitivity analysis is carried out to verify the stability of key parameters of the project. Their resistance can have a positive impact on the interest rate.

One of the key parameters in the project - capital costs for the purchase and installation of Autonomous Heating Systems, whose cost, unfortunately, is also not fixed. If in the case of the tariff and the amount of heated objects, the proponent of a self-set prices and claimed amounts, in case of AHS and interest rate conditions are directly dictated by the supplier. Regarding the cost of the AHS was installed price 12b5 mln KZT. However, according to data from respectful agency Global Insight demonstrates that annual consumer price index in Kazakhstan in 2016 was 10%. This data pushes me to apply sensitivity analysis on NPV toward changes of AHS prices.

Таблица 2 Sensitivity test on AHS price and interest rate

NPV, 000 KZT	Price of 1 AHS, thousands KZT	Price of 1 AHS, thousands KZT	Price of 1 AHS, thousands KZT	Price of 1 AHS, thousands KZT	Price of 1 AHS, thousands KZT	Price of 1 AHS, thousands KZT
2 221 378	11 250	12 500	13 750	15 000	16 250	17 500
8%	2371645	1667811	963977	260144	-443690	-1147524
9%	2372147	1668367	964587	260807	-442973	-1146753
10%	2372650	1668923	965197	261471	-442256	-1145982
11%	2373153	1669480	965807	262135	-441538	-1145211
12%	2373655	1670036	966418	262799	-440820	-1144439
13%	2374158	1670593	967028	263463	-440102	-1143668

Interest rate doesn’t change NPV to negative meaning when it grows until almost 50% present. In comparison to interest rate growth NPV more sensitive to capital expenditures growth for the same percent. For instance, rise in price of Autonomous heating systems of more than 30% makes the project not attractive for investments.

To summarize the results of sensitivity analysis of key economic metrics on NPV meaning it can be seen that changes in tariff prices affects the project’s efficiency considerably in comparison with another determinants such as CAPEX, interest rate. The second influential metric is number of heating objects and also may change NPV to negative number.

Discussions

Our analysis shows that despite of existing such unpleasing factors as capital-intensiveness, therefore long-term maturity, high technique losses of heat energy, entrance barriers to the market, low tariffs, relatively high interest rates in heat energy industry, investment projects under PPP still can be profitable for private sector and generate positive high NPV.

As the frame of the analysis was limited by Small Power Producers market, inference conditions are suitable for that market’s facilities.

Therefore, it was concluded that certain conditions should be met to get positive NPV for such projects. Sensitivity analysis results indicated that the most critical condition for financial stability of the project is tariff rate.

Traditionally low rates of heat energy in Kazakhstan makes this area less attractive for investments of the private sector. Moreover, any increase in price of the tariff must undergo a long negotiation and proving process with the governing body of the natural monopolies - Committee on Regulation of Natural Monopolies and Protection of Competition (KREMZK). The process of justification of rate increases or setting initially high rate may be rejected by the regulator to protect the interests of consumers, while the next application is representative of private sector may be considered only after 6 months, which does not guarantee that the price for this in the tariff is approved. [8] Such pressure from the regulator is very undesirable phenomenon to create a favorable investment climate in the thermal power industry.

Small Power Producers (PPP) compared to large monopolies that have existing long period on the market, are more vulnerable and less authoritative in the promotion of their interests before the committee.

However, the financial viability of SPP is most dependent on the price of the tariff, as the financial efficiency per 1 unit of product sold is extremely high. This type of companies do have an incentive to deploy its activity only at high rates. If a large monopoly can obtain the necessary income due to the large scope of the market and a large amount of energy transferred from one customer, SPP due to small number of market share and generation of small amounts of energy can not derive substantial benefit from the so-called "economies of scale".

In this regard the role of tariff level is becoming crucial in decision making process for potential investor whether to enter the market or not. High tariffs are huge stimulus to be a private partner in infrastructure project.

The policy developers in PPP should take into consideration this fact and collaborate with regulatory bodies in natural monopolies sector.

Table 1 Present Value of the project's Free Cash Flow

Forecast year	FCF	Discount rate	PV
2017	(1 250 000)	(1+	1 126 126
2018	(2 326 015)	(1+	1 887 846
2019	(5 668812)	(1+	4 144 986
2020	1 608 819	(1+	1 059 779
2021	1 877 066	(1+	1 113 947
2022	1 911 240	(1+	1 021 827
2023	1 945 384	(1+	937 011
2024	1 986 115	(1+	861 828
2025	2 027 351	(1+	792 542
2026	2 068 391	(1+	728 455
2027	2 130 493	(1+	675 970
2028	2 131 440	(1+	609 253
2029	2 201 777	(1+	566 989
2030	2 262 615	(1+	524 915
2031	2 334 026	(1+	487 822

Literature review

[1] International Energy Agency (IEA), 2011. Research on PPP.

[2] Analytical research «Electricity Governance Initiative in Kazakhstan”, prepared by analytical service of Peter Svoik, “Democratic expertise” entity, 2013. p.23

[3] Law of Republic of the Kazakhstan “On Public-Private Partnerships”, №379-V dated October 31st, 2015

[4] Cf. Graham & Harvey (2001) for a survey on the valuation methods.

[5] Cf. for example Ross et al. (2005), Copeland et al. (2005), and Brealey et al. (2007) for a discussion of the NPV method.

[6] A.Damodaran, “Investment valuation: Tools and techniques for determining the value for any asset”. 2015, 3rd edition.

[7] qfinance.com Archived September 11, 2010, at the Wayback Machine.

[8] Law of the Republic of Kazakhstan “On Natural Monopolies”, 9th of July, 1998, №272-I