Project bonds threaten financial and real earthquakes

The use of one of Europe’s first project bonds to help finance a gas storage plant off Spain’s coast has run into trouble. This does not bode well for the future use of such bonds, or the types of project that they are being used to finance, write Elena Gerebizza and Xavier Sol.

“It was not supposed to be like this. In July this year, the European Investment Bank and the European Commission hailed the first project to be financed under the Europe 2020 Project Bond Initiative. The honour of being the first such pioneering investment fell to the €1.7 billion Castor underground gas storage plant off Spain’s Mediterranean coast. Welcoming the deal, European Commission vice-president Olli Rehn noted that "The project bond initiative is an innovative way to unlock private investment in infrastructure and a key element in helping to boost growth and jobs.”

More prosaically, the initiative depends on public funds being used to improve the solvency of both companies and projects by allowing constructors to improve their access to credit for the financing of proposed projects – usually very large scale ones.

Yet by mid-September, the Spanish government was forced to halt work at the Castor plant after 220 mini earthquakes in the area had been detected in less than a month. Local residents reported the tremors following injections of natural gas to prepare Castor for use.

Work at the site has not since restarted, and speculation is mounting that the project may be halted for good. If Castor is scrapped then there are big uncertainties about who will foot the bill, especially under the new project bonds scheme. €1.4 billion worth of these bonds were issued in conjunction with the European Investment Bank (EIB) – initially issued with a BBB+ credit rating, ratings agency Fitch has since put the bonds on negative watch as a result of the suspension of operations, and has commented that it could downgrade the bonds if work is delayed beyond May 2014.

Of major concern for Spain’s beleaguered taxpayers is that, under the terms of the project contract and a royal decree arranging the Castor concession, the Spanish government is obliged to reimburse the operator Escal UGS, owned by Spain’s ACS and Canada’s Dundee Energy. This compensation clause remains shrouded in some mystery and much controversy – Spain’s Industry Minister José Manuel Soria has challenged the terms of the compensation contract at the Spanish Supreme Court, calling them "damaging to public interest", but the court rejected the appeal in a ruling made just last week.

The Castor project, on the planners’ table for some years now, had simply not been an affordable investment for Spain to advance due to the acute economic problems it has faced as a result of the financial crisis. The project bonds initiative was thus deemed to be an investment solution for Castor, another form of supposedly beneficial financial engineering if you like, and a further nine energy and transport projects in six EU countries have been cleared by the EIB for project bonds medicine. If Castor is anything to go by, however, the project bonds approach could simply end up exacerbating member states’ troubled finances, and see huge project costs being dumped onto unsuspecting European taxpayers.

Because what is being attempted by the European Commission, with the assistance of Europe’s public bank the EIB, is the transformation of infrastructure into an ‘asset class’, where clarion calls from the likes of Commissioner Rehn about the social and economic benefits of these major new projects conceal the extent to which the private sector is being offered a monumental leg-up with public money guarantees.

The scale of what is being attempted was further illustrated this month by energy commissioner Günther Öttinger’s unveiling of the long-awaited list of ‘Projects of Common Interest’ (PCI) – a 248 project shopping list of energy infrastructure projects eligible for speeded-up EU funding to the tune of €5.8 billion in the next seven years, with the project bond mechanism expected to play a role alongside traditional EIB and commission financing.

Yet far from being strategic, this whopping great list displays a marked bias in favour of huge fossil fuel infrastructure, including the likes of the Trans-Adriatic pipeline that would see Europe further cement ties with the oppressive Azerbaijan regime, with Öttinger also dropping hints that the EU’s pursuit of Turkmenistan’s hydrocarbons is far from over. The EU gas demand assumptions underpinning the PCI list would look to be almost twice the rate estimated to be necessary by the International Energy Agency.

An additional concern involves the highly preferential environmental clearance that PCI project promoters will enjoy under newly tailored EU law. So vital are these projects deemed to be that accelerated, ‘streamlined’ environmental impact processes are now deemed acceptable – the rationale appears to be that there should be no major barriers to the implementation of these projects, despite a number of proposals already attracting resistance from communities across Europe.

And the Castor project experience in Spain ought to make it abundantly clear that these high risk projects can, and most often do, pose a huge threat to the environment and people’s lives – indeed, the EIB’s due diligence for Castor remains a curiosity, though doubtless the bank would repeat its standard refrain that it operates at the cutting edge of environmental expertise. Environmentally and financially, then, these type of projects present major risks, and thus, as commissioner Öttinger has made plain, they need public backing. The public, though, should not be having to contend with financial and real earthquakes in return.”