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American Shipper

Panama Canal silver lining?

Panama Canal silver lining?



By Eric Kulisch


The confluence of the global financial crisis and construction inflation raised questions last fall about whether the massive project to expand the Panama Canal would remain on track.   

      But administrators and others who have studied it say the Panama Canal Authority may be even better positioned today to complete the project on time and on budget.   

      Nonetheless, there is less certainty among the preferred bidders that they can successfully negotiate a fair contract and complete the job under existing economic conditions and terms offered by the canal authority. And sources from one construction team say it is still possible one or more groups will bow out of the bidding, thereby creating less competition for the deal.   

      The construction of a third set of locks, along with water-saving basins, is the most significant contract in the massive $5.25 billion project to widen the heavily used passage between the Pacific and Atlantic oceans for super-size containerships and increase its overall capacity. The new locks are designed to handle 12,000-TEU vessels, more than double the size of vessels that can currently transit the 50-mile canal. Dredging of access channels and dry excavation of a new lane is already underway under separate contracts.   

      In late October, the Panama Canal Authority (ACP) extended until March 3 the due date for bids to build the new set of locks for the canal.   

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      The ACP said it agreed to extend the submission date a second time after receiving requests from the four global construction-engineering consortia competing for the massive infrastructure project. The construction teams said they needed extra time to modify technical and price proposals in the face of volatile activity in financial and commodity markets.   

      Proposals originally were due in August, but the ACP in July extended the deadline until Dec. 10. It now intends to award the contract in June.   

      Several experts in the engineering, port and financial sectors who are familiar with the Panama Canal's operations cautioned not to read anything negative into the bid extension. Delaying a project of this magnitude a few months is not unusual given the ambitious timeframes, they say.   

   'In my mind, I see the Panama Canal expansion as a done deal. They don't need to borrow money because they've got cash flow and reserves. So there is zero worry that they can do the project,' said one official who asked to remain anonymous because his firm is not allowed to speak about consulting work it has done for the canal authority.   

      The ACP is in good shape financially and has an existing customer and revenue base, unlike typical greenfield projects hoping to attract business that can help fund capital investment.   

      In 2008, it had estimated revenue of $2 billion and net earnings of $1 billion. Revenue increased 11.3 percent largely on the strength of toll increases for refrigerated cargo and passenger vessels, despite a slight downturn in transits through the waterway. Growing ship sizes also offset fewer vessels because vessels are charged fees based on their carrying capacity. During the past three years, the average annual toll revenue has increased 13 percent. The ACP has more than doubled revenue since 2000 and consistently generated a profit, with a return on equity of 23 percent last year. It has $1.65 billion in cash on its books.   

      The last round of toll increases announced in 2006 are scheduled to kick in for different shipping sectors in May and October. Officials have not ruled out the possibility of new tolls in 2010.   

      'We have been analyzing future toll increases but have not made any firm commitment yet as to when or the amount to be assessed in the future,' Rudolfo Sabonge, the ACP's vice president of market research and analysis, said in an e-mail. 'We are meeting with the industry to exchange ideas but have not made any formal proposal regarding fiscal year 2010 and beyond.'   

      Based on the canal's management and performance, Moody's Investors Service has given it a strong 'A2' investment grade credit rating.

      The ACP will use money it generates from operations to pay more than half the cost of the project and finance the rest.



Commodity Relief. The canal is also benefiting from the steep fall in commodity prices that began mid-way through last year. Oil prices last July were above $140 per barrel and closed Feb. 6 below $41 per barrel on the New York Mercantile Exchange. Copper prices were above $8,600 per metric ton a year ago and have dropped to about $3,540 per ton. Steel prices plummeted from more than $1,000 per metric ton last summer to near $500 per metric ton. Cement prices are also coming down as worldwide production capacity rapidly increases while demand decreases. And aggregate is cheaper than it was last year.   

      The materials are used for construction and oil is a key component of expenses to transport them to the job site. Shipping rates have also plunged in recent months in response to the slowdown in global trade. Charter rates for dry bulk vessels are at their lowest levels in more than 20 years.   

      That's a big change from the past few years when construction price inflation, largely exacerbated by booming demand in China and India, averaged 10 percent to 20 percent per annum and significantly drove up the price of new buildings and infrastructure.   

      Another factor in the Panama Canal's favor is that there is now less competition for infrastructure development resources such as engineers, labor, equipment, materiel and financing. Construction, energy and other big projects around the world have been put on hold during the global recession. With fewer opportunities elsewhere, the big consortia bidding for the lock expansion are likely to view the job as a key revenue source rather than weighing whether to add another mega-project to their existing contract portfolio that might stretch their resources.   

      It's an opportune time to start the expansion because 'right now the list of infrastructure projects is going down by the minute,' Sabonge said at a mid-January port industry conference in Tampa, Fla.   

Sabonge

      However, China could change the dynamic again with its new economic stimulus plan that calls for a sizable investment in infrastructure.   

      The construction slowdown due to the credit crisis has an upside by clearing the market of less worthy projects and allowing resources to be devoted to better prepared projects that have a stronger economic rationale, said Martin Bright, director of transport planning for Faber Maunsell Polska, in mid-December at an infrastructure conference in Washington. Faber is a Warsaw-based unit of engineering firm AECOM.   

   The supply and demand environment at the commodity and project levels is expected to keep a lid on the expansion cost.   

      'We will see better pricing and proposals for construction of the expansion as commodity prices for materials like oil' come down, Sabonge said.   

      The ACP was also able to obtain good loan terms and keep its financing costs low.   

      Five multilateral lending agencies from Europe, Asia and Latin America have offered $2.3 billion in financing to help the government of Panama expand the canal. Pledges have come from:   

      ' Inter-American Development Bank, $400 million.   

      ' International Finance Corp. (World Bank), $300 million.   

      ' European Investment Bank, $500 million.   

      ' Japan Bank for International Cooperation, $800 million. (Half the loan comes from two commercial Japanese banks, but will be managed by the JBIC.)   

      ' Corporaci'n Andina de Fomento (CAF), $300 million.   

      The loans follow a private sector financing model without sovereign guarantees by the government of Panama.   

      'The cost of debt is a lot less than we had anticipated, which should help the financial viability of the project,' Sabonge said.   

      The terms ' 20-year loan with a 10-year repayment grace period, with low interest rates based on the London Interbank Offered Rate (LIBOR), and lower commitment fees and commissions ' were better than those offered by commercial banks, according to the ACP.   

      The grace period allows the canal to reschedule or postpone payments in case volumes don't come through as quickly as anticipated.   

      Obtaining the loans at a time when banks are raising their risk standards 'tells you even in these very dire conditions, good projects can close,' Francisco Wulff, director of infrastructure analysis at CAF, told American Shipper.

      CAF, also known as the Andean Development Corp., is a bank controlled by several South American countries.   

      'The current operating revenues of the canal without the expansion are sufficient to cover the obligations with the lenders. They don't need to generate revenues from the expansion to repay the loans,' he said.   

      Although the ACP makes enough money to pay for the expansion out-of-pocket, borrowing allows it to cover part of the cost with new revenue streams from the project rather than tap current revenues used to make payments to the Panamanian treasury and to fund other investments and ongoing operations.   

      Other benefits of borrowing include spreading the cost to future users of the canal and ensuring smooth cash flows by creating a financial buffer against economic downturns that might lead to unplanned toll increases or construction delays that could harm global traders that rely on the waterway.   

      The backing of lending institutions is also important for giving contractors confidence that the ACP can pay them at a time when cash-strapped governments around the world are canceling and delaying projects, or asking contractors to take reductions in payments.   

      'If you have the assurance you can make the payments, then if the contractors have cash needs they can borrow against that cash-flow promise and stay in business,' said an analyst familiar with the expansion.   

      The ACP issued a statement Feb. 10 reiterating that the selection process will be 'fair, rigorous and transparent.' The submissions will be divided into price and technical proposals. The price proposals will be moved to an independent location and will not be reviewed until the technical proposals have been evaluated and graded, it said. In addition, it hired the giant Deloitte accounting firm as contracting auditor to certify that the ACP follows proper procedures in evaluating the technical aspects of the contract.   

      'As the largest and most important contract under the Canal Expansion Program, the ACP has taken additional measures to ensure that the contracting process is airtight, complies with Panamanian law, and is managed by experts and audited by a third party to certify thoroughness and transparency,' Administrator Alberto Al'man Zubieta said.   

      The ACP made no commitments to buy goods or services from a particular source, or contract with any country or financial institution, according to its annual report. That's important because Japan, more so than most other westernized countries, has a history of pressuring project developers it backs financially to hire Japanese firms to do a large part of the work, according to a port industry official familiar with infrastructure financing who spoke on background because he didn't want to damage ties with the canal authority.   

      Japan is the fourth-largest user of the canal in terms of tonnage and has been interested in pushing expansion of the canal for more than a quarter-century.   

      Resisting that type of pressure will be critical to ensuring strong proposals, the port industry official said.   

      The service provider knowledgeable about the inner workings of the ACP said the agency has been transparent, professional and able to prevent any leaks of confidential information throughout the bid process.   

      'There are developed countries that don't handle things that well,' he said.   

      ACP officials remain confident that the expansion plan will remain on track despite the turmoil in the global economy. They claim they have studied the issue from every angle with the help of more than 120 separate feasibility and business studies.   

   'We have made provisions for any contingencies. As such we have amply prepared and planned for every scenario. The ACP understands that the world economy goes through cycles and this is a long-term project in which these scenarios were taken into account. This is a seven-year program to be paid off in 20 years,' a spokesperson said via e-mail.



Winds Of Caution.    In December 2007, the ACP selected four giant consortia as pre-qualified bidders to design and build the new locks. The turmoil in financial and commodity markets is forcing infrastructure developers to take more time to double-check their cost assumptions before moving ahead with major projects.   

      Sabonge said the 23 amendments to the original request for proposals, the most recent of which was issued in early February, are designed to remove any complications for the bidders without compromising the ACP's performance requirements. Some of the new amendments deal with bonding and insurance requirements.   

      But a high-level source within one of the consortia indicated that the contractor teams have been pressing since March 2008 for the ACP to share more of the construction risk.   

      Submitting a bid for a massive project like the Panama Canal locks is an expensive proposition. The bid preparation cost, including preliminary design, for each of the teams is a minimum $13 million to $15 million, according to two sources involved with the process. They spoke on background so as not to jeopardize efforts to win the contract.   

      Before taking on a project of this magnitude, infrastructure builders, many of whom are experiencing profit declines in the current environment, want to make sure they have a good handle on how much costs might escalate and how much risk to price into their offers. The drop in commodity prices, for example, could be temporary and may not last for the project's term. Contractors could also encounter different soil conditions or other unanticipated factors that result in change orders.   

      In a design-build project the contractor normally takes all the risk of designing and building the project, and the customer just buys the finished product. By going that route, the ACP transferred the risk of uncovering unknowns to the bidder and put a cap on how much it is willing to pay, meaning the bidder would have to eat any cost overruns.   

      ACP officials say they are working to alleviate concerns on both sides.   

      The latest amendments attempt to help spread the bidders' risk and get them quicker reimbursement for costs, according to industry and ACP sources.   

      But the consortium official said the risk-sharing is still very limited and heavily weighted toward the construction firms considering the size of the contract.   

      The drop in commodity prices may help keep direct costs low at the moment, but the syndicates are skittish about taking the risk for tendering a lump sum bid for five years or more without adequate escalation clauses in case the price of steel, cement and other materials go up, he said.   

      'The proposed compensation rule is not at all satisfactory,' the official said.   

      He also expressed frustration at the continuing changes and the lack of a 'final' RFP that addressed bidder concerns at the outset. As of mid-February the ACP had yet to issue a final RFP. The industry source said the ACP has created great uncertainty by repeatedly changing the contractual requirements.   

      And he questioned the ACP's effort to get all four consortia on the same page by submitting bids without any qualifications ' referred to as a compliant, or responsive, bid.   

   'For such a huge and risky project there is no way to have a bid without qualifications' because it is impossible to get all the bidders to agree in advance on every term, the source said. 'ACP cannot use the same tendering process they are used to for other standard projects. This project is unique and should have been tendered under other principles and managed differently as well.'   

      Meanwhile, the economic slowdown is affecting in different ways the credit and bonding capabilities of the consortia to comply with the requirements of the RFP. The winning bidder in large-scale projects normally must post a performance bond that essentially acts as a guarantee that there will be funds from a third party to cover uncompleted work or liabilities should the contractor go out of business. In the case of the canal, administrators are seeking more than $400 million in bond coverage.   

      Other upfront costs sought by the ACP are a $50 million bid bond (originally $100 million) designed to ensure the winning bidder signs the contract within a certain period and a $50 million payment bond. The existence of a bid bond provides the owner with assurance that the bidder has the financial means to accept the job for the price quoted in the bid. A payment bond guarantees the contractor will pay parties who supply labor, material, equipment and supplies for the project.   

      The bond requirements pose a big risk to the construction teams because they have to pay a percentage of the coverage amount as a premium. The bonding amount is so large for the canal job that it can tie up a contractor's bonding capacity, another source for a different company within the same consortium said. That means the contractor could find it difficult to obtain other business during the duration of the multiyear project because surety companies will see that the applicant already has reached an acceptable debt, or risk, threshold and won't write a new bond.   

      Complicating the situation is the fact that two of the consortia leads are suffering from the severe downturn in the Spanish economy and are on shaky financial ground. The Spanish landscape is dotted by half-finished housing projects that have been abandoned by builders facing a credit crunch and fleeing consumers.   

      The Grupo Unidos por el Canal consortium is headed by Spanish construction firm Sacyr Vallehermoso S.A., which has taken a hit from overexposure to the crumbling housing market in Europe, and may have trouble borrowing money. The fourth-largest construction and infrastructure concession group in Spain is laboring under a huge debt burden and has been forced to sell, or consider selling, parts of its business and abandon a public offering for its toll road business in order to raise cash.   

      ACS Servicios, Comunicaciones y Energ'a, S.L.v, is the prime contractor for the Consorcio C.A.N.A.L. Spain's largest construction and engineering group is also in the process of unloading non-core businesses, including several port concessions.   

      Both companies are trying to sell toll road assets as traffic volumes in Spain and other countries have declined.   

      The second syndicate source credited the ACP for backing off some initial onerous requirements, including that the entire responsibility for the smooth operation of the locks must fall on the contractor and that bonds could only be obtained from American-registered sureties. The ACP has since agreed to take some responsibility for the locks meeting specified cycle times and will allow bonds to be obtained from London-registered brokerages as well.   

      And the ACP has agreed to provide a $5 million stipend to each losing consortium that submits a compliant bid, according to Jorge Quijano, executive vice president for engineering and administration.   

      Although the ACP has responded to the pushback from the various contractors, questions remain whether the revisions are extensive enough.   

      The primary industry source said it is still unclear whether his syndicate will proceed with a bid because of the cloud of uncertainty.   

      Under the circumstances it becomes a real crapshoot for the consortia. Do they submit a bid with contractual qualifications and hope their competitors do the same thing so they are on an even playing field? Or does doing so risk getting them automatically thrown out of the selection process and losing millions of dollars in preparations?   

      'It's not uncommon for contractors to pull out at last minute. It's sometimes better to write off the cost to that point than run the risk of winning the contract,' one participant in the process said.

      'The question is where does it end up on the due date? How many boxes of documents are going to show up on their desks and will the answer be acceptable to them (the ACP).'

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