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Africa could learn from Asia’s success with logistics corridors

10 January 2018
– 6 Minute Read

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There are important lessons Africa can learn from the success of Asia’s developing economies. Arguably the single biggest catalyst that propelled India and Malaysia to high-growth economic status was their successful introduction of transport and logistics corridors, leaving no corner of their countries unconnected.

The Malaysian economy was literally transformed by the North-South Expressway, a rail corridor connecting all of the country’s states and pushing across the border into Thailand.

Before the Expressway was up and running, Malaysia’s seven states were achieving GDP growth of between 3.9% and 5% in the period from 1989 to 1993.

After the expressway started operating, the states’ growth surged to between 7.1% and 7.7% throughout the period from 2000 to 2013.

Granted, other factors also came into play, such as Malaysia’s technology-rich economy, but its logistics corridors are key in allowing the transport of labour and interregional trade.

The same goes for India, which has 65 000 kilometres of railroads traversing three million square kilometres of land. Compare that to Africa, which has a landmass of 30 million square kilometres but only 66 011 kilometres of railroad – most of it concentrated in coastal areas.

The establishment of successful corridors in Africa could trigger a similar transformation on the continent – but only if investors can be persuaded that such corridors would be a safe and sound investment.

Biggest deal-breakers

World Bank investment surveys have repeatedly shown that protection of their legal rights is the overriding concern of investors when making decisions about where to undertake major infrastructure projects. These concerns outstrip all other considerations, including consumer payment discipline (a close second), government guarantees, government efficiency and the judiciary’s independence.

Corridor projects can be potentially high-risk investments because they are expensive and typically involve a multiplicity of stakeholders, from lenders, ship owners and rail operators to buyers, ports authorities and governments, and often have a cross-border component that can be difficult to manage.

From a coordination perspective, the African Union and the continent’s regional economic bodies would probably be best placed to manage the overall development of such corridors.

From the point of view of derisking corridor investment on a contractual level, there is much that an investor can do to build in proper recourse to the courts and secure compensation should things go sour.

Challenges linked to full concessions

The starting point is to be aware of the challenges around a typical build, operate, transfer (BOT) concession model, where the landlord retains ownership of, for example, the port terminal that is being built.

In the full concession model, a major problem is obviously that the operator, lender, sponsor or developer cannot take security over the port infrastructure.  In addition to the usual security taken over revenue flows from throughput agreements, the best way to overcome this would be to obtain government guarantees. If these are not forthcoming, investors and lenders could be excused for displaying a healthy scepticism as to the soundness of the investment.

Avoid traffic guarantees

Operators should be wary of contracts binding them to certain volumes of traffic using or passing through the facility. For example, eight or nine years ago, coal was riding the crest of a wave, but then the price plummeted. Many traders chose to sit on their coal stocks, hoping prices would pick up. The flow of coal through logistics terminals all but dried up, leaving providers who had agreed to traffic guarantees in a precarious position.

Back-to-back arrangements would be a better option than traffic guarantees, enabling providers to escape the vagaries of commodity price fluctuations.

Take all costs into account

Logistics terminals cannot function without infrastructure such as quay walls, which more often than not the operator is expected to pay for through private investment. This infrastructure is not an asset for the operator, and neither does it generate revenue, but it is essential to the operation nevertheless. The operator must ensure that these expenses are appropriately built into the financial model and concession agreement.

Similarly, the operator must make provision in the contract for any superstructure (such as locomotives, wagons, tipplers and ship loaders) that it is expected to pay for.

Watch out for tariff control

For the bankability of a corridor project, pricing to the user is critical. A potential pricing pitfall is the existence of tariff control, which could result in investors severely burning their fingers if the powers-that-be decide to change the tariffs charged at terminals. This happened in Nigeria in 2015 when, in the absence of a ports authority, the shipping council was made the interim regulator. It promptly reduced users’ rates to 2009 levels, plunging port providers into a financial crisis. The key here is to build watertight pricing safeguards into the concession arrangements.

Biggest sticking point of all

There are of course many other contractual issues that operators should be aware of, such as fixed costs versus variable costs, but the biggest sticking point of all is probably the question of compensation on termination of the contract. It is vital to ensure that agreement is reached as to what compensation is payable, to whom and when.

There are three possible default scenarios:

  • Institutional default, such as if the facility is expropriated mid-term for any reason. Provision should be made in the contract for the operator and lender to be fairly compensated for their investment and funding over the duration of the concession period.
  • Operator default, which might arise for instance if traffic to and from the facility dries up and the operator is unable to continue with the concession. Here, it is important to ensure that the lender is adequately compensated, but also that the landlord or grantor of the concession does not make a windfall gain. There should also be a punitive element, in the form of a disincentive such as a discount on full compensation, so that it is not too easy for the operator to just walk away.
  • Force majeure, such as where a war or environmental pollution makes a facility unusable early on in the concession. While it could be argued that such an event is simply “bad luck”, it should not result in the landlord receiving a windfall gain at the expense of the lender and developer, and the risk should be shared on both sides through a fair compensation formula.

Handled appropriately, the various contracts and projects that make up a bigger corridor project could help close the logistics gaps that are now so common across Africa, and give investors peace of mind that their legal rights will be protected. As always, the devil lies in the detail.