Galapagos is a relatively small island in the republic of Ecuador with an estimated population of about 25 million. According to recent UN (UN Water) estimates, between 20% - 30% of the population mainly in urban Galapagos have access to potable water, making water supply an important political issue in this tropical state. Experts believe that effective and efficient water supply can only be achieved via public-private-partnership (PPP), to which the government is receptive. An estimated US$2 billion investment is required to adequately address water problems. The Galapagos State Water Co. (GSWC) is responsible for urban water supply while the Rural Water Supply Agency (RWSA) caters for the rest of the Galapagos society. The amount and distribution of rainfall is adequate but water resulting from traditional water harvesting and treatment techniques is insufficient and sometimes unwholesome for the densely populated urban communities including Nangala, the state capital. Moreover, the provision of treated water has been identified as one of the instruments for the promotion of a healthy Galapagos. All water bodies in the country are vested in the Galapagos Natural Resources Authority (GNRA) while the Food Administration of Galapagos (FAG) and the Galapagos Standards Commission (GSC) are responsible for licensing of water processing companies and quality assurance respectively. All environmental issues are under the authority of Galapagos Environmental Agency (GEA), who requires that all projects in the country meet the World Bank-promoted Equator Principles. PPP Proposal AquaSure International BV (ASI), a pan-European company in water processing and supply incorporated in the Netherlands identify Galapagos as an investment-friendly state and claims not only to be the proprietary owners of the most efficient water processing technology but also experienced in the development and management of water processing plants. But they identify water distribution to be relatively risky (due to known difficulties faced by GSWC in collection of water bills) compared to just production. They also feel that the existing water distribution network in the country owned by the GSWC is adequate for distribution, giving GSWC a first-mover advantage. ASI has entered into a partnership agreement with the GSWC to produce bulk potable water in Nangala. The two companies have incorporated a Special Purpose Vehicle (SPV) known as AquaSure Galapagos Ltd (ASGL) for the establishment and management of a 40,000 m3 (8 million gallons per day) capacity water treatment plant.The ownership structure of ASGL is such that 70% owned by ASI and 30% by GSWC. The project is designed as a Build-Operate-Transfer (BOT). Ownership will revert to the Galapagos State Water Company after 25 years. ASGL has a 25year mandate to supply bulk water to GSWC who has agreed to buy all output of ASGL for distribution to the South Western Township, otherwise known as SOWETO in Nangala. Whereas Nangalas water requirement is estimated at 120 million gallons per day, the two existing water treatment plants have a combined capacity of 65 million gallons/day but currently supply 50 million gallons per day due to operational inefficiencies. The Project Summary A suitable site for the project has been identified and acquired by ASGL under leasehold near the KomLake, which feasibility studies demonstrate has abundant reserves for processing and other purposes at any point in time. This rain-fed reservoir is also used largely for irrigation by vegetable farmers, an important interest group in the province, and traditionally for fishing. In the past, there have been some talks about building a hydro-power project down the lake but this is not expected to affect water upstream where the project will be sited even if the hydro project materialises. The project will require the designing, manufacture and delivery of customised modular treatment plants which ASI has deployed in previous projects in Europe and the Middle East but not yet used in Latin America. ASIs partly-owned company, AquaDesigns BV, specialises in the supply of such modules in standardised capacities of 2500m3, 5000m3 and 10000m3 and ASGL has shortlisted this company as Engineering & Procurement Contractors (EPC).A fixed-price turn- key contract has been initialled. The majority shareholder of ASGL is negotiating arms-length Operations & Maintenance (O&M) contract to run the plant for the duration of the concession following a successful bid.Water tariffs in Galapagos are subsidised and current rate does not meet the cost of GSWC for which the government pays under recovery to allow the company to sustain production. Tariffs are regulated by the State Utilities Board (SUB) who is believed to be largely independent, at least in recent times. ASGL has negotiated a tariff rate payable by the GSWC at G$1.02/litre that will allow for full cost recovery, which has been approved by the SUB. The rate is to be reviewed annually in line with cost of production but no escalating rate has been stated in the approval. A reliable power supply is critical for the running of the plant as all vital processes will be running 24/7. However, power supply in Galapagos has been epileptic in recent times. Also continuous material supply including imported chemicals, filtering materials and other consumables is required for smooth operations. Required Investments ASGL estimates that the total capex required is approx US$75 million. They propose to provide 20% of this as equity in the form of cash, land and preliminary expenses. Under the shareholders agreement this 20% is to be provided according to the shareholding but GSWC has an option to be financed by ASI up to first water. However, should GSWC opt to fund its share, any investment or guarantees will have to be approved by the Ministry of Agriculture& Water Resources and ratified by the Parliament. A bank debt is required for the procurement of the modules and spare parts, payment for contractors and miscellaneous expenses. ASGL may also need some working capital once operations commence as they are to invoice GSWC quarterly but will always be paid in arrears in addition to being owed a quarters receipt by the off-taker. According to their projections the required debt can be amortized in 12 years. ASGL intends to commence establishment of the plant once funding is secured and will require about 18 months to set up the plant and up to another 6 months for test-running and commissioning. Funding Issues A financial model developed for the project demonstrates sufficient cash flows and financial viability. All relevant ratios are acceptable if tariffs are assumed to increase by 5% p.a. in line with inflation forecast. However, sensitivity analyses show interest and exchange rate risks need to be properly managed especially after year 5 of the project. The project output will be sold in US dollars. On the other hand, interest rates have also gone up especially for long-term borrowing following the global crises. Local banks have a peculiar problem in that they are able to raise short term deposits and can only fund up to 5 years based on their analysis of depositors behavioural and contractual maturities. In addition, there isnt one bank that can accommodate US$60m on its balance sheet but for the entire banking industry could accommodate however. The good news is, due to democratic success the states risk rating by both S&P and Fitch are satisfactory to most international investors in relation to the returns. Also, Development Finance Institutions (DFIs) are comfortable lending to Galapagos and the involvement of ASI may be of particular interest to European DFIs and Export Credit Agencies.

Answer the following questions based on the above case i. Using a diagram present structure of the project with the stakeholders clearly identified. (12 marks)

ii. Explain how significant each stakeholders role would be in successful implementation of the project. (8 marks)

iii. Outline project risks, rate each risk based on your assessment of its severity (as high, medium or low) and describe the risk mitigation techniques already in place or the one you would like to propose. (20 marks)

iv. Do you think this project can make a good project finance deal? Explain. (10 marks