As in many other infrastructure markets, bidding on PFI and BOT projects in Israel was fierce in 2006 and 2007, with aggressively priced tenders on roads, desalination plants and light rail networks, helped by low pricing on planned international debt tranches.

But in the new post-crisis environment domestic bank debt is back as the mainstay for PFI deals, and new bids will be able to factor higher long term debt finance costs into their bids, and lower valuations for infrastructure assets.

A number of new deals are moving forward and in late September final bids were lodged on the Soreq desalination plant. But some deals signed at the top of the market are in trouble, and none more so than Tel Aviv Light Rail, which has so far failed to reach financial close. Adding to the difficulties, the main sponsor – Africa Israel group – is financially overstretched and engaged in negotiations with banks for a restructuring of its debt, which it is otherwise expected to default on in two year's time.

The 32 year BOT on the first part of the planned Tel Aviv light rail – the Red Line – was won in December 2006 by MTS Group, which brought together a consortium of Lev Leviev's Africa Israel, Siemens, the Egged bus co-operative, Chinese infrastructure company CCECC, Da Costa Soares of Portugal, and Dutch transport company HTM.

The ILS7.1 billion ($1.92 billion) bid narrowly beat a rival ILS7.5 billion offer from Metrorail, and work was expected to start in 2008, with trains running by 2013.

As was the case in late 2006, bids were extremely aggressive. In addition, with a global glut of bank debt, cheap international bank financing was seen as likely to be available. But the project struggled with negotiations towards financial close in 2007 and early 2008, and the Lehman collapse in September 2008 dealt a blow to debt plans.

Making things even more difficult is the very large size of the project. While smaller projects can move forward on a club basis, the debt requirements make this difficult on Tel Aviv.

The problems at Africa Israel make any chance of a financing even more remote. Billionaire diamond dealer Lev Leviev has been hit hard by the downturn in global real estate prices, and has had to go to bondholders and bank lenders with debt restructuring proposals. In late September Standard & Poor's Israeli subsidiary Maalot downgraded Africa Israel to CC from CCC, its second downgrade in a month.

PPP development

The Tel Aviv light rail may be heading nowhere, but in other infrastructure areas the picture is brighter. There are a number of institutional investors in Israel available for both equity and mezzanine participations on future PPP projects. On the Cross Israel Highway, in January 2009, private equity firm Israel Infrastructure Fund (IIF) purchased part of the mezzanine debt of Derech Eretz Highways from its initial lenders. As Yaron Kestenbaum, CEO of IIF says: "The current financial crisis presents some excellent opportunities to get involved in existing infrastructure projects and contribute to their financial strength and long term viability."

In addition to IIF, Harel Insurance Group has also been active. Harel has identified the infrastructure and real estate sectors as strategic asset classes and owns 20% of Citypass – the consortium building Jerusalem light rail – and has invested in the Cross Israel Highway, the Road 431 PFI, and the Ashkelon desalination plant, which began operations in 2005.

The Israeli government is firmly committed to using PPP to deliver services such as road tunnels, courthouses, the New Government District premises for the Ministry of Finance, an expansion to the premises of the Knesset, a police academy, and a training base for the Israel Defence Forces (IDF).

More problematic is the prisons sector. The new privately run extension to the Beer Sheva prison has recently been built under a 23.5-year BOT, won by a consortium featuring Emerald Correctional Management, Africa Israel Group and Minrav Engineering. However, the 800 bed facility stands empty because of a legal challenge by groups opposed to private sector involvement in the correctional services.

Since the $1.4 billion financing of the Cross Israel Highway in 2004 there has also been little PPP deal flow in the roads sector. Cross Israel was followed by a 17km extension financing (Section 18) which closed in February 2007 and was led by Bank Hapoalim. And in the financing pipeline is another PPP for Road 531, which will connect The Cross Israel Highway and Road 2 (Coastal Road). But overall the demand for roads debt is low.

Desalination – Soreq and Palmachim

Furthermore, the impact of the credit crunch on sources of borrowing is still being felt – particularly in the water sector, which is a priority for the government. "On the Hadera desalination project, which reached financial close at the end of 2007, international banks were able to provide better financing proposals than Israeli banks. Today many of those banks have pulled back, and those who are still willing to lend would require much higher margins because of the credit crunch," says Shaul Ben Shimol at Standard & Poor's affiliate Maalot in Tel Aviv. "Concessionaires are now likely to be doing more financing with Israeli banks and domestic institutional investors, though there may still be some interest from foreign commercial banks, and the EIB is expected to come in on upcoming projects such as the Soreq desalination plant."

Final bids were lodged for the Soreq dealination project on 30 September. The project has a total cost of ILS2 billion and will eventually provide capacity of 150 million cubic metres per year. The initial agreement is to begin supplying 100 million cubic metres per year within 30 months of securing financing. Construction is expected to begin in 2010.

Like all desalination PPPs, Soreq is availability based with long term take or pay contracts involving the Mekorot Water Company, which has implicit government backing. PPP contracts also feature a variety of mechanisms to reduce risk, including protection provided by the government in areas such as linkages to inflation, indices of material and chemical costs, foreign exchange rates, and interest rates.

Three groups submitted final bids: IDE Technologies, featuring Delek Group, Israel Chemicals and Hutchison Whampoa; Arison Holdings' unit Housing and Construction with Azrieli Group and Granite Hacarmel Investments; and Shafir Civil and Marine Engineering, Tahal Group plus Veolia.

Some of the sponsors bidding were also involved in Hadera, but unlike Hadera the main emphasis is likely to be upon domestic sources of finance.

The expansion of planned and existing projects is a common feature of desalination deals in Israel – Hadera raised a Eu70 million expansion financing in July 2009. The government has been trying to speed up new tenders, as well as pressing for an expansion of around 25% on existing facilities such as Ashlekon and Palmachim. Temporary mobile plants are also being planned, which can later be dismantled and the sea area restored to its initial conditions.

The relatively small Palmachim reverse osmosis desalination plant on the Mediterranean coast south of Tel Aviv came onstream in May 2007, supplying 30 million cubic metres per annum. It was financed by domestic debt in a syndicate led by Bank Hapoalim. The plant was built on a 25-year BOO tender by Via Maris Desalination Consortium, a partnership between Granite Hacarmel Investments, Tahal Group, Ocif and Middle East Tubes (Metco). In summer 2009 financial close was reached on an expansion programme to 45 million cubic metres per year. Bank Hapoalim was sole debt provider.

Bank Hapoalim is also currently arranging debt financing on the 100 million cubic metre per year Ashdod plant, which is expected to begin operations in 2012. However, in spite of the deal being structured as an independent water project, the plant is being built by Mekorot National Water Company subsidiary Mekorot Development & Initiations, and the financing thus has many of the characteristics of public sector lending. Financial close is expected to come in early 2010, and the EIB may be involved in the syndicate.

Power has potential

The power sector also has potential for PPP and project debt, though final regulations have yet to be agreed, which is slowing down progress in the sector. However it is expected that the government will be willing to offer guarantees on offtake contracts as support for Israel Electric Corporation (IEC), which will make projects more attractive to sponsors.

Thus far activity has centred on captive power plants supplying oil refineries and industrial companies, and these sponsors have the strength to provide equity and put on-balance sheet debt in place. However the renewables sector will have more independent deals and is being promoted by the government, which is expected to soon introduce feed-in tariffs for greenfield solar plants between 50kw and 5MW.