Crocodiles and gnus in Iran’s water market
Published September 29th, 2016
I have been in Tehran this week for the first Iranian Water Summit. I say first, because attendance far exceeded my expectations, and what we are seeing in Iran today is just the beginning of something that is going to grow and grow.
Victor Garnreiter, Suez’s VP for International Development, captured the mood of the meeting with a great metaphor for the current situation in the Iranian water market. He compared it to the epic migration of gnu across the Mara River in the Maasai Mara game reserve. The animals first collect on the banks of the river, afraid to cross, lest they get eaten by crocodiles. Eventually, one or two summon up the courage to cross, and the whole herd follows. “If you notice in the films, the first gnus never get eaten by the crocodiles,” Garnreiter remarked.
The biggest crocodile in the river is no longer the international sanctions imposed on Iran. Now it is currency risk. Inflation in Iran is currently running at 25% per year, which – together with the political risk associated with the country – means that few gnus want to exchange capital invested in euros today for rials paid out over the 20-year duration of a water purchase agreement.
The government of Iran is fully aware of how this looks to foreigners, and it is also aware that unless it can attract investors into the country quite soon, the whole strategy of reversing the international sanctions will fail. It means that for the early investors, it is prepared to absorb the currency risk itself, facilitating and guaranteeing currency escalators in water purchase agreements. This is highly attractive, but the gnus are still not jumping.
The next biggest crocodile is the difficulty of raising hard currency debt for Iranian projects. Banking sanctions remain in place, prohibiting foreign lenders from participating in projects. The exceptions are the Islamic Development Bank and some of the Asian bilateral lenders. Asian lenders interested in the market include Korea Eximbank (KEXIM) and the Japan Bank for International Cooperation. These are committed to providing project finance (typically denominated in Euros). An international developer who can find a clever way of incorporating Korean and Japanese elements into their projects could probably finance a project without needing commercial bank debt at all.
If they make the jump, the rewards are potentially enormous. On the other side of the river there is 2 million cubic metres per day of desalination capacity to build, which together with related transmission infrastructure will require €18 billion of spending. The internal rates of return currently available in the market are as high as 30%, a prospect that looks more appealing now the country appears to have the perennial inflation issue that rose under the sanctions regime under control. It is potentially a larger and more profitable market than the whole of the GCC put together.
In many ways, Iran is in a similar situation to the Chinese market in the late 1990s, when international developers were still nervous of China’s private investment programme, and the first gnus to jump got guaranteed 20% returns and two decades of unfettered growth.
So why don’t the gnus jump? My suspicion is that they are waiting for the outcome of the American election. A win for Clinton would mean that the final banking sanctions are likely to be removed next year. A win for Trump would bring a new crocodile into the water.