Expert opinion

Irrigation: Five main risks for an investor

Olga Zhovtonog, Doctor of Science in Irrigated agriculture, Professor at the National University of Water and Environment Engineering, expert on the UAFATA Project

Securing investment in the restoration and modernization of irrigation systems is becoming a major problem for farmers in the South of Ukraine. At the same time, demand for new instruments of bank lending and attracting external investment resources in the implementation of irrigated projects is growing.

Loans from Ukrainian banks have long been unattractive to the farms due to high lending rates and short payback periods, as well as the high collateral requirements for loans. Thanks to recent cooperation between the Government of Ukraine and international financial institutions, however, new possibilities have opened up to provide loans through public and private Ukrainian banks while reducing lending rates to 5-8% and increasing the payback period to 10 years.

In order to provide direct investments to private agricultural enterprises, in addition to assessing traditional financial performance, banks must also assess the technical, technological and organizational risks associated with the implementation of infrastructure and technological projects in specific conditions. Such an assessment is especially needed in the implementation of long-term complex investment projects in the irrigation system. Such projects ensure the sustainable use of irrigated land and cover the costs of irrigation infrastructure, taking into account climate change and environmental requirements to reduce CO2 emissions into the atmosphere, preserve soil fertility, and help environmental reclamation of land.

Risk 1. “Chess” fields

The most important of all risks for creditors and investors in the irrigation system is the risk of land fragmentation within irrigated fields, which makes it impossible to carry out effective irrigation with wide-ranging sprinklers. This risk is due to the limited lease terms of landowners’ parcels (on average 5-7 years) or the reluctance of landowners to enter into lease or to continue agreements with farmers. Within one irrigated field (around 100 ha) in the southern regions of Ukraine, there can be 15 to 30 or more properties of landowners with an area of ​​2-4 hectares each.

Under such conditions, the usual farm practice is to decide about investments in the restoration and modernization of irrigation systems only within areas where they have a long-term lease agreement (more than 10-15 years), or where they have paid once for land owners for the 49 years land lease according to the right on land emphyteusis, that is permitted by the Land Code of Ukraine. Rarely, but it can be also other favourable options for investments in irrigation on areas, where the right of ownership over a share of land has been purchased by the farms many years ago during start of agriculture and land relations reforms.

Additionally, the land consolidation instruments   can be used to overcome the risk of land fragmentation by negotiating between land owners and farms to voluntarily ‘swap’ these parcels to the sides of these irrigation fields or to separate fields.

Risk 2. The right to water

Another key risk for bank lending and private investors in irrigation is the long-term permission on the special wate use. That means legally proved right for the farmers, proved by the regional offices of State agency of water resources, to have service on water delivery for irrigation from water management organizations. In permission document the maximum amount of water that can be taken from surface and ground water sources by the farms in definite climatic and ecological conditions is fixed. For definition of this amount of water the crops water requirements and ecologically safe irrigation norms are used.

Permission on special water use is provided to the farms in electronic view after presenting of all necessary documents on the Internet platform of the State agency of Water resources. After first three years of water use permission cab be prolonged on the next 25 years or cancelled in case when farms not follow agreed requirements on water use.  Besides, in case of water deficit in the water sources, agreement on special water use can be reconsidered and definite limits on water delivery set-up. Legally fixed rights of farms to have amount and terms for water delivery, that are needed for the crops growing, is the guarantee of effective water use and return of investments in irrigation.

Risk 3. Issues of ownership of water infrastructure

Another very critical risks for investment in irrigation systems is the ownership rights on Pumping stations and the distribution pipeline network at the farm level. On this level there are many   different entities that have ownership right on irrigation infrastructure: state-owned pumping stations, utility pipelines may have different owners (joint territorial communities, the state, individual private farms) or no owner at all. Besides, the water infrastructure that allocated within service area of one pump station or water intake point can be used by one or many farms.  Under such conditions farms have not motivations to attract investments in irrigation without ownership rights on infrastructure or not limited long term right use of it.  In the case of presence of many water users within the hydraulic modules of irrigation systems the risk to lose the integrity of   water management can appear.

To overcome this problem, in the framework of the State Strategy of Irrigation and Drainage until 2030, the creation of Water user organizations (WUOs) is recommended.  The draft law № 5202-d “On organizations of water users and promotion of hydraulic land reclamation” planned to be approved by the Verkhovna Rada for this very soon.  Then many WUOs can be established on a voluntary basis. These organizations will involve those farms that want to join forces to modernize and restore irrigation and continue to share irrigation systems creating non-profit organizations to receive an unlimited long-term right to use the irrigation system, including Pumping stations and utility pipelines.

The International Finance Corporation (IFC) of the World bank group and the USAID AGRO project are currently launching pilot projects to develop a business- and operational model for the operation of WUOs, including attracting external private and banking investment in the restoration and modernization of irrigation infrastructure. However, at the same time, the draft WUO-Law provides opportunities for private farms / members of a WUO to attract investment in simple and complex investment projects for the purchase of sprinklers, equipment, pipeline replacement and irrigation management technology. This allows farms to receive compensation for their private investments from WUO or acquire ownership of the new infrastructure, as far as they have built privately.

Risk 4. Ecological conditions of lands and water quality

Risks that should also be taken into account by banks and investors include the ecological condition of lands and the quality of irrigation water. In the absence or unsatisfactory technical condition of drainage systems in certain conditions, high levels of mineralized groundwater can be observed, which leads to salinization and alkalization of soils and reduced yields. The same consequences can occur when using water for irrigation, which, according to recognized standards, does not meet the required quality for irrigation.

Risk 5. Tariffs for water and electricity

There are a number of risks associated with the increasing of the costs on the   operation and maintenance of the main irrigation infrastructure that belongs to the state and also general changes of the energy price. That can lead to the increasing of tariffs on water and electricity that farmers need to pay for the State water management organizations and electricity companies for their services.  This risk not depends from farmers directly and couldn’t be totally overcome without serious institutional changes and modernization of the main irrigation infrastructure. Meantime, tariffs should be monitored during irrigation investment projects and in case of its rapid increasing the prolongation of investments return terms can be foreseen.

Long-term outlook

However, despite all the risks, in parallel with all the other processes of forming WUOs and reforming governance in the main canals of state ownership, and negotiating / applying tailor-made win/win solutions by the farms to the above-mentioned risks, bank lending to farmers is developing. Continuing the reform of irrigation systems management, as well as improving land legislation and developing the land market, will gradually improve the situation and increase opportunities for all types of investment in irrigation projects.