2011-12 Discussion Papers - Public Private Partnerships in Transport

COST Action TU1001

COST ACTION TU1001 Public Private Partnerships in Public Private Partnerships Transport: Transport: Trends & in Theory Trends & Theory

2011Discussion Discussion Papers 2011 Papers

Dr. Athena Roumboutsos

Assistant Professor Chair COST Action TU1001 Public Private Partnerships in Transport: Trends & Theory, Department of Shipping, Trade and Transport School of Business, University of the Aegean, Greece

Dr. Nunzia Carbonara

Assistant Professor of Management Engineering Department of Mechanical and Management Engineering Polytechnic of Bari, Italy

ESF provides the CoSt Office through an EC contract

CoSt is supported by the EU RTD Framework programme

12F11_University of the Aegeanresearch_INTERNO COST ACTION TU 1001

Edited by

COST Action TU1001 Public Private Partnerships in Transport: Trends & Theory 2011 Discussion Papers Revised papers selected throughout the COST Action TU1001. This publication is supported by the COST Office.


Editors: Athena Roumboutsos and Nunzia Carbonara

ISBN 978-88-97781-04-2 © 2012, for the papers, by the authors. © 2012, for the editing, by Athena Roumboutsos and Nunzia Carbonara.

Printed and bound in Italy by Arti Grafiche Favia srl, Bari.

Contents Contents _____________________________ _____________________________ ListList of Contributors of Contributors

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Preface Preface

ix ix

1. 1. Tendering Tendering procedures procedures in PPP: in PPP: a literature a literature review review Nunzia Nunzia Carbonara, Carbonara, Louis Louis Gunnigan, Gunnigan, Roberta Roberta Pellegrino Pellegrino andand Fabio Fabio Sciancalepore Sciancalepore

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2. 2. Risks Risks andand riskrisk allocation allocation in Transport in Transport PPP PPP projects: projects: a a literature literature review review Athena Athena Roumboutsos, Roumboutsos, Roberta Roberta Pellegrino, Pellegrino, Thierry Thierry Vaneslander Vaneslander andand Rosário Rosário Macário Macário

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3. 3. RiskRisk management management andand realreal options options in PPP in PPP projects: projects: a a literature literature review review Roberta Roberta Pellegrino Pellegrino andand Nevena Nevena Vajdic Vajdic

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4. 4. Project Project Development Development Model Model for for Procurement Procurement of Federal of Federal Highways Highways Hans Hans Wilhelm Wilhelm Alfen Alfen andand Bernd Bernd Buschmeier Buschmeier

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PART PART ONE ONE Decision Decision Models Models andand Performance Performance Measures Measures

PART PARTTWO TWO Short ShortTerm TermMissions Missions 5.5. The TheSignificance SignificanceofofIncentivising IncentivisingPerformance Performancebased based Contracts Contracts- The - Thecase caseofofPPP PPProad roadprojects projects Thais ThaisRangel, Rangel,Champika ChampikaLiyanage, Liyanage,and andJose JoseManual ManualVassallo Vassallo

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6.6. Competition, Competition,Transaction TransactionCosts Costsand andTendering TenderingininPPPs PPPs Fabio FabioSciancalepore, Sciancalepore,Athena AthenaRoumboutsos, Roumboutsos,Nunzia Nunzia Carbonara, Carbonara,Nicola NicolaCostantino Costantino

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PART PARTTHREE THREE National Nationaland andModal ModalPerspectives Perspectives 7.7. Institutional InstitutionalReasons ReasonsforforNot NotImplementing ImplementingPPPs PPPsininthe the Transport TransportSector Sector Kristian KristianWidén, Widén,Veiko VeikoLember, Lember,Stefan StefanOlander, Olander,Ole OleHelby Helby Petersen, Petersen,Walter WalterScherrer Scherrer

108 108

8.8. Italian ItalianPPP PPPapplications: applications:A ATheoretical TheoreticalFramework Framework Nunzia NunziaCarbonara, Carbonara,Nicola NicolaCostantino, Costantino,Roberta RobertaPellegrino Pellegrino and andFabio FabioSciancalepore Sciancalepore

122 122

9.9. The TheEmergence EmergenceofofTransport TransportPPPs: PPPs:Context Contextand anddrivers drivers Geert GeertDewulf, Dewulf,Colin ColinDuffield, Duffield,Mike MikeGarvin, Garvin,Kristian KristianWiden, Widen, Ole OleHelby HelbyPeterson, Peterson,Veiko VeikoLamber, Lamber,Walter WalterScherrer, Scherrer,Stefan Stefan Olander Olander

138 138

10. 10.PPP PPPModels Modelsininthe theports portssector: sector:A ACross-Sectional Cross-Sectional Analysis Analysis Sheila SheilaFarrell Farrell

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11. 11.Review ReviewofofPublic-Private Public-PrivatePartnerships Partnershipsininheavy heavyrailway railway infrastructure infrastructureprojects projects Ingo IngoArne ArneHansen Hansen

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Contributors _____________________________ Hans Wilhelm Alfen Faculty of Civil Engineering Bauhaus-Universität Weimar, Germany Bernd Buschmeier Bauhaus-Universität Weimar, Germany

Nicola Costantino Department of Mechanical and Management Engineering Polytechnic of Bari, Italy Geert Dewulf Department of Construction Management and Engineering University of Twente, the Netherlands Colin Duffield Department of Infrastructure Engineering, The University of Melbourne, Australia. Sheila Farrell Port Operations Research & Technology Centre Imperial College London, United Kingdom

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Nunzia Carbonara Department of Mechanical and Management Engineering Polytechnic of Bari, Italy

Mike Garvin Myers-Lawson School of Construction Department of Civil and Environmental Engineering Virginia Tech, US Louis Gunnigan Campus Development Office Dublin Institute of Technology Ireland Ingo Arne Hansen Department of Transport & Planning Delft University of Technology Netherlands


Veiko Lember Department of Public Administrations Tallinn University of Technology Estonia Champika Liyanage School of Built and Natural Environment, University of Central Lancashire United Kingdom Rosário Macário Instituto Superior Técnico Lisbon, Portugal Stefan Olander Division of Construction Management Lund University, Sweden

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Roberta Pellegrino Department of Mechanical and Management Engineering Polytechnic of Bari, Italy Ole Helby Petersen Danish Institute of Governmental Research Copenhagen, Denmark Thais Rangel Transport Research Centre Technical University Madrid, Spain Athena Roumboutsos Department of Shipping, Trade and Transport School of Business, University of the Aegean Greece

Fabio Sciancalepore Department of Mechanical and Management Engineering Polytechnic of Bari, Italy Nevena Vajdic Faculty of Civil Engineering University of Belgrade Serbia Thierry Vaneslander Department of Transport and Regional Economics University of Antwerp Belgium

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Walter Scherrer Department of Economics and Social Science University of Salzburg Austria

Jose Manual Vassallo Transport Research Centre Technical University Madrid Spain


Kristian Widén Division of Construction Management Lund University Sweden

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COST Action TU1001 on Public Private Partnerships in Transport: Trends and Theory (P3T3) is a research network, including over 70 researchers from 28 countries, funded by the EU COST Programme with the aim of developing a theoretical basis for Public Private Partnerships (PPPs) in the transport sector and making the shift from a descriptive approach to a normative one. More specifically, the objective is to develop theoretical models and tools needed to support the implementation of PPPs in the transport sector that take into account the different scenarios in which projects are implemented, in terms of macroeconomic context, political and institutional environment, entrepreneurial and innovation systems and transport modes. Research work within the network is conducted through the establishment of working groups, where research is accelerated by combining existing findings and setting common research agendas. Developments are presented and discussed in working group meetings. This knowledge is further disseminated to the academic community and professionals through conferences, workshops and journal publications. The 2011 P3T3 Discussion Papers are a selection of papers developed, presented and discussed in 2011 by the P3T3 network. The emphasis, during the first year of operation, has been on developing a common basis and balancing the various research interests and backgrounds. As such, most papers included in this publication concern or are a product of literature review or provide overviews of specific topics in order to become the basis of future research. The starting point, however, are the differentiating qualities of transport infrastructure that set it apart from other sectors of the economy. One basic characteristic of transport infrastructure is that its availability is of essential importance to most other sectors of society and the economy. Once provided, much infrastructure - especially roads – becomes a “public good” to be “consumed” to capacity by users without influencing its availability for others. Most transport infrastructure bears characteristics of a “natural monopoly” as the costs of provision are minimized when there is only one facility and “ownership rights” and their regulation is imperative. The scale of infrastructure undertakings and their technical specificities typically leads to the inherent difficulty of establishing a fully competitive market. Finally, transportation results in significant externalities, which currently in most cases are not fully accounted for in the pricing system. These qualities make it impossible for the public sector to divest itself of the responsibility to provide transport infrastructure and services. Faced with the challenge of maintaining surface transport infrastructure networks and adding new capacity in strategic areas most governments increasingly relied on infrastructure financing schemes, which involve the private sector. This tendency has also been stimulated by the EU deregulation policy. The large sunk investments required were balanced out by the economic value of accessibility, which allowed for private sector interest. After their (re) introduction in the ‘90s, Public Private Partnerships (PPPs) grew steadily as the preferred financing scheme. Herewith, Dewulf et al. present an overview ix


Preface


of institutional factors influencing PPP policies as well as projects, and highlight the factors, which led to their emergence. Widén et al. identify potential reasons of not implementing PPPs, while Carbonara et al. present a theoretical framework for the description of applications in Italy. In general, transport infrastructure represented the majority of PPP undertakings in terms of capital investments. In 2006 the EU PPP market reached 25 billion euro and 83% of all PPP contracts signed concerned transport infrastructure. The credit crisis hindered the growing trend in PPPs and the debt crisis was reflected in a slow down in macroeconomic figures. This has had a significant impact on the economic viability of many transport infrastructure projects delivered as PPPs, especially as exogenous effects impact vital revenue streams. Roumboutsos et al. present a comprehensive overview of risks and risk allocation in PPP projects as reported in literature. These are compared to the prime risks generated by the specificities of transport infrastructure under the PPP scheme of financing and how these are influenced by the current negative macroeconomic trends. The authors also highlight the issue of ownership and ability to handle the demand risk, which is also reflected on the type of concessioner and the PPP model. In this context, Farrell and Hansen present the specificities of the port and rail subsectors in their, respective, reviews. In 2011 total investment in PPP projects in Europe is estimated to reach the 2010 levels of 18.3 billion of which 55% concerned projects in the transport sector. This, however, is approximately half the 2006 figure for transport, indicating that PPP stakeholders seem to avoid transport PPPs altogether rather then look into evaluating real options as proposed by Pellegrino and Vajdic. In addition, the decline in private investments in financing infrastructure makes the introduction of incentives of paramount importance as identified by Rangel et al. when reviewing literature collected by working group 2 members. Moreover, the authors suggest that performance indicators and incentives should be included in the tendering process. Rightfully, three papers in the Discussion Series focus on tendering. Carbonara et al. present a review of tendering procedures and suggest the impact of transaction costs. Buschmeier and Alfen present a project development model for procurement of federal highways in Germany. Finally, Sciancalepore et al. taking as a starting point the inability to achieve fully competitive market conditions in the transport sector propose a model of identifying the optimum tendering process. The model is developed by combining findings reported in literature. The recent macroeconomic changes have highlighted the deficits in the approach on transport PPPs and the fact that ad hoc solutions are not sufficient when constructing long-term complex contractual arrangements extending into an unpredictable future. Contributions in this publication set the grounds for a holistic approach. Athena Roumboutsos Nunzia Carbonara

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PART ONE

Decision Models and Performance Measures


Tendering Procedures in PPP: A Literature Review Nunzia Carbonara Department of Mechanical and Management Engineering Polytechnic of Bari [email protected] Louis Gunnigan Campus Development Office Dublin Institute of Technology [email protected]

Fabio Sciancalepore Department of Mechanical and Management Engineering Polytechnic of Bari [email protected]

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Roberta Pellegrino Department of Mechanical and Management Engineering Polytechnic of Bari [email protected]

Abstract Purpose – This paper aims at providing an overview about literature on tendering process in PPP, with particular regard to transportation PPP case. Design/methodology/approach – The approach is based on the analysis of the pertinent publications on the theme. Findings – Three main interest areas can be found in the literature: tendering procedures, evaluation methods and evaluation criteria. Social implications – Contract authorities have several tools in order to pre-qualify and select bidders and negotiate with them: they can choose the instruments which best fit to their market Originality/value – The paper provides a complete overview on PPP tendering procedures both used by practitioners and proposed by scholar and offers suggestions for further research on this issue. Keywords: Tender, tendering procedures, bid evaluation methods, bid evaluation criteria


Contribution to Working Group WG1.

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Introduction

In last decades, due to the restrictions to the use of public budget and to the need of get higher efficiency levels, more and more Governments have chosen Public Private Partnerships (PPPs) as a way of satisfy the increasing demand for transportation infrastructure. In particular, the adoption of this delivery solution has found wide application in developing countries, where there is both a strong demand and reduced capital availability. Otherwise, also in developed countries, in many cases governments have chosen to provide new highway, railway, airport and ports by PPP for a set of reason, like budget constraints and larger efficiency of private companies in carrying out and manage infrastructure. Many factors can determine the success of a PPP project. One of these is the decision making process before the start of a PPP project. Many decisions are required to a public contracting authority going to address a PPP process. Among these: • whether carrying out a project by PPP or traditional procurement; • what phases to delegate to the private partner; • what risks to transfer to the private partner and what else to retain; • which partner to choose for the PPP. While much attention has been paid to the three former issues, not many contributions focus on the selection and awarding procedure of a private partner for the PPP. Generally, the private party of a PPP is awarded by means of a public tender, given the public interest of such a competition. The tendering processes of PPP are more complicated and more costly than those of conventional procurement. Birnie (1997) found that tender costs for PFI projects in the UK ranged from 0.48-0.62% of the total project costs, which are higher than those for conventional procurement (i.e., designbuild projects (0.18-0.32%) and traditional design-bid-build projects (0.04-0.15%)). Other estimates about impact of tendering on total PPP cost are even much higher, until to 10% [Zhang 2005b]. A well-structured tendering process is therefore the base for minimizing tendering costs and encouraging competition [Kwak et al. 2009]. Addressing tendering procedures is strategically relevant especially in transportation PPPs. Indeed, most of these markets are characterized by oligopolistic conditions, with actors having strategic power and using it [Meunier and Quinet 2010]. In such cases, contracting authorities have to design opportunely the tendering process, in order to maximize their outcome: a wide knowledge of the existing procedure is essential to this aim. An overview of the existing literature on the theme shows three relevant issues regarding tendering in PPP. The first one is about the procedure to follow in the tender: different phases can form the PPP tendering process, but some of them can be missing in some cases. Secondly, there are different awarding methods used in real projects and some other ones are proposed in the literature. Lastly, due to the complexity of such

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Figure 1: The PPP procurement stages up to financial close [CIC 1998; Ahadzi and Bowles 2001]. projects, most of the cited awarding methods are assessing different factors: consequently, it is important to provide a collection of the used evaluation criteria. This paper aims at providing an overview of the research about tendering in PPP, by offering a focusing on the existing contributions for each of the three cited areas of interest. An analysis about the existing gaps to fill and possible further research development is made.

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Procedures for PPP tendering

Five different kinds of procedures can be used in PPP tenders [Wang and Dai 2010]: • open competitive tendering • invited tendering • registered lists • project-specific prequalification and shortlisting • negotiated tendering

Figure 1 shows a possible scheme for the PPP procurement stages up to financial close. While some of these tasks are simple to be carried out by the contracting authority, like calls for bidders to be pre-qualified and calls for tenders of qualified bidders, three main phases can be distinguished in the tendering procedure [Tiong and Alum 1997]: • Prequalification of tenders. The aim of this prequalification stage is to reduce the number of interested tenders to a shortlist, which consists only of reputable and experienced tenders, which are able to take over project risks. Unnecessary tendering costs of weaker bidders are avoided. • Evaluation tenders. This stage consists in the selection of one or more among qualified bidders. Tenders on the shortlist are invited to submit detailed proposals that are evaluated in accordance with the predefined evaluation criteria. • Negotiation with preferred tenders. This stage consists in the negotiation prior to the final awarding with one or a few preferred tenders. At this stage, provisions in agreements are carefully reviewed. Once the agreement is signed, a contract award notice will be published and the contract is implemented. • PPP awarding. For instance, as the works of To and Ozawa (2007) and Tiong and Alum (1997) highlight, prequalification phase is missing in some Asian countries like Hong Kong, Thailand and Malaysia, because, their governments think that, due to large effort

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A survey made by Zhang (2004a) shows that, among these, open competitive tendering is the most used and the most recommended procedure. This consists of the following phases [Zhang 2004b]: • request for prequalification • prequalification • invitation to tenders • tender evaluation and shortlisting • negotiation with shortlisted tenders • selection of best tender and award


required by such works, only big experienced companies take part to the tender, while many other contracting authorities in countries like Australia, Canada, Philippines, USA, UK use the prequalification of bidders [Tiong and Alum 1997]. Also negotiation phase can be missing, as in the case of Philippines procedure [To and Ozawa 2007]. Hong Kong procedure is also illustrated in Zhang et al. (2002) for two tunnel projects: even if the Government propose a design to follow, different design solution can be proposed by each competitor by means of additional bids for the same tender. After the evaluation phase, the preferred tenderer is called to a final negotiation with the Government before submitting the Best and Final Offer. Otherwise, the UK’s PFI procurement process is an example of is a multi-stage tendering process which includes almost all stages [Kwak et al. 2009], as shown in Figure 2.

Figure 2: UK’s PFI Procurement Process [Kwak et al. 2009]. There is a wide literature comparing negotiation with auction as exclusive tendering procedure: nevertheless, these contributions do not express a clear preference of a procedure over the other one [Saussier et al. 2009]. As described before, in many cases

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Methods for private partner selection

The literature contributions about methods to rank candidate partners for PPP and choose the best one can be distinguished according two classifications. The first one is concerned with the moment of the procedure in which selection method is applied: according to this perspective there are some methods applied for supplier prequalification and other ones used in the final awarding. In addition to this, it is possible to distinguish techniques actually applied in the real cases and methods only suggested in the literature. Zhang (2004a) classifies four commonly used prequalification methods: binary method, simple scoring, multi-attribute methods, other methods. As illustrated above, these are methods used also for assessing tenders of pre-qualified bidders. As regards the bid evaluation, Wang and Dai (2010) reports some methods from practice: lowest price or shortest period, Kepnoe-Tregoe method and Least Present Value of Revenues (LPVR). According to the first case, the awarded concessionaire is the one asking for the lowest price for carrying out the project or the shortest concession period. This is an approach similar to that used in traditional procurement, but it is

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both approaches are used sequentially in the tendering process. As Saussier et al. (2009) state about Public Private Agreement (whose PPP is considered as an example), a final negotiation phase after the tender evaluation is useful because it allows joining the flexibility needed in such complex project with the rigor given by the tendering mechanism. In order to provide contracting authorities guidelines to follow for designing PPP tenders, Doni (2007) compares three kinds of procedures: the negotiation, the auction and the competitive negotiation procedures. In absence of collusion among one bidder and the public agent, the competitive negotiation gives a higher expected value to the Government than other methods and negotiation is preferable to competitive auction, especially if the public negotiation power is high and the bidder is quite reliable. In such a situation, competitive tendering can work better than negotiation only if the suppliers’ market is widely competitive. Otherwise, if there is a strong probability of having a corrupt public agent, auction determines a better value for Government. The power of the negotiation phase is affirmed also by Torta (2005), who underlines that, if negotiation phase had been used the BOT project for the Milano-Brescia highway in Italy, better final conditions could have been obtained by the public counterpart. The Irish PPP procurement process is set out in detail by the Central PPP Unit (2006). It is similar in many respects to the UK process but it also identifies eight tasks to be completed before the OJEC notice is issued. Most of these are concerned with the assessment of the project to establish that PPP is actually the most appropriate procurement method. One of the key decision points revolves around capital value, as a project with a capital value of greater than €20 million is required by legislation to be assessed as to its suitability for procurement as a PPP.


strongly criticized by many scholar for not taking in account non-price factors in the project. Kepnoe-Tregoe technique [Zhang et al. 2002] is based on the distinction between must and want criteria. The former are “on-off” criteria: all proposals not satisfying all musts are rejected. The remaining bids are evaluated on want criteria: a committee chooses the sponsor best meeting these requirements. The limit of this method is the discretionary power of the decision makers in distinguishing must and want factors.. The LPVR concept consists in awarding the bidder with the lowest price and letting her operate the concession until the budget value of the project (previously decided by the public client) is obtained. Some of these methods are also recalled in the classification offered by Zhang (2004a), which includes: - simple scoring; - NPV; - multi-attribute analysis; - Kepner-Tregoe; - two envelope method; - NPV+simple scoring; - binary methods+NPV. In the simple scoring, each criterion is assigned a maximum achievable score and each bid is assigned a score ranging from 0 to the maximum achievable for each criterion. The awarded bid is the one with the highest sum of scores on all criteria. According the NPV method, the project is awarded to the bidder with the lowest NPV of the overall required toll during the concession. NPV can be used together with scoring method for the qualitative evaluation of the bid or after the exclusion of bids violating mandatory requirements (binary method). Instead, in the multi-attribute analysis, criteria are grouped in packages and subpackages, each of which having its own weight. The bid with the best weighted sum score is awarded. As regards the two envelope method, technical proposal seals are firstly opened and bid are ranked against non-price criteria. Then economical price envelopes are open: the best technical-ranked bid within the Governmental budget is awarded. The choice of the method is influenced by the complexity of the project: binary, simple-scoring and two-envelope methods well suits to small-sized and simple projects, while NPV is a valid choice for projects with proven technologies and, finally, Kepner-Tregoe analysis better fits to complex projects. As regards the application of such techniques, Kepner-Tregoe is generally adopted in Hong Kong BOT projects [Zhang et al. 2002], while NPV and multi-attribute analysis are used in PFI projects in the United Kingdom [Kwah et al. 2009]. Simple scoring technique is adopted in some Italian PPP projects, like, for instance, the Brescia-Milano highway project described by Torta (2005). According to a survey of Zhang (2004a), among these, NPV and multiattribute analysis are the most used and the most recommended methods. Table 1 lists the described techniques by practitioners for prequalification of bidders and bid evaluation.

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Prequalification

• Binary method • Simple scoring • Multi-attribute methods

Zhang (2004a)

Bid evaluation

• Simple scoring • NPV • Multi-attribute analysis • Two envelope method • NPV+simple scoring • Binary method + NPV • Lowest price • Shortest concession period • Kepnoe-Tregoe technique • Least Present Value of Revenues

Zhang (2004a), Wang and Dai (2010)

Besides the methods used by practitioners, some other proposals can be found in the literature. Rudzianskaite et al. (2010) suggest an evaluation procedure based on TOPSIS (Technique for Order Performance by Similarity to Ideal Solution): even if the procedure is addressed to the choice among different projects, it could be applied to the evaluation of different bids for the same project. In addition to this, Costantino et al. (2011) propose a technique based on evaluating different bids according to different stakeholders’ perspective: the convenience of each of them is evaluated by means of an appropriate indicator. Finally, Zhang (2009) proposes the adoption of a fuzzy logic system for his best value concessionaire selection, based on four groups of criteria defined by the same author and illustrated in the following section.

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Criteria for private partner selection

Many authors have proposed different set of criteria for choosing the best among the candidate sponsors for a PPP project. Also in this case, some authors focused on prequalification criteria, while many else proposed criteria to be satisfied for the final awarding.

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Table 1. Methods for bidder pre-qualification and bid evaluations used by contracting authorities. Significant methods Selected literature

Table 2. Criteria for bid evaluations. Selected literature

Significant criteria

Financial and Economical criteria


Technical criteria

Safety, Health, and Environmental Criteria

• Sound financial analysis • Reasonable source and structure of funds • Innovation of financing method • Net present value • Tariff/toll setting up and adjustment mechanism • Ability to address commercial risk (e.g., supply and demand risks) • Minimal financial risks to the client • Internal rate of return • Financial strength of the participants in the project company • Financial guarantee • Total investment schedule • Concession period • Strong financial commitments from shareholders • PayBack Period • Profitability Index • Qualifications and experiences of key design and construction personnel • Experience in similar projects • Conforming to client’s requirements • Competencies of designer/subdesigners • Contractor/subcontractors • Conforming to design requirements • Costruction programs and abilities to meet them • Design and construction quality control schemes • Use of advanced technologies • Maintainability • Design life • Design standard • Quality management and assurance systems • Qualifications/experience of relevant personnel • Management system of safety, health and environment • Conformance to laws and regulations • Construction/demolition waste disposal • Control of air and water pollution • Past environmental performance • Protection of items of cultural/archeological values • Management safety accountability • Noise reduction and dust reduction

Social Criteria

• Importance of the project for public transport

Managerial Criteria

• Project management skills • Constitution of the management, their qualification and experience • Coordination system within the consortium • Success rate of cooperation among private consortium • Leadership and allocation of responsibilities in the consortium • Effective project controlling system • Working relationship among participants

Zhang (2005a), Rudzianskaite et al. (2010)

Zhang (2005a), Wang et al. (2007)

Wang et al. (2007), Zhang (2005a), Rudzianskaite et al. (2010) Rudzianskaite et al. (2010) Zhang (2005a), Wang et al. (2007)

As regards the prequalification, Zhang (2004b) proposes 11 requirements to meet. Some of them are financial, like the financial report of companies taking part to the consortium, used sources and debt/equity ratio. Other ones are concerned with the meeting of legal requirements, like details of pending or threatened proceedings.

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Conclusions

The tendering phase is one of the most important aspects in Public Private Partnership, but, until now, international literature has not paid this issue the same attention as other ones, like Value for Money and risk management, for instance. Nevertheless, there are some relevant contributions, illustrated in this paper, which traced a road for this research. An overview about the tendering procedures used in the different countries adopting PPP is lacking in the literature: this would be useful to understand what procedures are

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Another important subset of criteria is that of the experience requirements: in particular past similar work done by competitors, their current workload, their advisors’ experience, their experience in managing PPP projects. Finally, other prequalification criteria are the management structure of the consortium, the technical, operational and financial capabilities, quality, health and safety requirements and meeting and presentation of consortia. While the prequalification phase is simply based on the qualifications and the capabilities of the candidates, the awarding phase aims at assessing the specific features of the offers. Zhang and Kumaraswamy (2001) propose 9 main criteria used for BOT highway projects awarded in the early Nineties in Honk Kong: two of them are about the proposed toll regime, three are about the robustness of the presented solution, three more are about the financial sustainability, while the last criterion is the benefit that the community can gain from the assessed proposal. In a following paper, through a review of the international literature, experience about real case and interview with practitioners, Zhang (2005a) has found 83 criteria for the private partner selection. He divided them in four categories: financial (26), technical (26), health, safety and environmental (15), managerial (16). The author interviewed public practitioners, private practitioners and academics and found that the most important criteria are the financial and the technical one for all of them. No significant differences could be found among the assessment of the different interviewed groups. A similar but more synthetic criteria classification is that proposed by Wang et al. (2007): they proposed 18 criteria for the private partner, whose five are about the financial issues, four determine the ability to design, building, managing and operating, four are about health, safety and environment issues and the remaining are classified as “other factors”. Finally, Rudzianskaite et al. (2010) propose a set of seven sustainability indices regarding road projects: four of them are economical (Net Present Value, Internal Rate of Return, PayBack Period, Profitability Index), two of them are environmental (noise reduction and dust reduction) while the last one is a social factor (importance of the project for public transport). Table 2 shows a summary of significant criteria selected in the literature.


mainly used and whether there is a relationship between these and the economy of such countries. Moreover, it would be of great significance to understand how transaction costs increase by adding phases like prequalification and negotiation and if this increase is justified by the consequent benefit in terms of best and final offer. As regards the selection method, it would be interesting to verify whether bidders’ behaviour changes with the shifting of the method and, consequently, if a method can lead to a best awarded bid than the others. In addition, the application to PPP partner choice of other supplier selection methods coming from Supply Chain Management (SCM) could be tested. Moreover, even if the contributions about evaluation criteria for the private partner selection are quite exhaustive, also in this case a comparison with analogous works in SCM literature could enlarge the knowledge in this field. Finally, this overview on tendering methods in PPP can be a starting point for the definition of appropriate awarding process in the sector of transportation: the selection of the private partner is paramount in this project typology, due to the large required budget and the long time horizon. Consequently, setting tendering procedures which foster competition and best fit the features of this particular market is essential.

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Kwah Y.H., Chih Y-Y., Ibbs C.W., 2009, Towards a Comprehensive Understanding of Public Private Partnerships for Infrastructure Development. California Management Review, Vol. 51, No.2, pp. 51-78.

Torta F., 2005, The Concession Through a Bid – The New Brescia – Milan Highway: a Case Study, Research in Transportation Economics, Vol. 15, pp. 135–143. Wang D., Dai D., 2010, Research on the Concessionaire selection for BuildOperate-Transfer Projects,. Proceedings of International Conference on Management and Service Science (MASS), Wuhan (China), 24-26 August. Wang W-X., Li Q-M., Deng X-P., Li L-H., Cai Y., 2007, Selecting Optimal Private-Sector Partner in Infrastructure Projects under PPP Model. Proceedings of International Conference on Management Science and Engineering (ICMSE 2007), Harbin (China), 20-22 August. Zhang X., 2004a, Concessionaire Selection: Methods and Criteria. Journal of Construction Engineering and Management, Vol. 130, No. 2, pp. 235-244. Zhang X., 2004b, Improving Concessionaire Selection Protocols in Public Private Partnered Infrastructure Projects, Journal of Construction Engineering and Management, Vol. 130, No. 5, pp. 670-679. Zhang X., 2005a, Criteria for Selecting the Private-Sector Partner in Public– Private Partnerships. Journal of Construction Engineering and Management, Vol. 131, No. 6, pp. 631-644.


Zhang X., 2005b, Critical Success Factors for Public–Private Partnerships in Infrastructure Development, Journal of Construction Engineering and Management, Vol. 131, No. 1, pp. 71-80. Zhang X., 2009, Best value concessionaire selection through a fuzzy logic system, Expert Systems with Application, Vol. 36, No. 4, pp. 7519-7527. Zhang X., Kumaraswamy M.M., 2001, Hong Kong experience in Managing BOT projects, Journal of Construction Engineering and Management, Vol. 127, No. 2, pp. 154-162. Zhang X., Kumaraswamy M.M., Zheng W. and Palaneeswaran E., 2002, Concessionaire Selection for Build-Operate-Transfer Tunnel Projects in Hong Kong, Journal of Construction Engineering and Management, Vol. 128, No. 2, pp. 155-163.

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Risks and risk allocation in Transport PPP projects: a literature review Athena Roumboutsos Department of Shipping, Trade and Transport University of the Aegean [email protected] Roberta Pellegrino Department of Mechanical and Management Engineering Polytechnic of Bari [email protected]

Rosário Macário Instituto Superior Técnico [email protected]

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Thierry Vaneslander Department of Transport and Regional Economics University of Antwerp [email protected]

Abstract Purpose – This paper aims at providing a comprehensive overview of risks and risk allocation associated with PPPs. Design/methodology/approach – The approach follows two basic frameworks: (i) risk analysis/management principles and PPPs; (ii) transport sector risk principles and PPPs. Findings – The comparison of existing research trends against principles of risk analysis and management and the respective particularities of the transport sector offers a comprehensive overview of risk and risk allocation in PPP projects and highlights the specificities of transport sector identifying questions to which answers have not been provided for. Social implications – The identification of existing trends in risk allocation and management can support the decision maker process and allow for project risk management. Originality/value – While there is significant PPP literature on the topic of risk and risk allocation, it is fragmented. This paper provides a comprehensive overview of risks and risk allocation associated with PPPs, with particular focus on the PPP transport sector. Keywords: Risks, Risk management, Risk allocation, Transport PPP projects


Contribution to Working Group 1: Provide an overview of risk and risk allocation in PPP projects and highlight significant risks in PPP transport projects.

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Introduction

In recent years, the increasing need for the development of infrastructure and budgetary constraints in several developing and developed countries have led governments to seek new ways of financing facilities of public utility. One of the options is to involve private sector finance and expertise in the provision of public infrastructure and services. The term “Public-Private Partnership” (PPP) is commonly used throughout the world with a range of meanings. In the broadest sense, PPPs can be defined as “arrangements typified by joint working between the public and private sector” [HM Treasury 2008]. The Canadian Council for Public-Private Partnerships (2009) defines PPP agreements as follows: “A cooperative venture between the public and private sectors, built on the expertise of each partner, that best meets clearly defined public needs through the appropriate allocation of resources, risks and rewards”. Therefore, they can cover all types of collaboration between the public and private partner, involving collaborative risk sharing in order to deliver services and infrastructure to the community. The European Investment Bank [EIB 2005] defines PPPs as “risk sharing investment in the provision of public goods and service, seen by governments as a means to launch investment programs, which would not have been possible within the available publicsector budget, within reasonable time”. In practice, this strategy has materialized through a variety of well known contractual arrangements such as BOTs (Build-Operate-Transfer), BOOTs (Build-Own-OperateTransfer), BOOs (Build-Own-Operate), DFBOs (Design-Finance-Build-Operate), BTOs (Build-Transfer-Operate), BLOs (Build-Lease-Operate) to name a few and characterized as “concessions” depending on the transfer of ownership during the contractual period. Since the early ‘90s, these contractual arrangements have been considered under the umbrella term of Public Private Partnerships (PPPs). This strategy has been characterized by two basic approaches (and public-sector objectives): the finance-based and the service-based approach [Aziz 2007]. The finance-based approach has been the prime motivation by governments seeking to respond to demand especially in the transport sector, which is characterized by large sunk costs and cost-intensive investments. This is reflected in PPP statistics: in Europe, 83% of all PPP contracts signed in 2006 concerned transport infrastructure [DLA Piper 2007] and, internationally, about two thirds of all PPP transport projects concern roads, about 18% rail, 12% airports and less than 7% ports. The average project size varies across sectors ranging from about US$ 105 million in ports to about US$ 307 million in rail. The average project in roads and airports is roughly US$180 million [Estache et al. 2007]. This trend continues even as the PPP market is severely influenced by the financial crisis (see Figure 1). The European PPP Market in 2010 reached 18.3 billion (not considering contracts below 5 million euro) of which approximately 50% concerned the transport sector [EPEC 2011a]. This trend has generated substantial institutional, archival and popular literature and debate concerning the political, social and economic acceptance of the scheme. The latter has been generally focused in varying forms around the issue of Value for Money (VfM), loosely defined as the

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optimum combination of life cycle costs and quality to meet user requirements [Grimsey and Lewis 2005; Akintoye et al. 2003; Debande 2002] and, thus, seeking justification for PPPs through a service-based approach.


Figure 1: Value of European PPP Market (source: EPEC, 2011). However, at its heart, it remains a risk-sharing problem between two (or more) riskaverse agents, constrained by bounded rationality, stemming from the uniqueness of the undertaking, the considerable investments incurred and resulting length of contractual agreement, which stretches a few decades into an unforeseeable future [Wei-hua and Da-shuang 2006; Roumboutsos 2008]. The core of a PPP arrangement, as for any contractual arrangement, is the transfer of appropriate risks from the public to the private partner. This is considered central for the success of a PPP project. To this end, there is significant PPP literature on the topic of risk and risk allocation and how it impacts VfM. These studies focus on different types of PPPs, different infrastructure sectors and different countries. This paper aims at providing a comprehensive overview of risks and risk allocation associated with PPPs. As research on PPPs is, in principal, fragmented, the aim of this paper is to compare existing research trends against principles of risk analysis and management and the respective particularities of the transport sector, as well as to identify questions which answers have not been provided for. Following this introduction and the description of project and structured finance, the paper is organized in response to two basic frameworks: (i) risk analysis/management principles and PPPs; (ii) transport sector risk principles and PPPs. Discussion and targets for future work conclude the paper.

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Project and Structured Finance

Project Finance is a financial technique that allows project developers, whose creditworthiness would not enable them to borrow the required levels of capital, to actually gather the funds needed for the development of the projects. In other words, Project Finance is a type of long term infrastructure financing based on the projected cash flows of the project rather than on the balance sheets of the investors [Hillion 2011], allowing private parties to undertake new ventures without granting the lenders full recourse to their assets and, at the same time, giving the opportunity to governments to promote large scale projects without imposing fierce damages to the public budget. To shield the sponsors, a legally and financially independent project company, called Special Purpose Vehicle (SPV), is specifically created for each project, bearing its risks and not exposing the investors [Estache et al. 2007]. It shall be noticed that if the project company faces difficulties in complying with the debt terms, or especially in the event of default, senior project lenders have the right to assume the managerial control of the project. In general, Project Finance involves a consortium of equity investors associated to a strong banking syndicate, which will be responsible for the design of the financial plan, for the securitization of the investment and to assist in the equity capital raising and in the bond issuance. For the sponsor-shielding to happen, the loans provided are nonrecursive, meaning that the project is secured by its own assets and revenue-producing contracts [Hillion 2011], rather than being secured by the investors’ assets. Risk mitigation becomes imperative in these structures. Riskier projects may require more complex project finance structures, incorporating corporate finance, securitization, options, insurance provisions and other types of collateral enhancement, so as to mitigate unallocated risks [Tan 2007]. Concerning the contractual network in project financing, the structures are usually very complex not only due to the number of entities involved but mainly because of the direct and indirect interactions between all players. These multiple and bilateral relations are integrant part of project financing and that is why a thorough contract management procedure is essential for the success of any venture. In fact, these contracts are the basis of risk allocation and therefore, it is imperative, especially for lenders, to ensure the non-existence of any network gap and that every risk is properly allocated in order to guarantee the creditworthiness of the project. The complexity of these business structures lead many times to the creation of a ring-fence around project, not allowing an easy comprehension of the project’s operation, which are the partners involved, the existing contracts between them and especially about the financial profile of the company [Macário 2011a]. It is essential for the State to prevent situations like this, especially considering that State capture is frequent in project financing ventures. Structured Finance stands for a group of financial techniques used to help transferring investment risks with the ultimate purpose of allowing projects with special financing needs to be developed. This risk transference is achieved through complex financial tools, the derivatives, which are securities whose value is dependent upon one or more

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underlying assets such as stocks, bonds, commodities, currencies, interest rates or market indexes [Jobst 2005]. Due to the overuse of these derivative tools and because of its high level of leverage, Structured Finance has been widely criticized and pointed as the major source of the 2007-2008 financial crisis [Coval et al. 2008]. In Structure Finance, investment risks are reallocated from the parties less able to bear those risks to those more prepared. Besides, risk mitigation techniques are applied, through the incorporation of predictable cash flows in the structure, providing working capital in difficult changing environments [Servigny and Jobst 2007]. The end result is a financing model in which the risk is tightly controlled, allowing much better credit conditions, and enabling companies/projects, which would have been unable to qualify for more traditional loans, to develop their ventures. Furthermore, as these financial tools are debt-related, Structured Finance procedures are very susceptible to Credit Rating Agencies and the rating levels assigned by them. These ratings are an indicator of the credit reliability of the entity issuing debt/incurring loans and consequently have a huge impact on the definition of the interest rates of bonds and loans. Typically, since major investors are only allowed to buy debt with very high ratings (e.g. pension funds), it is needed to proceed to the credit enhancement, which stands as a solution of creating a security that has a higher rating than the issuing company [Macário 2011c]. Credit enhancement is processed through the issuance of subordinate debt, to which is allocated the losses as collateral of the Senior Lenders (thus the senior lenders are given credit enhancement) [Servigny and Jobst 2007]. As a consequence, since the risk of subordinated debt defaulting is higher than the senior debt, the interest rates applied to it are higher too. All in all, Structured Finance allows companies/projects, which in principle would not meet the minimum requirements to incur debt, to be financed, due to a thorough allocation of the investment risks. Companies such as corporations established in risky countries or start-up companies with no financial track record are good examples of good candidates for structured financing. The reasons behind this lay on the fact that usually loan providers specially focus on the borrower’s reliability and creditworthiness, in contrast to structured finance where the emphasis in given to the robustness of the business transaction and the value it may bring [Coval et al. 2008]. It must be considered that the complexity of these transactions is very high and it may mislead both debt issuers as well as investors, therefore carefully designed plans must be developed beforehand.

3

Risk analysis principles and PPP projects

According to classical decision theory, risk is generally understood to be the distribution of possible outcomes, their likelihood, and their subjective values [March and Shapira 1987]. Some researchers, such as Chapman and Ward (2003) and Flanagan and Norman (1993) have coined the term “uncertainty” (initially suggested by Knight in

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1921) in order to describe the situations in which there is no historical data, where in contrast, the term “risk” can be used in situations where success or failure is determined in probabilistic quantities by benefiting from previous available data. In PPP literature the term “risks” is used widely, neglecting the uncertainty involved in long-term contractual arrangements. Risks are identified and assessed qualitatively and quantitatively by estimating the probability of occurrence and the impact on project value of the probable occurrence. Probability and impact are project-specific. Once risks are identified and quantified, risk strategies are developed to eliminate, minimise or mitigate risk. Contractual agreements reflect the risk mitigation process [Chapman and Ward 2003]. Within this generic approach for risk within any project undertaking, the primary risk transferred within a PPP arrangement is the risk of project financing and project performance (finance and service-based approach, as described by Aziz (2007)). However, PPP contractual agreements, incomplete by nature, pose additional risks stemming from the arrangement per se. These aspects are identified in existing research.

3.1

Risk Identification

3.1.1 General and Specific Risks UNIDO (1996) developed a checklist classifying risks under two major categories (general/country risks and specific project risks). Political risks, commercial risks and legal risks are classified in the first category, whereas construction/completion risks and operating risks under the second category. Ng and Loosemore (2007) define general risks as not directly associated with project strategies, but with a significant impact on the projects’ outcome. These normally arise from events in the general macroenvironment surrounding the project, due to natural, political, regulatory, legal and economic causes. In contrast, project risks depend on the way a project is managed or from events in its immediate micro-environment. They may include natural risks such as ground problems and weather conditions, technical problems associated with designs, plant and equipment, materials problems associated with suppliers, organizational problems associated with subcontractors, manpower problems associated with unions, contractual problems associated with JV agreements and environmental problems associated with pollution, etc. Beyond this general risk classification, they provide the special risks associated with the PPP procurement process. These come from the identification of several broad areas that can potentially affect a PPP project’s creditworthiness proposed by Standard and Poor’s. These are: credit risk of the public sector entity, construction risks, revenue structure, operating risk, and financial and

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The first step is risk identification [Berkeley et al. 1991]. There are several studies focusing on the identification of potential risks associated with a PPP project and proposing multifarious classification approaches, which could be classified under: General and specific project risks. Risk Registers Project Life Cycle and the PPP model


legal structure. Likewise, Merna and Smith (1996) grouped the risks of PPP projects into two broad categories: global and elemental. Global risks include factors that are generally outside the control of the project participants. They are normally allocated through the project agreement and typically include political, legal, commercial and environmental risks. Elemental risks contain mostly the project level risk factors, such as those associated with the construction, operation, finance and revenue generation components of the project. 3.1.2 Risk Registers Many researchers have offered detailed risk registers and have assessed the respective importance of risks. Akintoye et al. (1998) carried out research on risk assessment/prioritization for Private Finance Initiative (PFI) projects in the UK. The top most important risk factors identified (based on a survey among clients, contractors and financial institutions) were design risk, construction cost risk, payment risks and tendering costs. Land acquisition, debt risk, bankers’ risk, and political risks were found to be the least important. Ozdoganm and Birgonul (2000) identified and studied 37 risk factors influencing the success of BOT projects. A checklist of 26 risks of PFI projects in the UK is presented by Hardcastle and Boothroyd (2003). Thomas et al. (2003) identify twenty-two risks associated with BOT road projects in general and unique to Indian project environment and use four project phases (developmental phase, construction phase, operation phase, and project life cycle phase) for classifying risks. Grimsey and Lewis (2004) presented a risk matrix for the allocation of risks in PPP projects, consisting of site risks, technical risks, construction risks, operating risks, revenue risks, financial risks, regulatory/political risks and asset risk. Li (2003) classifies risks in three levels which comprise: macro level risks (i.e., risks sourced exogenously, or external to the project itself); meso level risks (i.e., risks sourced endogenously, or risk events and their consequences occurring within the system boundaries of the project); micro level risks (i.e., endogenous risks which differ from meso risks in that they are party-related rather than project-related). 3.1.3 Project (construction) project life cycle and PPP model The Australian Department of Defence (2001) sees infrastructure project risks broadly covering five areas: design and development, construction, finance, operation and ownership. Grimsey and Lewis (2002) have identified nine risks which, at least, any infrastructure project faces: technical risk, due to engineering and design failures; construction risk, because of faulty construction techniques and cost escalation and delays in construction; operating risk, due to higher operating costs and maintenance costs; revenue risks, e.g., due to traffic shortfall or failure to extract resources, the volatility of prices and demand for products and service sold leading to revenue deficiency; financial risks arising from inadequate hedging of revenue streams and financing costs; force majeure risk, involving war and other calamities and acts of God, regulatory/political risks, due to legal changes and unsupportive government policies; environmental risks, because of adverse environmental impacts and hazards; project default, due to failure of the project from a combination of any of the above. Salzmann

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and Mohammed (1999) have presented a risk allocation framework for international BOOT projects based on four super factor groupings: host country, investors, projects and project organization. According to Kapila and Hendrickson (2001) typical risks include socioeconomic factors (environmental protection, public safety, economic stability), organization relationships (contractual relationships, attitudes of participants, communication), and technological problems (design assumptions, site conditions, construction procedures). Kumaraswamy and Zhang (2001) classify risks associated with BOT projects in social and political risks (e.g. internal resistance, political influence, uncertainty of government, corruption inclunding bribery, unfair process of selection of private investors), environmental risks, technical risks, and economic risks (e.g. devaluation risk, inflation risk, incapable investors). After noting that risk and uncertainty are inherent in all construction work no matter what the size of the project, Dey and Ogunlana (2004) adopt a classification of the risks of BOT projects in five categories: political risks, construction completion risks, operating risks, finance risks, and legal risks. Checherita and Gifford (2008) discuss risks that can occur during the lifetime of a road infrastructure project. They classify them in two broad categories: common risk and PPP-specific risks. Common risks can arise in any road infrastructure investment, irrespective of the structure of ownership, financing or operation. As suggested by Aoust et al. (2000), they can be classified according to the phase of the project lifetime in: (i) risks arising during the design-construction phase; (ii) operational risks, and (iii) permanent or indirect risk. Apart from these risks, several categories of risks are more likely to arise under a PPP project, i.e., PPP-specific risks. They stem from the particular relationship between private and public entities whose economic interests are distinctively bundled in the project. Three categories of PPP-specific risks can be identified: (i) fiscal risks, (ii) residual value risks, and (iii) bidding risk. In a similar approach, Roumboutsos (2008) adopted a broad categorization of transport project risks: (i) market risks which may be considered as external to the project (e.g., gross domestic product, growth, inflation, market structure) and internal to the project (e.g., traffic demand, elasticity, competition from other modes or alternative routes); (ii) political risks, related to country’s political stability, record of government interventions and frequency of legal framework changes; (iii) financial risks which may be considered external to the project (e.g. taxation currency, exchange rates, debt rating of the country), and internal (e.g. loan interest rate and payback period, grant financing, loans availability); (iv) environmental risks, related to possible changes of environmental laws, the protection of historical sites, the reaction of interest groups due to societal sensitivities about the environment; and (v) technical risks, such as physical conditions (e.g., soil, weather); problems during design, construction, operation, and maintenance; and natural disasters (e.g., earthquakes, flooding) and signified that these risks vary over the life of the project (figure 2).

Traditional Contracts

Concessions

Financial Risks Political Risks

Conception

Technical Risks

Design & Construction Development

Market Risks

Operation & Maintenance

Refurbishment

End of Project Life Cycle

Environmental Risks


Figure 2: Evolution of transport project risks [Roumboutsos 2008]. As Kwak et al. (2009) rightly pointed out, there is no list of risk that is applicable to all PPP projects and there is no risk classification approach, which is universally accepted as the best. Risks of a PPP project are affected by several factors, such as the type and scale of a project, the country where the project is located, and the type of PPP implemented. Along these lines an interesting example are ports, where the type of PPP arrangement applied depends highly on and is linked to the port organisational type. There are different types of port authorities worldwide. Port authorities differ mainly in terms of i) decisional independence, ii) unicity of command, iii) financial independence and iv) commercial management methods [Op de Beeck 1999; Bichou and Gray 2005; Chouly 2002]. These four dimensions can be grouped and reduced to two dimensions considering that on the one hand, decisional and financial independence of the port authority are a function of the degree of public involvement, which corresponds to the institutional setting the port is embedded in. On the other hand, unicity of command and integrated commercial management methods depend on the degree to which the port authority is involved in day-to-day operations [Vanelslander 2005]. Commonly used PPP structures in the port sector today are concessions. They relieve governments of substantial operational risks and financial burdens and simultaneously allow governments to keep ultimate ownership of the port land and the responsibility for licensing port operations and construction activities. On this account, governments

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remain in a position where they can safeguard public interests. In fact, they are one of the few trump cards left to port authorities in the chain power battle these days. [Aronietis et al. 2010]. The type of port authority will influence its attitude towards concessions. A landlord port will be more receptive to the concession instrument, since possession, occupation and use of property is transferred by the landlord port authority to a potential user, in exchange for a payment or a rent. The powers of a landlord port authority are limited to the decisions concerning land use, reservations of space for the port areas and construction and use of public port works. The port authority leaves it to individual operators (public sector or private enterprises) to construct and operate the works and equipment necessary for the operation of ships and the storage and internal transport of traffic, and / or to operate other services provided for traffic (sea pilotage, towing, inshore pilotage, and so on). Such port authority will make the necessary sites available to individual operators on the basis of contracts specifying public service obligations or, conversely, permitting private use of the facilities. The port authority acts like the owner of the port property, grants short or long term leases or concessions to other private enterprises [Aronietis et al. 2010]. It can be understood that risk will be highly different according to the degree to which and context in which concessions are applied. The main types of risks encountered in seaport concessions are the following ones [Aronietis et al. 2010]. • Commercial risk, that arises mainly from the uncertainty of traffic levels. Furthermore, it is often difficult to gather the adequate information to achieve accurate demand projections. • Government policy risk, which is related to the concessionaire’s fears about government commitment throughout the duration period of the concession contract, apart from eventual government policy changes. • Exchange rate risk, which arises essentially from input prices and tariffs that may be charged in a currency different than the one of the initial investment. This is not a great concern in the ports’ case for tariffs are usually charged to international companies and in US dollars. There can also be exchange rate risk associated with the repatriation of profits; however international investors by rule guarantee repatriation of profits as a pre-requisite for investment. • Exclusiveness: although competition encourages efficiency, revenues are likely to be higher and more predictable when there is no competition. Therefore granting exclusiveness may ease concession problems associated with financing and meeting payments. • Tariff risk, which is a sensitive aspect of a concession and is related to the existence or not of market competition. Tariffs tend to be regulated where some form of monopoly power exists. In case the government sets the tariffs, the mechanisms for change must be defined. In a competitive environment, concessionaires usually have a considerable scope to define their own tariffs, even if subject to utility rate regulations.

3.2 Risk mitigation/allocation strategies


Ball et al. (2003) note that “risk transfer accounted for 60 per cent of the total cost saving for the PFI projects” in the UK analysis of Anderson and LSE Enterprise (2000), and that for six of the 17 cases (i.e. 35%), achieving value for money was entirely due to risk transfer [Hodge 2004]. Risk allocation is connected to the type of contractual agreement, as it defines the amount of risk that may be potentially transferred. Figure 3 schematically presents the risk, generally, transferred between the public sector contracting authority and the private sector contractor or concessioner based on contract type [Roumboutsos 2008].

Figure 3: Schematic allocation of risks by type of procurement contract (extended from Queiroz, 2007). The risk transfer /mitigation subject is commonly termed in literature and practice “risk allocation”. Risk allocation is a very important aspect of PPP transactions, maybe the most important one. After having identified and understood risks in PPP projects, the problem is or should be the risk allocation among parties involved into the project. The principle is to transfer the risks to the party that is best able to manage them. The aim,

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therefore, is (or should be) to optimize, not maximize risk transfer. The effective distribution of risks, according to Loosemore et al. (2006) should follow established rules, whereas a risk is undertaken by a party when this party has: Full awareness of the risk to be undertaken Greater capacity to manage the risk effectively and efficiently The capacity and resources to cope with the risk eventuating The preference to undertake the specific risk The possibility to charge the respective risk premium. On the basis of this fundamental idea, researchers have explored risk allocation strategies in PPP projects. Surveys have been researchers’ preferred research method for risk allocation based on party preference. Bing et al. (2005) conducted a survey to explore preferences in risk allocation in PPP/PFI construction projects in UK. They found the preferred risk allocation in the construction projects in the UK. The survey response indicates that five risks should be retained by the public sector: nationalisation/expropriation, poor political decision making process, political opposition, site availability and government stability. Contrarily, the majority of the catalogued project risks should be allocated to the private sector. Finally, there are five risk factors in the shared risk category: force majeure and legislation change, lack of commitment from a partner, responsibilities and risk distribution and authority distribution between partnerships. Ng and Loosemore (2007) state that the best allocation of risk will depend on how the private parties price the risk, and whether this is reasonable for the public sector. Nisar (2007) discusses two strategies of transferring risks, i.e., implicit and explicit transfer of risk in PPP/PFI contractual arrangements. Roumboutsos and Anagnostopoulos (2008) present findings regarding preferred risk allocation of prime stakeholders, i.e., the public client, the construction companies and the financing institutes, and their respective risk ranking in the Greek PPP market. They found that the risks to be allocated to the public sector are: all political and legal risks, as well as risks concerning archeological findings. Construction, operation, relationship and third party risks are better handled by the private sector. Project finance risks and design risks, with the exception of availability of finance and permits should also be assigned to the private sector. Finally, the public and private sector preferably share macroeconomic, natural and social risks. Grimsey and Lewis (2002) state that successful risk allocation should take into account the differing (and conflicting) needs of the main participants involved in PPPs, i.e., the procuring entity, the project sponsors and the senior lenders. Later, Grimsey and Lewis (2004) presented a risk matrix for the allocation of risks in PPP projects. In this proposed matrix, not one category is assigned in total to a specific party. All available research describes survey findings either as a registration of risk allocation that has been practiced or apriori preference of allocation of risk. However, it is a welldocumented fact that risk allocation follows risk quantification. Risk quantification reflects “full awareness of the risk to be allocated” and risk premium, leading to the “capacity to better handle the risk”. Recently, the EPEC (2011b) notes that this “standard risk allocation” is not sufficient to satisfy the private sector under the current financial crisis and proposes the use of State Guarantees in support of PPP bankability

and attractiveness to financial investors for PPP company default risks, demand / usage risks, construction risks, technology; sub-sovereign risks; policy risks; macroeconomic risks and residual value risks. Moreover, the diversity of risk settings renders risk allocation scenarios difficult in the transport sector. There is no uniform format for risk allocation and the most appropriate combination must be considered for each case [Monteiro 2003].


4

The Specificities of Transport PPP Project Risks

While all PPP projects bear significant risks due to (i) the size of the investment, (ii) the respective length of the agreement and (iii) its complexity, PPP projects in the transport sector could be considerably more risky. They are inherently capital-intensive and often require large sunk investments whereby their recuperation may span over a long period, in many cases in the order of 30 or more years. They are immobile; in fact, transport infrastructure investments are particularly cumbersome to transfer or reallocate and, if reallocation were possible, it would imply prohibitive transfer costs [Grimsey and Lewis 2002]. Furthermore, transport infrastructure projects are proven to be [Flyvbjerg et al. 2002; 2004] characterised by enormous cost overruns, which are transport mode specific and due, possibly, to optimism bias in the ex-ante evaluation phase in an effort to secure project approval and funding but which result in the misallocation of scarce resources on the one hand and the reduction in project quality on the other, if cost escalation is upper limit bounded. Such is the case when developing funds (eg. European Structural Funds) are used. The outcome, in many cases, limits the range of anticipated benefits. In addition the life of the investment is in the 50-year range, while in many cases transport infrastructure precedes demand rather than serves it, as capacity is planned to serve growing needs. In this aspect, revenue-related risks are significant in transport projects and reflect the uncertainty in predicted traffic volumes and the willingness of users to pay for services rendered. When considering the long payback period required and the fact that traffic volumes are correlated to regional and international market structure, economic growth and land-use patterns then addressing the investment risk becomes crucial. Hence, investment in transport infrastructure involves significant risk taking on behalf of the parties participating in project planning and project financing. The latter arguments reflect risk quantification (i.e. probability and impact of identified risks) intensified by the particularities of the transport sector. In addition, as noted by Evenhuis and Vickerman (2010) asset specificity confers to hold-up risks for both the public and private sector. Once constructed by the private sector the asset cannot be used otherwise to generate revenues, but, simultaneously, the private sector as “owner” of the asset (say in a concession contract) creates for himself a “temporary monopoly”. In this case, the management of the asset is entirely regulated

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4.1

Transport Planning and Network Integration

Transport projects bear multiple impacts and are designed not only to address the principal issue of demand in transportation but also weigh out, minimize or improve external present and future effects on time saving, air quality, noise, safety, energy consumption, economic growth, land use and real estate development. These issues are highly correlated to development and local, regional, national, EU and global policies and influenced by respective changes. Transport planning aims at the optimization of transport systems and the optimal use of respective resources (conclusions of the Gothenburg European Council). The need to achieve “competitiveness” and “complementarity” has become an issue in transport policy. “Competitiveness” supports competition “in the market”. “Complementarity” is important when competing “for the market”. Network integration leads to improved quality services stemming from the “complementarity” of transport services, which is an important guiding principle for transport policies’ institutional and structural development in several countries. Improved integration between transport modes helps people and commodities to move seamlessly and reduces the costs and inconveniences of travel. However, as transport projects are developed in a fragmented manner through independent traditional and PPP contracts, integration is not always achieved and may

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upfront through the PPP contract leaving little room for adjustments or transport policy interventions. However, the very issue of asset ownership rights is at the heart of a very complex and interrelated set of risks specific to the transport sector. The benefits of “ownership” are affected by the planning of other new or upgraded transport infrastructure/services. In some cases, these plans may work in support; in others in competition, reflecting on traffic risk. Furthermore, transport pricing apart from describing the revenue stream of the PPP project, is also highly correlated to travel behaviour, social acceptance and the feeling of fairness [Fujii et al. 2004]. These issues (i.e. ownership, planning, network integration and pricing) have a different impact depending on the project type and the transport sector. Risk identification, risk allocation and ultimately project delivery design is closely related in the transport sector, especially with respect to the transport effort to be provided by the private party. When considering transport PPP projects, these include a wide range of project types spanning from service (operation and maintenance contracts) to the full range of designfinance-construction–operation-maintenance contracts describing various forms of ownership. These also address urban transport (bus services, metros, tramways etc.), transport platforms (eg. freight villages), transport e-services etc. and extend to include primary infrastructure such as motorways, airports, intercity rail links and ports. These very different structures and respective projects have very different risk settings. However, some basic principles could be identified as concentrated in transport policy. In general lines these may include transport planning and network integration and transport pricing/charging, which again along with macroeconomic figures are directly correlated to demand and respective revenues.


have a considerable negative impact on usage. From an other perspective, as transport services are assigned to independent private operators, “avoidance of integration” – on a functional and mode level - has been used or may be used by operators to restrict or minimise the effect of competitor operators in order to secure profitable “market” oligopolies or even monopolies [The World Bank 2004; Wang and Yang 2005; Roumboutsos and Kapros 2008]. This is the result of fragmentation of the transport effort (or missions), which is employed to introduce competition in the market. That is a service may be sub-divided (fragmented) in smaller “independent” project-contracts in order to achieve economies of scale, or scope or reduce the hold-up risk in governance as previously mentioned. Fragmentation may be either geographical or functional. Geographical may range from contracting a transport link (or part of) or a node to the entire network. Functional fragmentation may be technical or contractual. Vertical fragmentation may be limited by economies of scope. The European Railways Reform [CE 1991] was based on the separation between infrastructure and operations. The same is not valid for airports. Fragmentation is also a matter of the level of internalization of benefits in bundling of activities or economies of scale. For example, it is shown that motorways provide economies of scale up to couple of hundred of kilometers. Chung et al. (2010) show how this approach has lead to a disintegrated toll road network in Australia. Again, node fragmentation is the norm for other transport sectors (ports and airports). Fragmentation also depends on providing the ability to handle the downstream market, which is of different nature depending on the transport mode. This reflects diversity in infrastructure procurement conditions. Meunier and Quinet (2010) note the competitive nature of motorway downstream markets and the downstream markets of railways or ports, which are oligopolistic more subject to rapid changes, and where the actors have strategic power and use it. Risk allocation, as in all cases, is transferred to the party best able to handle it. In this case it is primarily dependent on who is capable of handling or addressing the downstream market competition. Demand (traffic or revenue) risk is usually ultimately assigned to the public sector in motorway PPP contracts, as the public sector through transport planning may decide to develop or upgrade an alternative competitive route. The public sector may or may not decide to improve overall network integration allowing access to wider networks. When the risk is allocated to the private party, then the agreement usually contains clauses providing exclusive rights (e.g. Athens Ring Road). These clauses, however, cannot protect against poor road network integration. For example one of the principle problems identified in the Hungarian toll motorways was the fact that they lead to boarder crossings with long waiting times which canceled any gains from using improved carriage ways [Carpintero 2010]. When considering ports, it is important to note that ports are only one link in the whole transport and logistics chain but a complex interface involving many functions. Coordination is a key competitive factor, which may be provided neutrally by the public sector but which has never been so. More specifically, the issue in ports has always been the level of public and private sector involvement. Growing competition has put strain on reducing costs and increasing productivity, as well as investing in new

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equipment, routines and innovation in order to cope with trends and innovations in the maritime and logistics sector [Meunier and Quinet 2010]. Investments in maritime entrance and port infrastructure involve very large amounts. Traditional financing of port infrastructure works, such as ‘pay as you go’, has reached its limits, especially because of limited financial means. Waiting is not a competitive option as it is linked to loss of competitive power, which in turn leads to potential welfare loss [Capka 2006]. Globally, three types can be distinguished: ways of alternative financing that by the investing government is purely considered to be a financial operation; a nonfinancial PPP, and privatizing infrastructure elements [Meersman et al. 2010]. Therefore, PPPs have been seen as a positive alternative to both financing (for the period 2005-2010, it is expected that about 10% of all PPP agreements in transportation were in the seaport sector [Cheatham and Oblin 2007]) and competition as following the internationalization and concentration trend in the maritime and stevedoring sector, big players are seen as capable of securing against the demand risk. However, this trend also raises concerns with respect to market power in an oligopoly setting. Big stevedoring companies are present all over the world, at a supra-continental scale. In the container shipping, the first 20 companies had less than 40% of the traffic 20 years ago; they now have more than 80%. These trends also imply increased volatility of traffic putting more weight on the commercial concerns of ports (commercial risks – demand risks) [Meunier and Quinet 2010]. This volatility is not irrelevant to a port’s hinterland connections, expressing the risk of network integration. Air transport demand can be very sensitive to external factors (eg. the SARS or HNI1 flu). Demand is also influenced by the strategies and developments in the airline market. An airline may decide on a hub-and-spoke strategy, which concentrates traffic at the main airport (hub), but if this airline is bought by another significant traffic loss may occur. All in all, airports have larger profit margins, enjoy a monopolistic position and government protection [Bel and Fageda 2009]. Many remain under public ownership and allow private investment in terminals and other services, very much like the landlord model of ports. However, airports tend to be more complex than ports and with few exceptions the public sector always retains a stake in the governance of airports. In terms of risks and risk allocation there are a variety of models identified. The key issue remains the prevention of predatory practices and market power abuses [Marques and Brochado 2008; Cruz and Marques 2011]. The network integration of airports is usually left with the public sector, who makes a variety of transport services available for access. Ports and airports suffer competition from road and rail respectively. A good example is the competition of air transportation and high-speed rail for distances up to 500km [Teixeira 2010]. Ridership or demand risk is the most important risk in rail and urban transit rail. Due to its high cost infrastructure rail based transport systems present significant obstacles in the participation of the private sector. The first, long-distance or regional rail services have been development through franchises of operations, with the rail infrastructure remaining the main responsibility of the state. Revenue and cost of operation risk remain the most important risks even in this case, with the length of contract allowing for rolling stock improvements. Market power has been identified to lie with the rolling

stock provider when franchise contracts are relatively short [Competition Commission 2009]. The situation has been similar for urban transit rail with difficulties arising from a number of sources: (i) expensive construction, operating and maintenance costs; (ii) the inadequacy of fare revenue resulting in the need for direct and/or indirect public subsidies such as land development rights; and (iii) the complexities of forming and sustaining coalitions and partnerships necessary in rail transit privatization [Phang 2007]. Again revenue risk and risk of cost of operation remain the most important risks, with significant asymmetry of information with respect to traffic flows and limited ability for fare pricing, especially in the case of fare integration of urban transit. In conclusion, while safeguarding against revenue (demand/traffic risk) and creating positive conditions for competition, network planning and integration becomes a tool for the private sector to obtain or retain market positional power.


4.2

Transport Pricing

The pricing policies are an important element in ensuring that infrastructure can be both financed and utilized efficiently. Expenditure on infrastructure has been in response to both increased trade integration and environmental concerns. Its assessment and respective pricing as summarized by Adler and Proost (2010) should consider amongst others: • The market environment and competition among infrastructure providers. This concerns competition between modes, for example high-speed rail and air transport in the medium distance transport markets in Europe and Asia. Not considered than expected prices, volumes of transport and user benefits of the projects are likely to be drawn from inaccurate market shares and expectations with regard to infrastructure utilization. • Regional equity considerations as large transport infrastructure projects may have important local benefits but may also shift activities between regions. Hence, there is a distributional effect to consider. • The overall efficiency costs of public funds within a wider economic framework, which is not limited to the valuation of time and the importance of reliability. Bonnafous (2010) argues in favor of a so-called public finding scarcity coefficient for project evaluation (and selection) and estimation of the toll revenues/subsidy ratio. • The risk to the provider of public funds and the misrepresentation of project benefits, as many projects charge average rather than marginal costs. Macário (2010) in summary of the ENACT project findings reminds us that in economic theory the social optimum is achieved when prices are set equal to the social marginal costs. As the first best is seldom possible (if at all), second best solutions are usually targeted. However, as pointed out by Maffii et al. (2007), second best demonstrates when there is perfect competition, there is neither concept of public good nor external effects, cost functions show no increasing return to scale and, finally, there

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is no information asymmetry. These conditions hardly apply to the transport sector. Under these conditions, the State intervenes setting transport prices and planning infrastructure. Some States have chosen to impose marginal cost pricing policies as a means to maximize welfare in the use of the transport system. However, social marginal costs pricing (SMCP) is oriented to maximize social welfare and to transmit the userpay principles. It is not oriented to ensure cost coverage, which in PPPs may include multiple origin costs, such as capital remuneration, risk premiums or financing costs. Therefore, it is likely that revenues obtained through SMCP for some transport infrastructure are not sufficient and second best pricing schemes are employed. These may include [Maffii et al. 2007] mark-ups, multi-part tariffs, fully allocated cost schemes, peak load pricing schemes. The later reflects the notion of scarcity (value of available slots) rather than congestion [Nash and Samson 1999]. According to findings reported by Macário (2010), while there is significant risk associated with revenue and respective future demand, the adoption a social marginal cost based pricing two additional risk determinants emerge: • Demand based revenue risk: this risk is mostly related with congestion/scarcity because it is associated with the non-linear variation of social marginal costs with demand, and consequently with price (SMCP principles dictate that user charges should be equal to the social marginal costs caused by the corresponding transport activity). • Future evolution of SMCs: some marginal cost elements present considerable future uncertainty. These are the costs of externalities that evolve along with the evolution of societies. Another source of risk when pricing transport is the ability to include most (if not all) activities, which contribute to marginal effects. Meersman et al. (2010) surveyed ports on the basis of identifying all such activities and, ultimately, estimating if cost recovery is possible. They concluded that SMC does not lead to recovery of fixed costs: only LMC would do so, because only in the long-run perspective, investments are included in the calculations. However, LMC has the disadvantage that in the short-run, which in a port context can still be fairly long, it either leads to overcapacity or a shortage of such capacity. The reason is that under a certain seaport investment, in a situation of demand which is lower than expected, overcapacity will occur, which shows that the price asked was too high. When demand is higher than expected, a capacity shortage will occur, showing that the price asked was too low. According to the authors, this is slightly different in other modes of transport, where the marginal effect on investments, in particular infrastructure, is more easy to observe. In road and rail transport, wear and tear of infrastructure is quantifiable, and well-developed cost figures exist, based on widely spread and long lasting cost records. It is less the case in barge and air transport, and extremely so in the port sector. Finally, apart from pricing transport in a context of social welfare and respective recovery of costs (both internal and external), in the perspective of PPPs it is equally important to define a pricing policy that will ensure that the private party has incentives to perform according to pubic goals at a reasonable price.


5

Conclusions and future challenges

Transport PPP projects share the same risks as most PPP projects. In this aspect, considerable research has been reported. High sunk costs set transport PPPs apart. Their positioning as ‘temporary monopolies” make them unique. To this end, while transport PPPs concern the majority of PPP projects, there is respectively less research reported. This may be due to two major reasons. Firstly, risk issues with transport PPPs are very much related to the specificities of the transport sector and are absorbed by other central issues such as infrastructure and service planning and networking, as well as the issue of competition. Secondly, their value and valuation is also connected to wider development and positioning issues, which are different for the various transport modes and the various operators competing for or in the market. Demand risk is at the heart of transport PPPs, which, however, has multiple correlations to endogenous and exogenous factors related to the planning and networking of transport services and infrastructure as well as to the externalities of transport. The later are usually seen as negative environmental impacts introducing social marginal cost pricing. However, while risks are usually assessed on an individual project basis, the greater risks of PPP projects in transport arise from the fragmentation of the network and “planned competition”. Equally so, while service scarcity is measured by users demand and willingness to pay of individual services, no reference has been found on the user price paid of the entire door-to-door trip. Finally, while recession is settling in, there is little reference on the respective impact on risks and risk allocation. This issue deserves further investigation and research as uncertainty of market short, medium and long-term behaviour becomes more pronounced and liquidity problems surface. At a second level hedge and other less aggressive funds (such as pension funds) seek relatively secure investments, increasing the number and nature of governance issues. The effects of these activities have not been found in literature.

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Risk management and real options in PPP projects: A literature review Roberta Pellegrino Department of Mechanical and Management Engineering Polytechnic of Bari [email protected]


Nevena Vajdic Faculty of Civil Engineering University of Belgrade [email protected]

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Abstract Purpose – The aim of this paper is to analyze the application of Real Option Theory in PPPs during the decision making process and particularly during the risk management of PPP projects. Design/methodology/approach – The approach is based on a literature analysis of PPP projects aimed at identifying key risks and possible managerial flexibilities (or real options) that naturally exist or are built “artificially” through contractual conditions and clauses, guarantees, etc., in order to manage or mitigate these risks. Findings – The literature analysis reveals that several studies propose use of real options theory as risk mitigation strategies which allow proper pricing and allocation of risks in complex agreements like PPPs. The results highlight that while in some cases it is difficult to distinguish the difference between strategies for addressing some of risks, in other cases the strategy of using the real options as risk mitigation tool is clear and straight forward. Social implications – Private and public sectors can benefit from this literature analysis in order to identify the way of mitigating risks which have been adopted in practice. Originality/value – The results of this study represent the first step of a more complex research project whose main goal is the development of approaches for modeling and valuing flexibilities (which naturally exist or are built artificially through contractual conditions and clauses, guarantees, etc.) during the risk management and allocation.

Contribution to Working Group1: Develop an approach to increasing flexibility and hedging risk in PPP transactions / contracts which support decision makers to find the cost-effective combination of forms of flexibility to embed in a PPP investment in order to optimally control risk and maximize investment value.

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Keywords: PPP risks, Risk mitigation strategies, Flexibility, Real options analysis.


1

Introduction

The decision-making process in PPP infrastructure projects is embedded with multiple uncertainties due to changes in political, economical, and social contexts. Key decisions during planning and design of a PPP project are often made without considering the uncertainties that characterize the life of the project [Zhao 2004]. At the same time, do not consider uncertainties, i.e., potential risks or opportunities, can cause an incorrect exploitation of opportunities or losses and, sometimes, even the failure of the PPP projects. This is the reason why it is necessary, from the beginning, analyze uncertainties embedded in the project and manage them adequately in order to minimize losses and capture opportunities. The procurement regulation and management (contract relationships) in public goods and services is a complex activity due to many competing interests of involved parties, government agencies, private sector providers, taxpayers, consumers, special interest groups, etc. This complexity increases substantially passing from traditional construction contracts to PPPs for infrastructure, because of risk allocation, duration and financing [Smith 2009]. As far as risk allocation is concerned, PPP requires the analysis and allocation of a broader spectrum of risks if compared to traditional contracts. However, both government and private sectors seldom appraise risks and opportunities inherent in PPP projects [Wei-hua 2006]. Traditional techniques of risk management, generally, consist of three phases: risk identification, risk analysis or measurement and risk mitigation. Risk mitigation approach can be further divided in risk avoidance, risk reduction, risk transfer or shifting, and risk retention [Cheah 2009]. These standard techniques, however, do not consider the flexibility of the management to react to the market and environmental uncertainties. Project managers, in fact, do not adopt static strategies, but tend to change their decisions and actions as uncertainty about the future is gradually resolved with the aim of reducing losses and exploiting opportunities. Risk management as well as PPP project evaluation should, therefore, take into account that managers react “proactively” to uncertainties, i.e., take decisions on the projects as the uncertainty is resolved. Conventional project valuation methods, such as Net Present Value (NPV), tend to ignore the existence and value of the managerial flexibility. As a consequence, the expected cash flows can differ from the forecasted values due to both uncertainty (the real world, in fact, is not deterministic, rather than probabilistic) and managerial flexibility that allows project managers to change their decisions and actions as uncertainty about the future is gradually resolved. This justify the need of including managerial flexibility, or real options, in the decision making process, and particularly in risk management of PPP infrastructure projects, where real options represents the possibility (the right, not the obligation) of taking some actions in the future by spending a certain cost to acquire this right. In other words, real options refer to the flexibility embedded in real operational processes, activities, or investment opportunities that are not financial instruments [Trigeorgis 1996]. 44

The aim of this paper is to analyze the application to PPPs of such a theory, i.e., Real Option Theory, during the decision making process and particularly during the risk management of PPP projects. As the strategy changes (to achieve reduced risk), the project’s cash flows can change and, therefore, the value of the project. The paper is organized as follows. The next section presents a brief overview of real options. Then, a literature analysis of PPP projects aimed at identifying key risks and possible managerial flexibilities, that naturally exist or are built “artificially” through contractual conditions and clauses, guarantees, etc., in order to manage or mitigate these risks is presented.

The concept of real option has its roots in the theory of financial options. An option is a contract that gives the holder the right - not the obligation - to buy or sell a predefined quantity of an underlying asset at a specific price, called strike price or exercise price, at or before the expiration date of the option (maturity). The holder (buyer) pays a price for this right [Damodaran 2001]. With respect to the action which the holder can take there are two types of options: call options and put options that respectively give the holder the right to buy or sell the underlying asset. Regarding the time when the option can be exercised, most common types are American options and European options: the first can be exercised every time before the expiration date, while the latter can be exercised only at the expiration date. There are also various combinations of these types of options like Asian options (observing average value of the underlying asset over certain period of time), barrier options, Bermuda options, etc. The option (call) will be exercised only if the value of the asset is higher than the strike price, on the contrary the option will never be exercised and will expire worthless. If the option is exercised, the buyer buys the stock at the strike price; hence, the gross profit of the option is the difference between the value of the underlying asset and the exercise price. The net profit on the investment is the difference between the gross profit and the cost to have this right, i.e., that one initially paid for the call (namely option premium [Yeo 2003]). Therefore, if K is the strike price and ST is the asset value, the payoff of a call option is max(ST - K; 0), while the payoff of a put option is max(K - ST; 0). Figure 1 illustrates a payoff diagram for call and put options.

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2 Overview of real options


Figure 1: Payoff of call and put options. A call option is defined in-the-money if the underlying asset value is higher than the exercise price, i.e., the immediate exercise of the option generates a profit. Contrarily, it is out-the-money if the underlying asset value is lower than the exercise price. In this case, the option will not be exercised. Recently, the concept of options has been applied extensively in a variety of areas other than financial instruments such as calls and puts. This subject is known as real options valuation. A real option, defined as an option on a “real asset” [Myers 1984], is the right, but not the obligation, to take action in the future [Dixit 1995]. Real Option Approach (ROA) has been introduced in literature as an approach that exceeds the limits of traditional techniques for investment valuation (such as those based on Discounted Cash Flow analysis) since it is able to capture the value of options embedded in a project and, therefore, the flexibility they give. A lot of progresses that have been done in the real option literature have changed the way of thinking about an investment opportunity. During project management, managers may make several choices about project characteristics every time new information from market is available. A real option is the way to respond to market changes. This possibility that managers have to adapt their decisions to the change of market has value that must be considered during the decision making process. In other words, this flexibility creates “options” that increase the value of the project and determines the failure of the traditional techniques. Neglecting the value of flexibility in the analysis may result in suboptimal decisions.

3 Key risks and identification of real options in PPP projects: a literature review

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As previously discussed, the decision making process in all projects is embedded with multiple uncertainties. Particularly, PPP projects involve high degree risks since they are characterized by participation of many stakeholders, long concession period, huge amount of investment [Wei-hua 2006]. These risks should be correctly assessed and managed from the initial stages of the project (planning and design). The decision maker, in fact, tends to change his/her decisions as the uncertainty is resolved, in order to mitigate losses and capture opportunities. This proactive behavior changes the risk profile of the project and, consequently, its cash flows. In other words, it impacts on the project convenience. The traditional risk management techniques ignore the manager’s ability to recognize and exploit opportunities to increase project value. For this reason, it is necessary that risk management process includes the managerial flexibility [Cheah 2009], i.e., the possibility to react to uncertainty. This managerial flexibility, as previously explained, can be considered as a real option. In last years an interesting literature on risk identification and allocation in PPP projects has been developed. Bing and authors analyzed risks in PPP/PFI construction projects in UK [Bing 2005]. Particularly, they conducted a survey to explore preferences in risk allocation. They classified risks in three levels, by using the approach proposed by Li [Li 2003]. The three levels comprise: macro level risks (i.e., risks sourced exogenously, or external to the project itself); meso level risks (i.e., risks sourced endogenously, or risk events and their consequences occurring within the system boundaries of the project); micro level risks (i.e., endogenous risks which differ from meso risks in that they are party-related than project-related). They found the preferred risk allocation in the construction projects in the UK. Grimsey and Lewis have identified six areas of risk associated with PPP projects, namely: public risk, asset risk, operating risk, sponsor risk, financial risk and default risk [Grimsey 2004]. Ng and Loosemore discussed risk allocation in the private provision of public infrastructure [Ng 2007]. A number of standard risk allocation matrices have been proposed to guide appropriate risk allocation in PPP projects. In reality, it is important to understand that these models are limited since risks must be analyzed and managed on a project-by-project basis. Furthermore, the best allocation of risk will depend on how the private parties price the risk, whether this is reasonable for the public sector [Ng 2007]. For all these reasons, strategies to shape and mitigate risks, often based on real options, become very important. Quiggin proposes the introduction of systematic flexibility into a PPP system, in order to “render PPPs more robust and assist in the management of the risks associated with overpayments and contract failure” [Quiggin 2005]. This can be done through the inclusion of put and call options. Either party, in fact, would be able to terminate the partnership at a specified date: the private party will receive a lump sum payment, determined by a valuation of the flows of payments and services remaining under the contract. This kind of put and call options would help to resolve the problems associated with lengthy contractual terms and the need for contract variation and renegotiation in the light of changing conditions. Bowe and Lee analyze the possibility of building-in some flexibility in the PPP project enabling it to alter the scale of operations at various times during the project’s life [Bowe 2004]. Particularly, this refers to the option to expand or contract project


capacity when market demand conditions may turn out to be stronger or weaker than originally expected, due, for example, to an economic downturn or upturn. The option to expand operations can be conceived as a call option to acquire rights to capacity expansion upon payment of the investment outlay as the exercise price. Its value, then, is max(eV-I, 0), where eV is the additional value of project generated by expansion and I is the additional investment cost. The opposite case, i.e., when market demand conditions turn out to be weaker than originally expected, gives value to the option to contract the scale of operations. It can be evaluated as a put option on the part of the project which can be contracted, with an exercise price equal to the potential cost savings, I’, and a reduction of project value due to the contraction equal to cV. Its value, then, is max(I’-cV, 0). Another scenario is the possibility to defer initiating construction activity for n months without penalty. This is the option to wait (or defer), that can be considered as a call option on the gross project V, with an exercise price equal to the required outlay next year I’’. Thus, its value is max(V-I’’, 0). Zhao proposes a multistage stochastic model for decision making development, operation, expansion, and rehabilitation [Zhao 2004]. It accounts for the evaluation of three uncertainties, i.e., traffic demand, land price, and highway deterioration. They modeled a right-of-way contract as a real option of expansion. The acquisition of the required right of way is needed for every highway expansion (widening) process. On the other side, acquiring additional right-of-way width beyond immediate need can be considered as reserving land. This reduces the risks associated with land availability and price in future highway expansion. In these conditions, the decision maker may exercise the expansion real option if it is convenient, according to traffic demand. Finally, they modeled rehabilitation decisions as real options, “because they can be made flexibly to cope with highway deterioration”. Wei-hua and Da-shuang propose a concession decision model with three real options embedded: the option to adjust concession price, the option to develop surrounding land, the option to expand project capacity [Wei-hua 2006]. The key risks considered in the decision process were demand risk, inflation risk, land price risk and completion risk. The option to adjust concession price gives the private concessionaire the right to revise the base price of products and services, when the inflation growth rate is expected to exceed the growth rate tolerance negotiated with the government in advance. The option to develop surrounding land gives the private concessionaire the right to develop land surrounding the infrastructure site only if the land price is sufficiently high, but he would not commit to the land development if the land price is low, thus saving the planned outlays (exercise price). Finally, the option to expand capacity gives the private concessionaire the right to accommodate the demand if it turns out to be higher than predicted. The exercise price will be the incremental investment and operation cost. When the profitability of the project is weak or risk is too high, governments can use some mechanisms to mitigate risks that adversely impact the return to the private sector. These mitigation mechanisms can be often modeled as real options. In transport concessions, one of the main risk factors is related to demand or traffic, which is difficult to estimate. Therefore, mechanisms that permit a mitigation and reallocation of 48

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this risk are often used. As Blank and authors propose, they can be classified according to three criteria: the trigger variable chosen, which can be traffic, revenues or even project’s internal rate of return (IRR); the “level” of risk allocation between parties, involving sometimes minimum and maximum target levels for the trigger variable; or the compensation mechanism adopted which may include a subsidy or a change in contract length [Blank 2009; Vassallo 2006]. On the basis of these criteria, three main approaches for risk mitigation are identified. The first approach is based on the economic balance of the concession length through the trigger variable (e.g., IRR) and establishes acceptable levels for this variable. An example is given by Alonso-Conde [2007] or Rose [1998]. They discuss some forms of contractual terms which transferred some of the risks of the project from the private provider back to the government, such as a) the flexibility given by the opportunity to defer the payments over a period of time and b) the possibility of early cancellation of the investment. The first refers to the option (that the government gives to the concessionaire) of deferring payment of the concession fees, which are due on a yearly basis, during the concession period. Particularly, the concessionaire will defer the payments until the end of the concession period if the IRR is lower than a predefined value. The second option reflects the right that the State has to terminate the concession period early. This can occur at a certain number of designated dates if investors have achieved an after tax IRR of a predefined value. Both options introduce flexibility to mitigate demand (traffic volumes) and price risks. Another example is a revenue sharing mechanism where the government has a right to claim the certain percentage of the revenue if the rate of return on the project’s investment is above 15% [Gomez-Lobo 2000]. The trigger variable is a level of the accumulated revenues set at the beginning of the concession. The second approach for risk mitigation is based on guarantees when risk is generally shared between the government and the concessionaire. Most common types of guarantees are those related to the level of traffic or revenues. A minimum revenue guarantee put option would grant the concessionaire a right, but not an obligation, to claim a revenue subsidy from an option underwriter. The parties choose an underlying asset, such as traffic volume or toll revenue, and negotiate the guaranteed value of the underlying asset. If the actual value of the underlying asset falls below this negotiated level, the concessionaire has the right to exercise the option and claim the subsidy. Contrarily, if the actual value exceeds the guaranteed value, the option is out-of-themoney and expires without being exercised [Dailami 1999; Irwin 2003; Huang 2006; Chiara 2007; Brandao 2008; Shan 2010]. Beside the minimum revenue and the minimum traffic guarantees, Wibowo discussed the maximum interest rate guarantee, the debt guarantee and the tariff guarantee [Wibowo 2004]. Government is providing the maximum interest rate guarantee which protects the concessioner against the market risk for cases when the actual interbank offered rate is higher than the expected by some predetermined percentage. This option can be exercised during the debt service. The debt guarantee obligates the government to overtake the outstanding debt, if any, at the end of the concession period. Tariff guarantees address the price and regulatory or policy risk where the government

provides compensation to the concessionaire if tolls cannot be adjusted according to the increase in domestic consumer price. This guarantee can be exercised during the concession period. Exchange rate guarantee is sometimes provided by the government as a mean for exchange rate risk mitigation [Gomez-Lobo 2000]. This type of guarantee covers part of the minimum income guarantee denominated in the foreign currency which is tied to the part of the debt service denominated in the same currency. The third approach is related to the length of contract which is defined on the basis of the moment when a target variable is achieved [e.g., Quiggin 2005]. For example, Least Present Value of Revenue (LPVR) approach is a tendering mechanism when concessionaires are bidding on the minimum value of toll revenues discounted to the present [Engel 2001; Vassallo 2006]. Thus, the length of the contract is a variable. Another example is a Revenue Distribution Mechanism where the government provides a guarantee of extra revenues. In turn, the concessionaire will make additional investments in the project and the concession will end when the guaranteed value of revenue is collected [Vassallo 2006]. Huang and Chou consider an option to abandon the project at the pre-construction phase as an investment flexibility which allows the concessionaire to walk away from the project and terminates the concession agreement [Huang 2006].


4

Literature summary

Several studies in literature propose use of real options theory as risk mitigation strategies which allow proper pricing and allocation of risks in complex agreements like PPPs. Table 1 presents the summary of the literature reviewed in this paper. While in some cases it is difficult to distinguish the difference between strategies for addressing some of risks, in other cases the strategy of using the real options as risk mitigation tool is clear and straight forward. For example, in order to address exchange rate risk, the government is providing the exchange rate guarantee. However, in order to reduce traffic demand risk, there are several alternatives which can compensate this type of uncertainty. In the literature, traffic and revenue risks are often equal in terms of the treatment in real options settings. However, sources of these uncertainties might be different. For example, traffic risk is treated as the uncertainty in the forecasted number of vehicles which uses the facility. This uncertainty could be result of unforeseen changes in the surrounding transport network, changes in gasoline prices or due to the uncertainty in the estimation of travel demands at the network level. On the other hand, revenue risk which is ultimately linked to the number of vehicles, i.e., traffic risk, is also connected to the project’s financial aspect like tax treatment and debt structure and level of toll rates, i.e., price/tariff risk. For this reason, these two risks are separated and real options strategies are grouped based on their treatment of these risks.

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Table 1: List of reviewed risks and associated real options strategies. Risk Real option strategy References Traffic demand risk Option to expand project Bowe and Lee, 2004 capacity Trigeorgis, 1996 Wei-hua and Dashuang, 2006 Right-of-way contract Zhao et al., 2004 Option to contract Bowe and Lee, 2004 project capacity Trigeorgis, 1996 Option of deferring Alonso-Conde et al., payments of the 2007 concession fees Rose, 1998 Option to abandon Huang and Chou, 2006 Trigeorgis, 1996 Revenue risk Minimum revenue Dailami et al., 1999 guarantee Irwin, 2003 Huang and Chou, 2006 Vassallo, 2006 Chiara et al., 2007 Brandao and Saravia, 2008 Shan et al., 2010 Least Present Value of Engel et al., 2001 Revenue mechanism Vassallo, 2006 Revenue sharing Gomez-Lobo and mechanism Hinojosa, 2000 Revenue distribution Vassallo, 2006 mechanism Price risk/ Option of early Alonso-Conde et al., Regulatory or policy risk cancellation 2007 Rose, 1998 Tariff guarantees Wibowo, 2004 Land price Right-of-way contract Zhao et al., 2004 Option to develop Wei-hua and Dasurrounding land shuang, 2006 Inflation risk Option to adjust Wei-hua and Daconcession price shuang, 2006 Debt guarantee Wibowo, 2004 Interest rate risk Interest rate guarantee Wibowo, 2004 Exchange rate risk Exchange rate guarantee Gomez-Lobo and Hinojosa, 2000

5

Conclusion


Risk management in PPP is fundamental to assure the project success. The decisionmakers should identify, evaluate and control key risks during operations, such as demand risk, inflation risk, construction risk, completion risk, etc. These risks are not only challenges but also opportunities to private concessionaire. This needs a correct and “proactive” risk allocation and evaluation which may require financial tools such as real options theory. The instruments with options characteristics used by governments (such as guarantees) or even embedded flexibilities identified in a project can add value and mitigate and reallocate risks, reducing the risk to the private investor and making the project more attractive. The correct valuation of the options involved is important since the feasibility of the project may also depend on it. This paper presents the results of the first step of a more complex research project whose main goal is the development of approaches for modeling and valuing flexibilities (which naturally exist or are built artificially through contractual conditions and clauses, guarantees, etc.) during the risk management and allocation. This first step consisted in a literature review about the use of real options for mitigating PPP project risks. Future work will focus on developing an option-based risk management framework able to support decision makers to find the cost-effective combination of real options (or forms of flexibility) to embed in a PPP investment in order to optimally control risk and maximize investment value.

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Bibliography

Alonso-Conde, A.B., Brown, C., Rojo-Suarez, J., 2007, Public Private Partnerships: Incentives, Risk Transfer and Real Options, Review of Financial Economics, Vol.16, pp. 335-349. Bing, L., Akintoye, A., Edwards, P.J., Hardcastle, C., 2005, The Allocation of Risk in PPP/PFI Construction Projects in the UK, International Journal of Project Management, Vol.23, pp. 25-35. Blank, F.F., Baidya, T.K.N., Dias, M.A.G., 2009, Private Infrastructure Investment Through Public Private Partnership: An Application to a Toll Road Highway Concession in Brazil, 13th Annual International Conference on Real Options: Theory Meets Practice, Braga, Portugal & Santiago, Spain. Bowe, M., Lee, D.L., 2004, Project Evaluation in the Presence of Multiple Embedded Real Options: Evidence from the Taiwan High-Speed Rail Project, Journal of Asian Economics, Vol.15, pp.71–98.

Cheah, Y.J., Garvin, M.J., 2009, Application of Real Options in PPP Infrastructure Projects: Opportunities and Challenges, In: Policy, Finance & Management for Public-Private Partnerships, Akintoye, A. and Beck, M. (eds.). Blackwell Press. Chiara, N., Garvin, M., Vecer, J., 2007, Valuing Simple Multiple-Exercise Real Options in Infrastructure Projects, ASCE Journal of Infrastructure Systems, Vol. 13 (2), pp. 97-104. Dailami, M., Lipkovich, I., van Dyck, J., 1999, INFRISK: a Computer Simulation Approach to Risk Management in Infrastructure Project Finance Transactions, Policy Research Working Paper No. 2083, World Bank, Washington, D.C. Damodaran, A., 2001, The Promise and Peril of Real Options, Working paper No. S-DRP-05-02, Stern School of Business, New York University, NY. Dixit, A., Pindyck, R., 1995, The Options Approach to Capital Investment, Harvard Business Review. Engel, E.M.R.A., Fischer, R.D., Galetovic, A., 2001, Least-Present-Value-ofRevenue Auctions and Highway Franchising, Journal of Political Economy, Vol. 109 (5), pp. 993-1019. 53


Brandao, L.E., Saraiva, E., 2008, The Option Value of Government Guarantees in Infrastructure Projects, Construction Management and Economics, Vol.26 (11), pp. 1171-1180.

Gomez-Lobo, A., Hinojosa, S., 2000, Broad Roads in a Thin Country: Infrastructure Concessions in Chile, Policy Research Working Paper No. 2279, World Bank, Washington, D.C. Grimsey, D., Lewis, K.K., 2004, Public Private Partnerships, Cheltman, UK: Edward Elgar. Huang, Y.L., Chou, S.P., 2006, Valuation of the Minimum Revenue Guarantee and the Option to Abandon in BOT Infrastructure Projects. Construction Management and Economics, Vol. 24 (4), pp. 379-389. Irwin, T., 2003, Public Money for Private Infrastructure, World Bank, Washington, D.C. Li, B., 2003, Risk Management of Public/Private Partnership Projects, Unpublished PhD thesis, School of the Built and Natural Environment, Glasgow Caledonian University, Glasgow, Scotland. Myers, S.C., 1984, Financial Theory and Financial Strategy, Interfaces, Vol. 14, pp. 126-137. Ng, A., Loosemore, M., 2007, Risk Allocation in the Private Provision of Public Infrastructure, International Journal of Project Management, Vol. 25, pp. 66–76.


Quiggin, J., 2005, Public-Private Partnerships: Options for Improved risk Allocation, The Australian Economic Review, Vol.38 (4), pp.445-450. Rose, S., 1998, Valuation of Interacting Real Options in a Toll Road Infrastructure Project, The Quarterly Review of Economics and Finance, Vol.38, pp.711-725. Shan, L., Garvin, M., Kumar, R., 2010, Collar Options to Management Revenue Risks in Real Toll Public-Private Partnership Transportation Projects, Construction Management and Economics, Vol 28, pp. 1057-1069. Smith, A.L., 2009, PPP Financing in the USA, In: Policy, Finance & Management for Public-Private Partnerships, Akintoye, A. and Beck, M. (eds.). Blackwell Press. Trigeorgis, L., 1996, Real options: Managerial flexibility and strategy in resource allocation, MIT, Cambridge. Vassalo, J., 2006, Traffic Risk Mitigation in Highway Concession Projects – The Experience of Chile Journal of Transport Economics and Policy, Vol.40 (3), pp.359-381. Wei-hua, Y., Da-shuang, D., 2006, Concession Decision Model of BOT Projects Based on a Real Options Approach. International Conference on Management Science and Engineering, (ICMSE '06).

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Wibowo, A., 2004, Valuing Guarantees in a BOT Infrastructure Projects, Engineering, Construction and Architectural Management, Vol. 11 (6), pp. 395403. Yeo, K.T., Qiu, F., 2003, The Value of Management Flexibility – a Real Option Approach to Investment Evaluation, International Journal of Project Management, Vol. 21 (4), pp. 243-250.

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Zhao, T., Sundararajan, S.K., Tseng, C., 2004, Highway Development DecisionMaking under Uncertainty: A Real Options Approach, Journal of Infrastructure Systems, Vol.10 (1), pp.23-32.

Project development model for procurement of federal highways Bernd Buschmeier Chair of Construction Economics Bauhaus-Universität Weimar [email protected]


Hans Wilhelm Alfen Chair of Construction Economics Bauhaus-Universität Weimar [email protected]

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Keywords: PPP organizational model, risk valuation, financial assessment. Contribution to Working Group 1

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Abstract Purpose - The decision process for procurement models of federal highway construction projects lacks sufficient transparency. Furthermore public authorities are not equipped with tools and measurement options for adequate project supervision and control. Just in case of PPP highway projects, value for money assessments are conducted due to political pressure in order to justify the PPP ahead of conventional operation. This paper develops theoretically a general framework for all possible procurement models. In this respect the model is predicated on the organisational model published by Alfen 2010 which allows a comprehensive description of every procurement method in each sector by using a toolbox with five main compartments, the privatisation, partnership, business, contractual, and financing models. Based on this the model will be geared to the specifics of the transport sector and further developed and transformed into a mathematical model which provides analysis of the theoretical variety of procurement models upfront of the tendering process. It also delivers a hierarchical structure according to net present value of each model. The general model is structured in four layers, consisting of definition and life-cycle, remuneration, and financing models. The calculation of the NPV is done for each model individually. Differences between each option are caused by efficiency criteria, risk allocations, transaction costs, fiscal effects or financing costs. Due to the uncertainty of the input factors the final step consists of a sensitivity analysis regarding these factors. Findings - The result is a model capable of analysing procurement models on a large scale across different combinations of the above mentioned model layers. With access to the tool, political authorities will be capable of making adequate decisions according to efficiency criteria on a project specific matter, providing them justification in the political agenda process. This will overcome current random PPP selection processes by increasing transparency and economic feasibility.


1

Introduction

Apart from the "conventional"1 procurement method, there are several other models in existence which consider the financing of federal highways in Germany. In the past, a certain number of projects have been realised using the Pre-Financing-model whereas other projects were conceived as Public Private Partnerships (e.g. the German A- and Fmodel). On the other hand, procurement was also implemented by using Construction and Maintenance Contract, which could be realized with or without the inclusion of private funds. When evaluating the procurement method, the public authority is obliged by the Federal Budget Law2 to do suitable risk adjusted value for money assessments. This also contains investigating whether private partners could be co-opted to assist with financing and implementing the project. It is also important to note that from economic point of view, the chosen procurement model adheres to the criteria of 'economic efficiency'3 which is the most promising procurement model [Kruse 1985; Beckers 2005]. Currently, there is no structured and life-cycle focusing method for selection of a particular procurement method. Moreover, in the budget period 2010, nearly 98% of the investment volume has been realised as the conventional model [Krause 2011], which means that no transparent value for money assessment in the above mentioned manner has been done for those projects. Only in the case of a potential project realisation implemented in the form of a Public Private Partnership did an economic comparison take place, assessing 'the one' conventional method in comparison to several Public Private Partnership variants. For this case, indicators have been developed, which compare several parameters of the project structure. However, in the end that is not overarching and it only analyses different parameters of the Public Private Partnership variants. The different models and parameters of the conventional method which also have important influence on "getting value for money" are not analysed. For this reason, economic comparisons of every conceivable procurement model have resulted in the following project development model. The model does not describe procurement models by utilising existing terms such as the A- and F-model, Construction and Maintenance Contract or Pre-Financing model. On the contrary, it defines models on the basis of criteria and characteristics which are important for the development of the mode of the procurement model [Buschmeier and Alfen 2011].

1 2 3

'Conventional' means that the construction would be realized by lot awarding constructions contracts and all other achievements by public authorities as its own. Bundeshaushaltsordnung 1969/2010. Economical efficiency can be divided into allocative efficiency (right prices and quantity), technical efficiency (production for minimum costs) and qualitative efficiency (suitable quality).

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2

Theoretical framework

When comparing the main differences of the procurement models which are currently in vogue, it becomes clear that these models could be described and separated by some decisive characteristics which allow for a structuring and a comparison of the models. Looking at these discussions Alfen (2010) felt compelled to develop an “organisational model” which not only compares the conventional procurement method with the PPP procurement method. Furthermore the model allows describing every procurement method by using a toolbox with five main compartments, namely the privatisation model, the partnership model, the business model, the contractual model and the financing model. There are several sub-compartments in this model which facilitate the structuring of the procurement models (figure 1) [Alfen 2010; Weber and Alfen 2010]. While doing this the model is based on the fact that every procurement method consists of the above-mentioned compartments and sub-compartments. Also the model could be used for developing and implementing projects by using elements of these compartments [Alfen 2010; Weber and Alfen 2010].

Privatisation model - formal - functional - material

Partnership model Type of cooperation between public and private partner • vertical • horizontal Type of PPP • urban development • management of infrastructure assets

Business model Type of revenue streams used for coverage of investment and operational cost • user fees • public budget payments

Contract model Type of contract in vertical or horizontal partnership

Financing model e. g. project financing

Figure. 1: Compartments of the organisation model [Alfen 2010].

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Organisational model

Type of privatisation

Concerning the above-mentioned compartments the parameters of the decision process for one procurement model will be discussed as follows.

2.1 Privatisation model The privatisation model contains three sub-compartments, the formal privatisation, the functional privatisation and the material privatisation. Formal privatisation describes the transformation of a public entity into a private law company, at which the public sector remains the sole shareholder. Functional privatisation describes the transfer of functions that were previously performed by the public sector in its own right to a private company. This includes planning, construction or infrastructure asset management services such as cleaning or servicing. Functionality of material privatisation always implies, that there is a necessity to transfer ownership of the assets to the private partner permanently. The main differences between the privatisation models could be described by the following characteristics: • nature and extend of the transfer of functions to the private sector, • allocation of the provision function, • ownership interests, • duration of transfer of ownership and ownership equivalent rights [Alfen 2010; Weber and Alfen 2010]


2.2 Partnership model There are two sub-compartments distinguished at the partnership model. On the one hand a horizontal partnership and on the other hand a vertical partnership. In the case of horizontal partnerships (also called contractual PPP) the agent is a purely private project company. In contrast, a vertical partnership (also called institutional PPP) always implies that the public sector retains a share in the project company [Alfen 2010; Weber and Alfen 2010; Burgi 2008; Budäus 2004].

2.3 Business model Describing a business model it must be distinguished between the income (remuneration) and the costs of a project. The income mechanism, which is mainly described in what follows, contains two sub-compartments, the budget-financed and the user-financed model. In the case of budget-financed models, the private partner receives fixed remuneration for example: • performance-based fees • availability-based fees • volume-based fees

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• •

results-based fees or usage-based fees.

In the case of user-financed models, the revenue flows required to cover the investment and current operation costs are obtained from user fees such as tolls, charges, entrance fees or rents. [Alfen 2010; Weber and Alfen 2010].

2.4 Contractual model

2.5 Financing model The financing model contains two sub-compartments. Financing could be structured as project finance or as forfeiting model. When using the project finance, the loan approval is based on the cash flows from the project. On the other hand, the loan approval in the forfeiting model is based on the creditworthiness of the public-sector principal [Weber and Alfen 2010].

2.6 Conclusion and research gap With the organisational model published by Alfen (2010) a structural tool for describing and developing infrastructure projects has been defined. It is a very useful base framework for analyzing and identifying modes of procurement of public infrastructure. Concerning the procurement of federal highways the organisational model has to be further developed and geared to the specifics of the transport sector.

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Concerning German PPP models there are seven mainly used contract models when projects will be tendered as a PPP, the ownership model, the purchaser model, the leasing model, the tenant model, the contracting model, the concession model and the corporate model. These models combine different life-cycle elements and the main differences between the models are: • transfer and/or status of: ownership or ownership equivalent rights, at any time of the contract period, realization / utilisation risks (after termination of the PPP contract period), • user or budget financing (concession model) and • with or without horizontal partnership (corporate model) [Alfen 2010; Weber and Alfen 2010].


3

Project development model

The project development model which builds on this model by Alfen (2010) is geared towards the specifics of the German transport sector from the point of view of a public authority. Based on a net present value calculation, it allows the comparison of each theoretically feasible procurement model. Therefore it could be used by the public authorities to develop the organisational model on a project-specific basis prior to the tendering process. They would be able to decide under the criteria of efficiency by using a standardized benchmark, the net present value comparison. This model should be used on a project basis prominently and not necessarily for general issues along with financing and provision within the transport sector as such. To transmit the organisational model for the German transport sector, first is to analyze what parts of the organisational model compartments are relevant for this area. Basically, once the compartment contractual model is replaced by life-cycle model, as the project development model wants to break away from the standardised terms. The other differences of the contractual models are also described well by the other compartments. Further restrictions on the combination of the different life-cycle phases of planning, construction, operation, maintenance and transfer to the effect that the life cycle phase production will probably always be performed by a private partner, because the public does not have the resources to provide it on his own. In addition, the life cycle phase transfer will always be responsible by the public sector, since a transfer of ownership as well as further exploitation by the private sector after the contract period is already eliminated from legal aspects. According to the Germen Basic Law4, the federal government owns the federal highways and even the Federal Road Construction Private Financing Act5 only allows assigning the tasks of construction, operation, maintenance and financing to private. A discussion of various models of privatisation is not necessary, since only the functional privatization of a combination of the above-mentioned life-cycle phases of planning, construction, operation and maintenance is possible. Models of formal privatization would make no sense here and models of material privatisation fail by reason of above-mentioned legal aspects. This eliminates the compartment privatisation model for the following project development model. The discussion of different partnership models is eliminated, too. On the one hand, no project has been realised as a horizontal partnership yet and on the other hand, no monetary differences could be expected when applying such a partnership in the analysis of the project development model. Within the business model, (also called remuneration model) for the analysis of the project development model the volume-based model and the usage-based model that is based on a rent fail out. The volume-based model is based on consumption, supply or production quantities of e.g. water, electricity, gas which is not the subject. To models 4 5

Grundgesetz für die Bundesrepublik Deutschland 1949/2010. Fernstraßenbauprivatfinanzierungsgesetz (FStrPrivFinG) 1994/2006.

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based on a rent divorced from again, because the private will not be owner of the object and therefore he could not even rent. Besides these two models, the service level agreements of the performance-based payments are excluded, at least indirectly. Service level agreements are usually to bear in mind for the definition of quality and intensity of operations and maintenance services. But again, this reflects only the requirements of the contracting authority and thus leads only to higher overall costs of the various lifecycle phases, but not relative to monetary differences, as this standard is basically set for the project. In addition to the three remaining compartments that divided the project development model into a general definition part. The result is then forecasted based on the theoretical efficiency potential of the different project structures or combinations of the above compartments, which can serve as a basis for any future tendering process. The figure below depicts the process flow, which is described in more detail in the following passage. Financing model

Start project development federal highway project Projectdefinition

k1: = 0

Share of private finance = y

Output k1 k1 = {0,1}

Calculation of the base net present value C0

Output of type / volume / lenth / duration

k2: = 0

Output y

no

1 2

yes

no

Variation

Output k2 k2 = {0,1,2}

Calculation of the net present value C0i , j ,k , k

Is the project marketable

no

Issue of project definition

k2: = k2 + 1

k1: = k1 + 1

Life-cycle model i

i: = 0

i: = i + 1 no

yes

Calculation of the net present value C0i

Net present value comparison

i≥7

Comparison of the net present values of the options

yes yes

Renumeration model

j: = 0

Output j j = {0,..,6}

Calculation of the net present value C0i , j

k1 ≥ 1

k2 ≥ 2

Output i

Sensitivity analysis of relevant factors

j: = j + 1

no

Selection

j≥5

End project developement

Legend: Start / End of a process

Issue of data

Process

Decision

Annotation

Figure. 2: Process flow plan of the project development model (simplified version). The model is based on the template of a sector organization, where sufficient funding exists and where there is central "user financing unit". Sector organization in this sense

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yes

means the unit within that organisation which is responsible for procuring the necessary resources and for their investment using appropriate selection criteria when examining the need to invest in particular projects. A central "user financing unit" means that in addition to the existing heavy goods vehicle toll, all other road users will contribute to the financing of federal highways by paying their own tolls. This ensures that the comparison is exclusively performed under criteria of efficiency and do not set sector problems disincentives for individual procurement models [Beckers 2005]. Prior to describing the relevant model, the required variables and the relevant risks and risk valuation methods will be defined. Table. 1: Definition of variables. KD / B / O / M KR

Indices

Life-cycle costs (design, build, operate, maintain)

=

Risk costs

EIndices C0

= =

Earnings Project net present value

n m t iB,O,M,E zF

= = = = =

Duration of construction Duration of operation Current period Base rate of costs and earnings Factor financing costs

Indices

Indices

Indices


=

xD / B / O / M

=

Assessment factor

y i j k1 k2 v p

= = = = = = =

Factor share private finance Index life-cycle model Index remuneration model Index public financing model Index private financing model Index comparison case Index plan case

Indizes

3.1 Definition of relevant risks and risk valuation methods Crucial for the monetary impact of each option is a balanced risk transfer to the principles of efficient risk allocation. [Irwin et al. 1997; Jacob et al. 2002; Weber and Alfen 2009; Frank-Jungbecker 2011]. Therefore, the relevant risks for the federal highways will be discussed in more depth in the following paragraph. In principle, relevant risks for federal highways could be split in unsystematic risks (usually project-specific risks) and systematic (usually global) risks [Investitionsbank Schleswig-Holstein, Schüßler-Plan, Alfen Consult GmbH, et al. 2008; FrankJungbecker 2011]. Unsystematic risks are usually directly related to the project and result from experience regarding damage and probability of occurrence which can be calculated [Investitionsbank Schleswig-Holstein et al. 2008]. In contrast, when considering the effect of systematic risks on the whole national economy, a statement

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Since two compartments contain risk analysis models with the Monte-Carlo simulation, the method for determining the pseudo-random numbers and the transformation of variables in a triangular distributed random numbers will be presented in the following section. The further steps will be explained at the appropriate points of the model. 6

7

Uncorrelation implies that the correlation coefficient of two random variables is zero. So there is no linear relationship between the variables. By implication, this means that a linear relationship between the variables exists if there is a correlation coefficient unequal to zero. Here, the correlation coefficient assumes all values between one (maximum rectified linear relationship) and minus one (maximum of opposite linear relationship) [Fahrmeir et al. 2004]. According to Gleißner 2004 the Monte-Carlo simulation is the most important method of risk aggregation [Gleißner 2004]. Also, Alfen et al. (2010) attest to the method the illustration of realistic potential models into precision [Alfen et al. 2010]. Denk et al. (2005) evaluate the Monte Carlo simulation method as superior to others and, above a certain level of complexity even as the only feasible method [Denk et al. 2005].

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about the extent of damage nor the probability of occurrence or the time of admission cannot be made [Frank-Jungbecker 2011]. On the other hand, the unsystematic risks are relevant for federal highway projects, planning risk, property transfer risk, building plot risk, construction risk (divided into completion risk and construction cost risk), maintenance risk, operation risk, availability risk, earning risk, funding risk and technical risk, of the systematic, traffic volume risk, political and legal risks and other risks [Frank-Jungbecker 2011]. For the project development model is assumed for simplicity that there is uncorrelation6 between the individual risks. Furthermore, on account of the prototype character of the projects, it is assumed that only minor or no data from past projects for the density functions of the probability distributions could be used. Therefore, it is assumed for the probability distributions of risks, a triangular distribution for each case of public and private risk-taking each a minimum, a probable and a maximum value is defined. By the assumed triangular distribution thus the probabilities of the individual values are implicitly defined. [Alfen et al. 2010] The determination of the total risk value is then based on random numbers using a simulation (Monte-Carlo simulation)7. The basic idea of this method is the simulation of many independent observations of random variables to obtain the empirical distribution function for a conclusion to the theoretical distribution [Schlittgen 2008]. The Monte-Carlo simulation runs according to the following scheme: 1. generate the required random numbers, 2. convert the usually uniformly distributed random numbers in the corresponding distribution of individual risks, 3. calculation of a scenario by addition of the random numbers resulting from the different values of the probability functions of the individual risks, 4. repeating steps 1 to 3 until the desired number of simulations is achieved and 5. calculation of mean, standard deviation, and quantiles [Gleißner 2004].

The pseudo-random numbers are drawn as uniformly distributed random numbers with the 163-generator. Here, z0 (any number greater than zero and less than one with 5 decimal places) will be multiplied by 163. The non-integer remainder represents the next random number z1. The algorithm is repeated until the desired number of simulations m is achieved [Bartsch 1999]. The algorithm is shown in the following formula: z n + 1 = 163 ⋅ z n − ⎢⎣163 ⋅ z n ⎥⎦ , n + 1 {1,..., m }

Formula. 1: Algorithm of the 163-generator [Bartsch 1999]. In order to get a triangular distributed random number from the uniformly distributed random number, the uniformly distributed random number has to be equated with distribution function F(x) [Domschke et al. 2007]. Below are therefore shown initially density function f(x) and distribution function F(x).

F(x)


f(x)

a

c

a

b x

⎧ 2 ⋅ ( x − a) ⎪ ⎪ ,if a ≤ x ≤ c ⎪ ⎪ (b − a ) ⋅ (c − a) ⎪ f ( x) = ⎨ ⎪ 2 ⋅ (b − x) ⎪ ,if c < x ≤ b ⎪ ⎪ ⎪ ⎩ (b − a ) ⋅ (b − c)

c

b x

⎧⎪ ( x − a) 2 ⎪⎪ ,if a ≤ x ≤ c ⎪ (b − a ) ⋅ (c − a ) F( x ) = ⎪⎨ ⎪⎪ (b − x) 2 ,if c < x ≤ b ⎪⎪1 − ⎪⎩ (b − a) ⋅ (b − c)

Figure. 3: Density and distribution function for a triangular distribution [Domschke et al. 2007; Forbes et al. 2011]. By equating the distribution function, the formula for generating the triangular distributed random numbers is designed.

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F( xn ) = zn ⇔ zn =

( xn − a)2 (b − xn )2 ,if a ≤ xn ≤ c ∧ zn = 1− ,if c < xn ≤ b (b − a) ⋅ (c − a) (b − a) ⋅ (b − c) 2

2

⇔ zn ⋅ (b − a) ⋅ (c − a) = ( xn − a) ∧ (−zn +1) ⋅ (b − a) ⋅ (b − c) = (b − xn ) ⎧⎪ (c − a) ⎪⎪ a + z ⋅ (b − a) ⋅ (c − a), if 0 ≤ zn ≤ n ⎪ (b − a) ⇔ xn = ⎪⎨ ⎪⎪ (c − a ) ⎪⎪⎪ b − (1− zn ) ⋅ (b − a) ⋅ (b − c),if (b − a) ≤ zn ≤1 ⎪⎩

Formula. 2: Values of the triangular distributed random numbers [Domschke et al. 2007].

3.2 Definition part The definition part defines the general parameters, such as type, size, length and duration of the project. The template used here is the Federal Transport Infrastructure Plan. On this basis, the marketability of the project will be examined in a provisional manner by using dynamic net present value comparison, that is, the total costs compared with the present values of earnings.

m

+ ∑ t=1

Ep ( m+n ) Ev + ∑ t=( m+1) t (1 + iE ) (1 + iE )t

Formula. 3: Base net present value calculation. Depending on the outcome at this point, the parameters can still be modified accordingly, in order to achieve marketability for this project. If this cannot be achieved, or is the project structure meant to be that way, a recourse must be implemented in order to collect start-up funds for the project. Otherwise, the analysis of the models would be limited, for instance, due to the fact that the real toll models would be uneconomical.

3.3 Life-cycle model The first analytical part presents the analysis of the life-cycle models. Starting from the basic model, which involves construction by a private partner and the subsequent transfer to the public sector, the other seven life-cycle models (cp. figure 2:

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m ⎛ ( m+n ) ( m+n ) K B ⎞⎟ KO KM ⎟− − C0 = −K D − ∑ t=1⎜⎜ ⎜⎝ (1 + iB )t ⎠⎟⎟ ∑ t=( m+1) (1 + iO,M )t ∑ t=( m+1) (1 + iO,M )t


i = {0, ..., 7}) combine all variations of the life-cycle phases of planning, operation and maintenance with this basic model. Here is a detailed examination of the models: • Model 0 (B = Built), • Model 1 (DB = Design, Built), • Model 2 (BO = Built, Operate), • Model 3 (BM = Built, Maintain), • Model 4 (DBM = Design, Built, Maintain), • Model 5 (DBO = Design, Built, Operate), • Model 6 (BOM = Built, Operate, Maintain) and • Model 7 (DBOM = Design, Built, Operate, Maintain). Monetary differences and the correlating increasing or decreasing efficiency of the models, transpires owing to the life-cycle approach. The output orientation stimulates innovation through competition and long-term project duration. The synergy effects are achieved by eliminating interface problems. On the other hand, efficiency gains which result from an optimized allocation of risks are affiliated with an analysis of this model [Jacob et al. 2002; Arthur Andersen and Enterprise London School of Economics (LSE) 2000; Lohmann 2009]. These consist of the planning risk, the property transfer risk, the building plot risk, the completion risk, the maintenance risk, the operation risk and technical risks. Cost efficiency is achieved by the fact that the person who bears the risk is the person who can best control and influence the risk. Here, it must be considered that it is not self-evident that the person who can best bear the risk is also the person who can bear it for the least amount of costs [Irwin et al. 1997; Jacob et al. 2002; Weber and Alfen 2009; Frank-Jungbecker 2011]. Both conditions must be balanced against each other [Irwin et al. 1997]. In addition, differences arise from variations in the transaction costs of procurement and differing tax regimes, if services which were previously provided by the State are now provided privately. The efficiency effects, which may be reduced by transaction costs and tax differences, are shown for each model of the factors xDi, xBi, xOi and xMi. The different risk costs are shown on the present value CKRi. This will be calculated by the Monte-Carlo simulation where the individual risks of random numbers will be aggregated into an overall risk. Here, many iterations are run with different random numbers. The entire risk is then assumed as their average. For this model, a triangular distribution was assumed for the risks. Also are the here used parent groups of risks uncorrelated.

3.3 Remuneration model The subject matter of the second analytical part is the remuneration model. It is possible to distinguish between performance-based, usage-based, availability-based and resultbased models. The performance-based one can be partitioned into unit price and all-in price models, the usage-based into real toll and shadow-toll, the availability-based models into availability and the result-based in active management models [Böger and

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Gerdes 2008]. In addition, combinations are possible from these models whereas the project development model considers seven different remuneration models (cp. figure 2: j = {0, …, 6}).

Remuneration mechanism

Performance-based fees

Usage-based fees

Availabilitybased fees

Results-based fees

Model 0

Model 1

Model 2

Model 3

Model 4

Model 5

Unit price

All-in price

Real toll

Shadow-toll

Availability

Active management

Essential to the monetary differences of the models here is the risk allocation of the risks associated with these models and incentives that are set for the private partner. Relevant for the remuneration model are the construction cost risk, availability risk, the traffic volume risk, the earning risk, political and legal risks and other risks. In applying the above principles to the allocation, enormous differences in the project costs can arise [Cp. among others Beckers 2005]. As with the life-cycle models, the risks are mapped on a present value, in this case CKRj. The determination of the total cost of risk is analogous to the life-cycle models using the Monte-Carlo simulation. Other differences arise in the case of lending to the project company with the contractual right to enter into a direct business relationship with users, since in this case, it can be resolved under existing VAT regimes [Martens et al. 2004]. This is considered in the factors xDi,j, xBi,j, xOi,j and xMi,j.

3.4 Financing model The final analytical part is the analysis of the financing models. In principle, the projects are funded from both public or private sectors or a combination of both. In the case of public funding, the model distinguishes between funding through the budget and the capital market (cp. figure 2: k1 = {0, 1}), in the case of private sector, between forfeiting, corporate finance and project finance (cp. figure 2: k2 = {0, 1, 2}). The amount of the minimum share private y depends on the life-cycle and the remuneration models. Depending on which life-cycle model is utilised, a correspondingly high ratio of private funding may be required in order to have sufficient capital at their disposal in

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Figure. 4: Remuneration models [Böger and Gerdes 2008].

the event of insolvency of the private partner where project reallocation is mandated. Depending on the particular remuneration model, private capital would be necessary to reduce or avoid disincentive. The remaining share of funding (1 – y) should be financed by the State because of the generally lower cost of capital. Apart from the higher cost of private funding, any benefits such as cost of due diligence, project evaluation and project monitoring are taken into account that the private performs depends on the model, since this would occur otherwise in the public sector also [Among others ÖPPInitiative NRW, in Zusammenarbeit mit der NRW.BANK and der Investitionsbank Schleswig-Holstein 2010]. For the shares of public and private financing, an interest in each factor is calculated (zFk1 for public funding and zFk2 for private), which reflects the annuity repayments during the operational phase in a factor equal to the corresponding present value of these finance charges. This includes the aforementioned monetary differences in their respective intensity.

3.5 Net present value comparison In conclusion, there is the net present value comparison of all variants. Since the capital value compares all the costs and remunerations in a dynamic fashion, it gives the public authority a hint, what added value it would achieves through the respective procurement option. Moreover it specifies the additional expense the public authority would have to put into account. ⎛ K B ⋅ xB ⋅ xB ⎞⎟ m i i,j C0i , j ,k ,k = −K D ⋅ xDi ⋅ xDi , j ⋅ ((1− y) ⋅ zFk + y ⋅ zFk ) − ∑ t=1⎜⎜⎜ ⎟⎟⋅ ((1− y) ⋅ zFk1 + y ⋅ zFk2 ) 1 2 1 2 ⎜⎝ (1 + iB )t ⎠⎟ 12F11_University of the Aegeanresearch_INTERNO COST ACTION TU 1001

( m+ n )

− ∑ t =( m+1) m

+ ∑ t =1

KO ⋅ xOi ⋅ xOi , j (1 + iO, M )

Ep (1 + iE )

t

( m+ n )

t

( m+ n )

− ∑ t =( m+1)

+ ∑ t =( m+1)

K M ⋅ xMi ⋅ xMi , j (1 + iO, M )t

− CK R − C K R i

j

Ep (1 + iE )t

Formula. 4: Net present value calculation. If the net present value is positive, this means for the public authority that it may retain parts of the toll, it is negative in the sense that in accordance with higher start-up funds or similar subsidies for the successful implementation of the project are required. It is conceivable that the combined contracting projects with negative net present value of projects that have a positive net present value of a similar amount, would then connote a budget neutral proposal. Also, a further adjustment of the project cut and a new calculation are possible at this point. Because of the uncertainty involved in some input variables, a sensitivity analysis of the values must take place which may cause relative differences between the individual variants. These are especially: • efficiency factors for private sector realisation,

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• • •

efficiency factors by combining life-cycle phases, transaction costs of tendering and potential loss of the risks.

The sensitivity analysis carried out here is in the form of a triple-bill, scheduled to be in each of the relevant values according to their impact, an optimistic value, a likely value and a more pessimistic value and the corresponding effects can be determined. Depending on the outcome of the analysis, and any impact on the profitability is to define a decision rule, under what conditions will be taken the choices [Bieg and Kußmaul 2009].

4

Conclusions

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The model allows an efficiency analysis of the different design options available in the tendering process. It is not intended to replace the existing value for money assessments [Investitionsbank Schleswig-Holstein, et al. 2008] which are completed during the tendering process. It shall however be implemented prior to these assessments. Thus, this model is to be understood as a prioritizing test that identifies the variants that are comparable in this value for money assessments. Analysing various design variants, it is possible to examine the efficiency potential of all possible procurement methods based on specific project structure and for each project in order to identify the most efficient alternative.

Bibliography

Alfen, H.W., 2010, Public Private Partnership (PPP) as part of Infrastructure Management solutions - a structural approach of delimiting PPP from other Private Sector participation Models, In: Conference Proceedings of CIB World Congress, 10-13 May 2010, The Lowry, Salford Quays, Großbritannien, Electronical ressource: http://www.cib2010.org/post/files/papers/603.pdf. Alfen, H.W., Riemann, A., Leidel, K., 2010, Lebenszyklusorientiertes Risikomanagement für PPP-Projekte im öffentlichen Hochbau : Abschlussbericht zum Forschungsprojekt, Oct. 2010., Verl. d. Bauhaus-Univ., Weimar, Germany (in German). Arthur Andersen and Enterprise London School of Economics (LSE), 2000, Value for Money Drivers in the Private Finance Initiative (Commissioned by the Treasury Taskforce, January 17), London. Bartsch, H.J. 1999, Taschenbuch mathematischer Formeln, 18th corrected edition Fachbuchverl. Leipzig im Hanser-Verl., Munich and others, Germany.


Beckers, T., 2005, Die Realisierung von Projekten nach dem PPP-Ansatz bei Bundesfernstraßen : ökonomische Grundlagen und eine Analyse des F-Modells, des A-Modells sowie des Funktionsbauvertrages, Doctoral thesis, Technische Universität Berlin, Berlin, Germany. Bieg, H. and Kußmaul, H. 2009, Investition, 2nd complete updated edition, Vahlen, Munich, Germany. Böger, T., Gerdes, E., 2008, Die Bereitstellung von Straßeninfrastruktur in Deutschland, In: Public Private Partnership, M.-H. Bettina, Riemenschneider, F., Weihrauch, O. (Ed.), Gestaltung von Leistungsbeschreibung, Finanzierung, Ausschreibung und Verträgen in der Praxis Carl Heymanns, Köln. Budäus, D., 2004, Public Private Partnership - Ansätze, Funktionen, Gestaltungsbedarfe, In: Gesellschaft für Öffentliche Wirtschaft, Verband Kommunaler Unternehmen, European Centre of Public Enterprises. Deutsche Sektion, et al. Public Private Partnership: Formen - Risiken - Chancen; Referate eines Symposiums der Gesellschaft für Öffentliche Wirtschaft, des Verbandes Kommunaler Unternehmen, der Deutschen Sektion des Europäischen Zentralverbandes der Öffentlichen Wirtschaft (CEEP) und des Deutschen Städtetages am 30./31. Oktober 2003 in Berlin Ges. für Öffentliche Wirtschaft, Berlin, Germany (in German). Burgi, M., 2008, Privatisierung öffentlicher Aufgaben Gestaltungsmöglichkeiten, Grenzen, Regelungsbedarf, In: Ständige Deputation

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des deutschen Juristentages In: Verhandlungen des siebenundsechzigsten deutschen Juristentages (Erfurt 2008) Beck, Munich, Germany. Buschmeier, B., Alfen, H.W., 2011, Modelle zur Beschaffung von Bundesfernstraßen, In: Internationales Verkehrswesen, Vol. 63, No. 5, pp. 17-19. Denk, R., Exner-Merkelt, K., Ackerl, E., 2005, Corporate Risk Management: unternehmensweites Risikomanagement als Führungsaufgabe, Linde Internat., Wien, Austria. Domschke, W., Drexl, A., Domschke, D., 2007, Einführung in Operations Research, 7th updated edition, Springer, Berlin and others, Germany. Fahrmeir, L., Künstler, R., Pigeot, I., 2004, Statistik: Der Weg zur Datenanalyse, 5th corrected edition, Springer-Verlag Berlin Heidelberg, Berlin, Heidelberg, Germany. Forbes, C.S., Evans, M., Hastings, N., 2011, Statistical Distributions, 4th edition, Wiley, Hobokon, NJ. Frank-Jungbecker, A., 2011, Verkehrsmengenrisiko bei PPP-Projekten im Straßensektor - Determinanten effizienter Risikoallokation, Doctoral thesis, Chair Constrution Economics, Bauhaus-Universität Weimar, Weimar, Germany.

Investitionsbank Schleswig-Holstein, Schüßler-Plan, Alfen Consult GmbH, 2008, Wirtschaftlichkeitsuntersuchung A-Modell Leitfaden für Wirtschaftlichkeitsuntersuchungen für die Vergabe der Betreibermodelle nach dem A-Modell in Bundesfernstraßenbau, Electronic resource: http://www.vifg.de/_downloads/_informationen_zu_modellen_und_projekten/081 030_Leitfaden_-_WU_A-Modell.pdf, Germany. Irwin, T., Klein, M., Perry, G.E., 1997, Dealing with public risk in private infrastructure, 1st print, Washington, DC. Jacob, D., Kochendörfer, B., Hauptverband der Deutschen Bauindustrie, 2002, Effizienzgewinne bei privatwirtschaftlicher Realisierung von Infrastrukturvorhaben: Wie effizient ist die Einbeziehung Privater bei öffentlichen Hoch- und Straßenbaumaßnahmen? Eine Forschungsarbeit, BundesanzeigerVerl.-Ges., Colgne, Germany. Krause, S., 2011, Beschaffungsvarianten im Bundesfernstraßenbau. In: 11. Betriebswirtschaftliches Symposium Bau: PPP in der Straßenverkehrsinfrastruktur 31st March 2011, Weimar, Germany. Kruse, J., 1985, Ökonomie der Monopolregulierung, Vandenhoeck und Ruprecht, Göttingen, Germany.

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Gleißner, W., 2004, Auf nach Monte Carlo - Simulationsverfahren zur RisikoAggregation, In: RISKNEWS, Vol. 1, pp. 31-37.

Lohmann, T., 2009, Effizienz bei Öffentlich Privaten Partnerschaftsprojekten: Entwicklung eines Verfahrensmodells in der Wettbewerbsphase von Hochbauprojekten, Doctoral thesis, Institut für Baubetriebslehre, University of Stuttgart, Berlin, Germany. Martens, C.P., Wortmann, B., Horn, L., 2004, Expertise for elaboration of the franchise agreement and regulations for invitation to tender/awarding franchises for the operator model for multi-lane motorway widening ("A-Modell"), DMBBundesdr., Bonn, Germany. ÖPP-Initiative NRW, in collaboration with NRW.BANK and Investitionsbank Schleswig-Holstein 2010, Finanzierungspraxis bei ÖPP, Germany. Schlittgen, R., 2008, Einführung in die Statistik : Analyse und Modellierung von Daten, 11th complete updated and new framed edition, Oldenbourg, Munich, Germany. Weber, B., Alfen, H.W., 2009, Infrastrukturinvestitionen - Projektfinanzierung und PPP : praktische Anleitung für PPP und andere Projektfinanzierungen, 2nd updated edition, Bank-Verl., Cologne, Germany. Weber, B., Alfen, H.W., 2010, Infrastructure as an asset class: investment strategies, project finance and PPP, 1st edition, Wiley, Chichester.


Federal Budget Law (Bundeshaushaltsordnung (BHO)) 1969/2010, As amended by 19th August 1969 (BGBl. I S. 1284),last modified at 9th December 2010 (BGBl. I S.1885). Federal Road Construction Private Financing Act (Gesetz über den Bau und die Finanzierung von Bundesfernstraßen durch Private (Fernstraßenbauprivatfinanzierungsgesetz - FStrPrivFinG)) 1994/2006, As amended by 6th January 2006 (BGBl. I S. 49). German Basic Law (Grundgesetz für die Bundesrepublik Deutschland) 1949/2010, As asmended by 23th May 1949 (Bundesgesetzblatt Teil III, Gliederungsnummer 100-1), last modified at 21st July 2010 (BGBl. I S. 944).

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PART TWO

Short Term Missions

The Significance of Incentivising Performance Based Contracts – the Case of PPP Road Projects Thais Rangel Transport Research Centre Technical University Madrid [email protected]


Champika Liyanage School of Built and Natural Environment, University of Central Lancashire [email protected] Jose Manual Vassallo Transport Research Centre Technical University Madrid [email protected]

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Keywords: Key Performance Indicators (KPIs), Performance Based Contracts (PBCs), Performance Based Mechanisms, Public Private Partnerships (PPPs), Roads Contribution to Working Group WG2

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Abstract Purpose – The main aim of the paper is to identify Key Performance Indicators (KPIs) in measuring performance based contracts in PPP road projects. Design/methodology/approach – The approach is based on an in-depth review of research papers that are based on PPP road projects. Findings – In the last few years, most of the infrastructure management contracts, including PPPs, have introduced incentives to encourage the bidders to reach the highest possible level of service, in such a way that any increase in efficiency will be transferred to the users to increase quality. These contracts have usually set up a minimum quality in such a way that if the contractor performs below this quality level, the contractor will be penalised and if they perform above this level, they will be rewarded. This approach has moved many countries such as the United Kingdom, Finland, Portugal and Spain to introduce performance based indicators tied to bonuses and penalties in their PPP contracts. These performance based standards often refer to different aspects such as technical, environmental and safety issues. Social implications – The main implications would be that the PPP contracts could reach the highest quality level through incentivizing the contractor. This would provide a win-win situation for all involved in the PPP projects (be it roads or any other sector). Originality/value – The Key Performance Indicators devised through the literature reviews and the example of the development of the measurement mechanism for the KPI would add value to the PPP performance based contracts, not only for the road projects but for other sectors in the construction industry as well.

1

Introduction

Public Private Partnerships (PPPs) are mostly implemented to circumvent budgetary constraints, and to encourage efficiency and quality in the provision of public infrastructure in order to reach social welfare. One of the ways of reaching the latter objective is by the introduction of performance based standards tied to bonuses and penalties to reward or punish the performance of the contractor. One of the most common ways of implementing PPPs in managing infrastructure is through the concession approach, which consists basically in transferring final design, construction, maintenance, and operation of the infrastructure to a private consortium, in exchange for which that consortium receives the right to charge a fee to the user or to the government on behalf of the user, for a period of time contractually agreed in advance [Vassallo and Gallego 2005].


One of the key aspects of PPPs is to encourage the private sector to manage and operate the infrastructure in the best way. To that end, in the last few years, PPPs are evolving from mere demand-based contracts (when the revenues of the contractor are related to the traffic demand) to performance-based contracts. Consequently, the revenues of the contractor tend to depend more and more to the quality of the services rather than on traffic demand [Harding et al. 2010]. The main aim of the paper is to study the aforementioned PBCs and, inter alia, to identify Key Performance Indicators (KPIs) in measuring these performance based payment mechanisms. These are identified through a through a thorough review of literature. In doing so, the main focus of the study was PPP road projects. The following discussions of the paper contain four main sections. Frist section discusses the significance of PBCs. The following section then defines performance based payment mechanisms that are integral to PBCs. It also explains why performance based payment mechanisms are becoming important in PPP contracts. Next section identifies KPIs that are specific to PPP road projects whilst final section presents the overall conclusions of the paper.

2

Performance Based Contracts (PBCs)

Concession contracts should include the necessary provisions in order that the relationship between the public and the private sector work at their best throughout the life of the contract. Therefore, the bidding terms and contracts should comply with two requirements: first, ensure that the most efficient bidder, in terms of price and quality, is awarded the contract; and second, provide incentives to the contractor to render the 78

highest quality level compatible with a reasonable cost. Some of the most common standards introduced in motorway contracts are: congestion (average travel times), road accidents (number of traffic incidents), quality (pavement surface conditions), impact on the environment (number of incidents of breach in noise/air quality requirements), provision of information for motorway users (accuracy and frequency) and vehicle breakdown (services/availability and response time) [Grimsey and Lewis 2004]. The contract must include mechanisms to encourage the bidder to reach the highest possible level of service, in such a way that any increase in efficiency will be transferred to the users. These mechanisms are generally based on fixing a number of minimum standards to be fulfilled by the contractor. If the contractor fails to comply with these requirements, the public authority will penalize the contractor or even rescind the contract.

These performance based incentives, however, have to be introduced in the right way in PPP contracts. To meet these objectives, the marginal reward to the contractor for reaching a certain quality level should never be larger than the marginal social benefit produced at that level. The contractor will provide a quality level at the point where the marginal revenue obtained due to a certain quality increase equals its marginal cost. If the incentives are defined this way, the contractor will be encouraged to provide the best service compatible with its production costs [Vassallo 2007]. The approach explained above has moved many countries to introduce performance based indicators tied to bonuses and penalties in their PPP contracts. Some countries, such as the United Kingdom, have mostly replaced the demand based approach [Debande 2002] by the performance based approach. Others countries, such as Spain, have incorporated bonuses and penalties tied to performance based standards in many of their PPP contracts [Delgado et al. 2007]. Performance based contracts (PBCs) is a type of contract in which payments for the management and maintenance of roads are linked to the contractor meeting or exceeding certain performance indicators. In the last few years, PPP contracts have introduced incentives to encourage the bidders to reach the highest possible level of service in such a way that any increase in efficiency will be transferred to the users to increase quality. These contracts have usually set up to a minimum quality that if the

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Most of the infrastructure management contracts, including PPPs, have not introduced explicit incentives to increase quality of contracts. Rather they have usually set up a minimum quality in such a way that if the contractors perform below this quality level, they will be penalised; but performance above this level, will not be rewarded. These types of contracts have the problem that they do not incentivise the contractor to reach an optimal quality level. This is the reason why nowadays most authorities encourage in PPP contracts the introduction of incentives tied to bonuses and penalties to foster the contractor to provide the optimal quality level.

contractor performs below this quality level, they will be penalised and if they perform above this specified level, they will be rewarded [Rangel 2011]. Two reasons lie behind this new approach of PBCs [Rangel 2011]. First, this type of contract transfers most of the risks to the contractor and assures that the costs associated with that are the responsibility of the contractor. And second, to encourage PPP contractors to provide a better service by aligning the social and the private benefits that will produce a more efficient outcome to society. The contractor is paid for its performance on specific management activities. These performance based standards often refer to different aspects such as availability, congestion, state of the pavement and safety issues. PBCs should specify the payment mechanisms clearly. The more precise the specifications are, the less uncertainties remain for the private sector, which allows a more accurate cost estimate.


3 Why performance based payment mechanisms is becoming important to PPP contracts? Performance based payment mechanisms have been used as a common compensation for Public Private Partnerships (PPPs) delivery systems. The main reason for offering incentives to contractors is to achieve government objectives such as an efficient traffic management, increase project demand, decrease accident rate, and improve overall road conditions and so on. Payment mechanisms are often a combination of some elements. The choice of payment elements and their weight in relation to the total compensation for the contractor depends on the government objectives [Harding et al. 2010]. The incentives given to the contractors should reflect and meet the government objectives in the project. For example, if the government objective is to decrease the accident rate, the main reason for using safety payment is related to the government objective to decrease accident rate. The overall objective of the government is to maximise social welfare. In contrast, the private sector is focused on maximising profits. These different goals may conflict with each other. For the purpose of maximising social welfare, it is necessary to establish a contractual relationship between both sectors with the introduction of some bonuses or penalties depending on certain KPIs. Performance based payments clearly reflect how much the contractor was successful in achieving the government objectives.

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PPP contracts should provide incentives to contractors to reach the highest quality level with a reasonable cost. Performance based payments mechanisms are generally intended to provide an incentive to the contractor to meet [Harding et al. 2010]: 1. 2. 3.

minimum operational performance technical availability of the asset quality management service

Payment mechanisms for PPP projects could be usually structured with one or more of the above compensation methods. It is important to highlight that incentives should include bonuses and not only penalties in order to encourage the contractor. These incentives refer to a “bonus” payment, not a “core” payment. Since performance based payments are a new approach for road administrations and contractors, close cooperation between both parties is necessary for success. Both parties should agree with the contractual arrangements and understand the risks involved [Zietlow 2004].

PBCs can lead to cost savings through incentives to the private sector for innovation and higher productivity. The private sector has greater flexibility (than public sector) to reward performance and react quickly against non-performers. Equipment innovations and project management appear to be the most dominant innovations (Pakkala, 2007).

4 Key Performance Indicators in measuring Performance based payment mechanisms A common approach to specifying the quality of service outputs is to develop a matrix of key performance indicators which set the requirements for each service output [Vassallo et al 2009]. The use of “performance measures” or “key performance indicators” (KPIs) are widely used to manage performance in PPP contracts. Performance indicators terminology is quite confusing as so many different countries are using different names and there is no common standard. Some countries use terminology such as “performance measures”, “performance Indicators” or “key performance indicators”. For the purpose of this study, distinguishing these terms provides useful clarification. Performance indicators are not direct measures of quality; rather they are flags to alert users to possible opportunities for improvement. 81


There is evidence from a number of sources concerning the cost savings of PBCs [Pakkala 2002; Stankevich et al. 2005; Zietlow 2004]. However, cost savings are difficult to document. Cost savings are often the difference between the agency’s estimated cost and the amount of the contract award.

Performance measures, on the other hand, are markers or signs of things you want to measure but which may not be directly, fully or easily measured [Adair et al. 2003]. Thus, a performance measure is one of several measurable values that contribute to the understanding and quantification of an indicator. KPIs, as the name implies, therefore, are the performance indicators that are ‘key’ in specifying the quality of a service output (in a contract).


The main purpose of this paper, as discussed in the introduction, is to identify these KPIs that are ‘key’ to performance based payment mechanisms in PPP road projects. The PBC approach explained earlier has been adopted in many countries in order to introduce performance based indicators that link to bonuses and penalties in their PPP contracts. For example, in the past few years, Spain has begun to introduce performance based indicators in both toll and shadow toll motorways [Vassallo and Pérez de Villar 2010]. Toll motorway concession contracts include a provision to extend the contract duration up to four years if several performance based indicators tied to quality aspects like queuing in toll plazas, congestion, state of the pavement and satisfaction of the users are ultimately fulfilled. Other PPP’s awarded recently in Spain also include incentives in terms of annual bonuses to be incorporated to the periodic fee paid by the government to the contractor linked to performance based indicators such as availability, state of the pavement, road safety and so on. Having completed a thorough review of literature the authors were able to extract a list of KPIs for PPP road projects for PBCs. These 8 KPIs were the ‘only’ KPIs the authors could identify in these selected research papers that can be linked to incentives. The research papers were selected based on their relevance to the topic researched by the authors, i.e. performance based KPIs in PPP road projects (Table 1). Table. 1: Key Indicators in Performance Based PPP Road Projects. KPI

Availability

Congestion

Demand Environmental issues

Transport mode

Country Slovakia, Austria, Latvia, Hungary, Canada and Russia

Authors

Motorways, bridges and Harding et al. tunnels (2010) Aziz and M. British Columbia (Canada) Motorways and bridges (2007) Washington, Missouri, Molenaar and Motorways and bridges Georgia and Minnesota (USA) Navarro (2011) Delgado et al. Spain Motorways (2007) Slovakia, Austria, Latvia, Motorways, bridges and Harding et al. Hungary, Canada and Russia tunnels Aziz and M. British Columbia (Canada) Motorways and bridges (2007) Washington, Missouri, Molenaar and Motorways and bridges Georgia and Minnesota (USA) Navarro (2011)

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Continue from Table 1.

Operation and Maintenance

Road safety

State of the pavement

User satisfaction

Country

Transport mode

British Columbia (Canada)

Motorways and bridges

Italy

Urban and rural network

Slovakia, Austria, Latvia, Hungary, Canada and Russia Washington, Missouri, Georgia and Minnesota (USA) Latin America, USA and Europe

Motorways, bridges and tunnels Motorways and bridges



Spain

Motorways

Slovakia, Austria, Latvia, Hungary, Canada and Russia Washington, Missouri, Georgia and Minnesota (USA) Spain British Columbia (Canada), Argentina, Uruguay, Brazil, Chile, Colombia, Australia, New Zealand and USA

Motorways, bridges and tunnels Motorways

Spain

Motorways

Latin America, USA and Europe British Columbia (Canada), Argentina, Uruguay, Brazil, Chile, Colombia, Australia, New Zealand and USA



Authors Aziz and M. (2007) Crispino et al. (2008) Harding et al. (2010) Molenaar and Navarro (2011) Stankevich et al. (2005) Aziz and M. (2007) Delgado et al. (2007) Harding et al. (2010) Molenaar and Navarro (2011) Rangel, T (2011)

Motorways and bridges Zietlow, G. (2004) Delgado et al. (2007) Stankevich et al. Motorways and bridges (2005)

Motorways and bridges Zietlow, G. (2004)

Aziz and M. (2007) Washington, Missouri, Molenaar and Motorways and bridges Georgia and Minnesota (USA) Navarro (2011)



The payment mechanism for PBCs may include different key performance indicators and according to the aforementioned findings given in the table, the authors identify eight (08) KPIs for performance based payment mechanisms in PPPs in different countries. They are:

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KPI

1. Availability: Compensation in relation to the availability of traffic lanes is given to the contractor. The assessment of availability deductions usually includes the spatial dimension (length of the motorway which was affected) and timing and duration. Availability deduction will be imposed if a motorway lane is not available (per hour during the day and during the peak hours). 2. Congestion: The contractor will be incentivised to reduce road congestion and receive full payment if traffic speeds are above the target speed and will be reduced if the speeds fall. 3. Demand: The contractor is compensated if the demand increases. There will be a traffic bonus, which is a compensation for additional maintenance expenses resulting from a higher traffic flow volumes than forecasted. 4. Environmental issues: It is related to the environmental compliance, stewardship, and preservation. Each country has some form of environmental requirements, regulations, and restrictions that must be applicable at the time.


5. Operation and Maintenance: The good performance of the contractor in the Operation and Maintenance tasks are the basis for determining the contractor’s compensation. The contractor is compensated based on performance, for example winter maintenance, vegetation control, functionality of mechanical and electrical equipment such as repair broken luminary within a tunnel, road and traffic signs should be clean and so on. 6. Road safety: A bonus and/or deductions depending on reducing the accident rate on motorways to an established benchmark. 7. State of the pavement: Potholes that would not be sealed in a specific response time will affect the payment. Surface drainage systems have to be structurally sound and clean to allow for the free flow of water. The contractor is not paid for the number of sealed potholes, but for the output of the work: no pothole remaining open (or 100% sealed). 8. User satisfaction: It is expressed as the increase in the number of drivers using the road and the percentage of overall customer satisfaction. This KPI is linked to the performance of the contractor in maintaining a safe and efficient motorway. According to the main findings of the literature review, each country given in Table 1, uses KPIs to provide the efficient outcome for its PPP projects and they are the basis for incentives and penalties as mentioned previously. Through the literature review it was apparent that the performance based indicators have been selected in many countries on the basis of their manageability by the private contractor and their impact on social welfare. These performance based standards often refer to different aspects, e.g. due to 84

technical and safety issues. What is mostly interesting in the given table is that, although EU has the highest concentration and tradition of incorporating performance based incentives in PPPs, only a couple of literature tackled the analysis of the experiences of some EU countries, whilst many other articles were focusing on either Asia, America or Australia. Therefore, the literature review highlights a gap in terms of PPP road projects research on PBCs in the EU.

4.1

Using KPIs for incentivising the PPP contractor

KPIs are used to define government performance objectives. Payment mechanisms are a combination of these elements. The choice of payment elements and their weight in relation to the total compensation for the concessionaire depends on the objectives of the government. The design of the KPI used to evaluate the improvement of road performance is quite heterogeneous. In many PBCs, the assessment/measurement of the indicator is done by comparing similar roads, in terms of traffic, number of carriageways, type of surroundings, and so on. With this methodology it is possible to filter the global evolution of casualties which is notably decreasing in the EU due to many factors, most of them not manageable by the road operator. Herein, due to the limitations to the length of the paper, only one KPIs is discussed as an example, i,e. ‘road safety’. As per the example given in Table 2, some road contracts where this indicator is set in this way are M-6 road in Hungary, E-18 road in Finland, IP-4 road in Portugal and some PPP roads in Spain (AP-46 and M-407), as shown in Table 2. However, there are differences between them. The road safety index in M-6 (Hungary) assesses four types of accidents from light to fatal accidents. This makes it possible to evaluate the existence of accidents and their severity. Regarding the period of time considered, PPP contracts that compare the results with other roads always take into account one year. Other contracts only assess the evolution of the indicator over the years from what happens on the road itself without comparing to other roads. This is the most common situation in PPP roads awarded by regional government in Spain [Delgado et al. 2007].

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In this research, the term “incentive” refers to any kind of economic profit with which the road operator is rewarded in terms of performance. Hence, for the purpose of this paper, PPP contracts are excluded, where its regulations only impose minimum standard levels of performance with penalties (if the standards are not met), but without bonuses if they are exceeded. The importance of highlighting those incentives with bonuses ensures the fact that they encourage the road operator to go “beyond” the expected standards of performance in PBCs. These expected standards are usually equal to the minimum levels mentioned above. In short, it is essential to link these explicit road KPIs with bonuses for the road operator (i.e. positive incentives) to enhance performance of PPP road projects.

Table. Table.2:2:Devising Devising a measurement a measurement mechanism mechanism for KPIs for KPIs – An –example. An example. KPI KPI

Country Country Motorway Motorway AtAtleast 90% of concession period, mortality indexindex and risk least 90% of concession period, mortality andindex risk remain index remain Spain –Spain – lower than 90% of average value of those toll motorways with similar lower than 90% of average value of those toll motorways with similar AP-46 AP-46 Annual Average Daily Traffic (AADT) (+/- 5.000 vehicles/day) Annual Average Daily Traffic (AADT) (+/- 5.000 vehicles/day) Measurement Measurement

Actual Accident Rate (AAR) compared to similar roads roads (sr): (sr): Actual Accident Rate (AAR) compared to similar HungaryHungary – – M-6 M-6 Road Road safety safety


Risk Index (RI) compared to similar roadsroads (sr): (sr): Risk Index (RI) compared to similar

FinlandFinland – – E-18 E-18 PortugalPortugal – – IP-4 IP-4 Spain –Spain – M-407 M-407

Source: et et al.al. (2009); Zietlow (2004). Source:Vassallo Vassallo (2009); Zietlow (2004). Themost moststriking striking finding after analysing the above wasthere that there weredifferences huge differences The finding after analysing the above was that were huge amongcountries countries penalties bonuses applied for similar of There KPIs. There among in in thethe penalties andand bonuses applied for similar levels levels of KPIs. werealso alsobig bigdivergences divergences in the bonuses or penalties. For example, the three were in the top top bonuses or penalties. For example, in the in three most representative representativePPPs PPPs mentioned in above i.e. Muurla-Lohja E18 Muurla-Lohja in most mentioned in above TableTable 2, i.e.2, E18 in Finland,IP-4 IP-4inin Portugal M-407 in Spain, although they the have the road samesafety road safety Finland, Portugal andand M-407 in Spain, although they have same indicator,bonuses bonuses penalties substantially different each other. Specifically, indicator, andand penalties are are substantially different from from each other. Specifically, the relationship relationshipbetween between Finish Spanish payments is approximately the thethe Finish and and Spanish payments is approximately 10/1 10/1 respectivelyand and difference between the Finish and Portuguese payments is approximate respectively difference between the Finish and Portuguese payments is approximate 100/1.What Whatis ismore more interesting is that, while the Finish and Spanish contracts 100/1. interesting is that, while the Finish and Spanish contracts have a have a toplimit limitforforboth both penalties bonuses, the Portuguese IP-4 not does notahave a maximum top penalties andand bonuses, the Portuguese IP-4 does have maximum forneither neitherthethebonuses bonuses penalties. Nevertheless, the global rates are much for nornor thethe penalties. Nevertheless, the global safety safety rates are much betterininFinland Finlandthan than Spain or Portugal: for instance, the number of fatalities per better in in Spain or Portugal: for instance, the number of fatalities per was billion kilometres in 2007 waswas 59 in59Finland whilewhile in Spain it was it108 and108 in and in billionpassenger passenger kilometres in 2007 in Finland in Spain Portugal12810. 12810.What What simply means is that performance payments Portugal thisthis simply means is that performance based based payments clearly clearly reflecthow howmuch muchthethe contractor successful in achieving the overall performance reflect contractor waswas successful in achieving the overall performance 86

objectives. If closely analysed, the result is, undoubtedly, the same for rest of the 7 KPIs mentioned within the literature review.

3

y–

– –

Discussions and Conclusions

The tender process is based on “the best value” which is not necessarily “the lowest bid”. It involves choosing a contractor who, having agreed to comply with the requirements of KPI established in the contract, submits the lowest tender in terms of price. The “best value” approach tries to ensure a high quality at a low cost [Crispino et al. 2008]. Quality requirements, competence and know-how are considered more important aspects as compared to the price, because it is essential to determine the service providers’ capability. PBCs should include the necessary provisions in order that the relationship between the public and the private sector work at their best throughout the life of the contract. Therefore, the bidding terms and contracts should comply with two requirements: first, ensure that the most efficient bidder, in terms of price and quality, is awarded the contract; and second, provide incentives to the contractor to render the highest quality level compatible with a reasonable cost. This trend has moved many countries such as the United Kingdom, Finland, Portugal, Spain, Hungary and Norway [Rangel 2011] to introduce performance based indicators tied to bonuses and penalties in their PPP contracts. Under PBCs, governments focus on the results, output, or outcome of the end product (project or facility) rather than the materials and methods used in building or maintaining the product. Payments are made for measured outputs instead of quantify of input. In other words, a PBC clearly establishes the expected outcomes rather than the processes to reach those outcomes [Aziz and Ahmed 2007; Crispino et al. 2008; Stankevich et al. 2005]. The overall objective of the government is to maximize social welfare. In contrast, the private sector is focused on maximizing profits. These different goals may conflict with each other. For the purpose of maximizing social welfare, it is necessary to establish a contractual relationship between both sectors with the introduction of some bonuses or penalties depending on certain quality indicators and according to the technical and safety regulations that may be applicable at the time. PPP contracts should provide incentives to contractors to reach the highest quality level with a reasonable cost. Performance based payments mechanisms are generally intended to provide an incentive to the contractor to meet: (1) minimum operational performance (i.e. winter maintenance), (2) technical availability of the asset (i.e. 87


yay

functionality of mechanical and electrical equipment such as repair broken luminary within a tunnel), and (3) quality management service (i.e. monitoring and reporting) [Harding et al. 2010].


It is important to highlight that incentives should include bonuses and not only penalties in order to encourage the contractor. These incentives refer to a “bonus” payment, not a “core” payment, or incentives related to the deadline of the projects as mentioned previously. Since performance based payments are a new approach for road administrations and contractors, close cooperation between both parties is necessary for success. Both parties should agree with the contractual arrangements and understand the risks involved [Zietlow 2004].

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Bibliography

Adair, C., Simpson, L., Birdsell, J., Omelchuk, K., Casebeer, A., Gardiner, H., Newman, S., Beckie, A., Clelland, S., Hayden, K., and Beausejour, P., 2003, Performance Measurement Systems in Health and Mental Health Services: Models, Practices and Effectiveness A State of the Science Review. The Alberta Heritage Foundation for Medical Research. Alberta. Aziz, A., Ahmed, M., 2007, Analysis of Usage-Based Payments for Contractors’ Compensation in PPP Projects. 86th Transportation Research Board, Washington D.C. Paper # 07-2572. Crispino, M., Flintsch, G., Pozzi, M., 2008, Key success factors for global service contracts for road management and maintenance. 7th International Conference on Managing Pavement Assets. Calgary, Canada. Debande, O., 2002 Private financing of transport infrastructure. An assessment of the UK experience, Journal of Transport, Economics and Policy, Vol. 36, pp. 355-387.

Grimsey, D., Lewis, M., 2004, Public Private Partnerships: the worldwide revolution in infrastructure provision and project finance. UK: Edward Elgar Publishing Limited. Harding, J., Bodarwé, H., Čadež, I. 2010, Evaluation of availability and service performance based payment mechanisms for PPP Road Traffic Infrastructure Projects. 89th Transportation Research Board, Washington D.C. Paper # 10-2114. Molenaar, K., Navarro, D., 2011, Towards the use of key performance indicators in highway design and construction. 90th Transportation Research Board, Washington D.C. Paper # 11-3055. Pakkala, P., 2002, Innovative Project Delivery Methods for Infrastructure. An International Perspective. Finnish Road Enterprise, Helsinki. Available: http://alk.tiehallinto.fi/julkaisut/pdf/pakkalae5.pdf (accessed Oct. 26, 2011). Pakkala, P., de Jong, W., Aijo, J., 2007, International Overview of Innovative Contracting Practices for Roads. Finnish Road Administration, Helsinki. Available: http://alk.tiehallinto.fi/julkaisut/pdf/internoverview.pdf (accessed Oct. 26, 2011). 89


Delgado, C., Vassalo, J.M., Sánchez, A., 2007, Aplicación de indicadores de calidad en concesiones de carreteras en España. Carreteras: Revista técnica de la Asociación Española de la Carretera, ISSN 0212-6389, Nº. 151, pp. 53-67.

Rangel, T., 2011, Evaluation of the effectiveness of safety-based incentives in Public Private Partnerships. Evidence from the case of Spain. PhD thesis presented at the Civil Engineering School of the Technical University of Madrid, June 2011. Stankevich, N., Qureshi, N., Queiroz, C., 2005, Performance-based Contracting for Preservation and Improvement of Road Assets. Transport Note No. TN-27, World Bank, Washington, D.C. Vassallo, J.M., 2007, Implementation of Quality Criteria in Tendering and Regulating Infrastructure Management Contracts. Journal of Construction Engineering and Management, Vol. 133, N. 8. Vassallo, J.M., Gallego, J., 2005, Risk-sharing in the New Public Works Concession Law in Spain, Transportation Research Record Nº 1932. TRB, National Research Council, Washington, DC, pp. 1-8. Vassallo, J., Pérez de Villar, P., 2010, Diez años de peaje sombra en España. Revista de Obras Públicas (3506).


Vassallo, J.M., Rangel, T., Pérez de Villar P., Arenas, B., 2009, Do PPP contracts improve road safety? Working paper, European Investment Bank (EIB) University Research Sponsorship Programme. Zietlow, G., 2004, Implementing performance-based road management and maintenance contracts in developing countries – an instrument of German Technical Cooperation. German Development Cooperation (GTZ), Eschborn, Germany. www.zietlow.com/PBMMC-GTZ.pdf Accessed 20 October 2011.

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Competition in PPPs, Transaction Costs and Tendering Fabio Sciancalepore Department of Mechanical and Management Engineering Polytechnic of Bari [email protected] Athena Roumboutsos Department of Shipping, Trade and Transport University of the Aegean [email protected]

Nicola Costantino Department of Mechanical and Management Engineering Polytechnic of Bari [email protected]

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Nunzia Carbonara Department of Mechanical and Management Engineering Polytechnic of Bari [email protected]

Abstract Purpose – This paper stemming from the existing level of competition in a PPP market, investigates the best correlation between tendering procedures and transactions costs. Design/methodology/approach – Analytical models, initially proposed by McAfee and McMillan, are further investigated with respect to the various tendering procedures. Findings – The research proposes an “instrument” for designing a PPP tendering process, on the basis of the number of potential bidders in the market (existing competition) and of their bidding transaction costs. Social implications – The proposed “instrument” reduces excessive transaction costs for the public and private sector and proposes tendering procedures suitable to the existing market. Originality/value – The present research work takes an alternative approach and reverses the common question of “how to improve competition in the market through the tendering procedure” to “how to exploit all existing competition in the market through the tendering procedure”, therefore designing efficient tendering procedures. Therefore, this work takes a rational approach endorsing the notion that for a specific level of transaction costs there is a maximum number of bidders that may tender and competition is optimum when this number is secured. Keywords: Transaction costs, Tendering, Competition, Transport PPP projects


Contribution to Working Group 1: This is the research work produced during the STSM of Mr Fabio Sciancalepore (PhD Student) to Dr. Athena Roumboutsos, the University of the Aegean.

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Introduction

The participation of the private sector in the provision of transport infrastructure and services in many countries has been introduced and this trend will continue, in an effort to reduce the state, obtain access to private financing and improve the level of services. Public Private Partnerships (PPPs), introduced in this context, have been established as a common method of transport infrastructure and services delivery. Major characteristics of this method of project delivery and consequent contractual arrangement, which may include design, financing, construction, operation/maintenance, are: large sunk costs, as transport investments usually concern significant levels of investment; long payback periods, expressed in contractual agreements which range over 25-35 years or even more in some cases; and a complex and relatively long tendering period, involving significant transactions costs for both the contracting authority and the private interested parties (bidders). Public procurement processes are, in principal, structured to secure transparency, public accountability and market competition. The complexity of the PPP arrangements may lead to mutual exclusion of these procurement principles. Rigorous tendering processes, reflecting the size of the undertaking, increase transactions costs and therefore can deter potential bidders. A study by Dudkin and Välilä (2006), based on the analysis of a sample of PPP projects in different European countries (UK, Ireland, Netherlands and Portugal), estimated that the average bidding cost in a PPP project is approximately 13% of project capital value. The larger contribution to this transaction cost comes from bidders: the joint bidding cost of winning and failed bidders is almost 9% of the project capital value. Yescombe (2007) shows that tendering costs can reach 5–10% of the capital cost of a project, depending on project characteristics and sector. A percentage of these costs are correlated to the complexity of the procured project, but a more important part is produced by the selected tendering procedure leading to a debate on the effectiveness of auctions and negotiations. Estache et al. (2009) based on an analysis of World Bank empirical data conclude, that “given a certain number of potential contractors, N, an English auction with N+1 bidders, (i.e.) by seeking one more contender, is more profitable for governments than any negotiation with N bidders”. This is in line with traditional expectations that the existence of a clear legal framework and tendering procedures reduces transaction costs, increases competition and leads to successful PPPs [Brown et al. 2006]. However, this is not what has been empirically registered. The 2007 NAO report showed that 85% of PFI projects that closed prior to 2004 attracted three or more developed bids compared to 67% in the study period (20042006). In addition, one third of the projects (with no differences between sectors) attracted only two bidders at the point they were requested to submit detailed bids. In France, since the compulsory use of competitive tendering, the average number of bidders for urban public transport has been continuously decreasing while the unit costs of service provision have been increasing [Yvrande-Billon 2006]. This tendency also manifests in the statistical analysis of all public work contracts in France of the period 93


1


2005-2007 [Chong et al. 2010]. A variety of bidder endogenous reasons (expertise, backlog etc) and project specifications (sector, technical complexity, financing structure etc) in connection to the transaction costs implied, may lead to this less than favorable in terms of competition result. Traditional auction theory suggests that increased competition would lower procurement costs under the fixed-n approach and uses the number of interested bidders as a proxy for competition. The present research takes an alternative approach to the topics of competition, tendering and transaction costs. Stemming from the original work of McAfee and McMillan (1987a) where an optimum number of bidders (n) is calculated based on a specific entry cost (k), it develops an instrument to determine which tendering procedures to apply, given the features of the PPP markets in terms of available bidders within the specific market and the level of transaction costs. Therefore, this work takes a rational approach endorsing the notion that for a specific level of transaction costs there is a maximum number of bidders that may tender and competition is optimum when this number is secured. The scope of the present paper is to identify suitable tendering procedures whistle given the number of “available” bidders and the expected transaction costs, as they are considered as a “constant” under the specific conditions each tender is conducted. These conditions or determinants of transaction costs are presented briefly in the next section, followed by a general categorization of the tendering methods used. By identifying the optimum number of bidders for the different evaluation methods for a given estimate of transaction costs, a contracting authority is able to select the tender evaluation method and phases (prequalification etc) that would secure maximum participation in the tendering process and, consequently, maximum competition in the specific market conditions.

2

Tender Transaction Costs in PPPs

The origins of Transaction Costs Economics (TCE) can be traced back to the seminal works of John Commons and Ronald Coase. Commons (1931) firstly defined the transaction as the activity linking two actors of a market, stating that this should be considered the smallest economic unit, in place of the product. Later on, Coase (1937) stated that firms exist because, until to a certain extent, the entrepreneur prefers producing the resources he needs by himself rather than buying it on the market where there are additional costs for search, information, bargaining, policing, enforcement. However, the entrepreneur function has decreasing returns to scale: as a consequence, firms’ dimension derives from an optimal trade-off between entrepreneur’s organizing costs and marketing costs. Later, Williamson (1975) defined them as transaction costs, giving birth to TCE. He classified transaction costs as market costs and hierarchy costs. The former are derived from the procurement of needed resources from the market, while the latter come from the internal organization of the activity of the firm. The focus of this paper is on market costs. 94

As regards the particular case of the PPPs, transaction costs are incurred from both involved parties: the contracting authority and the bidders. As regards transaction cost incurred by the contracting authority, Farajian and Cui (2010) defined a breakdown structure, where costs are classified according to the phase they occur (initiation and procurement, contracting) and into internal (hierarchy costs) and external (market costs). Dudkin and Välilä (2006) instead focused on the overall transaction costs related to a PPP project, caused by the following PPP tasks: organizing the bidding process, participation in the process, negotiating the contract between public sector and winning bidder, monitoring the private partner’s compliance with the contract and enforcing it, and, potentially, renegotiating it. The former three categories constitute the bidding costs, which are born not only by the contracting authority, but also by all the candidate bidders (awarded/preferred and failed).

2.1

Tendering Transaction Cost Determinants

Bidding costs (%)

Project size

Figure 1: Bidding transaction costs vs. project size.

95


The determinants of bidding costs are multifarious. The most prominent ones are presented in the following: Project Size: PPPs are in general large projects in terms of capital costs and effort. However, many activities of the tendering process require an effort, which does not vary with the size of the project. Consequently, the percentage of transaction costs on the project capital value tends to decrease with the increase of project size [Farajian and Cui 2010]. The empirical data by Dudkin and Välilä (2006) confirm such statement: in particular, the marginal transaction costs seems to decrease both for the contracting authority and for bidders with a trend described in Figure 1.


Economic sector: The application of PPP in different sectors can affect the incidence of bidding costs on the overall project capital value, both for the contracting authority and for the bidders. In particular, as regards the public party, some projects allow for the use of more internal resources and less consultation, achieving a reduction in transaction cost. Dudkin and Välilä (2006) find this tendency in the case of UK school PPPs. Similarly, contracting authorities posses more experience in some transport sectors than in others reducing the aspect of “design” in the procurement and contracting process. The NAO (2007) report does not identify a specific reason but in any case recognizes differences in between sectors expressed in length of tendering procedure. Project country: This variable usually refers to the maturity of PPP legislative framework in the considered country [Farajian and Cui 2010]. This can influence the bidding costs: for instance, in the UK average bidding costs are higher than in some other European countries, due to its common-law status which requires a broader effort in defining contracts [Dudkin and Välilä 2006]. Project Complexity: PPPs are generally highly complex projects for a number of reasons. Project structured financing is a complicated process requiring full allocation of risks. In addition, PPP agreements involve, at least, two parties having, ultimately, different (and often contrasting) objectives: the public partner tends to maximize the social benefit of the project, while the private partner aims at maximizing its return on investment [Farajian and Cui 2010]. Moreover, PPP projects have a long or very long time horizon and this increases risks and uncertainty. The uncertainty may lead the public client to change service requirements during project lifecycle, creating frictions with the private partner, which could decide to meet such requests by cost-cutting rather than quality-enhancing [Kee and Forrer 2008]. Consequently, a complex contract structure is required for the risk allocation between the two parties. Dudkin and Välilä (2006) consider the procurement phase duration as a proxy for measuring the project complexity: from the analysis of a sample of UK PPP projects, they find that the bidding cost presents an increasing trend with the procurement duration. This increasing trend is stronger in the case of lengthy procurement times (over 50 months), as Figure 2 shows. Number of bidders: The bidding costs for the contracting authority is expected to increase, due to an increased workload for the public contracting authority in terms of prequalification and proposal evaluations. At the same time, increased failed bidders add their bidding cost contribution to the total amount of transaction costs [Farajian and Cui 2010]. The bidding cost is expected to be the same for all losing bidders, while the preferred has also to bear the cost of negotiating the final contract with the public party [Dudkin and Välilä 2006]. While in the analysis of Sanchez Solino and Gago de Santos (2010) there is no evidence of an influence of the number of competitors on the bidding cost for the preferred bidder, Dudkin and Välilä (2006) state that, in some cases, the bidding cost can have a parabolic trend with the number of bidders. According to the these authors, the reasons for this are given by a reduced effort by competitors in preparing the bid, due to low competition when bidders are few and to the decreased probability to be awarded when bidders are too many.

96

Bidding costs (%)

Procurement time (months)

Figure 2: Bidding transaction costs vs. phase duration.

2.2

Discussion of Determinants and presentation of model assumptions

The objective of this paper is to identify the tendering procedure, which best fits the available number of bidders, given their bidding transaction costs. While all the determinants identified previously influence transaction costs, they do not vary under specific conditions. In this context, transactions costs may be classified as country specific, sector specific and, finally, the rest are correlated to the tendering procedure. Country specific determinants, especially with respect to legislative issues have been the focus of considerable scholar attention [Bruzelius 2005] and for the purposes of this research can be considered as constant, as all procurement procedures and related transaction costs are equivalent within the country of procurement. Obviously, a transparent and clearly defined /regulated procedure reduces uncertainties and allows for greater participation in the tendering process. Sector specific transaction costs relate to the specificities not only of the type of the undertaking but also of the market actors possessing the capacities to address the tender. This approach addresses the case of large PPP projects, for which bidding transaction costs can be considered constant with the number of bidders, as Figure 1 shows. As regards the other determinants of bidding transaction costs, i.e., economic sector, project complexity and bundling of services, they affect the bidding transaction cost 97


Bundling of services: Bundling of services is considered to be at the heart of the PPP procurement method [Hart 2003]. Through this approach, the private party is allowed to internalize benefits between the stages of project development. While increasing the number of services to be bundled may increase the costs of bid preparation, it also allows for improved benefits for the winning bidder. Estache and Iimi (2008) show that in the road cases they modeled reducing the engineering cost of the project by 10% would increase competition by 5.2% but would reduce the final bid by 2.3%.

according to a dynamic, which is out of the interest of this paper. In fact, bidding transaction cost is an exogenous variable in this approach, which is assumed to be constant with respect to the varying of the number of bidders, according to the findings of Sanchez Solino and Gago de Santos (2010). Given the bidders’ transaction cost, this work focuses on the setting of the tendering procedure maximizing the level of competitiveness (expressed as the number of bidders). Moreover, it is noted that the transaction costs inferred by the number of bidders, in principal, burden the contracting authority. This is the price a contracting authority needs to bear in order to increase market competition. While this cost needs to be included in the overall project cost and the value for money incurred, this is not addressed in the present paper. The scope of the present research is to identify the variables leading to an increased number of bidders and bidding transaction costs of the contracting authority do not affect bidders’ attitude towards the participation to the PPP tender.

2.3

The Tendering Procedures


The tendering procedure selected by the contracting authority may have a significant impact on overall transaction costs. There is a great range of procedures that may be identified and recorded in literature (Carbonara et al, of this publication). These can be, in general, categorized as described in the following Table 1. The phases described in the table are indicative. PPPs usually have a prequalification stage leading to a shortlist of candidates. The tender evaluation may be conducted through various methods and algorithms, which in principal may be classified as price based, price and the evaluation of quality offered over a certain threshold and, finally, over a total scoring system. Table 1 : Classification of Tendering Procedures Tendering Phases Procedure Pre-qualification Binary Tender Evaluation Price Based Price and Threshold quality Scoring system Negotiation Dialogue In a price based evaluation procedure, bids are evaluated only against price, in order to award the lowest bid. The evaluation of the economic aspect only is typical of some common PPP tendering evaluation methods, like NPV, Least Present Value of Revenues (LPVR) and Shortest Concession Period [Carbonara et al., 2012]. The price and threshold quality evaluation methods concern a joint evaluation of price and quality aspects of a bid, according to the perspective of choosing the lowest price among the bids guaranteeing a pre-defined minimum level of quality. This is the approach addressed with some methods like two envelopes and binary evaluation followed by NPV estimate [Carbonara et al. 2012]. 98

With regard to the scoring systems, these are compensative methods, where the performance level for other criteria can balance the deficiency in some criteria out. This reasoning is typical of evaluation methods like simple scoring and multi-attribute analysis [Carbonara et al. 2012]. A final negotiation phase after the tender evaluation is present in many cases (and not all cf. To and Ozawa, 2007) as it allows joining the flexibility needed in such complex projects with the rigor given by the tendering mechanism [Saussier et al. 2009]. Notably, each stage adds to the transactions costs born by each bidder. However, at each stage the candidate makes a separate decision concerning the entry into competition.

Bidding equilibrium models with transaction costs

Entering a tender determines transaction costs for all bidders, both the awarded and the failed. Consequently, bidders know that they have to bear a bidding transaction cost k (defined as entry cost), which will not be rewarded if they are not successful. Bidders tend to enter a tender only if they have an expected profit equal to their entry cost. This condition can be achieved only for a determined number of bidders n, given k [McAfee and McMillan 1987a]. Hence, k may initially be described as a function of n. This relation changes if different evaluation methods are adopted for assessing bids: in particular, different outcomes are achieved if the evaluation is essentially based on price or a predefined technical quality (see Table 1). This section studies the optimal relation between n and k in two different tendering procedures. In the former case, the described analysis is made by adopting the Independent Private Values approach by auction theory applied to the case of a first price sealed bid tender [McAfee and McMillan 1987b]. These functions describe the optimum number of bids with respect to the tendering method applied.

3.1 The lowest price evaluation Interested bidders are invited to submit a bid with a Call for Tender; the bidder offering the lowest price is selected as the preferred bid. The profit for each bidder can be defined as follows [Estache and Iimi 2011]:

⎧bi − θ i − k

if bi < b j

⎩ −k

otherwise

πi = ⎨

for

j = 1,2,...,n

99

and i ≠ j

(1)


3

where πi is the profit of the i-th bidder, bi is his offered price, θi is his production cost, i.e. the cost of carrying out the project, k is his entry cost and n is the total number of bidders. A number of assumptions are needed in order to find a Nash equilibrium in such a game. As usual, bidders are assumed risk-neutral. Then, under the holding Independent Private Value hypothesis, the project has a different cost for each bidder. Each bidder knows his cost θi but he does not know the cost for all other bidders. However, he does know the common probability density distribution f(θi) for all other bidders. Moreover, due to the symmetry hypothesis, all bidders’ behavior is modeled by the same bidding function. Finally, each bidder submits his offer by maximizing his expected profit [McAfee and McMillan 1987b]. Under the above hypotheses, bidders will take part in the tender if their expected profit is equal to k, that is [McAfee and McMillan 1987a]: θ

∫ [1 − F (θ )]

n −1

F(θ )dθ = k

(2)

θ

where F(θ) is the cumulative density probability function related to the relative stochastic production cost for bidders and θ and θ are respectively the lower and the upper limits of the production cost θ. In the hypothesis of defining both θ and k as a part of the project capital value, f(θ) is defined as an uniform distribution whose bounds are θ ,θ = [0,1].The optimal number 12F11_University of the Aegeanresearch_INTERNO COST ACTION TU 1001

[ ]

of bidders entering the tender can be found by solving (2). It is depending on the entry cost according to the following expression:

k=

1 n(n +1)

(3)

As expected the number of bidders, n, is decreasing with increasing transactions costs, k.

3.2 The lowest price with quality threshold evaluation Again in this case the interested bidders are invited by a Call for Tender to submit their bid in order to be awarded as private partner of the PPP project. As opposed to the previous case, only bids guaranteeing a minimum quality threshold for the provided service and/or infrastructure are ranked against price: the lowest price bid (among the ones with a sufficient quality level) is awarded the tender. For the sake of simplicity, it is assumed that bidders are evaluated against a unique quality index qi, even if in the real tenders more than one indicator may be used. 100

Offering quality to the contracting authority is costly and affects the total production cost ci(qi, θi) of providing the project for the bidder (together with his private cost θi). As a consequence, bidders’ optimal strategy in such game is to provide the threshold quality required by the contracting authority. On the other hand, the optimal strategy for contracting authority is setting the quality threshold so that her expected profit is maximized [Estache and Iimi 2009]. In other words, the quality threshold ξ* set by contracting authority is equal to:

[

}]

{

ξ* = arg max q V (q) − E min j b j ,(ϑ j ,q)

(4)

The optimal number of bidders, given their quality bidding strategy ξ*, can be obtained for an expected profit equal to k for all bidders. In such case, it can be shown that the optimal n as a function of the entry cost k can be obtained through the following equation: θ

∫ c' (θ ,ξ *)[1 − F (θ )]

n −1

F (θ )dθ = k

(5)

where ci(qi, θi) is the total production cost function, F(θ) is the cumulative density probability function related to the related stochastic production cost for bidders and the lower and the upper limits of the bidders’ private cost distribution θ are respectively θ and θ . One solution of (5) may be produced by the following assumptions. The private cost is defined as a quote of the of the project capital value and it is defined as a uniform stochastic variable θ ,θ = [0,1]. Respectively, quality qi � [0,1], and 1/2

2

V(q)=q , while c(θ, q)= θq

[ ]

Under such assumptions, it can be shown (Estache and Iimi, 2009) that the optimal number of bidders depends on entry cost k as follows:

(n +1)1/ 3 k= 16n

(6)

4

Tender Selection Procedure

4.1

Setting the tendering procedure

101


θ


Selecting the appropriate tendering procedure given the available number of bidders and transaction costs is facilitated by using the chart in Figure 3, where equations (3) and (6) reflecting two principal evaluation methods are mapped. The analysis neglects the cases in which the number of bidders is larger than eight, due to the exceptionality of such evidence. Taking a rational approach, tendering procedures are identified that match the number of available bidders to the evaluation method. Three main situations can be found by comparing the number of available bidders in the market and the required transaction costs for bidding. The first case is characterized by a high number of interested bidders on the market in a tender with relatively high transaction costs. This condition is unrealistic and may be induced by the need to obtain new contracts and is manifested in aggressive bids. This should not be a desirable situation for the contracting authority, as aggressive bids in most cases lead to re-negotiations increasing overall transaction costs and reducing the quality of project. In this case the contracting authority should introduce a prequalification stage in the tendering procedure, which would reduce the number of potential bidders to the respective optimum with respect to the “lowest price” evaluation. The second case corresponds to a competitive market. In this case the number of potential bidders is too high for an optimal implementation of the quality threshold evaluation and fewer than required best for the “lowest price” evaluation method. Consequently, the best strategy for the contracting authority is to reduce the number of bidders through a prequalification based on technical, financial and legal requirements. The number of pre-qualified bidders should correspond to the optimum number as suggested by the “quality threshold curve” for the estimated level of transaction costs of the evaluation method. Finally, the third case mapped is a non-competitive market. In this case, the number of available bidders working in the market is smaller than the optimum under the least transaction cost evaluation method mapped. As a consequence, if the contracting authority selects an auction procedure, this will allow potential bidders to benefit from a “surplus”, which in turn will lead to sub-optimal bids and, finally, project costs for the contracting authority. In this case, the contracting authority is presented with two available strategies: (1) She can increase the level of project complexity, which will increase transaction costs and, therefore, create the situation where the existing number of available bidders is optimum for the “new” level of transaction costs; or (2) She may carry out the awarding procedure through a negotiation process or competitive dialogue.

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0,5 0,45 Lowest Price

0,4

Entry cost k

0,35 0,3

Unrealistic market

0,25 0,2 0,15

Competitive market

0,1 0,05

Quality Threshold

Uncompetitive market

0 1

2

3

4

5

6

7

8

Number of bidder n

4.2 Estimating k A final issue to be addressed, is the estimation of k. As identified in section 2, apart from country and sector determinants, project size and complexity, the number of tendering phases and the type of evaluation conducted at each phase impacts transaction costs and, therefore, k. Transaction costs as described above may be considered as related to the time, t, of the procedure. Therefore, entry cost, k, may be expressed as a function of time in the process, t, i.e. k(t). One approach would be to construct, k, empirically, by adjusting for tender duration per sector in each country. Another more diligent approach requires the calculation of transaction costs. Estimating k is the subject of further research.

4

Conclusions, Discussion and Future Work

103


Figure 3: Transaction cost vs. number of bidder in PPP tendering (Modelling eq. (3) and (6)).

related to the time, t, of the procedure. Therefore, entry cost, k, may be expressed as a function of time in the process, t, i.e. k(t). One approach would be to construct, k, empirically, by adjusting for tender duration per sector in each country. Another more diligent approach requires the calculation of transaction costs. Estimating k is the subject of further research.

4

Conclusions, Discussion and Future Work


It is commonly accepted that large transaction costs deter bidders interest in tender participation limiting the anticipated benefits of competition. This is especially so when considering PPP tendering processes, which by definition concern large capital projects with complex financing structures. Apart from increased tender transaction costs, which restrict competition, technical specialization required by the tender specification may further reduce competition due to specialization. Taking the above as a starting point, the present research took alternative path and, therefore, endorses a rational approach considering endorsing that for a specific level of 103 transaction costs there is a maximum number of bidders that may tender and competition is optimum when this number is secured. Building on the McAfee and McMillan (1987) models, an instrument is proposed supporting decision makers in designing tendering processes that, given the estimate of transactions costs, fit best the existing market conditions. This approach lows both public and private sector benefits, especially in the transport sector were specialization needs vary between transport subsectors and each sub-sector is characterized by its own market players. The present research presents an initiating point and requires further model development to include in the analysis of other procedures neglected in this paper, like the competitive dialogue and identify practical approaches in identifying the model parameters.

104

References Bruzelius, N., 2005, The Impact of Legal/Regulatory Frameworks on Transaction Costs for Private Sector Involvement in (Transport) Infrastructure Funding, Report to the Joint OECD/ECMT Transport Research Centre. Brown, A., Stern, J., Tannenbaum, B., Gencer, D., 2006, A Handbook for Evaluating Infrastructure Regulatory Systems, World Bank, Washington, D.C. Chong, E., Staropoli, C., Yvrande-Billon, A., 2010, Auction versus Negotiation in Public Procurement: Looking for Empirical Evidence, HAL : hal-00512813, version 1. Coase, R.H., 1937, The Nature of the Firm, Economica, Vol. 4, No. 16, pp. 386405. Commons, J.R., 1931, Institutional Economics, American Economic Review, Vol.21, pp.648-657. Dudkin, G., Välilä, T., 2006, Transaction Costs in Public-Private Partnerships: A First Look at the Evidence. Competition and Regulation in Network Industries, Volume 1, No. 2, pp. 307-330.

Estache, A., Iimi, A., 2008, Bidders’ Entry and Auctioneer’s Rejection: Applying a Double Selection Model to Road Procurement Auctions. Estache, A., Iimi, A., 2009, Auctions with Endogenous Participation and Quality Thresholds: Evidence from ODA Infrastructure Procurement, ECARES working paper 2009 006. Farajian, M., Cui, Q., 2010, Estimating Transaction Costs in Public-Private Partnerships, 2010 AEC Innovation Conference, June 9-11, State College, PA. Hart, O., 2003, Incomplete contracts and public ownership: remarks, and application to public-private ownership, Economic Journal, C69-C76, pp. 113:486. Kee, J.E., Forrer, J., 2008, Private Finance Initiative—The Theory Behind Practice, International Journal of Public Administration, Vol. 31 No. 2, pp. 151167. Sánchez Soliño, A., Gago de Santos, P., 2010, Transaction Costs in Transport Public–Private Partnerships: Comparing Procurement Procedures, Transport Reviews, Vol. 30, No.3, pp. 389-406.

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Estache, A., Iimi, A., Ruzzier, C., 2009, Procurement in Infrastructure What Does Theory Tell Us?, Policy Research Working Paper 4994, the World Bank

Yescombe, E., 2007, Public private partnerships: Principles of policy and finance. Elsevier (Amsterdam). Williamson, O.E., 1975, Markets and Hierarchies: Analysis and Antitrust Implications: A Study in the Economics of Internal Organization, New York, Free Press.


Yvrande-Billon, A., 2006, The Attribution Process of Delegation Contracts in the French Urban Public Transport Sector: Why Competitive Tendering is a Myth, Annals of Public and Cooperative Economics, Vol. 77(4), pp. 453-478.

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PART THREE

National and Modal Perspectives

Institutional Reasons for Not Implementing PPPs in the Transport Sector Kristian Widén Division of Construction Management Lund University [email protected] Veiko Lember Department of Public Administrations Tallinn University of Technology [email protected]


Stefan Olander Division of Construction Management Lund University [email protected] Ole Helby Petersen Danish Institute of Governmental Research [email protected] Walter Scherrer Department of Economics and Social Science University of Salzburg [email protected]

108

Abstract In the transport sector, PPPs have been seen as a way to overcome limited financial resources, get access to technological know –how and reduce risks for the public sector. Different types of PPPs have been used widely across Europe. The implementation of PPPs has also been strongly supported by the European Union (EU). Nevertheless, there are a few countries where PPPs in the transport sector have only to a limited degree been implemented, and where PPPs are looked upon with scepticism. It is also clear that the implementation of PPPs is highly influenced by national institutional settings, which may be key explanatory factors for not implementing PPPs in the transport sector. This paper compares the institutional reasons for not implementing PPPs in four countries, Austria, Denmark, Estonia and Sweden, where PPPs have not, or only to a very limited extent, been implemented in the transport sector,. The findings (tentative) show that a historic aim of public control over the transport sector has resulted in a fear of losing that control overshadowing the potential benefits of implementing PPPs. Keywords: PPP, Business systems, PPP sceptic countries, public traditions.

109


Contribution to Working Group 3


1

Introduction

PPP is used widely across the world for creating various transport related facilities such as roads, railways, ports, airports etc. Broadly defined PPP is an arrangement where the public sector together with the private engages in a long-term relationship for mutual gains [e.g. Bult-Spiering and Dewulf 2006; Andersson 2008; Robinson and Scott 2009]. One of the more prominent PPP programs, in general, is the British private finance initiative (PFI) that was launched in 1992. The purpose was to attract private finance, improve the procurement of public projects and to make the process more efficient [e.g. Spackman 2002; Robinson and Scott 2009]. One major initial reason to undertake projects in the form of PPPs are to avoid cost over-runs as well as delays [Grimsey and Lewis 2005]. Apart from the initial reason of avoiding cost over-runs and delays other important aspects of PPPs making them attractive are [Bing et al. 2005] risk transfer, solve budget restraints, non or limited recourse public funding, less tied up public funding, cap the final service costs, improve maintainability, facilitate innovation, enhance government integrated solution capacity and improve buildability. While a wide array of European countries have initiated various kinds of PPP projects in the transport sector, other European countries have chosen not to endorse PPP solutions on a broader scale. Thus, whereas PPPs have been widely used in a number of English-speaking and south-European countries, including the UK, Ireland, Portugal, Spain and Greece, another group of countries, mainly in central, eastern and northern Europe, have been considerably less active in terms of implementing PPPs [cf. Hammerschmid and Angerer 2005; McQuaid and Scherrer 2008; Petersen 2010]. Scrutinizing the reasons for these differences in national approaches to PPPs is essential for understanding the implementation mechanisms of PPPs in the transport sector, and maybe other public policy issues as well. The research presented in this paper looks at four European countries, Austria, Denmark, Estonia and Sweden, where PPP has not been used to any notable extent. The four countries together account for 0.3% to 0.4% of all European PPP projects and for 0.7% to 0.8% of the total value of European PPP projects in the period 1990-2009 [Kappeler and Nemoz 2010]. While Austria accounts for 0.2 % of the number of European projects and for 0.5% of the total value of European projects in this period the other three countries’ shares are negligible. Reasons for different national public approaches are often said to depend on differences in national institutions and culture. The work presented in this paper takes its origin from the national institutions perspective, with the aim of studying if there are any related explanations in why PPPs have not been implemented more widely in these four countries. The study is constructed as a comparative case analysis of the institutional origins and development of PPPs in the transport sector. The empirical material for the paper is mainly carried out as a document study with some additional expert-interviews.

110

2 National Institutions and the implementation of PPPs

• • •

the Anglo-Saxon business system the corporatist business system the state-led business system

The Anglo-Saxon business system, for example the UK and the USA, rely on liberal market values, low levels of state regulation, rely on the stock market for industrial finance, and have comparatively lower levels of worker protection. The corporatist business system, for example Germany and the Netherlands, is characterised by negotiated coordination between the ‘social partners’, greater willingness to intervene in the market to protect social values, greater reliance on banks for industrial finance, and comparatively high levels of worker protection. The state-led business system, for example France and Italy, rely on extensive coordination of the economy by public authorities, comparatively high levels of worker protection and rely on public industrial [Winch 2000].

2.1 PPPs and national contexts The empirical literature usually associates the emergence and development of PPPs with the existence of macro-economic challenges and, thus, according to many studies the spread of PPPs is related to the pressure from fiscal problems governments face 111


The theory of business systems was first developed by Bowley (1966) and has been reassessed and developed since then see for example Whitley (1992) and Boyer (1993) and Winch (2002). It was found that there are similarities between countries and different types of business systems could be identified. Any business system characterizing an economy consists of three fundamental issues [Whitley 1992]. Firstly, which and how economic interactions and resources are coordinated and controlled by authorities, secondly, how cooperative and competitive relations between those authority hierarchies are organised and, thirdly, authoritative coordination and control systems. According to Whitley (1992), it is mainly the financial system and cultural aspects that influence the business systems. The so-called ‘system’ allocates roles, defines responsibilities and specifies liabilities. This set of rules coordinates the actions of the participants in a specific business system. Members of a system act rationally that can only be understood within the logic of the specific system. Behavioural patterns become institutionalised and informal rules become seen as [Winch 2010] and can become very difficult to change. The characterisation of types of national business systems varies, commonalities though are that the national context shapes strategy and performance of businesses distinctively. It was Boyer who classified national business systems initially with others (mainly Whitley) continuing the development of the concept, but all agree on the three main types of business systems:


[Bovaird 2004; McQuaid and Scherrer 2008; Petersen 2011]. As public infrastructure development assumes high investments PPPs are seen as a critical mean to overcome the budgetary problems. For example, based on a detailed comparative analysis on Denmark and Ireland, Petersen (2011) concludes that the primary rationale for forming (or not forming) PPPs was a macro-economic one in Ireland, whereas Denmark’s strong public finances and well-built infrastructure made such a maneuver largely redundant. McQuaid and Scherrer (2008), when comparing Austria, Germany and the UK, there were country-specific factors such as high re-unification costs and the EU-driven budgetary rules in Germany, legacy of underinvestment in public infrastructure in UK and both internal and the EU-driven budgetary constraints in Austria that also lead to the increased reliance on PPPs. In addition to the fiscal concerns, the use of PPPs in different countries can be explained by the perceived problems of public sector functionality and effectiveness. For example, McQuaid and Scherrer (2008) suggest that strong value-for-money-related concerns in public service delivery have been the major driving force behind PPP developments in the UK, while it has not been that central issue in Austria or Germany. Specific systemic failures like the lack of co-operation among agents can also be overcome through PPPs. This is particularly relevant in innovation policy because establishing and fostering industry-science relationships is a key success factor for creating a (potential) innovation system at the regional or national level. However, PPPs can be introduced not only because of internal problems, but as a result of external pressure. As explained by Christensen & Lægreid (2007), the uptake and spread of policy and management ideas often set in as a result of isomorphic processes. In the context of PPPs this means that if PPPs become accepted policy tools in some influential countries (such as e.g. the UK), other counties would overtake the PPP ideas simply because it is felt as a leading policy idea of a time that cannot be overlooked. Of course, one cannot ignore the fact that PPPs are consciously promoted solution to public sector problems by many international stakeholders such as the EU, OECD, World Bank [see e.g. Jones 1998; Skelcher 2005]. PPPs are often associated with the concept of privatization, which rest on the ideological ideas of neo-liberalism and neo-conservatism, both ideologies are said to prefer using PPPs and other similar mechanisms for limiting the role of government in society [Linder 1999]. Still, the presence of external or internal pressure alone cannot explain how the PPP idea diffuses across public sector. Recent studies have found that the uptake and diffusion of PPP ideas depend on the presence and quality of dedicated institutional mechanisms, existence of strong policy entrepreneurs and public sector capacity [Petersen 2011]. In Denmark PPPs are subject to a loosely organised institutional framework with a number of fundamental policy and regulation issues being not very supportive to the uptake of PPPs. Ireland on the other hand has a welldeveloped institutional PPP framework, with major policy, regulation and procurement functions centralised within the Ministry of Finance and the Treasury. Hodge et al. (2010), when summing up the recent international experience with PPPs, suggest that “varieties of capitalism”, political dynamics and previous experience with privatization and contracting out all play a role in facilitating the introduction of PPPs. They argue that countries such as Australia and the UK have been more willing to adopt PPP 112

3

Country descriptions

3.1

Austria

Austria has 8.4 million inhabitants. With its GDP per capita of 34.100 EUR it ranks among the top five nations of the European Union. Annual average growth of real GDP was 2.4% in the period 1990 to 2000 and dropped to a modest 1.6% between 2001 and 2011. Government finances have been in a notorious deficit in the past decades: The level of taxation is apart from Denmark and Sweden among the highest in the member states of the European Union. The economic policy framework has been characterized by a corporatist culture which has a significant impact not only on economic policy but on many other areas like employment, social, etc. Austria’s territorial organization of government and administration is based on a federalist structure with by far most of the (financial) power concentrated at the central level of government. Austrian states receive less than 8% of the tax share and the share of local governments is approximately 11%. The central state and social security funds account for approximately 80% of all public revenues. Municipalities and states account for approximately three quarters of total public investment spending. In Austria the types of transport modes are coordinated at the respective levels of government. There is only little variation of financing as government funding dominates financing of transport related facilities. Apart from taxes national roads are financed by user charges. PPPs play a minor role at the national and at the regional levels of the road sector. Railway infrastructure is largely financed by the public sector, too. There are some PPP projects at the national level, while on the local level some private firms operate lines. In the airport sector Vienna International Airport is by far the biggest one. Half of its shares are owned by the States of Vienna, Lower Austria and an airport employees’ trust, the other half is traded at the Vienna Stock Exchange. Regional airports are owned by states and municipalities, while local airports have a mix of private and public financing. The public ports along the river Danube are publicly owned; only one small port is privately owned. There exists in Austria neither a specific regulatory framework nor a legal definition of PPP. Austrian government means that the existing body of legal norms is sufficient for the use of PPP. There is also no dedicated PPP unit. Political priorities have shifted twice at the federal government level during the past two decades. Experience with contractual PPPs in the transport sector was not encouraging until the late 1990s. The first shift which resulted in attributing PPP a positive role can be dated to 1998. The top priority argument for PPP was the budget relieves argument. The second shift in attitude 113


solutions compared to Germany or Scandinavian countries because of the latter countries can be associated with integrated and institutionalized corporatist arrangements [Greve and Hodge 2007].

of the potential of PPP – now toward a skeptical view – can be dated to the year 2008. In the aftermath of the financial crisis it had become difficult and more expensive for private firms to achieve long term financing of infrastructure projects so that PPP as a mode of delivery of public infrastructure has not been pursued by central government since then. Table 1: Traditional coordination and funding of transport related facilities in Austria. Transport Type Level of Type of financing mode coordination Road National National Public funding, some market finance, little PPP Regional Regional Public funding, some PPP Local Local Public funding Railway National National Public funding, little PPP Regional Regional Public funding Local Local Public funding, some Market Airports National National Public and market funding Regional Regional Public funding Local Local Public and market funding Ports National Regional Local Local Public and market funding


3.2

Denmark

Until the financial crisis, the Danish economy had witnessed ten years of government surpluses that have made it possible to finance major projects out of the public purse. In the period from 1999 to 2010, Denmark’s government sector produced an average annual surplus of 1.7 percent measured against GDP, compared to an EU average of 2.9 percent [Petersen 2010]. Also, Denmark’s general government debt was brought down from 58.1 percent in 1999 to 27.5 percent in 2007, rising to 43.8 percent in 2010 as a result of the global economic crisis. Danish policy-makers, both left-wing and bourgeois, have traditionally been reluctant towards imposing user charges, and there are only very few examples of use charges on infrastructure in Denmark. Roads are either national or local (no regional roads), and are financed through local and national taxes. However, two major bridges connecting the two parts of Denmark and connecting Denmark and Sweden are toll roads with direct user charges. Railways are financed by the respective authority as well as by user charges. Railways are coordinated at the national level as well as in a rather complicated setup involving both local and regional levels. Some local ports are owned and financed by the municipalities, whereas others are privately owned. There is one example of a PPP in the Danish port sector, in the small municipality of Soenderborg. 114

Table 2: Traditional coordination and funding of transport related facilities in Denmark. Transport Type Level of Type of financing mode coordination Road National National Public funding (user fees on two Bridges) Regional (no regional (no regional roads) roads) Local Local Public funding Railway National National Public funding and user charges Regional Regional and Public funding and user charges local in Local Local and Public funding and user charges regional Airports National National Public and market funding Regional Local Ports National Regional Local Local Public and private funding

3.3

Estonia

Estonia has a population of 1.3 million and annual GDP of 14.3 billion euros is among the smallest countries and economies in Europe. Since it become re-independent in 1991 Estonia quickly established its reputation as one of the most pro-market oriented countries in the whole of Europe. Negligible public sector dept-level, massive privatization of state-owned enterprises, almost unconditional opening up of local markets for international competition, heavy reliance on foreign direct investments and balanced state budgets have formed the cornerstone of the Estonian economic policy. The pro-market ideology has been influenced also other public policy areas and public 115


The concept of PPPs was launched in Denmark in 1999 by Ministry of Finance under the social-democratic government. From 1999-2004, a few government reports mentioned PPP as way to invest in infrastructure projects, but no concrete policies or regulations were formulated. Also, no money was earmarked for PPP projects in the transport sector. In January 2004, the Danish government launched a seemingly ambitious Action Plan for Public-Private Partnerships listing ten concrete initiatives to support PPPs in Denmark. But in reality the government was in fact ambivalent towards PPPs and was hesitant towards setting out a supportive institutional and regulatory framework. As a result of this, the effect of a legislative amendment that introduced a universal PPP testing requirement was in fact very limited because it only applied to construction type projects (buildings), whereas the infrastructure area was exempted from the testing requirement.


sector reform in general. This is reflected by a rather widespread usage of different New Public Management (NPM) tools such as contracting-out in almost all policy fields, creation of semi-market system in health-care or heavy reliance on semi-autonomous public agencies in public administration. In fact, many authors regard Estonia as the most NPM-favorable country in the whole CEE region. The use of PPPs, however, is not that widespread. Overall, there is no strong regional level as such in Estonia, but the national road authorities have their regional branches coordinating some activities on regional level. Roads are either national, regional or local, but they are all funded and coordinated publicly. Railways exist only on national level and are funded via public subsidies and user-charges, but are operated on contract basis by private capital. Airports are coordinated and operated by a 100% state-owned company. On national level airports are funded through public investments as well as via market operations. Regional airports are mainly subsidized through other activities of the state-owned company. The main national port is owned by the state and is operated by a state-owned company. The financing is mainly based on market operations. There are also some big ports owned and operated by the market. Regional ports are operated by another fully state-owned company, which uses a combination of public and private funding (user-charges). Local ports are coordinated by local level and mostly funded by public means. Table 3: Traditional coordination and funding of transport related facilities in Estonia. Transport Type Level of Type of financing mode coordination Road National National Public funding Regional National Public funding Local Local Public funding Railway National National Public and market funding Regional Local Airports National National Public and market funding Regional National Public funding Local Ports National National Market funding Regional National Public and market funding Local Local Public and market funding PPP policy in Estonia can be regarded as an example of no “policy” policy, where the existing PPPs have been implemented without any specific plans or dedicated institutional support structures. There is no existence of special governmental units supporting the development of PPPs, neither are there any special legislation in place. Just as the formal regulation has been rather nondescript on the whole topic, also the political rhetoric on the PPPs has been modest and sporadic. On local level the city of Tallinn has been the most active player on the field by, for example, adopting in 2002 116

the concept PPP as part of its future investment and budgetary strategy. The political and policy debate on PPP has not, however, been totally absent in Estonia. Especially during the recent years it has been discussed more vividly, but not necessarily because of the qualities related to PPPs, but rather how it relates to the issue of public sector debt level.

3.4

Sweden

Table 4: Traditional coordination and funding of transport related facilities in Sweden. Transport Type Level of Type of financing mode coordination Road National National Public funding Regional National Public funding Local Local Public funding Railway National National Public and market funding Regional National Public and market funding Local Local Public and market funding Airports National National Public and market funding Regional Regional Public and market funding Local Local Public and market funding Ports National Regional Local Local Public and private funding In Sweden procurement and maintenance of both roads and the railway on the national and regional levels are coordinated by the same organization, the Swedish Transport Administration. The roads are completely funded by public funds (tax) while the railway is funded by public money and service charges of the operators. Local roads (and to a small extent local railways) are coordinated and funded by the municipalities. Some airports of national and regional importance are nationally coordinated and initially funded, but there is a service charge for those using them. Local airports are coordinated and funded locally with a service charge for users. Ports are usually

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Sweden has, 2011, about 9.5 million inhabitants and GDP of 374 billion Euros. Sweden had a remarkable economic upswing during the mid-20th century. It started to fall behind some other European countries during the latter part of the 20th century, but is one of the countries that have managed the last financial crises best. Sweden is not part of the Euro zone. From a business perspective Sweden is considered to be SocialDemocratic. This means that there is a rather high degree of state regulation, a dialogue between the state, businesses and the unions, large focus on workers’ rights etc. In a business sense Sweden is not as combative as many other countries, there is a high level of trust between the various actors in Sweden.

coordinated and funded locally often as (publically owned) companies acting, more or less, as a private company. Sweden has chosen not to endorse PPP solutions on a broader scale. In modern times there has been only one large project that clearly labeled itself as a PPP and that was in the transport sector. However, when looking more closely there are several large, but mainly small public projects in Sweden that would fit in the quite wide scope of the PPP definition, for example some port facilities. These are seldom labeled as PPPs and it is hard to see any common procedures for how these projects are implemented and carried out. There are no particular regulations for PPPs. It would rather be the opposite, that the existing guidelines and regulations based on traditionally design and build contracts makes is an obstacle to more long-term relationships between a public construction client and their private suppliers and contractors. There has been a general reluctance to implement PPPs among National Politicians, and to some extent a misunderstanding of what it is. On regional and local levels there have been a higher interest of implementing it, but since there is no legislation, no earlier examples etc. no one has wanted to be the first to fail.


4

Concluding discussion

There are clearly some interesting commonalities between the four countries being studied in the context of not choosing to implement PPPs in the transport sector on a broad scale. They are all rather small countries with a history of fairly to really good public economies. Neither of the countries has any legal framework especially dedicated for PPPs. There are no or weak PPP policies and PPP units on the national level. In all four of the countries a lot of the transport related facilities are coordinated on a national level even when the facilities are not on a national level, especially regarding roads and railway. The times that PPPs actually have been discussed and in some cases actually has been endorsed is when the national economy has been difficult, as soon as the economy has gotten better again the discussion has diminished again. This suggests that in these countries the use of PPP is mainly seen as a tool to overcome national fiscal problems. In other contexts budgetary reason are only seen as one reason for adoption, others can be issues regarding risk, accessing know-how and innovation etc. In at least three of the countries (Austria, Denmark and Sweden) the business systems are quite similar with a strong reliance on coordination between social partners in a corporatist culture. This could suggest that traditional perspectives, on especially the national level, where the coordination, and funding, have been carried out through the public agents are believed to be better in controlling risk, getting access to necessary innovations and know-how. An example is the Swedish Transport Administration, which both coordinates the construction of transport facilities and the management of existing ones, where it even has been difficult implementing design-build contracts as opposed to design-bid-build contracts as there is a fear of losing control. This leaves 118

119


fiscal difficulties as the only reason to adopt PPPs. This in itself is a paradox as it has been seen in other contexts that the number of PPPs declines when there are fiscal problems. Estonia does not really fit this explanation with their pro-market orientation and awe of New Public Administration tools. It also seems to be more openness to PPPs in areas where there traditionally have been more market and private funding, for example ports in Sweden, or on local levels, for example PPP program in the city of Tallinn (Estonia). This may actually support the suggestion above where the tradition of existing business systems inhibits adoption. In those areas where there has been a tradition of less public coordination it is more likely that PPPs are adopted as well as where the traditions are not as strong or with greater fiscal problems than on the national level (as is the case in some states and municipalities in Austria and municipalities in Estonia). This study has given some interesting insight why some countries choose not to adopt PPPs. There need to be deeper studies of the four nations as such, but more importantly these countries need to be compared to other countries as well. Such comparisons should focus on similarities and differences across countries in business systems, political and administrative systems, development and current state of public finances as potential explanatory factors. For example, Norway has business system which is similar to Denmark’s and Sweden’s system, but has chosen to adopt PPP on a broader scale in the transport sector.

Bibliography

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Bult-Spiering, M., Dewulf, G., 2006, Strategic issues in public-private partnerships: an international perspective, Oxford, Blackwell Publishing. Christensen, T., Lægreid, P., 2007, Transcending New Public Management. The Transformations of Public Sector Reforms. Farnham, Ashgate. Grimsey, D., Lewis, M. K., 2005, Are Public Private Partnerships value for money? Evaluating alternative approaches and comparing academic and practitioners views, Accounting Forum, Vol. 29, pp. 345-378. Hammerschmid, G., Angerer, D. J., 2005, Public Private Partnership between Euphoria and Disillusionment. Recent Experiences from Austria and Implications for Countries in Transformation, The Romanian Journal of Political Sciences, 01, pp. 129-159 Hodge, G., Greve, C., Boadrman, A., 2010, Conclusions: Public-Private Partnerships - International Experiences and Future Challenges, In Hodge, G., Greve, C. & Boardman, A. (Eds) International Handbook on Public–Private Partnerships, Cheltenham, Edward Elgar, pp. 594-610. Kappeler, A., Nemoz, M., 2010, Public Private Partnerships in Europe – Before and during the recent financial crisis. Economic and Financial Report 2010/04, European Investment Bank.

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Winch, G.M., 2000, Construction business systems in the European Union, Editorial, Building Research & Information, Vol. 28(2), pp.88-97 Winch, G.M., 2002, Global Construction Business Systems, Editorial, Building Research & Information, Vol. 30(6), pp. 390-391.

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Italian PPP applications: A theoretical framework Nunzia Carbonara Department of Mechanical and Management Engineering Polytechnic of Bari [email protected] Nicola Costantino Department of Mechanical and Management Engineering Polytechnic of Bari [email protected]


Roberta Pellegrino Department of Mechanical and Management Engineering Polytechnic of Bari [email protected] Fabio Sciancalepore Department of Mechanical and Management Engineering Polytechnic of Bari [email protected]

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Abstract Purpose – Italian implementation of PPP has its own features which distinguish it from other models adopted in Europe and in the world. International literature lacks of contributions about the Italian case, while the analyses on this issue in the national literature are not systemic. To fill this gap we aim at characterizing the main features of Italian PPPs, in comparison to the features of such partnerships in Europe and in the world. Design/methodology/approach – In order to describe the PPP implementation, the paper proposes a theoretical framework describing PPP as it is conceived by international literature. Findings – A set of factors, like uncertainty on the rules, complex procedures and the lack of private competences on PPP, hinder the involvement of private operators in PPPs. Consequently, PPP project financing structure is mainly based on public guarantees, even because of scarce utilization of capital markets for funding. Social implications – Practitioners and scholars can use this framework analysis in order to know strengths and weaknesses of PPP application in their socio-economic context. Originality/value – The proposed framework represents a useful tool for comparing the application of PPPs among different sectors and different countries. Furthermore, the theoretical framework can be considered a starting point of future research aiming at developing a tool for assessing the expected performance of PPP projects. Keywords: Italy, framework, PPP arrangement structure, financing, public

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Contribution to Working Group 1 and Auxiliary Working Group 1


1

Introduction

In the 20th century, the more and more widespread adoption of Project Financing (PF) was encouraged by the need for getting financial resources to carry out infrastructure projects without recourse, that is, by offering to the lenders only guarantees about the expected revenues of the project. Public Private Partnerships (PPPs), known as “agreements where public sector bodies enter into long-term contractual agreements with private sector entities for the construction or management of public sector infrastructure facilities by the private sector entity or the provision of services [...] by the private sector entities on behalf of a public sector entity” [Grimsey and Lewis 2002], became popular because of the possibility to use the instruments offered by PF for the construction of facilities. More specifically, PPPs are collaborations between public governments and private firms aiming at providing services and infrastructures traditionally delivered by public sector. Passing from the management contracts to the concession contracts, the classification of the PPP agreements [Costantino et al. 2009] underlines the extension of the private involvement to an increasing number of the project phases. As a consequence, public-private collaborations have generally a long duration in such projects [Chinyio and Gameson 2009]. The participation of private partners in PPP projects guarantees a redistribution of project risks which has been studied by many authors [Akintoye et al. 2003; Bing et al. 2009]. Moreover, the financial structure of such initiatives is another important aspect, analyzed both in terms of financing sources and in terms of balance among them [Ye 2009; Chinyio and Gameson 2009]. However, literature also focused on the conditions under which a government should use PPP: to this aim, the concept of Value for Money was explained [HM Treasury 2008] and the approaches and techniques to evaluate it were analyzed [Grimsey and Lewis 2005]. The first country in the world to adopt a specific legislation for PPPs was the United Kingdom, where Private Financing Initiative (PFI) was introduced in 1992 and since 1981 private financing for public infrastructure and services has been ruled by Ryrie Rules [Spackman 2002]. Nowadays, PPPs are ruled by specific laws in many EU and not EU countries [Bovis 2010; Clifton and Duffield 2006; US Department of Transportation 2007] and the use of such an instrument to provide public services and infrastructure is more and more widespread. This is true also for Italy, where the use of Public Private Partnership started in the early 1990s: the first example of Italian PPP can be considered TAV (Treni ad Alta Velocità), a both publicly and privately owned company created in order to carry out an highspeed railway network in Italy [Presilla 2006]. This initiative was encouraged by new apposite laws regarding railway services. The following creation of a complete legislative framework, given by the Merloni law in 1994 and, successively, by the Code of Works, Services and Supplies Public Contracts in 2003 [Vigliano and Bicchieri 2007], favoured the first adoptions of this instrument by both central and local governments and public companies (particularly, ANAS, managing national roads, and RFI, managing national railroads) [OECD 2010]. 124

However, Italian implementation of PPP has its own features which distinguish it from other models adopted in Europe and in the world. International literature lacks of contributions about the Italian case, while the analyses on this issue in the national literature [some examples are Etro 2007; Iossa and Antellini Russo 2008; Bentivogli et al. 2008] are not systemic. Therefore, the aim of this paper is to characterize the main features of the Italian PPP, in comparison to the features of such partnerships in the Europe and in the world. In order to get a scheme to be used in the characterization of Italian PPP, the paper proposes a framework describing PPP as it is conceived by international literature. This is based on previously cited contributions on the theme and other ones, focusing on various aspects regarding this kind of partnership. The proposed framework represents a useful tool for comparing the application of PPPs among different sectors and different countries. The remainder of the paper is structured as follows. A framework synthesizing the findings of literature on PPP is proposed in Section 2, while Section 3 analyzes the Italian case on the basis of the previously introduced scheme. Finally, Section 4 concludes the paper.

The PPP theoretical framework

In order to analyze the Italian application of PPP and compare it with PPP/PFI international projects, a conceptual framework has been developed. The framework characterizes the PPP projects in terms of three main dimensions, namely, structure of PPP/PFI arrangements, financing of PPP/PFI arrangements and public leverage on PPP. Each dimension is then characterized by a set of variables that are more relevant to characterize the PPP projects. The first two dimensions characterize PPP arrangements between public and private parties and can be considered endogenous to the transaction. This justifies why, even if there could be a best practice on each of these dimensions, they often assume different values due to the specificity of the PPP transaction. Contrarily, the third one refers to some conditions – mainly created by the public sector – that should be met in order to guarantee a successful PPP transaction. The first variable that characterizes the structure of PPP/PFI is the PPP model or contract type. In general, PPPs come in a wide variety of models such that there is often no clear agreement on what does and what does not constitute a PPP form [Hemming 2006]. The definition of PPP depends also on the country concerned [Turina and CarPusic 2006], and this in part demonstrates the continued lack of standardization of nomenclature with respect to PPP structures [European Commission 2004]. PPP arrangements range from management contract (with little or no capital investment) through concession contracts (which may encompass the design and build of assets along with the provision of a range of services and the financing of the entire construction and operation), to joint ventures characterized by the sharing of ownership (and sometime also management) between the public and private sectors [Costantino et 125


2


al. 2009]. Based on the legal structure that characterizes the transaction, two main categories can be identified: institutional PPPs and contractual PPPs [European Commission 2004]. The first involves the establishment of an institutional legal entity held jointly by the private and public partners in order to supply an infrastructure or service to the community. The second only involves a contractual link between the private and public parties [Bovis 2010]. It assumes that the private party will partially or totally finance the project, in exchange of some form of compensation from final users or through regular payments by the public authority (revenues/payments). The payments from the public sector are generally based on usage volumes or demand (i.e., payments in lieu of fees or tolls for public lighting, hospitals, schools, roads with shadow tolls). Sometimes, however, they are given as lump sum payment, i.e., a form of financial contribution to assure the economic and financial feasibility of the project. From an economic and managerial point of view, the institutional PPPs do not differ so much from the contractual ones. Another classification of PPP models is based on operational aspects of the transaction, according to the remit of the private sector. The PPP model usually requires the use of private expertise and management skills, that should be one of the main reasons of a PPP implementation. This variable refers to the complexity and importance of the operational phase (in front of the design and construction phases) in the contract. The development of PPP project usually requires the private sector to be involved in almost all the phases of a project lifecycle. The public sector, in fact, should develop these alliances with the aim of exploiting the private sector’s resources and expertise in the provision and delivery of public service and, accordingly, improving the efficiency and quality of services. The PPP relations generally last long (contract duration), for typically 25-30 years [Chinyio and Gameson 2009]. An adequate length of time is often required to ensure investment and profit recovery [European Commission 2004]. When the contract is signed, a new company is generally created which is called ‘special purpose vehicle’ (SPV). It is an independent legal entity that would generally include a construction company, a facility management firm and a financial institution [Chinyio and Gameson 2009]. The structure, however, depends on the characteristics of the specific PPP project/transaction. The SPV could be a company completely private or jointly held by the private and public sectors. Risk allocation is another very important aspect of PPP transactions, maybe the most important one. As Bing et al. (2005) state, at the beginning of the use of PPP/PFI, governments appeared to view PPP projects primarily as a way of getting infrastructure costs off the public balance sheet, keeping investment levels up, cutting public spending and avoiding the constraints of public sector borrowing limits. Afterwards, the increasing use of PPP has led governments to see it a new approach to risk allocation in public infrastructure projects [Bing et al. 2005]. The principle of risk allocation is to transfer the risks to the party that is best able to manage them. The aim, therefore, is (or should be) to optimise, not maximise risk transfer [Costantino et al. 2009].

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Table 1: Incidence of PPP projects on the total amount of bids for national public works. Values

Based on the legal structure of the transaction

Institutional PPPs Contractual PPPs

Management contract Leasing model or Build-Lease-Transfer Design-Build (and Design-Build with warranty) Based on Design-Build-Operate-Maintain operational Design-Build-Finance-Operate aspects Build-Operate-Transfer Build-Own-Operate-Transfer Build-Own-Operate Degree of involvement of the private sector in the Use of private resources and lifecycle of the project (from design to expertise management) Time horizon of contract Long term (25-30 years) Payments based By private sector on usage By public sector Revenues volumes or By public and private sectors sources demand Public financial Lump sum payment by public sector contribution Special purpose vehicle Private company (SPV) Publicly- and privately-held company Private sector Public sector Risk allocation Shared between public and private sectors Financing in whole by the private sector Use of private finance Financing partially by the private sector Government-funded projects (no private capital) Bank debt Equity Type of funding options Bonds Loan from shareholders Mezzanine finance Debt to equity gearing High (debt exceeds 70%) Investment value High Scope

Assuring Value for Money

Legislation

Degree of PPP formalization by a Government legal/statutory framework

The second dimension selected to characterize PPPs was the financing of PPP/PFI arrangements. Fundamentally, in fact, the aim of PPP/PFI is to bring the private sector’s 127


Public Leverage on PPP

PPP arrangement’s financing

PPP arrangement’s structure

Dimensions Variables Contract type


finance as well as management skills into the provision of facilities and services traditionally delivered by public sector [Katz and Smith 2003]. Usually PPP projects are financed by the private party on a “non- or limited recourse basis” [Ye 2009]. This way, the private sector involvement allows projects to obtain more favorable long-term financing options and obtain this financing in a much quicker timeframe [NCPPP 2003]. At the same time, the possibility to privately finance public infrastructure and projects traditionally funded by public finance allows governments to cope with the ever-increasing demands on their budgets. The private financing can be total or partial. In this last case, there is even a financial contribution from the public sector. Three general funding options are used in financing a project: equity, subordinate debt (also called mezzanine financing or quasi-equity) and senior debt [Ye 2009; Chinyio and Gameson 2009]. Each kind of fund is exposed to different level of risks and therefore requires different returns. Consequently, the capital structure falls into ranges from total equity to total debt financing. In general, PPP projects are financed using a combination of both with varying ratios of equity to debt. Usually, debt financing exceeds 70% [Ye 2009]: the debt to equity gearing is often 90:10, but can start from 95:5 [Chinyio and Gameson 2009]. The complexity of a PPP arrangement and the consequent high transaction costs involved in setting up a PPP/PFI transaction require an adequate dimension of the initiative, i.e., a high investment value [Chinyio and Gameson 2009]. Finally, the last dimension is the public leverage on PPP, which can be characterized by two main variables: scope of the PPP and national specific legal/statutory framework. The first variable refers to what is or should be the aim of the PPP adoption from the public standpoint. In other words, the public sector should choose PPP route as a preferred delivery method if compared with conventional procurement (CP) when it is able to assure Value for Money (VfM). VfM can be defined as “the optimum combination of whole-life cost and quality (or fitness for purpose) to meet the user’s requirement” [HM Treasury 2008]. The second variable refers to the presence of specific legal/statutory framework at a national level. This could promote the PPP and facilitate the delivery of complex projects by centralizing and streamlining planning approval, or coordinating actions with the private sector in implementing PPP. Table 1 shows the proposed framework.

3

Main characteristics of PPP in Italy

PPP in Italy is a very recent practice. In fact, even though in 1994 and 1998 the Merloni law set the framework for using private sector contractors, only later a special PPP taskforce, UTFP, was created and its powers were reinforced in 2001. Most of the Italian PPP contracts have been mainly used in power sectors by involving the private sector on a concession-style basis. Other projects have been in roads, light railway and health services. In Figure 1 the trend of PPP projects carried out in Italy since 2002 up to 2010 is depicted (2010 data are referred to January-August period). The Figure shows a significant positive trend in the adoption of PPP as a way of 128

delivering public services and infrastructures. In particular, in the period JanuaryAugust 2010 there have been 1917 PPP bids versus the 1183 carried out in the same period of the 2009, with an increase of 62%. On the contrary, the total capital value is decreased of 19%. The incidence of PPP projects on the total amount of bids for national public works shows similar trends (Figure 2).

10000

3500

9000

3000

number of bids

7000

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6000

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4000 3000

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total capital v alue (ml €

8000

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0 2002

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y ears total capital value (ml €)

number of bids

Figure 1: PPP projects in Italy.

3 0,0 2 5,0 2 0,0 1 5,0 1 0,0 5,0 0,0

2 002

2003

2004

20 05

2006

2007

200 8

200 9

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years

number of bids

total c apital value (m l €)

Figure 2: Incidence of PPP projects on the total amount of bids for national public works. There are a lot of reasons that make the application and use of PPP less effective and efficient in Italy than in other countries. In particular, with regard to the administrative issues, three main factors contribute to slow down the use of PPP: 1) the complexity of the administrative procedures and the distortions of competition due to the so-called “right of pre-emption”, which used to discouraged firms to participate to biddings; 2) the difficulty of regulating through contracts a proper allocation of risks, due to the 129


Inc idenc e of PPPs on na tional public w o

3 5,0

“civil law” system in force in Italy; 3) the high administrative risk characterizing the adjudication procedures [Iossa and Antellini Russo 2008].

oth e rs tr a ns p o rt s ea p o rt a n d h a rb o u r u r ba n re g e ne r ati on h ea lth c eme te ry s c h oo li ng a n d w e l fa re le is u re p a rki ng to u ris m u r ba n d ev e lo p me nt tr a di ng s p or tin g fa c iliti es pow er 0

10 0

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n u mb e r o f PPP p r oj ec ts

Figure 3: Number of PPP projects by sector (2010). oth e rs t ou rism s e ap or t a nd h ar b o ur ce me te r y le is u re sc ho o ling a nd w elf a r e ur b an d ev e lo pm en t p a rkin g


tra d in g ur b a n reg en e r at io n s po rtin g f a c ilit ie s h ea lt h po w er tra ns po r t 0

5 00

10 0 0

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2 50 0

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e x pe nd itur e in PPP p rojec ts

Figure 4: Expenditure for PPP projects by sector (2010). With regard to the financial aspects, the main critical issue is the source of funding used for Italian PPP projects. The funding of PPP projects in Italy is generally granted by banks and rarely provided by capital market, by selling bonds or shares to investors (Etro, 2007). Using such a kind of funding gives disadvantages in comparison with other countries: the interest rate is about 10 - 11%, while in UK, for instance, the required spread on the risk-free rate is about 0,75 - 1% (Iossa and Antellini Russo, 2008). In addition to this, Italian banks tend to ask for traditional guarantees for the financing [Bentivogli et al. 2008] and this situation has been exacerbated by the recent financial crisis: nowadays, banks require greater spreads, reduced leverage and more 130

guarantees in order to grant a loan. In addition to this, the mean duration of the loan was reduced [UTFP, 2010]. Table 2: Characterization of Italian PPP projects: PPP arrangement’s structure. Variables

Based on the legal structure of the transaction Contract type

Based on operational aspects

PPP arrangement’s structure

Use of private resources and expertise

Time horizon of contract

Revenues sources

Payments based on usage or demand Public financial contribution

Special purpose vehicle

Risk allocation

Italian PPP values

Italian law allows both contractual PPPs (concession, sponsoring and financial lease) and institutional PPPs (companies owned by both private and public shareholders). PPP schemes in force according to Italian law are Build-OperateTransfer (BOT), Design-Build-Operate-Transfer (DBOT), Design-Build-Finance-Operate (DBFO), Design-Build-Finance (DBF, defined General Contractor scheme, where GC is also involved in the search for funding). In addition to this, there are public-private companies, like “società miste” or “Società di Trasformazione Urbana”, aiming at providing public services [Vigliano and Bicchieri 2007]. Some factors, like uncertainty on the rules, complex procedures and the lack of private competences on PPP, hinder the involvement of private operators in PPPs. As a consequence, there is a restricted number of firms in the PPP market, which is not competitive enough [UTFP 2010]. Italian PPP contracts are generally long-term: for instance, the mean duration of Lombardy projects is 22,6 years in case of public initiative and 28,3 years in case of private proposal [Finlombarda 2007]. In other projects, duration can be longer, e.g., in Florence tramway, concession period is 35 years (incl. 5 years of construction). The Italian law, in fact, establishes that the concession can have a duration longer than 30 years in order to guarantee the investment recovery and therefore financial sustainability. Revenues in projects like hospitals, schools, etc. are mainly constituted by an annual fee by the public authority, and only partially by end-user’s payments based on demand which concern only no-core activities such as parking, restaurant, and so on. Italian PPP often uses grants as main financial support [Martiniello 2008]. Some examples are: Florence Tramway, Hospital of Castelfranco Veneto and Montebelluna, New Mestre Hospital, where public contribution is respectively 52%, 25%, 42% of the total investment [Germani 2005]. In many Italian PPP projects, the SPV is mainly or totally held by local or national Government and /or public companies. Examples are the Stretto di Messina bridge, Malpensa 2000, Florence Tramway. For instance, in Emilia-Romagna region, the mean value of private participation is about 17.7%. The Italian law states that the call for tender gives the right, not the obligation, to constitute a SPV. Private Italian law, based on a “civil law” tradition, does not guarantee a “certain” risk allocation among parties according to a well designed contract, contrarily to “common law” systems such as in Anglo-Saxon countries. In addition, public authorities do not still use tools, such as risk matrix, to best evaluate and allocate risks.

131


Dimensions

Finally, as for the Italian Government’s influence on the use of PPP there are still some shortcomings in the legislative regulation that does not allow the PPP to be used in an effective way. First of all, Italian law does not prescribe the estimation of Value for Money before the approval of a PPP project. Nowadays, the evaluation of the feasibility of a PPP project is simply based on the “Economic-Financial Plan” which is made by the private sponsor. Secondly, in Italy the SPV is normally formed by local or national Governments and/or public companies [Bentivogli et al. 2008], as a consequence the level of commitment of the private sector is quite minimized. Finally, Figures 3 and 4 show that an extensive use of PPP contracts is made for power projects, characterized by 539 bids and a total capital value of almost €1,4bn with an increase respect to 2009 of more than 300%. The growth of PPPs in this sector is mainly due to tremendous growth in the installing of photovoltaic power plants. Other sectors with a relevant amount of PPP projects include sporting facilities, hospitals, urban developments, and other regional activities. Even if the number of transportation PPP projects has little relevance on the total, a significant expenditure characterizes these, with €3,2bn mainly devoted to road networks. Consequently, the transportation sector becomes the most relevant in terms of expenditure. Table 3: Characterization of Italian PPP projects: PPP arrangement’s financing.

Generally, private funding is used for these projects, but lenders give funding only in exchange for traditional guarantees [Bentivogli et al. 2008]. But PPPs are usually financed also by a quote of public funding: an example for this is the Autostrada Cispadana highway [Costantino et al. 2011]. The culture of the use of capital market, by selling bonds or shares to investors, for such projects is not spread in Italy: consequently, the financing is generally granted by banks with a deep experience of such projects [Etro 2007]. But even the Type of funding access to this source of funding is characterized by disadvantageous conditions in options comparison with other countries: the interest rate is about 10 - 11%, while in UK, for instance, the required spread on the risk-free rate is 0,75-1% [Iossa and Antellini Russo 2008]. Generally, Italian PPP projects are characterized by high leverage: for instance, debt to equity gearing is more than 80:20 for Vigliena port project in Naples Debt to equity [Micelli 2009] and it is estimated from 75:25 and 85:15 for wind energy plant gearing projects [Scarnati 2007]. PPP projects are characterized by little or medium economical dimension [Iossa Investment value and Antellini Russo 2008].

PPP arrangement’s financing


Use of private finance

In Tables 2, 3, and 4 the characterization of the Italian PPP is presented according to the proposed theoretical framework. Notice that the assessment of the values of the PPP variables is based on the analysis of the theoretical and empirical studies available in the literature.

132

Table 4: Characterization of Italian PPP projects: Public leverage on PPP.

4

Legislation

Conclusions and Future Research

As previously exposed, the research conducted to date on PPP has analyzed PPP/PFI literature with the main aim of developing a framework to characterize PPP projects on the basis of their main features and, consequently, compare multifarious PPP projects in several countries and sectors. The proposed theoretical framework has been used in order to characterize the Italian context for the PPP adoption, but it can also be considered a starting point of future research aimed at developing a tool for assessing the expected performance of PPP projects. This tool could be a useful instrument to support decisional process about the adoption of PPP by public sector. With this main goal, the principal steps of future research that should be addressed are the following. The first step should be devoted to assign to each variable of the framework the appropriate value on the basis of theoretical studies and the analysis of real cases of successful PPP projects. In this way, the framework would become a benchmarking tool that can be used by sponsors in order to derive managerial guidelines on how PPP projects should be correctly arranged and thus to move towards the best practices in applying PPP. In order to give the framework a focus on transportation projects, additional features describing the PPP for these infrastructures could be inserted in the scheme. The second step of the future research should be addressed to associate to the “qualitative” framework a quantitative approach that would allow decision maker to assess the expected performance of PPP projects, i.e., the probability of success of the PPP project, on the basis of the values assumed by each variable in the specific PPP project. A possible tool that could be used is the fuzzy logic, since it provides a natural framework to incorporate qualitative knowledge with quantitative information. Indeed, 133


Public Leverage on PPP

Scope

Italian law does not prescribe the estimation of VfM before the approval of a PPP project. Thus this practice is not still sufficiently adopted [UTFP 2010]. Contrarily, they often choose PPP route on the basis of other reasons, such as their financial situation, the possibility of getting infrastructure costs off the public balance sheet while keeping investment levels up [Iossa and Antellini Russo 2008]. Italian PPPs are ruled by Code of Works, Services and Supplies Public Contracts. This imposes some rules on PPP schemes, call for tenders, SPV, concessionaire default and its substitutions [Vigliano and Bicchieri 2007]. Until 2007, differently than in the other European countries, if there was a private promoter of the project, this had the pre-emption right on the awarding. This discouraged many firms entering the market [Iossa and Antellini Russo 2008]: in Lombardy, the 75% of the PPP tenders with promoter were without any other competitors [Bentivogli et al. 2008]. In 2008, a substantial modification about the use of the pre-emption right was introduced, which is expected to reduce the anti-competition effect [Ricchi 2009].

a two-valued logic may be inadequate when describing human reasoning. In fuzzy logic a proposition may be true or false to a point: the whole interval between 0 (false) and 1 (true) describes human reasoning. Therefore, fuzzy reasoning is particularly suitable for determining on the basis of qualitative knowledge provided by experts the values of some variables. For instance, the variable “use of private expertise” can be quantified only by using experts’ opinion (i.e., qualitative information) such as low or high involvement of private expertise in the project. Other variables, such as “investment values”, are quantitative and could be exactly quantified. However, their link to the project performance is expressed in a qualitative way: for example, investment value of PPP projects should be high since there are high transaction costs. As a consequence, the variable investment value, even if quantitative, can be treated as a fuzzy variable and its values could be, for example, low, medium, high, where the term low can be interpreted as an investment below about, say, 50 mln, medium as an investment close to 100 mln and, finally, high as an investment above about 150 mln, as shown in Figure 5.


1

Low

High

Medium

50

100

150

Figure 5: Example of a fuzzy number. Values and membership functions should be determined on the basis of literature review and experts’ interviews. Finally, to determine the project performance based on the values of each input variable, a Fuzzy Inference System (FIS) can be designed. To show briefly how the fuzzy mechanism works, consider, for instance, that the output is the performance P and the inputs are, for simplicity, only two, i.e., investment value I and time horizon of contract T. Once the involved inputs (I and T) are determined, the rules of FIS (e.g., “if I is high and T is high, then P is high”), obtained based on the experts’ suggestions, are considered to determine the FIS output (e.g., P), expressed for example in the 0÷1 range.

134

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Costantino N., Chiara N., Pellegrino R., 2009, PPP implementation throughout the world: a general selection/implementation scheme, Proceedings of the CIB W055 and W065 Joint International Symposium “Construction Facing Worldwide Challenges”, Dubrovnik (Croatia) 27-30 September 2009. Costantino N., Pellegrino R., Sciancalepore F., 2011, Evaluation of different tolling systems for a transportation PPP project, in Thai K.V., Towards New Horizons in Public Procurement, 301-316, PrAcademics Press, Boca Raton (USA). Etro F., 2007, Public Private Partnerships, Working Paper Series, No. 120, University of Milano Bicocca (in Italian). European Commission, 2004, Green Paper on public-private partnerships and Community law on public contracts and concessions, Brussels, COM(2004) 327 final. European Commission, 2004, Resource book on PPP case studies. Finlombarda, 2007, PF Focus, No. 3, December (in Italian). Germani, A., 2005, The PPP Experience in Italy (1999-2005), The European PPP symposium, London May 24th. 135


Clifton C., Duffield C. F., 2006, Improved PFI/PPP service outcomes through the integration of Alliances principles, International Journal of Project Management 24, 573 – 586.

Grimsey D., Lewis M.K., 2002, Evaluating the risks of Public-Private Partnerships for infrastructure projects, International Journal of Project Management, 20, 107-118. Grimsey D., Lewis M.K., 2005, Are Public-Private Partnerships Value for Money?: Evaluating alternative approaches and comparing academic and practitioner views, Accounting Forum, 29, 345-378. Hemming R., 2006, Public-Private Partnerships, Government Guarantees, and Fiscal Risk. Washington D.C.: International Monetary Fund. HM Treasury, 2008, Infrastructure procurement: delivering long-term value. Iossa E., Antellini Russo F., 2008, Potenzialità e criticità del Partenariato Pubblico Privato in Italia”, Rivista di Politica Economica, Maggio-Giugno 2008, 125-158 (in Italian). Katz G., Smith S., 2003, Build-Operate-Transfer: The future of construction?, Journal of Construction Accounting and Taxation, 12(1), 36-48. Martiniello L., 2008, Italian PPP at a glance, PPP Task Force. Micelli E., 2009, Modelli ibridi di partnership pubblico-privato nei progetti urbani, Scienze Regionali, 2 (in Italian).


National Council for Public-Private Partnerships (NCPPP), 2003, NCPPP White Paper. The NCPPP, Washington DC. OECD, 2010, Dedicated Public-Private Partnership Units: A Survey of Institutional and Governance Structures, OECD Publishing. Presilla S., 2006, Il project financing in Italia, Le Fonti Editrice (in Italian). Ricchi M., 2009, La nuova finanza di progetto nel rispetto dei contratti, UTFP Scarnati E., 2007, Analisi di bancabilità di progetti eolici, L’energia eolica: esperienze e prospettive, Rome, 15 November (in Italian). Spackman M., 2002, Public–private partnerships: lessons from the British approach”, Economic Systems, 26(3) 283-301. Turina, N., Car-Pusic, D., 2006, Overview of PPP models and the analysis of the opportunities for their application, Proceedings of the 7th International Conference: Organization, Technology and Management in Construction, Zagreb, edited by Mladen Radujkovic. U.S. Department of Transportation, 2007, Federal Highway Administration, “User Guidebook on implementing Public – Private Partnerships for transportation infrastructure projects in the United States. UTFP, 2009, 100 Questions and Answers. 136

UTFP, 2010, Partenariato Pubblico Privato in Italia. Stato dell’arte, futuro e proposte (in Italian). Vigliano F., Bicchieri N., 2007, Italy in GLG, The International Comparative Legal Guide to: PFI/PPP Projects 2007.

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The Emergence of Transport PPPs: Context and drivers Geert Dewulf University of Twente [email protected] Colin Duffield The University of Melbourne [email protected] Mike Garvin Virginia Tech [email protected]


Kristian Widén Lund University [email protected] Ole Helby Petersen Danish Institute of Governmental Research [email protected] Veiko Lember Tallinn University of Technology [email protected] Walter Scherrer University of Salzburg [email protected] Stefan Olander Lund University [email protected] 138

Abstract The paper is a first report of WG3 in the COST Action. Following a description of the emergence of PPP transport policies the paper analyses the institutional factors affecting PPPs and their performance. It may be concluded that the institutional mechanisms and factors are becoming standard. However, there is a need for tailorbased PPP business models. The last section therefore elaborates on this debate. This paper is aimed at setting the research agenda for the future. Keywords: Emergence of PPP, Enabling fields, Institutions, Barriers

139


Contribution to Working Group WG3: overview of the literature on institutional context and drivers for PPP.

1

Introduction

This discussion paper is based on several papers presented in the Working Group 3 sessions of the Cost Action. The aim of WG3 is to generate insight in the way institutional factors influence the performance of PPPs. Today, we see similar trends and developments all over Europe: the financial crisis, the pressure on budgets, and an increasing debate on how to safeguard public interests. To understand the context of transport PPPs we start with a description of the emergence of transport PPPs in the world. Second, WG3 members made a state-of-the-art of the current insights on institutional factors affecting the performance of PPPs. Today, there is a broad societal debate on the role and the influence of the EU. To enhance competition within Europe and increase the transparency and accountability of decisions there is a strong need for standarised approaches and mechanisms supporting PPP procurement. This is one of the basic assumptions underlying EU policies on PPP. The third section is aimed at launching a debate about the need for standardised framework versus the demand for tailor-made solutions per country or even projects.

2

The emergence of Transport PPPs


By Geert Dewulf

Public-private partnerships have a long history in many countries, but grew significantly more popular during the 1980s and 1990s. At this point, private sector thinking was introduced and used in the public sector, and market-based criteria were applied to the delivery of public products and services [Pierre 1997a]. During the 1990s, New Public Management (NPM) and New Governance philosophies have further influenced public management in many countries. This has resulted in a growing number of partnerships between public and private actors especially in the transport sector. In the last three decades, public-private partnerships became a derivative of the privatization movements and rethinking government. Private providers were assumed to provide higher quality goods and services at lower costs, which would significantly reduce the government’s tasks and responsibilities [Linder 1999]. PPPs are considered NPM mechanisms, as means of establishing new form of governing working across organizational boundaries [Keating 1997]. Under the Thatcher Administration in the UK, government turned to the idea of publicprivate partnerships as preferred method for economic regeneration. Other parts of Europe also started using PPPs in this appearance in the late 1980s and examples of PPPs in developed countries can also be found outside Europe. In Australia for example the introduction of public-private arrangements for the provision of infrastructure dates back to the early nineties. The first infrastructure projects focused on toll roads followed 140

3

Institutional factors influencing PPP

By Ole Helby Petersen, Veiko Lember, Walter Scherrer, Kristian Widén, Stefan Olander

3.1 Broader comparative public administration literature Over the past decades, comparative public administration literature has dealt intensively with comparative interpretations and explanations of various public administration and 141


by seaports. In the late 1990s airports were added to this list [Crump et al. 2005]. The introduction of PPPs in Australia are a reaction on to the large costs and inherent risks in terms of cost recovery involved in construction of many large infrastructure projects in Australia. Alongside some circumstantial and environmental factors, aspects that give PPPs their current appeal in the Australian context include the potential for achieving cost efficiencies, early project delivery, achieving gains from innovation, transferring some project and finance risk to the private sector, and creating and accessing improved services for citizens [English et al. 2003]. In the late nineties, several publications linked the development of PPPs to economic development strategy [Clarke 1998; Walzer and York 1998; Linder 1999; Rosenau 1999; DiGaetano et al. 2003]. Today, we can depict a similar trend in the emerging countries. In India the government has introduced several policy measures to create opportunities for private investors to invest in PPPs. For instance, in order to support the rapid expansion of the southern suburbs of Chennai (India) the government of Tamil Nadu decided to develop a 6-lane road form the city through the southern suburbs. This project was delivered through a PPP concession due to a lack of municipal finances [Delhi et al. 2010]. In South-Africa, the fist democratic government of Mandela was confronted with alarming budget deficits and significant infrastructure requirements. PPP concessions were launched to cope with these problems [Jooste et al. 2011]. The N3 toll road and the N4 Maputo Development corridors are PPP concessions of the first stream of PPPs. The rise of PPPs continued in the current century. Besides the political motives we can depict two major drivers for this continuation. First, economic crises, growing budget deficits and globalization have reinforced government’s reliance on markets. Due to decreasing governmental deficits governments have become increasingly depending on private funding for public infrastructure and services. Although governments are still the major funders of infrastructure development, the role of private investors is increasing. The larger this dependency the more necessary it is to have commitment of those actors who do control resources [Wong et al. 2006]. Second, the provision of public infrastructure has become more and more complex. Governments are dependent on private stakeholders, not only due to financial reasons but also due to lack of technical and market knowledge. Today’s complexity requires intensive cooperation. Public and private stakeholders are not able to achieve their goals without interacting.


management reform trends, particularly with reference to various NPM and post-NPM reform elements [Hood 1995; Barzelay 2001; Christensen and Lægreid 2002; 2007; Barzelay et al. 2003; Barzelay and Gallego 2006; Pollitt and Bouckaert 2005; Politt et al. 2007]. To a large extent, these reforms of public sector administrations have been said to be of a world-wide scope and magnitude, as noted, for example, by Boston et al. (1996), Kettl (2000), and public management protagonists Osborne and Gaebler (1992), who talks about an entrepreneurial spirit in the public sector that “is underway throughout the developed world” [Osborne and Gaebler 1992: 328]. Indeed, as noted by Homburg et al. (2007), the “label that has been given to these reforms – New Public Management or NPM – suggests commonality and uniformity”. However, within the last five to ten years, a growing strand of comparative public administration and management literature has increasingly challenged the ‘globalisation thesis’ [Christensen and Lægreid 2002: ix; Pollitt and Bouckaert 2005].Thus, rather than leading to similar outcomes across administrative systems, according to this growing body of literature, such reforms trajectories are shaped by a complex mix of specific policy and polity features, environmental pressures and historical and institutional context [Christensen and Lægreid 2007]. Moreover, various macro-level theories about different national institutional systems have gained widespread usage, as exemplified by Esping-Andersen’s ‘Three Worlds of Welfare Capitalism’ [EspingAndersen 1990] and Hall and Soskice’s ‘Varieties of Capitalism’ [Hall and Soskice 2001]. These macro-level theories could form an interesting starting point for research on how different institutional and contextual factors might be linked to different national PPP approaches. But they are also broad theories operating at a rather general institutional level, and this literature should thus be utilised in conjunction with more specific PPP literature on institutional and contextual factors, which we review below.

3.2

PPP literature on institutional factors

Although the literature on PPPs is now quite comprehensible, in terms of comparatively assessing and accounting for various institutional and contextual factors of PPPs across different countries, this is still a research field in its infancy. On the following pages, we begin reviewing the literature on institutional/contextual factors of PPPs. The empirical literature usually associates the emergence and development of PPPs with the existence of macro-economic challenges and, thus, according to many studies the spread of PPPs is related to the pressure from fiscal problems governments face [Bovaird 2004; McQuaid and Scherrer 2008; Petersen 2011; Greve and Hodge 2007]. As public infrastructure development assumes high investments, which can be for various reasons not possible to make for public sector, PPPs are seen as a critical mean to overcome the budgetary problems. For example, based on a detailed comparative analysis on Denmark and Ireland, Petersen (2011) concludes that the primary rationale for forming (or not forming) PPPs was a macro-economic one in Ireland, with a focus on placing major infrastructure investments off government balance sheets, whereas Denmark’s strong public finances and well-built infrastructure made such a maneuver 142

1

Although the temptation is still there, the possibilities have in many countries dried up [Hodge and Greve 2011]. See also OECD (http://www.oecd.org/document/47/0,3746,en_2649_34119_44983023_1_1_1_1,00.htm l). 143


largely redundant. McQuaid and Scherrer (2008), when comparing Austria, Germany and the UK, continue in similar vein by arguing that large infrastructure investment needs contributed to the uptake of PPPs. If urbanization trends, demographic change, technological advances and perceived tax competition did all play a general role in making PPPs important macro-economic policy tool, then there were also countryspecific factors such as high re-unification costs and the EU-driven budgetary rules in Germany, legacy of underinvestment in public infrastructure in UK and both internal and the EU-driven budgetary constraints in Austria that also lead to the increased reliance on PPPs (ibid.). Although in many occasions the rationale for placing infrastructure investments off the balance sheet can be regarded as “fiscal illusion” [McQuaid and Scherrer 2008; Shoul 2005], there exist signs that under the current financial crisis the temptation to use PPPs as a way to overcome budgetary constraints may have not decreased [Hodge and Greve 2011].1 In addition to the fiscal concerns, the use of PPPs in different countries can be explained by the perceived problems of public sector functionality and effectiveness. In accordance to the overall NPM ideas, PPPs are often seen as a mean to reorganize dysfunctional parts of public service delivery machine. For example, McQuaid and Scherrer (2008) suggest that strong value-for-money-related concerns in public service delivery have been the major driving force behind PPP developments in the UK, while it has not been that central issue in Austria or Germany. Specific systemic failures like the lack of co-operation among agents can also be overcome through PPPs. This is particularly relevant in innovation policy because establishing and fostering industryscience relationships is a key success factor for creating a (potential) innovation system at the regional or national level. In a comparative analysis the OECD (2005) identified the creation of PPPs as a successful policy instrument which has been applied successfully in several countries, while Hospers et al. (2008) are less optimistic because PPPs might reflect the impact of special interest on public policy and because some of the business risks are transferred onto taxpayers. At the same time Bovaird (2004) has argued that the drive for PPPs stem from emerging social issues (“wicked” problems), where governments simply lack the capacity to solve the challenges alone. This is allegedly so in areas depending heavily on ICT solutions (ibid.). However, PPPs can be introduced not only because of internal problems, but as a result of external pressure. As explained by Christensen and Lægreid (2007), the uptake and spread of policy and management ideas often set in as a result of isomorphic processes (see also DiMaggio and Powell (1991) for more in-depth discussion). In the context of PPPs this means that if PPPs become accepted policy tools in some influential countries (such as e.g. the UK), other counties would overtake the PPP ideas simply because it is felt as a leading policy idea of a time that cannot be overlooked. Of course, one cannot ignore the fact that PPPs are consciously promoted solution to public sector problems


by many international stakeholders such as the EU, OECD, World Bank [Jones 1998; Skelcher 2005] and even some governments [Holden 2010], but the underlying logic of isomorphism assumes that once a myth has established itself as a dominant ideology in some parts of the world it almost automatically diffuses around the world regardless to the fact whether it is rational or not [Christensen and Lægreid 2007]. It reads from Rosenau (2000) that the PPP drivers across different US policy domains are not to be found in the fact that PPP policies have performed in accordance to the expected rational goals (which they are often not according to the empirical data gathered), but it is to a large extent based on perceived intellectual power and philosophical attraction of the PPP idea [Pollitt 2003].2 PPPs are often associated with the concept of privatization, which rest on the ideological ideas of neo-liberalism and neo-conservatism and although for different reasons, both ideological campuses are said to prefer using PPPs and other similar mechanisms for limiting the role of government in society [Linder 1999]. Thus, the uptake and use of PPPs is dependent on the values or normative positions PPPs are associated with. And even if governments experience problems with finding enough evidence to persuade outsiders on the existence of traditional (rational) virtues of PPPs (such as project-level value for money), the continuation of PPP policy can be explained through the way stakeholders (especially governments) attribute new (symbolic) values to PPPs (e.g. PPPs as means for decentralization, downgrading public sector, maximization of representation and democratic processes, promoting innovation and local industries, involving private sector role in society etc). Still, the presence of external or internal pressure alone cannot explain how the PPP idea diffuses across public sector. Recent studies have found that the uptake and diffusion of PPP ideas depend also on the presence and quality of dedicated institutional mechanisms, existence of strong policy entrepreneurs and public sector capacity. In the study by Petersen (2011) of PPPs in Denmark and Ireland, the article reveals that despite their similarities in a number of dimensions, within a time-period of just ten years, PPP policy and regulation developed very differently in these two countries. Whereas PPPs in Denmark are subject to a loosely organised institutional framework with a number of fundamental policy and regulation issues being either unresolved or not very supportive to the uptake of PPPs, Ireland on the other hand now presides over one of the most ambitious PPP program in the world, with major policy, regulation and procurement functions centralised within the Ministry of Finance and the Treasury. A second finding from the comparative analysis is the importance of policy entrepreneurs as well as policy veto-players in decisions about PPPs. Hence, whereas the findings in relation to the Irish case are in line with the common interpretation of the pro-PPP role envisaged by the concept of a policy entrepreneur, a main finding from the Danish case was that PPP policies and regulations were largely impeded by the predominance of a strong policy veto-player. 2

For more recent empirical overview on the results of PPPs, see Hodge et al. (2010). For more specific critique on NPM-based management ideas see e.g. Lane (2006) and Drechsler (2005). 144

4

PPP: Standardisation versus tailor-made business models

By Geert Dewulf, Mike Garvin, Colin Duffield

World-wide, governments are launching PPPs to cope with decreasing budgets and the urgent need for new infrastructure. The speed of introduction, however, does differ strongly. Even within a country or market we depict large differences in the emergence of PPP schemes. This is, for instance the case in the US, Europe and Australia despite similar budget constraints and the high investment needs. Many believe that the absence of a common comprehensive procurement legislation hampers the development of PPP [Jooste et al. 2010] while others stress the importance of aligning the PPP schemes with the situational characteristics [Bult-Spiering and Dewulf 2005]. A delicate balance exists between the need for a standardized and common legal framework and the need for tailor-made solutions.

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This finding resembles the conclusions made by Greve and Hodge (2007) that compare experiences with PPP in Denmark with that of Victoria, Australia. While Victoria was as an early mover in terms of PPP reforms, and has finished a number of projects, Denmark is characterized by a reluctant attitude and little PPP activity. They conclude that Victoria has developed a clear institutional framework and has a dedicated policy entrepreneur in the Ministry of Finance, whereas Denmark’s institutional framework for PPPs has been characterized by scattered initiatives, the lack of a rationale for implementing PPPs, and a sketchy PPP policy and ‘Action Plan for Public-Private Partnerships’. This line of argument is further supported by Hammerschmid and Ysa (2010) and Boardman and Vining (2010), who, relying on the European and NorthAmerican contexts respectively, claim that next to supportive legislative and regulative governance mechanisms, dedicated PPP units and supporting loan arrangements contribute to the increasing usage of PPPs. Hodge et al. (2010) summed up this position by arguing that “but even stronger than the need for supportive legislative frameworks was the obvious need for strong and professional capacity inside of government to take on these deals” [Brown et al. 2006]. Another factor that explains the emergence of PPPs is the historical and cultural background of a country. Hodge et al. (2010), when summing up the recent international experience with PPPs, suggest that “varieties of capitalism”, political dynamics and previous experience with privatization and contracting out all play a role in facilitating the introduction of PPPs. They argue that countries such as Australia and the UK have been more willing to adopt PPP solutions compared to Germany or Scandinavian countries because of the latter countries can be associated with integrated and institutionalized corporatist arrangements, they had no immediate political pay-offs to gain and they had limited previous experience with privatization and contracting arrangements.

The concept of one common legal framework fits with the idea of a common business model. A business model articulates a value proposition to enable a customer to perform an important operational task or achieve its strategic objectives [Johnson et al. 2008] and identify market segments for profitable growth [Chesbrough and Rosenbloom 2002]. Translated to public infrastructure, this means that a common legal framework is supposed to increase the public interest or Value for Money. However, in practice various Business models do exist since local or state governments or specific project characteristics do ask for different value propositions.


Two major factors are driving the need for standardization: - market drivers - political factors: transparency and legitimacy. Market drivers Large engineering firms are active in many different parts of the world and in the complex engineering projects contractors with different nationalities are involved. Shortages on the labour market in both volume and specialism are stimulating this development. Moreover, to enhance competition clients have been launching open tendering procedures enabling foreign companies to get involved. Today, the construction market is an open global market. Standardization of procedures, legislation and approaches stimulates this open market system. It is generally argued that concession PPP projects should have a certain economies of scale. Projects need a specific volume (in terms of concession period and costs) to recover the transaction costs. Bidding costs are high. Due to the height of these costs in the United Kingdom often only few bidders sign up. In many smaller countries, as is the case in the Netherlands, concession PPP projects are relatively small and therefore time and cost consuming. Moreover, for every project a new contract has to be developed and negotiated. This is time consuming. Standardized approaches and contracts lead to a decrease of transaction costs. Political factors Beside these market developments, governments are launching standardized directives and procedures to enhance accountability and transparency. The government is accountability to the community for her actions. On behalf of the citizens the government purchases infrastructure assets. Two streams of accountability can be distinguished [Shaoul et al.2010]: Upward accountability or accountability to the Parliament and the public as taxpayer and electorate at macro-level. Downward accountability to the public as service users at micro-level. To safeguard the public interest or taxpayers' money governments have implemented various central governance rules, procedures and codes. These rules and procedures increase the transparency of the decision-making and the ease of accountability. In Europe, for instance, PPP concessions are subject to rules and principles resulting from 146

the Treaty: the principles of equal treatment, mutual recognition, proportionality and transparency. These principles are translated in the EU Directives for the co-ordination of procedures for the award of public contracts. The transparency principle for example, safeguards the transparency of the contracting public authority’s steps in all phases of the purchasing procedure. In order to safeguard the interests of clients in specific projects flexibility is required. Motives differ by country and situation and therefore customized approaches are needed. Different motives require different business models. A business model focuses on the way to deliver value for the customer and identifies both a firm’s strategic choices and operational implications and profit potential, which can be analysed, tested and validated [Shafer et al. 2005: 203]. A business model describes how all of the elements or components of a business – such as a firm’s capabilities, resources, and position in the value network as well as its strategy – fit together as a whole to create value for the firm and its customer [Magretta 2002].

Conclusions

This paper gives an overview of the literature on the institutional factors influencing PPP policies and projects. The paper reflects on the factors influencing the emergence of PPP policies and transport projects in the world. Today’s financial crisis may lead to an important turning-point. Countries are coping with growing deficits but the private sector is reluctant to invest as well. Besides, national governments and the EU is developing policy measures and instruments to increase the competition and to enhance the accountability. At the same time projects are struggling with specific problems. WG3 tries to set the agenda for the future by generating insight in the past and studying current developments. We would like to invite the transport partners and policy makers to discuss with us problems they face today in order to develop a demand-driven research agenda for the future.

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4

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Christensen, T., Lægreid, P., 2002, New Public Management. The transformation of ideas and practice. UK: Ashgate. Christensen, T., Lægreid, P., 2007, Transcending New Public Management. The Transformations of Public Sector Reforms. UK: Ashgate. Drechsler, W., 2005, The Rise and Demise of the New Public Management, Postautistic economics review, Vol. 33. Esping-Andersen, G., 1990, The Three Worlds of Welfare Capitalism. UK: Polity Press. Greve, C., Hodge, G., 2007, Public-Private Partnerships: A Comparative Perspective on Victoria and Denmark. In T. Christensen & P. Lægreid (Eds.), Transcending New Public Management: The transformation of public sector reforms. UK: Ashgate. Hall, P., Soskice, D., 2001, Varieties of Capitalism –The Institutional Foundations of Comparative Advantage. UK: Oxford University Press. Hammerschmid, G., Ysa, T., 2010, Empirical PPP experiences in Europe: National variations of a global concept. In: Graeme Hodge, Carsten Greve and Anthony Boardman (Eds) International Handbook on Public–Private Partnerships, Edward Elgar, pp. 333-353. 148

Hodge, G., Greve, C., Boadrman, A., 2010, Conclusions: Public-Private Partnerships - International Experiences and Future Challenges. In: Graeme Hodge, Carsten Greve and Anthony Boardman (Eds) International Handbook on Public–Private Partnerships, Edward Elgar, pp. 594-610. Hodge, G., Greve, C., 2011, Theorizing Public-Private Partnership Success: A Market-Based Alternative to Government? Paper for the Public Management Research Conference at Syracuse University 2-4 June 2011, Syracuse, NY, USA. Holden, C., 2009, Exporting public–private partnerships in healthcare: export strategy and policy transfer, Policy Studies, Vol. 30 (3). Hospers, G.-J., Sautet, F., Desrochers, P., 2008, Silicon somewhere: is there a need for a cluster policy?, In: Charlie Karlsson, Handbook of Research on Innovation and Clusters. Cases and Policies. Edward Elgar, Cheltenham, pp. 430446. Jones, R.A., 1998, The European Union as a Promoter of Public-Private Partnerships, In: Luiz Montanheiro (eds), Public and private sector partnerships: Fostering enterprise. Sheffield Hallam University Press, Sheffield, pp. 183-194. Kettl, D., 2000, The Global Public Management Revolution: A Report on the Transformation of Governance. Washington, D.C.: The Brookings Institution.

Linder, S. H., 1999, Coming to Terms with the Public-Private Partnership. American Behavioral Scientist, Vol. 43(1), pp. 35-51. McQuaid, R.W., Scherrer, W., 2008, Public and private sector partnership in the European Union: Experiences in the UK, Germany, and Austria, Uprava, Vol. 6(2), pp. 7-34. McQuaid, R., Scherrer, W., 2010, Changing reasons for public-private partnerships (PPPs), Public Money and Management, Vol. 30(1), pp. 27-34. OECD, 2005, Innovation Policy and Performance. A Cross-Country Comparison. OECD, Paris. Osborne, D., Gaebler, T., 1992, Reinventing Government. Reading, MA; Addison-Wesley Publishing. Petersen, O. H., 2011, Public-private partnerships as converging or diverging trends in public management? A comparative analysis of PPP policy and regulation in Denmark and Ireland, International Public Management Review, 12(2). Pollitt, C., 2003, The Essential Public Manager. Berkshire: Open University Press. 149


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PPP Models in the Ports Sector: A Cross-Sectional Analysis

151


Sheila Farrell Port Operations Research & Technology Centre Imperial College London [email protected]

Abstract Purpose - This paper is to set out the key characteristics of PPPs in the ports sector, so that they can be compared with those of PPPs in other modes of transport. In an attempt to get away from case-by-case descriptions, it has been based on a cross-sectional analysis by the author of over 400 container terminal concessions. It attempts to discover what constitutes the “norm” in port PPPs, and whether PPPs which are exceptions to the norm have any underlying features in common. It discusses briefly three generic types of PPP model, involving either the transfer of public assets to private management (usually with an obligation to invest), the right to develop new assets on a build-own-operate (BOT) basis, or public-private joint ventures. There are many variations on the basic models, which can usually be defined in terms of eight key policy variables: permitted activities, investment requirements, contract duration, exclusivity rights, performance requirements, labour transfers, tariff regulation and concession fees. Keywords: Ports sector, PPP models, PPP requirements.


Contribution to Auxiliary Working Group 2

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1

Introduction

There is still very little academic literature relating to public private partnerships in ports, and much of the existing literature is in the form of empirical case studies of individual PPPs. For example Psaraftis and Pallis (2012) describe the recent history of the Piraeus container terminal concession, whilst Parola et al. (2012) review the outcomes of concessioning at different ports within Italy, demonstrating that the results may not be the same even for ports which share a common legal framework. Robles and Guerise (2010) describe the legal and regulatory framework in Brazil and the impact of this on the behaviour of the various parties involved in PPPs in the port of Santos, whilst Harding (2009) considers how effective port and terminal concessions have been in Angola, Mozambique and Tanzania.

There have been few broadly-based empirical studies which look at similarities and differences in PPP contracts across a wide range of ports and ask why these have occurred. Notteboom and Verhoeven (2009) report the results of a survey of European seaports whilst Farrell (2012) examines worldwide differences in the concessioning of container terminals. This paper summarises the characteristics of the most common PPP models in the ports sector. It also points out a number of significant differences between countries in their choice of PPP models, in an attempt to identify some of the cultural factors which have influenced public-private partnerships [Trujillo et al. 2011]. It does not use traditional short-hand terms for describing PPPs like BOO, BOT etc, as there are many variants within these arrangements, and the terminology is interpreted differently in different parts of the world. Instead it tries to develop an alternative approach based on key clauses in PPP agreements [Cruz and Marques 2010] such as those governing obligatory/permitted activities, concession duration, exclusivity rights, investment requirements, regulation etc which allow PPP arrangements to be compared at a finer level of detail.

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Much of the theoretical work on the structuring of port PPPs has been done by international financial institutions [Kerf 1998], culminating in the publication of the World Bank Port Reform Toolkit. The part of the toolkit dealing with the legal tools for port reform describes in detail many of the technical issues which arise when drafting port concession agreements, and provides a good overview of current thinking about industry best practice. However some of this thinking is now beginning to be challenged; Ferrari et al. (2011), for example, explore how standard structures can be modified to achieve a better balance between public and private interests, whilst Patsiadis and Angelides (2008) illustrate the impact of the legal framework on the way in which public private partnerships are structured.

2

PPP Models in the Ports Sector

Most PPP models in the ports sector sit within a landlord port structure in which a public sector port authority (often autonomous) enters into PPP contracts for a series of individual terminals. The operators of the terminals are usually, but not always, different, and the PPP model used may differ from one terminal to the next. The role of the port authority is to provide and manage common facilities like the breakwater and entrance channel, utilities and road and rail access; to regulate the individual PPPs; and to plan and implement the expansion and development of the port [Van der Lugt and Langen 2007]. The most common PPP models for individual business units [Farrel 2012] are:


•

The operator/investor model for existing public assets: The private operator manages publicly owned assets and makes additional investments in them, in exchange for being given the right to use them for a specified period of time. Ownership of the public assets remains with the public sector throughout this period; privately-funded fixed assets are usually (but not always) taken into public ownership immediately after construction, whilst privately-funded mobile assets such as mechanical equipment usually (but not always) remain in private ownership. This is reflected in “transfer-back” arrangements at the end of the contract period, when the right to use the assets (now a mixture of public + privatelyprovided) reverts to the public sector, which may then re-assign them to another operator. Various arrangements exist for compensating the private operator for the residual value of any investments made during its period of tenure. For fixed assets “no compensation” transfers are probably still the most common. Mobile assets paid for by the private operator, in contrast, can usually be withdrawn or sold-on to the public sector, reflecting assumptions about ownership which are either explicit or implicit in the contract. This type of PPP model is generally associated with the port privatisation programmes which have taken place since the late 1980s in southern Europe, South America, Africa and South Asia.

•

The build-operate-transfer (BOT) model for new private assets: Here the private investor buys the right to build new port assets and have exclusive use of them for a fixed period of time before transferring them to the public sector. This is a model which has become increasingly popular in the ports sector as the stock of public assets suitable for private management has dwindled. However it raises the question of why private investors should have to give back their assets to the

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public sector, often free of charge, when a hotel complex built on the same waterfront site would be treated as freehold property. One of the surprising things about the ownership structure of the ports industry is how few freehold common user ports there are. There are freehold captive user terminals, usually part of vertically-integrated mining, agricultural or forestry enterprises, but common user terminals and multi-purpose ports are – with a few exceptions – concentrated in the UK and Turkey, both competitive free market business environments with long coastlines and many ports. There seem to be four main reasons why the BOT model prevails over the private freehold model: - The Latin legal tradition that the seabed up to the high water mark belongs to the State, and cannot be transferred irrevocably to any private enterprise. This has been a very important concept in Latin American port development.

- The limited number of sites which are suitable for port development in some countries. Here the State may seek to retain a permanent stake in their development for strategic or monopoly control reasons, without putting up any of the necessary investment. Road and rail schemes, in contrast, may have fewer locational restrictions. - Safeguarding of the value of State-owned ports, in the face of competition from lower cost private freehold sites. This is apparent in the current arguments in Brazil between the operators of recently privatised public ports (grouped together as ABRATEC) and the developers of new greenfield sites at Itapoa and Santos, which has resulted in government intervention to halt the greenfield developments on “unfair competition” grounds. A paper by the Centro de Estudos em Gestão Naval [CEGN 2009] shows how these new circumstances have led to some basic changes in PPP regulation in Brazil, with clauses in BOT contracts used to ensure that ports compete under conditions established by governments rather than markets. Although the BOT model is associated with greenfield site developments in many different countries, it has been particularly important in North-West Europe where there is a long-established landlord port tradition.

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- The high costs of shared infrastructure such as breakwaters and dredged channels, which need to be partially recovered from the shore-based terminals which benefit from them, as well asfrom ships. BOT contracts give public port authorities a continuing claim on terminal revenues/assets which would not be possible if freehold terminal development was allowed.

•

The public-private joint venture model: In this, the public sector has an influential or controlling stake in the Special Project Vehicle (SPV) which is set up to hold either a management-investment contract or a development rights contract for new port facilities. These contracts otherwise operate broadly as described above, although the existence of a large public sector stake in the SPV has a significant effect on the detailed provisions of the contract. This type of PPP model has become the norm in China [15], Indonesia, Algeria and Mozambique, but is rarely found elsewhere. Management contracts, where the private sector operates port facilities on behalf of the public sector with minimal investment of its own, are now quite rare. This is partly because they generate small returns in relation to the inputs of relatively scare management time required. There is also a history of failure caused by conflicts over strategy, usually arising when private operators are not given the freedom they need to satisfy public sector objectives for the contract.


Short-term leases of public assets of up to 15 years, often renewable, are more popular than management contracts because they give the operator greater commercial freedom. However they tend to be concentrated amongst: • Small, slow growing sub-sectors of ports which are experiencing limited technological change, such as general cargo berths.

3

•

Dedicated berths for the exclusive use of a single shipping line, where they are used as a means of locking-in key customers. These usually have ample spare capacity, and so require little private investment.

•

Specific countries such as Japan whose port ownership/operating models are highly fragmented and now regarded as rather archaic.

Defining Characteristics of PPP Models in the Ports Sector

This paper defines the main characteristics of PPP models in the ports sector in terms of eight key policy issues: permitted activities, investment requirements, contract duration, exclusivity rights, performance requirements, labour transfers, tariff regulation and concession fees. These are standard items in most port PPP contracts, and are the clauses which vary most from one concession to another. The sub-sections which follow focus on container terminals, the sub-sector which has generated the majority of PPP agreements, and the only one for which large amounts of information have been published.

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3.1

Permitted activities

Most port PPPs impose strict limits on what private operators are allowed to do, usually in terms of the types of cargo they are allowed to handle. Intended to encourage efficiency through specialisation, this protects the interests of the other private operators, and maximises the value which the port authority can extract through the creation of local monopolies. It also prevents the use of scare waterfront land for nonport activities such as hotels and commercial/residential development. Two other common limitations on PPP activities are the separation of cargo handling from marine services (pilotage and towage), and the design of PPPs on a terminal rather than a whole port basis.

The introduction of additional marine service providers in ports such as Hamburg, Rotterdam and Le Havre has begun to define the limits of these economies of scale more clearly, and this is leading to some PPP schemes which allow cargo handling companies to provide their own marine services. Although this is still uncommon, it may increase in importance as ports and terminals become larger. The level of specialisation found in ports is not replicated in other modes of transport, and is one of the reasons why ports have entered into PPPs on a terminal rather than a whole port basis. Although some whole ports have been privatised on a PPP basis (e.g. Port Sultan Qaboos in Muscat) these are mostly small. The main reasons for the focus on terminals rather than whole ports in PPPs are: • Variations in the profitability of different types of port activity. Most PPPs are for container terminals (usually the most profitable component of a port) or captive user bulk terminals linked to vertically integrated supply chains. There are plenty of specialist private operators in these two areas, but fewer companies willing to take on multi-purpose ports as a whole.

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Cargo handling activities have traditionally been separated from marine services, and involve different types of private investor. Marine services need to achieve significant economies of scale in order to become financially viable, and ports which can support several terminal operators are often unable to support more than one pilotage organisation or tugboat operator. Safety & security issues have led to marine services often being kept in the public sector or outsourced to a single private operator of good reputation. There have also been concerns that allowing terminal operators to provide their own pilotage and towage services might lead to the bundling of port services and encourage anti-competitive behaviour.

•

3.2

The reluctance of Governments to “let go” of ports, which are often seen as strategic assets and/or cash cows. The landlord port structure which sits above the terminal PPPs allows private sector efficiency and investment to be combined with continuing public sector control and a regular public sector income flow.

Investment requirements


The private investment requirements associated with PPP contracts may be either: • Obligatory - clearly specified, with an agreed time schedule. •

Event-triggered – usually a requirement to increase capacity once berth utilisation reaches a certain level, with the form of the investment either prespecified in the PPP or left to the operator’s discretion.

•

Indicative – a broad programme agreed in advance but subject to change as the PPP progresses.

•

Discretionary – left to the private operator on the understanding that investment will take place when necessary. Sometimes the PPP includes an estimate of expected investment costs over the life of the contract for benchmarking purposes.

Obligatory investments are most common in competitively-tendered PPP projects in countries with corruption problems, as pre-specifying the investment schedule increases the comparability of bids. It also reduces the number of evaluation criteria, and the amount of discretion given to the evaluation panel when scoring bids, as well as making the investment programme easier to enforce. Obligatory investment programmes may also be specified when the investments are urgently required, and/or there is only a single technical solution available. Experience has shown that obligatory investment programmes lasting more than five years are rapidly overtaken by technological and market changes, and unless periodically renegotiated they can lead to investments which are not really needed and costs which are higher than they should be. They have therefore been largely replaced by indicative investment programmes which can be modified by mutual agreement. This creates a less confrontational atmosphere between the PPP partners, encourages innovation, and ensures that the majority of investments are commercially justified. There are large variations between PPPs in the total amounts of investment required – even for terminals of similar sizes and types – and in the split of responsibility for this investment between the public and private partners.

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There has been a steady increase over time in the average amount of private investment required. This has been recovered through the use of longer concession periods rather than increases in the tariffs charged to port users or reductions in the concession fees paid to the port authority/Government. Table 1: Relationship Between Private Investment in Container Terminals and Concession Duration. Date of award of concession 1990-95 1996-2000 2001-05 2006-10 Private investment (US$m) 182 126 184 306 Average concession duration 27.2 25.2 29.7 31.6 (years) No. of concessions in sample 28 48 47 45 Source: Data compiled by the author. Figures relate to 168 concessions for which there is published information on investment requirements and concession duration The increase in private investment requirements in container terminals can be attributed to several factors, including: • The shift from brownfield to greenfield concessions as the best privatisation opportunities have been used up. Greenfield PPPs are much more capital

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Figure 1: Size of Private Investment Requirement in Container Terminal Concessions (US$m). Source: Data compiled by the author. Figures relate to 195 concessions for which there is published information

intensive than brownfield PPPs, where most of the investments have already been undertaken by the public sector. •

Higher traffic volumes, technological change and shipping industry concentration have increased the scope for economies of scale in terminal operations, resulting in new terminals which are significantly larger than old ones.

•

Many of the new terminals are being built in China, where there is a preference for large PPP projects.

•

Transfer of responsibility for investment in basic infrastructure like quay walls from the public to the private sector, as public sector budgetary constraints have moved the boundary line between public and private investments in ports.

•

Investor confidence after a long period of high growth in container traffic, which had – until the onset of the recession – made it relatively easy to obtain debt funding for large projects.


3.3

Contract duration

The initial duration of container terminal concessions, before allowance for renewal options or negotiated extensions, is shown in Figure 2. Around two-thirds are for 20-30 years. The distribution is not symmetrical, as there are relatively few concessions of 3149 years duration, and a secondary “spike” at 50 years caused mainly by the large number of 50 year JVs negotiated in China.

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Around 15 % of the container terminal concessions shown in Figure 2 included renewal options. In addition around 5-6% of concessions had already been extended by mutual agreement. If options and extensions are taken into account, the average concession duration increases by 10% from 27 years to 30 years. There are significant geographical variations in concession duration: • The Middle East and NE Asia (Japan, Korea and Taiwan) are the regions with the highest proportion of short term concessions (up to 10 years). In the case of the Middle East this may be due to the way the ports industry developed during the construction boom of the mid-1980s, with a high reliance on expatriate management contractors such as Grey McKenzie and Sealand. In the case of NE Asia, it reflects the continued use of the asset leasing model, although this is now changing in favour of concessions which include private investment. •

Concessions in China are dominated by 50 year contracts, reflecting the continuing involvement of the port authority through JV agreements as well as a cultural preference for long term relationships.

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Figure 2: Duration of Container Terminal Concessions (years). Source: Data compiled by the author. Figures relate to 293 concessions for which there is published information on duration.

•

Individual countries at particular periods of time seem to settle on preferred contract durations and then apply them to all PPP projects, irrespective of their economic fundamentals (copy-cat concessioning).

There is a clear relationship between concession duration and investment requirements when the data are highly aggregated. This can be seen by comparing the average investment associated with container terminal concessions of different duration in Figure 3. However there is considerable variation in the investment required in concessions of similar duration, so the correlation between investment and contract duration is low (r2 = 0.37) when based on individual terminals rather than size bands.


There are no known examples in the ports sector of PPPs in which investors have been allowed to propose their own concession period, or where the concession lasts only until the costs of the original investment have been recovered and an agreed profit margin earned, as occurs in some road and bridge PPPs.

Figure 3: Relation Between Container Terminal Concession Durations and Investment Requirements.

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Table 2: Relationship Between Concession duration and Investment in Container Terminals. Concession duration Up to 11-15 16-20 21-25 26-30 31-40 Over 40 (years) 10 Investment (US$m) 49 52 98 151 257 287 398 No of concessions 8 10 Source: Data compiled by the author.

36

34

45

11

26

Five main explanations can be put forward: • Asymmetric risk. Most port authorities are “failure averse” rather than “risk averse”. For port authorities the “worst case” scenario is often that no bidders will turn up, whilst the second worst scenario is that of the private partner requesting a major restructuring of the agreement part way through. So there is a tendency to add a few extra years onto the concession period just to be on the safe side. •

Recovery of “soft” investments in marketing, training, IT systems etc. These are rarely included in investment costs, yet absorb a lot of senior management time for which compensation is required. The concept of “intangible” investments is rarely encountered in discussions of port PPPs, although it is a common item in the balance sheets of private terminal operators.

•

Continuity of employment. Short duration PPPs create considerable uncertainty for the workforce, which in ports is often highly unionised and resistant to PPPs. Longer concessions provide more incentives for operators to invest in the labour force, as well as offering greater continuity of employment, but often result in no arrangements being made for labour transfer at the end of the concession.

•

Transaction costs. Private operators’ bidding costs can easily reach US$ 1.0m even for a fairly simple concessions, and the port authority’s costs, which are less obvious, may be a lot higher.

163


Economic logic suggests that concession duration should be linked not only to investment costs but also to the breakeven period required to recover these costs, and the rate of return required by private operators. This has been studied using financial models of container terminals by Theys and Notteboom (2009). It is not possible to make a precise comparison between their theoretical results and the empirical findings in Figure 3 as insufficient information is available on the tariffs and operating costs of the terminals involved. However the general impression gained is that real-life concession periods are longer than would be predicted by the Theys and Notteboom model, and less regularly distributed. Why does this occur?

•

3.4

Reduction in Government interference. Short concessions increase the scope for government interference, whether this is through changes in the terms and conditions of the PPP contracts each time they are renewed, or pressure on the operator to adapt (at its own cost) to unforeseen policy changes in order to improve its chances of contract renewal. This has been one of causes of the decline in popularity of contracts of ten years or less.

Exclusivity rights

Exclusivity - monopoly rights over the provision of a specified port service for a fixed period of time or until traffic reached a certain level – was a common feature of early port PPPs, but has become less prominent due to acceptance of the inevitability of competition, increased investor confidence in the PPP process, and the fine-tuning of other clauses in PPP contracts to reflect the needs of small, marginally viable projects.

3.5

Performance requirements


Port authorities often want PPP agreements to include legally enforceable performance targets, even though it is difficult to define meaningful targets which fully capture customers’ requirements. What is regarded as essential by one customer may be seen as no more than “nice to have” by another. Some key customer requirements – for example “flexibility”, “regular information” or “faster document processing” – are difficult to quantify or affected by factors outside of the terminal operator’s control such as Customs working hours or delays in ship arrivals. So the inclusion of productivity targets in port PPPs has been restricted to targets which are easy to measure and fairly easy to achieve, for example unchallenging gross or net handling rates (TEUs per crane-hour or ship-hour) and is now declining. Two performance requirements have been increasing in importance, however. These are minimum guaranteed throughputs and environmental targets [Langen at al. 2012].

3.6

Labour transfer

Labour is a sensitive issue in port PPPs because many existing terminals are still substantially overmanned and exposed to restrictive working practices. Strong unions have often resulted in wage rates which are well above those paid for comparable skills in other sectors, and there are still cases of nepotism in the reservation of jobs for family members. Labour transfer arrangements have been particularly important in the management/investment model, where private operators take over the workforces

164

employed by their public sector predecessors. They are less important in the BOT and JV models, although these types of PPPs also try to avoid disturbing labour relations. One of three main approaches in normally used when transferring an existing labour force into a PPP [Turnbull 2006]: • The port authority or Government undertakes a major labour force restructuring in advance of the PPP, so that the staff transferred to the private operator are broadly in line with its requirements. • The pre-PPP workforce is transferred to the private operator, who must retain it for a specified period of time before reducing it through natural attrition or voluntary redundancy schemes. In this situation, private operators are usually allowed to make gradual changes to the terms and conditions of employment, providing these are no worse than before and/or are acceptable to the unions or workers’ representatives. • The private operator is given complete freedom to hire and fire, and to set its own terms and conditions of employment. This is quite rare in brownfield PPPs but is becoming more common in greenfield PPPs, particularly those which are physically distant from existing port operations. Private operators are rarely allowed to undertake compulsory redundancy schemes, but the rapid growth in international trade has absorbed a lot of surplus labour, reducing the need for redundancies.

Tariff regulation

There is a fundamental distinction between PPPs which are free to set their own tariffs and those whose tariffs are regulated, either by a formula within the PPP agreement or by the port authority or an independent regulator. Unregulated tariffs are found in areas where there is a lot of inter-port or intra-port competition. Tariff regulation is required where geography, traffic volumes or terminal specialisation create natural monopolies. Unlike toll roads whose tariffs are set at a specific level, tariff regulation in ports usually takes the form of tariff ceilings which are not to be exceeded for individual shipments or – more rarely – in aggregate. This reflects the political hope that over time tariffs will drift downwards below the ceiling in response to competition from other ports; this sometimes happens, but most regulated tariffs remain close to the permitted maximum. The main cause of any downward drift below the tariff ceiling is customer discrimination i.e. the offering of discounts to customers who have the option of going somewhere else. Although most PPP agreements in ports contain clauses prohibiting discriminatory treatment of customers, these are so un-alike in their requirements that it

165


3.7

is quite easy to differentiate between them and argue for different tariffs on economic grounds. The level of customer differentiation which exists in the ports sector, and terminal operators’ knowledge of their customers’ business strategies, are both much larger than in road and rail PPPs. These is similar scope for customer discrimination in the airports sector, but it does not seem to be exercised as much as in the case of ports [IATA 2005].

3.8

Concession fees

The structure of payments made for the right to operate a PPP may also differ by mode of transport. In the ports sector a wide variety of mechanisms is used, from lump sum payments through annual rents and throughput-related royalties to revenue sharing agreements. Some PPP agreements combine these elements into more complex payments structures designed to share risks more equitably.


There are at least 85 container terminals with published data on concession fees. Of these 60% have a simple fee structure (one mechanism only), 20% use a combination of two payment mechanisms (usually rent + royalty), whilst 20% have a more complex fee structure or publish only the expected level of fees (usually as an NPV), not their structure

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In general: • Lump sum payments are the most common mechanism in competitively-tended concessions, partly because of the popularity of terminal auctions in South America. •

Annual rents are most common in ports which have a property-oriented culture, are risk averse, or wish to do no more than recover the costs of port infrastructure. Rents are a particularly common form of payment in negotiated – as opposed to competitively tendered – concessions, as they can be benchmarked against near-by commercial properties or use administrative formulae linked to the taxable value of the land.

•

Royalties are a popular way of sharing the benefits of traffic growth, but expose the port authority to increased commercial risks if – for reasons beyond its control - there is a downturn in traffic.

•

Revenue sharing first became popular in the Indian sub-continent, and is also found in the smaller ports in the Philippines, but is now spreading into complex fee structures as a way of protecting port authorities against inflation risks. Conflicts of interest arise when a revenue-sharing port authority is also the tariff regulator.

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Figure 4: Concession Fee Structures for Container Terminals. Source: Data compiled by the author.

•

Complex fees with more than two elements allow the flow of payments to be more closely tailored to the terminal’s cash flow. They are usually associated with a fairly sophisticated approach to risk sharing.

In container terminal PPPs the size of the concession fee offered is probably the most important single criterion for selecting the private sector partner. This may be because the design of most terminals is fairly standard, with limited scope for innovation (container terminals now have almost the status of a “commodity”); the bidders are usually well known international terminal operators or shipping lines, or prominent local businesses capable of providing a similar standard of service; or the port authority wishes to use the PPP process to capture for itself some of the “economic rent” associated with container terminals [Rodrigue et al. 2010]. Private investors bidding for individual terminal concessions have widely differing views about their value, and the proportion of that value they are prepared to hand over to their public sector partners. A review by the author of 14 container terminal concessions which attracted a total of 41 bids showed that although 20% of losing bids were within 20% of the winning bid, the “worst” 20% of the losing bids were more than 70% below the winner [Farrell 2010].


4

Conclusions

National culture has been one of the most significant factors in choice of PPP model in the ports sector, and also affects the detailed provisions found in individual contracts. However the majority of ports still use fairly standard PPP models as a means of attracting private investment. There is a lot of work to be done in exploring how well these models match the needs of the various stakeholders. Theys et al [22] have identified nine areas for further research: • The objectives of port authorities in entering into public-private partnerships, and how they handle the trade-off between their commercial and strategic (public interest) objectives. • The advantages and disadvantages of different award procedures in different market conditions. • The selection of optimal concession periods which balance the benefits of stability against the desire for regular competition for the market. • The level and structure of concession fees, and how these relate to the economic fundamentals of different types of project. • The role of throughput guarantees to reduce port authority risks, and the way private investors price them into their bids.

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• • • •

Performance incentives, particularly the advantages of moving from mandatory performance targets (the stick) to financial incentives for private investors to act in the public interest (the carrot). Economies of scale in terminal operations, and the optimum point for introducing competition. Entry barriers to new operators and ways in which these can be reduced in order to weaken the dominance of large international terminal operators (ITOs) in container terminal concessions. Contract renegotiation procedures, and how these can be used to improve the performance of PPPs without encouraging non-sustainable bids initially.

Much of the academic work carried out to date on port PPPs relates to container terminals. But the cost structures and institutional frameworks for other types of terminal – oil, dry bulks, ferries – may be significantly different. There is a need to extend the analysis to cover these as well, as they will probably account for a higher proportion of future PPPs.

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The research proposals listed above look at port PPPs in isolation. However another topic worth further investigation is the way in which PPP models very between modes of transport. The primary distinction between links (road and rail) and nodes (ports and airports) has already been touched on in this paper, but further research is required into their similarities and differences. This in turn needs to be related to the cost structures of different types of transport infrastructure, and the organisational structures of the operators.

Bibliography

Centro de Estudos em Gestão Naval, 2009, Port sector reform and investments in Brazil after new regulation, 13th Annual LATAM Conference, Cancun, January 2009. Cruz, C.O., Marques R.C., 2010, An Overview of contracts arrangements in seaport concessions, International Association of Maritime Economists Conference, Lisbon, 7-9 July 2010. De Langen, P.W., Van den Berg, R., Willeumeier, A., 2012, A new approach to granting terminal concessions: the case of Rotterdam World Gateway terminal, Management Policy & Management, Vol 39, No.1, pp: 79-90. Farrell, S., 2010, Concession fees and financial performance of container terminal operators, Maritime Economics & Logistics Terminal Management Workshop, Erasmus University, 18 October 2010. Farrell, S., 2011, The ownership and management structure of container terminal concessions, Management Policy & Management, Vol 39, No.1, 2012, pp: 7-26.


Ferrari, C., Parola, F., Tei, A., 2011, Port concessions: are they really structured for the port’s development, International Association of Maritime Economists Conference, Santiago de Chile, 25-28 October 2011. Harding, A., 2009, Review of the Effectiveness of Port and Port Terminal Concessions, US AID Southern Africa, March 2009. IATA, 2005, Airport privatisation, Geneva. Kerf, M., Concessions for infrastructure: a guide to their design and award World Bank Technical Paper No. 399, 1998. Notteboom, T., Verhoeven, P., 2012, The awarding of seaport terminals to private operators: current practices and viewpoints in European ports, International Association of Maritime Economists Conference, Copenhagen, 2426 June 2009. Parola, F., Tei, A., and Ferrari, C., 2012, Managing port concessions: evidence from Italy Management Policy & Management, Vol 39, No.1, pp: 45-61. Patsiadis, P., Angelides, D.C., 2008, Legislative framework for port concessions in Greece, Proceedings of the Institution of Civil Engineers – Management, Procurement & Law, Vol 161, No. 4, pp: 157-162.

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Psaraftis, H.N., Pallis, A.A., 2012, Concession of the Piraeus container terminal: turbulent times and the quest for competitiveness, Management Policy & Management, Vol 39, No.1, pp: 27-43. Robles, L.T., and Guerise, L.C., 2010, Regulation issues concerning Santos port expansion: public and private investment partnerships, International Association of Maritime Economists Conference, Lisbon, 7-9 July 2010. Rodrigue, J.P., Notteboom, T., Pallis, A.A., 2010, The financialisation of the terminal and port industry: rediscovering risk, International Association of Maritime Economists Conference, Lisbon, 7-9 July. Shou, E.C., Impact of path dependency on the institutional transition of Tianjin port, Hong Kong Polytechnic University, Department of Logistics and Maritime Studies, www.lms.polyu.edu.hk/Event/IFSPA2009/.../PA-2B_4.pdf. Theys, C., Notteboom, T., 2009, The economics behind terminal concession durations in seaports, IAME Conference, Copenhagen, 24-26 June 2009. Theys, C., Notteboom, T., Pallis A.A., 2010, The economics behind the awarding of terminals in seaports: towards a research agenda in Cullinane K International Handbook of Maritime Business, pp: 232-268.

Turnbull, P., 2006, Social dialogue in the process of structural adjustment and private sector participation in ports: a practical guidance manual, International Labour Organisation, Geneva. Van der Lugt L.M., De Langen, P.W., 2007, Port authority strategy: beyond the landlord, International Association of Maritime Economists Conference, Athens, 4-6 July 2007. World Bank Port Reform Toolkit Module 4: Legal tools for port reform http://www.ppiaf.org/ppiaf/sites/ppiaf.org/files/documents/toolkits/Portoolkit/Too lkit/module4/full.html.

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Trujillo, L., González, M.M., Jiménez J.L., 2011, An overview of the reform process of African ports, International Association of Maritime Economists Conference, Santiago de Chile, 25-28 October 2011.

Review of public-private partnerships in heavy railway infrastructure projects


Ingo Arne Hansen Department of Transport & Planning Delft University of Technology [email protected]

172

Abstract The promotion of public-private partnerships (PPP) in transportation projects by governments aims to attract private capital to make up for a shortage of available public funding. PPP is expected to generate extra benefits and reduce the life-cycle cost of infrastructure projects by innovative design and construction, more efficient project management, on-time delivery and transfer of risks to private companies. A review of current heavy railway infrastructure PPP projects in the world shows that the majority applies a concession excluding the operation of trains. PPP railway projects, in general, cannot refinance themselves from ticket revenues, as the infrastructure investment costs are very high, while the expected transport volume and revenues easily may be limited. PPP contracts that combine private financing of railway infrastructure investment, train operations and maintenance may suffer significantly from less than expected transport demand. Separate concessions for railway infrastructure and train operations can reduce the overall costs and risks of large heavy railway PPP projects by stimulating increased competition and enable higher contractual flexibility. Keywords: Railway infrastructure, contract models, concession period, public funding, feasibility

173


Contribution to Working Group Transport Mode Perspectives

1

Introduction

Over the past decade, public-private partnerships (PPP) in the planning, construction and operation of transport infrastructure have become more and more common in many countries. Governments that are eager to extend the capacity and size of their transport networks in order to cope with growing mobility, but lack sufficient public financial resources, are backed by project developers and private capital investors to build, operate and maintain costly road and railway infrastructure.


PPP is often propagated as being superior to solely public financing [Akintoye et al., 2003; Aberle et al., 2005; PricewaterhouseCoopers, 2005; Deloitte, 2006]. According to the Executive Secretary of the United Nations Economic Commission for Europe (UNECE) “PPPs combine the best of both worlds: the private sector with its resources, managements skills and technology; and the public sector with its regulatory actions and protection of the public interests…There are lots of good reasons…why governments…favour PPPs and plenty of evidence that they work well” [UNECE, 2007]. The specific benefits to the public would be lower cost, higher levels of service and reduced risk. The Directorate-General for Energy and Transport of the European Union describes PPPs as a possibility to “both increasing access to financing options and delivering efficiency gains while maximising quality of service” [European Union 2009].

Figure 1: Models of Public-Private Partnership (source: Deloitte, 2006). There exist different models of PPP contracts depending on the split of responsibility between public and private parties (Fig. 1). The share of private capital financing varies depending on the degree of private responsibility and public grants. The number of PPP railway infrastructure projects is still rather limited compared to road projects, which already have been reviewed comprehensively [Estache et al. 2007]. The specific problems of urban railway PPP projects have been evaluated recently, too [Phang 2007; Tang and Hong 2010; Buchanan 2010]. The characteristics, performances and specific risks of current heavy railway PPP projects, however, are less known, so far. This paper is organised as follows. First, the results of a comprehensive world-wide review of main technical and contractual characteristics of current heavy railway

174

infrastructure PPP projects are presented. Then, some important issues of these PPP projects are discussed.

2

Review of heavy railway infrastructure PPP projects

The key characteristics of heavy railway infrastructure projects, which have been tendered or contracted, designed and constructed in public-private partnership in the last 20 years are listed in Table 1. Conventional heavy passenger railway lines are designed for inter-city transport by means of rolling stock having a maximum axle load of 17 tons and operating at a maximum speed of 160 km/h, whereas high-speed lines are designed for a maximum service speed of at least 200 km/h up to 350 km/h.

To the author’s knowledge 15 heavy rail PPP infrastructure projects exist currently in the world, while airport and urban transit lines are not taken into consideration. Projects that are 100% managed and financed by private capital, like the Channel tunnel, are not considered either. The Öresund road-rail link is not a typical PPP project as it is backed by a 100% state guarantee. Most contract schemes exclude passenger train operations, which are granted under separate concessions often to incumbent state-owned railway companies. The Taiwan High-Speed PPP between Taipei and Kaohsiung includes procurement and operation of rolling stock, but after 2 years of revenue service it had lost two thirds of its equity capital due to very high interest payments and depreciation charges, while the operating costs were well covered by ticket revenues. The government, thus, took majority control of the company in November 2009 [Taipei Times 2010]. In the following sections the current heavy railway PPP projects in European countries and Australia are described in more detail.

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The principal goals of the public sponsors and the main contractual and technical characteristics are described briefly for each of the heavy railway infrastructure projects. The performance analysis is based on publications and considers contractual scope, financing, design options, period of design and construction, transport volume, economic and financial results.


Table 1: Current heavy railway infrastructure PPP projects in the world. Route length [km]

Investment costs

Public funds

Contract

19962003/2007 1991-2000

Concession period [years] 90

109

£5.8 bn

£2,010m

DBFM

25-30

38

€2bn

DBFM

2000-2007

25

100

€6bn

100% state guarantee €110m /year A$559m

DBOFM

Country

Design & Construction period

Channel tunnel rail link CTRL Öresund roadrail link HSL-Zuid AmsterdamBelg. Alice SpringsDarwin rail TaipeiKaohsiung HS rail PerpignanFigueras HS rail Diabolo rail link Brussels

United Kingdom DenmarkSweden Netherlands

Liefkenshoek raillink Antwerp ToursBordeaux HS rail GSM-R network Lisbon-Madrid HS rail NimesMontpellier HS rail Brittany-Pays de la Loire HS rail Rio de Jan.Sao PauloCampinas HS rail KokkolaYlivieska rail link

2.1

A$1.2bn

DBFM

Australia

2000-2004

Taiwan

2000-2007

35

335

US$18bn

FranceSpain

2005-2009

50

45

€1.1bn

€540m +62m

DBFM

Belgium

2007-2012

35

3

€540m

DBF

Belgium

2008-2013

38

16

€840m

€250m track & signalling €50m/ year

France

2010-2016

44

340

€7.2bn

≤ 50%

DBFM

France

2009-2015

15

14000

€1bn

€160m

DBOFM

PortugalSpain France

2009-2013

40

>165

€7.8bn

DBFM

2011-2016

80

€1.62bn

DBFM

France

2011-

182

€2.85bn

DBFM

Brazil

2011-2017

40

518

$18.7bn

DBOF

Finland

2011-2014

20-30

76 2nd track

€660m

DBFM

DBOFM

DBFM

United Kingdom

The Channel Tunnel treaty for a 50 km long twin railway tube between Dover and Calais was ratified by the British and French governments in 1987. It stipulates that the 176

fixed link “shall be financed without recourse to government funds or to guarantees of a financial or commercial nature”. The concession to build and operate the tunnel for a concessionary period of 55 years and then transfer the tunnel in full working order to the two states was given to the private consortium Eurotunnel. It retained the freedom to fix user charges but had to provide certain minimum service standards during off-peak periods, and set a maximum for delays in the busiest periods. The two governments established an Intergovernmental Commission to supervise the tunnel’s security, safety and environmental impact. As the concession does not include any public funds it is not a real PPP project, but it demonstrates the difficulty of purely private financing of big and costly transport infrastructure projects.

The total investment costs of £5.8 billion are backed since 1998 by a bond of £3.8 billion in loans with government guarantee and financial support for operational losses of Eurostar worth a minimum of £140m, which reduces significantly the financial costs of the private investors. The shareholders of LCR are a number of leading engineering consultants (Arup, Bechtel, Halcrow, Systra), a subsidiary of the state-owned French power distribution company EDF, the private British transport provider National Express, the public French railway operator SNCF, and the investment bank UBS [LCR, 2006]. LCR is managing the project through its LCSP property division and through three subsidiaries: Union Railways (South) for the delivery of section 1, Union Railways (North) for section 2 and CTRL for the operation and maintenance of section 1. International Eurostar trains operate on section 1, where services to Brussels and Paris from Ashford started in 2003. Section 2 to the terminal station London St. Pancras has been opened in 2007, while the operations concession by Eurostar actually lasts until 2010. The contract between LCR and the British railway infrastructure manager contained a binding commitment for lease of the assets of section 1 on completion until 2086 and an option for section 2. The British government guaranteed it would contribute up to £140 million to compensate for Eurostar’s likely operating losses due to track charges until 2020 and took a stakeholder share in LCR, which entitles it to receive at least 35% of the pre-tax cash flow after 2020 and the same share of the proceeds of any future share of LCR or its assets [Railtrack 1999]. Indicative bids for a 30-year concession to 177


The concession for design, construction, financing and maintenance of the new 109-km high-speed rail link connecting the Channel tunnel to London (CTRL) and awarded in 1996 to London & Continental Railways (LCR), is a typical PPP project. The new line was necessary to increase the train speed to high-speed standards, and to increase the frequency of trains between London and Paris, which on the existing line terminating at Waterloo Station is limited to 4 trains per hour in each direction. The original concession collapsed nearly in 1998, when the contractor asked for a further ₤1.2bn of public loans to be paid back after the opening of the line in 2003 [Railway Gazette International 1998]. The patronage and revenues of Eurostar fell substantially behind expectations.

operate High-Speed 1 rail link have been received in August 2010 [Railway Gazette 2010]. It remains to be seen whether the concession will cover the operating and maintenance costs, as well as revenues to pay back the infrastructure investment costs.

2.2

Denmark - Sweden

The combined bridge and tunnel link crossing the Baltic Sea between Denmark and Sweden was opened in 2000 after a design and construction period of 9 years. The €2 billion investment costs were financed by a private Danish-Swedish consortium, which is responsible for the operation and maintenance of the transport link. The consortium, however, is 100% owned by the two states and has received public grants for the loans. The costs of interests, depreciation, operations and maintenance are to be borne by the expected toll revenues and rail infrastructure charges of €160 million annually. The amortisation period of the investment was estimated to be 25 to 30 years based on a forecast daily traffic volume of 10,000 vehicles per day [Oeresundsbron 2006].


As the project, in fact, is financed and 100% guaranteed by the two governments, it is not a real example of a PPP. Typical risks of the transport infrastructure project (traffic volume and toll revenues) are covered by state grants. The observed number of vehicles to use the Öresund link, so far, and the resulting revenues from road and rail charges are still significantly less than expected. The income from user charges is not sufficient to cover the running financial costs and the state grants might need to be written off if the forecast growth of the cross-border traffic between Copenhagen and Malmö continues to be less than expected. The project’s construction works were realised on schedule and within budget. This performance may be a result of the DBOT contract and of efficient project management by the private consortium. Whether the operation of the toll road and the maintenance of the tunnel and bridge will be executed more effectively in the long term by private companies, and whether that grants traffic safety, remains to be seen. The dilemma of stimulating longer car trip distances and higher social costs by creating a new motorway link simultaneously with an alternative rail transport link may lead to an inefficient allocation of economic resources, lower use of overall transport capacity and less sustainability.

2.3

The Netherlands

The HSL-Zuid project was divided into seven Design & Construct contracts for the civil construction lots, one Design-Build-Finance-Maintain (DBFM) contract for all of the superstructure, power supply, signalling, and telecommunications provisions, and one franchise for the operation of international and national shuttle trains. The different contracts were based on a description of the functional requirements and a preliminary

178

reference design of the line in order to stimulate the submission of separate innovative proposals for: -

design and construction of civil works (tunnels and viaducts), design, supply, testing, commissioning and maintenance of all of the electricalmechanical equipment over a period of 25 years, train operations over a period of 15 years.

The proposals for the civil works, however, exceeded the original cost estimates by more than 30%, due to price inflation, while the extension of scope due to political decisions (tunnel boring, capsulation, tunnel safety equipment) contributed another 76% to the increase in costs and 15% were caused by unexpected extra needs for interface works [Tweede Kamer 2004]. The investment cost for the civil works was €3.3 billion higher than originally planned and came up to €6 billion, or €60 million/km, excluding the costs for remuneration of the DBFM contract for the electrical-mechanical equipment!

The concession for operating the HSL-Zuid was awarded separately in 2000 for €1.6 billion to the High Speed Alliance (HSA) consortium, a subsidiary of NS (the national Dutch rail company) and KLM airlines. HSA is obliged to operate at least two international trains per hour between Amsterdam, Rotterdam and Brussels, as well as a minimum of two national high-speed shuttles per hour between Amsterdam and Breda/Eindhoven. It must guarantee not to exceed a level of train occupancy and achieve a certain minimal punctuality. The fixed concession fee of about €100 million per year will be used to remunerate the infrastructure provider. The start of operations on the HS line, however, has been delayed, because the commissioning of ETCS Level 2 on-board units for automatic train control of the existing Thalys trains was delayed and the new high-speed trains for domestic line services are still not available. The domestic HS shuttle trains called Fyra between Amsterdam and Rotterdam are operated provisionally by means of leased locomotives and standard IC-carriages, which cannot travel faster than 160 km/h.

2.4

Belgium

In 2007 the Belgian railway infrastructure manager Infrabel and the private investors HSH Nordbank, together with Babcock & Brown, signed a contract to design, build, 179


The DBFM contract for the electrical-mechanical equipment was granted in 2001 to the Infraspeed consortium (Fluor Daniel, Siemens, BAM). Repayment began at the delivery of the high-speed sections in 2007 and totals more than €100 million per year, if the availability of the infrastructure is not less than 99.46% and the cleanliness of the tracks is satisfactory. If these conditions are not met, the remuneration fee will be reduced according to the incentive scheme.

finance and maintain an underground railway link consisting of the extension of the current airport station Brussels-Zaventem including the grade-separated connections to both the existing railway lines to and from Brussels and Mechelen. The handing over for operations would take place in 2012, while the private consortium is responsible for maintaining the link for the next 35 years [Lallemand 2008]. At the same time, a new railway line to which the airport link must be connected will be built via conventional tendering and contracting in the wide central reservation of the existing E19 motorway between Scharbeek and Mechelen. The costs of the privately financed airport link are estimated at €290 million. The investment and maintenance costs of the private consortium will be reimbursed by an indexed annual payment from Infrabel of €9 million per year, a track user charge from the train operators equivalent to 0.5% of all fare receipts for domestic passenger traffic, and a fixed charge of €3.80 on all tickets to and from Brussels Airport [Railway Gazette International 2007]. The design, construction, financing and maintenance of the new railway tunnel in the port of Antwerp was contracted in 2008 by Infrabel to LOCORAIL NV, a consortium of BAM, CFI and Vinci [BAM, 2008]. The contract amounts to around €840 million and the private capital investment will be paid off by approximately €50 million/year track charges [Robson 2009].


2.5

France

The contract for construction, operation and financing of the 45 km railway link Perpignan-Figueres, which includes a 9 km tunnel through the Pyrenees was awarded in 2004 and completed on schedule 2009. Total cost was put at €1.1bn, of which €524 were covered by grants of the French and Spanish governments. Through train services are now planned to start in 2012, because the construction of the new high-speed standard gauge line from Figueres to Barcelona is 3 years late. The original concession period was extended in 2009 by 3 years to 53 years and the Spanish government provides additional €66 million in loans and €62 million in grants as compensation [Railway Gazette 2009]. The French railway infrastructure manager RFF tendered and received recently proposals for the construction and maintenance of a new and upgrading of the existing route between Montpellier and Perpignan (80 km) mixed-traffic route between LGV Méditerranée and Perpignan-Figueras through a PPP concession [Railway Gazette 2010]. The estimated investment costs are €1.62bn. Agreement on the final terms of the concession is scheduled in 2011, with the line expected to open in 2016. The BrittanyPays de la Loire line project (182 km) will extend the Paris high-speed line in the direction of Rennes and Nantes at an estimated cost of €2.85bn [EIB 2009]. The EIB may contribute a loan up to €600m. RFF recently awarded the DBFM contract for the High-Speed line Tours-Bordeaux to a consortium led by the VINCI group [Rail-News 2010]. The projected construction costs 180

for the 302 km railway link are huge (€7.2bn). A maximum of half will be funded by the sate and five regional authorities. The concessionaire will receive income from the user charges of the train operating companies, while RFF is responsible to set the quality of service targets, negotiates the performance regime and monitors its enforcement by bonuses or penalties [Reseau Ferré de France 2010]. RFF signed its first PPP concession agreement that covers the installation and operation over 15 years of GSM-R communication systems on 14,000 km of the French core railway network in February 2010 [Railway Gazette 2010]. The contract value of €1bn is split approximately equally between the capital cost of installation and the ongoing costs for operation and maintenance.

2.6 Australia

2.7

Brazil

In 2010 the National Agency for Land Transport launched a tender for the design, construction and operation of a new high-speed rail linking Rio de Janeiro to Sao Paulo and Campinas to open before the 2016 Summer Olympics in Rio de Janeiro. The construction costs were estimated at US$ 18.7 billion and the intended concession period would last 40 years. However, no contractor showed interest and no consortium submitted a proposal, while foreign technology suppliers only showed principal interest. The government announced in December 2011 to prepare a new invitation to bids and to split the bid into two parts: one for technology supply and one for construction.

3

Discussion

First, common key characteristics of and main differences between the 15 heavy rail infrastructure projects presented in table 1 are shortly discussed with regard to the 181


The heavy railway project for the extension of the transcontinental railway in Australia from Alice Springs to Darwin was awarded in 2000 to Asia Pacific Consortium, while train operation was subcontracted to FreightLink, which started services in 2004. However, the consortium failed to make profit and in May 2008 its assets were offered for sale at A$1.2bn [The Australian Financial Review 2008]. The Australian federal government, as well as the government of the Northern Territory and South Australia had granted a total of A$559 million or 50% of the total investment cost as (contingent) equity and subordinated debt to the consortium based on an earlier estimated economic benefit-cost ratio of 1.88 by Booz-Allen and Hamilton [AustralAsia Railway Corporation 2003]. The transport demand and revenues from operation of the line were obviously overestimated.

contract scheme, estimated design and construction time period, investment costs, and duration of the concession. Then, the expected economic and societal benefits of PPP transport projects based on a review of relevant literature are discussed.


Most of the reviewed heavy railway infrastructure PPP projects apply a DBFM contract scheme. Thus, operation can be either granted to public-owned railway companies or franchised to private train operating companies. The few integrated DBOFM contracts (Alice Springs-Darwin and Taipei-Kaohsiung) suffer from unsatisfactory revenues, while the GSM-R contract in France is limited to the operation of the telecommunications system and does not include train operations. The earlier started DBFM projects in UK, Denmark and Taiwan have been built within schedule, whereas the start of operation of the HS project in The Netherlands has been seriously delayed due to interface coordination problems between the signalling systems of the two involved countries, late implementation of the train control on-board units in existing trains (Thalys) and the still pending delivery of the new rolling stock for domestic train operations in the Netherlands. The realisation of the majority of heavy rail PPP contracts, especially in France, is still in the early design and construction phase and it will be seen until 2016, whether the infrastructure can be delivered on time and within originally estimated budget. The specific investment costs of the railway projects vary between about 20 to a maximum of € 90 million per kilometre depending on geography, design and alignment. Public funding up to 50% of the investment costs is granted, while up to 90% of the private investment is financed by commercial loans. As the discount rates of Federal Banks and interest rates of loans in the past years have been historically low and it is not known, whether and for which period the interest rates applied by the PPP contracts have been fixed, the future refinancing of loans may be much more costly. On the other hand, replacing of private borrowing by public-sector loans, as intended by Transport for London of the PFI contracts for Docklands Light Railway and the former buy-out of PPP contractors Metronet and Tube Lines may bring considerable financial savings over the remaining concession period [RGI 2012]. The economic and societal benefits of PPP projects in the transport sector are not at all evident. The claim that private financing of public infrastructure reduces pressure on public sector budgets and provides more infrastructure than otherwise achievable is objected to [Hodge and Greve 2007]. Private-sector finance cost of capital for a PPP will typically be around 2-3% p.a. higher than that of public-sector funding [Yescombe 2007]. The current PPP heavy railway infrastructure projects allow to launch construction earlier than would be possible by public-sector funding only due to the constraints on public budget deficits and the actual credit crisis. The co-financing of heavy railway infrastructure projects by private capital, however, means a long-term obligation to the

182

governments to assure the pay back of higher than usual interest rates for public loans either from user charges or from tax income. If the PPP fails the public authority will incur even extra costs to maintain the public service. By defining the required level of efficiency through the performance regime, the public authority sells future possible efficiency savings over the contract period by its own to the private partner. There are no fundamental differences in the abilities of the public and private sectors to absorb risk provided that the public sector appoints competent project managers and applies efficient objectives, incentives and accounts [Glaister 2000; 1999]. There is a need to protect the public interest in PPP agreements of the essential London underground infrastructure [Glaister 2004].

Nearly all of the recent heavy railway infrastructure PPP projects apply a DBFM contract scheme, which is based on public grants, public and/or commercial loans and user charges and depends on certain performance criteria as on-time delivery, availability, reliability, cleanliness etc. Additional revenues may be generated from property development near or in combination with multifunctional stations. The level of user charges from train operating companies has a big impact on traffic volume, capacity use and cash-flow. Even a monopoly on a certain railway link or network does not protect from competition by other modes as road and airways. The high sensitivity to and cross-elasticity of price differences between alternative transport modes can easily disturb the predicted market share and financial outcome of the railway PPP project.

4

Conclusions

The analysis of PPP in heavy railway projects shows that, in general, at least a substantial part of the investment costs needs to be financed by public funds to assure the economic viability of the projects. PPP itself cannot turn unprofitable railway infrastructure projects into profitable projects, the funding must come, earlier or later, from the taxpayers [Glaister, 2000]. The public authorities remain responsible for 183


Demand risk is a major issue in virtually all transport projects. Higher traffic volumes automatically generate social costs from higher levels of emissions, noise and danger, which must not be neglected when making comparisons with public sector funding. The prime goal of private investors in managing and financing transport infrastructure, operations and maintenance projects is to earn a secure and attractive return on the invested capital over a long period of time — about 15 to 30 years. Any PPP project needs to generate a sufficiently high rate of return on the private capital invested. Before the recent deep financial and economic crisis banks and institutional investors expected a rate of return of between 10% and 20% per year, otherwise private capital would seek to invest in other business opportunities.


sustainability and efficient use of the infrastructure. The more risk is transferred to the private sector, the higher the costs will be. Further research is recommended regarding a comprehensive analysis of the impact of contractual models, input and output delivered for PPP projects in different transport sectors on robustness, efficiency and value for public money, user benefits and environment.

184

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