Advantages & Limitations of the different Public

Private Partnership
Risks

Eric Francoz phD

Public Private Partnership
Workshop
June 2010, Jordan 1
Public Debt in % of GDP

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The vicious circle of budget constraints

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4
 Definition of PPP

A cooperative venture between the public and private

sectors

where the private sector ,

- offers a service traditionaly offered by the public sector

- Accepting a subtstantial transfer of risks

- And looking for a reward against this risk

Traditionaly, Government specifies design, build and

operates
In PPP, the Government specifies outcome or service
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A wide spectrum of models

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To invest and to operate

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Breakdown of different types of PPP

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Public investment Public Private Partnership
FINANCING FINANCING
Public budget Private equity
& private debt
FUNDING
Taxation FUNDING
User pay or State pay

DELIVERY
DELIVERY
Public Sector
Private Sector

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10
The most common PPPs

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The most common sectors

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Advantages for the Public sector
Finance

Reduces public debt

Favorable accounting treatment
(off balance)
Preserves the country rating
New financial sources for
development
Clear accountability (no hidden
costs)
Mobilizes excess or underutilized
assets

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Advantages for the Public sector
Construction

Faster procurement
Promotes innovation
Access to an expertise not
available in the public sector
Minimizes development risk
Better compliance with
environmental regulation
Improves cost effectiveness
Less political interference

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 Advantages for the Public sector
Operation

Figure 1: Distribution of wages in the public and private sectors by sex

Improve the service performance
Male Female

Transfer the responsability

1.5

No public employees to manage

1
Density

No more strikes to manage

.5

Improve operating efficiency

0

2 4 6 8
(log-) wage
2 4 6 8
Reduction in scope for user claims
Public Private

Penalties for poor performance

Replacement for poor service
Flexible concession period (Millau
2080 ou 2044)
Right to terminate contract

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 Limitations for the Public sector
Finance

Attractiveness of sectors (water/telecom)

Bidding process (few bidders)
Private funding is expansive
Sensitivity of investors to political risk
Highs transaction costs (financial advisor, lawyers)
Long term commitment of the lease payment
Accusation to favorise private/foreign companies
Government supports to attract investors
Capacity constraints & asymmetry of expertise
Financial risk (termination fees) 16
Limitations for the Public sector
Construction

Obligations of the concedant (to provide &

clear land)
Loss of influence on investment
Loss of control and technical skills
Reduction of bargaining position with civil
works companies
Loss of technical staff

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 Limitations for the Public sector
Operation

Creation of a private monopoly

Resistance of beneficiaries of the existing situation (Lobbies
trucks/taxis/buses)
Resistance of public sector unions
Resistance of final users (Raising prices)
Tendency to distrust private sector
Loss of the best managers of the public sector
Disputes can affect the reputation of the country

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Advantages for the Private sector
Finance

Debt is on the project company (off balance)

Tolerance for high leverage
Risk only on equity
Generate cash flows for a long term period
Low correlation to equity markets (private equity)
Government supports (subsidies, tax, guarantees)
Global management is a source of synergies
Partnership for future PPPs
Asymmetry of expertise

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 Advantages for the Private sector
Construction

Construction contract
Economies of scale in design, construction
Creates the local standard (first subway line) and a captive
market
Benefits from coordinated decision
Creation of a market for after sales service, spares (subway,
power plants)

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 Advantages for the Private sector
Operation

Operation contract
Natural hedge to inflation
Viaduc de Millau
Powerful incentives to perform
Economies of scale in
management, operation,
training.
Shared resources with other
projects
45 Barriers to entry / competitors
Potential upside

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Limitations for the Private sector
Finance

Hight bidding costs

Lack of skilled teams
Lack of bankability
High transaction costs (advisors, lawyers)
High margins of project debt
Cost of project bonds
Completion guarantee required
Covenants
Accusation of corruption
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Limitations for the Private sector
Construction

Risk if a bad design

Penalties in case of delay
Mega projects = megarisks
Turn key fixed price contracts
Regulation changes (safety, pollution)
Force majeure
Expropriation of the population

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 Limitations for the Private sector
Operation

Penalties for underperformance

Traffic risk
Resistance to high tariffs
Conflict with local partners
Social conflicts with trade unions
Regulation changes (safety,
Impact of Loma Pieta earthquake in 89
environnment)
Force Majeure
Demonstrations against price increase
Blockage (airport, tollway)
Measurability of quality is discutable 24
Advantages for the Users

Creation of a new service

Social tariffs for low income
Better quality for a lower price
(running water/tanks)
Improved reliability
Less public debt means less taxes
Better maintenance
Better compliance with
environmental regulation

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 Limitations for the Users

Creation of a private monopoly

35.0% Raising of prices for users of
30.0% infrastructure
25.0%
Quality & accessibility of services
Annual RO E %

20.0%
15.0%
Transfer of exchange risk
10.0%
5.0% No more hidden subsidies
0.0%
-5.0% Disputes can affect the quality of
-10.0% service
20 25 30 35 40 45
Tariff rate ($/MWH)
Termination can affect the continuity of
service

Investors are looking ROE & ROE Depends Critically

on the Tariff Rate
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PPP successes

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PPP disasters

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 PPP cheaper than public investments ?

PPP can only lead to cost reductions if there is room for

efficiency improvements
Because private funding is more expansive than public funding 29
 Price issues

Capital intensity
fixed assets to annual
revenue ratio

Water 12.2 :1
Electricity 4.1 :1
Telecoms 2.8 :1
Gas 2.1 :1
Supermarket 0.4 :1
Source: Banyard, J

Gvt support for Water and roads…. Taxes for telecoms

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 Market issues

• The bidding process is not perfect

• Detailed development of the project. This must be set out

clearly in the bidding documents, specifying the responsibilities of
the concessionaire and the relevant Government departments.

• A draft concession agreement prepared by the Government, to

ensure that all bidders make similar assumptions.

• The maximum level and nature of Government support.

Economic analysis of the project -
feasability, appropriate level
of Government support

• The decision criteria.

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 Government supports
Tagus Bridge, Portugal
Land purchase & clearance
Ancillary facilities
Direct revenue support
Loan/equity guarantees
Subsidies/grants
Preferential & subordinated loans
Shadow tolls
Tax relief, tax exempted bonds
Foreign exchange guarantees
Additional rights for development
around the road

Revenues from tolls on existing assets like the Tagus Bridge ,

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 The unofficial “Reasons” for PPPs

• Labour union issues

• Highly paid public sector workers
• Keeping debt off the government balance
sheet
• Hiding information from public
• Gifts to the friends of the government
• Deflecting blame for low levels of services

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 PPPs & common sense
Good PPPs:

• create economic benefits and growth

• create confidence in a country’s
economy
• create value for money solutions thus
minimising tax-take

Bad PPPs:

• create liabilities for the long term

•big projects = big risks

•failure is often high profile: nationally and internationally
•can undermine investor confidence in the country
•can jeopardize the good projects
•A good contract can not save a bad project 34
Risk profile

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 PPP risk matrix

Risk Type Mitigation

- C os t ove r - r u n s (a) F i x e d p r i c e t u r n k ey con t r a c t s
P r e- c om p l e t i on - D e l a ys ( b) W a r r a n t i es / p e n a l t i es / i n ce n t i ve s
(c) F i x e d p r ojec t s p e ci fi ca t i on
(d) S t r on g con t r a ct or s

- R even u e for e ca s t s (a) C om m i t t e d s u p p l y c on t r a c t s

P os t - c om p l e t i on - R even u e bu i l d - u p ( b) C om m i t t ed off- t a k e con t r a ct s
- O p e r a t i n g c os t s (c) S t r on g op er a t or s
- M a n a g em en t fa i l u r e (d) P e r for m a n c e g u a r a n t ee s

- P e r for m a n c e ( a ) W a r r a n t i es
T e ch n i ca l - E n vi r on m e n t a l ( b) P r oven t ec h n ol og i es
- S a fet y ( c ) P u bl i c c on s u l t a t i on a n d a p p r ova l

- S t r u ct u r e : d e bt / eq u i t y r a t i o, e g 7 5 / 2 5 ( a ) E q u i t a bl e R O E , ( eg . 1 5 - 2 0 % )
Fin an cial - S t r u ct u r e : r e t u r n on ca p i t a l ( b) A c ce p t a bl e cover r a t i os ( e. g 1 . 5 - 2 . 0 )
- S t r u ct u r e : r i s k / r ew a r d r a t i o ( c ) E s c r ow a n d r es e r ve a ccou n t s
- F or ei g n e x c h a n g e ( d ) D i vi d en d con s t r a i n t s
- I n t e r es t r a t e s ( e ) Loa n s yn d i ca t i on
- D e bt s e r vi ce c over ( f) I n s u r a n ce / fi n a n c i a l d e r i va t i ve s
- T a x a t i on ( g ) S t a n d by fu n d i n g a r r a n g em e n t s

- R eg u l a t or y fr a m ew or k ? ( a ) E x p e r i e n ced l a wye r s .
Le g a l - C on ce s s i on l a w ? ( b) C l e a r , s i m p l e d ocu m en t s

- R eg i m e s t a bi l i t y ( a ) C l e a r r e g u l a t or y r eg i m e
P ol i t i ca l - F or ce m a jeu r e a g g t . ( b) I n ves t m e n t i n s u r a n ce
- P ol i t i ca l i n t er ven t i on ( c ) I F I s u p p or t
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 Comparison of Actual/Forecast Traffic
X <= 0.19010
Normal(0.72, 0.32); n = 67 X <= 1.2583
5.0% 95.0%

0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6

S&P Research Results 2002 Actual (Observed) Traffic

Real traffic 70% Spread: 18% - 146% 38

Eurotunnel: short history

- Albert Mathieu in 1802

- Not a public penny
-April 1985 Tenders Invitation
-July 1987 Treaty of Canterbury to
regulate construction & operation
-Concession signed in 1987
-IPO in november 1987
-Construction from december 87 to
june 94

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Eurotunnel: Construction

-Cost overruns (70 % pour Eurotunnel)

-Rolling stocks reengineering(2.45MdsF-
>7MdsF
-Design changes (cooling system)
- Capex 4.9 billions GBP
-IPO 770 mios GBP in november 1987
-High leverage (20 % equity/80% debt)
-Construction from decem. 87 to june 94
-Total capex 12 billions GBP
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 Eurotunnel: Operation

- 2 years delay in 1994

- Fierce competition with
ferries & then low costs
- In 1995, the rail traffic was
30 % of initial forecast.
- Fire in the tunnel: 6 months
interruption

- In 1996, loss of amost 1 billion GBP (highest in UK)

- In 1997, restructuring: loans into equity
- in 1998, concession + 34 years to 2086 but
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corporate tax up to 59%
Eurotunnel: Lessons

- Absence of public support

- No sponsors but IPO
- Warren Buffett, said, "if you overpay
for an asset, there ain't no cure"
- Missing passengers (21 mios / 7 mios
for Eurostar)
- Competition with ferries.. & Low cost
airlines
- Missing freight (in 1993 10 % of initial
forecast)
- Vicious circle with debt burden
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 An exemple of Risk
Traffic Risk in Toll Facilities

•Systematic errors in forecasts

•Optimism bias
•Commitment & entrapment of the
teams
•Consistency of error-drivers
•Sensitivity testing is essential

Standard & Poor’s (S&P)

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 Traffic risk depends on the context

Project Attributes More Reliable Less Reliable

Tolling Regime Shadow tolls User-paid tolls
Tolling Culture Tolls well No toll roads in
established country
Infrastructure Estuarial crossings Dense road
networks
Extension of existing Green field site
road
Highly congested Limited or no
corridor congestion
Few competing Many alternative
roads routes
Only highway Multi-modal
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competition competition
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 Institutional capacity

• Technical expertise and trained staff to design,

negotiate and monitor the PPP contracts

• Capacity building

• Maintain the necessary institutional memory and

staff over the long term

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 The key role of a PPP UNIT

• Promotes Credibility with the Market

• Promotes Projects to the Market
• Co-ordination of public bodies
• Can be the promoter of initiatives eg legal
guidance documentation
• Can bring in new knowledge, skills, mindset and
experience
• Can check proposed projects for errors
• Advice and support to project sponsors
• Can approve projects

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 Main Lessons

- PPP is not a ‘miracle’ solution (15% in UK)

- Different PPP structures according to projects and sectors. No
universal perfect model
- Each type of PPP has inherent strengths and weaknesses
- Each partner to a PPP has responsibilities.
- Public acceptance is a key issue
- The Public sector: from a service provider to manager of
private contractors.
- Public benefit from PPPs will depend on effective management
and monitoring systems
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 Main Myths

PPPs can solve all the world’s infrastructure problems

Every project is a potential PPP

All PPPs will create big financial rewards

Governments are selling away all of their Assets

PPP will replace public investments

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 Conclusion

• PPP is not always better than public investment.

• PPP does not give guarantee to be successful.

• There is a risk for public and private partners.

• For infrastructure projects in low income countries, PPP

could be difficult to involve.

• Political forces consistence and willingness as key factors

of success.

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Thank you for your attention

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