Life-Cycle Project Delivery
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1 Life-Cycle Project Delivery A Note for Discussion IndII Round Table 11 th December 2012
2 Concerns with Conventional Project Delivery Government pays for inputs, not outputs Incentive for time/cost over-runs Difficult to control quality No performance standards over project life Risk of time/cost over-runs borne by Government Separate Design, Construction and O&M contracts: no life-cycle optimization eg, contractor bears no consequence for taking short-cuts Significant fluctuations in Government expenditure Construction O&M Risk 2
3 Concerns with Current PPP Approach Objective is to attract additional funds, not to deliver projects in the most efficient way Poor project preparation Lack of understanding of what drives PPP investors Inconsistency, mixed messages and lack of a single institutional point of contact No proper specification of performance standards Poor risk allocation: developers cannot manage land and toll revenue risks Hence delivery costs will be high, relative to public sector alternative Project viability too dependent on toll revenues Necessitates viability gap funding, which significantly dilutes risk transfer 3
4 Conventional v Life-Cycle Procurement Conventional Procurement: Government meets all expenditures when they occur Construction O&M Risk Conventional Procurement: Government pays for inputs, not outputs Separate D/C/O/M contracts no life-cycle optimization No performance standards over project life Contractors have incentive to expand their workload Risk of time/cost over-runs borne by Government Significant fluctuations in Government expenditure Life-cycle Procurement: Government pays only for the service provided Govt Outlays Life-cycle Procurement: Concessionaire provides a service over project s life Concessionaire manages D/C/O/M risk through sub-contracts over-runs don t impact on Government Life-cycle optimization Government pays only for what it gets Concessionaire incentivized by payment mechanism to maintain high performance standards Predicable Government expenditure pushed into the future 4
5 A Better Value-for-Money Alternative De-couple tolls and life-cycle delivery Tolls are for road pricing: Government should keep control over them Pass to the private sector only those risks they can manage Government should take land acquisition risk Private sector can manage financing, design, construction, materials, O&M and (insurable) force majeure risks o But not all interface risks (eg, an existing poorly-constructed pavement) Pay the private sector a Unitary Charge for providing a road service (once open to traffic) over the life of the agreement Deductions for failure to meet KPIs Pressure from equity-holders and lenders also encourages optimum life-cycle performance Experience elsewhere shows that this solution is cheaper than conventional procurement Extra costs of private finance are outweighed by life-cycle economies Demonstrated by a VfM comparison (i) on preparation of the business case and (ii) prior to contract-signing with preferred bidder 5
6 Typical Structure D&C contractor locked in for several years after construction completion MPW CA modeled on familiar international banked projects. No surprises! SMI or similar Comprehensive risk transfer minimizes time/cost overruns Project Sponsor Equity Shareholders Shareholder Agreement Other Equity Shareholders (eg SMI) D&C Contractor Fixed-Price D&C Contract (with full risk pass-through) Concession Agreement Project Company Fixed-Price O&M Contract (with full risk pass-through) Bank Lenders Bond Holders O&M Contractor Banks pressure Project Company to perform they want their loans repaid 80/20 or 90/10 gearing. Cost of borrowing much lower than expected equity returns Not shown: Performance bonds and guarantees 6
7 Dealing with Multi-Year Contracts Key feature: PIP loan agreement supports multi-year funding Note: IIGF guarantee only permitted for tollroads (Perpres 13/2010) Credit: Erwin Sukandar, IIGF 7
8 Risk Allocation Risk Description Private Public Economic risks Fluctuations in exchange, inflation, interest rates Political risks Change of government, change of policy, war, riot, terrorism, expropriation of land etc Legal risks Unexpected change in legislation, regulations Force majeure (insurable) Preconstruction risks Construction risks Weather, earthquake, natural disasters and other uncontrollable, insurable risks (relief events allow time but no cost protection) Planning and other approvals not achieved in time for work to start; required land, environmental permits, construction permits etc CAPEX cost overruns and construction delays O&M risks OPEX cost overruns and road closure Traffic risks Traffic higher/lower than forecast private risk within band limits 8
9 Performance-Based Payment Output Requirements Safety Availability Responsiveness Road quality & upkeep Hand-over Link to Payment Deductions when annual Crash Reduction Strategy target is not met Deductions when any lane is closed Deductions when Company fails to meet specified response times (eg emergency) and rectification times (eg debris removal) Deductions when Company fails to meet minimum quality/safety standards for pavement, structures etc Deductions for failing to meet standards for quality and residual life on hand-over at the end of the concession period 9
10 Benefits Better value-for-money based on PSC comparison No VGF necessary Optimal life-cycle management (to minimize Unitary Charge at bidding) Higher quality over economic life (reinforced by lenders) Full payment only on project opening and satisfactory performance Predictable, even cash-flows Manageable risks, so low bid price Risks managed through in-built incentives: Life-cycle performance risk Risk of traffic variations Truck overloading Design & construction risk (eg, pavement thickness/quality) Corruption risk Opportunities for shared refinancing gains 10
11 Life-Cycle Delivery: Key Messages Indonesia urgently needs a new approach The present PPP situation destroys confidence Change thinking: output/performance-based service, not input-based projects Focus on life-cycle synergies between design, construction and operation Cash-flow advantages of deferring capital expenditure are significant but private finance is not mainly about funding: it drives efficiency, better quality and innovation Private equity and lending at risk strongly incentivizes innovation and performance For many projects, the higher costs of private finance and the procurement process are outweighed by these efficiency gains Privately-financed life-cycle delivery is not ideal for all projects: a VfM comparison has to be carried out Private financing capacity and appetite depend on the risk profile Sovereign risk (a big issue for Indonesia); project risk (resolved by sensible risk allocation in contract design); risks associated with competing lending/investment opportunities Transfer of land and toll revenue risks adds significantly to costs Private sector cannot control most land and traffic risk factors Government should maintain control over infrastructure pricing (tolls) Competition in the procurement process is critical to ensuring value-for-money 11
12 Thank you 12
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