Equitable Risk Allocation in Chinese Public Private Partnership Power Projects

Transcription

1 Equitable Risk Allocation in Chinese Public Private Partnership Power Projects Yongjian Ke, ShouQing Wang, and Albert P. C. Chan Abstract It is important for the public and private sectors to establish effective risk allocation strategies for PPP projects in order to achieve a more efficient process of contract negotiation. This paper has studied the equitable allocation of risks in China s PPP power projects based on a comparative analysis of preferred and actual risk allocations. According to the analysis, three risks, namely, Change in law, Competition (Exclusive right) and Organization and coordination risk had different allocations. Reasons behind the differences were analyzed and more appropriate allocations for the three risks were also discussed. The preferred and actual allocation for other risks would also be reported in this paper. Keywords Power projects Public private partnership Risk allocation 1 Introduction Public Private Partnership (PPP) financing modality, as an innovative tool for attracting foreign and private capital in the development of infrastructure, has the ability of alleviating the budgetary pressure to the government, fulfilling the need of infrastructure development, and improving the efficiency of investment and operation [1]. In China, the tremendous economic growth has resulted in an immense demand for basic infrastructure like roads, ports and power facilities. Since most of Y. Ke (*) and S. Wang Department of Construction Management, Tsinghua University, Beijing , People s Republic of China kyj05@mails.tsinghua.edu.cn; sqwang@tsinghua.edu.cn A.P.C. Chan Department of Building and Real Estate, The Hong Kong Polytechnic University, Kowloon, Hong Kong, SAR, China bsachan@polyu.edu.hk D.D. Wu (ed.), Modeling Risk Management in Sustainable Construction, Computational Risk Management, DOI / _15, # Springer-Verlag Berlin Heidelberg

2 132 Y. Ke et al. the local governments are still subject to severe budgetary pressure, there is a heavy reliance on the private sector investment. This might provide a great opportunity for private investors to get more involved in infrastructure development via PPP mode. However, only a few PPP projects in China could perform successfully and disputes often arise during concession period because of changes in various risks or nonperformance of its obligations, especially when one party was forced to accept the requirements by the other due to the project urgency or other reasons [1]. Therefore, it is worth examining the application of PPP in the past and deriving lessons learnt for future references. Given that private participation in infrastructure development in China was first seen in the power sector in the 1980s in the form of Build- Operate-Transfer (BOT), this paper thus focuses on the power sector. 2 PPP in Chinese Power Sector Shajiao B power plant in Shenzhen, which came to operation in 1988, is regarded as the first BOT project in China. However, government took over too many risks in Shajiao B project due to the lack of BOT experience [2]. Thereafter, several stateapproved pilot BOT projects have been awarded in order to introduce BOT on a larger scale since late 1996, such as Laibin B power project etc. Since then, the involvement of private investors in infrastructural development of public utilities has improved greatly. However, at the end of last decade, the central government invested huge amounts of treasury bonds in infrastructure, and was determined to clean up the unregulated or illegal projects, which led to a gradual fade out of the first round of private investment in infrastructure [3]. Taking a closer look at the PPP history, it could be found that the government only encouraged foreign investment in the power sector initially. Followed by corporatization and decentralization of the industry, domestic investors gradually came into the sector and nowadays domestic investors become major investors in the Chinese power industry [4]. After nearly two decades of utilization of private funds to mainly build and renovate power plants, China is still facing a number of fundamental issues that are critical to the success of attracting private capital. An imperfect legal framework, underdeveloped local financial markets, transitional accounting systems and a yet to be developed institutional capability for implementation are major areas that need to be carefully studied and addressed [5, 6]. Excessive layers of approvals required for launching a power project adds more development costs, and is time consuming. The rigid approval process does not provide investors with enough flexibility to amend the project structure according to the latest market developments [5]. Tariffs have also been an issue that frustrates investors and puts them in a weaker position [7]. Given the above existing issues, it is thus essential for public clients and private bidders to place particular attention on the procurement process while negotiating contracts for PPP to ensure a fair risk allocation between them.

3 Equitable Risk Allocation in Chinese Public Private Partnership Power Projects Research Aim and Methodology The aim of this research is to develop an equitable risk allocation scheme between the public and private sectors. As part of a previous research into PPP implementation by the authors, a two-round Delphi survey was conducted in China from December 2008 to February 2009 with experienced practitioners to identify the preference of risk allocation in China s PPP projects, which has been reported in the authors other publication [8]. However, the preferred risk allocation based on the perception and understandings of experts may not be appropriate for all sectors. A round of face-to-face interviews was subsequently carried out from March 2009 to May 2009 to collect actual risk allocation in the past PPP power projects. By comparing the preferred and actual allocations and discovering the reasons behind the differences, an equitable risk allocation scheme which is more appropriate for the power sector could be obtained. Instead of collecting pieces of project information and analyzing the risk allocation, the authors requested the experienced experts to provide their understandings on the actual risk allocation in one of their successful PPP power projects. In order to improve the interview efficiency, an invitation letter was accompanied by a structured questionnaire and sent to the selected experts. The letter explained the purpose of the research and the interview process. The definition of each risk as presented in the authors previous paper [8] was also provided at the beginning of the questionnaire, to ensure that experts have the same understanding of these risks. These respondents were requested to evaluate the success degree of the selected case based on eight criteria indexes and allocate the described risk according to a five-point Likert scale (1 Government takes sole responsibility, 2 Government takes the majority of responsibility, 3 Both parties take equal responsibility, 4 Private sector takes the majority of responsibility, and 5 Private sector takes sole responsibility). A comparative analysis of the actual and preferred allocations was conducted once the responses from the experts were returned. Reasons behind the actual allocation of those risks which have different preferred allocation as well as the commercial principles and contract terms for the allocation were also collected from the interviews. Experts from eight different PPP power projects were interviewed. Table 1 shows the respondents information and their roles in the power projects that the survey respondents reported as their PPP case studies. 4 Discussion of Survey Results The survey feedback concerning the preferred and actual risk allocations is presented in Table 2 (where D.M. means mean values from Delphi survey, P.A. means preferred allocation, I.M. means mean values from Interviews taking into account the success degree, A.A. means actual allocation, T. and Sig. are the results from the T-test between actual and preferred allocations, Diff. means differences).

4 134 Y. Ke et al. Table 1 Information of the respondents and selected projects No. Title Year of PPP experience No. of PPP involved Investment of the case project (RMB) Role in the case project 1 Director More than 20 More than billion Stakeholder of project 2 Vice general manger billion Government agency 3 Investment manager 3 6 Stakeholder of project 4 Deputy dean billion Stakeholder of project 5 Director More than 20 More than billion Stakeholder of project 6 Division chief Less than billion Stakeholder of project 7 Consulting manager Less than billion Consultant 8 Consulting manager Less than billion Consultant The preferred allocation as presented in Table 2 shows that the public sector would take the majority of responsibility for 13 risks related to government or government officials and their actions. Fourteen risks which neither the public nor private sector could be able to deal with them alone are preferred to be shared equally. The private sector would take the majority of responsibility for ten risks that are at the project level. However, this paper focuses on the reasons behind the differences and discusses whether the actual allocation would be more appropriate for the power sector. As mentioned above, differences in allocations would only be considered if the T-test returns a significant result in mean values between two sets of allocations. There are five risks which had different actual allocations, i.e. Corruption, Change in law, Competition (Exclusive right), Uncompetitive tender and Organization and coordination risk. It is worth noting that the number of eight PPP power projects is still regarded as a small sample, and a closer look at the allocation in every case would be necessary to check whether the difference is common in the power sector. 4.1 Corruption This risk is preferred to be allocated to the public sector. The mean value of the actual allocation fell in the category of shared between the public and private sector. But a closer look at the allocation in every case shows that the allocation score in 6 out of 8 projects was two (Government takes the majority of responsibility). Only experts from 2 projects thought it was taken by the private sector and provided a high score of 4 and 5 respectively. This observation suggests that the allocation difference is not common in the sector. The equitable allocation for the risk of corruption is therefore to be assigned to the public sector.

5 Equitable Risk Allocation in Chinese Public Private Partnership Power Projects 135 Table 2 Comparative analysis of preferred and actual risk allocations No Risk factor D.M. P.A. I.M. A.A. T. Sig. Diff. 1 Corruption 2.11 Public 2.58 Share * p 2 Government s intervention 1.70 Public 1.47 Public Expropriation and nationalization 1.28 Public 1.51 Public * 4 Government s reliability 1.65 Public 1.46 Public Third party reliability 3.39 Share 3.26 Share Public/Political opposition 2.54 Share 2.50 Public Immature juristic system 2.43 Public 2.50 Share Change in law 2.33 Public 2.66 Share * p 9 Interest rate 3.39 Share 3.51 Private Foreign exchange and convertibility 3.26 Share 3.51 Private Inflation 3.22 Share 3.38 Share Poor political decision-making 1.83 Public 2.38 Public * 13 Land acquisition 2.00 Public 1.85 Public Approval and permit 2.11 Public 2.25 Public Improper contracts 3.15 Share 3.23 Share Financial risk 4.07 Private 4.25 Private Construction/operation changes 3.52 Private 3.50 Share Construction completion 4.02 Private 4.02 Private Delay in supply 3.96 Private 4.14 Private Technology risk 4.37 Private 4.77 Private * 21 Ground/weather conditions 3.33 Share 3.23 Share Operation cost overrun 4.20 Private 4.49 Private * 23 Competition (exclusive right) 2.30 Public 2.87 Share * p 24 Market demand change 3.37 Share 2.98 Share * 25 Tariff change 2.87 Share 3.14 Share * 26 Payment risk 3.00 Share 3.08 Share Supporting utilities risk 2.26 Public 2.34 Public Residual assets risk 3.52 Private 3.54 Private Uncompetitive tender 2.28 Public 2.59 Share * p 30 Consortium inability 3.78 Private 4.63 Private Force majeure 2.91 Share 2.89 Share Organization and coordination risk 3.65 Private 3.15 Share * p 33 Tax regulation changes 2.35 Public 2.24 Public Environmental protection 3.02 Share 2.88 Share Private investor change 3.85 Private 4.41 Private * 36 Subjective evaluation 3.13 Share 3.39 Share * 37 Insufficient financial audit 3.04 Share 3.14 Share Change in Law Experts in five power projects agreed that this risk was shared in the past PPP projects. This actual allocation would be considered as common. The change history in law in the power sector includes three stages, i.e. first stage reform to raise capital ( ), second stage reform to change the role of government ( ), and third stage reform to introduce competition (2002 present) [9]. Taking case 8 for example, in December 2002, China announced its intent to implement the standard global model of deregulation toward competitive utility

6 136 Y. Ke et al. markets, including the separation of electricity generation and transmission. The wholesale market price for electricity thereafter turned out less than the price in the concession agreement of case 8. Private investors thus failed to earn expected investment return. However, the change in law is out of authority of the local government, which does not have the ability to cover all the additional costs and helps private partner be restored to the same economics position. Actually, in recent cases, an agreed threshold of tariff is usually set. The government only covers the additional costs above the threshold. In addition, since 2002, the reform of power sector has been a hot topic and some regulations related to the tariff reform were promulgated one after the other. In October 2009, the National Development and Reform Commission, State Electricity Regulatory Commission, and National Energy Administration together released the announcement about standardizing power transaction price. This paper therefore suggests that special attention should be paid to the risk of change in law for both public and private sectors. Under current system, this risk shall be assigned to the government when the concession agreement is signed by the provincial government, but be shared when the agreement is signed by the municipal (city) government. 4.3 Competition (Exclusive Right) The risk of exclusive right was actually shared by the public and private sectors in 7 out of 8 projects, which is clearly regarded as a common allocation. There are many types of power projects such as coal-fired power, hydropower, wind power, solar, hydrogen, etc. If the exclusive right is fulfilled, the governmental authorities shall not permit the development projects of new competitive projects in any type or the alteration and expansion projects of any existing power projects during the term of the concession agreement. This guarantee would be against the long-term policy by the central government to encourage the development of new energy. In addition, the policy support to the new energy projects actually caused great competitive pressure to those regular PPP power projects, such as control of emission reduction target, purchase priority to new energy projects, subsidy to new energy project companies, etc. Since the local government actually does not have the authority to fulfill the requirement of exclusive right, none of the selected case projects provided specific clauses to deal with this risk. It is worth noting that private investors from all projects signed a take or pay electricity purchase contract with the government, which is believed to be able to mitigate the negative influence by the risk of exclusive right. In light of the above, this paper thus suggested that the equitable allocation for the risk of competition (exclusive right) is to be shared on the premise that a take or pay electricity purchase contract is set.

7 Equitable Risk Allocation in Chinese Public Private Partnership Power Projects Uncompetitive Tender The allocation difference of this risk is not common in the sector, because the allocation score in 6 out of 8 projects was 2 and only experts from 2 projects provided a high score of 4 and 5 respectively. The equitable allocation for the risk of uncompetitive tender is therefore to be assigned to the public sector as the preferred allocation. 4.5 Organization and Coordination Six out of eight power projects had the actual allocation score smaller than 4. It means that instead of being allocated to the private sector in the perspectives of experts, the risk of organization and coordination was usually shared by both the public and private partners. For instance, as case 6 is a pilot project, the government paid special attention to it, and undertook most coordination tasks for the project. Similarly in other projects, the partners as the fuel supplier, electricity purchaser, dispatching station and some other process were the government s subsidiary department or companies. It is therefore unavoidable for the involvement of the government in the organization and coordination task. In light of this, this paper thus recommends a better allocation for the risk of organization and coordination in the power sector to be shared. However, the private sector is also suggested that the timing and process of the government s involvement should be clearly defined so as to avoid the risk of government s unreasonable intervention. 5 Conclusions This paper has studied the equitable allocation of risks in China s PPP power projects. According to the analysis, there are three risks which had different actual allocation from the preferred allocation, i.e. Change in law, Competition (Exclusive right) and Organization and coordination risk. The equitable allocation for other risks would be the preferred allocation reported in Table 2. The risk of change in law shall be assigned to the government when the concession agreement is signed by the province government, but be shared when the agreement is signed by the city government. The equitable allocation for the risk of competition (exclusive right) is to be shared on the premise that a take or pay electricity purchase contract is set. The risk of organization and coordination shall be shared but the private sector needs to define the timing and process of the government s involvement so as to avoid the risk of government s unreasonable intervention. Acknowledgments The work described in this paper was fully supported by a joint grant from the National Natural Science Foundation of China (Project No ) and the Research

8 138 Y. Ke et al. Grants Council of the Hong Kong Special Administrative Region, China (RGC Project N_PolyU514/07). Special gratitude is extended to those industrial practitioners, who have kindly participated in the interviews reported in this paper from March to May References 1. Ke YJ, Wang SQ, Chan APC (2009) Public-Private Partnerships in China s Infrastructure Development: Lessons Learnt. In: Proceedings of International Conference on Changing Roles: New Roles and New Challenges, Noordwijk aan Zee, The Netherlands, p Feng LJ, Luo ZS (1999) Laibin Model Application of BOT Financing Modality in China (in Chinese). Guangxi People Press, Nanning 3. Shen JY, Wang SQ, Qiang MS (2005) Political and Sovereign Risks in Chinese BOT/PPP projects: A Case Study (in Chinese). Chinese Businessman: Investment and Finance, 1: Zhang L (2009) Development of Infrastructure Sectors in China: Status Quo and Trends (Seminar speech). Revamping PPPs: From Revisiting and Rethinking to Revamping and Revitalising PPPs, The University of Hong Kong, Hong Kong, China 5. Cunningham EA (2007) Chinese Power: Reform and Development in China s Electricity Industry. China Public Administration Review, 6: Williams JH, Kahrl F (2008) Electricity Reform and Sustainable Development in China. Environmental Research Letters, 3: Asian Development Bank (2003) Power Pricing Strategy Tariff Setting and Regulation. Technical Assistance 4117-PRC 8. Ke YJ, Wang SQ, Chan APC, Lam PTI (2010) Preferred Risk Allocation in China s Public Private Partnership Projects. International Journal of Project Management, 28(5): Zhang C, Heller TC (2004) Reform of the Chinese Electric Power Market Economics and Institutions. Program on Energy and Sustainable Development, Working paper #3