Concession Contracts and Regulation: Lessons from over 1000 Concessions in Latin America

Transcription

1 IBRD Concession Contracts and Regulation: Lessons from over 1000 Concessions in Latin America J. Luis Guasch World Bank and University of California, San Diego November 28, 2005 Palermo, Italy ANEA Seminar: La Regolazione del Servicio Idrico Integrato 1

2 OUTLINE MOTIVATION FOR INFRASTRUCTURE REFORM REFORM PROGRAM IN INFRASTRUCTURE REGULATORY FRAMEWORK: CONTRACT VS OTHER OUTCOMES OF REFORM PROGRAM RETURNS TO INVESTORS (Sirtaine, Pinglo, Guasch and Foster 2005) PRODUCTIVITY, COVERAGE, QUALITY PRICES (Andres, Foster and Guasch 2004) RENEGOTIATION (Guasch 2004) 2

3 Motivation for Reform on Infrastructure Sectors Infrastructure matters: growth and poverty Deficient sector performance: Search for improvements in efficiency, technology and know-how Desired increases in coverage: poverty angle Need for investment: scarcity of state resources Redefining the role of the state Led to Private Sector Participation 3

4 Types of Private Participation in Infrastructure 4

5 Salient Choice: Concessions Concessions instrument mostly utilized for private participation in infrastructure services: ( 65% total, 98% transport, 90% water and santitation) Privatization mostly used in the Telecom, and in Electricity - Generation sectors 5

6 DIFFERENCES Rights/ Property Duration CONCESSION Transfer of right of exploitation and use of the company's physical assets Limited/ years PRIVATIZATION Transfer of property to the company Unlimited Obligations Clauses Responsibility More Extensive Provision for Termination/ Cancellation of the concession Government retains proprietory rights Less Extensive Generally non-existant Non-existant 6

7 CONCESSIONS VS PRIVATIZATIONS MAIN DIFFERENCE: Limited operation period vs unlimited operation period THE ONLY ASSET UNDER A CONCESSIONS IS THE (CANCELABLE) RIGHTS TO THE CASH FLOWS OF THE PROVISION OF THE SERVICE THE CONCESSIONAIRE DOES NOT OWN ANY PHYSICAL ASSET 7

8 Concession Versus Privatization Legal and/or constitutional impediments to privatization Public Services high visibility social & political impact belief that they should remain under state ownership and control: thus the preference of concessions over privatization Concerns about outcomes of privatizations 8

9 Key Determinants of Sector Performance (from theory and experience) i) The design of the concession, the clarity and transparency of the rules of the game, and ii) The regulatory framework, along with resolution of conflict mechanisms iii) Those two are the best predictors to reduce regulatory risk and improve sector performance. iv) Regulation by contract focus on concessions and contract design 9

10 Concession Design and Regulation are Intrinsically Linked An excellent concession design but poor regulatory oversight will lead to deficient sector performance. An excellent regulatory oversight but with poor concession design will lead to deficient sector performance. Regulation CANNOT solve the problem of a poor concession design. Key message: you need both for effective sector performance and to secure the gains from private sector participation. 10

11 Types of Regulatory Frameworks Law, Decree, Contract, and role of Regulatory Agency Where the rules, rights and obligations are stated Regulatory agency implements and interprets them: issue degree of detail and discretion Contract, Regulatory Agency: Key differences. Degree of discretion on regulatory issues and autonomy/independence Contract (issues: dealing with disputes and incomplete contracts) Ministry Ministry-Experts Panels: examples (first three in water) Bucharest concessions: for tariff adjustments Chile: for appeals from regulators s decisions Sofia concessions: dispute review board for all disputes London Underground PPP arbiter: deciding periodic reviews if parties cannot agree 11

12 The French Water Sector: Regulation without a Regulator The French water sector has operated for many years under regulatory contracts without a regulator. Under this system, implemented through hundreds of municipally granted concessions or leases, private companies provide about 80 percent of the water supply and about 45 percent of the sewage services. Model contracts Well-developed case law and legal doctrines A respected appellate tribunal Private operators are French companies Common educational backgrounds Cultural traditions 12

13 Alternative Regulatory Models France (Water Sector) Latin America Great Britain United States India Separate Regulator? No (Regulation by contract) Yes Yes (national) Yes (national and state) Yes (national and state) Specifity of Regulatory Contract Medium High (Bolivia, Chile, Peru) Low (Brazil, Colombia) High Low (general principles interpreted in case law) Low (general principles without case law) Regulatory Decisions Reviewed by Special Appellate Tribunal? Yes No except for Bolivia and Chile Yes (Competition Commission) No No, but proposed by government Ownership of Regulated Entities Private Mostly public (only Chile private) Mostly private Mostly private Mostly public Form of Private Sector Participation Concessions and leases Concessions Full privatization Full privatization Mostly Concessions 13

14 Limits of Regulation by Contract Different than commercial contract: gov role Incomplete contracts: how to respond to issues not in contract? Who bears the risk? Dealing with disputes Capture vs no discretion Regulatory credibility (large impact regulatory risk: 2-6 percentage points of cost of capital) Investor confidence In practice some convergence 14

15 But Recall that Regulation Means The main objectives of a regulatory framework are: to induce the regulated firm to operate at lowest (efficient) possible costs; to closely align prices (tariffs) with costs allowing the firm to earn only normal profits. Usually there are other subordinate objectives as well that complement the main ones such as to induce increase coverage and access, improve quality of service and to address issues of universal service obligations 15

16 CRITICAL FACTORS Determining future tariffs Cost of capital Valuation of assets Efficient benchmark criterias Triggers for adjustments Financial equilibrium Incomplete contracts Conflict resolution Regulation by contract in the strict sense, does not do well handling these factors 16

17 Regulatory agencies Yet regulatory agencies have had also problems: Limited autonomy/independence Limited capacity Limited experience Potential capture 17

18 Conflicts of interest: non- compatibles Government Maximize fiscal revenues Investors Labor force Users Maximize earnings Protect jobs Expand coverage for those with no service Seek lower tariffs

19 Data Set Based on the analysis of more than 1,300 concessions in the infrastructure sector awarded since the 1980s to date, in Latin America and Caribbean (Guasch 2004). The data set has seven blocks describing: (i) country characteristics; (ii) type of project or transaction; (iii) award and bidding details; (iv) regulatory framework; (v) concession details; (vi) renegotiation details; and (vii) risk bearing details Roads Telecoms Rail Ports Water & Sanitation Electricity Airports 19

20 Sample Characteristics Water and Sanitation Concessions about 300 Most of them were regulated by contract In addition many of electricity distribution concessions were also regulated by contract Most of transport concessions were regulated by contract OUTCOMES: On average regulation by contract did worse than when there was an autonomous regulatory agency 20

21 OUTCOMES Returns to Investors 21

22 Long-term Concession Returns by Sectors Project IRR vc WACC 25% 5% -15% -35% -55% Water Transport Telecom Energy IRR, no TV IRR, with FV IRR, with TV IRR with fees adj IRR with fees & Inv Mkup adj WACC Source: own calculations, based on concessions historical financial statements and the authors growth assumptions. 22

23 DID THE QUALITY OF REGULATION MATTER ON THE LEVEL OF RETURNS TO INVESTORS? Objective: To align cost of capital with rate of return 23

24 Construction of Regulatory Quality Indices Weight Scoring Legal solidity if regulatory framework established by law, 0 otherwise. Financial capacity 0.33 Sum of scores on factors detailed below. Financial independence if funded from regulatory levy, 0 if funded from public budget Financial strength 0.17 Regulatory budget as % sectoral GDP normalized on [0,1] scale Decision-making autonomy 0.33 Sum of scores on factors detailed below. Independence of appointment if appointed directly by executive, 1 if screening by legislature Duration of appointment for a single fixed term, 0 for indefinite appointment Collegiality of decisions if headed by regulatory commission, 0 if by individual regulator Note: Scores between 0 and 1 are given for intermediate cases. 24

25 Summary of Regression Results Dependent variable ln(irr-wacc absolute differential without terminal value) ln(irr-wacc absolute differential with terminal value) ln(irr-wacc absolute differential with terminal value and adjustment for management fee) ln(irr-wacc absolute differential with terminal value and management fee and adjustment for transfer pricing) Financial independence Financial strength ** ** ** Legal solidity ** Independence of appointment Duration of appointment Collegiality of decisions Constant ** ** ** P-value * ** R-squared No. of observations Notes: Regressions based on 30 observations; *, **, *** indicate significance at 10 percent, 5 percent, and 1 percent level respectively 25

26 OUTCOMES Sector Performance Outcomes: 26

27 DEPENDENT VARIABLES-PERFORMANCE RELATED TESTED RENEGOTIATION PRODUCTIVITY COVERAGE QUALITY OF SERVICE PRICES SOURCE: GUASCH (2004) and ANDRES, FOSTER AND GUASCH (2005) 27

28 OBJECTIVE OUTCOME RESULT FINANCING/ OPERATIONAL PARTICIPATION OF THE PRIVATE SECTOR OPERATIONAL EFFICIENCY COVERAGE ALIGNMENT OF COSTS AND TARIFFS SUSTAINABILITY OVERALL CONCLUSION VERY POSITIVE FAIRLY POSITIVE ADEQUATE PROBLEMATIC DEFFICIENT MIXED, PARTIALLY POSITIVE 28

29 Empirical Resuls: Changes in Trends Númber os users (*) Distribución de la electricidad Telecomunicaciones fijas Water and Sewage Transición Post-transición Transición Post-transición Transition Post-transition Output (*) Númer of Workers Númer of workers Sector Labor Producty (*) Losses in distribution Quality Coveraqge (*) Prices?? Nota: (*) Estas variables fueron reportadas tras considerar los efectos fijos de la firma y otros fenómenos contemporáneos en la economía. Fuente: Andres, Foster y Guasch (2004). 29

30 Water - Distribution Connections of drinkable water per employee t ALL Trend before Trend after 30

31 Water - Distribution Coverage t ALL Trend before Trend after 31

32 Outcomes: RENEGOTIATION High Incidence reflects: GOVERNANCE OR/AND REGULATORY FAILURE? 32

33 WHY ARE WE CONCERNED ABOUT RENEGOTIATION? IT BREAKS THE CONTRACT IT ELIMINATES THE COMPETITIVE EFFECT OF THE AUCTION ALLOCATING THE CONCESSION: QUESTIONS CREDIBILITY OF MODEL RENEGOTIATION TAKES PLACE AWAY FROM COMPETITIVE PRESSURES IN A BILATERAL- GOVERNMENT/OPERATOR-ENVIRONMENT COMPETITIVE BIDDING DISTORTED MOST LIKELY WINNER IS NOT MOST EFFICIENT OPERATOR BUT THAT MOST SKILLED IN RENEGOTIATION WHILE SOME RENEGOTIATIONS ARE EFFICIENT, MANY ARE OPPORTUNISTIC AND SHOULD BE DETERRED 33

34 RENEGOTIATION THE NORM RATHER THAN THE EXCEPTION Higher in regulation by contract contexts 34

35 Incidence of Renegotiation of Infrastructure Concessions in Latin America and Average Time to Renegotiation Renegotiated Concession Average Time to Renegotiation All Sectors 42% 2.1 years Electricity 10 % 2.3 years Transport 57% 3.1 years Water 75% 1.7 years Source: Guasch (2004) 35

36 Very Low Incidence of Cancelled Concession Total World Infrastructure PPI Projects Cancelled Percentage 2, Composition 19 toll roads 9 energy 7 water & sanitation 8 telecom 2.1% By Sector 5.8% 3.5% Source: Harris (2002) 36

37 CORRELATION BETWEEN RENEGOTIATION AND PROFITABILITY CORRELATION BETWEEN AGGRESIVE BIDDING AND RENEGOTIATION AGGRESSIVE BIDDING-LOW PROFITABILITY- RENEGOTIATION AGGRESSIVE BIDDING: PQ-OC-T-D<rK FINANCIAL EQUILIBRIUM ISSUE 37

38 CORRELATION BETWEEN RENEGOTIATION INCIDENCE AND PROFITABILITY: Average Profitability by Sector of Privatized and Concessioned Firms and the Cost of Equity in Latin American and Caribbean Countries, (percent) Sector IRR (adjusted) a Initial Cost of Equity b Telecommunications Water and Sanitation Energy Transport a. The IRR has been adjusted to incorporate management fees. b. Cost of equity is evaluated at the time of the transaction. 38

39 Contract Award Processes for Concessions in Latin America and the Caribbean by Sector, mid-1980s 2000 Award process Telecom Energy Transport Competitive bidding Direct adjudication (bilateral negotiation) Water and sanitation Total Share of total (percent) (46% renegotiated) (8% renegotiated) Total Source: Guasch (2004) 39

40 Distribution of Concessions by Type of Regulation Price Caps 56% Rate of Return 20% Hybrid* 24% *Hybrid regimes are defined when, under a price or revenue cap regulatory regime, a large number of costs components are allowed automatic pass through into tariff adjustments Source: Author s calculations 40

41 Distribution of Concessions by Existence of Investment Obligations in Contract Investment Obligations in Contract 73% No Investment Obligations in Contract but Performance Indicators 21% Hybrid 6% Source: Author s calculations 41

42 Typology of Renegotiation Initiated by Government Opportunistic (politically) Change in priorities Initiated by Operator Opportunistic (rent seeking) Shock related Ambiguous 42

43 Who initiated the Renegotiation?(% of total requests) Both Government Government Operator and Operator All sectors 13% 26% 61% Water and 10% 24% 66% Sanitation Transport 16% 27% 57% Source: Author s calculations 43

44 Who Initiated the Renegotiation Conditioned on Regulatory Regime? (% of Total Requests) All sectors Both Government and Operator Government Operator Price Caps 11% 6% 83% Rate of Return 39% 34% 26% Hybrid Regime 30% 26% 44% Source: Author s calculations 44

45 Water Sector Incidence of Renegotiated Concession Contracts According to Characteristics Feature Incidence of Renegotiation (percent) Award Criteria Lowest tariff 81 High price 66 Regulation Criteria Regulation by means (investments) 85 Regulation by objectives (performance indicators) 25 Regulatory Framework Price cap 88 Rate of return 14 Existence of Regulatory Body Regulatory body in existence 40 Regulatory body not in existence 87 Impact of the Legal Framework When regulatory framework imbedded in law 55 When regulatory framework imbedded in decree 83 When regulatory framework imbedded in contract 70 45

46 Common Outcomes of the Renegotiation Process Percentage of renegotiated concession contracts with that outcome Delays on Investment Obligations Targets 69% Acceleration of Investment Obligations 18% Tariff Increases 62% Tariff Decreases 19% Increase in the number of cost components 59% with automatic pass-through to tariff increases Extension of Concession Period 38% Reduction of Investment Obligations 62% Adjustment of canon-annual fee paid by operator to government Favorable to operator Unfavorable to operator Changes in the Asset-Capital Base Favorable to Operator Unfavorable to Operator Source: Guasch (2004) 31% 17% 46% 22% 46

47 Contract Features and the Incidence of Renegotiated: Determinants Feature Award criteria Incidence of renegotiation (percent) Lowest tariff 60 Highest transfer fee 29 Regulation criteria Investment requirements (regulation by means) 70 Performance indicators (regulation by objectives) 18 Regulatory framework Price cap 59 Rate of return 16 Existence of regulatory body Regulatory body not in existence 62 Regulatory body in existence 23 Impact of legal framework Regulatory framework embedded in contract 61 Regulatory framework embedded in decree 41 Regulatory framework embedded in law 18 Source: Guasch (2004). 47

48 I. PROBIT ANALYSIS II. Award Criteria Selecting the highest transfer fee decreases the probability of renegotiation by 30-40% Selecting minimum tariff increases the probability of renegotiation by 30-40% II. Proper Regulatory Body in Place Having in place a proper regulatory body decreases the probability of renegotiation by 40-50%. If regulatory body is part of Ministry (thus not autonomous) increases the probability of renegotiation by 20-30% III. Proper Regulatory Type Framework Having a Price Cap Regime increases probability of renegotiation by 15-30% Having a Rate of Return Regime increases probability of renegotiation by 15-30% 48

49 Significant Variables and Largest Marginal Effects Award Criteria 25 to 40% Existence of Proper Regulatory Body 40 to 50% Type of Regulation (Price Caps vs. Rate of Return) 20 to 30% Regulating by Means (Investment) vs. Regulating by Objectives (Parameter) 15 to 30% Nationality of Operator 15 to 20% Autonomy of Regulator 10 to 35% Political Cycle 10 to 20% Macro Shocks 15 to 25% 49

50 Other significant variables Existence of investment obligation increases the probability of renegotiation The longer the duration of the concession the lower the probability of renegotiation The stronger the legal groundings (law, decree, contract) of regulatory framework the lower the probability of renegotiation Reputation effect As the country has renegotiations incidence the probability of renegotiation increases (there might be also a learning effect) Competition: number of bidders The greater the number of bidders the higher the probability of renegotiation 50

51 ISSUES ON RENEGOTIATION FINANCIAL EQUILIBRIUM SANCTITY OF THE BID: R= PQ-0C-T-D<rKi REGULATORY ACCOUNTING INCOMPLETE CONTRACTS INFORMATIONAL ASSYMETRIES CONTINGENT EVENTS 51

52 Regulatory Accounting: Deficiencies Adjusted Results for Water Services Companies (Year Ending March 1992) As stated As Remodeled Average CCA Capital Employed CCA Operating Profit CCA Rate of Return Average CCA Capital Employed CCA Operating Profit CCA Rate of Return ( million) ( million) (percent) ( million) ( million) (percent) Anglian 10, % % Northembria 3, % % North West 18, % 1, % Severn Trent 19, % 1, % Southern 9, % % South West 3, % % Thames 34, % 1, % Welsh 7, % % Wessex 5, % % Yorkshire 11, % % TOTALS 124, , % 7, , % Source: Carey, Cave, Duncan, Houston, Langford

53 Common Questionable Actions That Need To Be Addressed Through Regulatory Accounting Management fees often equivalent to half of the firm net s profits Contracting subsidiaries or related companies to provide services or equipment at significantly higher prices than standard market prices Accuracy of reported investments Transfer of accumulated profits into the regulated capital base Transfer of capital in non-regulated areas of the firm into the regulated capital base of the firm Valuation of pre-privatized assets at replacement costs Using, when convenient, past performance as justification for demands for future higher tariffs Financial equilibrium, yes but based on best practices and the sanctity of the bid 53

54 Lessons: Efforts Should be Placed in Properly Addressing: I. Pre-Concession Issues II. Concession Design Issues III. Concession Award Issues IV. Regulatory Issues a) Institutional b) Economic/Technical c) Administrative Procedures 54

55 Instruments for Regulation Information!!! Cost Model Financial Model Regulation Accounting & Standards Benchmarking Efficiency Measures Tariff Structure 55

56 LESSONS AND DESIGN FOCUS: Key determinants of Sector Performance: o Design of Concession o Regulatory Framework: inducing firms to produce at efficient costs and aligning tariffs with costs 56

57 Key Lessons: Concession Design Assign Concession through Competitive Bidding High transparency of process Communications campaign if needed Performance Bond: should be binding: 2% of total value of contract or 20% of estimated annual revenue Award Criteria: transfer price (annual or lump sum) vs minimum tariff Respect for and enforcement of the sanctity of the bid at the time of the auction Dissuasion through financial incentives of opportunistic renegotiations and development of a credible commitment to the non-renegotiation of opportunistic petitions Costly unilateral changes of the agreed-upon contractual terms of the concession 57

58 Key Lessons: Regulatory Framework Regulatory credibility An incentive-based regulatory framework Price caps vs rate of return vs revenue caps Performance Indicators rather than investment commitments Appropriate regulatory and antitrust legislation Autonomous regulatory institutions, well-trained and wellcompensated professionals, and effective enforcement Issues with regulation by contract. Informational requirements to operators and regulatory accounting system should be stated in the contract An appropriate set of regulatory instruments should be used such as cost and financial models, and benchmarking referential data Valuation of Concession Assets Determining future tariffs Cost of Capital and how should it be determined Conflict resolution rules 58