1. European Investment Bank The PPP Premium in European Roads Projects Hugh Goldsmith PPP Coordinator, Projects Directorate Frederic Blanc-Brude & Timo Välilä 5 th Conf. On Applied Infra Research (INFRADAY) Berlin, 6-7 October 2006

2. 2 A road, is a road, is a road … except when its a PPP! Does it cost more to build infrastructure as a PPP than via traditional procurement? Agenda: 1. Theory 2. Practice 3. Data 4. Analysis 5. Interpretation 6. Conclusions

3. 3 Theory – Value for Money Does PPP deliver VfM? Well only know once large sample of projects have completed life-cycle 1. Full cost-benefit comparison 2. Ex-ante use of PUBLIC SECTOR COMPARATOR Cost to Govt of PPP Cost to Govt of Traditional Procurement

4. 4 Theory- Benefits & Costs Benefits Bundling Life-cycle approach Innovation Depends on scope in tender dossier Risk sharing Better risk management Private asset ownership Cost saving innovation & more efficient contracting Costs Transaction costs Bidding, negotiation, monitoring Renegotiation over life-cycle Private finance costs Pursuit of cost efficiency may impact service quality Institutional and administrative capacity requirements in public sector VfM Scope for VfM varies across sectors

5. 5 Theory – Construction Costs Ownership + Incentives + Bundling (Hart, 2005) [a(i*) - α(e*)] + [b(i*) + β(e*)] > i + e Higher construction costs expected due to: + Greater investment for Lifecycle cost savings + Pricing of risks (more efficient contracting) + Higher transaction costs for complex contracts Lower construction costs expected due to: – Design innovation responding to output based specification Cost of making cost- saving investments Improved productive efficiency benefit Impact on allocative efficiency (quality)

6. 6 Practice - Contracting SPV EPCO&M Govt X Govt EngineerContractor Operator Traditional PPP XX Cost to build Ex-ante = Price of construction contract

7. 7 Practice – Risk Allocation SponsorsEquity Debt Taxpayers Design & Construction Operating Risks Force Majeure Uninsurability Payment Market rates Sub-contractors SPV Public sector Allocate risks to the party best able to manage them

8. 8 The Sample EIB financed roads projects 1990-2005 Projects divided into sections or lots Different technical characteristics (length, terrain, proportion bridges/tunnels, no. lanes) Motorway & non- motorway standard roads Both public & private projects Large variety of procurement routes

9. 9 Data – Country Coverage 65 PPP162 Non-PPP 227 EIB-financed road sections in 15 countries

10. 10 At face value, cost of a PPP road higher and more variable Construction cost/km, in millions of 1999

11. 11 Outliers are mainly fixed links median mid-50% of observations Construction cost/km, in millions of 1999 most outliers are fixed links

12. 12 Unit costs vary with project characteristics

13. 13 Estimation methodology OLS Regression Dependent variable: Unit costs (1999 million /km) Explanatory variables: Economic; Technical; Countries Dummy variables for: PPP Urban terrain, Mountainous terrain No. lanes (avoiding dummy trap) Countries General to specific methodology 10% significance threshold Diagnostic & robustness testing

14. 14 Robustness Testing Alternative samples Motorways only Cost range 20 to 300 million Observations +/- 1.5 x Stdev Only countries with both PPP and non-PPP No fixed links (< 50% bridges or tunnels) Alternative specifications With/without country dummies Common sense: Sign & magnitude of coefficients Unit cost benchmark: 4.9 million /km (1999 prices)

15. 15 Results PPP dummy coefficient significant in all samples & specifications

16. 16 Sample Bias Adjustment Different data quality due to timing of appraisal Ex-ante cost data: PPP = EPC contract price Non-PPP = variable timing/quality Adjustment: PPP Premium = 100 x {exp(PPP coef ) –1} – 10% Median estimateSample bias

17. 17 PPP Premium estimates 31 estimates of PPP premium

18. 18 Good fit for preferred model Motorways without fixed links Observed unit construction cost (mill 1999) Predicted unit construction cost(mill 1999 ) Perfect fit line PPP Premium = 23%

19. 19 Cost Overruns in Traditional Procurement Previous Studies: Flyvbjerg (2002) for European roads: + 22% Mott MacDonalds (2002) for UK roads: + 21% Interpretation: Systematic optimism bias PPP Premium = Expected Cost Overrun under traditional procurement Is there any additional investment for quality enhancement & lifecycle cost savings?

20. 20 What are we getting for the PPP Premium? Construction on-time and on-budget Higher transaction costs? Construction companies taking out profits upfront? Better quality? The road was built to a higher standard than normal motorways (in the country), because the contractor new he was fully liable for maintenance over 20 years EIB. EV Report on PPPs June 2005 Better lifecycle performance? … too early to tell !

21. 21 Conclusions PPP Premium in European roads is 20 to 25% Significant and robustly estimated Close correspondence with optimism bias of traditional procurement Rational construction risk pricing by contractors PPP delivery success = cost + time certainty VfM: Too early to judge about long term lifecycle costs & quality

22. 22 The road ahead … PPP here to stay: Challenge is to do it well … … by learning from mistakes & successes at EU level EIB public policy role: Support the development of EU-wide best practice On-going research Questions: Why are some countries cheaper? How to achieve Lifecycle VfM?

23. http://www.eib.org Address : 100, Boulevard Konrad Adenauer, L-2950 Luxembourg Contact : Hugh Goldsmith Email : h.goldsmith@eib.org Tel : 00352-4379-2783 Fax : 00352-4379-2860