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Undertaking PPP Projects: Feasibility Stage Vickram Cuttaree The World Bank St. Petersburg – May 23, 2008.

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Presentation on theme: "Undertaking PPP Projects: Feasibility Stage Vickram Cuttaree The World Bank St. Petersburg – May 23, 2008."— Presentation transcript:

1 Undertaking PPP Projects: Feasibility Stage Vickram Cuttaree The World Bank St. Petersburg – May 23, 2008

2 Objectives of the Feasibility Phase OBJECTIVE 1 GET THE PROJECT READY FOR BIDDING STAGE OBJECTIVE 2 ASSESS IF PROJECT IS VIABLE AND PPP RESULTS IN BETTER VALUE FOR MONEY

3 Lessons from International Experience Several issues/delays during procurement/operations could have been avoided with a solid feasibility study. Examples include: 1.Project failures during operations due to weak demand analysis and estimation of user willingness to pay 2.Delays in procurements often linked to important legal review not done prior to bidding stage

4 Key considerations in preparing a Feasibility Study Feasibility stage should not be seen as a administrative step to obtain the necessary City approvals Understanding and incorporating the objectives and constraints of all stakeholders (City, Federal, Users, Private partner) will ensure quality of PPP project The use of consultants with strong expertise in PPP is essential, but the involvement of public sector officials (coordination, decision making, communication) should not be underestimated

5 Key steps in the Feasibility Stage Needs Analysis Options Analysis Due Diligence Financial Analysis Affordability Assessment Value Assessment Economic Analysis Project Viability Verification and Sign-Off Project Management Plan

6 Needs Analysis Options Analysis Due Diligence Financial Analysis Affordability Assessment Value Assessment Economic Analysis Project Viability Verification and Sign-Off Project Management Plan

7 Purpose of Needs Analysis An important objective is to ensure that the project is in line with the Citys strategic objectives During this step, the available budget will be identified and analyzed (incl. potential savings resulting from the project) On the basis of the needs assessment, strategic objectives and budget, the following will be determined –Output Specifications –Performance Indicators Define the service that the city needs to deliver and specify the minimum standards for the output

8 Content of Needs Analysis Output Specifications Performance Indicators Output specifications forms the basis of project preparation Output specification define what the required services are, but they do not specify how they should be delivered Ex: Defining a road in terms of routing, capacity and operational quality requirements Performance indicators are defined to ensure that the service will be delivered to the desired level of performance Performance indicators should be realistically set- up, as they will directly determine the cost of the service to the City and/or users

9 Options Analysis Needs Analysis Options Analysis Due Diligence Financial Analysis Affordability Assessment Value Assessment Economic Analysis Project Viability Verification and Sign-Off Project Management Plan

10 Rationale for Options Analysis Consider all technical, legal and financial options that meet the output specifications Options considered should include low-investment solutions that can meet the needs (ex. managing demand for services instead of building new capacity) Option analysis does not tell whether PPP is the correct option or not – it identifies the most viable option for further analysis Examine the range of reasonable options for meeting the Citys output specifications, reject unviable options, and choose the best solution for further examination

11 Conducting the Options Analysis Listing and Evaluation of Options Selection of Best Option List all reasonable options to be considered Assess the advantages and disadvantages of each option based, for example, on: - technical aspects - funding and financial impacts - market capability and demand - environmental impacts and costs - etc Reject all options that are illegal, too expensive or too risky Analyze and score each option in a matrix form against each of the abovementioned criteria Select the preferred option with justifications

12 Illustration of Option Analysis Example of Options: –Build a new road vs. increase capacity of public transport –Develop current port or build a new one –Use of source of energy (coal, renewable, etc…)

13 Due Diligence Needs Analysis Options Analysis Due Diligence Financial Analysis Affordability Assessment Value Assessment Economic Analysis Project Viability Verification and Sign-Off Project Management Plan

14 Objective of Project Due Diligence A thorough due diligence is expensive, but saves time and money down the road Early identification of issues and quality of exercise is essential for future success Importance of legal, social and environmental issues should not be underestimated Identify and Analyze ALL LEGAL, LAND AND SITE, TECHNICAL, SOCIAL and ENVIRONMENTAL ISSUES

15 Scope of Project Due Diligence Environmental and Land Revenue sources and Demand Analysis Legal Ensure compliance with all related City and Federal laws and regulations (at minimum) Due diligence should go further and identify and mitigate any related issues that could raise concerns for the potential private partner Review should be professionally done and conservative This analysis is the backbone of assessment of private sector interest and financial contribution from the State/City Ensure that all foreseeable legal requirements are met for the project development (incl. sector laws) Poor legal review will raise concerns from potential bidders and could lead to delays in bidding and negotiations

16 Scope of Project Due Diligence Financing Market Analysis Other Items Review the availability and cost of financing, financial instruments, hedging and risk mitigation products, insurances and applicable tax regime for the project Review should include number, size and capacity of sponsors, contractors and financiers, as well as known competing projects being prepared in other countries Due diligence is also project-specific and examples include: Technical site analysis Technical design analysis Availability and quality of supporting infrastructure Availability of raw material and fuel supply

17 Financial Analysis Needs Analysis Options Analysis Due Diligence Financial Analysis Affordability Assessment Value Assessment Economic Analysis Project Viability Verification and Sign-Off Project Management Plan

18 Objective of Financial Analysis The central component of the financial analysis is the development of a financial model The financial model represents the costs of delivering the preferred solution through a PPP arrangement and may be called the PPP model The results of the financial analysis are highly dependent on the quality of assumptions and advice from experts is essential OBJECTIVE 1 DEMONSTRATE THAT THE PROJECT WILL BE FINANCIALLY ATTRACTIVE TO THE PRIVATE SECTOR OBJECTIVE 2 ASSESS THE LIKELY FINANCIAL CONTRIBUTION FROM THE CITY TO THE PROJECT

19 Construction of Financial Model Step 1: Technical definition of project Step 2: Identifying direct costs Determine the technical parameters of the project construction and operation with their cost implications Direct capital costs are specifically associated with the construction of a new facility or the acquisition of a new asset. Direct maintenance costs will include the full lice- cycle costs of maintaining the assets in the condition required to deliver the output specification (e.g. raw materials, equipment and labor) Direct operating costs are associated with the daily operation of the service (incl. staff, raw materials, etc…)

20 Construction of Financial Model Step 3: Identifying indirect costs Step 4: Identifying project revenue Indirect costs will include that portion of any additional overhead costs related to the project (e.g. personnel, accounting, billing, legal, rent, communications) Revenue and demand study from due diligence is used as base case for revenue projection Any assumption on revenue collected should reflect projects ability to invoice and collect revenue – beware of revenue over-estimation

21 Construction of Financial Model Step 5: Financing and other assumptions Assumptions regarding financing, project structure and tax should be tested with financial experts Proposed source of funding (e.g. debt, equity and government contribution) should be identified City should assume that cost of capital would rely on projects own credit, and not on government bond yield All relevant financial ratios should be set out in detail (e.g. annual debt service cover ratio, return on investment for equity holders, etc…) Step 6: Calculation of explicit government financial support to the project Explicit government budget support will be required if base model with simple costs, revenues and financing assumptions will not meet required ratios If budget support is needed, City can undertake measures to: 1) reduce costs in PPP model 2) increase revenue in PPP model 3) reduce amount of private financing

22 Construction of Financial Model Step 7: The Base Case model The base case model is created based on the anticipated revenues, costs, assumptions, payment/subsidy mechanism and structure for this project Step 8: Adjusting base model for risk The base model is then adjusted to take into consideration all risks likely to impact the project, with a estimation of their potential impact City should pay attention to optimal risk transfer – in general, risks should be allocated to party best able to manage them

23 Construction of Financial Model Step 9: Adjusting PPP Model to reflect total cost to City The adjusted PPP Model includes all-in cost to City for undertaking project through PPP City will still be responsible for some costs in PPP, such as costs of managing PPP agreement – these costs should be identified in Model Step 10: Sensitivity Analysis Sensitivity analysis determines resilience of PPP Model to changes in assumptions Sensitivity of following variables should be tested on key variables, including demand, financial terms, capex and opex The City should learn how much its contribution to the project will change if key assumptions are different in reality

24 Illustration of Financial Model Output Note: Graph for illustrative purposes only – does not correspond to any existing project Model used to determine project attractiveness to the private sector: Equity IRR Calculation

25 Illustration of Financial Model Output Note: Graph for illustrative purposes only – does not correspond to any existing project Model used to determine project attractiveness to the private sector: Financial sustainability

26 Illustration of Financial Model Output Model used to determine financial contribution by City Note: Graph for illustrative purposes only – does not correspond to any existing project

27 Illustration of Financial Model Output Example of output: assessment of minimum toll rate (US$ per km) for a highway PPP based on construction costs Source: PPP in Highway Toolkit and Cesar Queiroz Construction cost, $ million/km $/km 20,000 vpd 15,000 vpd 10,000 vpd 5,000 vpd

28 Affordability Assessment Needs Analysis Options Analysis Due Diligence Financial Analysis Affordability Assessment Value Assessment Economic Analysis Project Viability Verification and Sign-Off Project Management Plan

29 Objective of the Affordability Assessment PPP projects should provide services that are affordable either to USERS of the services (tariffs) GOVERNMENT paying for the services (availability payment, subsidies) Affordability for users is assessed by willingness to pay for the specific services provided Affordability for Government is based of expected payments during life of project and budget assumptions during same period Determination of project costs and available budget should be as accurate as possible Collaboration with Budget preparation is essential

30 The Case of Demand Risk Risk allocation based on principle that risk should be allocated to the party best able to manage it In practice, demand risk is difficult to fully allocate to the private sector In addition, demand for the services are often over-estimated (optimism bias) –S&P Survey of PPP projects showed that actual traffic on PPP projects are on average 70% of forecasted one If not mitigated, demand risk can result in higher perceived project risk, increased cost to the City or reduced interest from the private sector

31 Case Study: Hungary M1/M15 Toll Project Illustrates importance of traffic forecasts and difficulty in justifying high toll rates First PPP motorway in Hungary to be fully financed by tolls Financial close reached in November 1993 and construction of M1 completed in January 1995 on schedule and within budget Traffic was 40% below expectations with no demand risk guarantees from Government Tolls considered the highest in Europe contributed to accusation that Concessionaire was abusing its dominant position Negotiations took years and resulted in Government taking a large part of the debt in 1998

32 Risks Associated with Guarantees Minimum Revenue Guarantee (MRG) reduces the risk to the private partner of lower than forecasted revenue Government contribution can be significant, especially given usually over-optimistic traffic forecasts Affordability Calculation for Government should include sensitivity analysis on lower revenues impact on Government payments Affordability Calculation for Government is therefore extremely sensitive to quality of demand forecasts and user willingness to pay Minimum Revenue Guarantee Revenue shared with City Revenue (Rubles) Payment by City

33 Risks Associated with Availability Payment From a budget perspective, availability payments replace capital expenditure by recurrent ones Moreover, traffic risk is transferred to Government, baring the cost of any downturn in traffic Affordability assessment should include future payments and take into consideration the net cost of lower than expected traffic Traditional Procurement Rubles PPP with Availability Payments Rubles Capital Expenditure Maintenance

34 What if a Project is NOT Affordable? A project not affordable for users means tariffs are too high and can result in –Negative social impact if users dont have alternatives –Reduced benefits or even project failure if alternative exists (ex. use of parallel road) A project not affordable to Government means available budget is not sufficient to pay commitments to private partner If project is not affordable, Government has several options –Reducing the scope/quality of services –Abandon the project –Obtain more financing from Budget

35 Value Assessment Needs Analysis Options Analysis Due Diligence Financial Analysis Affordability Assessment Value Assessment Economic Analysis Project Viability Verification and Sign-Off Project Management Plan

36 Definition of Value for Money Value for Money (VfM) describes a net benefit, both in quantitative (financial) and qualitative terms, from the outcomes of a PPP project compared to the same project delivered by the public sector over the entire lifespan of the project. VfM is not the choice of the goods and services based on the lowest cost bid Several factors directly influence the VfM –Risk allocation between City and Private Sector –Focus on whole life rather than upfront costs –Use of output specification approach –Sufficient flexibility in relation to design and service delivery

37 How to determine Value-for-Money QUALITATIVE ASSESSMENT Project has efficiencies that private sector can provide There is a suitable competitive market Risk can be transferred to the private sector QUANTITATIVE ASSESSMENT Development of Public Sector Comparator (PSC)

38 Illustration: Using PSC to Assess VfM Rubles PSC A B Risk Adjusted PSC PPP Model plus Retained Risk Actual Bids plus retained Risk NPV of capital and operating costs associated with the project should it be procured and operated by the City Full costs to the City (NPV) of delivering the required service according to the specified outputs using conventional public sector procurement Best estimate (NPV) of the total (risk inclusive) cost of the project to the City with estimate of the risk retained by the City Total cost (incl. risk) of the project to the City based on actual bid received A: Vfm at feasibility is difference with Risk-adjusted PPP B: VfM at financial close is difference with Risk adjusted PPP

39 Example of PSC Calculation: Base PSC Note: Table for illustrative purposes only – does not correspond to any existing project

40 Example of PSC Calculation: Risk Valuation Note: Table for illustrative purposes only – does not correspond to any existing project

41 Example of PSC Calculation: Risk Adjusted PSC Model Note: Table for illustrative purposes only – does not correspond to any existing project

42 Benefits and Limitation of using PSC Benefits -Provides basis for selecting a PPP project, with very long and significant fiscal implication for the City -Provides City with credible alternative to deliver project should bidding/negotiations not provide an acceptable PPP solution Limitation -Developing PSC brings additional cost and time in the preparation of the feasibility study -PSC is complex and requires institutional capacity that might not be available PSC provides a tool to reconcile City decision to undertake a project with assessment of the PPP option

43 Overview of Risks related to PPP Project Availability Completion Cost overrun Design Environmental Exchange rate Force majeure Inflation Insolvency Insurance Interest rate Latent defect Maintenance Market, demand or volume Operating Planning Political Regulatory Residual value Resource or input Subcontractor Tax rate change Technology utilities Source: South Africa Treasury Risk should be allocated to the party best able to manage it If the private sector is asked to take over a risk it cannot manage (macro, demand…), it will either refuse or price it with a premium

44 Economic Analysis Needs Analysis Options Analysis Due Diligence Financial Analysis Affordability Assessment Value Assessment Economic Analysis Project Viability Verification and Sign-Off Project Management Plan

45 Objective of Economic Analysis Estimate all economic costs and benefits of the project to ensure that it is the least-cost option and that all externalities to stakeholders have been considered Economic analysis is required to calculate the incremental costs and benefits of the project to society as a whole – with or without project This way the City understands the various economic costs and benefits to the project entity, private sector entity, government and local community Changes may be necessary to the project design if negative externalities are large

46 Stages of Economic Analysis Determine economic costs of project Calculate EIRR and ENPV Determine major assumptions for economic analysis Estimate economic benefits

47 Project Viability Needs Analysis Options Analysis Due Diligence Financial Analysis Affordability Assessment Value Assessment Economic Analysis Project Viability Verification and Sign-Off Project Management Plan

48 Project Viability The project is viable if it is 1.Technically deliverable 2.Socially and Environmentally sustainable 3.Financially viable to investors 4.Affordable to users 5.Affordable to the City 6.Provides Value for Money to the City 7.Economically viable

49 Verification and Sign-Off Needs Analysis Options Analysis Due Diligence Financial Analysis Affordability Assessment Value Assessment Economic Analysis Project Viability Verification and Sign-Off Project Management Plan

50 Verification and Sign-Off City and transaction advisers expected to sign off the feasibility study after all the analysis has been completed. Description of Assumptions Explanation of Methodologies Description of how assumptions used in constructing financial model are realistic and appropriate Obtain record of methodologies used for valuing various costs, including costs of key risks Ensure that all inputs into feasibility study are signed off as accurate and verifiable by Line Committee, PPP Support Unit and each of transaction advisor specialists Sign-Off on Accuracy of Study

51 Project Management Plan Needs Analysis Options Analysis Due Diligence Financial Analysis Affordability Assessment Value Assessment Economic Analysis Project Viability Verification and Sign-Off Project Management Plan

52 Project Management and Procurement Plan The objective of the Project Management Plan is to summarize the key issues, institutional/approval arrangement and the schedule of activities until the completion of procurement The plan should be part of the feasibility study and agreed by all the committees and agencies involved in the project The plan should contain at least –Project timetable, with key milestones and approvals required –List of potential issues and how they will be tackle –Governance process to be used by the City (incl. decision making) –List of all required approvals from all committees and agencies –Bid evaluation process and teams, and quality assurance process for bud documentation

53 Feasibility Study: Key messages The feasibility study is an essential component of project preparation and allocation of time, as well as human and financial resources, contributes to preventing issues later The need to obtain City approval should not undermine the project attractiveness to the private sector Feasibility study is broader than just a technical assessment The decision to undertake a project as a PPP vs. traditional procurement should be based on value-for-money and affordability assessment Optimal risk allocation contributes to increased Value for Money and does not mean maximum risk allocation to the private sector Early identification of issues and planning of preparation (incl. necessary approvals) save time and money down the road

54 Undertaking PPP Projects: Feasibility Stage THANK YOU !!! Vickram Cuttaree The World Bank vcuttaree@worldbank.org


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