Presentation on theme: "Brussels, June 27, 2008 Guide to COST-BENEFIT ANALYSIS of investment projects Structural Funds, Cohesion Fund and Instrument for Pre-Accession NEW EDITION."— Presentation transcript:
1 Brussels, June 27, 2008Guide to COST-BENEFIT ANALYSIS of investment projects Structural Funds, Cohesion Fund and Instrument for Pre-AccessionNEW EDITION 2008
2 The New EditionThe present Guide updates and expands the previous edition (2002), which in turn was the follow up of a first brief document (1997) and of a subsequent substantially revised and augmented text (1999).The new edition builds on the considerable experience gained through the dissemination of the previous versions and particularly after the new investment challenges posed by the enlargement process.The objective of the Guide reflects a specific requirement for the EC to offer guidance on project appraisals, as embodied in the regulations of the Structural Funds, the Cohesion Fund, and Instrument for Pre-Accession Assistance (IPA).
3 The CBA Guide TeamProfessor Massimo Florio, Scientific Director, CSIL and University of MilanDr. Silvia Maffii, Project Coordinator, TRTScientific AdvisorsDr. Giles Atkinson, London School of Economics and Political Science (UK)Professor Ginés De Rus, University of Las Palmas (Spain)Dr. David Evans, Oxford Brookes University (UK)Professor Marco Ponti, Politecnico, Milano (Italy)Project evaluation expertsMario GencoRiccardo ParolinSilvia VignettiResearch assistantsJulien BollatiMaurizia GiglioGiovanni PanzaDavide Sartori
4 Table of contents (1) Introduction and Summary Chapter 1 - PROJECT APPRAISAL IN THE FRAMEWORK OF THE EU FUNDS1.1 CBA scope and objectives1.2 Definition of projects1.3 Information required1.4 Responsibility for project appraisal1.5 Decision by the CommissionChapter 2 - AN AGENDA FOR THE PROJECT EXAMINER2.1 Context analysis and project objectives2.2 Project identification2.3 Feasibility and option analysis2.4 Financial analysis2.5 Economic analysis2.6 Risk assessment2.7 Other project evaluation approaches: CEA, MCA and EIA
5 Table of contents (2)Chapter 3 - OUTLINES OF PROJECT ANALYSIS BY SECTOR3.1 Transport3.2 Environment3.3 Industry, energy and telecom3.4 Other sectorsChapter 4 - CASE STUDIES4.1 Investment in a motorway4.2 Investment in a railway line4.3 Investment in an incinerator with energy recovery4.4 Investment in a waste water treatment plant4.5 Industrial investment
6 Table of contents (3) ANNEXES GLOSSARY BIBLIOGRAPHY A: Demand analysis B: Discount ratesC: Project performance indicatorsD: Shadow wageE: Affordability and evaluation of distributive impactF: Evaluation of health and environmental impactsG: Evaluation of PPP projectsH: Risk assessmentI: Determination of EU grantJ: Table of contents for a feasibility studyGLOSSARYBIBLIOGRAPHY
7 Introduction and Summary The introductory chapter presents the motivations, ambitions and some caveats of the suggested approach.At the same time, it offers a concise summary of its key ingredients, both in terms of methodological assumptions and of some benchmark parameters.
8 Chapter 1Chapter one provides a reminder of the legal base for the major project and co-financing decisions by the Commission, highlighting the main developments from the period :CBA scope and objectivesDefinition of projectsInformation requiredResponsibility for project appraisalDecision by the Commission
9 STEP 1. Admissibility check Commission Services ManagingauthoritySTEP 1. Admissibility check Commission ServicesManaging authority submits the application form AND encoded informationThe project is complete.PROJECT ADMITTED TO APPRAISALThe methodology is not consistent in some pointsCBA RESULTS ARE UNRELIABLEThe methodology is soundCBA RESULTS ARE RELIABLEThe Commission asks for missing informationSTEP 2. Methodology check(Commission services in consultation with EIB and external consultants if necessary)The Commission asks for explanation/revisionsThe project is not desirable from a socio-economic point of viewSTEP 3. Commission decisionThe project is rejectedThe application form and the encoded information is not complete.PROJECT INADMISSIBLEThe project is not co-financedCalculation of EU grantA major projects enters within the indicative list of the OPThe project is desirable from a socio-economic point of viewThe project is not in need of co-financingThe project is in need of co-financingFurther assessment of the Commission services on the basis of information other than CBA
10 Chapter 2Chapter 2 illustrates the standard methodology for carrying out a CBA.It reviews the key information and the six analytical steps that a project examiner should consider for investment appraisal under the EU (Structural, Cohesion, IPA) Funds.It is structured as a suggested agenda and check-list for the Member States and Commission officials or for the external consultants who are involved in assessing or preparing a project dossier.
12 1. Context analysis & Objective definition The first logical step is a qualitative discussion of the socio-economic context and the objectives that are expected to be attained through the investment.This discussion should include consideration of the relationship between the project objectives and the priorities established in the Operational Programme, the National Strategic Reference Framework and consistency with the goals of the EU Funds:Socio-economic contextDefinition of project objectivesConsistency with EU and National frameworks
13 2. Project identification Identification means that :the object is a self-sufficient unit of analysis, i.e. no essential feature or component is left out of the scope of the appraisal (“half a bridge is not a bridge”);indirect and network effects are going to be adequately covered (e.g. changes in urban patterns, changes in the use of other transport modes);whose costs and benefits are going to be considered (‘who has standing’?).
14 3. Feasibility and Option analysis A typical feasibility analysis should ascertain that:the local context is favourable to the project (e.g. there are no physical, social or institutional binding constraints),the demand for services in the future will be adequate (long run forecasts),the appropriate technology is available,the utilisation rate of the infrastructure or the plant will not reveal excessive spare capacity,personnel skills and management will be available.
15 3. Feasibility and Option analysis The next step consists of identifying the range of options that can ensure the achievement of the objectives.The basic approach of any investment appraisal aims to compare the situations with and without the project.To select the best option, it is therefore helpful to describe a baseline scenario. This will usually be a forecast of the future without the project, i.e. the ‘business as usual’ (BAU) forecast.Once the BAU scenario and a small number of ‘do-something’ alternatives have been identified, simplified CBA should be carried out for each option in order to rank them and choose the most promising.
16 4. Financial analysisThis should be based on the discounted cash flow approach. The EC suggests a benchmark real financial discount rate of 5%.A system of accounting tables should show cash inflows and outflows related to:Total investment costsTotal operating costs and revenuesFinancial return on the investment costs: FNPV(C) and FRR(C)Sources of financingFinancial sustainabilityFinancial return on national capital: FNPV(K) and FRR(K)
18 Investment costsResidual value should always be included at end year. It is considered with a positive sign in this table because it is an inflow, while all the other items are outflows.These are funds, not flows
19 Operating costs & Revenues During the investment phase no operating revenues and costs occur.
20 Financial return on investment Financial rate of return on investment is calculated considering total investment costs and operating costs as outflows and revenues as an inflow. It measures the capacity of operating revenues to sustain the investment costs.A discount rate of 5% has been applied to calculate this value.
21 Sources of financingLoan is here an inflow and it is treated as a financial resource coming from third parties.
22 SustainabilityLoan here is considered at the moment it is reimbursed as an outflow.Financial sustainability is verified if the cumulated net cash flow row is greater than zero for all the years considered.
23 Financial return on capital Financial internal rate of return on national capital is calculated with outflows including the national (public and private) capital when it is paid up, the financial loans at the time they are paid back, in addition to operating costs and related interest, while with revenues as inflows. It does not consider the EU grant.
25 5. Economic analysisCBA requires an investigation of a project’s net impact on economic welfare. This is done in five steps:Observed prices or public tariffs are converted into shadow prices, that better reflect the social opportunity cost of the good.Externalities are taken into account and given a monetary value.Indirect effects are included, if relevant (i.e. not already captured by shadow prices).
26 5. Economic analysis(2)Costs and benefits are discounted with a real social discount rate (5.5% for Cohesion and IPA countries, and for convergence regions; 3.5% for Competitiveness regions).Calculation of economic performance indicators: Economic Net Present Value (ENPV), Economic rate of return (ERR) and the benefit-cost ratio (B/C).
28 The Shadow WageIn an economy characterised by extensive unemployment or underemployment, the opportunity cost of labour used in the project may be less than the actual wage rates.Under severe unemployment conditions and very low public unemployment benefits, the shadow wage may be inversely correlated to the level of unemployment.
29 Examples of Externalities Benefits:Advantages in terms of reduction of risk of accidents in a congested urban area as an effect of a project for the re-location of a manufacturing plant.Individuals consuming vaccine against the influenza virus. Those who do not vaccinate themselves receive the benefit of a reduced prevalence of the virus in the community.Costs:Water pollution by industries that adds poisons to the water, which harm plants, animals, and humans.When car owners freely use roads, they impose congestion costs on all other users and harmful emissions to pedestrians .
30 Focus: Environmental Externalities Three main methodologies can be applied for estimating the monetary value of changes in environmental goods:Revealed Preference MethodsStated Preference MethodsBenefit Transfer Method
32 Social Discounting r = eg + p A generally used formula for estimating the social discount rate from the growth rate can be expressed as follows:r = eg + pwhere:r = real social discount rate of public funds expressed in an appropriate currency;g = is the growth rate of public expenditure;e = elasticity of marginal social welfare with respect to public expenditure;p = rate of pure time preference.
34 6. Risk assessmentA project appraisal document must include an assessment of the project risks. Again, five steps are suggested:Sensitivity analysis: identification of critical variables, elimination of deterministically dependent variables, elasticity analysis, choice of critical variables, scenario analysis.Assumption of a probability distribution for each critical variable.
35 6. Risk assessment (2)Risk analysis: calculation of the distribution of the performance indicator, typically FNPV and ENPV).Discussion of results and acceptable levels of risk.Discussion of ways to mitigate risks.
40 Other evaluation approaches Cost-effectiveness analysisMulti-criteria analysisEconomic Impact AssessmentThese approaches should be see as a complement of CBA and NOT as a substitute.
41 Chapter 3 Chapter 3 includes outlines of project analysis by sector. The outlines are based on the approach described in Chapter 2 and follow the suggested steps. Each sector presents a general description of possible project objectives as well as the main inputs for the financial and economic analysis.As uncertainty and risk concerning variable trends and values are important points to be considered when appraising investment projects, a list of the most critical factors has been included for each sector.
42 Chapter 3 Transport Environment Industry, Energy and Telecommunication Transport networksCBA of High Speed Rail investment in EuropePorts, airports and intermodal facilitiesEnvironmentWaste treatmentWater supply and sanitationNatural risk preventionIndustry, Energy and TelecommunicationIndustries and other productive investmentsEnergy transport and distributionEnergy production and renewable sourcesTelecommunications infrastructuresOther sectorsEducation and training infrastructuresMuseums and cultural sitesHospitals and other health infrastructuresForests and parksIndustrial zones and technological parks
43 Transport – Project Objectives reduction of congestion by eliminating capacity constraints on single network links and nodes, or by building new and alternative links or routes;improvement of the performance of a network link or node, by increasing travel speeds and by reducing operating costs and accident rates through the adoption of safety measures;shift of the transport demand to specific transport modes;completion of missing links or poorly linked networks;improvements in accessibility for people in peripheral areas or regions.
44 Transport – Project Identification Typology of investments:New infrastructures (road, rail, ports, airports) to satisfy increasing transport demandCompletion / extension/ renovation of an existing infrastructureInvestment in safety measures on existing links or networksImproved use of the existing networks (i.e. better use of under-utilised network capacity)Improvement in intermodality (interchange nodes, accessibility to ports and airports)Improvement in networks interoperabilityImprovement in the management of the infrastructure
45 Transport – Demand and GDP There is a strong positive correlation between GDP and the distance travelled by passengers and goods: goods transport tends to grow faster than GDP while, at least recently, passenger demand has tended to grow at a slower rate. In terms of elasticity, goods elasticity to GDP is above 1 while for passengers it is below 1.
47 Transport – Economic Analysis Variations in the consumer’s surplus: change in generalised transport costs, which incorporate the money costs travel, (i.e. the perceived cost: fares, tariffs and tolls, and vehicle costs perceived by the users);Variations in road user producer’s surplus: the unperceived costs (e.g. tyres, maintenance and depreciation) of the private the road users enter into the calculation of the road users producer’s surplus as they are considered as producers of the services they supply to them selves (car users) or to their customers (trucks);Variations in operator producer’s surplus: profits and losses of infrastructure managers, if available, and transport service operators;Variations in taxes and subsidies for the government;Variations in external costs (emissions, noise, etc.).
48 Transport – Economic Analysis (2) HEATCO recommended values of travel time savings
49 Transport – Economic Analysis (3) DG TREN recommended values for CO2 emissions
50 Transport – Economic Analysis (4) HEATCO recommended values for casualities avoided
51 Transport – Risk assessment Critical factors-Investment and operating cost overrunsImplementation timeTransport demand (optimism bias)Competition with other existing infrastructureMainvariablesto considerAssumption on GDP andOther economic variables trendRate of increase of traffic over timeValue of timeNumber of years necessary for the realization of the infrastructureNumber of years necessary for the full efficiency of the infrastructureInvestment costs (disaggregate)Maintenance costsPricing policiesRegulatory policies
52 Waste – Project Objectives Specific objectives involve:The development of a modern local and regional waste management sector;The reduction of health risks linked to an uncontrolled management of municipal and industrial waste;The curbing of raw material consumption and the planning of the final phases of material production and consumption cycles;The reduction of polluting emissions such as water and air pollutants;Innovation in technologies for waste collection and treatment.
53 Waste – Project Identification The main types of waste management facilities are:Investments in facilities for the collection, temporary storage and recycling of waste (whether collected separately or not), such as municipal collection centres.Compost production facilities.Investment in facilities for physical and chemical treatments, such as oil waste treatment facilities.Household and industrial waste incineration plants and incinerators (with or without combined heat and power).Landfill sites.
55 Waste – Demand Analysis The estimation will often be based on:the evaluation of the production by type of waste and by type of producer, in the geographical area of the project;present and expected changes in national and European norms in waste management.The evaluation of the future demand for municipal waste management will take into account the demographic growth and the migratory flows. For industrial waste, the key parameter will be the expected industrial growth in relevant economic sectors.
57 Waste – Economic Analysis The main benefits and costs are as follows:BenefitsThe treatment of waste, which minimises impacts on human health, urban environment, etc. (do nothing alternative)Energy recoveryCostsImpacts on human health (morbidity or mortality due to air, water or soil pollution)Environmental damages induced such as water and soil contaminationsAesthetic and landscape impacts and the economic impacts, such as changes in land prices or economic development induced by the projectImpacts on mobility, existing infrastructures and so on, due to the increase in local traffic deriving from the waste transported to the landfill or treatment plant
58 Waste – Risk Assessment Critical factorsDemand elasticityKey input dynamic costsRecovered product pricesCosts of remediation and other environmental costsMainvariablesto considerThe change in demand for waste disposal related to the diffusion of new products or new technologiesThe change in behavioursThe variation in economic or population growth or decreaseEnergy costsRaw materials costsVariations in the sales price of recovered productsThe dynamics of costs over time of some goods and critical services for certain projectsThe cost of electricityThe cost of fuelThe cost of remediation and decontamination of the sites
59 Water – Project Objectives The investments in the sector may be grouped into two project categories:The projects intended to promote local development. In this case, the specific objectives are the population that will be served and the average resource availability (litres/inhabitant*day) or the hectares which shall be irrigated, the types of crops, the average expected production, the resource availability (litres/hectare*year), the time and periodicity of waterings, etc.The projects intended to promote a regional or interregional development. In this case, the specific objectives shall also refer to the volumes made available (millions of cubic metres per year), the maximum conveyed flow rates (litres/second) and the overall capacity of the long-term resource regulation.
60 Water – Project Identification Civil servicesinfrastructures and/or plants serving high-density urban areas,infrastructures and/or plants serving the districts of towns or villages,infrastructures and/or plants serving small (agricultural, mining, tourist) settlements and/or isolated houses,infrastructures and/or plants serving high-density industrial settlements and/or industrial areas,rural aqueducts.Irrigation servicedistrict aqueducts for collective irrigation,local aqueducts for individual or small-scale (oasis-like) irrigation.Industrial servicedistrict aqueducts, sewage nets and depurators for large industrial areas, industrial districts, technological parks or similar industrial concentrationslocal infrastructures for individual factories and for small craft/industrial areas.Mixed serviceaqueducts for irrigation and civil and/or industrial service,industrial and civil aqueducts.
61 Water – Demand Analysis The demand for water may be broken down into separate components according to the use (demand for drinking water, for irrigation or industrial purposes, etc.), and the timing of demand (daily, seasonally, etc.).Demand is fundamentally made up of two elements:the number of users (civil use), the surfaces that will be irrigated (agricultural use) or the production units which shall be served (industrial use);the quantity of water, that is being or will be delivered to users for a given period of time;
62 Water – Demand Analysis (2) Identification of requirementsDefinition of usersContext analysis (reconnaissances, historical analyses, field studies, etc.)Tariff policies Regulatory framework Price and income elasticity of demandDefinition and evaluation of requirements (Potential demand)Definition and evaluation of consumption (Actual demand)Forecast estimated for the project life cycleCoverageCheckIndirect socio-economic benefitsDirect socio-economic benefitsEnvironmental sustainability analysisMarket prices Shadow prices Availability
63 Water – Option Analysis The analysis should include a comparison with:the BAU scenario;the possible alternatives within the same infrastructure, for example:different location of wells,alternative routes for aqueducts or trunk lines,different building techniques for dams,different positioning and/or process technology for plants;the possible alternatives of sewage drains (lagoons, different receptors, etc.);the possible global alternatives, for example: a dam or a system of crosspieces instead of a wells field or the agricultural re-utilisation of properly treated sewage.
64 Water – Financial Analysis Financial inflowsFinancial outflowsTariffs or fees applied for the water servicesPossible reimbursements for the collection and transport of rainwaterPossible proceeds for the sale of water in case of reusePrices of any additional service the utility may offer to the user (for example hooking up, periodic maintenance, etc.)Investment costsLand acquisitionWorksEquipmentsLegal feesStart-up costsOperating costsEnergyMaterialsServicesTechnical and administrative personnel costsMaintenance costs
65 Water – Economic Analysis The main benefits can be identified as follows:Water supply projects with the aim of increasing the quantity and/or the reliability of water supply for civilian uses, irrigation and industrial purposes: the benefit is equal to the water demand satisfied by the project and not satisfied in the do-nothing alternative.Water supply projects with the aim of protecting the resources of high quality and environmental value: the benefit is given by the water preserved for other uses, current or future.Interventions aimed at limiting water leaks: the benefit is the reduced volume of water used for supplying the networks compared to an equal or greater quantity of distributed water.
66 Water – Economic Analysis (2) Interventions intended to guarantee the availability of drinking resources in areas with sanitary problems: the benefit may be directly estimated by valuing the deaths and illnesses that can be avoided by means of an efficient water supply service.Sewer and depurator projects: the benefit may be evaluated on the basis of the potential demand for sewage, which will be fulfilled by the investment and estimated according to an adequate accounting price.
67 Water – Risk Assessment Critical factorsThe forecasts of the demand dynamicsThe rate of change in tariffs or fees, largely dependent upon the decisions taken by the national or regional regulatory bodiesThe lack of capacity to respond to shocks (which often requires excess capacity in the first operating periods)The determining influence of collateral interventions (for example, the effectiveness of water supply is strictly related to the good state of repair of distribution networks)The dynamics of costs over time of some critical goods and services for certain projectsMainvariablesto considerThe cost of the investmentThe rate of demographic growthThe forecasts of any migration flowThe development rate of crops and the national and/or international dynamics of the sale prices of agricultural products (for irrigation purposes)The variation in tariffs or fees over a period of timeThe demand and price dynamics of the water that may be recovered in case of reutilization;The operating costs (maintenance, management, etc.)The cost of fuels and/orThe cost of electric energy for desalination plantsThe cost of chemical additives and the mud disposal cost for depurators
68 Industry – Project Objectives The co-financing of productive investments usually has the following objectives:encouraging the industrialisation of specific sectors in areas that are relatively backward;developing new technologies in specific sectors or applying more promising technologies which require a high initial investment;creating alternative employment in areas where there has been a decline in the existing productive structure.
69 Industry – Project Identification The first essential aspects to be covered are:a description of the company proposing the investment project (multinational, local, SME cluster, etc.);the sector in which the company intends to operate (hi-tech, innovative, mature, traditional);the nature of the intervention (new plant, modernisation or expansion of existing plants).
70 Industry – Feasibility Analysis The feasibility of the project should be verified evaluating both the technological features (e.g. the production technologies employed) and the economic/financial ones (the financial solidity and the economic efficiency of the company and the possible dynamics of the product market).Moreover, it could be important to make a more in-depth analysis with regard to the:Management skills and capabilities;Organisational activities described in the business plan supplied by the companies, like logistics, supply chain and commercial policies.
71 Industry – Option Analysis The options analysis should consider:LocationAlternative methods of financing (e.g. financing the interest account instead of the capital account, financing a leasing contract, or other methods of financing)Technical or technological alternatives to the proposed project and the global alternatives (e.g. supplying low-cost real services)
73 Industry – Economic Analysis Investments in the industrial sector usually exhibit a better financial and economic performance than investments in other sectors.The main external costs and benefits are related to the environmental impact of the investment. A new plant will increase air pollution because of polluting emissions; on the contrary, for example, a project involving the renovation or conversion of an old plant, could reduce emissions.Other non-financial costs and benefits can come from the improvement or deterioration in the safety conditions faced by the workers.
74 Chapter 4 The case studies include: This chapter presents five case studies providing worked examples of the methodology presented in the previous chapters.The case studies include:Investment in a motorwayInvestment in a railway lineInvestment in an incinerator with energy recoveryInvestment in a waste water treatment plantIndustrial investment
75 Motorway“Recent developments in a Convergence region has been accompanied by fast growth in the volume of traffic along the corridor between two medium size urban areas. [..]Congestion problems are expected to increase in the future due to the foreseen growth in both passengers and freight transport demand. Furthermore, the existing network runs across the most densely populated areas of the region thus causing serious environmental and safety problems for the people living in the area.For these reasons, the planning authority has proposed to assess the feasibility of a new motorway link by-passing the more densely urbanised areas. The main objectives of the project are therefore to reduce future congestion and to limit the population exposure to transport emissions.”
78 Railway“A government of a country eligible for Cohesion Fund assistance has planned to improve the rail connection along a corridor that runs across one of its most densely populated regions.Currently the transport supply in that area includes a relatively old single-track railway line, 215 km in length and a well developed, but congested road network. Road congestion particularly affects the network near the main cities and the railway line cannot offer a competitive service: train speed is low and the services provided are unreliable.The main objective of the project is to develop a high-quality rail connection for passengers and freight by improving the existing line. ”
80 Incinerator“A municipality proposes to build a new incineration plant to treat together urban and any special (not recycled) waste. The plant recovers energy in the form of electricity and heat with the latter used for industries and houses by means of an existing district heating net. Some recyclable waste components are selected and recovered in the plant before burning.The project takes place in a convergence region in a Country not eligible for the Cohesion Fund.”
82 Waste water treatment plant “The project is an investment in the field of waste water treatment, and for the reuse of well purified waste water for multiple purposes after an intensive tertiary treatment. It takes place in a Convergence region in a country eligible for the Cohesion Fund.The project includes the construction of a new water purifier, in keeping with current regulations, to serve a medium-sized city. Currently wastewater is discharged untreated into the river crossing the city.”
83 WWPT – Financial Performance FNPV(C) – € 29,083,911FRR(C) 1.9%FNPV(K) – € 8,357,812FRR(K) 3.7%Public partner of the PPP (municipality):FNPV(Kg) € 3,491,008FRR(Kg) 7.8%Private partner of the PPP (operator firm):FNPV(Kp) € 5,139,536FRR(Kp) 6.5%
85 Industrial investment “ In order to assist a Convergence Region development strategy in a Cohesion Country, the government decided to co-finance an industrial investment project.The objective of the project support is to pursue the productive base of the region in the manufacturing sector as a growth catalyst for economic development.The government identified an investment in the automotive supply-chain sector. This industry guarantees a reasonably safe financial return and at the same time it assures an improvement in the technological level of the regional industrial structure.”