undertaking ppp projects: feasibility stage vickram cuttaree the world bank st. petersburg – may...

Undertaking PPP Projects: Feasibility Stage

Vickram Cuttaree

The World Bank

St. Petersburg – May 23, 2008

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

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 pay2. Delays in procurements often linked to important legal

review not done prior to bidding stage

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

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

Needs Analysis

Needs Analysis

Options Analysis

Due Diligence

Financial Analysis


Value Assessment

Economic Analysis

Project Viability



Purpose of Needs Analysis

• An important objective is to ensure that the project is in line with the City’s 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 todeliver and specify the minimum standards for

the output

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

Options Analysis

Needs Analysis

Options Analysis

Due Diligence

Financial Analysis


Value Assessment

Economic Analysis

Project Viability



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 City’s output specifications, reject unviable options, and choose the best solution

for further examination

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

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…)

Due Diligence

Needs Analysis

Options Analysis

Due Diligence

Financial Analysis


Value Assessment

Economic Analysis

Project Viability



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

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

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

Financial Analysis

Needs Analysis

Options Analysis

Due Diligence

Financial Analysis


Value Assessment

Economic Analysis

Project Viability



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

Construction of Financial Model

Step 1: Technical definitionof project

Step 2: Identifying directcosts

•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…)


Step 3: Identifying indirectcosts

Step 4: Identifying projectrevenue

•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 project’s ability to invoice and collect revenue – beware of revenue over-estimation


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 project’s 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


Step 7: The Base Casemodel

•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


Step 9: Adjusting PPPModel 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

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

Equity IRR on dividends distributed (in Rbl)

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%



Model used to determine project attractiveness to the private sector: Financial sustainability

Model: Debt Service Coverage Ratio (DSCR)

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0.50

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3.00

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DSCR


Model: Sources and Use of CF

-600,000,000

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0

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600,000,000

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K

Operating Revenue Gvt Debt Subsidies Government DSCR Subsidies Debt disbursement Debt Principal Repayment

Debt Interest Repayment Capital Expenditure Operating Expenses Govt Counterpart

Model used to determine financial contribution by City



Example of output: assessment of minimum toll rate (US$ per km) for a highway PPP based on

construction costs

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0.1

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1 1.5 2 2.5 3 3.5 4 4.5 5

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


Needs Analysis

Options Analysis

Due Diligence

Financial Analysis


Value Assessment

Economic Analysis

Project Viability



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

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

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

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 revenue’s 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

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

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 don’t 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

Value Assessment

Needs Analysis

Options Analysis

Due Diligence

Financial Analysis


Value Assessment

Economic Analysis

Project Viability



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

How to determine Value-for-Money

QUALITATIVE ASSESSMENT

Project has efficiencies that private sector can provideThere is a suitable competitive market

Risk can be transferred to the private sector

QUANTITATIVE ASSESSMENT

Development of Public Sector Comparator (PSC)

Illustration: Using PSC to Assess VfM

Rubles

PSC

A B

Risk AdjustedPSC

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

Example of PSC Calculation: Base PSC

Note: Table for illustrative purposes only – does not correspond to any existing project

Example of PSC Calculation: Risk Valuation


Example of PSC Calculation: Risk Adjusted PSC Model


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

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 itIf 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

Economic Analysis

Needs Analysis

Options Analysis

Due Diligence

Financial Analysis


Value Assessment

Economic Analysis

Project Viability



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

Stages of Economic Analysis

Determine economic costsof project

Calculate EIRR and ENPV

Determine major assumptions for

economic analysis

Estimate economicbenefits

Project Viability

Needs Analysis

Options Analysis

Due Diligence

Financial Analysis


Value Assessment

Economic Analysis

Project Viability



Project Viability

The project is viable if it is

1. Technically deliverable2. Socially and Environmentally sustainable3. Financially viable to investors4. Affordable to users5. Affordable to the City6. Provides Value for Money to the City7. Economically viable


Needs Analysis

Options Analysis

Due Diligence

Financial Analysis


Value Assessment

Economic Analysis

Project Viability




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


Needs Analysis

Options Analysis

Due Diligence

Financial Analysis


Value Assessment

Economic Analysis

Project Viability



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

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

Undertaking PPP Projects: Feasibility Stage

THANK YOU !!!

Vickram CuttareeThe World Bank

[email protected]

undertaking ppp projects: feasibility stage vickram cuttaree the world bank st. petersburg – may...

Documents

options analysis listing

purpose of needs analysis

demand analysis legal

output slide

financial options

objective of project

weak demand analysis

new capacity option