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Risk Assessment for Public-Private Partnerships: A Primer

September 10, 2012

DRAFT
For review by P3 Evaluation Toolkit Beta-Testers

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Chapter 2 - Project Risks in Public-Private Partnerships

This Chapter discusses how the extent of risk transfer varies by type of project (i.e., scope) and what phases and functions of a project are covered by a P3 contract. 

Extent of Risk Transfer by Project Type

P3s can involve existing "brownfield" projects (which is the lease or sale of an existing facility), or they can involve proposed new facilities, which are known as "greenfield" projects. 

For brownfield projects, a public entity generates a capital inflow or debt payoff by transferring the rights, responsibilities and revenues attached to an existing asset to a private sector entity for a defined period.  Risks are significantly lower, since little or no new construction is involved and traffic volumes and toll revenues can be more accurately projected based on existing traffic patterns.

In the case of a greenfield project, a public agency transfers all or part of the responsibility for project development, construction and operation to a private sector entity. Greenfield projects generally present higher risks to both parties than do brownfield projects because of the greater uncertainty surrounding traffic forecasts, permitting and construction. 

In the case of a hybrid project, an existing facility is in need of capital improvement (usually either extension or expansion), and a private sector entity is brought in to finance the necessary improvements and to operate the facility.  While traffic risks may be lower for a hybrid project relative to a greenfield project, they may still be significant due to difficulties in forecasting the users' willingness-to-pay any new or substantially increased tolls that may be proposed to pay for the project.

Extent of Risk Transfer by Type of Public-Private Partnership

P3s encompass a variety of contractual structures, with various degrees of risk transfer to the private sector.  Table 2-1 illustrates the extent of risk transfer in the most common forms of project procurement.

The P3 structure with the lowest level of private sector involvement is Design-Build (DB). Under DB, the same firm is responsible for both design as well as construction of the facility, whereas under the traditional Design-Bid-Build (DBB) approach, separate firms are responsible for design and construction. For both structures, the public agency remains responsible for setting the design specifications and then financing and operating the project. However, a greater amount of risk is transferred to the private sector entity under a DB structure, as the contractor provides a maximum price for both design and construction.

Table 2-1. Procurement Models and Range of Risk Transfer to Private Sector
P3 Structure Design Risk Const. Risk Financial Risk O&M Risk Traffic Risk

Revenue Collection Risk

 

Traditional Design-Bid-Build   X        
Design-Build (DB) X X        
Design-Build-Operate-Maintain (DBOM) X X   X    
Design-Build-Finance (DBF) X X X      
Design, Build, Finance, Operate and Maintain (DBFOM) with toll or shadow toll-based payment X X X X X X
Design, Build, Finance, Operate and Maintain (DBFOM) with availability-based payment X X X X    

Under the Design-Build-Operate-Maintain (DBOM) structure, the private sector entity is responsible for the facility's design, construction, and operations and maintenance (O&M) for a defined period of time. The public agency finances the project.

With a Design-Build-Finance (DBF) structure, the private sector entity is in charge of financing and building the project, but leaves the O&M of the facility to the public agency.

Design-Build-Finance-Operate-Maintain (DBFOM) adds private financing to the design, construction, and O&M of the project. The public agency may have to provide a public subsidy to the project which may require use of bond proceeds or budgetary authority, but the public agency will not usually finance the entire project under this P3 structure. This form of P3 is also called a "concession."

In the case of a toll-based DBFOM concession, the private sector entity shoulders a considerable amount of risk linked to the uncertainty of traffic over the life of the project. The investment decision and the financing structure are determined based on traffic projections; if actual traffic is lower than projected, the private sector partner is exposed to financial loss and to the risk of defaulting on project debt. If traffic and revenue are higher than expected, the private partner could make super profits. In order to protect against this, a revenue sharing clause is usually included in the P3 agreement. In some P3 agreements, the concessionaire may be protected from revenue shortfalls when lower than expected traffic is realized by allowing for "flexible term" concessions and "revenue bands."  With flexible term concessions, the term of the concession ends when a specified net present value (NPV) of the gross toll revenue stream is reached.  With the revenue band approach, upper and lower bounds of the expected toll revenue stream are set contractually.  If toll revenue is below the lower bound, the public sponsor provides a subsidy to make up some of or the entire shortfall. On the other hand, revenues in excess of the upper bound are shared with or turned over entirely to the public sponsor.

Excessive traffic risk can deter private sector entities or reduce their ability to secure financing.  For greenfield projects, traffic volume is more difficult to accurately forecast than for already existing brownfield projects.  Public agencies may therefore modify the P3 structure for greenfield or hybrid projects to offer guaranteed payments to the private sector partner. A shadow toll-based concession allows the public agency to compensate the private sector entity based in part on a "shadow toll" or fee (called a "pass through toll" in Texas) paid by the public agency for each vehicle that uses the facility. Such payments generally have a fixed component that guarantees partial revenue, even if traffic volume were to be below projections.

With an availability payment-based concession, the public agency retains the traffic risk by making payments directly to the private sector partner based on the availability of the facility rather than on the number of vehicles. Payments are contingent on achievement of pre-agreed performance standards.  U.S. examples include the I-595 express lanes in Florida and the Presidio Parkway in California.

 

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