Private Investment in Infrastructure: Dealing with uncertainty in contracts

June 2018, Paris

Dejan Makovšek, Economist, OECD/ITF

What was the WG’s objective?

• Clarify basics – what is the role of with PI?

• Take stock of most recent evidence (does it work?)

• Map how uncertainty matters in contracts

• See how private finance approaches handle uncertainty

• Provide guidance to policymakers

2

What is the role of PI? (I)

3

The state

State Owned (infra) Company

Lenders Road/Railway

users

Construction contractors

Maintenance contractors

Share capital

Repayment

Loan

Tolls/fares

Performance Contracts

When the state is judge and party

4

Road maintenance trends in selected countries, 2005-

2014, (2005=100)

50

60

70

80

90

100

110

120

130

2006 2007 2008 2009 2010 2011 2012 2013 2014

Med

ian

of

ann

ual

ind

ices

Maintenance expenditures in EU-19 (2005=100)

4

Base year

fixed (2005)

Evidence about PI in transport infrastructure

5

?

Mixed/limited experience

Positive

Positive

“Positive” is subject to conditions

+ +

What is the role of PI in transport? (II)

6

Efficiency type Relevance

Productive (cost efficiency)

Allocative (preventing bridges to nowhere)

Dynamic (extending the public borrowing constraint)

X

X

Pursuing PI on the right merits matters!

Competition for the

contract

Credible commitment

to the contract

Proven superior

performance

Public acceptance

of the approach

Why is it important to know what PI can do?

• Making choices about PI on the wrong merits will lead to

adverse outcomes.

8

• Choosing PI on the right

merits is still unsustainable,

if we can’t explain them to

the civil society or provide

evidence!

PI is concentrated in a few countries

Cumulative Private investment in transport infrastructure per European

OECD country and mode, 1995-2016, US$ million

9

>85%

How uncertainty affects contracts?

10

11

Transferred Risk

P = Efficiency

gains - Value for Money x

Transferred Risk x

Project phase bundling (life-

cycle costing), less cost

overruns/delays, …

The nature of any contract is risk transfer

12

Return/Risk

Uncertainty Risk

High losses t

High returns

+

-

Two conditions for efficiency:

1. Credible commitment

2. Competition

When is the price of risk “efficient”

3. Information (about risk)

The starting point

.

13

14

SPV

Uncertainty matters beyond finance

• Observed (median) construction risk for the SPV (outturn

cost vs. contract value at financial close) is zero.

• “Insurance” against construction risk is effective.

Median

-10

0

10

20

30

40

50

60

70

-80 -60 -40 -20 0 20 40 60 80 100 120 140 160 180 200 220 240 260 280

Project finance construction risk - financial close (NATIXIS dataset, n=75, 1993-2012)

Source: Blanc-Brude & Makovsek (2013).

Short-term contracts and complexity (I)

What if we place a very strict requirement (e.g. 100 %

insurance) on an agent (contractor) with limited risk info?

16

Impact

Pr(x) Median (full

diversification)

EUR 100 m EUR 70 m EUR 190 m

Winning bid for a

fixed price contract?

High-powered incentives and risk?

Short-term contracts and complexity (II)

Applying a fixed price contract on a complex project

• Construction risk: risk premium in roads above ex-post risk

(+20% in EU), LCC does not explain diff.)

17

Traditional procurement

Public-Private Partnership

Total cost

Cost overrun Cost at contract signature

Unexplained

cost difference?

Source: Makovšek & Moszoro 2018.

18

The accessibility to jobs within 30 minutes in Lisbon – current and in

the “taxi-bot” model

ITF (2016).

Long-term contracts – disruptive events

19

New market entrants

• 20% of them now offered lower

bids (bid more aggressively)

• On average they stayed longer

in the market (+37%).

The market

(bidders) Additional info

(less uncertainty)

What happens if more information is made available to the

bidders? (e.g. publication of a detailed cost estimate)

How does uncertainty matter - competition

Source: De Silva et al (2009).

Uncertainty in contracts matters beyond risk pricing!

20

Contract

signature

Risk pricing

Competition

Circumstance surprises

Uncertainty

Project ↑E(revenues) ↓E(cost)

LT contract execution

LT contracts, complexity, and unknown unknowns

21

Year 20

End of

contract

Competition

for the

contract Market type A

Roads, hospitals,

railways, schools…

Market type B

Sea ports, airports,

…

Reducing risk pricing inefficiency in the construction phase

• Greater information provision upfront (e.g.

fully costed reference design)

• Use of select collaborative principles during

bid preparation (e.g. joint-risk register)

• A critical need to build in-house capacity (e.g.

IPA/UK, Sund&Belt Partner/DK…)

• ….

22

How to ensure continuous pressure for efficiency in a monopoly?

Inefficiency

t

Traditional procurement/management

Competition for the contract

Outturn efficiency

PPP

A bet on the future

Inefficiency

t

Traditional procurement/management

Incentives (targets/resets)

Outturn efficiency

RAB

A series of smaller/short term bets on the future

Thank you! Dejan Makovšek, Economist Procurement and Private Investment in Infrastructure Lead

International Transport Forum at the OECD

dejan.makovsek@itf-oecd.org