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PPP International Best Practice and Regional Application Tegucigalpa, Honduras April 23 - 25, 2008 PPP International Best Practice and Regional Application Tegucigalpa, Honduras April 23 - 25, 2008 Sponsored by the Spanish Trust Fund

Case Study Session 5. 1 Highways Sabino Escobedo, TAG Financial Advisors Case Study Session 5. 1 Highways Sabino Escobedo, TAG Financial Advisors

Session 5. 1 Day 2 – Session 6 Readiness of Government Upstream Policy Readiness Session 5. 1 Day 2 – Session 6 Readiness of Government Upstream Policy Readiness of Government Private Sector View Day 1 - Session 5 Day 2: Session 5 Case Studies: Case Study: (1)Highways (2)Water. Highways & Sanitation (3) Ports Day 1: Session 1. 1 Capacity Building For PPP Overview of PPP Day 1: Session 1. 2 Challenges: Latin America Day 1: Session 1. 3 Considering Private Participation PPP Approach Day 1: Session 2. 1 Day 1: Session 3 Case Study: Transmission Day 2 : Session 4. 2 Selecting an Operator Day 2 : Session 4. 1 Day 1: Session 2. 3 Standards, Tariffs, Subsidy, Financials Involving Stakeholders Planning the Process Day 1: Session 2. 2 Regulation & Institutions

Session 5. 1 PPP’s in the Transport Sector • PPP’s in the Sector • Session 5. 1 PPP’s in the Transport Sector • PPP’s in the Sector • Case Studies

Developing Effective PPPs in the Transport Sector Main Objective: Mobilize Private Capital and Management Developing Effective PPPs in the Transport Sector Main Objective: Mobilize Private Capital and Management into Transport Infrastructure Development

Contents § Transport Infrastructure Investment Ø The Economics of Transport Infrastructure Ø Fiscal Space Contents § Transport Infrastructure Investment Ø The Economics of Transport Infrastructure Ø Fiscal Space (Public Investment) Ø The Real Gap : Cost Recovery and Affordability Ø Key Drivers of our clients demands § Public Private Partnerships (PPPs) Ø Leveraging Public Money Ø Public Sector options for Infrastructure investment Ø Risk Assessment and Risk Allocation § Bank’s response to infrastructure finance needs Ø The shift in development burden from central to local entities Ø Performance based subsidies Ø Innovative risk mitigation products § Way Forward

The Economics of Transport Infrastructure Investments § Infrastructure investments are inherently “lumpy” (involve huge The Economics of Transport Infrastructure Investments § Infrastructure investments are inherently “lumpy” (involve huge sunk costs and create assets that are long-lived and location-specific). § Creation of Infrastructure has economics both of scale and scope (i. e. , minimum size of facilities, inelastic adjustment of capacity to demand, long term project completion, etc. ). § Infrastructure supply systems contain elements of natural monopoly (competition). § Demand is wide spread (difficult to target). § Revenues are usually in local currency (mismatch if foreign debt financing). § Transport services have an essentiality component that raise legitimate public policy concerns of affordability. § However ………. . § Sound transport infrastructure allows countries to integrate to the global economy and increases competitiveness (transport and telecom sectors are the highest contributors to a country’s competitiveness) impacting economic growth. § Transport infrastructure development has a strong impact on competitiveness, growth, poverty alleviation and MDGs.

Fiscal limits to increased public investments in infrastructure § § § § Public Investments Fiscal limits to increased public investments in infrastructure § § § § Public Investments needs are sizeable in most countries but difficult to quantify. Countries face important trade-offs between infrastructure spending and other expenditure items (i. e. , health and education). Little empirical evidence that reductions in public investments had an adverse impact on growth. Countries with relatively high public debt burden have a limited scope for increasing investment via public borrowing. Significant scope to improve the quality of infrastructure investment. Changes in fiscal accounting cannot create room for additional spending for infrastructure. Most of the public enterprises in the pilots did not meet the “commercially run” criteria. Effective PPPs is encourage as a way to bring in leveraging and efficiency in infrastructure investment.

The Service Delivery Gap § § There is limited affordability in the provision of The Service Delivery Gap § § There is limited affordability in the provision of most of infrastructure services (when including the costs of the required infrastructure facilities), specially when considering low income end-users. The Service Delivery Gap Tariffs Cost recovery Infrastructure services has strong characteristics as a public good and creates major positive externalities. Full cost recovery is only possible in some situations (i. e. , air transport). Most of the basic public services have strong limitations to reach full cost recovery even in developed markets (mass transport systems). There is a role for the provision of “smart” subsidies to make possible the delivery of the service. Affordability Time Output Based Aid Approaches

Key Drivers for Client Demands § Change in the risk profile of our client Key Drivers for Client Demands § Change in the risk profile of our client base: • 80 s : developed and developing countries • 2000 s forward: Ø Ø Middle Income Countries Transition Economies Post Conflict Failed States § Need to fill the service delivery gap (full cost recovery not possible at the required pace for market driven incentives to support investments) § Fiscal Space for Public Investments will be limited at best (limited new borrowing capacities to allocate to infrastructure development)

Leveraging Public Money • Need to reconcile infrastructure development needs with criteria for fiscal Leveraging Public Money • Need to reconcile infrastructure development needs with criteria for fiscal prudence. • Need to mobilize additional private capital to match the gap if infrastructure development is to keep its pace sustaining economic growth. • Need to maximize private capital mobilization per unit of public sector contribution (e. g. , direct investment, subsidies, guarantees, etc. ). • Need to develop PPPs approaches as a procurement tool for better and efficient allocation of scarce public sector resources (the concept of value for money). • Need to develop an adequate risk management framework to manage contingent liabilities arising for public money support to PPPs development.

PPPs : Spectrum of Options Transport Infrastructure Facilities Provision of Transport Services PPPs : Spectrum of Options Transport Infrastructure Facilities Provision of Transport Services

PPPs in Transport • Pure Public Option: Ø Ø Ø Funded via ordinary revenues PPPs in Transport • Pure Public Option: Ø Ø Ø Funded via ordinary revenues Funded via earmarked taxes (i. e. , gas taxes for road network development) Funded via public debt financing (i. e. , future tax payers) • Public Private Partnerships Options: Ø Ø Ø Funded via tolls or tariffs (i. e. , full cost recovery basis) Funded via tolls or tariffs with initial co-investment contribution (e. g. , Bridge Rosario-Victoria, Argentina) Funded via tolls or tariffs with minimum revenue guarantee (e. g. , Motorway Santiago-Valparaiso, Chile) Funded via tolls or tariffs with supplemental subsidies (e. g. , BA metro system) Funded via shadow tolls or subsidies (e. g. , Portugal toll roads)

Public Sector Options for Infrastructure Investments SSA Toll Roads Case (1): • Parameters: – Public Sector Options for Infrastructure Investments SSA Toll Roads Case (1): • Parameters: – 40 KM toll road linking two important urban centers (existing road under very poor conditions) – Traffic Study : 70, 000 vehicles per day – Total Investment : $ 200 million – Annual operating & maintenance costs: 5% of total investment ($ 10 million) – SSA Credit Rating: B+ – If private options are considered: • Debt : Equity ratio : 75%-25% • Debt services conditions: 10 year @ 10% • Equity expected rate of return: risk free rate + premium = 5%+11% (16%)

SSA Toll Roads Case (2): • Required Annual Cash Flows (including remuneration to debt SSA Toll Roads Case (2): • Required Annual Cash Flows (including remuneration to debt & equity) – – • Operating & Maintenance : $ 10 million Debt Service : $ 24 million Equity returns: $ 8 million Total = $ 42. 4 needed in annual revenues ($ 3. 52 million per month assuming no seasonality Required Average tariff per vehicle – $ 3. 52 million / 70, 000*30 = $ 1. 68 per vehicle

SSA Toll Roads Case (3): Scenario 1 : Willingness to pay = zero (A) SSA Toll Roads Case (3): Scenario 1 : Willingness to pay = zero (A) Pure Public Investment Funded via tax payers (government budget) an/or donors’ assistance Performance risk is assumed by Government Upfront investment of $ 200 million (B) PPP via 100% shadow toll road equivalent to $ 1. 68 per vehicle Concession structured as an performance based scheme with shadow toll paid by government budget allocations [tax payers] on the basis of performance based criteria (i. e. , maintenance and safety of road usage). Shadow toll payments likely to need strong backstopped by MLAs and Donors (e. g. , guarantees, liquidity facilities) Upfront investment by the PPP special purpose company.

SSA Toll Roads Case (4): Scenario 2 : Willingness to pay = between zero SSA Toll Roads Case (4): Scenario 2 : Willingness to pay = between zero and $ 1. 68 per vehicle ($0. 84 per vehicle) (C) PPP via a collected toll fare ($0. 84) plus a supplemental subsidy ($0. 84). Subsidy can be paid as a shadow toll or can be structured as a traffic minimum revenue guarantee (defining a predetermined level of total revenues). Performance risk is transfer to the private sector. No initial disbursement by the public sector. (D) PPP via a co-investment between the Public and Private sector. Size of public co-investment will be equal to the difference between total investment and the investment amount supported by the existing tariff (i. e. , $ 126. 7). Performance risk is transfer to the private sector. Initial disbursement by public sector.

SSA Toll Roads Case (5): Scenario 3 : Willingness to pay = equivalent to SSA Toll Roads Case (5): Scenario 3 : Willingness to pay = equivalent to required tariff ($ 1. 68) (E) PPP via a collected toll fare ($1. 68) Depending on the robustness of the traffic studies and the willingness to pay [affordability] analysis, government and/or donors might need to provide some type of support to the traffic revenue scheme. Performance risk is transfer to the private sector

PPP : Risk Assessment Project Specific Risks § § Country (Economy wide) Risks Completion PPP : Risk Assessment Project Specific Risks § § Country (Economy wide) Risks Completion Risk (engineering & construction cost / time cost control) Operational Performance Risk (technical & operational know-how) Environmental Risk (future liabilities, project delays, costs overruns) Credit Risk (project leverage) § § Demand (traffic) Risk Pricing Risk (regulated and non-regulated) Environmental (past liabilities) Risk Inflation, interest rate and exchange rate fluctuations Political Risk (expropriation, political violence, currency convertibility & transfer) Regulatory Risks. (Government’s Risks default on contractual obligations, i. e. , pricing formulas, right of way ) Legal Environment (rule of law, i. e. , law judicial system, regulatory procedures and arbitration)

PPP : Risk Allocation § Principle : Risk should be allocated to those best PPP : Risk Allocation § Principle : Risk should be allocated to those best able to manage them § Allocating PPP Risk Guidelines: Ø Allocate to the party best able to influence the risk factor (e. g. , constructions costs – completion risk). Ø Allocate to the party that can best anticipate or respond to the risk factor --influence impact or sensitivity of risk factor on project value (e. g. , adapting size of the facility to demand fluctuations) Ø Allocate to the party best able to absorb the risk Ø Ø Ø Natural hedges (correlation between risk factors and stakeholder assets and liabilities) Access to markets offering derivatives and insurance Access to specialized financial institutions (IFIs, MLAs, Donors, etc. ) Ability to spread the risk among other risk bearers (shareholders and taxpayers) Risk Aversion

Toll Road Finance: Risk Mitigation Non-Sovereign Risks Cash Flow effect Impact Risk Mitigation Instrument Toll Road Finance: Risk Mitigation Non-Sovereign Risks Cash Flow effect Impact Risk Mitigation Instrument Provider Sovereign Completion Risk Performance Risk Environment al Risk Demand Risk Political Risk Regulatory Risk (inc. Land Acquisition Risk) Macroecon omic Risk Cost overruns and delays. Revenue generation and operational costs increase Hidden liabilities Revenue generation Expropriation, transfer, convertibility Cease of revenue generation Revenue generation. Tariff Adjustment; Right of Way, Termination payment Revenue generation. Devaluation / inflation impact of cash flows High Low High EPC Contract and performance bonds Performance based contracts Environment al Assessment Traffic Minimum Revenue Guarantees / VPN Concession Partial Credit Guarantees Political Risk Insurance Concession Contract Partial Risk Guarantees Local currency financing Private/ Public Private/ Public TBD

Developing Local Capital Markets : Chile • By the early 1990 s, a sizable Developing Local Capital Markets : Chile • By the early 1990 s, a sizable infrastructure gap had emerged in Chile, and significant investment was needed to prevent transportation and other bottlenecks from becoming a major obstacle to future growth • A challenge for the government was to close this gap while maintaining fiscal discipline that had placed public debt on a rapidly declining path. The solution lay in promoting private sector involvement in the provision of public infrastructure through public-private partnerships (PPPs). Chile thus embarked on an ambitious concessions program in 1994, centered around a number of projects to develop the highway network. • The concessions program in Chile covers 44 contracted projects with a total value of US$5. 7 billion (about 6¼ percent of 2004 GDP). These include: 8 projects to rehabilitate and upgrade the Route 5 highway which runs the length of Chile, with financing from tolls (US$2 billion); 11 other highway projects for connecting roads to Route 5 (US$1. 3 billion); 10 airport projects (US$240 million); 6 urban road projects (US$1. 8 billion); and 9 other projects (including prisons, public buildings, a reservoir, for US$360 million). Approximately 75% was funded in the local capital markets via local currency infrastructure bonds. • The government provides guarantees to concession operators. A minimum revenue guarantee is provided for highway and airport concessions, under which concession firms are compensated when traffic or traffic revenue falls below an annual threshold. In return for the minimum revenue guarantee, the concession firm enters into a revenue sharing agreement in which it shares a percentage of revenue with the government once a threshold is exceeded.

PPP and Risk Management Framework PPP Sector Teams Ministry of Public Works Ministry of PPP and Risk Management Framework PPP Sector Teams Ministry of Public Works Ministry of Energy Ministry of Communication PPP Projects Coordinating Entity Water Central PPP Unit üSelection Criteria üRisk Exposure üPricing üMonitoring üDocumentation Electricity Gas Airport Ministry of SOEs Railways Other Public Institutions MOF Risk Management Roads Ministry of Transport Local Governments (Minister or Council of Ministers) Ports Sanitation üCoordinating Role üProcurement Rules üScreening üMonitoring üCommunication Telecom Public Sector Support for PPP (guarantees, subsidies, etc. )

Bank’s response to client demands (PPPs support) § § § Shift in development burden Bank’s response to client demands (PPPs support) § § § Shift in development burden from central to local entities : the challenge of financing sub-national entities (IFC Municipal Fund, WBG scale up currently under consideration) Use of performance based subsidies (OBA approaches) Innovative Risk Mitigation Products (new applications partial risk guarantees) Public Financial Support for PPP’s development (risk management framework) Infrastructure Finance Vehicles (guarantee funds)

Infrastructure: Developing Local Capital Markets • There is no best substitute foreign exchange risk Infrastructure: Developing Local Capital Markets • There is no best substitute foreign exchange risk mitigation than matching the currency revenue generation with the currency of debt payment services (matching assets and liabilities). • Financing transport facilities and services (local currency based) in the foreign debt markets adds substantial risk to the structuring of adequate PPPs creating the need for additional public money support. • Local institutional investors (I. e. , pension funds, insurance companies, life annuities, etc. ) have a natural demand for long-term local currency debt instruments to match their liabilities. • In most cases, local capital markets initiate their development via the creation of a sovereign bond market (long-term yield curve). After the establishment of such market, investors develop a need to diversify the risk profile of their investments and the return mix, providing the incentives for the development of a private bond market, creating the opportunity for the introduction of infrastructure or utilities bonds (long-term annuities). • It is in the government’s best interest to stimulate, via adequate securities regulation and institutional investors overseeing, the development of local capital markets as a source of long-term local currency funding for needed PPPs infrastructure projects.

Innovative Risk Mitigation Products § Local Currency Debt Instruments Ø Ø Ø § Development Innovative Risk Mitigation Products § Local Currency Debt Instruments Ø Ø Ø § Development of Local Capital Markets (e. g. , Chile and Korea) IBRD (on-lending to private sector) • Currency conversion option in fixed spread loans (FSL) • Currency swap • Rolling forward/1 IFC Local Currency • Loans and Hedging Products • Partial Credit Guarantees (asset backed securities) Regulatory risk support Ø Partial Risk Guarantee supporting transaction related regulatory framework • Privatization of electricity utilities in Romania. • Guarantee Facility for Peru PPPs infrastructure development (15 projects, wholesaling PRGs) • Nam Theun 2, PRG supporting LAO’s government commitments (IDA and MIGA guarantees). • Tariff Indexation Risk Transfer (supplemental subsidies)

Public Financial Support for Infrastructure Development When should governments offer support to public private Public Financial Support for Infrastructure Development When should governments offer support to public private partnerships: § Internalize externalities (e. g. , sanitation) § Redistributing resources (e. g. , subsidize access to services) § Mitigate political and regulatory risks § Closing the gap between cost recovery and affordability § Market failure in financial markets (e. g. , lack of depth for local currency funding)

Public Financial Support for Infrastructure Development (2) Financing vehicles: • • Need to reconcile Public Financial Support for Infrastructure Development (2) Financing vehicles: • • Need to reconcile infrastructure investments needs with fiscal prudence. Ring-fenced government sponsored vehicles to limit amount of contingent liabilities arising from public support to public-private partnerships projects (i. e. , co-investment, guarantees, subsidies, off-take contracts, etc. ) and assist to improve governance and transparency of the allocation of government contribution (risk management). Funded by government’s contribution (tax payers) and donors-multilateral interventions. Limited experience with government sponsored vehicles (I. e. , infrastructure funds, guarantee funds, etc. ) – Relatively unsuccessful experiences with state-owned development banks in the 80 s and 90 s – Keen interest by some of our larger clients (e. g. , Russia, Indonesia, etc. . )

Way Forward § Rebuild and adapt the PPI Model of the 90 s on Way Forward § Rebuild and adapt the PPI Model of the 90 s on the basis of the lessons and experiences of the recent years and the immediate needs to reach MDGs by 2015. Private sector still is a key driver to sustain infrastructure development and economic growth. § Broader use of PPP schemes as a way to maximize public money leveraging for infrastructure development. Need to develop adequate risk mitigation instruments to support public contribution to infrastructure projects. Options other than private ownership of infrastructure assets are also effective to mobilize private capital and management into infrastructure development. § MLAs and Donors direct engagement with sub-national entities (well run public utilities) without central government support to assist them accessing private financial markets. Need to improve accountability and use of performance based incentives (commercially run entities). § Development of local capital markets (local currency debt instruments) as a mechanism for improving effective access to infrastructure financing by PPPs. § Increasing use of output based subsidies as a way to utilize better private sector resources via effective allocation of performance risks (PPPs to deliver services to poorer communities). § Build solid institutional capacities in the public sector to improve “good” infrastructure PPPs as well as the risk management of contingent liabilities arising from PPP support. Development of specialized financing vehicles (public sector driven).

Case Study Session 5. 1 THANK YOU! Highways Sabino Escobedo, TAG Financial Advisors Case Study Session 5. 1 THANK YOU! Highways Sabino Escobedo, TAG Financial Advisors

Contacts For comments or further details contact: Junglim Hahm Richard Cabello Sabino Escobedo David Contacts For comments or further details contact: Junglim Hahm Richard Cabello Sabino Escobedo David Stiggers [email protected] org [email protected] org [email protected] com [email protected] net

Case Study Session 5. 1 THANK YOU! Highways Sabino Escobedo, TAG Financial Advisors Case Study Session 5. 1 THANK YOU! Highways Sabino Escobedo, TAG Financial Advisors