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DEPARTMENT OF BUSINESS ADMINISTRATION
BUSINESS AND SOCIAL SCIENCES
AARHUS UNIVERSITY
Analysing Public-Private Partnership
Master thesis
MSc in Finance and International Business
Author: Jurgita Jakutyte
Student ID: JJ91185
Academic supervisor: Jingkun Li
September, 2012
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TABLE OF CONTENTS
Introduction .................................................................................................................. 5
Problem statement ...................................................................................................... 6
Structure ...................................................................................................................... 7
Delimitations ................................................................................................................ 9
1. Literature review ................................................................................................. 11
1.1. Definition ................................................................................................... 11
1.2. Types of PPPs .......................................................................................... 16
1.3. Reasons for implementing PPPs ............................................................. 19
1.4. value for money ........................................................................................ 21
1.5. Advantages and disadvantages of PPP .................................................. 26
1.6. Criticism of PPPs ...................................................................................... 29
2. Analysis ............................................................................................................... 32
2.1. The project ................................................................................................ 32
2.2. Alternatives for project implementation ................................................... 32
2.3. Identifying an appropriate PPP scheme .................................................. 34
2.3.1. Overview of Lithuania’s legal PPP environment .................................. 34
2.3.2. Choosing a PPP scheme ...................................................................... 38
2.4. Cost and benefit analysis ......................................................................... 39
2.4.1. Assumptions overview ....................................................................... 40
2.4.2. Data overview .................................................................................... 46
2.4.3. Financial analysis .............................................................................. 48
2.4.4. Socio-economic analysis ................................................................... 49
2.4.5. Sensitivity analysis ............................................................................ 52
2.4.6. Overview and the discussion of the CBA results.............................. 56
2.5. Factors not covered by CBA .................................................................... 58
3. Conclusions ........................................................................................................ 63
4. Bibliography ........................................................................................................ 66
5. Appendices ......................................................................................................... 73
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CONTENT OF F IGURES
Figure 1. European PPP trend, 1990-2009 ................................................................ 6
Figure 2. Cash flows in PPP and traditional procurement mode ............................. 16
Figure 3. Structure of Public Sector Comparator ..................................................... 22
Figure 4. Optimal risk allocation point ...................................................................... 23
Figure 5. Model for risk allocation ............................................................................. 24
Figure 6. Identifying Value for Money ....................................................................... 26
Figure 7. PPP scheme under economic activity....................................................... 37
Figure 8. PPP scheme under social activities .......................................................... 38
Figure 9. Sensitivity analysis – FNPV on investment............................................... 53
Figure 10. Sensitivity analysis – FNPV on capital .................................................... 54
Figure 11. Sensitivity analysis - Socio-economic results ......................................... 55
CONTENT OF TABLES
Table 1. Distribution of investment costs, % ............................................................ 46
Table 2. Financial return on the investment costs –PPP and traditional
procurement approach .............................................................................................. 48
Table 3. The structure of financing in PPP and traditional procurement approach 48
Table 4. Financial return on capital – PPP and traditional procurement approach 49
Table 5. Assumptions for the socio-economic analysis ........................................... 51
Table 6. Net benefits of non-market impact ............................................................. 51
Table 7. Socio-economic analysis results ................................................................ 52
Table 8. Sensitivity analysis – change in demand ................................................... 55
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L IST OF ABBREVIATIONS
BBO Buy-Build-Operate
BOOT Build-Own-Operate-Transfer
BOT Build-Operate-Transfer
CBA Cost-Benefit Analysis
CO2 Carbon dioxide
CPVA Central Project Management Agency
DBFO Design-Build-Finance-Operate
DBOM Design-Build-Operate-Maintain
EPEC European Public-Private Partnership Expertise Centre
EIB European Investment Bank
ENPV Economic net present value of investment
EU15 European Union of 15 member states
FNPV/C Financial Net Present Value of the Investment
FNPV/K Financial Net Present Value of Capital
FRR/C Financial Rate of Return of the Investment
FRR/K Financial Rate of Return of Capital
IMF International Monetary Fund
Kg Kilogram
Km Kilometre
OECD Organization for Economic Co-operation and Development
PPP (3P) Public-Private Partnership
PSC Public Sector Comparator
PwC PricewaterhouseCoopers
SPV Special Purpose Vehicle
STPR Social Time Preference Rate
t tonne
tkm tonne-kilometre
VAT Value Added Tax
VFM Value for Money
WACC Weighted Average Cost of Capital
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INTRODUCTION
PPP (3P) – public-private partnership – a concept used widely in the public
procurement that lacks both clarity and united definition (Meidute & Paliulis, 2011).
The concept has no clear boundaries for distinguishing what kind of private and
public partnership is assumed to be a form of PPP or a form of a traditional
procurement. This results in some confusion, both in the academic literature, as
well as within the international experiences. Nevertheless, PPP, in general terms,
could be defined as a long term contractual relationship between a public and
private sectors, which is usually characterised by having features such as bundling
of functions, exchange of resources, shared responsibility, risks and rewards, and
is arranged with the aim to provide a public service/asset.
PPP is not a new phenomenon even though it is perceived as such due to its
recent popularity. Growing interest is a result of changing attitudes as well as
expectations of the society towards the government and public services (Grimsey
& Lewis, 2004). Today society expects to see the government more as a governor
and regulator rather than the direct provider of public services. In addition, it
requires infrastructure of better quality, more efficient provision of public services,
as well as better use of public money. Considering all this, PPPs are seen as a
procurement mode that may satisfy these changing needs. Nevertheless, PPPs
are not a ‘miracle’ solution (European Commission, 2003; Harris, 2004; Meidute &
Paliulis, 2011) to the problems of the conventional procurement; they are complex
and expensive and, as a result, only certain projects qualify for the use of public-
private partnerships.
The figure below shows the trend of growing interest in the use of PPP within
Europe for the period of 1990 – 2009. It is important to note that between 1990 and
2004 from all PPP projects more than half were arranged in the United Kingdom.
Only recently the trend has changed and other European countries have
experienced increased use of PPPs (EIB, 2010).
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Figure 1. European PPP trend, 1990-2009
Source: Adopted from EIB (2010, p. 7)
Even though, the numbers are increasing, the portion of PPP projects in the overall
public procurement is still not that significant (Appendix 1). For example, in the
United Kingdom, the biggest producer of PPP projects, public private partnerships
represent only 10-13% of all public infrastructure projects (Deloitte Research,
2006).
Having this in mind, the question rises, why PPPs represent such a small fraction
of all public projects if they deliver benefits such as greater efficiency, timely
delivery of public projects, better quality of service provision, etc.? In order to try to
answer this, the paper examines the concept of public-private partnership and
reviews the advantages, disadvantages, and the reasons why PPPs are
implemented. In addition, the case study is performed where the conventional
procurement approach is compared to public-private partnership. The paper
investigates what PPPs are, what they deliver and when they prevail over the
conventional procurement approach.
PROBLEM STATEMENT
The aim of the paper is to analyse the concept of public private partnership and its
suitability for a procurement of a public project. The objectives of the thesis are
achieved by reviewing the relevant literature and performing an analysis on the
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case study by examining the different procurement approaches available for the
project: PPP and conventional procurement. The analysis will answer which
procurement approach should be the appropriate one for the case study
concerned.
STRUCTURE
The paper is divided into two main parts. The thesis is structured in the way that
from the very beginning an understanding of the concept of PPP could be
developed, which is used for the second part of the thesis, where the analysis is
performed.
The first part of the thesis provides an extensive discussion on the theoretical
foundations of public private partnerships. It focuses on the discussion of the
relevant concepts, characteristics, types, advantages and disadvantages of the
PPP. The first part of the paper answers questions, such as: what PPPs are, why
such a procurement mode is practiced and how it differs from other procurement
approaches, such as conventional procurement and privatisation.
The second part of the thesis is the analysis of the case study. It is divided into two
main sections. The first section includes an overview of the project’s background
and its adequacy for a PPP. It further includes a review of the Lithuanian
environment regarding PPP law and provides a discussion on the suitable PPP
form for the infrastructure project concerned. The second section of part two
consists of the cost and benefit analysis, which involves the following steps:
Data overview (identification of costs and benefits, assumptions);
Financial analysis;
Socio-economic analysis;
Sensitivity analysis;
Overview of the results.
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In addition, the second part of the thesis is expanded with a discussion on other
factors that are not covered by CBA, however, factors that are relevant when a
PPP approach is considered.
The last part of the paper concludes the discussion on public-private partnerships
and the analysis performed.
METHODOLOGY
The paper is written by following the deductive, in other words, a “top-down”
approach. The paper begins with the general overview of the theory and then
narrows down to the analysis of a specific case study. In addition, the paper is
based on the secondary sources.
The first part of the paper emphasises on the literature review. The literature
review is based on the European Commission, EPEC, Hong Kong Efficient unit,
Victoria Partnership guidance on PPPs, reports of OECD, IMF, PwC, Deloitte, and
views provided by a variety of PPP researchers – such as Grimsey and Lewis,
Akintoye, Hodge, etc. The articles, books and reports used in the paper were
accessed through a variety of research databases, such as OECD iLibrary,
Science Direct, Business Source Complete, etc.
The second part of the paper emphasises on analysing a particular public-private
partnership project. The analysis is carried out by performing a cost-benefits
analysis (CBA) while employing guidance of the European Commission: “Guide to
Cost Benefit Analysis of Investment projects: Structural Funds, Cohesion Fund and
Instrument for Pre-Accession” (2008) and “Guide to cost benefit analysis of
investment projects” (2002). Some additional insights for the application of CBA
have been adopted from OECD (2006), Boardman, Greenberg, and Vining (2011)
and Campbell and Brown (2003).
Cost and benefit analysis is a technique used to identify, measure and compare
benefits and costs of an investment project and it is used to assist the decision
maker in choosing the most beneficial project from the alternatives available
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(Campbell & Brown, 2003). In this paper cost and benefit analysis is used as a tool
to determine the main differences between procuring a project through a traditional
procurement mode and a PPP. It should be noted that the CBA used in this paper
does not try to compare different project implementation alternatives1. The idea of
the analysis is to compare the same project financed by public and private funds.
Therefore, it could be said that the aim the cost and benefit analysis performed in
this paper is to understand whether the inclusion of the private partner in the public
procurement influences the investment decision rule – whether to proceed with the
project or abandon it instead.
The addition to CBA is an overview of other factors that are not incorporated in the
aforementioned analysis, which, however, are influential when the choice of
procurement approach is considered. The discussion on these factors is performed
in accordance to the theory overview of the first part of the thesis.
DELIMITATIONS
The concept of public-private partnership encompasses a variety of different
partnerships and relationships, which are not covered fully in the thesis. The paper
focuses on one particular PPP infrastructure approach, within which the topic is
analysed.
What concerns the second part of the paper, due to time constraints and size
limitations, the CBA is performed only to the level that is enough to identify the
most important points regarding the differences between procuring a project
through PPP and conventional procurement approach. In addition, due to the
complexity and extent of the project, the analysis has been simplified and only
most important impacts taken into account. As a result, there is possibility for some
divergence between results presented in the paper and the reality. Further
development on the CBA could be made if more specific studies were conducted:
for example, a detailed market demand analysis or more specific environmental
1 The paper does not intend to compare the usual cost and benefit analysis’ alternatives: “Business as usual”,
“Do minimum”, “Do something”, “Do something else” (European Commission, 2008).
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studies examining the CO2 emission, air pollution, etc. Moreover, due to the lack of
relevant information, which is a consequence of the absence of the analogues
projects in Lithuania, most of the assumptions are based on the foreign countries’
experience, especially of the more developed Western economies, which might be
highly inaccurate when situation in Lithuania is considered. With addition to this, it
is a nature of CBA to use a variety of assumptions, which might sometimes appear
to be imprecise, in particularly, when a long term project is analysed.
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1. L ITERATURE REVIEW
1.1. DEFINITION
Public private partnership (PPP), in simple terms, is a form of private-sector
involvement (PSI)2 in which a private partner brings its skills, capital, commercial
innovation into the provision of the services the government is responsible for. It
should be noted, however, that such an explanation covers only a part of this broad
concept. It is widely acknowledged within the relevant literature that there is no
clear definition for PPP which would cover all aspects of different relationships that
these partnerships encompass (Daube, Vollrath, & Alfen, 2007; Hodge & Greve,
2007; OECD, 2008) and at the same time restricting it to a more narrow
description. As Weihe (2006) argues, the concept of PPP is nebulous – it “allows
for great variance across parameters such as time, closeness of cooperation, types
of products/services, costs, complexity, level of institutionalization as well as
number of actors involved”, as a result, nearly any type of the relationships that
include both the private and the public sector (whether it is a service contract or a
joint venture) may be called a public-private partnership (PwC, 2005). In order to
make some distinction between the variety of definitions present, Weihe (2006)
attempted to classify them into 5 categories: local regeneration, policy,
infrastructure3, development and governance approaches. The local regeneration
and the policy approaches are similar due to perceiving PPP concept as a very
wide definition that covers changes in policies of environment, economic renewal,
development, and institutional set up. The difference between the two is that the
local regeneration approach focuses on the local level while policy approach – on
the national. The third approach – the infrastructure approach – covers the
cooperation of private and public sector in order to create and maintain
2 Private-sector involvement is a new focus of EU which has been created in order to “assist the government in
meeting its priorities, building on the clear recognition that public funds are limited” (Tanga, Shena, & Chengb, 2010, p. 684). 3 In order to define infrastructure, we use the definition provided by Grimsey and Lewis (2004, p. 20):
“investment in infrastructure on some definitions is said to provide ’basic services to industry and households ’, ‘key inputs into the economy and ‘a crucial input to economic activity and growth’”. Infrastructure approach in PPP does not cover such infrastructure as “coal or steel or motor vehicles”, it concerns infrastructure like roads, motorways, ports, airports, telecommunication, prisons, schools, etc.
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infrastructure, as well as deal with the financial and legal aspects of such projects.
The fourth approach – the development approach – concentrates on the
development of infrastructure in developing countries where corruption, social
deprivation, global disasters are present. This approach includes many forms of
cooperation between the public and private sectors such as strategic or
entrepreneurial partnerships. The last approach is the governance approach which
does not specify any context or policy as it emphasizes on organizational and
management side, as well as new ways of cooperation and governing. For the
purpose of this thesis, the concept of PPP will be limited to the infrastructure
approach.
Even thought the concept has been narrowed down, there are still many definitions
explaining what a PPP is under the approach chosen. For example, the European
Commission (2004, p. 3) defines PPPs as “forms of cooperation between public
authorities and the world of business which aim to ensure the funding,
construction, renovation, management or maintenance of an infrastructure or the
provision of a service”; whereas OECD (2008, p. 12) defines it as “an arrangement
between the government and one or more private partners (which may include the
operators and the financers) according to which the private partners deliver the
service in such a manner that the service delivery objectives of the government are
aligned with the profit objectives of the private partners and where the
effectiveness of the alignment depends on a sufficient transfer of risk to the private
partners”. Further examples of definition include the one proposed by IMF (2006, p.
1) that explains the concept as the “arrangements where the private sector
supplies infrastructure assets and infrastructure-based services that traditionally
have been provided by the government”, and EIB (2004, p. 2) that views PPP as a
relationship of the two sectors which has an aim “of introducing private sector
resources and/or expertise in order to help provide and deliver public sector assets
and services…<it is> used to describe a wide variety of working arrangements
from loose, informal and strategic partnerships, to design build finance and operate
(DBFO) type service contracts and formal joint venture companies”. An overview of
the PPP definitions under the variety of international organizations draws some
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conclusions on the basic set of features that characterise PPP under the
infrastructure approach:
long term contractual arrangement between the public and private sector;
functions are bundled;
responsibility for the provision of the services is shared;
resources are shared:
o the private sector brings in capital, skills, experience, commercial
innovation, etc.;
o the public sector delivers skills, political authority, access to publicly
run services, assets, etc.;
risks and rewards are shared.
In order to understand the PPP concept fully, it is also useful to distinguish it from
the traditional procurement mode. The reason for this is that the boundaries
between the two modes are ambiguous. In order to remove this ambiguity the main
differences between the two modes are identified and explained.
First of all, the main differentiating point between PPP and traditional procurement
is that in PPPs risks are shared between the private and public partners whereas in
a conventional procurement most of the risks are retained by the government 4
(European Commission, 2005; OECD, 2008) . This is in line with the functions
included in the contracts. In a PPP different tasks are bundled together and, as a
result, private partner takes responsibility for the whole package of the associated
risks. In the conventional procurement, on the other hand, the government usually
purchases a single function from a private partner and, as a result, the private
partner is responsible only for the risks associated with this function. Consequently,
in the traditional procurement the private partner has no incentives to incorporate
decisions that may favour future operations as after completion of the task, the
private partner is no longer involved in the operations of the asset/service. For
4 Because there is no single clear definition for PPP, the most important factor that distinguishes the
procurement mode and the type of PPP used is the amount of risk and responsibility transferred to the private partner (European Commission, 2005, p. 1).
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instance, if the government proposed a tender to deliver a package of services,
such as design, build and maintain a facility, the private partner involved would be
incentivized from the very beginning to make decision that could minimize the
future risks associated with cost overruns. Such an example has been identified in
the international experience by Grimsey and Lewis (2004, p. 135), where an
innovative decision to construct 45-degrees windowsills in UK hospital was
proposed with an intention to save future cleaning costs. It is hardly likely that such
a decision would have been made in the conventional procurement case. A
government would propose a tender to design a facility with input requirements
already specified. The specific requirements can be seen as a frame from the
private partner’s point of view as these requirements restrict private partner to
innovate and come up with more efficient solutions. The aim of the private partner
responsible for a design function is to design a facility while incorporating all the
details required and within the budget stated. The review of function bundling and
risk allocation in both procurement cases help to determine what defines a PPP
and a traditional procurement approach.
Secondly, the two modes differ between each other when the function specification
is considered. What this means is that, in a PPP, government states what it
expects from the private partner in output terms, whereas in the conventional
procurement it does that through input specification. Considering the
aforementioned example, in a PPP case, government might require a hospital to
be big enough to accommodate 300 people and to be kept in a good condition by
clarifying what good condition means, whereas in the conventional procurement
option, a government would request a certain size, with a certain number of rooms,
with specific materials used, etc. In the PPP case, private partner is free to use its
skills and innovation in order to provide the outputs required in a most efficient
way, whereas the latter case does not allow such a freedom as a private sector is
restricted to the requirements specified.
Thirdly, in a PPP approach, returns to the private partner are linked to the
performance of their functions, i.e. the provision of outputs specified by the
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government, whereas in a conventional procurement approach, private partner is
remunerated for the completion of a specific function. This contributes to the level
of incentives attached to the private partner: in a PPP case, if a private partner
does not operate as expected, it might incur some sort of penalties (Harris, 2004),
if it operates better than expected, it may be awarded by, for example, receiving
higher portion of additional profits. In a traditional procurement case, on the other
hand, private partner is not awarded for an extra value added to the task it was
responsible for, however, it might be penalized for the uncompleted function.
Considering all this, the private partner in a traditional procurement is not
encouraged to provide more than the government requested for, which means
some possible gains might be overlooked.
Fourthly, the relationships involved in both of the procurement modes differ
(OECD, 2008). In the traditional procurement, in order to deliver the services and
infrastructure required, the government acts as an intermediary – on the one side it
deals with direct users of the services, taxpayers, and financial markets, and on the
other side – with other private companies. The idea behind such a relationship
structure is that the government gathers financing directly from the users of the
service, taxpayers and financial markets, and uses it to remunerate the other side
– the private companies for the capital goods provided to deliver the public service
and develope the infrastructure. If the project is handled through a public-private
partnership, the intermediary role of the government is decreased – public authority
deals with the taxpayers and the single private operator only. The role of the
private operator, on the other hand, is enhanced: private operator becomes
responsible for the intermediary role – it collects financing from the direct users of
the service and financial markets and remunerates the other side – other private
companies for the capital goods provided. If the private operator acts in
accordance to the performance standard specified, in some of the cases 5, it
receives additional payment from the government (Maski & Tirole, 2008). The
relationship structures of the two schemes are represented in the Appendix 2.
5 The private operator may be remunerated through: the collection of direct user charges only, through the
government payment only, or through a combination of both (Grimsey & Lewis, 2004).
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Finally, a crucial advantage of PPP from a government’s point of view is the
financing. In a PPP case capital is provided by the private partner. This means that
the government does not incur immediate cash outflow due to the project, which
might be an impossible task when restricted public funds are considered. In a
traditional procurement mode, on the other hand, the government finances the
project from its own funds, that is it incurs large investment costs instantly. Figure 2
represents the comparison between the two financing options in the public
procurement.
Figure 2. Cash flows in PPP and traditional procurement mode
Source: Akbiyikli, Eaton, and Turner (2006, p. 71)
All in all, the two modes differ between each other when the following factors are
considered: amount of risks transferred and tasks bundled, the way requirements
for the service delivery are specified, characteristics of private partners returns,
relationship between the parties involved and the financing flows. Nevertheless, it
is clear that sometimes these differences may be too ambiguous or too subjecitve
to state clearly which procurement approach is adopted.
1.2. TYPES OF PPPS
The spectrum of different PPPs range from the short term service contracts to
concessions. Nevertheless, as the focus of this thesis is the concept of PPP under
an infrastructure approach, the overview of different PPP modes will be limited to
the ones that are covered by the PPP approach chosen. These modes have
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common characteristics, such as: being long term, involving risk transfer, shared
responsibility, resources and rewards.
In general, private partner involvement arrangements in PPPs differ between each
other depending on the level of responsibilities and risks transferred to the private
partner (Amekudzi & Morallos, 2008). The responsibilities concerned include
activities such as: designing, building, financing, maintaining, operating, and
owning the facilities. The allocation of risks will be discussed in more detail later in
the paper; however, what matters at this point is the amount of risks transferred
and retained by the government.
Most common forms in the infrastructure approaches are:
Turnkey procurement, which includes: BOT (build-operate-transfer), BBO
(buy-build-operate), etc. (European Commission, 2003, 2005);
DBFO (Design-Build-Finance-Operate), which includes: DBOM (design-
build-operate-maintain), BOOT (build-own-operate-transfer), concessions,
etc. (Deloitte Research, 2006; European Commission, 2005; IMF, 2004).
Turnkey procurement6 is described as the scheme where the private partner takes
on the responsibility to design, construct and operate the asset, whereas the public
sector retains the responsibility for the financial risks involved. Using this
procurement mode, public sector sets the quality outputs required and by doing so
it ensures that the private sector brings the necessary efficiency gains as well as
the asset is maintained to the standards expected. This mode of procurement is
used in water and waste projects as it ensures incentivized management and
maintenance of the asset through the bundling of functions passed on to the
private partner (European Commission, 2005).
DBFO scheme7 is characterized by involving a private partner with responsibilities
(financing, designing, building, constructing, and operating the asset/service)
attached to it. Public sector’s role is to set the specific output requirements for the
6 See Appendix 3 for illustration of the turnkey procurement’s scheme.
7 See Appendix 3 for illustration of the DBFO scheme.
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private partner, whereas private partner’s role is to fulfil those requirements. The
DBFO schemes are usually long term and involve bundling of functions in order to
provide private partners with the necessary incentives for it to operate in the most
efficient and innovative way. These schemes involve performance linked payment
mechanisms with an aim to ensure the presence of motivation for the private
partner to operate on its full capacity. The idea behind such schemes is that the
private partner designs, builds, operates and maintains the asset for the agreed
term. At the end of this term, the asset is either transferred back to the government
or is left under the ownership of the private partner – depending on the specific
structure of the scheme chosen. For example, one of the most common schemes
under DBFO is concession. Concession is described as a PPP scheme, where
exclusive rights to operate an asset or provide certain services are granted to a
private company (usually a SPV8), which in return has to design, build, finance and
operate the asset/service for the time agreed upon. These exclusive rights usually
permit the private partners to collect the revenues from the direct users of the
asset/service. Concessionaires typically own the rights to the asset/service during
the time of concession, however, at the end of this period the ownership of the
asset/service is usually transferred back to the public sector (Deloitte Research,
2006; European Commission, 2005; IMF, 2006). Literature overview shows that
concession is usually assumed to be a form of PPP (Deloitte Research, 2006;
European Commission, 2004; IMF, 2006; Ng, Xie, Cheung, & Jefferies, 2007;
PwC, 2005), however, OECD (2008) argues the opposite. First of all, it states, that
the amount of risk transferred differs in PPPs and concessions: concessions
involve higher level of risks allocated to the private partner, compared to other
forms of PPPs. Secondly, it is usual for concessionaires to collect revenues from
the direct users of the asset/service and, according to OECD, this feature
differentiates concession from other PPP forms. As a result, OECD concludes that
concessions should not be treated as a PPP. Nevertheless, in this paper
concession is considered as a form of PPP.
8 SPV (special purpose vehicle) – “an organization that can be established as a distinct legal entity to bring
together the companies involved in a PPP in order to manage the project and share the risks and rewards” (Grimsey & Lewis, 2004, p. xv).
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The international experience shows that most of the time DBFO schemes are used
in transport sector for building highways, bridges, railways, whereas concessions
are chosen for mobile phone services, toll roads or provision of municipal water.
The similarities between the turnkey procurement and DBFO schemes are that the
activities involved are same in both of the schemes, differing only in the amount of
functions involved in the arrangements. What differentiates the two schemes is that
in the first one the majority of risks remains within the public sector, whereas in the
latter – risks are shared between the partners, allowing for the possibility to transfer
the optimal amount of risks to the private partner.
1.3. REASONS FOR IMPLEMENT ING PPPS
The main objective of procuring a public project through a PPP mechanism is to
achieve value for money (VFM) (Grimsey & Lewis, 2004; Harris, 2004; New South
Wales Government; Quiggin, 2004; Shaoul, 2005) which as Grimsey and Lewis
(2005, p. 347) argue is “the optimum combination of whole life cycle costs, risks,
completion time and quality in order to meet public requirements”. This definition
assents to the one implied by the European Commission (2003, p. 55) which
identifies a set of factors that determine value for money: life cycle costs, allocation
of risks, time required to implement a project, quality of a service, and ability to
generate additional revenues. Following this, a general principal used to determine
whether a project should be implemented through a PPP or a traditional
procurement is to evaluate which procurement mode ensures lower life cycle costs,
better allocation of risks, quicker implementation, higher quality and additional
profits. In other words, additional value for money represents additional efficiency
gains – delivering or maintaining the same service or asset in a more cost efficient
or a more qualitative way than it would have been if the government retained the
full responsibility for delivering/maintaining service/asset concerned (EIB, 2004, p.
4; Meidute & Paliulis, 2011; Nisar, 2006). EIB (2004) argues that the critical aspect
in order to reach value for money is the ability to share risks and rewards
appropriately. OECD (2008) confirms this view recognizing that main reasons for
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PPP establishment are the appropriate risk allocation and value for money gains9.
Grimsey and Lewis (2005, p. 347), however, imply that the value for money gains
can only be achieved if the following conditions are present: a competitive
environment, optimal risk allocation and if the comparison between the financing
options is handled in a “fair, realistic and comprehensive” way. Furthermore, when
questioning PPP’s ability to deliver additional gains, one should consider the
qualitative benefits of PPPs – whether they are achievable and whether they really
provide the benefits expected. It is essential therefore to check whether the private
partner is capable of bringing in skills that the government lacks and whether it has
the expertise and know-how necessary to operate more efficiently compared to the
government (PwC, 2005).
According to the literature review, further reasons that lie behind the use of PPP as
a procurement mode differ between countries depending on the environment
present. For example, the main aim of a PPP at the early stage of its development
in the United Kingdom was to finance the public infrastructure projects (Grimsey &
Lewis, 2004; IMF, 2006; Meidute & Paliulis, 2011). The issue at that time consisted
of a growing need for public infrastructure development (as it also is the case in
Hong Kong (Cheung, Chan, & Kajewski, 2009)) and a lack of available public funds
to finance this need. As a result, a new initiative took place – Private Finance
Initiative (PFI) – with the purpose to provide additional funds for public
infrastructure projects. On the other hand, countries like Australia do not have
such an issue. They are capable of financing projects by themselves, however,
they still choose to involve the private sector for the possibility of achieving
additional value (Cheung et al., 2009). Moreover, Hong Kong and Australia involve
a private partner into the procurement of public services with the aim to ensure a
better quality of services. This, on the other hand, does not seem to be the
prioritized reason for the PPP development in the United Kingdom, which
9 The gains associated with the inclusion of the private partner are based on the assumption that the private
partner has more to offer than the public entity could realize by itself - it is assumed that the private partner will bring more innovative and cost efficient solutions in addition to a better management. Nevertheless, caution should be taken here that the mere inclusion of the private partner will not be sufficient to generate value for money required (OECD, 2008, p. 18).
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emphasizes the point that reasons to implement PPP depend on the
circumstances surrounding countries’ economic and political environment.
In many of the countries the choice for PPPs, however, is due to financial reasons
(such as lack of public funds and restricted public investment). This reason is
amplified when “a tight fiscal environment following the development of European
Monetary Union” (EIB, 2004, p. 4) is considered as due to this European countries
experience difficulties in organizing large investment sums to finance public
infrastructure projects from the public funds only.
All in all, in theory, the main reason to develop PPPs lies behind the concept of
value for money, creating additional benefits due to private partner’s expertise,
know-how, ability to operate efficiently and generate additional revenues. Despite
the theoretical foundations, it is evident that PPPs are also often used in cases
when there is a lack of public funds for the growing need for public infrastructure.
1.4. VALUE FOR MONEY
The concept of value for money is ambiguous and in order to understand it better,
it is worth analysing the estimation procedure for it. When estimating the value for
money that a partnership creates, governments have to choose between four
methodologies: CBA of public and private partner proposals, PSC-PPP comparison
before the tender, PSC-PPP comparison after the bidding process, and
identification of value for money through the competitive bidding process (Grimsey
& Lewis, 2005; Sarmento, 2010). The literature review shows that the calculation of
PSC (public sector comparator) and comparison of it with the PPP option before
the tender is the most commonly used method. The purpose of public sector
comparator is to verify that value for money is generated (Harris, 2004; Quiggin,
2004) and in order to do this “the hypothetical risk-adjusted cost if a project were to
be financed, owned and implemented by the government” (Partnerships Victoria,
2001, p. 6) should be calculated. The calculation of such costs is done by
estimating four elements: raw PSC, competitive neutrality, transferable and
retained risks, all of which are represented in the figure below:
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Figure 3. Structure of Public Sector Comparator
Source: Partnerships Victoria (2001, p. 6)
To begin with, the first component – raw PSC – includes the calculation of project’s
base costs as if the government would procure the project through the
conventional method. It includes identifying and calculating project’s direct (capital,
maintenance, operating costs) and indirect costs (overheads, administrative costs)
as well as any revenues incurred (Amekudzi & Morallos, 2008). The next
component – competitive neutrality – involves adjusting the cash flows in order to
remove any competitive advantages or disadvantages that the government may
have over the private sector (Amekudzi & Morallos, 2008; Partnerships Victoria,
2001). The advantages and disadvantages concerned may be due to different
aspects of the taxing system applicable to the public and private sectors. For
example, land and income tax rates may differ as government authority may
receive exemption whereas bidder may not. In addition, competitive neutrality
adjustments may rise due to differing regulatory requirements for the partners
concerned. The third and fourth elements of PSC calculation concern the
estimation of transferrable and retainable risks, where risks are identified, allocated
and priced. The price of risks transferred to the private partner should be included
in PSC value. Transferrable risk element together with retained risk element ideally
should ensure the optimal allocation of risks between the partners involved in the
project.
The allocation and valuation of project’s risks is inherent in the value for money
concept (European Commission, 2003; Grimsey & Lewis, 2004; Nisar, 2006;
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Sarmento, 2010). The aim of the risk transfer is to transfer only those risks that the
private partner could offset in a most efficient and least costly way(Grimsey &
Lewis, 2004; Harris, 2004; Nisar, 2006). Risk allocation produces highest value for
money once the optimal risk transfer point is identified (Figure 4): transferring too
much or too little risks results in either procuring an inefficient project or procuring a
project with excess costs incurred by the government (for example, if risks are
transferred to the private partner that it does not have control over or cannot
control it at least-cost, then the private partner will require higher premium for these
additional risks assumed (Hodge, 2004)), consequently, producing lower value for
money (Amekudzi & Morallos, 2008).
Figure 4. Optimal risk allocation point
Source: Partnerships Victoria (2001, p. 52)
Unfortunately, there is no universal solution regarding risks allocation for every
single project, however, there is a general agreement on how different risks should
be allocated. To begin with, risks in general are allocated to different categories,
such as, for example, proposed by OECD (2008): legal and political risks in
addition to the commercial ones. Categories are differentiated on the basis of who
takes the responsibility for the risks concerned – private partner or the government
authority. For example, construction, supply and demand side risks lie under the
commercial risk category (market risk, project risk and internal risk) as they are
handled better by the private partner, whereas legal and political risks are assumed
to be handled better by the government. Other categorization is proposed by Li,
Akintoye, and Hardcastle (2001), who distribute risks into three levels: macro,
meso and micro. Macro level covers risks outside the project – environmental,
political, legal risks that are concerned with national or industry level. Meso level
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risks emerge within the project’s implementation phase – design, construction,
operation. Finally, the micro level risks concern risks that appear between the
partners involved, they rest on the idea that both of the parties have different
incentives and objectives, and therefore, risks due to power struggle, differences in
working methods and environment between the partners may emerge.
Furthermore, Grimsey and Lewis (2004) argue for more detailed risk categorisation
– they divide risks into nine categories that are suitable for the infrastructure
approach: technical, construction, operating, revenue, financial, force majeure,
regulatory/political, environmental and project default risks. This distribution is
similar to the one proposed by Gray (2004), IMF (2004) and the European
Commission (2005).
Finding the most optimal risk allocation point requires identifying what risk is
handled best by which party. As mentioned above, there is no one optimal risk
allocation solution that fits every specific project, however, some general guidance
is present in the literature on PPPs (Bing, Akintoye, Edwards, & Hardcastle, 2005;
European Commission, 2003; Grimsey & Lewis, 2004; OECD, 2008; Quiggin,
2004). For example, if Harris (2004) risk allocation model was considered, the risks
would be assigned accordingly:
Figure 5. Model for risk allocation
Source: Harris (2004)
The proposed model identifies risks that should be passed on to the supplier
(transferable risks), that should be retained by the government and the ones that
do not belong to neither of the parties. As the figure shows, risks such as design,
construction, operating performance, technology obsolescence, etc. are usually
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assigned to the private partner. The reason for that is that the private partner
receives most of these risks implicitly with the responsibilities passed on to the
private partner (Harris, 2004). When, for example, DBFO is concerned, the
responsibilities of the private partner include designing, building, financing and
operating the asset, all of these tasks include associated risks, and by contractually
agreeing to handle these tasks, the private partner, consequently, agrees to handle
the risks concerned (Akintoye, Beck, & Hardcastle, 2003). The risks that are
retained by the government authority are risks that the private partner has no
influence over while the government does (Nisar, 2006). For example, the
discriminatory regulatory risk – government might decide to change certain
regulations that may influence the success of the private partner. In order to keep
private partner safe from such possible modifications, the government has to take
responsibility for the consequences of such certain change. Risks under the shared
risk group are those that cannot be controlled at least cost or in the best way by
neither of the party, for example, inflation, exchange and interest rate risks
(Akintoye et al., 2003). An example of a more detailed risk allocation matrix,
proposed by Chan, Yeung, Yu, Wang, and Ke (2011), is presented in the Appendix
4.
After identifying and allocating the risks, the next step is to place a value on them.
There are three factors determining the price of the risk – probability of the risk
occurring, consequence of the risk and the contingent factor10. The value of the
transferable risk equals the contingent amount that the government would pay to
the private partner if a risk occurred under the conventional procurement approach
(Amekudzi & Morallos, 2008; Hodge, 2004).
Four elements: raw PSC, competitive neutrality, transferable risks as well as
retained risks, produces the value of PSC, which is then compared to the value
proposed by the private partner – estimate of PPP value. The value for money is
represented in net present value terms as a difference between the expected costs
of PSC and PPP (Amekudzi & Morallos, 2008), as shown in the figure below:
10
Value of risk = consequence * probability of occurrence + contingency factor (Partnerships Victoria, 2001)
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Figure 6. Identifying Value for Money
Source: Amekudzi and Morallos (2008, p. 121)
1.5. ADVANT AGES AND DISADV ANT AGES OF PPP
As it has already been reviewed, the appropriately constructed PPPs entail the
advantage of delivering better value for money compared to the traditional
procurement approach. Delivering projects on time and on budget set (Meidute &
Paliulis, 2011) are two of the most important advantages that are hidden under the
concept of value for money. As study conducted by UK’s National Audit Office
(2003) showed, from all conventionally procured projects, 70% were delivered late
and 73% with costs exceeding the initial budget (data of 1999), whereas only 22%
of PFI projects were late and only 24% delivered project in excess of the budget
(data of 2002). The reason for such a difference lies behind the risks transferred in
line with additional responsibility and accountability attached to the private partner
in the case of PPP, what incentivizes the private partner to operate in the most
efficient way. In addition, due to the long term characteristics of the partnerships,
partners involved tend to act in a more cooperative way to each other in this case
creating additional synergy benefits. Private partner manages complex financial
arrangements as well as highly technical tasks more efficiently by using its
innovative skills, on the other hand – the public sector preferably controls the legal
system, regulation and policies. As a result, a combination of the leading features
of both of the partners produces a higher value (Harris, 2004).
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The other advantage of PPPs lies behind the construction of the proposal to
procure a public project. Government constructs PPP proposals that focus more on
outputs rather than inputs. As a result, such mindset encourages government to
perform a thorough discussion on which services should be provided, what
standards should be expected, and what is the aim of the service provided/asset
developed. Such a detailed discussion on service provision or asset development
requires a detailed analysis of the project which in some of the cases may hinder
the government from moving ahead if the project becomes inadequate. In addition,
such kind of initial discussions encourage the government to think about the project
with long term strategic goals in mind rather than focus on short term objectives.
Furthermore, PPP’s ability to spread the costs of large investments over the
lifetime of the asset is seen as an attractive advantage for the public sector. This
eases the current debt of the government sector as it does not have to incur large
cash outflows immediately. It follows, that the government can get projects
financed even though in reality there are no public funds available. This advantage
could be considered from two points of view: first – large investment costs are
spread out, and second – private funds are considered as the new financing
opportunities for the government (Meidute & Paliulis, 2011). On the other hand, this
advantage should be considered with caution as sometimes the government might
be incentivized to prove better value for money for a PPP project than it actually is
just to guarantee the financing of the project.
Finally, from the private partner’s point of view, PPPs deliver opportunity for the
private sector to get involved in the new markets (telecommunication, municipal
water systems, energy, etc.) that otherwise would be closed for the private sector’s
participation. In addition to this, the private partner involved in the new markets has
a support of the government, which may facilitate gathering the funds required.
On the other hand, one of the main disadvantages of PPPs is large bidding and
contractual costs, which refer both to the government and the private partner.
Large bidding costs of the PPP projects act as a rejecting force for the private
parties as they are unwilling to invest heavily in the bidding process just to be
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rejected later. What concerns government, large preparation costs consist of
feasibility studies, lawyers, etc. Moreover, PPP projects are highly complicated.
Usually, they involve more than two parties: public, private and banking sectors,
and all of these parties have their own contradicting aims. In order to construct a
unified agreement, a lot of time and capital needs to be invested on complex
negotiations.
Furthermore, PPPs are said to deliver benefits because they transfer a significant
amount of risks to the private partner. Nevertheless, it should be kept in mind that
even though most of the risks are transferred to the private partner, the final entity
that is responsible for providing services to the public is the government. As a
matter of fact, if the private partner goes bankrupt, solely the government has to
deal with the consequences and try to find other expedients how to keep delivering
the service to the public. This implies that even though the risks are contractually
transferred to the private partner, in practice, government retains a large portion of
them in case of the private partner’s failure.
Moreover, in a PPP agreement, government bounds itself to a single private
partner for a long term period and it agrees today for services/assets that will be in
use in further future. There is a certain amount of risk concerning the future
consumers’ need for the specific service. The idea behind the risks concerned is
that the partnership may end up delivering services that are no longer required by
the public. As a result, the partnership will appear to be less valuable than initially
expected.
Finally, PPPs work well only for specific projects, which are complex and require
specific private partner’s know-how, skills, and experience. Therefore, advantages
that are attached to PPPs are attained only if certain project characteristics are
met, whereas if the project is simple, executing it trough a PPP implies higher
preparation costs, and as a result, lower value for money.
Considering all of the above, the main idea behind the PPP option is to have a
project intricate enough that its complexity could justify additional preparation and
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negotiation costs. Developing a project through a PPP usually ensures additional
benefits such as implementing the project on time and on budget. Nevertheless,
these benefits should be considered while keeping in mind the r isks involved in
having the long term agreement between private and public sectors for a certain
service provision: who can reassure that there will still be a need for some kind of
service in, for example, 30 years?
1.6. CRITICISM OF PPPS
Even though the majority of the international institutions seem to favour the PPP
option (EC, UK Treasury, OECD, IMF), some of the researchers see PPPs as a
language game in the politics – PPP is regarded as another way of privatizing a
service/asset (Hodge & Greve, 2007). This point of view has been neglected by
many other researchers who represent arguments proving that PPPs differ from
the privatization (Grimsey & Lewis, 2004; Harris, 2004; Hong Kong Efficiency Unit,
2008; OECD, 2008). One of the first differences identified is the sale/transfer
concerned. PPP involves government granting a right to the private party to
develop and provide certain services/assets for a period of time, whereas
privatization, in general terms, involves the sale of the asset. This assents to the
amount of risks transferred. In PPP case, the amount transferred differs on the
type of PPP chosen. Concession is the mode of PPP that involves the largest
amount of risks transferred to the private partner; however, it still does not
encompass the transfer of all risks. On the other hand, privatization includes the
sale of the full package, which means the transfer of all associated risks. In this
case, government is left with no direct responsibility for the service provided/asset
developed, whereas in a PPP case, government is the one that retains the initial
control and responsibility for the service/asset (Harris, 2004). If the private partner
goes bankrupt, the service/asset is transferred back to the government. If the
private partner does not operate to the standard required, the government has a
right to intervene and punish the private partner. All in all, it is true that privatization
and PPP share some similarities, but the idea of PPP is that it shares some
superior features of the privatization as well as of the conventional procurement
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mode – as Grimsey and Lewis (2004) argue: PPP fills in the missing gap between
privatization and the traditional procurement approach.
Other critiques concentrate on the idea that the government should be fully
responsible for the services provided as this is the role of the government and not
the private sector. However, as Harris (2004, p. 3) argues, the provision of public
services (such as free education, transportation or health) by the government is
“comparatively recent development”. So the question rises whether it is the actual
provision of the services or is it the regulation and control of the service provision
(what kind of services to deliver, what kind of standard should be kept, what policy
to follow, etc.) that is the role of the government? As Harris (2004) concludes the
role of the government is to ensure that a policy is being adopted. If delivering the
policy through the parties that are able to do that in the best possible way while
additionally creating value for money to the public means that the private partner
should be involved, then the advantages of private partner’s efficiency and
innovative skills should be utilized.
Further critique concerns the view that PPPs are a ‘trendy’ politics. This means that
countries might favour PPPs over the conventional procurement due to the lack of
public funds available. Owing to this, the government is left with a choice not
between a PPP and a conventional procurement project but with a choice between
a project and no project at all as a government is unable to finance the project from
its own funds (Robinson, 2000; Shaoul, 2005). The problem of such a preference
for PPPs is that there is a high degree of possibility for approval of projects that do
not generate better value for money but are accepted for the financial resources
only – getting a project procured while having debt off government’s balance sheet
(Maski & Tirole, 2008). In addition to this, as value of PPPs are most of the times
assessed by using PSC, problems appear when hypothetical risk-adjusted nature
of the model is considered. The PSC depends highly on the assumptions
employed (Amekudzi & Morallos, 2008), one of the most important one being the
rate used to discount the cash flows of the PSC. Furthermore, when risks
allocation is performed, it is criticized that not all of the risks may be identified and
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valued (Amekudzi & Morallos, 2008; OECD, 2008; Shaoul, 2005), thus leading to
inaccurate PSC estimate. As OECD (2008) argues some of the risks may be left
out and neither of the party initially agrees to take responsibility for it, however,
once the risk evolves, it is the government and the public that have to bear the
consequences and not the private partner, leaving some element of value for
money out of the initial estimate. Considering all this, the value for money estimate
may be easily adjusted in order to make the PPP proposal more attractive, which is
seen as a problem when the only reason for PPP project implementation is the lack
of public funds.
Moreover, it has been noted that an advantage of PPP is its ability to spread out
the huge initial investment costs throughout the years of the lifetime of the asset.
This means that the government avoids large investments today and is able to
incur them later on in smaller amounts. However, who may guarantee that the
government with increasing number of PPPs will be capable of financing these
payments in later years? Will it pass this contingent liability to the future taxpayers
(Harris, 2004)? In addition, who can be reassured that the same
service/infrastructure will be necessary in, for example, 30 years? In addition, will
the taxpayers be happy for paying taxes for the services that are unnecessary
anymore? These questions are especially relevant to the cases of PPPs where the
government contracts to pay availability payments for the services provided by the
private partner.
Overall, PPPs attract some significant critiques, however, it should be noted that
PPPs are not a magic solution for the conventional procurement issues. The true
experiences of PPPs have not been observed yet as it takes time to acknowledge
the full impact of each PPP, however, the initial stages of the PPP and the
theoretical foundations allow PPPs to be considered as a possible way to bring on
additional efficiency gains to the public sector.
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2. ANALYSIS
2.1. THE PROJECT
In the last decades the advantages of having a developed inland waterway in
Lithuania were forgotten. The politicians focused more on developing the road and
rail rather than the inland waterway network. This is understandable as the
potential for Lithuanian biggest river (Nemunas) to become domestically or an
internationally important part of the transport network is far more complicated
compared to the road or rail network. On the other hand, due to Lithuania’s
geographic position and increasing global emphasis on the environmentally friendly
modes of transportation, inland waterways are becoming a solution to many of the
European environment targets set11. As a result, the interest to encourage the
development of Lithuanian waterway is growing and one of the first steps is to
develop a wharf in the centre of Lithuania (Appendix 5). The aim of the wharf is to
stimulate the freight transportation in Lithuanian inland waterway network by
creating opportunity to accommodate barges transporting containers.
2.2. ALTERNATIVES FOR PROJECT IMPLEMENTATION
The traditional procurement approach for the delivery of public services and
facilities has been practised in Lithuania for decades already. The new rising trend,
however, is the use of public-private partnerships. Despite the fact that PPPs may
bring additional value for money, the PPP option is not always the best solution to
the provision of the public service or good. In order to assess whether PPP option
should be considered for the wharf’s project, the following circumstances, identified
by the Ministry of Municipal Affairs (1999) and adopted to this particular project,
should be reviewed:
11
For example, European Commission’s White Paper has noted that the GHGs emission should be decreased by 80-95% below 1990 levels, from which at least 60% decrease should be achieved in the transport sector by 2050; by 2030 the transport sector’s GHGs emission should be lowered to 20% below the 2008 level. In addition, freight transportation shift to other modes is advocated: the target has been set to transfer the road freight to other transportation modes – rail or waterborne – when the transportation distance exceeds 300km by at least 30% by the year of 2030, and by 50% by the year of 2050 (European Commission, 2011, pp. 3, 9).
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1. Does the government have enough know-how or financial resources to
consider the project on its own?
2. Is there a potential for the private partner to provide the public service faster
and in a better quality than the government would do on its own?
3. Is there a competitive environment for potential tender of a project?
4. Can the output of the project be identified easily? Can the performance of
the private partner be measured easily?
5. Does the project require innovative skills?
The wharf’s project is very specific and the government authority lacks the skills
and know-how required to operate the wharf effectively. As a result, due to the
expertise and experience of the private sector in the field concerned, the inclusion
of the private partner may bring additional value. Furthermore, additional value can
be enhanced by delivering the project faster than in the case of the government.
The experience of PPP projects around the world prove that PPPs most of the
times deliver the projects on time, whereas in the conventional procurement mode,
the delivery is often delayed12. Moreover, the output of the wharf can be identified
and measured easily, and as a result, monitoring private partner’s performance
should not be too problematic. The idea behind PPP is that only the outputs of the
project are specified, and the private partner has all the freedom it needs for
innovative decision making that could make the project more efficient. Following
this, it should be concluded that the PPP option is worth considering and, as a
result, the paper analyses the following procurement options:
1. Traditional procurement approach, where government takes a full
responsibility for the project and finances, designs, builds, operates and
owns it;
12
Study performed by Flyvbjerg, Holm, and Buhl (2002) proved that costs in the conventional procurement approach in 90% of transportation infrastructure projects were underestimated – actual costs exceeded the planned budget on average by 28%. Another study conducted by UK’s National Audit Office (2003) found that from all conventional procurement approach projects arranged, 70% were delivered late and 73% with costs exceeding the initial budget (1999 data), whereas only 22% of PFI projects were late and only 24% delivered project in excess of the budget.
Page | 34
2. PPP approach, where the responsibility of the project delivery is shared
between the private partner and the government, and where it is the private
partner that finances, designs, builds and operates the wharf.
Which of the two options delivers better value requires a detailed analysis, which is
presented in the following sections.
2.3. IDENTIFYING AN APPROPRIATE PPP SCHEME
In order to determine which PPP scheme should be the appropriate one for the
project concerned, first of all, the overview of possible PPP forms in Lithuania is
reviewed.
2.3.1. OVERVIEW OF L ITHUANIA’S LEG AL PPP ENVIRONMENT
Currently Lithuania has no one single legal act determining all existing forms of
public-private partnerships, their characteristics, etc. (Meidute & Paliulis, 2011).
Nevertheless, some forms of PPPs are covered by Lithuanian laws, such as the
Law on Management, Use and Disposal of State and Municipal Authorities’
Property, the Law on Concessions, the Law on Investment. The problem with these
laws, however, is that some of them do not fully cover the regulations necessary
and therefore, are insufficient (Meidute & Paliulis, 2011).
In Lithuania PPP environment is not yet developed. Some of the interest has been
identified, however, it is far away from what, for example, United Kingdom or
Australia has already achieved. As Meidute and Paliulis (2011, p. 262) note "there
are virtually no PPP projects implemented at a national level that would cover
some sector of importance for the society and where the public sector would be
represented by central authorities”. Nevertheless, Lithuania is improving its PPP
environment and as of today Lithuanian law provides two classifications of public-
private partnerships: institutional and contractual partnerships.
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INSTITUT IONA L P ARTNER SH IP
Institutional partnership is a PPP mode when functions of a state or municipal
authority are granted to a joint stock company or a limited liability company, which
ownership is shared between the state or municipal authority and the private
partner. The characteristics describing the nature of this PPP form are determined
in the Law on management, use and disposal of state and municipal authorities’
property (Seimas of the Republic of Lithuania, 2012c, article 2, paragraph 12).
The main requirement for establishing an institutional partnership is the exchange
of resources between each of the party involved, i.e. the state or municipal
government invests its property in exchange for acquiring the authorized capital in
either the newly established joint stock or a limited liability company or in a
company which is increasing its share capital. The acquired authorized capital
should provide the state or municipal government (or both of them together) with
more than 50 percent of the vote.
CONTRACTUAL PARTNERSH IP
In general terms, it could be defined as cooperation between the public and private
parties on the basis of the contractual agreement. The contractual partnership can
assume the form of a concession or public and private parties’ partnership.
To begin with the concession, the characteristics describing the nature of this PPP
form are determined in the Law on Concessions (Seimas of the Republic of
Lithuania, 2012a). Concession is an engagement of a concessionaire (private party
involved in the concession agreement), in accordance to the concession
agreement and the conditions laid down by the awarding authority, in economic-
commercial activities related to infrastructure design, construction, extension,
renewal, modification, repair, management, use and (or) maintenance, as well as
the provision of public service, management and (or) use of state, municipal
property (including the operation of natural resources), when the concessionaire
assumes all or most of the risks in addition to the rights and obligations associated
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with an activity awarded under the specific concession agreement.
Concessionaire‘s remuneration for handling the activity granted consists of:
1. The right to engage in this particular activity in addition to the income
generated from such an activity; or
2. The right to engage in this particular activity in addition to the income
generated from such an activity together with the payment made by the
awarding authority, which is subject to the risks assumed.
According to the concession agreement, the concessionaire is allowed to operate
certain economic-commercial activity, which is related to infrastructure
development or the provision of public service in the following areas: water
management, waste management, railway lines and networks, road transport
infrastructure, health care system, port and wharf’s infrastructure, etc. for a period
of time no longer than 25 years. The property that could be transferred to the
concessionaire for the use or management purposes is the property belonging to
the state or municipal government in addition to the property which exclusively
belongs to the state under the Constitution.
The main point differentiating concessions from other contractual partnerships is
that revenue can be collected from the direct users of the public service or
infrastructure managed under the concession agreement.
According to the recommendations For PPP feasibility study preparation provided
by the Central Project Management Agency (CPVA), concession mode is classified
under the economic activity, which includes services of general economic interest
(CPVA, p. 20). The aim of the economic activity is to create an open and
competitive internal market. Public-private partnership for the economic activity can
be arranged when the activity concerned is of economic nature, irrespective
whether it is under the responsibility of the government or the private party. Under
such activities, users pay for the services directly to the service provider – in this
case, private party. PPP scheme under economic activity is presented in the Figure
7.
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Figure 7. PPP scheme under economic activity
Source: CPVA (p. 21)
The other mode of the contractual partnership is the public and private parties’
partnership. The characteristics describing the nature of these particular
partnerships are determined in the Law on Investment (Seimas of the Republic of
Lithuania, 2012b). Partnership is a mode of PPP in which a private party invests in
the activity that the government is responsible for and the corresponding
infrastructure (which is owned by the government) and operates within it according
to the rules defined in the Law on Investment. The government is responsible for
remunerating the private party for the operations handled.
According to the public and private parties’ partnership, the right to operate a
certain activity can be granted to the private partner, which is related to the design,
construction, reconstruction, repair, renovation, management, operation and
maintenance of infrastructure and other property that government transfers to the
private party, in addition to the provision of public services in the following areas:
transport, education, health and social care, culture and other areas determined by
the state authorities. During the time of the partnership the property can be
transferred to the private partner for the operations defined in the partnership
agreement, however, after the duration of the partnership, the whole property has
to be returned to the government: the one transferred to the private partner at the
start of the partnership period in addition to all the new property created during the
time of the partnership.
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The partnership is arranged only when it provides an effective implementation of
the state functions, public interest and public needs and it cannot be shorter than 3
years and no longer than 25 years.
According to CPVA, the public and private parties’ partnership is classified under
the social activity, which covers all non-economic activities. Some examples of
social activities under PPPs include schools, prisons, health security, and various
social services. In this PPP mode, users do not pay directly for the services. It is
the responsibility of the government to allocate public funds in order to receive the
services concerned. PPP scheme under social activities is illustrated in Figure 8.
Figure 8. PPP scheme under social activities
Source: CPVA (p. 23)
2.3.2. CHOOSING A PPP SCHEME
After reviewing present forms of PPPs in Lithuanian legal environment, the next
step is to identify which one is the most suitable one for the wharf’s project.
When considering the institutional partnership, it is important to note that the
government within the wharf’s project case seeks to transfer the day-to-day
decisions to the private partner. The reason for that is that the government
authority does not have the skills and the know-how required to operate the wharf
in the most efficient way, whereas the private business has it all. In the institutional
partnership, the day-to-day operation management is in the hands of both parties
involved as the government has at least half of the votes. As this is not the aim of
the government authority in this particular case, the institutional partnership mode
as an adequate PPP form for the project has been rejected.
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The other PPP mode is the contractual partnership, which consists of concession
(economic activity) and partnership (social activity). Partnership under the social
activity has been rejected due to its differing goals and circumstances regarding
the payment mechanism. First of all, these partnerships are developed in order to
implement projects of non-economic nature. Secondly, under the scheme agreed
on, the users of the wharf will have to pay for the services directly, whereas in the
partnership the government remunerates the private party for the services
delivered.
Finally, the last PPP form – concession, has been considered as the most suitable
PPP form due to the following reasons:
1. The wharf’s business is an economic activity, irrespective whether the wharf
operates in the hands of the government or of the private partner;
2. Economic-commercial activity of the project is identified in the Law on
Concessions as an activity related to infrastructure development – building
port and wharf’s infrastructure;
3. The payment to the private partner consist of the right granted to engage in
wharf’s business, the income generated from direct user payments as well
as the payment made by the government authority in exchange for the risks
assumed.
2.4. COST AND BENEFIT ANAL YSIS
The next section of the paper represents the cost and benefit analysis carried out
on the project. In this paper the project is analysed by comparing the two
alternatives, i.e. implementing a project through a traditional procurement and a
PPP approach. The CBA will begin from the assumptions and data overview,
followed by the financial, socio-economic and sensitivity analysis. Finally, the
results of the analysis will be reviewed and the main question – which procurement
mode generates higher welfare – will be discussed.
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2.4.1. ASSUMPTIONS OVERVIEW
T IME H OR IZON
The project is assumed to take a time horizon of 25 years. The decision regarding
the length of the project is made in line with the recommendations provided by the
European Commission (2008) for the port development projects as well as
according to Lithuanian Law on Concessions where the maximum period of time is
set to 25 years.
STANDING
In order to assess and allocate the costs and benefits generated by the project, it is
important to understand whose costs and benefits count, in other words, CBA
requires the identification of who has standing (Boardman et al., 2011). With
respect to the project analysed, the chosen point of view is the national
perspective. The reason for this is that the wharf is of a national importance and it
has effect not only on a certain region within the country, but it has influence on the
whole economy of Lithuania and its development.
PRICE LEV EL
Identification and monetization of costs and benefits relevant to the project
concerned, first of all, require some assumptions regarding inflation and relative
price changes. The costs and benefits should be valued in the same comparable
way throughout the years of the project, therefore, it is important to define the
relevant components. The choice for projecting the costs and benefits is between
using nominal and real values (Boardman et al., 2011). From one point of view, the
inflation could be incorporated into the calculations of costs and benefits. This
would require the estimation of expected future inflation rates for the next 25 years.
However, as the Belli, Anderson, Barnum, Dixon, and Tan (2001, p. 42) note,
predicting the rate of inflation is “a difficult, if not impossible task”. As a result, the
inflation is usually netted out, i.e. the costs and benefits are valued in real terms.
OECD (2006, p. 44) proposes using the real terms and valuing all costs and
Page | 41
benefits from a perspective of the base year, i.e. “the year of the appraisal”. This
view is also supported by Belli, Anderson, Barnum, Dixon, and Tan (1998), who
note that the real values for costs and benefits calculation should be employed.
The reason for that is that the inflation raises the value of costs and benefits in
same levels, which means they net out each other’s impacts (Campbell & Brown,
2003). As a result, the project’s costs and benefits are valued in real terms.
Furthermore, the valuation needs to be conducted, as mentioned above, from a
base year perspective, which has been settled to be year 2012. Most of the costs
and benefits were initially valued at the price level of 2012, therefore no adjustment
was necessary. Cost and benefits that required an adjustment are represented in
the socio-economic analysis.
Moreover, it is important to consider the relative price changes, which are changes
in prices that are significantly above or below the inflation rate. The price changes
occur due to changes in demand, the scarce nature of goods, technological
development, etc. (Campbell & Brown, 2003; HM Treasury, 2003). The evaluation
of the project’s costs and benefits assumes unchanged relative prices.
Finally, monetizing costs and benefits requires a choice of the currency. All cost
and benefits have been calculated in the national currency – Lithuanian Litas,
however, some of the values used in the socio-economical analysis require
exchanged from Euro to Lithuanian Litas, and for this purpose, the official fixed
exchange rate of 3.4528 LTL/EUR13 is in use.
D ISCOUNT RAT E
The goal of comparing the two project implementation models is to assess which of
the two procurement approaches ensures higher value. In order to assess and
compare the net values, costs and benefits of each of the alternative are
discounted to the present terms. Discounting is crucial for CBA as it ensures that
the time value of money is incorporated in the valuation of costs and benefits. If
13
In use from February 2002.
Page | 42
time value of money was not captured, having one dollar today would be the same
as having one dollar in a hundred years. However, this does not seem to be true as
having one dollar in one hundred years involves uncertainty and this uncertainty
decreases the value of future money. Determining the appropriate discount rate is
very complex, however, it has great impact on the CBA results, which provide
guidance on whether the project should be passed or rejected. Finding the right
discount rate also involves distinguishing how the rate differs for the private and
public sectors. This is especially relevant when PPP and conventional procurement
approaches are compared. Currently there are two opposing views regarding what
rates should be used for the sectors considered. The first one states that the rates
should be indifferent. Grimsey and Lewis (2004) make an overview of this
perspective. They represent Klein’s (1997)14 view that it does not matter what is the
source of the funds (the default risk is irrelevant), what matters is the actual project
and its specific risks. Therefore, allowing government to use a risk-free discount
rate undermines the amount of project’s risks and presents it as being less risky
than it actually is. Private sector, however, analyses the project thoroughly in order
to identify the risks inherent and, in accordance to these risks, determines the
relevant cost of capital. It is also argued that the discount rate attributable to the
government should be lower than the private sector’s one due to government’s
ability to transfer project’s risks to the taxpayers, spreading the risks out, what the
private partner is incapable of doing. However, transferring these risks to the
taxpayers is not costless. Imposing contingent liabilities on the taxpayers due to
transferred project’s risks is a cost to a society, which usually is overlooked in CBA,
and as a result, the costs of the project are undermined. Incorporating these costs
to the cost of capital might lead to the same rate used by the private partner. The
second point of view argues for differing discount rates, where the private partner
has a higher cost of capital. One of the reasons for this is the risk of default. Private
partner is more likely to default compared to the government as the latter has an
ability to increase taxes in order to avoid its bankruptcy. Consequently, the
discount rate used by the private sector is expected to be higher compared to the
14
See Klein, M. (1997), ‘The Risk Premium for Evaluating Public Projects’, Oxford Review of Economic Policy, 13(4), 29–42.
Page | 43
public sector. Furthermore, the differing discount rates are justified by the nature of
the risks attributed to the project’s cash flows in the case of the private sector and
government (Grout, 2003). When PPP structure is considered, for example, a
Private Finance Initiative, from the government’s perspective, the discounted cash
flows are the costs incurred by the government as it pays the private partner for the
services delivered, whereas from the private partner’s point of view these cash
flows are the revenues. There are no reasons to assume that cost and revenue
cash flows are the same regarding their risk characteristics. Contrarily, Grout
(2003) argues that these cash flows have different characteristics and the one of
the private partner – the revenue cash flow – is riskier in its nature compared to the
cost cash flow. Moreover, another reason to assume why the discount rate
attributable to the private partner is higher compared to the public sector is the
premium a private partner requires for a long term nature of the PPP agreement
(PwC, 2005).
Despite the preceding discussion, practice shows that the discount rate used in the
private sector is higher than the one used in the public sector (PwC, 2005;
Stevens, 2004). Private partner’s discount rate is dependent on private partner’s
attitude towards risks and returns, whereas government’s rate usually depends on
the society’s preferences of consuming today as opposed to the future (Campbell
& Brown, 2003; HM Treasury, 2003; Stevens, 2004). In order to evaluate the
private partner’s expected return from the project proposed, the calculation of
weighted average cost of capital (WACC) has been employed (Goldbach,
Goldman, Phillips, & Seymour, 2012). The reason for this is that the private partner
will invest its funds to the project only if the project delivers the minimum rate of
return required, which is represented by the following formula:
-
, where RE – cost of equity; RD – cost of debt;
E/V – percentage of equity financing; D/V – percentage of debt financing; Tc –
corporate tax tariff.
Page | 44
To begin from the cost of equity, it should be acknowledged that there is a lack of
data concerning the appropriate rate of return the private investor would expect to
receive in case of a PPP project, especially in the market of wharf or port
operations in Lithuania. Owning to this, the alternative way to value the cost of
equity was employed. The idea behind this method was to analyze returns on
equity that randomly selected Lithuanian companies, present on the stock
exchange, generate. Following this, 10 Lithuanian companies were reviewed and
data regarding their return on equity in 2011 was gathered (Appendix 6). The
average of these returns was calculated, which equals to 14,3%, and used as a
cost of equity for the private partner in a PPP project concerned. It is, however,
likely that the cost of equity could be even higher as the project is much riskier
compared to the average company currently operating in the market. Nevertheless,
due to the lack of relevant data available, the average cost of equity will be
assumed to be the appropriate rate. The other components of the WACC formula
include the cost of debt, which is equal to 6%, an interest rate used to repay the
loan, as well as proportions of equity and debt present in the private financing
structure – 40% equity and 60% debt. The last component is the income tax, which
is 15%. After incorporating all of the data in the WACC formula, the estimated cost
of capital rate is 8,78%.
When considering the appropriate discount rate for the government, the social
discount rate needs to be considered. Identifying the appropriate rate for the public
projects from the government’s point of view requires a choice of the methodology.
Boardman et al. (2011) discuss the use of four methodologies, which are based on
the market behaviour: marginal rate of return on private investment, social marginal
rate of time preference, government’s borrowing rate, and weighted average
approach. The four approaches are criticized due to their complexity in determining
one single rate, difficulties in aggregating preferences and opportunities of each
individual, their inaccuracy when market distortions and externalities are
considered, etc. The alternative methodology proposed by HM Treasury (UK) is the
Social Time Preference Rate (STPR), which is represented by the following
formula:
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, where ρ is an element of two components – the catastrophe risk (L)
and pure time preference (δ), which represent the time preference, g – the growth
of per capita consumption and μ – elasticity of marginal utility of consumption.
STPR is a rate that represents society’s preferences to consume at different points
in time. Following HM Treasury’s recommendations, the chosen social discount
rate for the conventional procurement approach in CBA is STPR. In order to
determine the rate, first of all, each of the STPR’s components should be valued.
To begin with, the social time preference implies that an extra unit of consumption
now, as opposed to the one received in the future, generates higher utility as the
future consumption involves uncertainty “which attaches to it through human
mortality” (Campbell & Brown, 2003, p. 223) . This assents to the components of
the time preference value identified by HM Treasury (2003) – catastrophe risk and
pure time preference, where catastrophe risk implies the likelihood of some
disaster happening that may alter the returns expected. As it is difficult to calculate
both of the components, HM Treasury (2003) proposes the time preference rate to
be equal to 1,5%, which will be incorporated in the calculation of a social discount
rate for the wharf’s project. The other component is the elasticity of marginal utility
of consumption, which is also difficult to calculate for every specific project,
therefore, a recommendation of HM Treasury (2003) to use a rate equal to 1 will be
followed. The last component that needs to be considered is the growth of per
capita consumption, which is evaluated by calculating the average rate of growth of
per capita household consumption in Lithuania (Evans & Sezer, 2005) in the period
of 1995-201015. The growth of per capita consumption is estimated to equal 4,4%
(Appendix 7). After including all of the components into the formula, the STPR
used as a social discount rate for the government is equal to 5,9%, a rate just
above the one used by the European Commission (5,5%) for the countries such as
Lithuanian, the ones that are entitled to the Cohesion Fund. The reason for having
higher rate in countries that are entitled for this fund is that these countries need
15
Period of 1995 – 2010 has been chosen due to the limits of the data available, i.e. data is available only for the period chosen.
Page | 46
faster growth, more rapid development and, as a result, the project selectivity
should be enhanced (European Commission, 2008).
Comparing the private and public sectors’ rates derived from the calculations,
results in private partner’s cost of capital being 2,88% higher than the
government’s. This outcome appears to fit in the frame distinguished by PwC
(2005, p. 30), which note that the private sector’s cost of capital is usually 1-3%
higher compared to the public sector.
2.4.2. DAT A OVERVIEW
The project implies a construction of 200 m long wharf that is able to accommodate
three 64 m16 long barges, building administrative premises as well as constructing
an open storage area and a warehouse, acquiring the machinery and equipment
necessary for the cargo handling. The distribution of the investment costs is
represented in the table below:
Table 1. Distribution of investment costs, %
Year 1 2 3 Total
Works 0,0% 85,9% 46,3% 53,9%
Equipment 0,0% 0,0% 53,4% 43,1%
Services 0,0% 14,1% 0,0% 2,7%
Other investments 0,0% 0,0% 0,3% 0,3%
Total 100,0% 100,0% 100,0% 100,0%
Assets that have their economic life less than the time horizon of the project will be
replaced some time before the end of the project, depending on their economic life.
For example, cargo handling equipment will be purchased on the third year of the
project. The expected economic life of such assets is 12 years. As a result, the
replacement of the asset will take place on the 15th year. It has been assumed that
the value of the equipment in the year of replacement will compensate the costs of
the disposal, as a result, no net impact on the cash flows will be recognised.
Residual value is calculated according to its economic life and the market value of
the asset. It is assumed that the asset loses its value every year till the end of its
economic life.
16
A base barge has been adopted with respect to technical details of river Nemunas – its depth and width.
Page | 47
Operating costs have been identified in accordance to the investments and
reinvestments planned as well as the demand projections estimated. The reason
for that is that the three components mentioned above determine what level of
maintenance, labour, marketing campaigns and other expenses is required to keep
the wharf operational and up to the standard expected. Furthermore, the demand
projections are used to determine the expected levels of revenues. The demand,
however, due to the lack of relevant statistics (which is non-existent as a result of
absence of the market concerned) and project’s specificity is fairly uncertain. The
project is new and has no analogues in Lithuania. In addition, taking other
countries’ experience in this case is irrelevant as the circumstances surrounding
the freight transportation in Lithuanian river Nemunas are too different compared to
other, already developed, European inland waterways. Consequently, forecast ing
the demand for services is complex and requires a lump of assumptions.
Determining the demand, first of all, involves identification of a range of services a
wharf is expected to provide. These services include: mooring a barge, loading and
unloading barges, storage of containers in an open warehouse area, rent of the
closed warehouse and other additional services (weighting vehicle, container,
cleaning of containers, electricity, water, etc.). Next step is to determine the
potential amount of demand for the services identified. The approach chosen was
to look at the amount of container flows from two points of view:
1. To calculate the maximum wharf’s capacity and then adjust it by the
expected rate of occupancy;
2. To forecast the expected amount of containers transported through Klaipeda
State Seaport with the destination and origin of Lithuania.
The two points give a plausibility frame for the expected demand. The idea behind
these two points is that the wharf’s expected level of demand conducts a part of
the demand levels of Klaipeda State Seaport. The estimated demand expectations
for the wharf amount to 6,8% of all containers that are expected to pass Klaipeda
State Seaport. This is held as a reasonable expectation for the future demand
projections.
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2.4.3. F INANCIAL ANALYSIS
The financial return on the investment takes into account the investment and
reinvestment costs, operating expenses and the revenues generated throughout
the years of the project. The discounted cash flow analysis presents the results
that are the basis for the investment criteria:
Table 2. Financial return on the investment costs –PPP and traditional
procurement approach
Results Traditional procurement PPP
Discount rate 5,9% 8,78%
FRR/C 11,2% 11,2%
FNPV/C 18.494,4 6.364,2
When considering the financial return on capital, the two approaches available
should be overviewed in more detail regarding their financing structure. The
traditional procurement approach is when a government uses public funds to
finance a project. When the PPP approach is taken into account, the private
partner’s funds are the source of project’s finance. However, private partner’s
funds most of the time involve a third party – a bank. As a result, a PPP option
considered will consist of equity and debt. In literature it has been observed that
the portions of financial sources usually distribute accordingly: private partner’s
equity accounts to 10 -35% while debt – 65-90% of total financing required (Gray,
2004). In the case of this particular project, it is assumed that due to the riskiness
and specificity of the project, the funds will be distributed accordingly: 40% of
private equity and 60% of bank loan (provided for a 10 year period with the interest
paid at the end of the year, equal to 6%).
Table 3. The structure of financing in PPP and traditional procurement approach
Finance source Total Year 1 Year 2 Year 3 Years 4-25
Option I – Traditional procurement approach
Public funds
National grant 37.908 0 7.193 30.714 0
Replacement of short life components financing
National grant 10.387 0 0 0 10.387
Option II – PPP approach
Private funds
Equity 15.163 0 7.193 7.970 0
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Loan 22.745 0 0 22.745 0
Total 37.908 0 7.193 30.714 0
Replacement of short life components financing
Equity 10.387 0 0 0 10.387
Loan 0 0 0 0 0
With regards to the financing structures proposed, the calculation of financial return
on capital reveals the following results:
Table 4. Financial return on capital – PPP and traditional procurement approach
Results Traditional procurement
PPP
National
capital17
Private
Equity
Discount rate 5,9% 5,9% 8,78%
FRR/K 11,6% 14,1% 14,1%
FNPV/K 20.522,2 20.269,9 9.537,3
2.4.4. SOCIO-ECONOMIC ANALYSIS
Socio-economic analysis is carried out by performing fiscal corrections in addition
to corrections for externalities. Converting market into accounting prices did not
require calculation of conversion factors as the assumption was made that all
market prices represent correct accounting prices, i.e. the conversion factor used
in calculations equals to 1.
To begin with, fiscal corrections are used to correct for distortions that appear due
to financial transfers within the society that in reality create no economic value, i.e.
they represent a pure transfer only (European Commission, 2008). The procedure
of fiscal corrections consists of identifying indirect and direct taxes, as well as
certain government’s subsidies and omitting their impact from the financial
analysis’ flows. For the project considered the fiscal corrections were applied in
order to remove the impact of VAT, individual income tax and social insurance
contribution. VAT tax impact has been calculated by adjusting investment costs
17
In the case of PPP, looking at the financing structure of the project, the return on private equity and national capital needs to be distinguished. For evaluation of the financial return on national capital, the discount rate used is the one attributable to the government. The reason for that is that, from the society’s point of view, the national capital is of similar nature as public funds: it could be assumed, that society is indifferent between having an investment financed directly by the private sector, or the government first gathering the funds from them and only then investing into the project. As social discount rate used represents the society’s time preference to consume today as opposed to tomorrow, this rate is the adequate one for the evaluation of the financial return on the national capital.
Page | 50
and operating expenses (except remuneration related expenses) on year by year
basis. The assumption was made that 60% of the investment costs relate to
equipment, machinery, material, while the rest 40% of investment costs relate to
labour. As a result, 60% of total investment costs in addition to operating expenses
are relevant for fiscal corrections, for which VAT rate used equals the tax rate of
2012 – 21%. The other fiscal correction is made for the individual income tax,
which has been calculated by identifying new workplaces arranged as a result of
project implementation. The remuneration associated with these workplaces
includes the individual income tax to the government, which is assumed to equal to
the tax rate settled in 2012 – 20%. In addition, the remuneration flows in the
financial analysis have been adjusted for the social insurance contribution
component, which is equal to 31%.
Next part of the socio-economic analysis consists of correction for externalities.
The analysis focused on identifying and pricing benefits that incur due to changes
caused by the project emergence. The benefits considered were changes in
external economic variables, such as CO2 emission (climate change), air pollution,
and accident costs. The calculation of these external economic effects was
conducted comparing road and inland waterway. The reason for this is that the
wharf’s development aim is to take off additional transport from the road and move
it to the river. In order to monetize the non-market impacts, the shadow prices of
the relevant external effects have been used. In addition to this, the average
amounts of CO2 emitted by both modes of transport were incorporated as it
facilitated the calculation of the average amount of CO2 emitted by road transport
in comparison to inland waterway transport. The shadow price of CO2 has been
used with respect to the guidance provided by Ministry of Transport and
Communications of the Republic of Lithuania (2011), whereas the averages
regarding amount of CO2 emitted were taken from the study conducted by The
European Chemical Industry Council (Cefic) (2011). What concerns the valuation
of the rest non-market impacts – air pollution and accident costs, the relevant
shadow prices have been taken from a study on external cost of transport
(Infras/IWW, 2004). The shadow prices used in the paper are the average costs
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calculated for air pollution and accidents. The study determined the price for air
pollution impact by considering damages it has on human health and buildings, as
well as its influence towards crop losses. Price for accidents was determined with
respect to additional costs accidents create, such as medical care, loss of
economic production, and suffering costs. The cost for accidents was conducted by
valuing “willingness to pay to reduce accident risks” (Infras/IWW, 2004, p. 169). It
should be acknowledged that the shadow prices used are the average prices
calculated for EU15 countries, nevertheless, due to lack of specific data for
Lithuania, the aforementioned shadow prices were incorporated in the calculations
of the non-market impact. The data used in calculations is represented in the table
below:
Table 5. Assumptions for the socio-economic analysis
Road Inland
waterway
Freight (t) 500.337 – 781.777
Average distance (km) 430 557
Average amount of CO2 emitted (g/tkm) 62 31
Shadow price for CO2 emitted (LTL/kg) 0,14 0,14
Shadow price for air pollution (LTL/1000tkm) 238,5 78,6
Shadow price for accident costs (LTL/1000km) 42,4 0 *Shadow prices are converted to price levels of 2012 using the GDP deflator
The comparison of the road and inland waterway transport prove inland waterway
to be more beneficial to the society compared to the road transport mode (Table 6).
Table 6. Net benefits of non-market impact
External savings, in thou. LTL
External effect Per year In total
CO2 emission 1.015 22.845
Air pollution 43.827 986.115
Accident costs 13.568 305.290
In total 58.411 1.314.251
All in all, after conducting the full socio-economic analysis, the results obtained for
both procurement approaches are indifferent. If the project is developed in the
same way in both of the cases, then the socio-economic values of these
approaches should be the same as it does not matter whether benefits such as
Page | 52
reduction in CO2 or air pollution are provided by the private partner or by the
government. The results of the socio-economic analysis are presented below:
Table 7. Socio-economic analysis results
Results
Economic rate of return of investment 108,8%
Economic net present value of investment, thou. LTL 531.595
Discounted Benefit/Cost index 7,63
The socio-economic analysis could be further expanded by taking into account
other factors that are difficult to quantify and monetize, which, however, are still
useful in order to reveal the full picture of potential impacts the project has. The
additional factors include benefits, such as: decreased levels of noise, especially in
Kaunas and Klaipėda, and introduction of new services to the transport market, as
well as costs, such as: damaged scenery, in addition to possible river degradation
problems. Nevertheless, as the aim of this paper is analysing PPP and not
performing the full socio-economic analysis, the examination of the socio-economic
factors is limited to the most important ones, the ones monetized above.
2.4.5. SENSITIVITY ANALYSIS
Most of the investment projects incur substantial amount of risk and uncertainty
and in order to understand its effect on the results expected, sensitivity analysis
was performed. The idea behind sensitivity analysis is to point out variables that
impact the base scenario of the project most, especially the ones that might turn
the results of CBA from positive to negative ones. The sensitivity analysis may be
performed to a wide variety of variables, however in the case of the project
concerned and with the aim of comparing traditional and PPP procurement
approaches, the sensitivity analysis will be based on variables that may facilitate in
the decision of which procurement approach to choose.
To begin with, CBA’s results rely heavily on the assumption made regarding the
discount rates used, therefore, the first variable examined is the discount rate
attributable to the private and public sectors. The sensitivity analysis was
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conducted by changing values of the discount rate for each of the sector analysed,
i.e. applying 5% and 10% discount rates18.
The analysis shows that increasing the discount rate lowers the financial return on
both investment and capital.
The figure below shows the relationship between the discount rate and the FNPV
on investment from the point of view of the traditional procurement approach and
PPP, as if the same rate is used for both of the procurement modes, the return on
investment will be indifferent, if the rates used differ, then the net present value
accordingly differs. For example, if the rate used for the conventional procurement
approach is 6%, then the generated financial net present value is around 20.000
thou. LTL, whereas if the rate used for the PPP is 12%, then the project, from the
point of view of the PPP, is not beneficial, and should not be undertaken.
Figure 9. Sensitivity analysis – FNPV on investment
Financial return on capital, on the other hand, differs for the two procurement
approaches even if the same discount rate is used. For example, when 5%
discount rate is applied to the traditional procurement approach, the financial return
on capital is 26.158 thou. LTL, whereas for the private partner it is 25.048 thou.
LTL. However, when the same cash flows are discounted using a rate of 10%, the
results change significantly, and the more beneficial project implementation
approach appears to be the PPP option:
18
More detailed results of the sensitivity analysis are presented in the Appendix 8.
0%
2%
4%
6%
8%
10%
12%
14%
-5.000 0 5.000 10.000 15.000 20.000 25.000 30.000
Dis
co
un
t ra
te,
%
FNPV, thou. LTL
Financial NPV on investment
Page | 54
Figure 10. Sensitivity analysis – FNPV on capital
As the figure above shows, when the high discount rate is used, the procurement
approach that delivers higher financial return on capital is PPP, however, when a
lower discount rate is used (lower than 6,18%), the more beneficial approach
regarding the financial net present value on capital, is the conventional
procurement approach. The reason for this is that the higher discount rate favours
projects that defer the expenditure and deliver benefits in short term (Shaoul,
2005). In this case, the short term cost outweighs benefits, whereas in the PPP
approach, due to the loan, costs are spread out over the years and therefore, the
difference between short term costs and benefits is smaller compared to the public
procurement case.
Considering the particular case when the 5% discount rate is used, the two
decision-making indicators, i.e. FRR/K and FNPV/K, seem to contradict. The
financial rate of return implies that PPP is the approach that delivers higher value.
From the financial net present value point of view the public procurement is more
beneficial. Even though the two decision making indicators seem to contradict, the
priority is given to the FNPV results as the internal rate of return may be
misleading, especially in the cases when the cash flows discounted have a
significant cash outflow in the middle (in this case it is year 15th) or at the end of the
project (European Commission 2008).
Finally, what concerns the socio-economic performance the discount rates affect
the results significantly, however, as the socio-economic benefits are really high,
0%
2%
4%
6%
8%
10%
12%
0 5.000 10.000 15.000 20.000 25.000 30.000
Dis
co
un
t ra
te,
%
FNPV, thou. LTL
On public funds (traditional procurement) On private equity (PPP)
Page | 55
increasing the discount rate up to 10%, still delivers substantial benefits equal to
329.770 thou. LTL. The socio-economic benefits are highly dependent on the
social discount rate, however, in the discussed range of rates, it is likely that the
project will generate additional welfare to the society.
Figure 11. Sensitivity analysis - Socio-economic results
The next part of the sensitivity analysis emphasises on the change in demand as it
is one of the most uncertain variables in the project concerned. The method
chosen here is similar to the one proposed above – the impact of change in
demand was examined by testing how a 5% and a 10% increase or decrease in
the demand affects the final results:
Table 8. Sensitivity analysis – change in demand
Change in demand19
5% -5% 10% -10%
Difference from the base scenario Traditional procurement approach
FNPV/C) 20,86% -20,86% 41,73% -41,71%
FNPV/K) 19,61% -19,61% 39,23% -39,21%
ENPV 5,48% -5,48% 10,96% -10,96%
Difference from the base scenario PPP
FNPV/C 43,78% -43,77% 87,58% -87,53%
FNPV/K on national capital 19,86% -19,85% 39,72% -39,70%
FNPV/K on private equity 30,38% -30,38% 60,78% -60,75%
ENPV 5,48% -5,48% 10,96% -10,96%
As the above table shows, the results are significantly influenced by changes in
demand, therefore, it should be acknowledged that the project is of a risky nature.
19
More detailed calculations are provided in the Appendix 7.
0%
2%
4%
6%
8%
10%
12%
14%
16%
0 100.000 200.000 300.000 400.000 500.000 600.000 700.000
Dis
co
un
t ra
te,
%
ENPV, thou. LTL
Socio-economic results
Page | 56
The biggest impact is in the PPP case when a 10% decrease in demand results in
nearly 88% decrease in projected financial net present value of the base scenario
(6.364,2 thou. LTL). If the demand falls by 10%, the financial net present value of
the investment would be reduced to 793,7 thou. LTL.
Overall, it could be concluded that such an investment is highly risky, and it does
not seem to provide the appropriate returns for the risks expected. When the
conventional procurement approach is compared to the PPP approach, it appears
that changes in assumptions affect the traditional procurement’s results less. The
reason for that is that the government requires smaller rate of return compared to
the private partner and that the government might be willing to accept higher
financial risks in exchange for high socio-economic benefits.
2.4.6. OVERVIEW AND THE DISCUSSION OF THE CBA RESULTS
The cost-benefit analysis was used to evaluate the project from two perspectives:
procuring project through conventional procurement approach and PPP. The
analysis’ results show that the project from the socio-economic point of view is
beneficial regardless who assumes the responsibility for its implementation. The
desirability of the project’s development is represented by significant economic net
present value, which is 531.595 thou. LTL. The sensitivity analysis shows that
socio-economic results are directly dependent on the flow of containers as a
change in demand affects the benefits significantly, nevertheless, due to the
benefits being vast, a 10% decrease in projected demand still allows a project to
deliver substantial socio-economic benefits. Furthermore, taking into account the
benefit-cost ratio, the implementation of the project will results in discounted
economic benefits exceeding costs 7,6 times. However, this measure may be
misleading in some way as it depends heavily on whether a cash flow is defined as
a benefit or a cost reduction (European Commission, 2008). From the financial
point of view, the project generates more value if the government procures it as
opposed to the private partner: FNPV on the investment costs in the case of the
traditional procurement approach is 18.494,4 thou. LTL, 2,91 times more than the
Page | 57
FNPV generated in a PPP case. The reason for that is the higher rate of return the
private partner requires compared to the public sector. If the assumption was made
that the two procurement approaches use the same discount rate, for example,
equal to the private partner’s rate of return, the project would deliver the same
financial rate of return on investment and higher rate of return on the capital
employed for the private partner. Nevertheless, as practice shows the rate of return
for the private partner is higher, therefore, with such an assumption in hand, the
public procurement generates more value. In addition, the project is highly risky as
it depends heavily on the change in demand. A 10% decrease in demand results in
a 42% decrease in FNPV on the investment costs in the traditional procurement
case and in a nearly 90% decrease in the PPP case. Moreover, as there is no
analogue for similar project in Lithuania, the project’s overall riskiness is further
increased. Consequently, the project’s success is uncertain, which is compounded
by the irreversibility of most of the investments (Brent, 2009). The risk could be
diminished if better market assessment was performed, however, at this stage with
the currently available data, it is unlikely that the private partner would get involved
in the project, even when a PPP is considered, as it delivers a non sufficient return
for the risks assumed. In addition, such uncertainty may affect the bank’s
eagerness to provide debt to the private partner as the bank prefers limited
exposure to risk, especially at this time as a result of the financial crisis. In a PPP
case, the debt is usually provided with project’s cash flows being the only collateral
to the bank (Akbiyikli et al., 2006). However, in this project, the cash flows are
highly uncertain, and therefore, it is unlikely that the bank would participate. In
order to attract the private partner, as well as the bank, the government should
consider the provision of guarantees or some kind of availability payment for a
certain period of time until the risk is diminished and the market becomes clearer.
Incorporating government’s guarantees would lower the riskiness of the project
and, as a result, make project more attractive for both the private partner as well as
banking sector. Nevertheless, it should be considered that due to guarantees, the
additional PPP value may be further reduced when compared to the conventional
procurement. With all this in mind, the public procurement is the option that from
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the economic point of view should be chosen as the one generating the highest
value.
2.5. FACTORS NOT COVERED BY CBA
The comparison of two procurement modes through the CBA shows that the
conventional procurement is the option that delivers higher value. Nevertheless,
the CBA is unable to take into account many factors that constitute the main
advantages of PPP. The CBA looks at the project from the cost and benefit point of
view, and the difference between the results for two procurement approaches lies
in the choice of the discount rate. In order to provide a more extensive discussion
on the two procurement modes, other factors that are not incorporated in the cost-
benefits analysis are reviewed.
In the project considered, the aspect that the government authority lacks the
expertise and know-how required to operate the wharf efficiently, is an important
reason to consider the involvement of the private partner. The private partner may
enhance the operations of the wharf by bringing in its innovation, expertise and
know-how, as well as motivation to act efficiently, on a timely basis and within the
budget. With these at hand, the private partner can deliver significant benefits
compared to the public sector. For example, delivering project earlier than
expected means realising socio-economic benefits quicker, which results in higher
value to the present society. However, in order to ensure that the private partner
has all incentives necessary to deliver benefits considered, the transfer of risks
should be performed. The transfer of risks motivates the private partner by
attaching additional responsibility and accountability. The appropriate risk
allocation is crucial as otherwise the efficiency gains will not be achieved and, as a
result, the involvement of the private partner in the partnership will not generate
any additional value, as was shown in the CBA.
In the traditional procurement approach, most of the risks involved in building,
financing, operating and maintaining the wharf are in the hands of the government,
i.e. the public authority is responsible for delivering the facility to the standards
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specified and services of the quality required, and if it fails to deliver what was
expected, the public funds are used in order to fix the failure. On the other hand,
with concession, most of the risks are transferred to the private partner, and in a
case of a risk appearing, it is the private partner that is responsible for dealing with
the risk and any costs incurred due to its occurrence. This is a substantial benefit
of concessions that was not incorporated in the CBA.
The potential risk transfer for the wharf’s project could be reviewed with regards to
the risk allocation matrix proposed by Chan et al. (2011) (Appendix 4). The reason
for choosing Chan et al. (2011) is that the paper reviews a wide range of literature
on risk management and provides a sophisticated review of 34 risk factors with
guidance towards an appropriate risk allocation. Some additional guidance has
been adopted from CPVA and Grimsey and Lewis (2002).
To begin with, the political risk group which includes risks such as government
corruption, intervention, nationalization, public credit and poor public decision-
making process should be retained by the government. The Lithuanian corruption
perception index during the last decade has ranged between 4,6 and 520, which
means that the country is perceived as fairly corrupt, especially in levels of political
parties, parliament, legislature, and judiciary (Transparency International, 2012).
Due to government being the only one having influence over this risk, the
corruption risk should be allocated to the public sector. The government
intervention, nationalization, and public credit risks are also under the control of the
government as it can intervene in private partner’s operations, seize the project
and chose whether to fulfil the responsibilities undertaken in the initial contract. In
order to secure the private partner that it will not be penalised for such
government’s actions, the risks mentioned are allocated to the government.
Furthermore, the risk of poor public decision-making process is especially relevant
to the wharf’s project, in particular when public-private partnerships are considered.
As was mentioned above, the PPP environment in Lithuania is not yet fully
20
Scale between 0 and 10, where 0 represents highly corrupt and 10 very clean countries (Transparency International, 2012).
Page | 60
developed, and as a result, lack of PPP experience in the public sector might
influence the effectiveness of the project development. Moreover, the bureaucracy
in the public sector is also an obstacle for an efficient decision making, which
further amplifies the risk. As these risks are the responsibility of the government,
they should be retained with the public sector. The next risk group – economic
risks – is expected to be handled best by the private partner. Risks that are
associated with an interest rate and foreign exchange fluctuations are allocated to
the private partner in accordance to Chan et al. (2011) and CPVA. The financing
risk is also a responsibility of the private as it is the private partner that has to
organise the financing sources. Risks associated with inflation change are
allocated to the private partner (Chan et al., 2011). However, it should be
acknowledged that government’s decisions and actions also influence the change.
Consequently, the risk should be shared in such a way that the private partner
would not benefit from slow growth of the inflation rate, but at the same time, it
should not take the full consequences of high increases in inflation rate.
Furthermore, legal risks are usually assigned to the public sector. The reason for
that is that the public sector has the exclusive right to change the law or the tax
system which may harm the private partner’s operations. Risks incurred due to the
political or public opposition should be handled by the public as it is the strategic
decision of the government what projects to develop or abandon. Force majeure
risks cannot be controlled by any of the party, whether it is an earthquake or
flooding, and as such, should be shared by both public and private parties
(Grimsey & Lewis, 2004; CPVA). Environment risks should be also shared equally
due to ability of both parties to influence the risk equally. For example, private
partner should take the responsibility for its actions that are hazardous. On the
other hand, if the government increases the requirements regarding the
environment that may influence the operations of the private party, then the
government should assume the consequences incurred. Moving on to the specific
project risks, all of construction and operation risks should be assumed by the
private partner. The reason for that is that in the concession, the private partner
receives the full responsibility for day-to-day operations and is fully responsible for
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designing, constructing and maintaining the facilities concerned, in this case – the
wharf. Private partner should assume completion, material and labour non-
availability, unproven engineering techniques, project’s operations, operation cost
overruns, as well as price change risks. These risks may be further extended to
include site condition and preparation risks, other technical risks, such as design
and keeping the facilities to the standard required. On the other hand, risk
described as market competition should be handled by the public sector due to its
ability to develop an additional project that may influence the demand projections
that the private partner has initially expected to receive. In the case of the wharf’s
project that means that if the government decides to build another wharf in
between Kaunas and Klaipeda, then the risk would occur that a part of the initial
demand might be transferred to the new project and, as a result, the private
partner’s profitability would be affected. Moving onto the changes in the market
demand, this risk should be captured by the private partner as it has control over
the business and is able to adjust it in order to keep its market share. As far as the
relationship risk group is concerned, the private partner should take the
responsibility for the third party delays and violations as it is the private partner that
deals with the third parties and it is private partner’s choice which parties to involve
in the process of delivering the service to the public. Risks such as organization
and coordination of the project should be also transferred to the private partner, as
well as concessionaire’s ability to deliver the responsibilities assumed.
Concessionaire should deliver the service as agreed and in case of a failure,
financial penalties should be considered. Other risks – land acquisition, delay in
project approvals and permits and lack of supporting infrastructure – should be
assumed by the government as it is the government that is in the perfect position to
control them. In addition, public sector should also take the responsibility for
collecting the approvals and permits necessary for projects’ implementation, as
well as it should ensure that the private partner has an access to the supporting
infrastructure that the government promised to the private partner. Finally, the risk
of residual value should be attached to the private partner as it is the private
partner that operates the asset for the period of concession and then transfers it
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back to the government. In order to ensure that value is captured, the responsibility
should be assigned to the private partner as otherwise the private partner may
have an incentive to overuse the assets concerned.
It should be acknowledged that the risk identification and allocation presented
above is a pure recommendation towards the project considered. The proposed
risk allocation model could change when the pricing of the risks comes into the
consideration. This may happen if a public sector desires to transfer a certain risk
to the private partner. However, private partner believes that it is not in the most
suitable position to manage the risk effectively and at least costs, and due to that,
requires a premium for taking the risk concerned. The premiums required for the
risks transferred may influence the risk allocation model and, consequently,
decrease the initial estimate of value for money.
Comparing the proposed risk allocation model in the case of PPP with the
traditional procurement approach proves that a significant part of risks may be
removed from the government’s hands and transferred to the private partner’s.
This has a value that would change the results of the CBA, however, it is
questionable whether the value would be high enough to outweigh the benefits of a
traditional procurement approach valued in CBA. In order to answer this question,
the PSC should be conducted and in such a way that the estimate for VFM could
be determined.
The final note that needs to be considered is a potential aim of the government
authority to have a project implemented by using private sector’s funds as opposed
to the publics’. The reason for that is that the government authority may lack the
funds required to implement the project immediately. However, such an aim should
not prevail as it gives incentives for the government authority to favour PPPs even
though they do not deliver the necessary value for money. It is especially a crucial
note when the long term characteristics of the contracts are considered, and from
this it follows that the PPP in the long term may turn out to be a more expensive
option compared to the traditional procurement approach.
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All in all, factors that are not covered by CBA have a high value when PPP
advantages are considered. The valuation of these advantages may have an
impact on the CBA decision whether to implement a project through PPP or
conventional procurement approach. Therefore, it is recommended to conduct a
PSC and compare it to PPP, and the difference in values of the two will facilitate
the more extensive decision.
3. CONCLUSIONS
Public private partnership is a way to procure public projects in order to achieve
additional value for money in terms of efficiency and higher quality of services.
Interest in delivering projects through PPPs is increasing as the advantages they
deliver seem to overcome the issues currently outstanding: inefficient provision of
public services, wasteful use of public funds, delivering projects late and over the
budget expected, etc. Nevertheless, PPPs are very complex and expensive. In
order to construct a PPP, large preparation and bidding costs arise and, as a
result, only very specific and complex projects are granted the option to be
considered for PPPs.
As a result of such contrasting arguments for and against PPPs, the thesis aimed
to explore the concept of public private partnership and its implication for the
procurement of public projects. This has been achieved by reviewing the relevant
literature and performing an analysis on a particular project. The analysis consisted
of two parts: first, the project was analyzed through the CBA technique, where the
conventional procurement approach was compared to the public-private
partnership, a concession, second, where other PPP relevant factors, which were
not incorporated in the CBA, were reviewed and discussed.
The literature overview defined and explained the PPP concept and illustrated what
PPP is, and what advantages and disadvantages this kind of partnership delivers.
In addition, the reasons for PPP implementation were reviewed and circumstances
surrounding them were explored. The question raised in the introduction part of the
paper – why PPPs represent such small fraction of all public projects if they deliver
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benefits such as greater efficiency, timely delivery of public projects, better quality
of service provision, etc. – was answered by identifying significant shortcomings
and criticisms these partnerships encompass.
The analysis part of the paper focused on the particular project, comparing the two
procurement options available – conventional procurement approach and PPP.
The paper investigated whether PPP scheme was a suitable procurement
approach for the particular Lithuanian infrastructure project and identified the
concession as the adequate PPP form. The comparison of two procurement
approaches was carried out by employing a CBA technique. The CBA results
proved that from the financial point of view, the conventional procurement
approach delivered higher value than a PPP. The reason for such an outcome lies
in the assumption that private and public sectors employ different discount rates,
i.e. private partner using a higher one. Sensitivity analysis showed that when the
discount rates are indifferent, the PPP delivers higher benefits in case of high
discount rates (above 6,18%), whereas the traditional procurement approach
prevails over PPP when low discount rates are in use (below 6,18%). The next
component of CBA was the socio-economic analysis, which proved project’s socio-
economic benefits to be substantial. The outcome of the analysis showed that the
society is indifferent of who delivers the project, whether the public or private
sector, as long as the project is implemented in the same way.
The second part of the analysis overviewed other factors’, which were not covered
by CBA, impact on the decision based on CBA results. CBA assumes that both
procurement approaches develop the project in the same way, with the same
materials, technologies, time necessary to implement a project, etc. However, what
PPP offers is the possibility to implement a project through a different way where
private partner’s skills, innovation, expertise, and know-how are utilized. In order to
ensure the realization of PPPs’ advantages, the appropriate risk allocation has to
be employed as it motivates the private partner to deliver the project on time, at
least-cost, to the quality requested, as well as to provide services to the standard
expected. The transfer of risks can be valued and attached to the results generated
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by CBA. However, in order to do this, the techniques of evaluating PSC should be
employed.
To conclude, the paper provides an overview and discussion on the concept of
PPP and its effects on the procurement of public projects. The analysis part,
dedicated to a particular infrastructure project, recognised that if only the CBA is
considered, the project should be implemented through the traditional procurement
approach, however, when other PPP related factors, that were not incorporated in
the CBA, are considered, then a more detailed analysis should be carried out in
terms of conducting a PSC and comparing it to the potential PPP proposal, as a
PPP option in the wharf’s project seems to deliver a variety of potential advantages
that were overlooked in the CBA.
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5. APPENDICES
AP P ENDI X 1: Comparison of public investment and PPP as a percentage of GDP
in European countries ............................................................................................... 74
AP P ENDI X 2: Relationship structure of a conventional procurement approach and
PPP ............................................................................................................................ 75
AP P ENDI X 3: The structure of PPP agreements: turnkey delivery and concession
................................................................................................................................... 77
AP P ENDI X 4: Risk allocation model adopted from Chan et al. (2011, p. 140):...... 78
AP P ENDI X 5: Location of a wharf ............................................................................ 83
APPEND IX 6: The average cost of equity (rate of return) ....................................... 84
APPEND IX 7: GDP deflator and the average growth of per capita consumption ... 85
APPEND IX 8: Sensitivity analysis ............................................................................ 87
Page | 74
APPENDIX 1: Comparison of public investment and PPP as a percentage of
GDP in European countries
Source: Adopted from EIB (2010, p. 17)
*FR – France, DE – Germany, EL – Greece, ES – Spain, HU – Hungary, IE – Ireland, IT – Italy, NL – Netherlands, PT – Portugal, UK – United Kingdom; **UK/1 estimate of EIB, UK/2 estimate of HMT.
Page | 75
APPENDIX 2: Relationship structure of a conventional procurement approach
and PPP
In the traditional procurement in order to deliver the services and infrastructure
required, the government acts as an intermedeary – on the one side it deals with
direct users of the services, taxpayers, and financial markets, and on the other side
– with other private companies (the scheme represented below). The idea behind
such a flow of relationships is that the government gathers financing from side A
and uses it to remunerate side B which provides capital goods necessary for the
public service provision and infrastructure development.
Source: OECD (2008, p. 41)
If the project is handled through a public-private partnership, the intermediary role
of the government is decreased – public authority deals with the taxpayers and the
single private operator only. The role of the private operator, on the other hand, is
enhanced: private operator becomes responsible for handling relationships
between side A and side B. Here private operator takes the main role of the
intermediary – it collects financing from side A (direct users of the service and
financial market) and remunerates side B (other private companies) for the capital
goods provided (the scheme represented below). If the private operator acts in
Page | 76
accordance to the performance standard specified, in some of the cases 21, it
receives additional payment from the government (Maski & Tirole, 2008).
Source: OECD (2008, p. 41)
21
The private operator may be remunerated in three ways: through direct user charges only, through government payment only, or through a combination of both of the payments (Grimsey & Lewis, 2004).
Page | 77
APPENDIX 3 : The structure of PPP agreements: turnkey delivery and
concession
Source: European Commission (2003, p. 18)
Page | 78
APPENDIX 4 : Risk allocation model adopted from Chan et al. (2011, p. 140):
Risk group Risk Risk description Risk allocation
Systematic risk category
Political risks Government corruption
The behaviour of the corruption of government
officials will increase the cost of keeping the relationships between the government and the project company. Meanwhile, it will increase the
risk of contract breaking by the government.
Public
Government intervention
Government officials intervene in the project operations directly, which will affect the autonomy of private investors’ decision making.
Public
Nationalization/expropriation Central or local government seizes the projects. Public
Public credit
The rejection of government to implement the responsibilities agreed in the contract, which brings direct or indirect damages
Public
Poor public decision-making process
Non-standardized procedures, bureaucracy, lacking of PPP project experience and ability, insufficient preparation and information asymmetry,
leading to poor decision making.
Public
Economic risks Interest rate fluctuation
The loss of PPP projects arising from the
uncertainties of the interest rate volatility.
Private
Foreign exchange fluctuation
The risk of the variability of foreign currencies exchange and the foreign currencies
exchangeability risk.
Private
Inflation
The increase of the price level of the commodities,
the decrease of purchasing power of currencies, which cause the increase of cost and other consequence.
Private
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Financing risk
The risk arising from the irrational financing structure, unsound financial market, and difficulty in financing.
Private
Legal risks Legislation change
Change of law and regulations and other government macroscopic economic policies will cause the increase in project costs and decrease
in revenue, etc.
Public
Imperfect law and supervision
system
The damage arising from the current PPP
legislation which is low level, low effectiveness, conflict bearing, and poor operability.
Public
Change in tax regulation The change in tax regulation of central or local government.
Public
Social risks Political/public opposition
For various reasons leading to the public interest being unprotected and damaged, which, as a
consequence, causes political and even public opposition to the risk of the project construction.
Public
Natural risks Force majeure
Before signing contract, the contract party cannot control or prevent reasonably. When the events happen, the situation cannot be escaped or
conquered, such as a worker strike, or other unforeseen items that are not “natural” risks.
Public
Unforeseen weather/geotechnical conditions
Because of the project site’s bad natural conditions, for example, climate condition, special geographical environment, and poor site
conditions, etc.
Private
Environment risk
Because of the increasing requirement of the
government or social organization regarding the environment protection, risk generated from the project cost increase, delay in work schedule, or
other loss.
Equally shared
Specific project risk category
Page | 80
Construction risks Completion risk
Project delay and cost overrun, etc., which cause insufficient cash flow and inability to pay off debts on time.
Private
Material/labour non-availability Loss because of delay in raw materials, resources, machines and equipment, or energy supply.
Private
Unproven engineering
techniques
The techniques adopted are immature and cannot
fulfil the standards and requirements as expected, or the techniques are of poor applicability which makes private investors to reinvest for the
technology improvement.
Private
Operation risks Project/operation changes
Poor constructability in design phase, design error or vagueness, standards and contracts variation, owners’ variation leading to the project, or
operation changes.
Private
Operation cost overrun
Government raises the standard of the products or
services leading to the cost overrun by the non-commercial factors such as increase in interest rates, exchange rates or force majeure, or poor
operation management.
Private
Price change
Price of PPP products or services are too high, too low, or inflexible to adjust, leading to the revenue of the project company lower than expected.
Private
Expense payment risk Infrastructure of the project or the process of the service provision is affected by other factors which
prevents the timely payment of the client’s (or government’s) fees.
Private
Market risks Market competition (uniqueness)
An actual market competition of the existing project caused by the new project or rebuild project of government or other investors.
Public
Page | 81
Change in market demand Apart from the risk from arising from market competition, factors attributed to macroeconomics, social environment, change in population,
adjustment of laws, and regulations leading to the change in market demand.
Private
Relationship risks Third-party delay/violation
Apart from government or private investors, other
project participants do not implement the responsibilities agreed in the contract or project delay.
Private
Organization and coordination risk
Because of the insufficient coordination ability of project company, the cost of communication
among project participants increases and conflicts occurs.
Private
Inability of the concessionaire
The insufficient ability of the concessionaire leading to low productivity of project construction and operation.
Private
Other risks Land acquisition
The increase in project cost and extension of project duration caused by the difficulty of acquiring the rights of the land. The cost and time
for land acquisition exceeds the original plans.
Public
Delay in project approvals and permits
Complicated procedures are required for project approval with high cost and long time. Upon
approval, it is very difficult to proceed business adjustments regarding the project scope and nature.
Public
Conflicting or imperfect
contract
The risk of the contract with inaccuracy,
vagueness, inflexibility, inconsistency, inequitable risk-sharing, unclear division of responsibility, etc.
Private
Lack of supporting infrastructure
The risks generated by the unavailability of the supporting facilities of the project.
Public
Page | 82
Residual risk
Investors overuse the resources like equipment or other technical conditions, etc., which cause insufficient materials and equipment with
depreciation at the end of the concession period. As a consequence, it affects the continuous operation of the projects.
Private
Inadequate competition for tender
The risk includes unfair, non-transparent tendering process, incomplete tender information, insufficient
number of tenders, vicious market competition, and bidding lowest price to win the tenders.
Public
Page | 83
APPENDIX 5 : Location of a wharf
The wharf is going to be located in Kaunas (green star in the figure), in such a way
connecting Kaunas and Klaipėda, where the most important Lithuanian transport
point, connecting road, rail and sea transport, locates.
Source: Adopted from Lithuanian Inland Waterway Authority (2008)
Page | 84
APPENDIX 6: The average cost of equity (rate of return)
Company name ROE, 2011 m.
1. TEO LT 15,4%
2. Klaipėdos Nafta 9,5%
3. Utenos Trikotažas 16,4%
4. Lietuovs Dujos 4,6%
5. Apranga 20,2%
6. Rokiškio sūris 9,6%
7. Grigiškės 13,8%
8. City Service 16,5%
9. Kauno energija 5,1%
10. Vilniaus baldai 31,9%
Average 14,3% *All data has been extracted from the financial accounts of the corresponding companies, available at http://www.nasdaqomxbaltic.com
Page | 85
APPENDIX 7: GDP deflator and the average growth of per capita consumption
I. GDP deflator:
Year GDP deflator
Base year 2000* Base year 2000*
1995 70.353 0,436
1996 84.548 0,524
1997 95.044 0,589
1998 99.647 0,617
1999 98.812 0,612
2000 100.000 0,620
2001 99.745 0,618
2002 99.795 0,618
2003 98.875 0,613
2004 101.510 0,629
2005 107.259 0,664
2006 114.314 0,708
2007 124.171 0,769
2008 136.122 0,843
2009 145.416 0,901
2010 151.438 0,938
2011 155.944 0,966
2012 161.418 1,000
2013 165.556 1,026 * Data is extracted from Data and Statistics database of the International Monetary Fund (http://www.imf.org); ** Own calculations based on the data extracted from International Monetary Fund database.
II. The average growth of per capita consumption:
Year
Household
consumption at current
prices,
Mln. LTL*
Household
consumption at constant prices (base year - 2012 ),
Mln. LTL**
Average number of
inhabitants*
Household income per
capita,
Mln. LTL
Change, %
1995 17.051 39.122 3.629.100 0,010780
1996 21.792 41.605 3.601.600 0,011552 7%
1997 25.025 42.501 3.575.200 0,011888 3%
1998 28.132 45.571 3.549.300 0,012840 8%
1999 29.220 47.733 3.524.200 0,013544 5%
2000 30.437 49.131 3.499.500 0,014040 4%
2001 32.572 52.712 3.481.300 0,015142 8%
2002 34.583 55.938 3.469.100 0,016125 6%
Page | 86
2003 37.709 61.562 3.454.200 0,017822 11%
2004 41.819 66.499 3.435.600 0,019356 9%
2005 47.578 71.602 3.414.300 0,020971 8%
2006 54.329 76.716 3.394.100 0,022603 8%
2007 63.153 82.097 3.375.600 0,024321 8%
2008 72.285 85.718 3.358.100 0,025526 5%
2009 62.605 69.494 3.339.400 0,020810 -18%
2010 61.101 65.128 3.286.800 0,019815 -5%
Average 4,41%
* Data extracted from The Lithuanian Department of Statistics (Statistics Lithuania) at http://www.stat.gov.lt/lt/; ** Own calculations based on data extracted from The Lithuanian Department of Statistics.
Page | 87
APPENDIX 8: Sensitivity analysis
Change in discount rate:
Traditional
procurement
PPP Traditional
procurement
PPP
Discount rate, % 5% 10%
Financial return on investment
FRR/C , % 11,2% 11,2% 11,2% 11,2%
FNPV/C, thou. LTL 23.812,1 23.812,1 2.843,2 2.843,2
Financial return on capital
FRR/K , % 11,6% 14,1% 11,6% 14,1%
FNPV/K, thou. LTL 26.158,1 25.047,8 3.868,2 6.478,7
Economic performance indicators
ERR, % 108,8% 108,8%
ENPV, thou. LTL 595.602,5 329.770,3
Discounted B/C index 7,91 6,51
Changes in demand, PPP and traditional procurement approach:
Base scenario
Change in demand
5% -5% 10% -10%
Traditional Procurement
FRR/C 11,2% 12,2% 10,2% 13,2% 9,1%
FNPV/C, thou. LTL 18.494 22.353 14.636 26.212 10.780
FRR/K 11,6% 12,6% 10,6% 13,6% 9,5%
FNPV/K, thou. LTL 20.522 24.547 16.497 28.573 12.474
ERR 108,8% 113,1% 104,3% 117,4% 99,8%
ENPV, thou. LTL 531.594 560.717 502.471 589.840 473.349
Discounted B/C index 7,63 7,91 7,35 8,18 7,06
Difference from the base scenario
FNPV/C 20,86% -20,86% 41,73% -41,71%
FNPV/C 19,61% -19,61% 39,23% -39,21%
ENPV 5,48% -5,48% 10,96% -10,96%
Public-private partnership
FRR/C 11,2% 12,2% 10,2% 13,2% 9,1%
FNPV/C, thou. LTL 6.364 9.150 3.578 11.937 793
FRR/K on national capital 14,1% 15,7% 12,5% 17,3% 10,9%
FNPV/K on national capital, thou. LTL 20.269 24.295 16.245 28.321 12.222
FRR/K on private equity 14,1% 15,7% 12,5% 17,3% 10,9%
FNPV/K on private equity, thou. LTL 9.537 12.435 6.640 15.333 3.743
ERR 108,8% 113,1% 104,3% 117,4% 99,8%
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ENPV, thou. LTL 531.594 560.717 502.471 589.840 473.349
Discounted B/C index 7,63 7,91 7,35 8,18 7,06
Difference from the base scenario
FNPV (C) 43,78% -43,77% 87,58% -87,53%
FNPV (K) on national capital 19,86% -19,85% 39,72% -39,70%
FNPV (K) on private equity 30,38% -30,38% 60,78% -60,75%
ENPV 5,48% -5,48% 10,96% -10,96%