Spectrum of PPP agreements
In the context of PPPs, technical acronyms like BOT, PFI , DBFM, DBFOM and so on are usually present.
By Hassan Abdulrahim.
These terms may be confusing for those who are not fairly acquainted with PPP terminology. Thus, we will give in this section a brief highlight of these types of contacts. In addition, we will focus on two principal issues which need to be investigated at the outset, ie the objectives to be achieved from a particular contract and the extent of responsibilities that are allocated to the private sector.
A thorough examination of these two issues would makes it much easier to choose the appropriate structure of any project development and whether that project fits into the PPP criteria. The figure above shows the spectrum of PPP agreements in terms of public and private partners involvement, with the extreme left of the figure shows a high degree of public sector involvement and low degree of private sector involvement, while the extreme right side of the figure depicts the opposite situation, ie low public sector involvement and high private sector involvement. In between these two extremes and as we go through the figure, from left to right, we notice that public sector gives up more involvement to private sector and hence bears less responsibilities and risks and at the same time we notice more responsibilities and risks are shifted to the private sector.
Lets start from the left side of the figure (public owns and operates assets) with models that feature more government control and where risks, obligations, and investments are mainly borne by the public sector, while at the same time the partnership itself is of a relatively short-term nature. We then move gradually towards the right with progressively more involvement from the private sector, this is where PPPs lie.
Now, to decide which PPP model to use, the authority has first to clarify whether or not they expect the private sector to make capital investments to build or expand public infrastructure. Even if the authority is not seeking private capital investments, they might still want to employ a PPP model to achieve other objectives such as improving the performance of a public Asset.
In one variation of a PPP model, the authority might consider assigning the operation and maintenance of a public asset to a private partner and linking payments to the private partner to specific key performance indicators (KPIs). Such association between performance and payments creates an incentive for the private operator to achieve higher efficiency. In the water sector for example, the management of water utilities can be contracted out to private operators to encourage efficiency gains.
The private operators payments are tied to specific targets such as the volume of water saved through leakage reduction. In this model, there is no transfer of commercial risk as payments to the private operator do not depend on utility tariffs or the number of users. However, the absence of commercial risk for the private partner can make this model less challenging to implement.
Another example of linking private partner s payments to performance is the performance-based road maintenance contract. This type of contract differs from the traditional price-per-unit contract, where fees are paid in accordance with agreed-upon rates for maintenance, eg a fixed fee per pothole filled in a road. The performance-based contract, on the other hand, is based on agreed-upon standards that a contractor must maintain, eg all potholes bigger than a certain dimension must be filled within a certain length of time.
In this case, if the standards are met, the contractor can collect the full fees, otherwise penalties are applied. Thus, the private operator is incentivized to maintain the asset in a good condition. Navigating the maze a look at various PPP models as we have mentioned previously, PPPs have become a popular strategy for governments to leverage private sector expertise and resources for infrastructure development and service delivery. However, with a variety of models available, choosing the right one can be crucial for project success.
We explore in this section some of the most common PPP models, highlighting their key features and considerations.
Build-Operate-Transfer (BOT)
A popular model for developing new infrastructure assets like toll roads or bridges. The private partner finances, builds, and operates the project for a set period, recouping their investment through user fees (user-pays PPPs) or government payments (government-pays PPPs). After the concession period, ownership transfers back to the public sector. This model offers the private sector high control over design and construction, but also carries significant risk.
Build-Own-Operate (BOO)
Similar to BOT, but the private partner retains ownership of the asset throughout the concession period. Revenue generation typically comes from user fees. This model incentivizes the private sector to focus on long-term efficiency and maintenance, but requires strong user demand to ensure profitability.
Build-Operate-Lease-Transfer (BOLT)
A variation of BOT where the public sector leases the completed infrastructure from the private partner for a period before taking ownership. This model allows the public sector to spread out its financial commitment while benefiting from private sector expertise in construction and initial operation.
Design-Build-Finance-Operate (DBFO)
The private partner takes on a broader role, encompassing design, financing, construction, and operation of the project. This offers a more streamlined approach for the public sector, but also transfers a significant amount of risk to the private partner.
Design-Build-Finance-Operate-Maintain (DBFOM)
This model extends DBFO by including the long-term maintenance responsibilities of the infrastructure. The private sector partner finances, designs, builds, operates, and maintains the project for the entire concession period. This offers the public sector a single point of contact and incentivizes the private sector to ensure long-term asset quality. However, DBFOM places the greatest burden of risk and responsibility on the private partner.
Operation and Maintenance (O&M)
O&M focuses on existing infrastructure. The private sector takes over the operation and maintenance responsibilities for a set period, often with performance-based incentives. This model allows the public sector to tap into private sector expertise for improving efficiency and service delivery in existing assets. Choosing the Right Model (the optimal PPP model) depends on several factors, including:
Project type: Greenfield projects (entirely new) may be suited for BOT, DBFO, or DBFOM, while brownfield projects (existing) might benefit from O&M.
Risk allocation: The level of risk transferred to the private sector should be balanced with potential rewards. DBFOM involves the highest level of risk for the private partner.
Financial viability: User demand and revenue generation potential are crucial for models relying on user fees.
Government capacity: The public sector needs the capability to manage and oversee complex PPP arrangements. We may say that PPPs offer a valuable tool for infrastructure development, but success hinges on selecting the right model. By understanding the different options, including DBFOM, and carefully considering project specifics, governments can leverage private sector expertise while mitigating risks and ensuring project success.
Note: Hassan Abdulrahim is Senior Instructor, Economics & Finance, Canadian College Kuwait and Deputy CEO, Visionary Consulting.
