Risks to overcome and make this the most feasible process

This paper analyses a number of untouched issues related to PPP projects which play an immensely important role in these types of projects. Also it highlights various risks associated with PPP and carries out a detailed risk analysis on the various aspects of such projects and also discusses various means of mitigating these risks.

It includes detailed analysis of the organization structure of the both public and private sectors involved in the project and study the importance and interrelationship between various segments and departments, the division of roles and responsibilities.

The aim of this paper is to carry out a comparative study between various types of PPP projects and infer so as to which one would be the best for the Indian Construction Industry as a whole. A number of case studies as reference have been used so as to carry out the detailed analysis. Also this paper makes a general assessment of the various terms commonly used in these types of projects which are often neglected but indeed play a vital role. This also focuses on the elements that are important for evolving a working and efficient structure and methodology to select appropriate private partners. The overall approach followed in this paper is informative rather than prescriptive.

This paper is based on:
  • Literature review
  • Detailed case study on a life project "6 laning of Pune-Satara NH4 Project"by Reliance-infrastructure.
  • Interviewing key technical officials at PSTRPL.
  • Interviewing key officials at NHAI.
  • Case studies on various PPP projects undertaken in India.
  • The main focus in this paper will be on the contractual intricacies, project bottlenecks, problematic issue during execution.
  • Also various issues which may cause disputes between the EPC contractor, client and subcontractors.
Purnima Bajpai, Research Graduate ME (Construction & Management)
Dr S.S.Pimplikar, Professor & Head-Civil Department MIT- Pune

Background and Introduction

Trends in the provisions of infrastructure development over recent years indicate that the private sector is playing an increasingly important role in the infrastructure process. This trend has partly arisen out of the necessity for the development of infrastructure to be undertaken at a rate that maintains and allows growth.

The problem we have at the moment is that Asia has a tremendous demand for infrastructure but the government is not able to meet the demands so we look at private sector to provide innovative ways of meeting this demand. The PPP model has gained prominences as the GOI preferred means to undertake infrastructure development, facing significant debts and fiscal challenges that limit its ability to find the required investments, the GOI expects the private sector to partner it in bridging the Countries infrastructure deficit.

PPP in Road Infrastructure

PPP in Road Infrastructure

In 11th five year plan, 292 projects worth Rs.2.4 lakh crore are being implemented under the PPP model while 404 projects worth Rs.3.8 Lakh crore are expected to be awarded in med-term. The road and ports sector have garnered the highest shares of 35.4% and 15.9% respective of the total PPP investment.

The Indian corporate bond market though one of the largest in Asia is still at on early stage of development and its growth is hampered by institutional, legal, and regulatory constraints that make bonds a more expensive way of financing.

Recent studies indicate that India must invest close to $400 billion over the next 5 years in infrastructure development at least 40% of which must be developed through PPP. PPP projects also encounter several risks that often lead to cancellations or significant renegotiations. The evidence from developing countries indicates that actual or perceived tariffs, macro economics, fluctuations in currency and institutional environment etc against the pvt sector are some of the key reasons for the failure of PPP projects (Harris, 2001, Klein and Roger 1994).

PPP in Road Infrastructure
Attempts have been made to standardize the form of BOT contracts on road projects and Mca’s have been created. NHAI has currently released the 3rd version of the MCA which seeks to allocate the risks to the party best placed to bear these risks. PPP as a means of engaging private sector in infrastructure development has gained across the world. The main reasons for this universal phenomenon are as follows: First the government’s try to tap the activity and creativeness of the private sectors to improve efficiency and settle the ubiquitous problems of the inefficiencies in the operation of infrastructure, second, the Government’s try to solve the problems of PPP in the face of financial constraints and the decrease of investment ability. Last Public works and private works and facilities could be shifted to the track of private ownership by means of PPP.

According to the United Nations Commission on International Trade Law (UNCITRAL), PPP is mot only being used for large scale projects but also being utilized for medium and small scale projects.

However, while PPPs can present a number of advantages, it must be remembered that these schemes are also complex to design, implement and manage. They are by no means the only or the preferred option and should only be considered if it can be demonstrated that they will achieve additional value compared with other approaches, if there is an effective implementation structure and if the objectives of all parties can be met within the partnership. PPP is not the only method to deliver project financing and realization. It does not provide a ‘miracle’ solution or a quick fix and should only be used where appropriate and where it is able to deliver clear advantages and benefits.

PPP in Road Infrastructure
  • A multitude of PPP structures exist and must be selected according to project type, needs and sector. There is no single perfect model.
  • Each type of PPP has inherent strength and weaknesses which need to be recognized and integrated into project design.
  • Each partner to a PPP has responsibilities. The Public sector must transform its role from a service provider to manager / monitor of private contractors.
Guaranteeing and enhancing public benefit from PPPs will depend to a large degree on effective.

Requirements of PPP parties:
  • Management and monitoring systems this Part will address:
  • PPP structures
  • Suitability of alternative structures
  • Success factors for partnerships

Risk Factor in PPP

Risk- "a concept that denotes the precise probability of specific eventualities"Risk- "The threat or probability that an action or event will adversely or beneficially affect an organization’s ability to achieve its objectives."

PPP in Road Infrastructure
In simple terms risk is ‘Uncertainty of Outcome’, either from pursuing a future positive opportunity, or an existing negative threat in trying to achieve a current objective.

Concept of Capital Asset Management Model (CAPM)
Introduced by Jack Treynor (1961, 1962), William Sharpe (1964), John Lintner (1965a,b) and Jan Mossin (1966) independently Used to determine a theoretically appropriate required rate of return (IRR) of an asset. Studies how investors’ asset demand determines the relation between Assets’ risk and return in a market equilibrium (when demand equals supply). The risk of an individual asset is characterized by its co-variability with the market portfolio provides a risk adjusted discount rate for evaluation of capital investment projects.

Bottlenecks, Enablers & Key Issues

There are a number of bottlenecks which act as bigger barriers than expected in PPP project. These require an early detection and should be dealt with as early as possible. Bottlenecks may be characterized into three main criteria’s for understanding purpose: Firstly, Institutional bottlenecks which may include: lack of legislation, absence of policies and frame work. Secondly, Organizational bottlenecks which may include: lack of capacity-administrative, political, private implementing, low trust between the parties. Thirdly, Project bottlenecks: these may include factors like economic viability, social aspects, contractual issues; management regularization etc. The best way to overcome these bottlenecks is through capacity building.

Organizational Problems in PPP Projects

PPP in Road Infrastructure
Traditionally infrastructure projects have been labor intensive and have employed adhoc project planning and control techniques. With the exponential growth of the Indian construction industry and the increase in scale and complexity of the projects, manpower is now a scarce resource and systematic project planning, management, and control are now required. Several projects therefore face delays in execution as the private sector strives to acquire these competencies.

These issues are not limited to the construction phase alone. A lack of experience with PPP’s on the part of private sector has led to a fiasco in the conceptualization and the structuring of projects as well.

A final organization issue that has hampered PPP projects at the State level is the lack of trust between the Private and Public sector.

The Private sector is often reluctant to engage with the public sector due to the fear that after the expiry of the ruling party’s term, a new govt can renege on the contract and that dispute resolution mechanism are excessively bureaucratic and biased, making the pursuit of justice an uphill battle for private sector. The public sector on the other hand has often tended to view the private sector with suspicion.

PPP in Road Infrastructure

The private sector is perceived as being overlay profit minded, to the detriment of the society and the citizen that it is expected to serve. Both the private and public sectors therefore need to build more confidence in their collective abilities, in order to embrace PPP as a sustainable approach to infrastructure development. Finally, the occupational and organizational cultures of the Indian private and public sectors differ with the public sector being relatively bureaucratic and more process focused and the private sector being more result oriented, lack of PPP in Indian Infrastructure at the State level.

However, PPP projects also encounter several risks that often lead to cancellations and/or significant renegotiations. The evidence from developing countries indicate that actual or perceived rise in tariffs, macroeconomic fluctuations in currency or purchasing power, inadequate regulatory and institutional environments, societal discontent against the private sector and political reneging are some of the key reasons for failure of PPP projects (Harris, 2003; Gomez-Ibanez et al, 2004; Vernon, 1971;Klein and Roger, 1994).

Capacity Building

What precisely are the capacities that organizations in India need to develop and how they should do so? Training and education and partnership with academic institutions are one set of solutions. However, some of these competencies can be outsourced by the Government agencies to coordination agencies. In the long run, it is important to determine which of these competencies can be outsourced, which need to be nurtured in house and how this can be done. Issues of capacity have been recognized as one of the foremost bottlenecks to India’s Infrastructure growth by the government of India and several private agencies. (Ashwin Mahalingam1)

PPP in Road Infrastructure

Enhanced mobility’s and instantaneous communications have enabled rapid movements of both physical and financial resources to areas where they are needed or could reap more benefits. For example, excess construction capacities or surplus funds from one region could easily flow into another to redress shortages and meet sudden needs. The reconceptualization of project finance through imaginative financial engineering (Merna and Smith 1999) enabled the mobilization of vast resources of private capital for public projects.

This in turn facilitated creative financing packages for mega projects that would hardly have attracted traditional financing. Further more this mechanism also affectively mobilize a user pay scenario, whereas on the other hand, more pressing socio-economic and/or political priorities of cash-strapped govts may have directed their scarce resources to less capital intensive projects or to those with quicker economic and political returns.

Strength and limitations
Implementation of PPP contracts in infrastructure public services has generated benefits in terms of efficiency, service quality, and network expansion (Murphy 2008; Vining and Boardman 2008 and Marques and Berg 2009). Compared with the full privatization option, PPPs do not require very detailed information about costs, demand and other features of the projects, neither is a – traditional regulatory agency nor a contractual management agency required (Viscusi et al. 1995). In addition, PPPs do not promote overinvestment.

During the contract length, the private partner is interested in maintaining a good reputation which constrains possible hold-up behavior by the operator.

The hypothesis of early termination of contract is possible and anticipated in contracts. Compared with public provision (even without considering funding needs), the advantages of PPPs are potentially greater. Beyond those anticipated in the contract, the PPP-holder captures additional gains associated with efficiency improvements and new service introductions (Crew and Zupan 1990). These profits will be passed on to the customers when the PPP concludes.

Expected rents are captured by customers (government) in the competition for the market, where the abnormal profits were eliminated by competition. Even without considering better efficiency in the private sector (emphasized in some streams of literature), in fact, the PPP-holder is more accountable to customers and to the government since its duties are defined in the contract, including penalties (and rewards).

As a rule, the operator in a PPP provides a higher quality of service, and will more likely meet the predicted budget and the deadlines than a purely public organization. Furthermore, the (potential) better allocation of risks leads to the development of risk mitigation strategies, cost savings, and service quality improvements.

A New Turn From the Traditional Bot to DBFOT. . .

For Better or for Worse?????
The MCA for awarding PPP projects of National Highways has been revised. MCA follows the Design, Build, Finance and Operate (DBFOT) approach that requires the private investor (concessionaire) to bear the responsibility for detailed design, construction, operation, and maintenance of the project highway during the period of concession. The government will provide only the feasibility study report of the project prepared by the contractor. The MCA envisages a Manual of specifications and standards. The Ministry formulating the MCA consists of various officers from DORTH, NHAI, and NITHE etc all of which are reputable members of the road sector. The concept of developing a "Forgiving Highway has been the main constitutions in developing this manual besides amenities to the users who would be paying the fee for the use of the facilities and expect higher levels of service than traditionally available until now.

The manual is generic in nature However, for the project to be taken up through PPP considerations to the viability of project may need to be given. This manual consists of general planning, detailed design, overall scheme of work, safety. design, specifications, standards, user facilities, operational objectives. The technical standards prepared by IRC and accepted by Ministry a well as by State Government are same both for National Highways and for State Highways.

This manual therefore can be used for State Highways as well, however some of the provisions contained in this manual such as advance traffic management systems may not be feasible.

What is the role of Government experts in PPP?

PPP in Road Infrastructure

The government plays a very important role in checking the feasibility of projects specially when the cost of projects is so large. It always has an upper hand in decision making determine which projects can be taken up through PPP and whether they are bankable, facilitation at the design stage- project preparation – preparing detailed feasibility report, facilitation in the pre-construction stage, providing avenues for long- term finance, understanding contingent liabilities, ensuring quick and effective dispute resolution mechanism, ensuring transparency and fair play through adequate regulation and disclosure, and building effective and sustainable partnerships. The government has to take care of mainly Viability Gap Funding, PPP Cells - PPP Appraisal Committee, providing transaction Advisors, training/Information kits, set standard Bidding Procedures and Model Concession Agreement.

Viability Gap Funding

The road sector has also embraced several innovative methods of project structuring. In projects where revenue risks are likely to be present, contracts are awarded on an Annuity basis as opposed to using a traditional toll collection revenue formula. Also in cases where road stretches are not economically viable NHAI has introduced a scheme for Viability Gap Funding (VGF) wherein the private operator can collect toll and seek an upfront VGF Grant to balance any projected deficits between cost of the project and the expected revenues.

PPP in Road Infrastructure

The VGF is limited to 40% of the total project cost. In a competitive bidding scenario, the winning bid is often the one that requests the minimum VGF. In some cases where stretches of roadway can be extremely profitable this sector has also embraced the concept of Negative Grant wherein the bidding firm for the project will offer the Government a Grant in return of being awarded the concession for the project. As in case of 6 laning of NH4 ongoing project in which the concessionaire i.e. Reliance Infrastructure has agreed to pay a Premium of 90.90 cores per year to NHAI i.e. the client.

Formation of a Project Scoring Table

Ashley et al. (1988) developed a project scoring (PST) tool based on nine high level evaluation criteria to assess the suitability of a project for PPP from the view point of transportation projects. Decisions corresponding to these criteria’s are grouped into nine clusters: (1) political clearance; (2) partnership structure; (3) project scope (4) environmental clearance;(5) construction risk allocation; (6) operational risk allocation; (7) financing package.; (8) Economic viability and (9) developer financial involvement.

Evaluation of each of these components is done first from the view point of the government/sponsor, and next from that of potential franchise.

WIN-WIN scenarios are distinguished from Win-Loose or Loose-Loose scenarios according to the simple scoring system.

Important Finding About Risks and Their Mitigation

Merna and Smith (1996) who classified risks first into two categories of global and elemental- first being those deemed to be generally outside the control of the project parties (including political, legal, commercial, and environmental factors) and the second including project risks (such as construction, design, technology, operation, finance, and revenue risks). However, it may be argued that some of the above global risks may be even to some degree within the control of the project sponsors, particularly if it is the government; hence the following classifications are preferred, also because of their greater detail in breaking down risks.

Chsroenpornpattana and Minato (1999), who presented a detailed identification of privatization- induced risks in transportation projects. Their analysis extended to characterizing risks as static /dynamic, fundamental/particular, government/private/other source, speculative/pure, financial/non financial and measurable/non measurable. After checking and analyzing each risk against each of the above sets of characteristics, they are recommended whether it should be allocated to private party or the Government or shared.

Salzmann and Mohamed (1999), who identified families of risks (containing factors and sub factors) found to need addressing in BOOT projects. They presented these in two separate frameworks corresponding to the development phase and the operation phase, respectively. Their identification of 12 RISK FACTORS, together with 58 risk sub factors in the development phase and 11 risk factors with 39 risk sub factors in the operation phase.

Success Factors and Winning Elements in PPP

Tiong (1996) studied a set of recent projects and surveyed their participants in order to identify critical success factors (CSF’S) that need to be focused upon by bidders in pursuit of BOT type projects. He identified 6 such factors:
  • Entrepreneurship and leadership
  • Right project identification
  • Strength of the consortium
  • Technical solution advantage
  • Financial package differentiation
  • Differentiation in guarantees Analysis of these CSF’S and the formulation of corresponding critical success sub factors led to the identification of a proposed model for developing superior proposals for BOT tender and negotiation.
  • Meanwhile additional CSF’S have been proposed by others for example: ability to provide a suitable transfer package, built in flexibility for future growth and changes and supportive community (based on smart marketing of expected benefits from the project).

NBMCW March 2012