Public-Private-Partnerships-in-Infrastructure-Development--CYJ

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1、Four short words sum up what has lifted most successful individuals above the crowd: a little bit more.-author-datePublic-Private-Partnerships-in-Infrastructure-Development-CYJCreating and Sustaining Competitiveness of Small and Medium-sized Construction Enterprises in ChinaPublic-Private Partnershi

2、ps in Infrastructure Development: On Value, Risk and Negotiation Charles Y.J. Cheah Assistant Professor, School of Civil and Environmental Engineering Nanyang Technological University e-mail: cyjcheahntu.edu.sg AbstractDevelopment of large-scale engineering and infrastructure projects that solicits

3、the support of private capital is no longer a new phenomenon. This is usually fulfilled through procurement arrangements such as Build-Operate-Transfer, Private Financing Initiatives and other technical variations of public-private partnerships. Publications reporting both success and failure cases

4、continue to increase globally. Some have commented that the pre-award process is protracted and arduous, either for the case of tendering or sole-source negotiation. A major factor prolonging the conclusion of an agreement is risk, as each party brings its own set of expectations and risk transfer/a

5、voidance strategies to the negotiation table. Since much focus have been placed on risk management, it is sometimes easy to overlook the counterpart, which is value enhancement. Almost by default, certain values are implicitly embedded in the transaction, as manifested by items such as subsidies, gu

6、arantees, price caps, credit support and other types of concessions. Nonetheless, it is unfortunate that many of such concessions are granted on a “give-and-take” basis without any attempt to assess or even quantify the value of these concessions. A more accurate reflection of the true value of a pr

7、oject incorporating these concessions helps to promote a higher level of risk tolerance rather than concentrating on risk transfer and avoidance most of the time. In this aspect, real option stands as a promising tool that improves value assessment. More importantly, instead of focusing solely on it

8、s superior evaluation methodology in capturing flexibility inherent in many concessions, the paper suggests that the RO thinking process itself helps to infuse a spirit of positive management. By widening the perception on the range of value, conciliation of differences among key players is easier t

9、o achieve and negotiation can proceed on a more informed ground. In the end, it is hoped that good and sensible projects are not passed out due to negotiation breakdown. Likewise, projects with exploitative and unfair concession terms can be better identified. KeywordsConcessions, guarantees, infras

10、tructure, negotiation, public-private partnerships, real options IntroductionA lot have been written and reported on private participation in infrastructure projects globally. In developing countries alone, committed total investments involving private participation amounted to more than US$750 bill

11、ion during the period 1990-2001, according to the World Banks Private Participation in Infrastructure (PPI) Project Database. As of the late 1990s, private share in infrastructure investments now ranges from lows of 9% and 13% in Germany and France to highs of 47% and 71% in the U.S. and U.K. (Roger

12、, 1998). Likewise, Asia has been witnessing a growth in concession projects since the 1980s (Kwak, 2002; Chatterjee, 1996). Lately, more strains are added onto public financing given heightened concerns of security, warfare, social disorders and environmental issues, thus potentially triggering dist

13、ortions in the allocation of tight public funds. It follows that private sectors financial and technological contributions in projects that are traditionally under the purview of public agencies would become more important and apparent. On the other hand, competitions within the market for private p

14、articipation in infrastructure projects are also getting more intense. Some has resorted to unsolicited proposals in order to gain business access (Hodges, 2003). While there is definitely a need to garner more support from the private sector, it is equally important to distinguish between competent

15、 participants who genuinely pursue a “win-win” interest and opportunistic “speculators and arbitrageurs” who try to exploit a particular circumstance. Properly structured, collaborations formed between the public and the private sectors help to alleviate some of the challenges currently faced by gov

16、ernments and work towards the betterment of the society.Parallel to the continual efforts by multilateral agencies in tracking trends of infrastructure development privatization market and developing policies and guidelines on this subject, the academic world matches these efforts with its research

17、in major themes, which include tendering and negotiation issues, risk and guarantees, capital structures and others. In many cases, the notions of risk, value and negotiation are discussed in isolation. This paper focuses on the confluence of these notions. A review of the concept of risks is first

18、presented. The perception of value is then widened to include flexibility and options inherent in many projects. Real options (RO), an approach to evaluate flexibility, is introduced and some cases of applications are discussed. It is suggested that integration of value (which is quantified by RO or

19、 other means) and risk will facilitate a more meaningful negotiation process that results in a more transparent and equitable risk-reward distribution among project stakeholders. Finally, the role of RO thinking from a strategic standpoint both in structuring a deal and shaping long-term initiatives

20、 is emphasized. Notion of risksIn the context of most infrastructure development projects, risks span different categories including start-up, operating, financial, market, technological and political risks. The list goes on with further decomposition into subcategories as financial risks would enco

21、mpass interest rate and currency fluctuations, and political risks could be linked to expropriation and regulatory concerns. Overall, the process of risk management can be viewed as consisting of identifying, mapping, analyzing, allocating and controlling risk components that exist in different stag

22、es of a project life cycle. The process often draws ex ante strategic considerations of project stakeholders in assessing various options such as risk avoidance and risk transfer. Risk avoidance and transfer naturally result in a zero-sum game. From a broad perspective, total risks are not necessari

23、ly reduced when they are merely transferred from one party to another, perhaps at the price of a premium as in the case of insurance. On the other hand, positive-sum collaboration could come only in the ideal case of risk allocation to a party who is in the best position to manage the risk. Addition

24、al values can thus be created in the case of proper design of project execution and risk allocation.In current days, the risk management process enjoys advancements and contributions from both quantitative and qualitative fronts. Quantitative approaches, largely classified into deterministic and pro

25、babilistic approaches, have expanded beyond conventional techniques such as sensitivity analysis and decision tree analysis to more “modern” ones such as Monte Carlo simulation and Value-at-Risk. While quantitative approaches attempt to provide objective measures of the likelihood and impact of unde

26、sirable events, sometimes risks can be simply described as ones subjective interpretation and socially constructed judgment of the uncertainties and threats of such events (Giddens, 1991). Probabilistic rules, inherent in many quantitative approaches, may give a false impression of control when risk

27、s are conveniently translated into figures. On this ground, Hancock (2004) commented that one should focus upon the limits of probability theory to arrive at less ambitious, but ultimately more realistic, risk modeling. The same logic forms the rationale of many “softer” approaches to manage risk. I

28、n the case of Terminal 5 Heathrow, Hancock showed how a properly configured risk workshop was proven to be effective in formulating satisfactory resolutions to “messy and wicked problems” that are inherently unsolvable through strictly probabilistic means. Assessment and allocation of risks, in both

29、 quantitative and strategic aspects, are even more critical in unsolicited proposals submitted to governments. Unsolicited proposals are not uncommon and have been linked to many of the worlds most controversial private infrastructure projects (Hodges, 2003). In some of these proposals, projects dev

30、eloped by sponsors are attached with overly optimistic assumptions in order to gain business in the infrastructure market. Furthermore, unsolicited proposals attempt to bypass the competitive bidding process, meaning that independent checks against alternative proposals on financial terms and techni

31、cal solutions do not exist naturally. The lack of transparency in the procurement process implies that risks and difficulties of major tasks are sometimes underestimated or even intentionally downplayed. Granted, not all unsolicited proposals are ill-intentioned. Yet, with incomplete and shifting in

32、stitutional arrangements in many developing countries, it is no surprise that these projects often have a lower probability of success. Ultimately, while the interests of governments and private sponsors need to be safeguarded, sole focus on risks is not very desirable delivery of infrastructure fac

33、ilities critical to economic growth and social welfare would be unduly prolonged, while meaningful projects may even be passed out totally if development solutions are sought only to address all kinds of risks which may not be practical. Stakeholders should also embark on a project with the noble in

34、tention of value creation so as to strive toward a “win-win” setting. Value creationGovernments need to be shrewd in project delivery strategies. Simply put, the bar has been raised and traditional procurement methods alone are no longer sufficient (Miller, 2000). New arrangements and innovations of

35、ten call for detailed negotiations so that solutions can be customized and worked out based on individual partys concern and expertise. Such negotiations exist not only in unsolicited proposals but may also occur after an initial tendering process is completed (Tiong, 1996). Given the fact that tran

36、sactions in large engineering and infrastructure projects often involve lumpy, dedicated and irreversible investments, the importance of design and planning of project execution strategy is elevated. Project implementation needs to be strategically segmented to incorporate innovations and flexibilit

37、y. When major decisions and actions in a project life cycle are anticipated, brought forward and discussed during the initial negotiation stage, more opportunities are created to align risks with the additional values derived from these innovations and flexibility.Many infrastructure projects are em

38、bedded with items such as subsidies, guarantees, price caps, credit support and other types of concessions granted by the public sector. Already, credit facilities and guarantees are gaining prominence in the world of project financing (Devapriya and Allen, 2003). Almost by default, these elements a

39、re introduced into contracts to promote economic feasibility of a project and alleviate risk concerns of the private sector. Perhaps due to complexity in evaluation, these subsidies and incentives are often granted on a “give-and-take” basis without fully realizing the value added to the contract. T

40、ruly, guarantees are a form of options and all options have values (Mason and Baldwin, 1988). By properly accounting for these values, the level of risk tolerance of concessionaires and grantees who receive such subsidies and incentives should be higher. For example, in a power purchase agreement, a

41、 lower tariff level would seem more acceptable if a concrete evaluation of concessions granted is considered in a total perspective. It may be hard to quantify an exact value, but efforts pursued in this direction should be encouraged as they will ultimately lead to a more equitable alignment betwee

42、n risk and reward. In many ways, the real option approach stands as a promising tool to achieve this goal as will be discussed in the next section. The aforementioned aspects are largely financial in nature. Value can also be created through structuring operating options and flexibilities in the cou

43、rse of project execution. Creating options to allow for a greater range of responses in line with uncertain future outcomes is one of the critical steps within Lessard and Millers (2000) layering model. Going by the evidence gathered from the IMEC study IMEC stands for International Program in the M

44、anagement of Engineering and Construction., many successful projects are not selected a priori, but shaped and structured along the way projects are shaped in episodes to gradually transform the initial hypothesis, make progress on critical issues, and solidify initial coalitions of players to achie

45、ve temporary and final commitment. In addition, contractual devices can be designed to avoid rigidities in project execution. Flexibility can be built into contracts by introducing special clauses which can be used to alter the timing and sequence of activities to achieve reduced risks (Floricel and

46、 Miller, 2000). A good example of creating flexibility and using options to shape project execution is an acquisition project described by Ceylan and Ford (2002). In that project, a new and improved laser glass production technology is required, but the technical uncertainty is very high. Failure of

47、 the technological development efforts would have severe implications to the project. Rather than relying on a usual one-vendor strategy, the client made initial investments in independent development efforts by two producers, thus increasing the likelihood that at least one effort would be successf

48、ul so that the project could carry on. If only one effort was successful, the failed development effort would be abandoned and subsequent investments could be channeled only to the successful one. If both were successful, the client would have the benefit to choose the better among the two. Obviousl

49、y, such flexibility would not come free; it cost the client approximately $12 million to invest in a second vendor. Presumably, the additional cost was justified when it was weighed against the probability of technological failure and its associated consequences. In short, it is evident that options

50、 create values, and these need to be considered in conjunction with risks in infrastructure project delivery. The next section introduces the concept of real option which serves as an evaluation tool to quantify the value of flexibility. The real option concept and cases of applications Real options

51、 is not a new concept and has been applied in sectors and industries such as oil and gas, pharmaceutical, manufacturing, airlines, mining, real estate and R&D projects just to name a few. By definition, an option is a right, but not an obligation, to exercise a certain action in the face of uncertai

52、nty. The fundamental theory was first developed to value options on financial assets. The theory was subsequently “exported” and applied to value options on “real” assets (e.g. development of a piece of vacant land; exploration of an oil field); hence the term real options. Literatures on real optio

53、ns have now built up to a rich repertory. For general exposition to the subject readers may refer to Trigeorgis (1996). Some typical types of options that can be identified in large engineering and infrastructure projects are as follows:(a)Call options examples include: capacity expansion; procureme

54、nt option; splitting of projects into two phases, whereby execution of the second phase would be contingent on the success of the first. (b)Put options examples include: capacity contraction; shutdown or sale of assets; abandonment option; guarantees granted by government. (c)Switching options examp

55、les includes: switching of operation or production mode; switching of fuel source. (d)Timing option this refers to the option to defer a specific action such as to develop a piece of vacant land or to commence construction. Conceptually this may be referred as a type of call option. (e)Compound opti

56、ons these refer to a combination of two or more type of options. For example, a project split into multiple phases would imply a “sequential call option”. The interactions among various types of options impose greater complexity in evaluation as the total value is usually not a simple sum of the par

57、ts. (f)Learning option this is a more subjective type of option as it treats the entire project or business initiative simply as a learning ground or part of a larger strategic plan to pursue future goals. For example, in its entirety, a pilot project in a politically unstable or less developed coun

58、try is a learning option for a corporation to explore future business opportunities in the country. Obviously, project components do not automatically appear with “real option” labels. It is therefore important for different project stakeholders to identify scenarios or settings that give rise to fl

59、exibility and options. For example, imagine a project, under high public scrutiny and being politically sensitive, has its internal rate of return capped at 16% by the government. Meanwhile, this project is also exposed to substantial sovereign risk, whereby expropriation of the project assets will

60、lead to a total loss of the initial investment. Although not initially obvious, the payoff structure as shown in Figure 1 shows that the sponsor of the project has essentially written a call option to the government at a “strike price” K1 when IRR reaches 16%. At the same time, it has also written a

61、nother binary call option at strike price K2 which would result in a maximum loss of -100% return (total loss resulting from sovereign risk). It is interesting to note that K2 is not fixed and will vary with the probability of expropriation the higher the value of the project, the more probable that

62、 expropriation is triggered. The payoff structure reflected in Figure 1 can be evaluated using RO theory and this provides additional insights to assess the position of the sponsor. More importantly, the value of the options granted in this scenario has not been conveniently neglected.Payoff from pr

63、oject in terms of IRR16%S K1K2Strike Price of written Call(Varies)Value of Underlying Assets of the Project0-100%(Project Assets Expropriated)Figure 1Payoff Structure faced by Sponsor of Project in a Hypothetical ScenarioThough more commonly applied in other industries, the RO concept remains largel

64、y alien to the engineering, construction and infrastructure community who play a key role in infrastructure development which often incorporate multiple flexibilities during various stages of the project life cycle. Limited applications and publications currently exist on this subject related to con

65、struction engineering and management. By broadly categorizing RO models into continuous-time and discrete-time models, Garvin and Cheah (2004) commented on the merits and challenges of applying each of them to the context of infrastructure projects. They subsequently illustrated the use of a simple binomial model to evaluate the deferment option in a toll road project. Ford et al. (2002) also used a similar approach to quantify th