(a)        Demand / Revenue risk projects

In revenue-generating projects where the concessionaire takes demand risk, such as toll roads, ports or airports, the concessionaire takes advantage of the licence given to it to raise revenue from project users directly.

In some cases, prices are likely to be governed by simple market forces, such as electricity offtake on a waste-to-energy project or car parking charges in an airport.

In many cases, however, the government may want to retain a level of tariff control. It is often the case that government-run projects are being run at a subsidy rather than with realistic levies and, when the private sector is introduced into the project, then unless the subsidy continues, they will need to raise prices to the real cost of delivering and maintaining the assets. Therefore, the government may want to introduce a slow increase in prices. Even if an immediate sharp rise is not expected, governments would still want to maintain control over tariffs over time to avoid profiteering from a monopoly or strong market position.

Constraints can therefore be introduced through regulation (and ideally the regulator setting the price will be independent from the procuring government) or through the PPP contract itself. The concessionaire, for its part, may be concerned that the regulator may have the power to impose price caps that prevent it from recovering all of its operating and financing costs or from recovering its anticipated return. If so, the contract may need to provide a safety net for the concessionaire by way of a financial adjustment in the concessionaire’s favour.

Where the project is a net revenue-generator (after allowing for all project costs and funding costs) then the government may expect to receive a share of the profits. Some projects are structured on a share-of-gross-revenue basis so that the government still receives a payment even if the project is unprofitable. The structure of the project will be a function of the economics of the project and the state of the market at the time.

(b)        Availability based projects

On an availability-based scheme (e.g. government accommodation, public hospital, public schools, public highways with no tolling, etc.) – the concessionaire will be paid a fee (here referred to as an availability fee, although many different terms are used) for the successful delivery and management of serviced accommodation. In other words, does the accommodation itself meet the availability requirements, and do the services provided within it also meet the service requirements? The concessionaire will often be penalised for poor performance of services on a “no service, no fee” basis, the principle being that a complete lack of service should result in zero fees.

Since poor service may affect the concessionaire’s ability to service its debt, the lenders will be strongly motivated – usually through due diligence over the construction process and also over the methods of delivery of services – to ensure that 100% service delivery can be obtained. This is the essence of project finance risk in an availability-based PPP project.

Some projects are structured in a way that is more protective where only a maximum amount of the availability fee is put at risk. Whilst this can assist with a value for money pricing of the risk component of the deal, the government and its advisers would need to look closely at some disaster scenarios to ensure that the lenders and sponsors still remained sufficiently motivated to deliver performance.

The concessionaire and lenders will usually be keen to ensure that the “no service, no fee” mechanism operates as a sole remedy mechanism, such that the government cannot use the same breach of contract to make financial deductions and also sue for general damages for breach of contract. This is often accepted on projects, however the government should ensure that in doing so it does not create a mechanism whereby it is cheaper for the private sector to accept the stated deductions rather than actually provide the service. The simplest way of dealing with this kind of “deliberate breach” is to apply a “ratchet mechanism” which increases the financial deductions for repeated or persistent breaches under a carefully calculated formula. Alternatively the project could provide that breaches with no financial penalties can lead toward termination if they are sufficiently repeated or persistent.

In some projects, particularly those with complex technological solutions, it may be appropriate to allow the concessionaire some latitude in the early months of service delivery as services are “bedded in”. This can be achieved by including a “ramp up” provision in the payment mechanism, with lower deduction levels applying in the early months of operations.