Private Investment in Infrastructure:
Dealing with uncertainty in contracts
June 2018, Paris

Dejan Makovšek, Economist, OECD/ITF

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What was the WG’s objective?
• Clarify basics – what is the role of with PI?
• Take stock of most recent evidence (does it work?)• Map how uncertainty matters in contracts• See how private finance approaches handle uncertainty• Provide guidance to policymakers

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What is the role of PI? (I)The state
Share capital
Repayment

Lenders

Loan

State Owned(infra) CompanyTolls/fares

PerformanceContracts
Constructioncontractors

Maintenancecontractors

Road/Railwayusers

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When the state is judge and party
Road maintenance trends in selected countries, 20052014, (2005=100)
Maintenance expenditures in EU-19 (2005=100)

Median of annual indices

130
120
110
100
90
80
70
60
50

2006

2007

2008

2009

2010

2011

2012

2013

2014
4

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Evidence about PI in transport infrastructure?

Positive

Mixed/limited
experience

Positive“Positive” is subject to conditions++

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What is the role of PI in transport? (II)
Efficiency typeRelevance

Productive(cost efficiency)

Allocative(preventing bridges to nowhere)
Dynamic(extending the public borrowing constraint)XX

Pursuing PI on the right merits matters!
Competitionfor thecontract

Publicacceptanceof theapproach

Crediblecommitment
to thecontract

Provensuperior
performance

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Why is it important to know what PI can do?
• Making choices about PI on the wrong merits will lead toadverse outcomes.

• Choosing PI on the right
merits is still unsustainable,
if we can’t explain them tothe civil society or provide
evidence!

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PI is concentrated in a few countries
Cumulative Private investment in transport infrastructure per EuropeanOECD country and mode, 1995-2016, US$ million

>85%

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How uncertainty affects contracts?

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The nature of any contract is risk transfer

Transferred
Riskx

Efficiencygains-Transferred
Risk

Project phase bundling (lifecycle costing), less cost
overruns/delays, …

xP=Value forMoney12

When is the price of risk “efficient”
Return/Risk

High returns
Two conditions for efficiency:
1. Credible commitment
2. Competition
3. Information (about risk)+-High losses

UncertaintytRisk

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The starting point.

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Uncertainty matters beyond financeSPVShort-term contracts and complexity (I)• Observed (median) construction risk for the SPV (outturncost vs. contract value at financial close) is zero.
• “Insurance” against construction risk is effective.
7060

Median50
40
30

20
100-10-80-60-40-20

02040

60

80

100

120

140

160

180

200

220240

Project finance construction risk - financial close (NATIXIS dataset, n=75, 1993-2012)
Source: Blanc-Brude & Makovsek (2013).

260

280

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High-powered incentives and risk?
What if we place a very strict requirement (e.g. 100 %insurance) on an agent (contractor) with limited risk info?
Median (fulldiversification)

Pr(x)EUR 70 m

EUR 100 m

Winning bid for a
fixed price contract?

EUR 190 mImpact

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Short-term contracts and complexity (II)
Applying a fixed price contract on a complex project• Construction risk: risk premium in roads above ex-post risk(+20% in EU), LCC does not explain diff.)
Unexplained
cost difference?

Traditional procurement
Cost at contract signature

Cost overrun

Public-Private Partnership
Source: Makovšek & Moszoro 2018.

Total cost18

Long-term contracts – disruptive events
The accessibility to jobs within 30 minutes in Lisbon – current and in
the “taxi-bot” model

ITF (2016).

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How does uncertainty matter - competition
What happens if more information is made available to thebidders? (e.g. publication of a detailed cost estimate)

Additional info
(less uncertainty)
Source: De Silva et al (2009).

Themarket(bidders)

New market entrants• 20% of them now offered lower
bids (bid more aggressively)• On average they stayed longer
in the market (+37%).

20Uncertainty in contracts matters beyond riskpricing!
Risk pricing
Competition

Project↑E(revenues)↓E(cost)LT contract execution

Uncertainty
Contract
signature

Circumstancesurprises

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LT contracts, complexity, and unknown
unknowns
Year 20
End ofcontract

Competition
for thecontract

Market type A
Roads, hospitals,
railways, schools…

Market type B
Sea ports, airports,…

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Reducing risk pricing inefficiency in theconstruction phase• Greater information provision upfront (e.g.
fully costed reference design)• Use of select collaborative principles during
bid preparation (e.g. joint-risk register)• A critical need to build in-house capacity (e.g.
IPA/UK, Sund&Belt Partner/DK…)• ….

How to ensure continuous pressure forefficiency in a monopoly?
Traditional procurement/management

PPP
Inefficiency

Competition for the contract
Outturn efficiency
A bet on the future

RAB
Inefficiencyt

Traditional procurement/management
Incentives (targets/resets)
Outturn efficiency
A series of smaller/short term bets on the futuretThank you!
Dejan Makovšek, Economist
Procurement and Private Investment in Infrastructure LeadInternational Transport Forum at the OECDdejan.makovsek@itf-oecd.org