Japan Expressway Holding and Debt Repayment
AgencyTokyo, Osaka, September-October 2008

The Current Trend of Global Toll
Road Business
José Manuel Vassallo
Professor on Transport Economics

CENTRO DE INVESTIGACIÓN DEL TRANSPORTE
UNIVERSIDAD POLITÉCNICA DE MADRID

1

Per capita investment in infrastructure

Infrastructure and Economic Development

GDP per capita 1990 (in $ PPA)

2Highway Management Mechanisms

Users pay

Taxpayers pay

PUBLICMANAGEMENT

Earmarked taxes
Public Tolls

Budgetary Funding

PRIVATEMANAGEMENT

Toll Concession

Shadow Toll
Concessions

Build, Maintain,
Operate, Fund

CONCESSIONS AND PPP CONTRACTS
3

Characteristics of PPP Contracts (I)• According to the Green Paper on PPPs published by theEuropean Union (2004):– Long duration of the relationship between the public and theprivate sector– The project should be funded at least in part by the private sector– The private sector should take part in the design, construction or
upgrade, and operation– A risk distribution between the public and the private sector
should be established4Characteristics of PPP Contracts (II)• PPP Contracts can be classified in:– Contractual PPPs
• Refers to a partnership based solely on contractual
links between the different players• i.e. concession contracts, DBFO Contracts– Institutionalized PPPs
• Involve the establishment of an entity held jointly by
the public partner and the private partner
5Characteristics of PPP Contracts (III)• Main reasons to implement PPPs:– Circumvent Budgetary Constraints– Increase Technical Efficiency by:• Taking advantage of the private sector skills• Integrating the design, construction, and operation
phases– Increase quality of service
6Concession Contracts (I)MAIN CHARACTERISTICS OF CONCESSION CONTRACTS

1. The private sector carries out the ultimate design of the
project
2. The construction and operation costs are financed by theprivate company which was granted the concession
3. The assets always belong to the government
4. Most of the risks are transferred to the private company
5. The private company has the right to collect tolls and theobligation to maintain and operate the highway for a periodof time contractually agreed in advance
6. A user fee is the main revenue source

7Concession Contracts (II)• Private capital for investment in infrastructure is
now “in fashion”• From 1985 to 2007 400,000 M€ were invested inTransportation, Water and Public Facilities
though concession contracts:• 240,000 in Europe, US and Canada• 100,000 in Asia
• 50,000 in Latin America• 10,000 in Africa
8Present trends regarding concessions (I)• Europe is recovering the concession model– PFI at full speed in the UK– Spain passes a new Concessions Law– Eastern countries implement toll road concessions• A major default in Argentina is reducing theimplementation of concessions in South America• USA and Canada are implementing huge Brownfieldtenders:– Chicago Skyway– Indiana Toll Road
– Pennsylvania Highway
9

Present trends regarding concessions (II)• Major Construction Groups are becoming DEVELOPERS• Pure international construction → an impossible market• Spanish Groups are becoming international leaders• Other players are coming into the business:– Investment Funds for infrastructure– Toll highways with plenty of cash10

Three key issues of concession contracts• TENDER– To award the concession to the most efficient consortium– To ensure that the profitability of the concessionaire equals its
cost of capital• REGULATION– To grant quality to the users– To preserve the Public Interest• RISK ALLOCATION– To align incentives and abilities– To be fair
11Concession Tender (I)• Objectives of the TENDER– Promote Competition. “Competition for the market”
instead of “competition in the market”– To choose the most efficient consortium from thesocial point of view

• Selection is based on what is declared by
the bidders in the offer– Problems of Asymmetries of Information
12

Concession Tender (II)Objectives of the Tender Process
STAKEHOLDERGOVERNMENT

BIDDERSOBJECTIVES

A) To build more infrastructureB) To release public resourcesA) To be awarded the concessionB) To make moneyC) To increase its expertiseUSERSA) Minimum priceB) Maximum quality
13

Concession Tender (III)Different Models

TENDERING MODELSDBFO in the UK

1. Closed
Prequalification
2. Negotiation

Concessions in
Spain

Concessions in

1. Requirements
to bid
2. Combination oftechnical andeconomic
criteria

1. OpenPrequalification
2. Technicalevaluation
3. Economic
auction14

Chile

Concession Tender (IV)ADVANTAGES¾

All the contract’s clauses areagreed between the parties

Technical andeconomic
variables¾¾

Short time until the award
Take into account both
economic and technical issues

Final economic¾

Short time until the award

auction¾

Very objective

Negotiation

15

How the concessionaires bid? (I)Economic Balance of a Concession Contract( pi ⋅ qi ( pi ) − ci − ti )Io − S = ∑
i
(
1
+
α
)
i =1

i=n
( pi ⋅ qi ( pi ))ci + ti=Io + ∑
∑
i
(
1
+
α
)
(1 + α )i
i =1
i =1

Io: Initial investment

ECONOMIC BALANCE OF THE CONCESSION

i=n

S: Upfront subsidyn$α: Cost of capital of the project

Construction

Operation

Discounted
Revenues

n: Concession term
pi: Price for year iqi: Annual traffic in year i

Discounted
Costs

ci: Operation and maintenance cost in year I Io
ti: Corporate taxes in year i

16
Equilibrium

Years

How the concessionaires bid? (II)If there is competition, the expected profitability
should be equal to the weight averaged cost ofcapital (WACC)
D
E
rWACC = (1 − tc ) rd + reVV

D: Debt value

rd: Debt cost

E: Equity value

re: Equity cost

V: Firm Value

tc: Profit Taxes
17

How the concessionaires bid? (III)Cost of Equity can be estimated through theCapital Asset Pricing Model (CAPM)

re = r f + β i ( r m − r f )re: Cost of equity
rf: Rate of return free of risk

σ
σσ ρ
σ
β i = im2 = i m2 im = i ρ im
σm
σm
σm

rm: Average return of the market
βi: Beta of the projectσi: Volatility of the project returns
σm: Volatility of the market returns
ρim: Correlation between the market
and the project returns

Cost of capital depends on the project risk
18

How the concessionaires bid? (IV)Cash Flow of a Concession Contract

19

Regulation of Concessions
TWO KEY ISSUES

1. Encouraging the private sector to provide
the best QUALITY OF SERVICE•

By including incentives in the contract

2. Protecting the PUBLIC INTEREST•

By defining some clauses in the contract
20Regulation of Quality (I)Quality
Quality indicators
indicators
appliedapplied inin thethe last
last
motorway
motorway concessions
concessions
inin SPAINSPAIN

SAFETY INDEXCONGESTION INDEXTOLL QUEUING INDEX
BONUS:
BONUS:
An
An extension
extension inin thethecontract
contract term
term
PAVEMENT STATE INDEX
21

Regulation of Quality (II)• The “progress clause”, implemented in Spain, is theobligation of the concessionaire to maintain and operate
the infrastructure according to technical, environmental
and safety regulations that may be applicable at each
moment• It may increase substantially the operational risk due to:– Relevant modifications on the environmental requirements– Relevant changes on the technical issues required
22Regulation of Quality (III)Mechanism established in some concession contractsIF

And IF

THEN

Substantial

Re-balance of thefinancial planNon-substantial

Risk borne by theConcessionaire

Imposed by an
official requirement

Not imposed byand official
requirement

Re-balance of thefinancial plan
23

Regulation of Quality (IV)Trend followed by DBFO contracts in the United Kingdom
INCOME OF CONCESSIONSHADOW TOLL
1
9
9
8

2
0
0
0

2
0
0
2

A1M
AlconburyPeterboroughA419/417
Swindon-Gloucester

A-13
Thames Gateway(London)

A1
Darrington-Dishford

PERCEPTION

TRAFFIC BANDS:
Four bands and differentiates
between light vehicles and big
trucks
INCREASEDTOLL DEPENDING ON:- Disponibility (opened lanes, hourof the day and type of vehicle)- Use of big trucks (band system)- Coefficients (accidents, level ofservice)
TOLL DEPENDING ON TRAFFIC:-No payment if speed < 60 km/h andcapacity < 80%- Full payment if speed > 90 km/h orcapacity > 100%
- A Bonus if both limits are achieved

PERCEPTIONOFGOVERNMENTBUYINGSERVICES
AND NOTINFRASTRUCTURES

24

Regulation of Quality (V)Toll depending on the relationship between traffic
flow and average speed (DBFO Contracts)
Bonus

ple
Com

ym
te p aent

Impossible zone

Impossible Zone (zero headway)
Medium
Speed
Km/h

No

110

t
men
y
a
p
120%
110%
100%

90
Objetive60
Mínimum

80%

0Traffic as apercentage ofcapacity(Equivalent Light
Vehicles / hour)

Diagram of Payments

25

Protection of the Public Interest (I)•Legal limitation of the contract duration:– 40 years for Design-Build-Maintain-Operate-Transfer in Spain– Extendable to 60 years if the economics of the contract are to be rebalanced
according to the contract– 50 years in Chile•

The USA and Canada are granting concession up to 100 years long
– The objective is to raise as much money as possible upfront– It is not a good practice:• It reduces competition• It gives much power to the concessionaire

26Protection of the Public Interest (II)• Maximum toll levels are often regulated in the contract– Adjusted to Inflation – X% (in Spain X% depends on traffic)– The concessionaire can reduce the tolls whenever it wants– In urban areas the maximum tolls applicable can vary dependingon the congestion of the road or the time of the day• Giving a lot of power to the companies to fix tolls can bea dangerous practice for the government– Case of the ETR-407 Highway in Toronto (Canada)27

Protection of the Public Interest (III)• The government should keep the right to take over andoperate the concession if:– The concessionaire is not able to operate the concession
correctly– This situation may affect the users• In any case, the government should keep the right to get
the concession back whenever it wants– In this case the government should compensate theconcessionaire
28

Risk Allocation in Concession Projects (I)• It is important to distinguish between:– Risk → statistical behaviour → MANAGEABLE– Uncertainty → unpredictable behaviour →UNMANAGEABLE• Risks in long-term contracts exists regardless themechanisms implemented to mitigate them
– Risks are merely allocated to different stakeholders
29

Risk Allocation in Concession Projects (II)• General principle: “Risks should be allocated to thestakeholder best able to control them”• Some risks have a clear stakeholder to be allocated:– Construction– Operation• Some risks does not have a clear stakeholder to beallocated:– Traffic– Force Majeur
30

Risk Allocation in Concession Projects (III)• Only few risks in long-term contracts can be covered byinsurance companies– Traffic risk is not insurable• Monoline insurance companies are becoming quite
popular to improve the rating of the long term contract
loans– They require a minimum rating → they are not applicable formany developing countries
31

Risk Allocation in Concession Projects (IV)
According to the economic equation of the project¾¾¾

Construction
Land acquisition
Permits and licenses¾¾

Demand (operating and commercial
revenues)
Competition
Charging approach (evasion andtechnology)
Prices or tolls variation

OPERATION COSTS¾¾¾

Availability
Labor force
Technology

FINANCIAL¾¾

Interest rate
Exchange rate

INVESTMENTREVENUES¾¾

32

Risk Allocation in Concession Projects (V)According to the origin of the risk

MARKET RISKSUNPREDICTABLE
AND FORCE
MAJEURE RISKS¾¾

They come from market fluctuations
They are mostly assumed by the private
sector¾¾

Events difficult to predict
They are usually taken on or mitigatedby the government¾

They refer to the legal and regulatory
framework
They are usually covered by thegovernment

POLITICAL AND
LEGAL RISKS¾

33

Risk Allocation in Concession Projects (VI)

According to the stakeholder that ultimately bears the risk

Risks borne by the project itself (Sponsors)
Risks transferred to third parties through contracts
Risks that can be insured
Risks borne or mitigated by the government
Risks covered or mitigated by the sponsors as a guarantee for thelenders34

Risk Allocation in Concession Projects (VII)• The main risk allocation principles of the Spanish
Concession Law:
– The private sector should take on all the market risks• Construction and operation risks• Traffic risk up to a certain level– Risks that are difficult to manage by the private sector may be
mitigated:• The mitigation is carried out through re-balancing the economics ofthe concession contract if some events eventually happen• The re-balance of the concession contract can be in favour either theconcessionaire or the government
35

The Traffic Risk Problem (I)• Who can control traffic risk?
– The government?
– The concessionaire?

• Traffic depends on:– The evolution of the economy → Difficult to manage– Urban development → Difficult to manage– Competition → Government in a certain way– Quality of service → Contractor in a certain way
36

The Traffic Risk Problem (II)
Traditional concession approach
Users’ Revenues
Users

PPP Contractor

Alternative concession approach
User’s Revenues

Payment basedon performance

Users 1
Users 2
Users 3

PPP Contractor 1
Public Fund

PPP Contractor 2
PPP Contractor 337

The Traffic Risk Problem (III)First year traffic forecast deviations in road projects
Deviation =Traffic ( year1)
TrafficForecasted ( year1)

Study

Projects

Main geographicalareas studied

Samplesize

MeanStandard(Real/Forec.) Deviation

Standard&Poor’s(2004)

Toll
roads

North America, North
Europe, Asia, South
Europe,

87

0.76

0.26

Baeza (2008)

Toll
Roads

Spain

14

0.57

0.26

Flyvbjerg et al.
(2004)

MostlyFree
roads

Mostly European
Union

183

1.09

0.44
38

The Traffic Risk Problem (IV)Traffic

Strategic
estimations
Real traffic

Strategic error

Trueestimations

Natural error

Year
39

Traffic Risk and Renegotiation (I)Contracts and renegotiation: What does theliterature say?
Renegotiation of
COMPLETE
contracts

Renegotiation of
INCOMPLETE
contracts

Always inefficient

1. Pareto optimal
2. Globally Efficient
3. INEFFICIENT
40

Traffic Risk and Renegotiation (II)Asymmetric behavior when traffic risk is fully
allocated to the PPP contractor

TRAFFICCONTRACTOR

Higher thanNo pressure

expected

to renegotiate

Lower than
expected

GOVERNMENTThe
government is

ULTIMATE EFFECT•

contractor

pleasedGreat

The govern.

pressure towants to keep

renegotiate

its reputation

Upside for the•

Loss for the users

41

Traffic Risk and Renegotiation (III)Vicious cycle when contractors know that
renegotiation is possible
Fiercecompetition in
the bidding
procces
Concessionaires
know that
renegotiation ispossible

Renegotiationof thecontracts

Inflated traffic
forecast

Traffic lower
than
expected42

Traffic Risk Mitigation Mechanisms (I)• Traffic risk mitigation mechanisms can beclassified according to:– The trigger variable• Internal Rate of Return (IRR)• Revenues• Profits• Etc.

– The compensation mechanism adopted• Subsidy• Toll modification• Contract length modification43

Traffic Risk Mitigation Mechanisms (II)Classification
TRIGGER VARIABLE
RISK SHARING
APPROACH

Annual Traffic or
Revenues

Accumulative
Traffic or
Revenues

Profits / IRR

Approach 1:

COMPENSATION

Subsidy /payment

Cap and floor
limitsApproach 4:

Toll

Modification of
the economic
balance of thecontract

Approach 2:

Toll bands
Approach 3:

Contract
LenghtFlexible duration
LPVR
44

Cap and floor limits (I)Traffic lower than expected$
Construction

Revenues
expected

B
Real revenuesA
MIG i
Payment by thegovernment

S

TYears 45

Cap and floor limits (II)Traffic higher than expected

D$Real revenues
Construction

C

Mirror line

Revenues
expected
MIG i

SSharing revenues withthe government

TYears 46

Cap and floor limits (III)• Main advantage:– Improvement of the LENDERS’ PERCEPTION of the
project ⇒ reduction of the financial cost

• Main drawback:– HIGH CORRELATION in case of an economic crisis
so the government may be bearing an important risk
47

Toll bands (I)Toll bands approach€

Band 3

Real traffic

Band 2
Band 1Year48

Toll bands (I)Sensitiveness analysis€

Single toll

Toll bands

Traffic year i

49Modification of the economic balance• A provision to change contract terms if a target goal isreached– The target goal is often fixed in terms of IRR or PROFITS– The compensation is usually NEGOTIATED• Main advantage → flexibility• Main drawbacks:– IRR and PROFITS are difficult to monitor by the government– A future NEGOTIATION may be costly and tough for thegovernment
50

Contracts with flexible duration (I)• Foundation:– Traffic lower than expected → extension of the contract duration– Traffic higher than expected → reduction of the contract duration• These contracts have been implemented in:– United Kingdom: Severn Bridge– Portugal: Lusoponte– Colombia: several highway concessions– Chile: implementation of the “Least Present Value of the
Revenues” approach in several highway concessions
51

Contracts with flexible duration (II)i=n( pi ⋅ qi ( pi ))ci + ti=∑Io + ∑
i
i
(
1
+
α
)
(
1
+
α
)
i =1
i =1
n

ECONOMIC BALANCE OF THE CONCESSION

PVR$
Construction

Operation

Discounted
Revenues

Io: Initial investment
Discounted
Costs

S: Upfront subsidy

α: Cost of capital of the projectn: Concession term

Iopi: Price for year iqi: Annual traffic in year i
ci: Operation and maintenance cost in year I
ti: Corporate taxes in year i
Equilibrium

Years

52

Contracts with flexible duration (III)
Variable duration of the contract due to LPVR
Traffic higher
than expected
Expected traffic
A’’A’

Traffic lower
than expected

Accumulated revenues

A

Construction

TH

TE

TL

53

Contracts with flexible duration (IV)• LPVR has important advantages for the government– A compensation based on a variable term does not commit publicresources– LPVR sets up a clear buy out price– LPVR reduces renegotiation expectations so bidders have lessincentives to inflate their offers• However LPVR was applied only few times– Strong opposition from private promoters• Upside almost inexistent• Possible downside is there is a maximum duration established54

Contracts with flexible duration (IV)
Profitability of a concession under traffic uncertainty(LPVR vs. fixed term)

55

Highway Concessions in Spain (I)56Highway Concessions in Spain (II)Periods in the construction of highway concessions in Spain
PERIOD 1

PERIOD 2

PERIOD 3

3.500

2.500
2.000
1.500
1.000
500
2003

2001

1999

1997

1995

1993

1991

1989

1987

1985

1983

1981

1979

1977

1975

1973

1971

1969

0
1967

Kilometers

3.000

Year
Highway Concessions In Operation

Highway Concessions Awarded57

Highway Concessions in Spain (III)58

The Spanish Concession Law (I)• A new Law was necessary:– To extend the concession model to every type of public
infrastructure• To promote private financing– To reinforce the legal framework by defining a new risk-sharing
approach• The Law was approved in May 2003
• Regulatory dispositions for each type of infrastructure
can be developed
59

The Spanish Concession Law (II)MAIN CONTRIBUTIONS OF THE NEW LAW
The concession contract does not
imply necessarily the construction ofa new infrastructure

The Law introduces what iscalled the “progress clause”

Private persons and entities may
propose concession projects to the
Public Administration

The Law introduces a newmechanism to mitigate trafficrisk

The Law introduces bonuses
or penalties related to quality
criteria

The Law regulates new private
funding sources to financeconcession projects

Maximum term of 40 years for DBOT
concessions

60

The Spanish Concession Law (III)• The revenues of the concessionaire come from:– Tolls charged to the infrastructure users– Revenues obtained from the operation of commercial
areas that belong to the infrastructure– Contributions from the government if necessary• Lump subsidy upfront• Subsidies to the users (shadow toll)
61

The Spanish Concession Law (IV)• The Law establishes the circumstances that may cause
the re-balance of the economics of the contract– Contract modifications required by the government– Force majeur events– Large traffic deviations• Ways to re-balance a concession contract:– Extension or reduction of the contract duration– Modification of tolls– Subsidies
62

The Spanish Concession Law (V)UNPREDICTABLE EVENTS•

Impossible to foresee at the
beginning of the contract•

Impossible to do a checklistof them at the beginning

THE LAW SAYS THAT:The government must reestablish the economic balanceof the contract only due to force
majeure causes

FORCE MAJEUR EVENTS ARE:
1. Fire caused by Atmosphere
electricity
2. Natural phenomena withcatastrophic implications
3. Damages caused by war andalteration of public order 63

The Spanish Concession Law (VI)

• Construction risks have to be borne by the private
contractor• The concessionaire should carry out the final design inorder to avoid future claims• The concession contract can be re-balanced in case thatsome specific events cause cost overruns:– Design changes imposed by the government– Force majeur events
64

The Spanish Concession Law (VII)• Operational risks have to be borne by the private
sector• Concession contracts should include bonuses
and penalties to encourage the concessionaire
to render a good quality level• The “progress clause” has to be applied
65

The Spanish Private Promoters (I)Spanish developers
consistently rank
amongst theworld's top
transportation
developers

66

The Spanish Private Promoters (II)67

The Spanish Private Promoters (III)
Mexico• 13 airports (26M Pax)
• 1st Underwater Tunnel• 33% Mw Installed capacity• GLP Leaders
Costa Rica
• 4 Motorway concessions• 250 km. Toll roads
Perú• 34% GLP Market Share• 26% MW Installed Capacity
Bolivia• 3 Airports (TBI)• 35% GLP Market ShareChile• 84% Toll Road Concessions• 90% Toll Access to Santiago• SCL Airport (80% INTL Traffic)• 30% Mw Installed capacity• 38% GLP Market Share

Puerto Rico
• Puente Teodoro• 47,5% Mw Installed Capacity
Colombia• 1,484 km. Railways• 2.1 M Clients (Electricity)• 25% MW Installed Capacity
Brazil
• 2,000 km Toll Roads• Sao Paulo 3 main Concessions• 12.5 M Clients (Electricity)• GLP leaders
Argentina• 4 Toll Concessions• 2.1 M Clients (Electricity)
68 Capacity• 15% MW Installed

The Spanish Private Promoters (IV)U.K.
• BAA & TBI: 10 airports (160 M pax)
• 90% London Air Traffic• 10 incineration plants• 5 Toll Road Concessions (270 km.)• 5,413 Mw Installed Capacity• 5.2 M electricity users• 112,000 km transmission lines
Ireland• 4 toll road concessions (250 km.)France• 1,771 km toll roads (SANEF)• 2,000 km. Toll roads (Eiffage)• 2,600 Mw Installed Capacity
Portugal• 4 toll roads (375 km.)
• 1,300+ km toll roads(Brisa & Autoestrade)• 1,000 MW (4 plants)• 16.5 k parking spaces

Sweden• Stockholm Skavtsa Airport
Eastern Europe• SMVAK & ASA-Abfall(Environmental Services)• Alpine Mayreder GroupItaly• 3,400 km toll roads(Autoestrade)• Naples Airport• 4,012 km. GLP pipelines• 6,360 Mw Installed Cap.
• 15.5 k parking spaces
Greece• Ionan Roads (380 km.)
• Central Motorways• 260 Mw Installed Capacity

69

The Spanish Private Promoters (V)Canada• 407-ETR Motorway (108 km.)U.S.
• 5 airports (65 M pax)
• 6 Motorway Concessions (380 km.)
• Desalinization Plants (Acquaria Water LLC)
• 16 Power Plants (Wind & Thermic: 2,200
Mw)• Nevada Solar One (Wind Mill)• 3 M electricity users

70

The Spanish Private Promoters (VI)
Spanish firms have grown from pure construction companies
into diversified concessions businesses and other activities
Market Cap* (Euro Billion)

EBITDA breakdown
2 yr growth:
121%
36%
151%
186%
61%
21%**
210%

Construction

Concessions

As of June 29th 07

Other activities** From June 2005*** From sept 2005

Source: Santander research

71The Spanish Private Promoters (VII)• Main Characteristics of the new concession developers:– Understands the difference between construction and concession
business– Integrates a multitask team:• Design• Land expropriation• Construction Management• Finance• Operation and maintenance• Electronics– Frequently new developers integrate financial institutions aspermanent equity partners
72

Thank you very much for yourattention

Further Information:
jvassallo@caminos.upm.es

73