When it is impossible to charge user fees that pay for the capital costs of the project (though they may pay for the marginal costs of providing services), there are three alternatives. First, the government can use conventional provision. Second, it may use shadow fees, where the government pays the private operator a fixed fee for each user of the infrastructure. Finally, it can pay a fixed periodic fee, contingent on a quality-of-service standard being met, under an availability contract.
A fixed-term contract where the firm is remunerated with shadow fees introduces demand risk, because the firm and taxpayers are forced to bear the opposite sides of risks they could avoid under an availability contract. This will increase the risk premium included in the winning bid. Since having the firm bear this risk brings no countervailing benefit, this approach should be deprecated. The purported benefit of shadow tolls is that, because they are demand dependent, they avoid waste. Consider, however, that a project in which all the payments are made by the government is a project that should be subjected to careful social evaluation, so the benefits of filtering waste are limited. It follows that, at least for projects with contractible quality, availability contracts should be the preferred option when financing mainly out of general funds.