Market risks typically arise where payment for service depends on the level of usage, or where the project is exposed to market forces and their accompanying risks. The main consequence of market risk is that the revenue from users is less than expected.
The primary market for the contracted services takes one of three forms:
• public buys services directly (direct market exposure)
This is a straightforward, user-pays situation where revenues depend on usage. It is extremely market-sensitive and may require government to take measures to lessen the chance that rival government-subsidised services will reduce usage of the contracted services materially below projected levels, in turn jeopardising the viability of the project. While such measures may encourage demand for the contracted services, they do not guarantee it. Accordingly, in this scenario the private party remains fully exposed to demand risk.
• Government buys services on behalf of consumers (intermediate demand)
This model is market-sensitive to the extent that government pays for the level of public consumption of the contracted services. For example, government may pay 'shadow tolls' that reward the private party according to the level of consumption of its services. However, as there is unlikely to be price discipline on end users, demand is unlikely to be constrained and the private party does not bear true market risk. Government needs to carefully consider the extent of value for money provided in such structures.
• Government buys services for itself, which it then may provide to the public or use
in the provision of core services (government demand).
In this model, demand may well be sourced exclusively within government (although, in the case of accommodation services in particular, the facility should be structured to be able to service other demand in conjunction with government demand). Where government is the sole (or major) source of demand, there is pressure for it to underwrite demand risk by committing to a minimum quantity of services per annum or to undertake not to create or use similar facilities within the project region. Such measures, if implemented, lessen the private party's exposure to demand risk (particularly if a minimum consumption is specified). Government, in these circumstances, generally shares the demand risk. However, setting the minimum below the level of optimal government usage and the level of usage required to achieve the desired project returns may also help maximise value for money by ensuring that the private party retains a continuing incentive to optimise usage.
The underlying objective for government in considering to what level of demand to commit and to what level of demand risk the private party is to be exposed, should be to maximise value for money. A rigorous assessment of the value of allocating the demand risk to the private party should be undertaken.