Despite the clear importance of this phase and the specific problems and risks it entails, the level of effort and detail required for economic supervision depends to a large extent on the structure of the PPP contract. If the contract takes the form of a price or revenue cap, the private partner bears all the risks of cost overruns and therefore in principle there is no reason to supervise costs. On the other hand, if the contract takes a cost plus format there is a clear need for a detailed analysis of the constructions costs.
Although the basic idea of PPP contracts is to transfer construction risks to the private sector by adopting a price or revenue cap payment mechanism, this is not always possible.
According to Grimsey and Lewis: "a defining characteristic of a PPP is not private-sector involvement in itself, but 'bundling' […] With a PPP, the asset and service contracts are combined, and there is integration within a private sector party of all (or most of) the functions of design, building financing, operating and maintenance of the facility."
The conceptual basis for this approach relay on transactions costs, reputation and information costs and incentive structures models114. The intuitive explanation is straightforward. In most cases there are good performance indicators for the quality of the service while the quality of the asset is non observable. In this way by entrusting both construction and service delivery to a single party and relating payment to the provision of the service at a predetermined level of quality standards, the right incentives are created for the entity to design and build the assets efficiently, operate in an efficient way so as to contain costs while not sacrificing quality.
In a well-designed PPP contract, construction risks are generally allocated to the private party, and therefore, this party is the most interested in completing the work, because completion which shall trigger the payment agreed upon in the contract. On the other hand, if this party does not observe the agreed-upon terms and budget levels, it shall not only be unable to collect the payment but also will be liable for the penalties set forth in the contract. This is basically defined on the rules agreed at the contract's design stage. These rules must clearly set the penalties in case of delays or any other event that may occur.
Two factors can affect the possibility of adopting a pure price cap mechanism. Firstly, bundling design and construction implies that it is very difficult to estimate the final costs as several variables, which are not know at the moment of bidding or contract signing, affect them. Secondly, the cooperative nature of PPP means that government plays an important role during the construction stage on matters affecting the final costs of the project.
As shown by the S&P study (see Chart 2 above) there are several factors influencing the costs behind budget or schedule problems in this stage. Aggressive budget and tight schedules set by the government are often cited as sources of problems. Ground site conditions and delays with permits and approvals also rank high among the causes of delay and cost overruns. The first two can be seen as risks which the private party should take into account in the bidding process. But the other two are mostly out of their control and, especially in the case of permits, is clearly a government responsibility.
The governance issues, in terms of both sides' transparency, predictability and efficiency, emerging from the conditions cited above, involve an extra increase in the costs of the private partner. Due to the budgetary problems in which the private actor may incur, the public partner needs to carefully supervise the unexpected costs during the construction stage.
Non-compliance is not always related to the operator's inefficiency. Lack of control and the impossibility to forecast the diversity of investments required in a plan generate in many cases delays or cost overruns which are outside the control of the operator.
It is also important to point out that some of the factors outside the operators control are directly in the hands of the government. Construction permits are a clear example. Other factors are not directly controlled by the public partner but nevertheless the public sector is in better position to manage them. Dealing with the opposition to the project by some stakeholders (specially those related to civil society actors or citizenry - "not in my backyard" attitude) is the most common example of situations in which the government pursuing a public good can help to avoid unexpected higher costs in the construction stage (see ).
BOX Siting Permissions for High voltage Lines
| In the 1980s and early 1990s, siting and constructing electric transmission lines was a straightforward process for the utility, entailing engineering and preparation of the application to the siting agency. The efforts of Cross-Sound Cable Co. LLC to site and construct a 330-megawatt electric transmission line buried under the seabed of Long Island Sound from New Haven, Conn., to Long Island, N.Y., illustrate the new siting reality. Today, siting and constructing an electric transmission line has become a multi-disciplinary municipal, regulatory and litigation process with a maze of twists and turns. The process can be circuitous, repetitive, time-consuming and costly. On July 24, 2001, Cross-Sound applied to the Connecticut Siting Council for a Certificate of Environmental Compatibility and Public Need to construct, operate and maintain the cable project. On Jan. 3, 2002, the siting council granted a certificate to Cross-Sound. The siting council determined the cable project would provide a public benefit and would not have any environmental impact that would provide "sufficient reason to deny the application." After the siting council approved the project in January, that decision was challenged over a period of eight months by the state legislature, the city of New Haven, Connecticut's attorney general, and several shellfish companies, but each challenge was either withdrawn (in the case of the shellfish companies), or dismissed by a higher court or other legal authority. During this time Cross- Sound installed its transmission cable. |
Source: Bruce L. McDermott - Chronicle of a Transmission Line Siting. Public Utilities Fortnightly, January 1, 2003
The need for the public sector to take an active role in solving these types of problems in the framework of its duties as a partner to the project should be stressed. An active management of stakeholders' relations is critical during the construction phase of the project.
____________________________________________________________________________________
114 See Grimsey and Lewis for a summary of Hart 2003, Parker and Hartley 2003 and Grout 2003.