Under the right circumstances, PPPs can help improve infrastructure project selection, by harnessing the analysis and ideas of private sector investors, whose financial returns depend on getting cost and revenue forecasts right.
Private investors and lenders undertake their own project analysis based on their experience and strong, profit-driven incentive to carefully assess benefits and costs. Lenders to project finance transactions, in particular, carry out extensive project due diligence, as described in Section 1.4 How PPPs Are Financed. A 2002 Standard and Poor's study [#24] found that traffic forecasts for toll roads commissioned by banks tended to be less optimistic than those commissioned by other agencies, including developers and governments, although still biased on average.
The PPP tender process can therefore act as a filter for non-viable projects. As described by Engel, Fischer, and Galetovic [#74], if the private sector sponsor and lenders are being asked to take revenue and cost risk under a PPP, a non-viable project may simply not attract private interest. For example, a McKinsey report on infrastructure challenges in India [#124, pages 25-27] notes that several of the National Highways Authority of India (NHAI)'s toll road projects have not attracted bidders. In some cases demand forecasts were too high, in others bidders found NHAI's cost estimates to be low, and the project not viable on more conservative cost assumptions. Conversely, Engel, Fischer and Galetovic [#74] note that if the government is bearing a risk-for example, by providing a demand guarantee-then a non-viable project could still be profitable for the private partner, reducing the "filtering ability" of PPPs.
Experienced private companies can also be well-placed to identify infrastructure needs, and come up with innovative ideas to meet them. Accepting unsolicited proposals for PPP projects from private companies can be a way to capitalize on these ideas. Box 1.5: Hot lanes in Virginia-An Example of Private Sector Innovation provides an example of an innovative project developed from an unsolicited proposal. While unsolicited proposals can be a useful source of ideas, in order to improve project selection they need to be subject to the same analysis as other major government investments. Section 3.6: Dealing with Unsolicited Proposals describes how some governments have introduced policies to encourage unsolicited proposals, while subjecting them to rigorous analysis and competition.
Box 1.5: Hot lanes in Virginia-An Example of Private Sector Innovation A portion of the I-495 and I-95 highways-the 'beltway' around the Washington, DC metropolitan area, and a major North-South corridor-had been in need of repair and expansion to alleviate congestion since the early 1990s. The State of Virginia Department of Transportation (VDOT) initially developed a plan to rehabilitate and expand the highway at a cost of US$3 billion, but lack of funding and public opposition over the proposed displacement of over 300 businesses and homes had stalled the project. In 2002, Fluor, an engineering and construction company, submitted an unsolicited proposal to develop High Occupancy Toll (HOT) lanes on the I-495, as an alternative way to accommodate traffic volume. HOT lanes are an innovative technology that allows drivers to pay to avoid traffic. The tolled lanes run alongside highway lanes, and are designed to be congestion free. To regulate demand for the lanes, tolls for the HOT lanes change depending on traffic conditions. When traffic increases, tolls go up. Cars with three or more passengers and buses are allowed to use the HOT lanes free of charge. The Fluor proposal reduced the number of business and homes displaced from 350 to eight, a major factor in garnering public support for the project. The proposal also minimized project costs, by meeting minimum standards for road specifications. In 2005, VDOT awarded the PPP agreement to construct the HOT lanes. The total cost of the project was US$1.9 billion, compared to the estimated US$3 billion under initial plans developed by the government. The State of Virginia contributed US$400 million of this cost. The HOT lanes project reached financial close in 2007 and opened in 2012. Building on this experience, VDOT went on to make further use of the HOT lane concept, with a second contract awarded in 2011. Source: Virginia HOT Lanes website (http://www.virginiahotlanes.com); Gary Groat (2004) 'Loosening the Belt', Roads and Bridges, 42(4); Virginia Department of Transportation (2008) Virginia HOT Lanes: Fact Sheet, Richmond, VA |