Executive summary

Public-private partnerships (PPPs) are becoming increasingly commonplace in Europe,

with models varying across member states according to national legal frameworks and

sectors of application. As there is currently no overarching European definition of PPP,

the term is a sort of “umbrella notion” covering a broad range of agreements between

public institutions and the private sector aimed at operating public infrastructures or

delivering public services. A closer look at national examples reveals that PPPs have

reached different degrees of development across the European Union, with some

countries having achieved advanced results in PPP adoption and implementation, and

others still at an intermediate or even preliminary stage.

This briefing note provides a general description of European experiences with PPPs and

the sectors where this type of public-private arrangement is adopted. Four relevant

national experiences (the United Kingdom, Portugal, Spain and Hungary) are examined

in greater detail, in order to present success stories and problems that occurred due to

specific country or sectoral characteristics.

The analysis contained in this briefing note demonstrates that some sectors are better

suited than others for PPP adoption. The widespread use of PPP arrangements to provide

rail and road infrastructure in all analysed national experiences testifies that private sector

involvement in asset provision produces real value for money. It remains to be

ascertained whether the same results can be achieved in other areas such as healthcare or

education: so far, existing PPP contracts in these fields are quite recent, and it is therefore

difficult to draw solid conclusions at this stage.

Finally, national political attitudes and existing competences play a key role for the

development and success of PPP arrangements. The creation of dedicated units within

public administrations and the increased managerial competences and attitudes in both

the private and the public sector are likely to foster better results in the future.

Introduction

There is currently no overarching definition of public-private partnership (PPP) in Europe. As a result, PPP is a sort of “umbrella notion” covering a broad range of agreements between public institutions and the private sector aimed at operating public infrastructures or delivering public services. Existing European legislation does not regulate PPPs and only general EC Treaty principles and specific secondary legislation on public procurement and concessions set some guidelines on the topic.1 Nevertheless, PPPs are becoming increasingly commonplace in Europe,with models varying across member states according to national legal frameworks and sectors of application.There are different reasons that render PPPs appealing to national governments: budgetary constraints for Euro zone countries, the need to absorb EU funding for CEE member states, New Public Management approaches in Anglo-Saxon administrations, etc. Moreover, institutional arrangements and political expectations play a significant role in further spreading PPPs. For example, the creation of dedicated PPP units at governmental level or the adoption of specific legislation can considerably speed up PPP diffusion. To this end, the development of appropriate competences not only in the private sector but also within the ministries themselves is a crucial element, as the Irish example demonstrates.2 Only experience can indeed guarantee that the public party retains the power and ability to control the implementation of PPPs to secure desired results.

In this respect, some countries seem to be better equipped than others to promote and achieve the needed cultural change in public administrations.At the same time, the influence of political expectations on the expansion of PPPs should not be underestimated. Despite the fact that some innovative PPP models are being introduced in traditionally core public sectors such as healthcare, prison facilities, and education, in many European member states the use of PPPs in these areas is still a taboo. Citizens often have very strong opinions on areas that should remain within the exclusive competence of the government.

The issue becomes even more delicate when human resources are directly involved and civil

servants often fear that involving the private sector might lead to job losses and a lower quality of services. In addition, it is too early to draw conclusions on the welfare enhancing capacity of PPPs in these sectors, as existing examples are too recent.

Political expectations on activities and services that the State may and may not delegate to the

private sector also exert a significant impact on the financing of PPPs and on governments’ ability to control and address possible failures without severe consequences for public accounts. This can be clearly observed in the case of Spain, where the legislation spells out that the State always maintains responsibility in contracts involving the public party. As a result, when a PPP turned out to be more expensive than what had been calculated ex ante, the government was expected to fund the project and ensure its viability, thus setting a precedent for future cases.

It is against this background that European experiences with PPPs in different sectors are presented in this briefing note.

European experiences with PPP

For what concerns PPP adoption, European member states can be divided in three groups: the

“advanced PPP adopters”, such as the United Kingdom and to some extent France, Germany,

Ireland and Italy; the “intermediate PPP adopters” like Spain or Portugal where considerable results have been achieved but not in all sectors; and finally the “latecomers”, where PPP use is still at a very early stage. Despite the inevitable degree of simplification, this taxonomy provides a helicopter view of the different levels of development and diffusion of PPPs within the European Union. CEE countries form a separate group because of their different economic and political characteristics.

“Advanced PPP adopters” have experienced PPPs in many sectors, from the provision of basic public infrastructures such as roads and railways to the most innovative and challenging fields of healthcare, schools and prison services. These countries can count on a substantial number of closed projects and have already developed a somewhat clear idea of those sectors in which PPPs are best suited and those in which PPPs face substantial problems. Advanced PPP adopters have already introduced appropriate national and sometimes regional legislation to deal with PPPs, and use specific tools to assess whether individual PPP projects can be expected to really deliver value for money. Some countries, such as Ireland, have created ad hoc governmental departments to ensure that PPP expertise is developed and centralised. In some cases, such as the United Kingdom, traditional instruments to evaluate the efficiency and the welfare enhancing potential of PPPs are being reviewed, and innovative solutions are currently under discussion.

“Intermediate PPP adopters”, like Spain, Portugal and to some extent the Netherlands, have

achieved significant progress in adopting PPPs for infrastructure provision, with many projects already procured and some closed. Nevertheless, the extension of PPPs to other sectors has proven more difficult due to ambiguous provisions in existing legislation, or to frequent changes in governments and in political attitudes towards this instrument.

The group of “latecomers” includes those member states – such as Luxembourg or Sweden – where PPPs are almost absent from all sectors or are only at a fairly preliminary stage of adoption. Possible reasons lie in a different, more rigid approach to the role of the State in the provision of core public infrastructure; or in better budget management at public level, which reduces the needand the incentive to call on private sources of financing for the provision of assets and services. In the case of Belgium, the complex federal structure of the state has delivered mixed results: Flanders can be considered as “intermediate PPP adopters”, while Wallonia is still lagging behind. The Greek case is particularly interesting, as it combines advanced examples of PPP projects (the Athens International Airport, roads, sports and leisure facilities) with the complete absence of PPP initiatives in other sectors.

Finally, CEE countries deserve separate attention due to the role that PPPs play in facilitating

infrastructure development and the absorption of EU funding. When compared with “old” member states’ experiences, in post-communist countries PPPs have to overcome significant challenges caused by the absence of human resource with adequate skills and expertise in dealing with such type of contracts, by underdeveloped capital markets and by a strong bias in favour of traditional procurement associated to EU funds. So far, infrastructure and greenfield projects constitute the majority of PPP initiatives. Even if many projects had to be renegotiated at an early stage and were generally characterised by bad risk evaluation, is must be acknowledged that CEE countries have achieved significant progress in managing PPPs. The most common cause of failure of PPP projects in Central and Eastern Europe, as the Polish and Hungarian examples demonstrate, lies in the overestimation of the potential demand for services, which leads governments to bear a substantial part of the demand risk initially allocated to the private party. Conversely, the Czech Republic provides an interesting example of how infrastructure can be successfully delivered without a strict separation of the allocated funds from the government’s budget.The table below summarises the European Experience with PPPs by country and sector.

Conclusion

As the cases presented so far demonstrate, PPPs have reached different stages of development

within the European Union. Moreover, some sectors appear to be better suited for this type of

arrangement than others.

The widespread use of PPP/PFI arrangements to provide rail and road infrastructure in all the

analysed national experiences testifies that private sector involvement in asset provision can

produce real value for money. Despite some drawbacks in the overall cost and risk evaluation – as occurred in the Hungarian M1/M15 case and, at least to some extent, in the London Underground projects – the adoption of PPPs for infrastructure-related projects has reached a mature stage. The creation of dedicated units within public administrations and the increased knowledge and managerial competences in both the private and the public sector are likely to promote further positive results and set best practice examples for the “latecomers” in this field.

What remains to be seen is whether the same results can be achieved in other sectors such as

healthcare or education. All existing PPP contracts in the latter fields have been launched only

recently, and drawing any conclusion would be premature at this stage. Even in the United

Kingdom, where the NHS has often made use of PFI arrangements, a closer look reveals that the majority of ongoing projects are about facilities construction and maintenance of assets, without a massive transfer of core public-interest competences to the private sector. Some studies argue that PPPs are not suited for the delivery of clinical and schooling services as the quality of outputs provided by a profit-driven private operator is likely to be lower than what would be achieved by the public sector.21 Without appropriate and credible means of control and quality indicators from the public party, the political opposition to extending PPPs to core areas of public service provision will certainly rise. The positive/negative outcome of ongoing projects, such as the Spanish Infraestructuras Sanitarias mentioned above, will provide a clearer picture of the possibilities for future developments of PPPs in this field.

Finally, PPPs are not suited for sectors with fast-pace technological change, such as IT. It is almost impossible to set credible quality outputs for a long-term period without hampering possible innovations and constant improvement in the quality of services. Frequent renegotiations to adapt the contract to technological development would be overly costly, thus contradicting the basic reason for PPP adoption: the creation of value for money.

To sum up, PPPs are not a miracle solution and need long time to produce visible results. More than on a general expansion of this type of agreement to other sectors, governments should focus on refining their administrative capacities and their evaluation tools to ensure that PPPs allocate risks to the party that is best suited to manage them and that the benefits of involving the private sector in service provision are effectively reaped. Without this approach, the public sector runs the risk of using PPPs for the wrong reasons, for example to seek a short-term make-up of public accounts to the detriment of long-term financial sustainability.

 

Water and Waste Water Treatment Sector Analysis

Introduction

PPPs have existed for many years in the international water and waste water sectors. For example, the

current system of water concessions in France has been common place for at least 40 years and has

contributed to the growth of the large and diversified French private utility companies. In the UK,

many municipalities are now experiencing their third generation of PPP type contracts4. The

European Union Drinking Water Directive and the Urban Waste Water Directive have also resulted in

a substantial change in public sector responsibility within the water industry.

In the future a broader application of PPPs is anticipated in this sector. To meet Directive

requirements, many Member States will have to undertake substantial investments in upgrading old

facilities or building new ones. As a result, countries that have not yet involved the private sector are

now considering the potential to make use of its skills and financial resources to implement

investment programmes and generate the required quality and efficiency improvements.

The considerations that influence the form and structure of PPP’s in the water sector include the

project’s size, scope, complexity, regulatory and operational requirements, application of user charges

and risk allocation.

A full range of PPP structures and traditional procurement arrangements have been applied in the

water sector. Water supply and waste water facilities are well suited to BOT, DBFO contracts and

Concessions where there is a secured mechanism of user charges. The rising risks associated with

operating increasingly complex treatment processes and the need to develop and improve

infrastructure networks, particularly in the Candidate Countries, support the growth of PPP

opportunities in this sector.

Selected Cases

The selected cases, drawn from both EU Member States and Candidate Countries, are illustrative of a

generalised international trend to use PPP models in the water sector. From the wide variety of

international examples, a group of cases was selected to demonstrate several PPP models and the

impact of Commission co-financing. In particular the cases demonstrate the following:

· The differences between the privatisation process, the development of PPP projects and the

development of long term markets for water assets and operating rights.

· The ability of Commission co-financing particularly to improve operational efficiency and

fairness of a PPP agreement by promoting a more equitable distribution of the costs and benefits

through standards and market regulation mechanisms.

· The ability of PPPs to capture the value of private sector expertise and new technologies in

complex projects.

· The ability, through incentives and risk transfer, to generate increased speed of project realisation

and to create operational efficiencies.

· The fact that the PPP approach does not need to result in reduced concern for environmental

issues, service quality standards or social and employment concerns.

Lessons Learned

On the basis of the project selection criteria the main common lessons learned can be summarised as

follows:

· There is a considerable difference between privatisation and PPP principles. This is particularly

true in the water sector and in new Member States. It has been common practice, particularly in

the Candidate Countries, to firstly privatise assets and then develop and implement a PPP project

to attract investment and know-how. Of major concern is the method of asset transfer and their accounting in the subsequent PPP project. It is to be expected that the State wishes, at least initially, to maintain a degree of control over public services and thus, may wish to retain control over fixed assets. However this should not hinder the longer term development of PPPs and in particular regular and equitable investment in assets.

· The degree of risk transfer is a crucial issue to the success of PPP projects. Particularly in

environmental projects there is a confluence of standards, liabilities, service and quality provision

targets and, in many countries, a need to establish the principle of full user charges for services.

This adds to revenue risk and requires a suitable approach to the structuring of the agreement and

the commitment of all parties to the sustainability of the project.

· Given the wider issues related to environmental infrastructure, it is even more necessary for the

public sector to have effective monitoring, control, payment and penalty systems in place to

ensure the project meets expectations and can be corrected effectively in case of problems.

However such systems should also be used to develop incentive schemes to encourage the private

party to improve performance and efficiency. This addresses the difference between the public

sector’s statutory responsibility to guarantee standards and the private sector’s desire to enhance

revenue. The Karvina project is typical of a project where such schemes have been considered.

The development and publishing of uniform performance criteria and operational results, notably

in the UK, is another example of how both objectives can be met. In this case the availability of

data allows public scrutiny of performance against targets and hence pressure on user charges if

performance is not satisfactory. This ‘consumer pressure’ provides an added incentive to increase

the provision of value for money.

· It has been demonstrated that the Commission’s grants can play an important role in achieving an

equitable balance between commercial and public interests. The Karvina, Trencin and Constanta

projects are good examples of this. While the Commission may not be ideally suited to address

the commercial aspects of an investment, it can effectively ensure that quality standards are fully

incorporated, ensure that there is no undue benefit flowing to either party and that PPP contracts

are developed in an open and transparent manner. The Commission , because of its financial

contribution, has been able to enhance the overall socio-economic quality of projects through

reviews of contracts or project designs.

· Undertaking realistic and rigorous project preparation particularly on affordability and financial

sustainability factors is critical to project success and to correctly determining the appropriate

amount of Commission funding.

· The appropriate length of agreements should ideally reflect the amount of investment,

commitment of rate tariffs, the expected returns, and other factors. The Constanta project

demonstrates how establishing an agreement period balancing financial, investment, grant

financing and risk allocation factors can increase private sector interest in the project.

· As the Dublin project demonstrated, as indeed in many of the Candidate Countries, the

involvement of private investors and operators is an effective method for accessing expertise and

technology. This is expected to become increasingly important as communities strive to conform

to EU quality and performance standards.

Conclusions

The following ‘Radar’ diagram highlights the qualitative conclusions of the water and wastewater

case studies according to the criteria of:

· Investment Value

· Contract Duration

· Responsibility Transfer

Case 1. Apa Nova in Romania

Background

The privatisation process for the Bucharest water system took place in 1996, following World Bank

recommendations, and resulted in a concession agreement between Vedia and Bucharest Municipality

for the management of the water system. In 2000, Apa Nova, then controlled by the French utility

company Vivendi, now restructured under Veolia Environnement, won a tender for the management

of the Bucharest water concession including the development of the Crivina Plant. Apa Nova is an

enterprise created on an already existing link between Vedia and Bucharest Municipality. The general

conditions of the PPP agreement between Apa Nova and Bucharest for the Crivina Plant, are the same

as for the 1996 water system PPP agreement with Vedia. In practice, Vedia has been incorporated

into Apa Nova.

The rational for the PPP is as follows :

· Private sector participation. The Project supports private participation in the utilities sector in

Romania, which has been awarded through international competitive tendering. By giving control

of management and investments to a private company and by linking its remuneration to

efficiency gains and operational performance, the Municipality expects to maximise the benefits

of the private sector involvement, in the form of significant improvements to Apa Nova’s capital

and operating efficiency and higher standard of service.

· Transfer of relevant skills. Through the introduction of international management practices and

operational expertise important skills will be transferred to Apa Nova’s staff. The lack of

adequate skills in Romania is one of the main rationales for inviting a foreign operator. The

Sponsors will develop local skills in areas such as operations management, energy efficiency,

capital budgeting and financial management.

The management tender was launched by the Municipality to attract financial resources and know –

how to improve the water and water treatment system for the city. The project consisted of two main

items: (i) the improvement of the water distribution network in Bucharest, and (ii) the completion of

the Crivina potable water treatment plant located in the outskirts of Bucharest. The completion of

Crivina would increase the capacity for potable water treatment to 259,000 m3/day.

PPP Features

As one of the first PPPs in the local water sector, the private contractor was selected through

international competitive tendering. The terms and conditions of the agreement are considered

consistent with international best practice. In particular, the concessionaire is paid under a price cap

type tariff mechanism. This provides incentives for cost reductions, which are shared with consumers

in the form of lower prices and / or higher levels of service quality.

Following an international competitive tender process organised by the Municipality of Bucharest,

with the support from the International Finance Corporation, Vivendi Universal was selected as the

preferred bidder. The agreement foresees that Apa Nova Bucuresti, owned 85% by Vivendi

Universal, operates the Municipality’s water and sewerage assets for a period of 25 years. The

Concession Contract with the Municipality was signed on 29 March 2000, and became effective on

17 November 2000. Subsequent to the agreement execution, Vivendi Universal transferred its shares

in Apa Nova to Compagnie Generale des Eaux S.C.A. following the signing of the Loan Agreement

(although Vivendi was initially awarded the contract).

The agreement helped create a source of capital to support an upgrade and extension of the Bucharest

water system. The partnership agreement required the private partner to provide financial resources to

upgrade the system. Bucharest will contribute the existing infrastructure and own new infrastructure

while the private operator obtains the right to manage and maintain the water system.

The water tariff was fixed at the moment of contract signature, with the agreement that it would be

regularly adjusted. The decision to change the tariff will be made by the City Council on the basis of

an application presented by the private operator. Apa Nova is, according to the agreement,

responsible for the collection of tariffs and, when appropriate, pays dividend s to all shareholders,

including Bucharest.

The co-ordination between the two parties – Apa Nova and Bucharest, and the decision-making

powers, are regulated by a board, on which the City of Bucharest and Vivendi are represented. In

addition a Director General is responsible for the day-by-day management of the operations.

Part of the project included the upgrading of the Crivina plant. The project had already started 10

years earlier but the municipality lacked the financial resources and expertise to complete it.

To finance the project Vivendi and the City of Bucharest applied for an EBRD loan which offered

better terms than other commercial sources of capital. The loan terms required Vivendi to intervene if

necessary and to assume the responsibility for monitoring and reporting on Apa Nova’s performance

to the EBRD. Bucharest has the right, as shareholder, to also monitor Apa Nova’s operations.

Bucharest looked for a private sector participation in the operation of its water and waste water

system for two main reasons: to enable the necessary investment in upgrading the infrastructure and to

bring in the needed new technology, know – how, and management methods. For Vivendi Universal

the investment in the Romanian water sector and in Bucharest was part of its own strategy to develop

new business.

Lessons Learned

· The project represents a classic PPP model employed in the European water sector. It foresees a

degree of stability and risk / profit sharing. The “tried and tested” nature of the model may have

been beneficial to Bucharest given the uncertain PPP environment still reigning in Romania at the

time.

· The PPP contract is bringing advantage to both parties. Bucharest is receiving reliable financing

for upgrading and improving the quality of its water system. Additionally it is able to access the

required expertise and technology and may also look forward to sharing a profitable dividend.

The size of the dividend or the ability of the operator to generate profits is directly related to

performance and increasing efficiencies due to the price cap mechanism. This provides a degree

of consumer protection. The private operator is expecting economic profits, which they are trying

to obtain by improving operational efficiency and by ensuring that revenues from the water tariff

are effectively collected.

· There is some risk concerning revenue flows as tariff collection is the responsibility of the

operator and the contract foresees no tariff changes in the short to medium term. This implies a

degree of risk for the operator as operational efficiencies will not have an impact in the short term.

Case 2. Scottish Water Solutions, UK

Background

The Scottish Water Authority, SWA, was formed in April 2002 from the merger of three former water

authorities. SWA provides water and wastewater services to 2.2 million household customers and

130,000 business customers across an area, one third the size of Britain. With a Ј1 billion turnover,

SWA ranks No 16 in Scotland's top 20 businesses and is the 4th largest water and wastewater service

provider in the UK.

The introduction of the 2002 Water Act (Scotland) followed a detailed review of how the water

industry was positioned to respond to the need for the biggest capital investment programme in recent

history. The industry had become significantly less efficient than the private sector in England and

Wales. Infrastructure was worn out, customer service was poor and investment was urgently required

to meet new European directives aimed at improving water quality and better protecting the

environment. The Scottish Executive decided that as a result of economies of scale, a single authority

would be better placed than three separate authorities to:

· Deliver the necessary capital investment programme

· Become a more competitive force in the UK water industry

· Harmonise charges across Scotland

· Provide better quality drinking water, a cleaner environment, and improved customer

services, at least cost to customers

SWA is a public sector model in the UK water industry. It remains answerable to the Scottish

Parliament but is structured and managed like a private company.

SWA has been set the challenge by its economic regulator, the Water Industry Commissioner for

Scotland (WICS), of reducing its operating costs by 40% between 2002 and 2006 and of delivering

savings of Ј500 million on its capital investment programme between 2002 and 2006.

New expertise was brought in to join experienced industry personnel in leading the reform of the

water industry in Scotland. This expertise was purposely drawn from different sectors including

banking, utilities and the private sector.

The first task was to carry out probably the most complex merger that has ever taken place in

Scotland as the former regional authorities – East of Scotland Water, West of Scotland Water and

North of Scotland Water were merged. As an example, 300 inherited IT systems were reduced to 80.

SWA has responsibility for delivering a capital investment programme covering the period from 2002

to 2006 and amounts to some Ј1.8 billion. It decided that the best way of making this investment was

to create a subsidiary company, Scottish Water Solutions (SWS) to deliver the investment required in

the most cost-efficient way.

PPP Features

Scottish Water Solutions, SWS, is a unique joint venture set up to deliver SWA’s Ј1.8 billion capital

programme. SWS was formed by SWA and two consortia in one of the largest partnering agreements

of its kind and a first for the UK’s water industry. Whilst alliances are becoming more common in the

water industry they are generally not on such a large scale. SWS is also set apart as there are eight

partners with equity in the business – making it a PPP partnership within a company structure.

SWA owns 51% of SWS with the rest split equally between the two consortia: Stirling Water,

comprising Thames Water, KBR, Alfred McAlpine and MJ Gleeson and UUGM which is formed by

United Utilities, Galliford Try and Morgan Est. Today, SWS brings together some of the most

experienced figures in the UK water industry with global experience of asset management,

engineering, programme management, construction skills and delivering major capital investment

programmes.

Interest from other parts of the UK and overseas is growing as SWS accelerates work on over 1,200

projects to improve water quality and wastewater treatment processes across Scotland.

SWA is reported as delivering real benefits to the Scottish public only two years after it was created to

transform the water industry. SWA is now significantly more efficient, with opex running at around

20% less than it cost two years ago. The quality of drinking water is improved and the delivery of the

Ј1.8 billion investment programme to modernise the infrastructure is now gathering pace, moving

towards the implementation of at least Ј40 million worth of investment every month.

Achievements include:

· Making the industry more efficient by reducing opex by around 20 per cent in only two years.

· Delivery of around 50 transformation projects across the business which have changed ways

of working and will deliver savings of around Ј80 million between 2002 and 2006.

· Completing one of the most complex corporate mergers ever undertaken in Scotland –

bringing together East of Scotland Water, West of Scotland Water and North of Scotland

Water.

· Successfully merging the terms and conditions of all employees from the three former

authorities.

· Launching Scottish Water Solutions, an innovative partnership to deliver efficient investment

for Scottish Water and its customers

· Since being formed in April 2002, Scottish Water has invested around Ј670 million on

improvements to water and wastewater.

· Projects delivered include major water treatment works, improvements to wastewater

systems, schemes that prevent flooding to homes and work to replace old and leaking pipes.

· Work has now started on the prestigious Ј100 million Katrine Water Project which will

protect Glasgow’s water supply for the next generation.

· Planning to invest Ј317 million between 2002 and 2006 to improve the quality of drinking

water.

· Planning to invest Ј483 million between 2002 and 2006 to clean up Scotland by improving

the environment with cleaner beaches, rivers and coastlines.

· Leading the way in customer service with ‘Promise to Resolution’ - a new way of working

which delivered an ongoing annual saving of Ј18million.

Lessons Learned

· Separate international specialist service providers can be brought together to deliver added value

solutions for capital expenditure projects and using experts from alternative sectors can aid

innovation.

· SWS JV includes a significant number of SWA managers and staff which has helped in

developing an effective partnership and internal expertise.

· Robust sector regulation (Economic, Service, Environment, Quality, H&S) aids contractual

negotiation and application.

Case 3. Scottish PPP Water Projects, UK

Background

Given the levels of infrastructure investment required, prior to the formation of the single Scottish

Water Authority in 2002 (see case 2), the three former water authorities used Public Private

Partnerships (PPP) and Private Finance Initiatives (PFI) to finance their large scale investment

projects. It was also possible to tie several smaller projects together under one finance package. The

water authorities entered into contracts with a total value in excess of some Ј600m. The financial

framework within which the Water Authorities operated was determined by meeting the following

key financial objectives:

· Meeting the statutory rate of return set by Scottish Ministers

· Setting charges at a rate which were sufficient to meet the expenditure requirements of

Authorities

· Containing borrowing within the limits set by Scottish Ministers (External Finance Limits)

Their sources of income included:

· Revenue from consumer charges

· Scottish Executive authorised borrowing (External Finance Limits)

· Funding from EU Structural Funds

· Public - private partnerships

After an extensive consultation process, competitive tenders were invited. These were compared to

traditional public sector options and, taking into consideration risk transfer, the PPP option offered the

best value. With the development of PPP / PFI projects in Scotland, across many sectors, a Private

Finance Unit was established with the aim of providing guidance and support to both the public and

private sectors on PPP in Scotland. It is a ‘first stop’ source of advice and data on PPP in relation to

programmes managed directly by the Scottish Executive, its agencies and other public bodies, and on

the use of PPP in local authorities. In addition to providing advice and guidance, the PFU produces

regular updates on progress / issues in relation to PPP/PFI projects in Scotland.

Given the size and range of the investment programme a number of typical projects are presented.

Following Stirling Water taking over five wastewater treatment plants (WWTP) from East of Scotland

Water, in West Lothian and Edinburgh, some Ј100M was invested in upgrading the works. Stirling

Water is a consortium, which includes three private companies:

· Thames Water (49%)

· M J Gleeson (41%)

· Montgomery Watson (10%)

Stirling Water is responsible for designing, building; operating and maintaining improved treatment

facilities. The consortium arranged the financing of the scheme and won the Project Finance Award

for ‘European Water Deal of 1999’.

A key aim was to ensure compliance with new European Union Directives on the quality of

wastewater facilities, and initial works have already enabled the ending of the disposal of sewage

sludge in the North Sea. Treated sludge from the works is now being recycled for use in agriculture

and, as a result of the investment, radical improvements have been made to the quality of discharged

wastewater.

The completed works have been successfully handed over to the operator, Thames Water

International, who will operate the works for a 30-year concession period.

The Almond Valley and Seafield project was the biggest Private Finance Initiative (PFI) contract

awarded in the UK water and wastewater industry at the time. The project serves a population of

585,000 (rising to 685,000), an operating duration of 30 years and a value of Ј105 million.

The project includes:

· Primary and secondary treatment of sludge

· Digestion and thermal drying of sludge

· Improved odour control

· Effluent disinfection using UV light

All in accordance with EU Urban Wastewater Directive, North Sea Directive, and Scottish

Environmental Protection Agency (SEPA) consents.

Levenmouth

A joint venture between Northumbrian Water and Scottish Power was successful in winning the Ј45

million Private Finance Initiative (PFI) to construct and operate a wastewater treatment plant

(population equivalent 500,000) on behalf of East of Scotland Water (now Scottish Water) for a

period of 40 years.

Caledonian Environmental Services, CES, a 50/50 joint venture, was named as preferred bidder for

the Levenmouth purification scheme, to provide wastewater and sludge treatment facilities for

500,000 along the coast of Fife.

The aim of the 40-year contract is to improve the quality of the Firth of Forth and bathing water

quality between Kelty and Leven, in line with the requirements of the EU Urban Wastewater

Treatment Directive, UWWTD.

Subsequently, Northumbrian Water, issued Ј65 million-worth of credit wrapped insurance bonds of a

38-year duration to fund its Levenmouth joint venture project in Scotland.

At the time of the award, East of Scotland Water said they wanted a scheme which was 'flexible' and

provided 'genuine value for money'.

Caledonian Environmental Services (CES) and East of Scotland Water (ESW) signed the Levenmouth

Service Contract in October 2000. Prior to this date, CES carried out construction works under a

direct Enabling Works Contract with ESW, the scope of this work was ultimately subsumed into the

Service Contract.

Lessons Learned

· Access to ‘central’ PPP expert guidance and an advisory unit can minimise potential for problems

by providing the opportunity to learn from the experiences of others.

· Risk can be transferred with PPP, but it is important to understand the risk and to allocate it to the

most appropriate party. The risk / reward balance needs to be understood and recognised in the

contract.

· PPP can help ensure that a Water Authority will comply with its environmental obligations and

improve service to customers while at the same time balancing its financial obligations.

· When compared with the public sector, with a process of competitive tendering, the PPP route can

help deliver good value solutions for customers, taking into consideration risk transfer.

Case 4. BerlinWasser, Germany

Background

BerlinWasser Holding is at present one of the largest water companies in Europe, serving over three

million water and wastewater customers in Berlin and its surrounding areas.

After national reunification in 1992, the German government implemented a privatisation programme

to increase the overall performance of most large state owned companies inherited from the socialist

era. Since the privatisation process took place under time constraints, it was not possible to include a

large PPP component in the programme. However, a number of enterprises were able to attract the

interest of private companies. This is the case of the Berlin Wasserbetriebe, former public water body

of the Berlin State.

The Berlin Wasserbetriebe was privatised through a European wide tendering process, which resulted

in the constitution of a PPP in the form of a joint venture between an international consortium and

Berlin City. The international consortium comprises RWE Aqua GmbH, Allianz Capital Partners

GmbH, both German companies and Veolia Deutshland GmbH (formerly Vivendi of France). The

newly created company is the BerlinWasser Holding AG.

At present BerlinWasser operates 11 water works for water supply and 7 wastewater treatment plants,

all complying with regulatory standards for drinking water quality and effluent discharges.

PPP Features

The agreement reached between Berlin and the consortium provides that Berlin maintains control of

the company with a 50.1% stake. The minority 49.9% stake is retained by three private enterprises,

RWE Aqua GmbH, Allianz Capital Partners GmbH, Veolia Deutshland, in equal shares.

The PPP agreement aimed to achieve two main objectives: restructure and reorganise the company to

introduce new management methods and expertise to the water and waste water system; and to bring

in new investment. At present the PPP agreement foresees:

· A Euro 250 million investment, up to 2009.

· Upgrading and improvement of the economic, environmental and technical standards of the

system.

· A fixed tariff up to the end of 2003, tending to its reduction in the long term.

· No staff redundancies until 2014.

· Transfer of know – how.

· An annual concession fee of Euro 68 million.

The private partner, selected through a European-wide tender, was judged to offer the best response to

the selection criteria in a transparent, and competitive way.

The PPP contract is structured as a joint venture agreement with the private partners assuming most of

the risks. In addition, a loan of 420m Euros was granted by EIB to support the investment needs of

the company.

Since its establishment in 1999, BerlinWasser has been able to expand its activities in other countries

including Croatia, Hungary, Poland, Russia, and China.

Unfortunately Berlin Wasser experienced a liquidity crisis due to the large amount of new

investments required, a 9% interest rate on contracted debts and the weight of the concession fee.

This was resolved through an agreement between the Berlin State and the company for a debt

guarantee of Ђ 361 million, shared in equal part between the public and the private counterpart.

BerlinWasser introduced a new management toll and rotation system and time schedules for

employees. This allowed labour cost reductions without layoffs, increasing efficiency and

consolidating the company financial assets. In addition, as further cost reductions were hard to

implement, the State of Berlin and BerlinWasser agreed on a 30% increase of the water tariff for the

year 2004.

A set of new measures to improve the long-term liquidity problem and to increase economic

efficiency has been under discussion in the last two years, including the sale of a portion of Berlin’s

share in the company, refocusing the company on the water business, and simplification of the

management board. These measures are intended to increase the financial viability of BerlinWasser,

while keeping the water tariff at a reasonable level.

Lessons Learned

· The PPP contract consists of two parts: A joint-venture agreement between an international

consortium and the public body as far as the asset ownership is concerned; and a concession

agreement to operate the water system, under a Ђ68 million fee. This type of agreement

presents a number of advantages. First it is proven by experience in other sectors, in transition

economies, that joint ventures facilitate the transformation of state owned companies to

privatised one as both parties have a direct interest in the success of the venture.

· The joint venture had a series of conditions which, in principle, should have protected both

the end consumers, as the tariff was to be kept constant and then reduced; and the employees

as layoffs were not allowed.

· The contract foresaw an annual constant rate of investment for several years, which ensured

the capital inflow necessary to update the existing water system.

· However, as attractive as the contract provisions appear in the context of the needs of a

transition economy, the operator faced unmanageable conditions. This included the fact that

BerlinWasser had to pay a rent to the public authorities for the concession to operate the water

system and may have been over burdened by the social considerations.

· While it appears that the contract was partially unbalanced, as the private operator took most

financial risks, once the liquidity crises manifested itself, the public counterpart showed

willingness to assist the private operator and ease the contract in its favour, allowing both an

increase in the tariff and the laying off of employees to reduce cost and increase efficiency.

Case 5. Constanta Water and Wastewater Project, Romania

Background

The County of Constanta has identified the need to undertake a major investment programme

exceeding Eur 200 million over 20 years. Key targets of this program are increased water and waste

water coverage, reduced unaccounted water losses (currently 66% of gross water input), increased

metering, reduced operating costs, compliance with EU environmental standards, and rehabilitation or

replacement of pipelines and pumping stations and four sewage treatment plants.

The current operating entity is RAJAC, Regia Autonoma Judeteana Apa Constanta, an intermunicipal

company wholly owned by Constanta County Council. RAJAC undertakes water

catchment management, water treatment, the supply and distribution of water and the collection and

treatment of waste water for the City of Constanta and six neighbouring municipalities with a

population of 747,000, increasing to over 1 million during the tourist season in June-September.

PPP Features

RAJAC is at present conducting a two stage tender for the private partner of the NEW CO

Concessionaire for water and sewerage project with the active participation of the European

Commission and the EBRD. Five international water utilities have been pre-qualified. The local law

required only a single stage tender but a two stage tender that involved a technical review bases on a

pass/fail basis and a financial review based on the lowest tariff for the same level of services was

developed to increase transparency in the selection process through the use of objective, output-based

criteria.

The PPP project will be established by setting up a Special Purpose Company, New Co., to be

financed with equity from the selected international utility investor and with recourse to long term

debt, likely to include the EBRD.

The project plan has been developed with the following sources of financing:

· A EUR 72.4 million ISPA grant to the Government of Romania with RAJAC as financial

beneficiary representing 75% of the cost of an investment programme for the rehabilitation of

sewerage waste-water treatment systems and technical assistance intended to bring RAJAC

into full compliance with EU waste water effluent standards.

· A USD 75 million loan from the EBRD’s Municipal Utilities Development Programme,

Phase II to the Government of Romania secured by a sovereign guarantee, and on lent under a

subsidiary agreement between the Ministry of Finance, the County Council of Constanta and

RAJAC.

· A EUR 20 million loan from the EBRD’s Municipal Environmental Loan Facility for the

refurbishment and modernisation of sewerage system.

· A foreseen private component for investment between 20 to 50 MЂ.

Advisers to RAJAC and the County Council were appointed in 2002 by the EBRD using EU PHARE

technical assistance funds amounting to approximately EUR 600,000. In consultation with the

European Commission and EBRD the consultants evaluated options for commercial structures and

risk sharing between the public and private sectors, organised meetings to promote investor

awareness, set bid criteria and formulated the bidding process consistent with the requirements of the

Commission and the IFIs.

RAJAC and its consultants (appointed separately with own resources) considered a number of

different arrangements for engaging the private sector, including the outright privatisation of RAJAC.

A new company was the preferred option because this allowed existing assets and liabilities to be

transferred smoothly. The contribution of existing assets (net asset value EUR 7.6 million) will

provide the County Council with an estimated 28.8% share in New Co. This shareholding is regarded

as important for achieving wider public acceptance for a PPP solution while providing the County

Council with an opportunity to share in the long-term profits of New Co. Operating and maintenance

responsibilities (including billing and revenue collection) in respect of all existing water and sewerage

services will be transferred to New Co., which will also have responsibilities for all extension and

rehabilitation investments.

The European Commission has stated that it has no objections of principle to the proposed

restructuring of RAJAC, and the introduction of PPP, including the transfer of RAJAC assets to New

Co., provided the concession contract and the manner in which it is awarded complies with the

principles of non-discrimination, equality of treatment, transparency, mutual recognition and

proportionality.

The evolving nature of the regulatory environment for utilities (private and public) requires that the

agreement be enforceable and provide for sufficient performance monitoring rights to ensure

compliance with terms and conditions of the agreement. The agreement provides for a dual role for

the County as a shareholder in New.Co whilst at the same time being responsible for enforcing

regulations pending the establishment of a national regulatory capacity. This aspect will have to be

closely monitored.

Significant evaluation occurred regarding the appropriate duration of the agreement. Duration must

consider the balancing of many factors including expected investment programme, tariff structure and

forecasts, and investor rates of return. Too short a period would leave the investor with an inadequate

rate of return on equity invested or excessive tariff increases, whereas a too-long period may weaken

compliance with the need for competition to play its appropriate role in time.

The County has negotiated a concession fee to be paid at closing of deal and a smaller annual

concession fees. The upfront concession fee will be financed by the capital funding sources as part of

eligible project costs upon agreement of the financial institutions and the Commission. Annual fees

will be paid through annual cash flow from tariffs.

· Bid Criteria Employed

Bidders are required to comply with milestone targets specified for each five year period of the twenty

year agreement for the following:

· Percent of households provided with water and waste water connections

· Proportion of connections metered

· Compliance with drinking water and effluent discharge quality

· Reduction of unaccounted water losses

· Achieving mandatory investment expenditures.

The principal criteria of award, subject to the commitment to the achievement of the above

performance criteria, will be the level of tariff, or more precisely the average annual rate of growth in

tariffs required by the bidder. The lower the average rate of increase required, the higher the bid will

be ranked. In order to address affordability issues a two-part tariff structure has been utilised, as

follows:

· Tariff A relat es to metered units (corresponding to an average household) for the first 300

litres per day of consumption. Increases in Tariff A are capped at 4% per annum in real terms.

· Tariff B relates to consumption in excess of 300 litres.

The focus on an output based specification is consistent with the PPP Guidelines and will potentially

increase the value for money aspect of the project and reduce the tariff levels for customers.

Lessons Learned

· Affordability constraints require that an imaginative approach is taken to tariff-setting and reliable

economic and customer information to allow options for tariff structures to be evaluated, using

financial modelling.

· PPP agreement lengths must balance financial returns to investors, customer tariffs, investment

programmes, and risk allocation factors.

· Legislation and election cycles should be considered early in project planning.

· Local authorities may have to be prepared to support legislation enabling PPP solutions.

· Selection and award criteria must be clearly formulated and emphasize desired outputs.

· Commission funded investments in the public sector are capable of being converted into PPP

programmes provided the Commission is included at an early stage and its funding criteria are

adequately addressed.

· Where there is no complete regulatory framework and the concession is regulated by contract,

there is an inherent risk that political imperatives, for instance price pressures, conflict with the

principles of good regulation founded on proper process.

· The dual role of the public partner (County) as shareholder in New Co and as public authority

signing the contract with the concessionaire must be carefully monitored.

Case 6. Dublin Region Waste Water Scheme, Ireland

Background

The Government of the Republic of Ireland has encouraged private sector involvement in the upgrade

of its public utilities and infrastructure through PPPs. In most cases PPPs ha ve been implemented

either through ‘design-build-operate’ (“DBO”) contracts, or ‘design-build-finance-operate’ (“DBFO”)

contracts, in which the private sector had also contributed to finance the assets.

In the case of the water and wastewater sector the Government has launched a Water Services

Investment Programme (2000 –2006), which has a large PPP component. This includes pilot water

projects at Ballymore Eustace, (serving Dublin), Clareville (serving Limerick) and Lee Road (serving

Cork).

The recently opened Dublin Bay Waste Water Treatment Plant was also developed through a PPP.

This operates as a DBO project and is part funded by the E.U. Cohesion Fund, the Department of the

Environment, Heritage and Local Government and Dublin City Council, and non-domestic users.

The treatment plant is responsible for treating wastewater arising from consumers, both domestic and

commercial, in the Greater Dublin Area, which includes Dublin City, Fingal, South Dublin, and Dun

Laoghaire-Rathdown. The plant uses modern technologies for secondary and tertiary wastewater and

sludge treatment. The wastewater treatment uses Sequencing Batch Reactors, in a 2-story

configuration, with UV disinfection of the final effluent to ensure bathing water standards in Dublin

Bay. Waste sludge generated by the process is further treated by a combination of Thermal

Hydrolysis, Anerobic digestion and Thermal Drying. The dried sludge by-product of the process is

turned into pellets to be used as fertiliser for farming. The Ringsend plant is the only facility in the

world to use this combination of treatments.

Biogas produced by the sludge processing is used to generate up to 60% of the electrical energy

requirements of the plant.

The plant was chosen as it required a relatively small area and could be constructed on the existing

site. In fact, if a different technology were to be used, this would have required a larger site and

involved land reclamation works.

PPP Features

The PPP of the Dublin Region Waste Water Scheme is represented by the plant itself, which is

operated as a DBO project. The main objectives of the PPP are to enhance the quality and the

efficiency of the services to the public by attracting the best technology and expertise available on the

market. Additionally the project aims to create a structure which better protects the capital

investment.

The contract has been awarded through a public bid to an international consortium, which is formed

by Ascon (IRE), Black & Veach (UK) and Anglia Water (UK). The operational phase of the contract

for the treatment plant has been awarded for 20 years. It requires the operators to manage the

performance of the treatment works on a basis, complying with the relevant provisions of the Urban

Waste Water Treatment Directive as regards effluent and sludge quality standards.

The contractor is paid for the operation of the plant. The Municipality sets the tariffs and collects the

revenues from non-domestic consumers only, since domestic consumers do not pay for water

treatment in Ireland. Non-domestic consumers pay a tariff, which takes into account the amount of un

– treated discharges. In fact, according to the E.U. directives, non - domestic consumers are meant to

pre - treat their discharges to an acceptable standard before release into the municipal sewers.

The tariff is set at a level sufficient to cover both capital and operating costs. No profit sharing is

envisaged. The assets remain publicly owned. The costs sustained by the local authorities to operate

the plant are covered by the revenue collected from the non- domestic consumers and by a local fund

allocated by the National Government.

The private operators have the legal obligation of maintaining the treatment plant and to cover its

operating costs. In this way the international consortium has an incentive to increase efficiency to

reduce both operating and maintenance costs, and increase profit.

E.U. Support - Cohesion Fund

The European Union (E.U.) Cohesion Fund has supported this project, considering it as a very good

example of sustainable regional development, which has also allowed Dublin to meet the

requirements of the Urban Wastewater Treatment Directive. The overall cost of the project amounted

to Ђ265 million, of which Ђ133 million was provided under the Cohesion Fund as a Grant.

The Government did not provide any guarantee to the private operators, since it financed the other

half of the investment. The international consortium did not take any equity.

The financial support provided by the Cohesion fund made possible the construction of the new Waste

Water treatment Plant and investment in some of the most innovative technology for updating an old

treatment site, without reclaiming land from the sea.

Lessons Learned

· Dublin City Council recognised the need for a new treatment plant under the pressure of the E.U.

Urban Waste Water Treatment Directive, which required improving the quality of seawater in the

Dublin Bay. It decided to procure the treatment plant using the DBO method to ensure the best

value over the whole life of the project. At the same time, building the plant on the restricted site

available at Ringsend required using the most up-to-date technology, thus more expensive than

others. The Cohesion fund enabled the financing of the gap needed to attract the private

company detaining the needed expertise and technology.

· The capital and operation costs are recovered through the level of the tariff, which is paid only by

non- domestic operators.

· The consortium holding the DBO agreement receives a rent to cover their maintenance and

operating costs.

· By using this scheme and a local fund to cover the total operating costs, the Government

indirectly subsidizes the domestic consumers, as they are not paying for the treated water. A

recent attempt to introduce water fees for the domestic consumers has encountered much

resistance and thus failed.

· The PPP agreement aims to protect the capital investment and to ensure the sustainability of the

project. The operator has a direct incentive to maintain the assets and enhance operational

efficiency

Case 7. Karvina Sewerage, Czech Republic

Background

SMVak was originally a state owned enterprise responsible for the North Moravia Region in the

Czech Republic, which includes Karvina. In May 1991, SMVaK was privatised together with similar

enterprises in the other regions. The privatisation process consisted in SMVak being converted into a

stock company, whose shares were distributed free of charge among the cities and municipalities of

the region according to number of inhabitants.

Approximately 92% of the shares were transferred in this way and the remaining 8% went to

individuals and privatisation funds. The value of the share was based on the book value of the

company assets.

In early 1999, nearly all municipalities sold their shares to private companies and investors. The sale

of shares by municipalities to private investors during 1999 took place through normal channels over

the stock exchange, where SMVaK is quoted. Following this sale of shares most of the company

stock is held by British and French water companies.

The transfer of ownership of the assets belonging to the former state enterprise therefore apparently

followed normal procedures. No specific measures were undertaken to ensure transparency and

competition other than those used for other public stock firms. Today SMVaK is the second biggest

company of its kind in the Czech Republic.

PPP Features

The PPP agreement existing since October 2000 on drinking water supply and sewage discharge is a

service contract, with Karvina Municipality in the traditional role as customer, and with no risk

sharing or efficiency incentives. The infrastructure and the operations are in the hands of SMVaK.

A board has been established to facilitate the co-ordination and the decision making process among

the cities and municipalities served by SMVaK. These all have seats in the leading bodies of SMVak:

municipalities are represented with 5 out of the 9 members in the managing board and 6 out of the 9

member of the supervisory board. The representation is based on the decision of the main

shareholders of SMVaK.

In addition, a forum, including the Northern Moravia Water Association was established, to discuss

further investment and price strategy. Increases in water charges are discussed and mutually agreed

after the Municipalities have proposed the underlying calculations.

A pre-contract agreement regulates the operation of a water main of Karvina (Karvina-Louky). The

water main (650 m of pipe) is financed and owned by Karvina Municipality and the pre-contract does

not foresee any payment of lease on the part of SMVaK. The contract contains very general

provisions regarding cost distribution, technical documentation to be submitted by SMVaK and the

right for SMVaK to bill consumers.

EU - ISPA Component

This is a case in which an EU ISPA grant was considered after the privatisation took place. The PPP

considers a lease/operation contract, which combines elements of lease and concession. The grant

was requested to extend the sewerage network system by the Karvina Municipality. The ISPA

financed assets are to be owned by the Municipality, and to be leased to SMVaK, which will also

operate them. SMVaK will pay an annual rent for the assets, calculated as the difference between

revenues from costumer charges and cost related to the water connection. In case of revenue

exceeding costs, the result is considered profit.

The municipality cannot sell the assets without consulting SMVaK, and can use the revenue only to

invest in the infrastructure. SMVaK takes the risk of the assets being in compliance with prevailing

regulation and technical standards, as well of maintenance. Karvina Municipality is responsible for

costs beyond the scope of normal repairs and maintenance. SMVaK sets charges/tariffs and

procedure for billing costumers.

This contract is supposed to enter into force once the sewage extension have been constructed and

delivered.

The contract does not envisage any performance monitoring of the operating activities of SMVaK. It

is quite normal in PPP relationships and is seen as an important guarantee for the public partner that

the public services work properly. This includes not only supervision of output but also of preparatory

activities of the operator, such as repairs etc. However, there is no indication that the contract will

contain any specification of quality targets, performance criteria (such provisions are not found in the

above SMVaK standard contract either). Consequently, there are no rules envisaged laying down

procedures for monitoring of performance. Additionally the Municipality does not have in-house

technical staff for such tasks.

Lessons Learned

· The lease/operation contract requires well-designed monitoring and performance measurement

systems, payment mechanisms and sanctions to encourage and even reward improved operational

efficiency. The public partner is, in the normal situation, outsourcing the operational activities but

retains the statutory responsibility. The public partner must therefore on a permanent basis have

the necessary information and means to ensure that satisfactory operation is maintained and that

remedial steps can be taken in case of deficiencies.

· The key difference between public private partnerships and conventional public procurement is

the transfer of appropriate risk to the private partner. It is therefore important that this risk aspect

is reflected in the contractual mechanisms.

· The chance of extra undue benefits as result of an ISPA grant is reduced through an appropriate

treatment of risk transfer and operating efficiency gains in the contract.

In conclusion, from the perspective of prevailing PPP practice, it can be assumed that a fully-fledged

lease/operation contract will not provide sufficient checks and balances between the parties. It is

particularly unfavourable towards the Municipality, who will have virtually no influence over the

performance of SMVaK.

Case 8. Trencin Water System, Slovak Republic

Background

The Law No. 92, of 1991, has regulated the privatisation of public owned enterprises in the Slovak

Republic. Accordingly the transfer of ownership needs to involve the Ministry for Privatisation, the

National Property Fund and the government body administering the state property. The procedure

usually requires that the government body administering the assets submits a project to the Ministry of

Privatisation, which, after having evaluated it, decides on the best way to privatise it. In the case of

direct sale, the privatisation has to be approved by the Government. The National Property Fund

executes the transfer of property.

The transfer of assets from State to Municipal level is usually free of charge; therefore it does not

require a tender procedure. However, in the case of the water and wastewater sector, the Government,

because of its large scale and natural monopoly, has set some special criteria and specified a general

approach for the transformation of assets.

In the case of Trencin, which is to be considered a special pilot project, the transformation took place

according to a set of rules issued by Government and Parliament during the period 1995-1997, which

state that: the assets of one municipality which serves several municipalities can be transferred free of

charge to a jointly owned company, once all municipalities have agreed; and the operational assets

can be sold to the municipal companies for a “balanced price”.

Thus, the Trencin water system was transformed by transferring free of charge the assets from the

State to the municipality level, and in a parallel privatisation: the operating assets were sold in 1998 to

TVS, a privately owned company.

TVS was chosen through a public tender on the basis of its qualifications to operate the assets and its

good business plan. In addition TVS was the only firm interested in the acquisition

As a result two companies are at present responsible for the water system: TVK - the Trencin

municipality owned company - and TVS - a privately owned company whose ownership is split

between national shareholders and a foreign water company (Lyonnais des Eaux of France)

The PPP agreement between TVK and TVS was concluded in 1999, after the privatisation was

completed.

Features of the PPP

During the transfer of property from the state to the municipal level, the operating assets were

privatised in view of increasing the operational efficiency without transferring the ownership to the

private sector.

The PPP agreement was established in 1999, between TVK and TVS. The private operating company

for the concession was selected by a commission of the Department of Control and Transition of State

Owned Property of the Slovak Republic of Slovakia from a list of applicants. In the case of Trencin

TVS was the only buyer.

The TVK/TVS contract concerned a 1ease and operation contract combined with a financing

agreement. This kind of PPP scheme is widely used and is considered to be the most appropriate

when there is scope for big increase in operating efficiency, but small new investment, which is not

the case of the Trencin water system.

The contract gave TVS a 20 year exclusive right to operate the infrastructure assets owned by TVK

against the payment of a rent.

In addition the contract fixed:

· A profit margin of 15% based on its operational costs for TVS.

· The rent and tariffs are decided by TVK after consultation with TVS.

· That the rent and the operational costs are to be covered by the tariff.

· That TVS bills and collects the revenues from the tariffs.

The contract also required close co-ordination between the parties regarding major repairs and new investment.

TVS is responsible for routine maintenance on a costs plus fee basis, which is included in the tariffs.

As part of the contract TVS provides a loan up to 1 Million Ђ to TVK. The loan and the main part of

the rent were to be used for major repairs and new investment of the water infrastructure.

As far as liability, TVS was not responsible for sufficient supply of raw water of good quality or for

the current/future state of the infrastructure.

The structure of the PPP contract foresaw little risk for the private company – TVS – which in

principle would have been able to recover all costs through the tariff and to have a fixed 15 percent

profit margin. In addition, the company was not hold responsible for coverage or quality of the

service.

EU - ISPA Grant

TVK applied for an EU - ISPA grant at a 75% rate to finance a new Waste Water Treatment Plant

(WWTP), eventually to be operated by TVS.

The European Commission was interested in the project, as it appeared to be a sound investment that

could eventually benefit the final consumer. However, after having carefully scrutinised the

agreement, the Commission decided that the ISPA grant would need to be conditional on a

renegotiation of the contract. In fact the analysis brought to light that the contract was unbalanced to

the benefit of the private operator. The agreement foresaw considerable advantages for TVS, among

which a 15% fixed profit margin on the total cost recovery. This latter would have in the long run

affected the sustainability and affordability of the investment. In addition it could have increased the

profit to the point of becoming unfair in relation to the expected benefit of the local population.

Through the re-negotiation of the contract, it was possible to balance the agreement cost and the

benefits to the advantage of the final consumer, which is one of the main Commission objectives.

After the re-negotiation the Commission granted a 50% financial support, while the Government

provided for the 25% gap.

This is a case in which the information asymmetry brought one contractual party to use their

information and experience at the expense of the other contractual part. In this case the private

operator was able to structure a deal which gave it, among other advantages, an unfair 15% fixed

profit margin which would have been passed onto the consumer through the tariff. If maintained, the

agreement could have negatively affected the sustainability of the ISPA investment.

The new PPP contract, which was negotiated with Commission assistance, resulted in the abandon of

the criticised fixed profit rate, the introduction of a new procedure to set the tariff (by decisions of a

newly created Institute for Regulation of Network Industries) and a system of sanctions and

monitoring, to control the quality of the service.

Lessons Learned

· The PPP agreement came into place only after the property transfer was completed. The contract

was designed in an unbalanced way, giving to the private operator several advantages, among

which a 15% fixed profit margin and the absence of liability for water and service quality. The

water tariff to be paid by the end consumer was set in consultation between the Municipality

owned company and TVS, to a level, which covered the rent and the operational cost.

· The Trencin Municipality put forward an application for ISPA funding to finance a new Waste

Water Treatment plant. The Commission after having thoroughly analysed the contract, decided

to give the grant under the condition of a contract re-negotiation. In fact the asymmetry between

the two counterparts of the agreement could have seriously compromised the sustainability of

investment, and eventually produce an undue profit to the detriment of the consumer benefit.

· The contribution of the Commission in the Trencin case, can be measured not only in terms of the

ISPA funding which allowed the municipality to finance the new WWTP, but also in terms of

increased long term benefit for the end consumer.

· By forcing the two companies to re-negotiate the PPP agreement, and find a more balance

contract between the parties, the Commission has reduced the risk of failure, better protected the

new investment, and set more equitable tariffs for the end consumers.

Case 9. Dwr Cymru, Welsh Water Not for Profit Model, UK

Background

Glas Cymru, a ‘not-for-profit’ entity, acquired Welsh Water's assets from Western Power

Distribution, WPD, in 2001, after securing investment grade credit ratings for a bonds issue. This was

seen at the time as a major step forward for companies considering debt-financed asset spin-offs,

particularly as previous similar proposals had been rejected by the UK water regulator Ofwat.

Ofwat approved the take-over, separating ownership and operations, the latter continuing to be

undertaken by Dwr Cymru, Welsh Water (DCWW). Glas Cymru is set up as a Company Limited by

Guarantee without share capital, i.e. a normal company but with members rather than shareholders. It

can be described as a not-for-profit company but not as a customer-owned mutual. The regulator was

convinced by the likelihood of a reduction of the weighted average cost of capital compared to other

water companies. Glas Cymru also offered better safeguards for customers and stakeholders, albeit

falling short of ownership or control, it also claims to keep control of the water service in Wales.

Other key factors for Ofwat support include the backing of the National Assembly for Wales, the wish

of the private owner to leave the water sector and the significant discount offered by the private owner

on the purchase price and the independence between purchaser and seller.

The Glas Cymru solution has certain strengths. It brings the advantage of ring-fencing the core water

services activities in Wales and for Wales. It also demonstrates how capital investment can be

accessed at a lower cost than through equity financing by a company that combines explicit social

objectives – a sustainable high quality of service in Wales – with economic objectives. Ј2bn was

readily raised on the British and Continental Bond Markets, thus reducing the cost of capital by just

over 4% in real terms. Customers are due to benefit from annual savings of about Ј11m - Ј12m a

year from 2004, equivalent to Ј10 off the average bill in the first year. Despite customer benefits in

the medium-term, it leaves ownership and control in the hands of a private company, whose members

are to be recruited in Wales on the strength of their knowledge and expertise, not as representatives of

any particular stakeholder group. They are to elect a Board that consists of highly qualified and credit

worthy individuals.

The approval by Ofwat of the Glas Cymru proposals has also given rise to comments about the

openness of the regulator to alternative solutions, to a framework of privatisation that has not been

entirely successful in the UK.

Dwr Cymru Financing, a special purpose vehicle, issued Ј2 billion of bonds for Welsh Water in ten

tranches. The innovative package included fixed, floating and index-linked rates, and provided for

lender step-in rights and controls to remedy underperformance. The bonds attracted three ratings

categories, from AAA/Aaa through to BBB/Baa2, with those benefiting from the AAA/Aaa ratings -

valued at Ј1 billion – being ‘credit wrapped’ by the Municipal Bond Insurance Association. Some

financial commentators speculated at the time that Glas would not attain the ratings it wanted because

of its unusual and untested structure. At the time it was felt by many that water companies

restructuring into debt-financed asset owning entities could face credit rating downgrades because of

their exposure to regulatory risk and uncertainty over allowed rates of return.

In order to meet Ofwat’s conditions Glas Cymru agreed to limit itself to:

· Quantifying potential rebates to customers and setting a time-scale for their payment; subject to

the need first to establish adequate reserves;

· Publishing the remuneration scheme for directors, focused on performance;

· Limiting Glas Cymru to the single purpose of providing water and sewerage services;

· Publishing and using best practice criteria for the appointment of members of Glas Cymru;

· Ensuring that the rights proposed for bondholders do not impede the Director's duties under the

Water Industry Act 1991

· Consent to Ofwat’s licence modifications

Glas Cymru indicated their intention to provide further benefits to customers through additional

investment, subject to prior agreement from Ofwat that such investment will be included in the

Regulatory Asset Value of the company at the next Price Review, with DCWW continuing to bear all

the licence obligations of a water and sewerage undertaker and regulated in the same way as the other

UK water companies.

PPP Features

Over the course of the five years to March 2005 DCWW targeted a 15% reduction in running costs.

However, even these substantial savings are insufficient to cover the rising cost of financing

DCWW’s Ј1.2 billion capital investment programme over the same period. Additionally Ofwat set

price limits for DCWW such that bills can rise in real terms by on average 1% only in each of the next

four years.

In 2003, DCWW’s investment programme cost Ј208 million and, at almost half their revenues, means

they spent more than receipts from customers. The cash shortfall was covered by new borrowings.

When Ofwat set price limits for DCWW for the five-year period to March 2005 it projected a total

cash shortfall over the period of over Ј300m, which would have to be financed by new capital raised

from investors. However, at its first Annual General Meeting, Glas Cymru, announced that its new

“not for profit” structure would still allow the Company to target customer bill rebates worth Ј11

million in 2003/04 and Ј12 million in 2004/05.

Glas, via DCWW, has outsourced all operating and customer contact responsibilities to United

Utilities and Thames Water respectively. These outsourcing contracts, which were won in a

competitive tendering process, are initially only for 4 or 5 years. Whilst these are relatively short

timescales for such contracts, there was tough competition from all the major operators to win them.

The initial contracts are coming to the end of the contracted period and Glas are now looking to agree

different outsourcing contracts for extended periods.

At the time of the Glas proposal being given the go-ahead the government asserted its faith in the

equity model and added a number of notes of caution for Glas and other utilities considering a similar

move. Government ministers issued a studied warning to the English water industry not to view the

Glas proposals as a precedent, which will automatically be applicable outside Wales. They stressed

that any restructuring schemes would be considered on their merits and in light of ‘customers’

interests, public health and the environment’.

They said that the Government would consider whether the splitting of assets from operations would

lead to problems in managing the business safely and effectively; and whether any additional financial

risks were transferred to customers. It was also indicated that if further non-profit company models

were proposed, the Government would additionally be looking at the incentives for efficiency, at the

same time stressing that despite shortcomings, the equity model was delivering ‘very considerable’

efficiency gains.

The following chart summarises the main organisational structure:

It is the responsibility of Executive Management to ensure that policy is delivered in such a way that

the Company meets all its legal and regulatory obligations and outputs and delivers the highest

possible standard of service to the customers of DCWW.

Day to day responsibility for policy delivery lies with the designated managers who maintain close

contact and communication with the service providers. Performance is monitored against agreed Key

Performance Indicators and reported by Contract Managers on a routine and on an exception basis

An Executive Management Report which reports on all aspects of the performance of the business,

and identifies key policy and performance related issues as well as contract management generally, is

considered by the Board each month.

The risks associated with the business of DCWW are evaluated by Executive Management and

assessed by a Risk Management Group (“RMG”), chaired by the Managing Director, under a risk

management framework approved by the Board.

DCWW's performance has improved significantly since privatisation: overall compliance with

drinking water quality and bacteriological standards has improved, all customer service measures

have improved significantly, and significant improvements in cost efficiency have helped to keep

down the burden on customers.

Lessons Learned

· DCWW has attracted sufficient high level expertise, even with a short-term contract (4 years).

However efficiency levels are increased if capital expenditure requirements are sufficiently large

to allow adequate ‘efficiencies’ to be achieved.

· Contract incentives are effective if there is real potential for the contractor to achieve key

performance indicators and remain incentivised.

· DCWW has managed a number of major out-sourcing projects simultaneously but retains overall

responsibility for the delivery of the capital expenditure programme.

· Robust management and control and clearly defined responsibilities have assisted DCWW in

monitoring and reporting performance.

· DCWW has only retained high level contract management resources.

Case 10. Stadtentwässerung Schwerte GmbH, Germany

Background

The “Stadtentwässerung Schwerte GmbH” in the German state North Rhine-Westphalia (NRW) was

founded as a company in 1993. It was the first public-private joint venture in the sector in Germany.

The most important reasons for developing the “Schwerter Model” were growing problems in

ensuring technical, quality and environmental standards. The question of environmental standards was

in Schwerte crucial since the city (52.800 inhabitants) is almost completely (97%) part of a water

protection zone. 700.000 customers in NRW are supplied with water from the municipal ground of

Schwerte. A demand for Ђ65.5 million short term investment in the maintenance of the technical

infrastructure had been identified.

Due to high budget deficits the state of NRW, which is responsible for municipal budget supervision,

blocked further investments. The construction department as the responsible institution in Schwerte

could not solve these economical and ecological problems without financial and political support. To

avoid further increases in tariffs the help of private capital and management know how in a PPP joint

venture appeared as a possible solution. After a European wide tendering process, prequalification,

due diligence and two years of negotiations the “Schwerter Model” was completed. Hochtief

Projektentwicklung GmbH, Philipp Holzmann AG and Heitkamp Umwelttechnik GmbH as

enterprises with international experience signed a “memorandum of understanding” (framework

contract) with the municipal waste water managers and the city treasury.

52% of the shares of the new joint venture would belong to the city (partnership agreement). The

private partners accepted the public majority in the hope of buying further shares and at least part of

the technical waste water infrastructure network after having proven their ability to rise the

management and environmental standards. There was no contractual agreement in this direction but

political signals sounded positive.

A leasing contract between the company and the City Schwerte and a framework contract with a

detailed task specification to transfer all municipal waste water duties to SEG were completed. Due

to this contract the company is not subject to sales tax. All infrastructure should remain in municipal

ownership as a special budget item (“Sondervermögen”).

The company should be completely responsible for all economic and environmental risks. Special

tools for the risk management like service level agreements or duties of additional investment in

certain cases were not arranged.

Different private and public banks, the “Initiativkreis Ruhrgebiet”, a municipal service organization

and cooperation network in NRW, representatives of employees and environmental initiatives

participated in the negotiations. The role of the banks was to specify the lending rates and financing

conditions for the leasing contract. In 2002 road and water construction/maintenance were also

transferred to the company as additional tasks. The shares of Hochtief Projektentwicklung GmbH and

Philipp Holzmann have been transferred to RWE Umwelt Aqua GmbH because of changing financial

relations between the three private partners.

PPP Features

The objectives of the public-privates company can be summarised as follows:

· the modernization of the MWWM infrastructure and organization according to state of the art

technical, economical, environmental and quality standards in 15 years while in the same period

of time tariffs should not rise more than on an average of NRW cities

The expected benefit through PPP was realized in the year 2003 faster and better than initially

planned. The investment costs, based on different bank loans, are 12% below the average of German

cities. The management and productivity improvement due to the transfer of private business and

technical knowledge was even slightly higher than calculated in 1993.

The case shows that a PPP can be economically and environmentally beneficial. As 48% shareholders

of the joint venture the participating private parties had to share full responsibility for all

environmental standards. Furthermore they provided new technical know how and the most important

single environmental benefit of the PPP is the successful certification due to DIN EN ISO 9002 and

14001 at international Lloyd`s Register Quality Assurance (LRQA). Another important benefit is that

the tariffs did not rise more than in the average of NRW cities in spite of substantial investments.

A further positive experience with the “Schwerter Model” concerning the political relations is that no

new additional formalized structures have been established. To avoid an unnecessary complex project

management the private partner(s) and new employees were integrated into former public bodies.

Lessons Learned

· Private-public capital and knowledge transfer with the help of experienced and committed private

partners can lead to lower investment costs, state of the art quality and environmental standards in

a faster process than a public solution.

· Existing structures can be used to integrate public and private parties provided that there is

sufficient flexibility to allow each to operate effectively.

· Future developments and intentions of the parties should be clearly elaborated in order to avoid

misunderstandings affecting investment strategies. Political statements are not sufficient to

provide sufficient confidence.

· An extensive “memorandum of understanding” is a helpful framework in the preliminary stage of

public-private negotiations after the tendering process. This helps to define the boundaries of a

project and each party’s responsibilities. However it should maintain sufficient flexibility to

allow negotiations and adaptations.

· Changing political considerations restricting further private investment, which may reduce further

accrual of benefits.

Solid Waste Management Sector Analysis

Introduction

The modernization of Municipal Solid Waste Management (MSWM) has four interrelated elements:

(1) the modernization of vehicles and equipment, (2) the construction of sanitary landfills to European

Union standards, (3) the adoption of integrated and holistic MSWM strategies and (4) the

regionalization of collection and transport services centred around regional facilities. The

interdependence between these elements is crucial. For example, it is prohibitively expensive to

transport un-compacted waste over long distances to a new regional landfill with traditional low

capacity trucks. This interdependence is sometimes forgotten when, for example, new landfills are

built at public expense but communities continue to use their obsolete vehicles to deliver waste

because they lack the resources to replace their vehicle fleets. In other cases modernization is confined

to big towns without reaching into the regions around them.

In the Candidate Countries, and particularly in the Czech and Slovak Republics and Hungary, private

enterprise has been in the forefront of modernizing waste management along the four interrelated

dimensions through PPPs. This mirrors developments in Member States where the MSWM sector has

been increasingly opened to private participation.

In traditional MSWM each settlement has its own disposal facility and the local municipal service

provider carries the waste in up to eight or ten trips per day using low capacity / non compacting

transport vehicles. The evolution to the present systems of waste management, which use high

capacity compactor trucks that make at most two trips a day to a central regional landfill, took a long

time to evolve. MSWM in transition economies is now required to catch up with this evolution, in part

due to market forces, and in part due to European Union regulations stipulating, amongst other

measures higher standards of landfill construction that are unaffordable at the local level thereby

reinforcing the economies of scale in MSWM.

The rationale for PPPs is not difficult to establish in MSWM. Municipalities generally faced a

deteriorating financial situation which, in MSWM, meant growing obsolescence of equipment,

spiralling maintenance costs, and deteriorating services. Further, in spite of the financial constraints,

municipal service provision often remained a place of political patronage, with bloated staff and poor

management practices. The need to meet increasingly stringent environmental standards, rising waste

profiles, address public health issues, rising costs and waste taxes and private sector interest in service

provision and investment, opened the sector in both Member States and Candidate Countries.

Selected Cases

The cases attempt to particularly illustrate the application of PPP principles in situations of

unfavourable legal and business environments and demonstrate generally how uncertainty can be

addressed. The case studies in this sector include

· A comparative case study of two joint ventures between foreign investors and Hungarian

municipalities, by Rethman in Szolnok, and ASA in Debrecen. These cases describe different

paths to successful modernization of MSWM through foreign strategic investors.

· A case of a strategic investor’s attempt to establish a dominant market share in two Bulgarian

towns – Rousse and Varna - in an unpredictable business and legal environment.

· A case of a privately operated landfill in Nessebar, Bulgaria, which makes its profits from

recycling but is struggling for its survival in an uncertain market.

· A large scale MSWM PPP in the UK demonstrating a municipality’s attempt to find an optimal

long term strategy and devolving control to the private sector.

· A case of a privatisation of MSWM in the Romanian town of Targoviste where a private company

faces a potentially uneven playing field in competition with public enterprise.

· The first instance of privatised MSWM in Macedonia, a concession established against odds in an

unfavourable legal environment for private participation in municipal service provision.

· A case of a PPP approach in Mulheim Germany encountering difficulties as it tried to circumvent

using public procurement for the selection of the private party.

While all PPP’s generally aim to improve service compared to levels achievable under public

schemes, many of these cases illustrate variations in the depth of the change, in terms of ownership

and control, risk sharing, and investment commitments, that affect the degree of success in achieving

this objective.

The form and stability of the contracts is presented in the following table.

Distribution of PPP Structures

The three prevalent types of PPP contracts are service contracts, concessions, and joint ventures. A

wider survey of PPPs would bear out the hypothesis that joint ventures tend to be associated with long

term contracts between the municipality and the company, and are also the most stable contracts.

Rethmann’s case in Hungary and Kirklees in the UK are examples of a stable relationship resting on a

thoroughly prepared and transparent contractual relationship.

RWE’s partnership with Varna is a joint venture in name, as the municipality is a passive partner and

does not participate in the management of the JV. Further, RWE’s Varna JV is one of five companies

competing in the market for the yearly changing budget allocation. This case could also be

categorized as a service contract as the company is subject to the vagaries that normally characterize

short term service contracts in a risky environment. It is however considered as an unstable joint

venture.

Prescom’s case illustrates utter uncertainty in a changing legal environment fraught with conflict.

Where the legal and business environment poses high risks, service contracts tend to be short term and

risky. However it should not be concluded that service contracts are inherently short term and risky.

In a positive legal environment service contracts can be stable and long term, where the enabling

environment permits it.

In between is the less well defined area of concession contracts. Concessions are a relatively new

structure in transition economies, and their definition changes unpredictably in time and place.

Golden Bug’s arrangement with the Municipality of Nessebar seems to be a concession in name only,

as it does not appear to have concrete and legally enforceable provisions of a concession. RWE’s

concession in Rousse is a more structured arrangement, bolstered by active municipality participation

in the Company’s operation for almost a decade now.

Some elements of the financial and contractual arrangements are summarised below.

Key Financial and Contractual Conditions

The risk profile is often closely related to the ownership structure. Wholly owned private companies

tend to face more commercial risk than joint ventures. Prescom is an extreme case of risk exposure by

a wholly private company, as the municipality offers no support arrangements for the collection of

fees. Delva in Macedonia also assumes the entire commercial risk, but at least has an exclusivity

agreement with the host municipality. Golden Bug is another case where the private company faces

the entire risk of its landfill operations, which depend on the changing market for recyclable wastes

as on the vagaries of local politics.

In the rest of the cases, the Municipality collects fees from the population and reimburses the

Company under a separate contractual formula, which determines revenues in advance. This

arrangement prima facie reduces the Private Party’s risk; however in reality when the structure of the

contract is flawed (as was the case in Debrecen) or where municipal finance is unpredictable (as it is

in Varna), risks remains high.

Risk tends to be reduced when the Private Party can count on the active support and participation of

the Municipality in Company management. In general this is more characteristic of joint ventures,

where the municipality has a stake in profits. In addition to profit sharing, direct participation in

management is also a positive factor. In the two Hungarian joint ventures the Municipality reserves

the right to appoint the financial director of the Company, which goes for strong partnership in

management decision and in ensuring transparency. No such arrangements are found in Bulgarian

joint ventures.

Lessons Learned

The cases provide two instances of pre-ISPA Commission support, under the PHARE programme.

Unfortunately both cases are instances of insensitiveness to the needs and apprehensions of the private

sector. In Hungary, PHARE’s support of a landfill in the potential service area of a recently installed

private regional landfill became a cause celebre and prompted vocal protests from ASA against the

government policy of subsidizing competing landfills with grant financing. Indeed the Hungarian

policies of the late nineties, which resulted in a large number of subsidized landfills, made for an

uneven playing field between public and private landfills, with private landfill construction essentially

coming to a halt. The PHARE supported Mako landfill was just one instance of that process.

In the Targoviste case PHARE supported the establishment of a municipal waste management service

which started to compete for market share with a duly privatised company. As the case study details,

at this stage the private company fears for its survival in the face of perceived uneven competition.

ISPA and Structural Funds

The example of Targoviste brings to the fore issues facing the European Commission with grant

financing and in its stated objective to foster private participation in waste management. ISPA, with

its extensive program for supporting regional landfills in several Candidate Countries, poses a

challenge for finding ways of reconciling subsidized development with private sector development.

These issues face local decision makers as well as the Commission’s attempts to enlist private

participation in ISPA supported projects.

The first issue that needs examination is that of affordability, or, as articulated in Commission

documentation, the population’s ability and willingness to pay. The Szolnok/Rethmann case is a clear

example of a privately controlled joint venture that is able to generate profits without subsidies,

collecting fees directly from the population. The Debrecen/ASA case is different, since here the

municipality pays the joint venture directly, and under a changing tariff regime the population has

been sporadically subsidized. Nevertheless in the end Debrecen was able to pay, not only for the

collection and transport service, but also for the construction of an EU-conform landfill, from its own

resources. In Targoviste Romania, Prescom runs a profitable business in a direct business relationship

with customers: it sends monthly bills and collects directly from households without any support

arrangements from the Municipality. But perhaps the clearest evidence comes from the Slovak and

Czech Republics, which have, through the policies described below, managed to transfer much of the

cost, as far as landfill construction is concerned, onto the private sector, which runs waste

management as a normal and generally profitable business. This would tend to suggest that the use of

grant financing needs to be carefully adapted to the local situation and the ability to pay. This leads to

the crucial balance which needs to be achieved in assessing the need for and best use of grant

financing.

The other aspect of grant financing that needs consideration is the high costs of the projects, as

compared with privately financed MSWM investments of the early 90s. These are related to a number

of factors. One is the general tendency to over-design engineering solutions that have no financial or

social justification. This has been documented plentifully and is not subject of this paper, except in

noting that when money is free the recipient may not apply the same financial viability criteria as

otherwise. These excesses are gradually being realized and combated.

A more important factor is the high cost of compliance with EU directives embedded in the project

design. The main aspects are (1) compliance with the policy to reduce the proportion of biodegradable

waste over time, which in practice means composting; and (2) compliance with EU targets for the

selective treatment of recyclable waste streams. These activities will generally lead to high financial

losses in transition economies under foreseeable market conditions. The evidence is in, from a number

of project and sector analyses, that project design which aims to satisfy EU targets may result in more

than doubling capital and operational costs in MSWM. In micro terms at the project level, this has

important implications on cost recovery policies, and on the subject at hand: private participation in

waste management.

This is not unique to Candidate Countries, as most complete recycling activities are either subsidised

or are run as non profit making organisations. Private business naturally shies away from loss making

activities. The private sector is involved in selective recycling activities where it is profitable: the car

battery subsector offers examples, as well as the paper industry, for example in Macedonia. To

involve the private sector in loss making activities will require mechanisms for clear, transparent, and

enforceable means of compensating the losses. This will be a challenge to project design as the

Commission engages in efforts at PPP promotion but may prove to be an effective application of

grants.

The issue of private sector participation in ISPA / Structural Fund projects will be relevant to the

future of the Szolnok and Debrecen cases, as both these municipalities (or rather agglomerations of

municipalities centred on them) are recipients of major ISPA projects. Therefore the transfer of assets

financed by ISPA to the joint venture operator in these cities. The terms and conditions of such

transfers will be important.

There are many instances, including in major Bulgarian and Hungarian towns where the Commission

intends to finance parallel operations, or where the public sector operates a landfill but the private

sector manages part or whole of the collection and transport of waste. However, the recipient of the

vehicles and equipment, under Commission rules, has to be a public sector entity, i.e. the recipient

municipality or group of municipalities. In such cases, “engineering” a PPP solution whereby the

vehicles are transferred to the operation of private service providers is an issue. It would appear that

renting or leasing the vehicles could be a viable option. Leasing would have the advantage of

providing incentives for the proper maintenance of the equipment. It would also infuse equity

funding by private service providers into the project, not up front but nevertheless significant. Such

mechanisms are still to be elaborated under Commission projects, and the local sponsors of these

projects will need to exercise initiative to propose ways to deploy Commission resources for the

development of existing PPP relationships.

The Constanta case in the water sector may point towards a structure that could be transferable to

MSWM financing. As described in that case, a private consortium is bidding to take over the

operation of assets financed by ISPA, against an up front fee and a periodic concession fee payable to

the beneficiary. Similar mechanisms may find application in the transfer of ISPA funded landfills to

private concessions; though there is no actual example of such a project. Also, private investors have

so far not featured as co financiers of landfills supported by ISPA grants.

Case 11. ASA and Rethmann, Hungary

Background

The market penetration of strategic investors in the Hungarian MSWM market took place in the first

half of the 1990’s. The second half was characterised by large public grants for landfill construction.

By mid decade about a dozen foreign waste management companies had established footholds in one

or more Hungarian municipalities. A.S.A., an Austrian controlled waste management company (later

acquired by Vivendi) and the prominent German waste management company Rethmann were the

earliest and biggest entrants to the market.

Debrecen is Hungary’s second largest city, with a population of about 250,000 in north-eastern

Hungary. In 1991, ASA and the city of Debrecen formed a joint venture (AKSD) for waste

management. The foreign partner committed itself to the replacement of the vehicle fleet and to the

construction of a landfill compliant to E.U. standards. The municipality contributed facilities in kind.

After taking over the collection and transport service, AKSD decided to sell out the fleet of some 40

vehicles inherited from the municipality, and replaced them with a fleet of nine new high capacity

compactor vehicles imported from Germany. The landfill was entirely financed by the foreign partner

and was commissioned in 1994. It was the first landfill in Hungary designed to meet E.U. standards.

Szolnok is a middle-sized town of about 80,000 inhabitants in the Central Plains Region of Hungary.

In the early 90s the Municipality embarked on an aggressive strategy of privatizing its public services,

which included the construction and operation of a municipal waste water treatment plant through a

private consortium. As in the case of ASA in Debrecen, Rethmann committed itself to the

replacement of the vehicle fleet and associated containers, and to the construction of the landfill. The

former was accomplished shortly after the formation of the joint venture. However, no fixed date was

set for the construction of a new landfill.

The motivation of the municipal governments to invite private investors to take over the MSWM

functions was fundamentally the same. They both operated the service with an overly large number of

obsolete and deteriorating equipment, with excessive maintenance costs and a bloated staff. Both

municipalities lacked the financial resources for the modernization of equipment. Further, their old

landfills were nearing the exhaustion of their capacity and they were aware of the need to introduce

higher E.U. conform standards of landfill construction, for which they equally lacked the funds. At the

same time, foreign strategic investors were present and interested.

PPP Structure

As of 1991, the City of Debrecen and ASA embarked on a joint venture with the foreign partner

holding a 51% controlling share, and the Municipality holding a 49% share.

As of 1996, most municipal services in Szolnok, including waste management, were privately

operated. The town attracted a total investment of about Euro 20M through public and private

enterprises. Rethmann was awarded the contract for MSWM in Szolnok in 1995, and hence becoming

majority shareholder (51%) of the joint venture. The Municipality of Szolnok retained a 45% share

and remaining 4% were shared between the County and a regional association of municipalities.

Competitive Tendering in Szolnok vs. Direct Contracting in Debrecen

Debrecen founded its joint venture with ASA through direct negotiation. Szolnok’s approach to

privatisation is an outstanding example of an award after competitive bidding, which is described

below.

Step 1: Awareness Building. The vehicle fleet was obsolete, maintenance costs were rising, staff was

bloated, and the service constituted a perpetual drain on the city’s budget. The existing landfill space

had a capacity of a few years left; and a new landfill would need to comply with new regulations.

Step 2: Strategy Formulation. The City Council mandated a series of strategic papers:

· A preliminary concept for the transformation of the Public Utility Company of Szolnok

· Valuation of the Company’s assets

· Development of alternative business plans, under a number of scenarios

· A transformation plan of the Company, featuring alternative privatisation concepts.

The business plans confirmed that neither internal resources, nor increases in fees could provide

sufficient funds to meet urgent investment requirements. The Municipal Council reached the decision

to establish a separate municipal corporation for MSWM, SZOLKOM Rt., and to subsequently offer

shares in the corporation to an investor who would undertake the required investments. This strategy

had the advantage that after the asset valuation and the separation of accounts, the financial situation

of MSWM in Szolnok became transparent to interested investors under their due diligence.

Step 3: Tender Documentation. With outside legal advice, documentation was prepared to solicit

offers from investors. This documentation was quite specific about the Municipality’s expectations

but allowed sufficient flexibility in submitting offers. Important items the bidder was to specify

included:

· The intended ownership stake of the bidder, which could not be less then 51% or more than 74%

of the company. It was decided during the strategy phase that it was necessary to offer a majority

stake to attract a serious foreign investor, but at the same time retain the requisite minority share

to safeguard the Municipality’s interest on vital matters (26% under Hungarian law).

· The vehicles and equipment it intended to provide to meet service standards specified in the

documentation.

· The phasing of investment for a new landfill to cater to the needs of Szolnok and surroundings for

at least 50 years.

· A plan for introducing selective collection and recycling of reusable wastes, and the selective

treatment of hazardous household waste, and to specify the respective investments it proposed for

the purpose.

· Proposals for tariffs and a method for collection, of indexation for inflation and other changes

· A 5-year business plan for the joint venture

Step 4: Tendering and Bid Evaluation. A number of offers were evaluated by ad hoc Committee,

which made its recommendation to the Municipal Council. The Municipal Council had the exclusive

right for the final decision on the tenders, including the right to reject all the tenders. In the event the

tender was awarded to Rethmann.

Szolnok thus adopted a transparent and professional tendering process, one of the first municipalities

to do so for an MSWM contract award in Hungary. Main advantages of such a process are

transparency and competition. Also, as the contract is an open covenant of the Municipal Council, it

implicitly reflects a consensual approach for problem resolution. The partnership between Szolnok

and Rethman, now in its 9th year, can be regarded as a positive case of consensual decision making

between the partners.

Most early MSWM service contracts and joint ventures (including in Debrecen) were concluded in

direct negotiations, with the Mayor in the chair. One advantage of direct contracting is the short time

needed to conclude the contract. The Szolnok procedure took three years, most of which spent in

building consensus. However, in the absence of a consensus-building phase, a direct contract is prone

to be assailed by political and business opponents. In fact, Debrecen paid a higher price later.

Tariffs Fees and their Collection

The fact that the two joint ventures have remained financially viable concerns to date, with high

standards of service, and in the case of Debrecen, with a high standard landfill disposal, demonstrates

that private investment can be mobilized to modernize the service, thus contributing to meeting the

needs of higher service levels and environmental sustainability, and, in the process, contribute

significantly to meeting the costs of compliance to EU Directives.

While the basic rationale and strategy of ASA and Rethmann in Hungary are similar, there are also

important differences in the structure and operation of the two PPPs, as noted in the table below:

In Szolnok, the company earns its entire revenues from tariffs and fees, which are directly collected.

The joint venture contract explicitly mandated the company to collect the fees from households. This

was at the time an exceptional arrangement in Hungary. In most other PPPs, the municipality

determines the fees, and the households pay to the municipality, while the municipality pays the

service company on some other basis, e.g. a formula related to the number of inhabitants served.

Further, in most municipalities, the service remains subsidized. Thus Rethman’s case demonstrates

that it is possible to operate MSWM in a financially viable and self-financing manner based on direct

client relationship with the customers5.

ASA’s experience in Debrecen has been altogether different encountering the difficulties of risk

sharing in an uncertain environment. AKSD’s initial contract with Debrecen is the case of a risk

sharing structure based on expectations that turned out to be wrong. The contract was based on the

principle of guaranteeing that yearly annual revenues, fixed in advance, would cover investment and a

return on capital over the five-year period (1991-1996). Over this period, AKSD was to receive

escalating lump sum fees for the core service of collection, transport, and disposal of household

waste. The notion behind this structure related to the population’s limited capacity to pay at the start,

coupled with expectations of a rapid increase in both the municipality’s revenues and the population’s

capacity to pay. According to the agreed formula, the lump-sum fee in the last year was to be five-fold

the fee in the first year. The expectations of rising incomes and revenues did not materialize. In the

event, after considerable acrimony, AKSD reduced its fee for the last years of the original contract,

and starting in 1997, the parties agreed to adjust the lump-sum fee annually, for inflation and other

factors, according to a complex formula. While the formula for fee determination proved to be

inappropriate, the case still demonstrates positive conflict resolution. What eased the conflict was that

the Municipality had a stake in the financial survival and viability of AKSD, having a 49% stake in

the venture. It was also fully informed of the Company’s financial difficulties, as the Finance Director

of the company, according to the original contract, was a nominee of the Municipality.

5 In addition to revenues from households, the company has direct contracts with industry, and specific subcontracts with the

municipality for special services (e.g. snow removal, maintenance of sidewalks and bus stops, maintenance and operation of

pay-parking lots, and another dozen activities.

Lessons Learned

· Joint venture deals in MSWM can be financially viable and sustainable, without central

government support, and can effectively contribute in MSWM regionalization;

· Direct negotiations and competitive tendering can both result in a positive outcome, but a

professionally conducted competitive tendering process has major advantages, including possible

long term cost savings;

· Pricing and risk sharing can be resolved in different ways, but it is risky to base contracts on

loosely founded expectations regarding income growth.

Case 12. Kirklees Metropolitan Solid Waste Project, UK

Background

The Kirklees Metropolitan Council faced a deteriorating solid waste management situation, a rapidly

diminishing landfill capacity and the prospect of strengthened environmental legislation and cost of

landfilling. In 1995 it launched a comprehensive review, including consultation with the private

sector, to identify the preferred long-term waste management strategy. This included all options from

‘do nothing’ to exclusive reliance on landfilling to a fully integrated solution based on a holistic

management approach. The latter was adopted as the preferred option together with a ‘business

model’ based on a joint venture arrangement with the private sector.

In 1998 Kirklees signed a 25-year joint venture agreement with United Waste Services Limited to

deliver the integrated waste solution. The contract involves new capital investment of approximately

Ј41 million, incorporates re-use, recycling and recovery principles and decreases dependency on

landfilling. The capital infrastructure will include a new waste to energy plant, a multi-materials

recycling centre, a transfer loading station, 2 composting plants and 2 household waste recycling

centres. Ј33 million of the total was provided by a Government credit scheme.

PPP Features

Kirklees decided that a joint venture model would be the most effective solution after substantial

consultation which included the private sector. This resulted in the creation of a special purpose

vehicle called Kirklees Waste Service Limited in which Kirklees has a 19% minority voting interest.

Kirklees transferred assets into the company in return for voting rights and equity shares which were

in turn transferred to the service provider in return for reduced gate fees. The provider is responsible

for delivering a waste management solution guaranteed to divert a minimum of 60% of waste from

landfilling through a combination of re-use, recycling and energy recovery schemes.

A unitary fee is charged over the contract life which is adjusted based on volumes received and

achievement of landfill diversion targets.

The current system was selected through a comprehensive strategic planning exercise. This included

predicting the point at which alternative treatment methods would become cheaper than the landfill

tax which was expected to rise and the cost of increasing landfill capacity which is in any case in short

supply. A key consideration for selecting the PPP method was a comparison of life cycle costs of the

alternative procurement methods.

The planning / research included consultation with the private sector (before publishing a tender in the

OJEC), this included asking:

· Whether Kirklees approach was in line with that of the potential service provider

· Whether there were alternative options

· What could Kirklees afford

Selection of the joint venture model, as opposed to a classical contractual model or BOT / DBFO, was

determined by the fact that Kirklees had positive experience of using the JV model and that this was

the preferred approach of the private sector. These reasons were considered more relevant than any

consideration of favourable risk transfer through other models.

Procurement should have followed the EU conform negotiated procedure (according to the Public

Procurement Directives), however this was difficult to reconcile with the tendering requirements of

the 1990 Environmental Protection Act. As a result a restricted procedure was followed in which

Kirklees issued a complete set of tendering documentation including project and shareholders

agreements and output specifications. This also implied that post tender negotiations were not

possible but an extended process of clarifications was provided for.

The JV provides Kirklees with a 19% voting only shareholding and a representation on the board. It

maintains certain other intervention rights but these are limited. The payment mechanism has been

designed to provide incentives for increased waste diversion. The period up to 2002, during which

the facilities were being completed, provided a gradually increasing fee rate, fixed and variable

tonnage charge and low recycling rates. From 2002 there is a guaranteed minimum tonnage, a fixed

gate fee per ton, a guaranteed diversion (of 60%) and a deduction in fees based on the percent of

recycling not met. The unitary payment made by Kirklees covers all costs related to service

provision.

The provisions for risk sharing / transfer are such that Kirklees assumes only the risk of increases in

landfill taxes and the major financial impact of new legislation (subject to a review of impact on cost

of services). Additionally the risk of residual value and major changes in waste volumes are shared

subject to review agreements.

Lessons Learned

· Public authorities need to take a very realistic approach to what can be achieved. This includes

recognising the needs and constraints of the private party. Additionally the requirements of

external financiers need to be integrated at an early stage so as to reduce time delay and cost at

later stages. These points highlight the need for a partnership based on mutual understanding and

a certain amount of trust or each other’s objectives.

· The public party benefits greatly from having a small and consistent core project team with the

necessary skills, budget and ability to take decisions.

· The cost and required time of procurement should not be underestimated. This includes selecting

the correct procurement procedure for the project and which meets relevant procurement

regulations. Should derogations be necessary, these should be sought at an early stage to provide

clarity to the procurement process.

· This project was complicated by parallel efforts to disband existing arrangements. Given the

complicated nature of PPP projects, they should, ideally, be planned and implemented on a standalone

basis in an already determined supporting framework.

· The joint venture model with a minority publicly-owned company proved to be the best delivery

model for this situation. While this model also helps in the development of an effective

partnership, they are not the only method and special purpose vehicles wholly or majority owned

by the public or private sector are alternatives depending on the circumstances.

· A critical element of any PPP project is the degree of risk transfer. The public body must be

realistic about what level of risk transfer represents the best value for money but also provides the

optimal operating structure for the project and the parties.

Case 13. Mülheimer Entsorgungsgesellschaft mbH, Germany

Background

The case of Mülheim an der Ruhr is especially illustrative for German pilot PPP-projects in MSWM

in the early 90s. Economical, technical and environmental problems of solid waste management

cumulated, while at the same time the transition to a dynamic market driven solid waste market in the

Ruhr area forced the local authority to rethink its traditional role as a local monopolist for MSWM

services.

To participate in the increasing volume of private capital and know how in the emerging regional

market, the city of Mülheim in 1994 invited two private partners to found the public-private MSWM

enterprise “Mülheimer Entsorgungsgesellschaft mbH” (MEG limited). 25.1% of the shares belonged

to the city. The 74.9% of private shares were divided equally between one international (Trienekens

AG) and one domestic waste enterprise. In 1997 all private shares were transferred to Trienekens AG.

MEG was to concentrate on hazardous waste incineration and develop this business as a regional

service for the Ruhr area as a whole. All other MSWM services remained until 1997 in a public body

for solid waste management, road cleaning and waste water management. In 1998 the city council

asked the city management, the management of MEG I and Trienekens AG to develop a PPP concept

for all municipal solid waste services. The political idea was to concentrate MSWM in one

organization again and to mobilize additional private capital and know how. The majority of the

shares – 51% – of the new PPP should be held by the city to keep political control in a sector with

controversial public discussions. Trienekens AG accepted this proposal, which meant resigning its

majority in MEG I, because it could enlarge its engagement in the Mulheim MSWM to all existing

services and help to create new ones in different business segments. After two years of preparation

and negotiations the new “MEG II” started work in October 2000.

PPP Features

The objectives of the public-privates enterprises MEG I – and later – II were multidimensional:

· a high quality solution for the problem of hazardous waste incineration

· the costs for technical and environmental modernization of the infrastructure for the whole

MSWM and road cleaning sector should be equally shared between the public and private partner:

the exact volume of the necessary investment relative to the assets and the value of the assets are

kept confidential, but in media reports 10 to 15% of the value of the assets was estimated as

investment volume for the first five years of the PPP

· the mobilization of private capital and knowledge to achieve cost saving to finance the

modernization of the infrastructure in the situation of limited government funding

· intensive cooperation between different municipalities in the Ruhr area to use the landfills for

hazardous waste and technical facilities for biological waste more effectively: in both MSWM

business segments capacities were lacking in the whole Ruhr area in the early 90s and existing

service contracts resulting from the PPP phase of MEG I could be extended

· the stabilization of rising tariffs for customers

· job security for public employees in a region with a high rate of unemployment

To handle the complex multidimensional objectives and to protect their interests the parties had to

agree on several informal and formalized agreements. These agreements had to combine in the form

of a joint venture and central elements of a BOT model.

As a first step the city management and Trienekens presented an informal “Letter of Intent” (LoI) to

the city council. The most important conditions for MEG II as a PPP were stated in this LoI: A public

share of 51% and public majority in the governing body, transfer of the technical infrastructure,

capital, services and staff concerning MSWM to MEG II. Tendering should be avoided with this

“Inhouse Agreement” as it was considered that Trienekens AG seemed to be the suitable private

partner for the city management because of its knowledge and experience in MSWM. After the city

council had accepted the LoI, eight different contracts were signed for

· transfer of shares/capital (partnership agreement: “Gesellschaftervertrag”)

· infrastructure (public asset)/services (MSWM, road cleaning, maintenance of the

infrastructure/vehicle fleet) and staff (“Überleitungsvertrag”)

· the private investment over 15 to 20 year and economical, technical and environmental standards

to be realized in 2005, 2010 and 2015,

· the tariff level for the period 2000/2005 and certain annual contract payments for the Trienekens

AG (sales taxes included)

· building and operation of a new landfill for hazardous waste in an outskirt of Mülheim

· building and operation of a new technical facility for biological waste

· risk of the private and public partner to guarantee a certain annual volume of waste (risk

allocation).

The direct public-private negotiation process with Trienekens AG to formulate these detailed

contracts in Mülheim showed two main problems relevant for all municipalities trying to establish

PPP. The first problem is the risk that competitors sue the municipality if negotiations take place with

one private enterprise only. Even if the partners agree on an in-house contract, national and European

rules for tendering are very strict. In the Mülheim case the responsible chamber for tendering of the

state North Rhine-Westphalia confirmed in October 2000 the decision of the city council concerning

the MEG II PPP concept. The given reasons were only of a formal nature being that the time limit for

filing complaints had expired. As a second problem it has to be mentioned that dealing with

multidimensional objectives direct public-private negotiations can be similar time consuming – if

experiences are lacking under the conditions of a emerging market driven economy – as competitive

tendering. The experiences with MSWM in Mülheim showed that the sometimes proposed time 

advantage of direct PPP-Negotiations is not an automatism if different complex and detailed

agreements have to be contracted.

Regarding the relations between the parties constituting the MEG II PPP in Mülheim the way of direct

public-private negotiations with only one private partner implies certain risks. A disadvantage for the

public of this tight relation is that information about the financial agreements – including the role of

the involved banks, annual contract payments and methods of contract award – is kept confidential.

Beside the legal risk, which is implied, the lack of public information and therefore lacking

competition is one problem of direct negotiations. The fact of lacking competition leads to the further

risks that with different private tenderers the price for the transfer of the public asset to a private

partner could have been higher, that the degree of cost saving with the Trienekens AG as private

partner never has been really substantiated and that the danger of corruption is rising. There is no

valid information to answer these questions clearly for the case of Mülheim, but in Cologne and other

municipalities in NRW corruption was observed in similar PPP cases in MSWM in the 90s. In these

cases representatives of the Trienekens AG and public employees, who accepted financial grants of

the company therefore, had agreed on the non-consideration of the bids of competitors in case of

direct negotiation or how the bids of Trienekens should be formulated in detail in case of competitive

tendering.

Lessons Learned

· restricted competition and concentration on one private party in the development phase implies

risks in effectively addressing the multidimensional set of economical, technical, quality and

environmental objectives

· these risks included lack of public information, potential for increased costs, corruption

allegations and insufficient competition to promote efficiency gains and technological

improvements.

In spite of these risks there are some positive factors of the Mülheim approach, which facilitated the

PPP success:

· for clear and detailed solutions regarding the pressing economical, technical, quality and

ecological problems of MSWM contracts are signed in a time-effective process

· a new landfill for hazardous waste and technical facility for biological waste have been built,

which are used by different municipals in the Ruhr area and therefore help to improve the

cooperation between different municipalities slightly by using the “simple” instrument of service

contracts

· the employment and tariff situation are kept stable

Transport Infrastructure Sector Analysis

Introduction

PPP principles have been applied in the transport sector for a considerable period. With the

popularisation of transport and the advent of sophisticated and high-speed connections it has, if

anything, become easier to apply PPP principles. However, while experiences are numerous, the

transport sector is useful in demonstrating the potential for failure if fundamental issues are not

correctly addressed. These include: demand forecasts, cost control, coherent planning or ensuring

sustained political support, to cite but a few causes.

Some of the most important issues that will influence the selection of a preferred form of transport

PPP are the size and scope of the project, the ability to apply user charges (or shadow tolls) and the

extent of risk transfer required. Major road schemes or mass transit systems are well suited to

traditional design and build contracts, as operating costs in a typical scheme are low compared to the

capital costs of construction while the collection of fees is relatively straightforward.

In some instances and particularly for major road schemes, construction may be funded in part or in

whole by user charges. For example, bridges and tunnels are well suited to user charges where there is

a clear benefit to be gained from choosing the tolled route over an alternative route. In such

circumstances, the public sector must decide whether to transfer responsibility for financing the

project and collecting charges to the private sector contractor. As will be seen in certain cases, the

existence of alternative routes severely affects the financial viability of such schemes and will

ultimately result either in the public sector having to take larger financial responsibilities or project

failure.

Different types of PPP contracts are already being implemented in Europe. Toll motorway concession

contracts are suitable where the private sector contractor will finance a major road scheme, collect

user tolls and bear the risk associated with traffic demand. BOT contracts are more suitable where the

private sector will receive fees paid by the public sector (shadow tolls), but the public sector will

finance the project and accept the risk associated with demand. Shadow toll DBFO contracts are

likely to be more suitable where the private sector contractor will accept some of the risk associated

with traffic demand, but direct user tolls are not applied. A number of major road projects have been

undertaken in England, Finland, Scotland, Spain and Portugal on this basis and the private sector

contractors are paid on the basis of Shadow Tolls. However, there are also a range of issues

associated with this approach including the greater level of demand risk retained by the public sector

and the fact that, as motorists do not directly pay for the economic cost of infrastructure provision,

infrastructure investment may not be rationally allocated.

Minor projects are more suited to traditional design and build contracts and are not likely to be

suitable for other forms of PPP unless bundled together into a larger contract with a significant

operating element.

Selected Cases

A broad selection of transport projects were selected including roads, tunnels, rail and airports in both

Member States and Candidate Countries. Numerous other examples of transport PPPs exist including

the French motorway system, toll bridges or even port developments. However the limited cases are

presented in order to demonstrate the following:

· The absolute importance of undertaking effective and rigorous demand and cost forecasting in

order to avoid cash flow problems. Associated to this is the need of having a degree of flexibility

in the PPP agreement should demand forecasts and revenue projections need to be revised

· The need for capable national expertise in PPP development and implementation so as to

effectively design and monitor the agreement and intervene as required

· That to use the problem solving potential of PPPs effectively, the integration of private partners

must occur at the earliest possible stage

· That assistance from the European Commission can be an important catalyst to mobilising local

public and private investment, but that it cannot substitute a long term viable financing concept

· That transport projects cannot exist in isolation and must form part of a regional development

plan geared to fully exploiting their potential

· That new PPP projects, particularly in Candidate Countries, require committed and sustained

political support but must also demonstrate a clear benefit over traditional methods of project

realisation and financing

Lessons Learned

While the sample of projects is obviously too small to draw definitive conclusions, they are useful in

demonstrating a number of issues and the solutions found. These can be of value as the Candidate

Countries develop the next generation of transport projects under restrictive national budgets,

increasing access to European grant funding and an obligation to upgrade and extend their transport

infrastructure.

The principle lessons learned include the following:

· As the Wijkertunnel project demonstrated, a PPP is a relationship between two parties with very

different objectives and working approaches. In order for PPPs to be successful, these differences

have to be identified, understood and integrated, allowing ea ch party to realise its objectives but

also to facilitate a viable and sustainable project.

The public authorities must develop their expertise to design, negotiate and manage a PPP. A

successful model has been the early establishment of a national PPP resource centre. This can

also help in developing and sustaining the crucial political support.

· As the Hungarian M5 project demonstrated, given the inherent difficulties in correctly forecasting

traffic volumes, sustained and, when required, active Government and political support is critical

both in ensuring the continuation of a project but also in reducing its long term costs which can be

increased through uncertainties and risk perceptions.

· The Wijkertunnel, CTRL, M5 and M1 – M15 projects demonstrate the importance of travel /

demand forecasting and the inherent difficulties in getting the forecasts right. Additionally they

demonstrate the need for a degree of flexibility in the contractual and revenue provisions, which

foresee the possibility of having to adjust revenue flows in respect of changing demand realities.

The M5 project highlights the need for an appropriate allocation of risks between the parties and

the important requirement of avoiding the total transfer of unmitigated traffic risk to the private

party. This is particularly important in economies without previous PPP experience or on traffic

corridors with no previous tolling experience.

The M1 – M15 project demonstrates how, despite initial political support and strong economic

justifications, a project can fail due to over optimistic traffic forecasts. However it also

demonstrates the need to avoid developing transport projects in isolation but as part of a coherent

strategy, which integrates PPP needs and characteristics, particularly financial viability. In this

case the existence of a parallel road undermined the project’s financial viability.

· The need for effective and rigorous preparation is brought out by all projects and in particular the

Perpignan – Figueras rail and Kassel-Calden airport projects. This showed that 3 conditions need

to be fulfilled in terms of strategic planning and project preparation, including:

· A rigorous cost benefit, competition and demand analysis

· A viable long term financing plan which is able to decrease dependence on EU and national

funding support over time

· The inclusion of the project in a coherent regional / national strategy and plan

· The political concerns and potential for public outcry should not be underestimated. As already

stated PPP projects, as indeed the PPP concept, require strong and sustained political commitment

particularly in economies with little or no experience of private investment in public infrastructure

and direct, or indirect, tolling and user charges. This was demonstrated on the Hungarian

motorway projects where the tolls were judged to be excessive. But public outcry is also

prevalent on such issues as quality of service, environmental and national concerns. The

inclusion of the ‘paying public’ in design and monitoring considerations is therefore a critical step

in ensuring use of infrastructure, ease of implementation and the sustainability of the PPP

concept.

· Political and public pressures can play a negative role on the further expansion of PPP projects or

the further expansion of private sector participation. This is demonstrated by the Hamburg

International Airport project in which a political consideration restricted the degree of private

ownership and therefore impacted negatively on the speed and degree of airport development.

While it can be expected that the public sector will wish to maintain a certain amount of control

over public infrastructure, if only to fulfil its role as the guarantor of services and quality to the

paying public, this should not be confused with political considerations. There are a multitude of

ownership structures, financing methods and above all contractual provisions which can be used

to control and orientate the private party while at the same time not hindering their desire or

ability to invest further and thereby harnessing further private sector advantages of the PPP

model.

Case 14. M1-M15 Motorway, Hungary

Background

As the level of State debt did not permit public financing, a PPP approach was considered necessary

for the realisation of non-recourse financing of 57 km of new motorway. Additionally it was judged

that a PPP allowed more rapid implementation, including earlier financial close, of the Project than

would have been permitted in conventional public sector procurement and financing. The debt would

also have a longer maturity than would have been possible at the time by the Government of Hungary

acting on its own as a sovereign borrower, or as a guarantor of a Special Purpose Company.

The project consisted of the design, financing, building, operation and transfer (35 years after

effectiveness of the Concession Agreement) of 43 km of motorway from Gyor to the Austrian border

(M1) and 14 km of motorway linking the M1 to Bratislava (M15). This would have a semi-open toll

collecting system with one main toll plaza and five tolling stations on three interchanges. The

parallel, un-tolled country road was to remain unimproved. The traffic volume un-tolled was

forecasted to amount to 25,000 AADT (annual average daily traffic), comprising 70% international

traffic and 60% commercial traffic. The full traffic risk (volume and revenue) was transferred, without

mitigation, to the private sector.

In contrast to other motorway schemes in Hungary, there was no support from the State other than in

initial planning and site acquisition, whose costs were to be reimbursed in the form of profit sharing.

The Concessionaire was free to set initial tariffs (tolls) at their revenue maximising level and

thereafter to adjust them in accordance with agreed indexation provisions (HUF CPI inflation and

adjustments for HUF/foreign currency exchange rate variations). The economic rationale for the

Project was largely based on time savings to be realised by users (estimated at 20 minutes per full

journey). There were no significant construction (ground or geological) risks as the terrain is flat

without the requirement for significant structures to be constructed.

PPP Features

The principal parties involved were the Bureau for Concession Motorways, established by the

Ministry of Transport in the Motorway Directorate in 1991, and ELMKA, Rt., a private sector

company, comprising the international contractors and toll-road operator. The private party provided

19% of total financing required in the form of equity and shareholder funds. In addition, the Lenders

were involved for Euro 329 million arranged by Banque Nationale de Paris (BNP), co-arranged with

the European Bank for Reconstruction and Development (EBRD), and syndicated to 11 commercial

banks. The Loan maturity was 14 years. At the time this was the longest maturity secured by a

Hungarian public or private borrower. Hungarian Forint financing amounted to HUF 12,000 million,

arranged and provided by the EBRD and Hungarian commercial banks and insurance companies,

together providing 81% of total financing.

The PPP Process

The design and construction permit was secured by the Bureau for Concession Motorways in advance

of the tender being initiated. Similarly the site had been acquired and paid for by the State. A two-part

tender was launched in 1992 (in compliance with the Act on Concessions (No.XVI), approved by

Parliament in 1991. Four consortia were pre-qualified in August 1992. The best and final offers were

received from two preferred bidders in January 1993. The Concession Contract was executed with a

single preferred bidder in April 1993, effective in January 1994. The principal tender criteria was the

level of tariff required by the Concessionaire, subject to meeting technical commercial and financial

criteria specified in the tender documentation. A two-year construction period was required and the

M1 opened to traffic in January 1996.

Actual Experience

Traffic volumes in the first full year of commercial operation amounted to 6,350 AADT, 46% of

original estimates and ELMKA’s total revenues were some 50% below forecasted levels. This

reflected a significant diversion by many commercial vehicles to the un-tolled alternative route.

Additionally the overall passenger car volumes were much reduced in part due to the development of

large shopping centres within Hungary, removing the need for cross-border travel. Furthermore,

delays in border crossing formalities for some users of 8 to 10 hours or longer, reduced the apparent

value of the time savings potentially generated by the Project.

In 1996 litigation proceedings were launched against ELMKA, amongst others by the Automobile

Club of Hungary, contesting the fairness of the toll levels. The court ruled that toll rates were not

consistent with the level of service provided. In consequence senior lenders suspended loan

disbursements for the M 15 Project and construction was suspended. ELMKA experienced serious

cash-flow shortfalls and defaulted on its loans in 1998.

Following the election of a new Government, the Concession was taken over by a special purpose

public sector company in 1999 and the Republic of Hungary assumed debt service obligations, from

January 2003. The loans were restructured to give an overall maturity of 20 years, reduced rate of

interest and a reduction in the amount outstanding, (debt write-down) secured by a sovereign

guarantee.

Other Hungarian Motorway Projects

The Bureau for Concession Motorways subsequently initiated tenders for other motorway schemes in

Hungary including the M5, M3 and M7. Feasibility studies showed, in contrast to the situation for the

M1-M15 that a stand-alone private sector financing solution was not possible and would require

traffic volume or revenue shortfall support mechanisms. A tender procedure for the award of a private

sector concession for the M3 Motorway was cancelled in 1995 and the Project was implemented by a

state-owned public sector special purpose company. This was financed by means of direct

Government contributions and Government guarantees. EIB loans initially made up 50% of project

costs but this loan has subsequently been cancelled.

Lessons Learned

· Notwithstanding the high economic and political priority of the Project at the time, the viability

of the PPP was undermined by underlying economics, which in practice did not bear out the

optimistic traffic forecasts at the time the Concession was first negotiated and financed.

· Traffic forecasts are widely recognised as difficult to get right (compare forecasts for passenger

forecasts for Eurostar passenger train services London to Paris and Eurotunnel revenues with the

actual outturn), especially so when alternatives modes of transport or corridors are available to

users.

· Optimism in the traffic forecasts was exacerbated by the adoption of tender criteria which

emphasised the lowest possible tariff, and the insistence on a stand-alone private sector investor.

· The M1-M15 Project has established itself as a benchmark of the dangers to which project

participants are exposed when traffic risk on a greenfield project is transferred to private sector

participants without mitigation or contingent support (as opposed to the M5, see case 19).

· There is a wide variety of different commercial structures (availability charges, shadow tolls,

etc.) for attracting PPP involvement in motorway and highway investments.

· A defaulting private sector concession can lead to a re-nationalisation.

Case 15. M5 Tolled Motorway, Hungary

Background

The 157-kilometre M5 forms part of the Pan-European Transport Corridor IV (Berlin-Prague-

Bratislava-Budapest-Bucharest-Thessaloniki-Istanbul). It is the main link from Budapest to

Hungary’s Southern region and an important extension of the western and central European motorway

network towards Belgrade and Bucharest.

Pre-qualification documents were released to private sector bidders in April 1992. Following the

selection of three pre-qualified bidders in September 1992, a tender was launched in 1993, leading to

the selection of two preferred bidders in February 1994. A 35-year concession contract was signed

with the successful bidder, a Special Purpose Company formed by a French-Austrian-Hungarian

consortium, Alflold Koncesszios Autopalya Rt. (AKA). The main shareholders in AKA are the

general contractors, Bouygues S.A. and Bau Holding AG. Financial close was delayed until

December 1995 as a result of a requirement imposed by lending banks for a fresh traffic study. In

turn, this led to a requirement to increase the revenue support arrangements available to the Project

from the Hungarian authorities. The operating and maintenance services are provided to AKA by

Maygar Intertoll Rt, a company fully owned by the South African toll road operator, Intertoll. The

concession award was made in accordance with the local Concession Act XVI/1991.

The first Phase comprises the upgrading and rehabilitation of existing roads and the construction of

approximately 90 kilometres of new highway. A semi-open tolling system was adopted with two main

toll plazas and 8 toll barriers on interchange access roads. AKA was required to complete the

construction of the second and third Phases of the Project by 2003. The second Phase comprises a 45

kilometre extension from Kiskunfelegyhaza to Szeged and the third a further 15 kilometre extension

from Szeged to the State border.

PPP Features

The toll for passenger cars was set at HUF 5.00 per km in 1993 terms, and approximately at a fourfold

multiple for heavy goods vehicles. Discounts for residents and frequent users were agreed. AKA is

permitted to adjust toll rates in accordance with Hungarian retail price inflation and with any

devaluation of the Hungarian currency, should such depreciation exceed the inflation differential

between HUF and the respective foreign currency in which AKA’s external indebtedness is

denominated.

The EBRD “A” Loan is provided directly by the EBRD, whilst the “B” Loan is provided by

commercial banks, arranged by Commerzbank and ING. However, the EBRD extends its preferred

creditor status (ranking ahead of other lending institutions in the event of rescheduling or revenue

shortfall, by virtue of its multilateral status). At the time the “B” Loan was the largest non-sovereign

international commercial bank loan raised by a Hungarian borrower. Repayment of the loans is in the

form of annuities, calculated on the basis of an 18 year maturity, but with final repayment due in Year

13 as a ”bullet” payment. The “bullet” payment corresponds to 55% of the initial principal amount. In

order to achieve acceptance of this structure amongst commercial banks, the EBRD undertook to

provide a guarantee of the final repayment.

A refinancing of all AKA’s borrowings was undertaken in 2003, with the objective of extending loan

maturity, taking advantage of lower prevailing interest rates, increasing gearing, (the amount of debt

in the overall financing in relation to the equity) thereby allowing the equity rate of return to investors

to be enhanced. Subject only to the support arrangements and in particular the revenue deficiency

facility described below, all operational, commercial and financial risks were placed on AKA. Thus,

repayment of AKA’s borrowings and the payment of dividends to AKA’s investors are dependent on

AKA’s cash flow and profitability.

Experience to Date

Construction was achieved on schedule, or for some sections, ahead of schedule and within budget. In

1997, the first year of operations, the average daily traffic volumes at 7,700, were significantly below

forecast levels and AKA was obliged to draw on the stand-by facility (cash deficiency / revenue

shortfall fund) agreed with the Government. Following a proactive marketing campaign by AKA and

traffic calming measures, implemented by the Government on competing routes, the requirement to

draw on the Stand-by Facility in 1998 and in subsequent years was significantly reduced. The

availability of the revenue shortfall mechanism provided a critical safety net to AKA, without which it

would have found itself in default in the same way that the M1-M15 was unable to pay its debt service

obligations.

As a result of the imposition of tolls on an existing road alignment, extensively used by domestic and

international heavy goods vehicles, a significant amount of traffic in the corridor, (50% or greater in

the first year of commercial operation), diverted to Route No. 50, an untolled road running parallel to

the M5. Traffic volumes on Route No. 50 had increased by 30% in relation to the levels prevailing

before the opening of the M5. The vehicles diverting to Route 50 comprised principally local

residents and cross border truck traffic, especially from the Ukraine and Turkey. The increased noise

pollution and safety hazard led to protests by local residents. Subsequently, following negotiations

involving the Ministry of Transport, AKA, AKA’s lenders and the relevant municipalities, it was

agreed to implement traffic calming measures on Route No. 50 and to build by-passes. AKA was able

to resist pressures to reduce the agreed toll rates on the M5 (in contrast to a similar situation

prevailing on the M1 Motorway) but did agree to a programme of more substantial discounts for

frequent and local users. Some users brought legal cases against AKA concerning toll rates in force

but the Courts rejected these complaints.

Government Contributions

Revenue Shortfall Mechanism. The Government of Hungary is obliged for the first six and a half

years’ of commercial operations (i.e. until 2006) to provide AKA with compensation in the form of a

subordinated loan facility, repayable after discharge of Project indebtedness to senior lenders, in the

event that AKA’s actual revenues, for whatever reason, are below the levels in the Agreed Base Case.

The total amount of the shortfall facility is capped at HUF 9,000 million in 1993 terms (approximately

EUR 50 million).

The Concession Agreement provided for the Government to contribute at no cost the following: the

preliminary design for the Project, building permits and environmental clearance, land acquisition and

such roads and motorways that are already in existence and traffic calming measures on competing

roads. In return for the above in-kind and financial contributions the Government will be reimbursed

through a profit sharing scheme, which is expected to account for approximately one third of the

dividend stream forecast in the agreed base case.

The M5 continues as a viable PPP. The Government of Hungary provided capped, contingent,

revenue shortfall support during the first nine years of commercial operations. Traffic volumes were

significantly below forecast levels, but the Concession Company was able to avoid a default by

drawing on the contingent Government support payments and a restructuring of its long-term

borrowings.

Lessons Learned

· The M5 experience highlights the importance of an appropriate allocation of risks between the

public and private sectors and the critical requirement for avoiding the transfer of unmitigated

traffic risk to private sector investors and their lenders. This is especially important in transport

corridors without previous experience of tolling.

· The early operating experience of the M5 illustrates the difficulties, which even the most

experienced traffic forecasters have, in arriving at dependable forecasts of toll acceptance by

drivers in a traffic corridor with no prior experience of tolling.

· Given the inherent uncertainty of traffic forecasts in such situations, the Government support

arrangements, especially the revenue deficiency facility, were critical in ensuring the financial

existence and viability of the Project and in avoiding the risk premia, which lenders and investors

would otherwise have required.

· Experienced technical, traffic, financial and legal advisers were important to both the Government

and private sectors in order to achieve a satisfactory allocation of risk and an appropriate revenue

support mechanism.

· The financial viability of a capital-intensive road project is dependent on achieving loan

maturities of acceptable length. The loan maturity available to borrowers in Hungary in 2003 has

substantially increased in relation to the circumstances prevailing when the M5 financing was first

initiated as a result of Hungary’s improved economic position and EU accession status. The

EBRD played a critically important role, at that time, in enabling the necessary loan maturities to

be achieved.

· Even without the improvement in Hungary’s overall economic position, the rate of return to

investors would have been significantly improved by refinancing the initial borrowings, once

construction risks had disappeared and the financial results for a number of the early operating

years can be made available to lenders.

Case 16. Beiras Litoral and Alta Shadow Toll Road, Portugal

Background

Following the launch of the National Road Programme in 1996, the Portuguese Government initiated

a programme of new motorways on a project finance basis, with an aggregate investment cost of

around EUR 5 billion. The first phase of the programme included two real toll and six shadow toll

(SCUT6) road concessions (an additional SCUT was included later). Some of these highways provide

main transit corridors between Portugal and Spain, which constitute a vital part of the national

motorway network. A rapid programme of road construction was required at a time when public

sector budgets for new capital investment were heavily constrained. The objective was not only to

enhance the availability of the road infrastructure, but also to compensate for regional economic

imbalances and generate employment opportunities, with the smallest possible initial financial

contribution from the government.

Project Description

The project entails the widening and upgrading of 167 kilometres of the existing two-lane (2x1) IP5

highway between Aveiro, in the Coastal West, and the Spanish border at Vilar Formoso (East), via the

cities of Viseu and Guarda. The existing road goes across hilly terrain with gradients of up to 8%.

Vehicles per day range between 9 000 and 12 000, varying with location and season. Trucks account

for as much as one third of total traffic flow. The accident rate on IP5 has been notably high. Despite

the heavy traffic, the absence of non-tolled alternative routes, induced the government to adopt a

shadow toll regime for the concession, then with expected construction costs under Ђ 250m. The

concessionaire thus receives tariff payments directly from the grantor, which are calculated according

to the number of vehicle kilometres of usage and determined with reference to a banding system.

PPP Features

Institutional and Management Structure

In 1998, the Portuguese Government, through the Ministries of Public Works and Finance, solicited

bids from the private sector in a public tender. After a preliminary screening process, two of the

bidding groups (led by Portuguese contractors) were admitted to the negotiating phase as preferred

bidders, and their respective Best and Final Offers were submitted in October 2000, presenting bid

values much higher than the ones presented in the initial phase of the tender: the expected net present

value of payments from government to the concessionaire nearly doubled relatively to the initial bids,

reflecting the fact that estimated construction costs almost trebled, attaining Ђ693.4m; start-up costs

amounted to Ђ75.5m and financing costs to Ђ164.9m. In February 2001, the consortium Lusoscut -

Auto Estradas das Beiras Litoral e Alta S.A. was awarded the concession for a thirty year period,

including 5 years for the construction with phased opening. In order to reduce costs and increase road

safety, the project included the construction of large new sections of highway, instead of enlargement

of existing ones. The concessionaire is incorporated as a limited liability SPV company under

Portuguese law. The shareholders comprise several Portuguese contractors and financial institutions

with commercial interest in the Project also as lenders.

Shareholders SPV Equity (%)

The Government is paying for existing sections of the IP5 road, which will either be widened,

duplicated or replaced by new sections. In 2002, the environmental appraisal of the project resulted in

the refusal of the project and the requirement of enlargement of all existing sections regardless of their

gradient or sinuosity (that should be, nevertheless, corrected). As this represents a deviation of more

than 200 metres away from preferred alignment, the concessionaire is entitled to compensation for

any additional costs or for delays in relation to the baseline of the submitted variant. As the

environmentally accepted alternative (of just enlarging the existing road) was not accepted by

government, construction works were stopped, and work schedule is delayed several years, waiting

for an agreement between concessionaire, government and local authorities (and for the result of its

ulterior environmental evaluation). Only the eastern section of IP5, 35km between Vilar Formoso and

Guarda, is completed.

The commercial bank loan is repayable in annuities over 25 years, commencing on the final

completion date of the project. It is structured as a non-recourse loan, with repayment entirely

dependent on the SPV’s revenue performance according to the level of motorway usage and the

resulting revenue stream. The loan from the European Investment Bank has a slightly longer maturity

of 27 years and is guaranteed by a commercial bank syndicate, with the possibility for guarantee

release during the loan life – 50% after year 8 and 50% after year 16 – provided agreed covenants,

including debt servicing ratios, meet certain contractually defined tests.

The revenue risk under the shadow toll regime is mitigated due to the existing heavy traffic and the

fact that around 81 per cent of the traffic flows forecast in the SPV business case at full completion in

2005 was already achieved on the existing IP5 route in 2000. This risk profile is reflected in the

interest rate margins charged by the commercial banks, starting at 125 basis points during

construction and progressing towards 100 basis points thereafter depending on the project

performance.

Shadow Toll Regime

The shadow toll regime reduces the uncertainty attached to traffic forecasts under a fully tolled (user

pays) regime. Under the shadow toll regime there is no deterrence to use alternative non-tolled routes,

and savings in operational (toll collection) costs and in land investment costs (construction and

equipping of toll plazas) can also be made.

Shadow tolls present some adverse aspects to the public sector that must be evaluated against the

benefits. In first place, the regime implies the transfer of costs from users to the public purse and

ultimately to the taxpayer. In second place, the regime provides some guarantees to concessionaires,

in order to reduce the traffic risk or to create additional sources of profit. For instance, in Portugal,

they implied the granting of some local “monopoly” to concessionaires: the government agreed

contractually to freeze the Road Plan as it was in 2000, in the vicinity of road concessions, for 30

years, abstaining from increasing the level of service of those roads beyond the stipulated in the Plan.

That is very difficult to satisfy in the long-term. The conditions related to future enlargements are also

important. Some of these matters may be significant when payment is made according to shadow toll,

but non significant if payment is made according to availability.

The shadow tolling for IP5 is based on four categories of potential traffic volumes. The first category

is intended to cover the concessionaire’s fixed operating & maintenance costs plus interest and

principal payments on senior debt. The second category covers variable operating & maintenance

costs plus interest and principal payments on subordinated debt. Revenues derived from the third

category are used to pay dividends. During the first six years of the project (including the construction

period plus the first operational year) the government pays only fixed amounts based on the

availability of the motorway. Thereafter, shadow toll payments are made three times a year: May and

September payments are set at one third of the respective year’s estimated traffic and the January

payment is adjusted to reflect actual traffic volumes achieved in the preceding twelve months.

The dramatic increase in projected costs of Beiras Litoral e Alta concession to the public purse

occurred also in other road concessions, creating a significant burden to public accounts. The expected

amount of shadow tolls in 2007 is higher than the current highways agency budget for construction

and maintenance of national roads in all country. That, and the fact that traffic prospects are very good

in this concession, prompted the government to announce in May 2004 that this highway (as well as

several other SCUT roads) will have real tolls when completed.

Lessons Learned

· The absence of environmental approval (at least for the road alignment) is a negative factor that

impacts significantly in the process of implementing a PPP. In this case, as in others in Portugal, it

created large delays (several years) and the possibility of large cost overruns that will be

supported by government. This changes the initial risk allocation, eventually destroying the wellbalanced

distribution of risks designed during tender.

· Without a clear statement of the project objectives (standards of quality and service required),

there is opportunity for presentation of sub-standard bids in the initial stage of tender, forcing an

upgrade of proposals in the second stage (negotiation), with corresponding increase in proposed

level of shadow tolls. This reduces the degree of effective bidding competition, even in formally

competitive tenders, as bidders are allowed to present unrealistic proposals with unreasonable

prices (because they know that the projects will be forced to upgrade, creating the chance for

increasing prices). The definition of objectives is also useful in avoiding the introduction of

changes in the projects during construction, by public authorities, something common in PPP in

Portugal and source of ulterior compensations to concessionaires.

· With no careful initial appraisal of the project and inherent development of a public sector

comparator, project sponsors cannot reasonably expect the outcome of tender to present prices

(for the public sector or for the users) that justify the option for a PPP. Additionally, there is no

guarantee that the result is sustainable from the viewpoint of public accounts. When the traffic

allows, the option of real tolls should be considered; in the alternative case, the option of

availability payments should be considered.

· The lessons obtained in Portugal, in this and in other PPP projects, mainly in the road and train

sectors, were the drivers of recent changes in legislation • requiring an adequate appraisal of PPP

proposals and the evaluation of their long-term impact on public accounts, as well as some rules

for efficient design of risk sharing in PPP • and lead to the creation, in 2003, of a PPP Unit, in

Parpublica SA, with significant responsibilities in PPP evaluation and appraisal and in both

research and dissemination of information. Those institutional changes are crucial in the new PPP

programmes, in transport and in the health sector, more focused on the provision of services to the

end-user.

Case 17. International Airport Hamburg AG, Germany

Background

According to a forecast made by the German Federal Ministry of Transport in April 2001, air

transport volumes are planned to more than double by 2015 as against 1997. The rise of flight

movements is increasingly causing capacity bottlenecks at international airports. Therefore, upgrading

and expansion of airports has become a priority in transport policy. The Federal Government

presented an airport concept in 2000 in which it expresses support for the further development of

airports by means of extending their capacities in all functions in line with demand. However the

application of PPP principles in German airports is, at the moment, in an initial stage.

Traditionally, the Federal Government, the individual state (“Land”), and the municipalities involved,

hold shares in the individual airport companies. Involvement of private partners initially took place at

four locations: Düsseldorf, Hamburg, Hanover and Frankfurt/Main. The partial privatisation of the

Hamburg airport is the most advanced and successful example of the above four cases. The extension

measures are focussed on construction of a new terminal with large commercially usable real estate as

well as connection to the suburban rail network. Together with further construction measures, e.g.

extension of parking areas, the entire investment between 2001 and 2007 will reach a total of Ђ350m.

The decisive factor for the Hamburg strategy was an effort of consolidation on the part of the public

authorities, which aimed at a budget income from the proceeds of the project. In December 1997, the

partners of the company Flughafen Hamburg GmbH (FHG) at that time (City State of Hamburg 64%,

FRG 26%, State of Schleswig-Holstein 10%) appointed an investment bank for further preparation of

the intended sale, amounting to a partial privatisation. Whilst the Federal Government and the state

government of Schleswig-Holstein wanted to dispose of their shares entirely, the City (State) of

Hamburg aimed at maintaining a majority stake in the airport operating company. From its point of

view, the introduction of private sector partners would increase the profitability and would therefore

result in greater revenues flowing to all partners in the long term.

PPP Features

An EU-wide tender procedure was held and the contract was awarded, with the Senate of Hamburg’s

approval in July 2000, to a consortium (Hamburg Airport Partners) formed by -“Hochtief AirPort

GmbH”- and -“Aer Rianta International GmbH”, a subsidiary of the Irish airport operating company-.

The consortium initially acquired 36% of the company shares in FHG at DM 540m (Ђ296m) and

obtained an option for the purchase of a further 13%. The stake of the private consortium in FHG has

meanwhile increased to 40%. In addition, the EIB granted a loan to the City State of Hamburg

through a local bank of Euro 220m of which Ђ 110m has been disbursed.

The objectives of the international airport joint venture had to be agreed between the City, as public

majority partner; and the private consortium. Moreover, a right of veto in cases of conflict has been

granted to each of the partners within the partnership agreement, e.g. with reference to fundamental

issues of operation management. In addition, a so-called price-cap regulation has been agreed between

the City as approving authority and FHG after its partial privatisation. This means that a contract

regulates the fixing and adjustment of charges for take-off, landing, parking of aircraft, as well as the

use of passenger bridges. The aim of the contract is to agree on a fixed maximum charge and to create

flexibility for the airport operator in pricing without relinquishing sovereign control. The contract is to

be valid from 01/01/2000 until 31/12/2004. After September 2001 and the associated traffic loss at

Hamburg airport the private sector partners would have liked to renegotiate this price cap contract and

achieve a better sharing of the traffic risk between the airport and the airlines.

Besides these contractual agreements, the publics’ interest ha s been considered in the planning

procedure. A diligent but time-consuming public zoning procedure integrating different societal actors

was initiated in 1997 and terminated in May 1998. As a result the expansion measures had been

subject to little political dispute. Apart from a noise-protected hangar for trial runs of big aircraft,

“unique world-wide“ according to the airport operator, a total of around Ђ25.5m has been invested in

three main noise protecting programmes for the 11.000 surrounding households. The graduation of

compensation according to noise emissions, a noise quota system, and a restriction on night flights for

low-noise equipment between 23.00 and 06.00 h, exempting night airmail, complement the range of

protection measures.

The interest of the private partners in the context of public-private cooperation will be determined at

the end of the project. While the financial gains are not expected to be significant there is an evident

business development value given the trend to apply PPP in the airports sector. Up to September

2001 airports were a highly interesting field in this respect due to growth in air traffic, political

objectives of extensions „in line with demand“, and partial privatisation. According to this long term

interest companies like Hochtief AG and Aer Rianta International were ready for some commercial

compromises in PPP pilot projects concerning e.g. price-cap regulation, private and business

customers can benefit from, or noise protecting programmes. After a decade of relentless enthusiasm

for investment into the airports sector, the market has since the onset of international terrorism in its

current from “sobered up” and become more cautions. The risk profile of such investments has

changed for ever, and the price for investment in Hamburg airport is now largely considered as having

been higher than warranted.

Lesson Learned

Major PPP projects in airport construction can be successfully realised if the needs of all parties are

integrated. Airports present particular environmental and social issues but these can be successfully

addressed.

· Compensations like advanced noise protecting programmes or noise quota systems can be

established contractually and financially integrated

· Private and business customers can benefit from sophisticated contractual instruments like pricecap

regulations

· A right of veto in cases of conflict has been granted to each of the partners within the partnership

agreement. This was seen as a central instrument of risk management strategy.

Case 18. Local Airport Kassel-Calden, Germany

Background

Due to the increase of actual and forecasted air traffic in the 90s, local sports airfields and former

military airports in the old and new German states were investigated for their potential as regional

airports. Regional airports should on the one hand catalyse the economic development of regions as

centres of transportation clusters and on the other hand release pressure on dynamically expanding

international airports. Therefore airport-operating companies like FRAPORT AG in Frankfurt/Main,

the nearest international airport to Kassel-Calden, provided support to such regional airport initiatives

in the late 90s. Because of the economic and environmental complexity and necessary long-term

planning it was almost impossible to find private investors for regional airport initiatives, though this

situation is actually changing due to the growing interest of national airport companies.

The first German local airport PPP “Kassel-Calden” was built in 1971 in a sports airfield and has been

operated as a PPP since 1991. Calden with around 8.000 inhabitants is located near the central

Northern Hesse city of Kassel with 200.000 inhabitants). Due to the German unification the

development of the local airport for air services and even more as an industrial park has shown

growing potential. Kassel-Calden being situated in the “heart of Germany” shows an increasing

economic potential for services in logistics/transportation and related sectors. The necessary

investment volume for the transformation of the local airport Kassel-Calden into an internationally

competitive regional airport was estimated at approximately Ђ100 to Ђ255m in the early 90s.

The estimated investment volume depended on the chosen options for the expansion and

modernisation of the runway and security equipment. Option A comprised the simple extension of the

present runway from 1.670 to 2.500m. It implies the highest noise pollution for the airport residents in

the region. Option B meant a displacement of the runway. B has been evaluated as the most expensive

option in two feasibility studies in the 90s. Option C, a compromise between A and B, was the

favourite of the airport management since 1991. This is yet to be confirmed by an ongoing geological

feasibility study. A longer runway is in all expansion options discussed as necessary for bigger

airplanes of tourist charter traffic. Tourist charter traffic is estimated as the most important business

segment of a regional airport in Northern Hesse besides services related to freight traffic.

PPP Features

The “Flughafen GmbH Kassel” (FGK) is since 1991 operating as a joint stock company equally

shared as a public-private joint venture between the city of Kassel and changing “silent” private

partners. The German model of the silent partner agreement was chosen because it enables an equal

risk and investment allocation without further contracts. In 1995 the municipality of Calden and the

rural district of Kassel started to participate in the FGK GmbH. Two thirds of the public shares were

divided equally and transferred to the new public partners. From the beginning of 2000 until summer

2003 the local chamber of commerce took the place of the silent private partner of the FGK. The

reason for this change in the partnership was that no short or even medium term return on investment

could be expected with a maximum of approximately 250.000 annual passengers between 1999 and

2003. Between 1991 and 2003, facing investments of Ђ7,5m, the annual deficit could be reduced from

Ђ0,25m in 1991 to an almost balanced budget, but a positive return on investment has not been

realised. The minor investments relative to the costs of a structural expansion have been used to

modernise the existing technical infrastructure, especially buildings, security equipment and vehicles.

An E.U. Grant of Ђ340.000, co-financed by the state of Hesse, supported this modernisation since

1999. The main reason for this grant, which could not be used for measures of structural airport

expansion, was the importance of the airport industrial park for the development of a regional

transportation cluster.

The continuation of the expansion option C was recommended in a report of FRAPORT AG. The

majority of regional politicians and business associations also voted for this expansion option in the

late 90s. In 1999 an enhanced public-private steering committee was formed. It consists of

representatives of FGK, IHK, the city, rural district and provincial government of Kassel, the

FRAPORT AG and of further institutions with importance for Northern Hesse.

Since the establishment of this additional institutional and political structure, the airport management

can be characterised as a “triangle relationship” of public and private partner(s) and citizens. The

regional public zoning procedure for the airport expansion due to international standards of air traffic

started in January 2002 and should be finished by the end of 2003. Environmental standards,

especially due to the Flora-Fauna-Habitat- and avian-protection-Directive posed by the E.U. and

national government, are included in this procedure.

The project approval procedure – timed for approximately two years – can start once FGK decides on

an expansion option in 2004. In the summer of 2003 IHK transferred its shares and position of a silent

partner to the government of the federal state of Hesse. The reason for this transfer was its restricted

competences as a self-governing body of private companies to bear long term financial risks

connected with own business activities. The airport engagement of the state of Hesse is planned also

to be temporary: FRAPORT AG in Frankfurt/Main shows interest in taking over the “private” shares

of Kassel-Calden. Since FRAPORT AG is organised as a joint stock corporation with a public

ownership majority.

In connection to the future planned development of the local/regional airport Kassel-Calden, several

downsides are to be mentioned. In spite of two official and one private, (financed by local NGOs),

feasibility studies, a diligent and sophisticated cost-benefit and competition analysis has not been

conducted so far. The potential market allocation between the airports of Kassel-Calden and its

competitors or partners Paderborn, Hannover and Frankfurt/Main, all three of them located in a

distance of under 200 km, is not evaluated. Forecasts, concerning the necessary investment and annual

number of passengers for a structural expansion range between Ђ120m and Ђ500m and 780.000 to

1,46m passengers.

Lessons Learned

· In order to build a successful PPP in the transportation sector, a diligent and sophisticated costbenefit

and competition analysis must be carried out, which ensures the long-term viability of the

project without public financial support, and includes the local airport in a wider regional

transportation cluster and development concept.

· A durable partnership and consistency in partners is essential to the development of project

ownership and the ability to further develop project opportunities.

Case 19. International Airport Warsaw, Poland

Background

A significant growth of freight volume and passenger numbers is forecasted for the Candidate

Countries for the period 2002 to 2020. In this context the construction of a new passenger terminal

and associated infrastructure between 1990 and 1992 for the International Airport in Warsaw was the

first major planned PPP airport pilot project in the EU Candidate Countries. The private partner was

Hochtief Construction AG. The Warsaw airport PPP was financed by Citybank AG, which had some

experiences in international PPP financing, especially together with Hochtief AG. Because of the

unique character of the airport extension, the European Investment Bank (EIB) supported the

construction of the new terminal I in the year 1992 with a Ђ50m loan to PPL (Przedsiebiotwo Porty

Lotnicze), the state enterprise Polish Airports.

This first extension helped to increase the airport’s capacity to 3 million passengers. Passenger traffic,

however, has grown at rates exceeding forecast, reaching 4.7 million passengers/year in 2001 and is

expected to increase to almost 6.3m by 2005 and 9.4m by 2010. Therefore in December 2002 EIB

decided to lend PPL a further Ђ200m for co-financing a new passenger terminal and associated airside

and landside work. The new terminal will provide capacity for an additional 6.5m passengers per year

thus increasing the airport’s overall capacity to 10 million passengers.

An important argument for EIB to support the airport extension was the added value that this project

could give to other major projects in the metropolitan region of Warsaw with private participation

including a Technology Park, Integrated Logistics Centre, Exposition of Warsaw Products, Futurallia

2006, Congress Centre, Convention Bureau, Multifunctional Sports and Entertainment Arena, New

City Hall and PPP possibilities in the National Motorway Programme. The accumulation of publicprivate

partnership experience would foster a local knowledge transfer concerning the opportunities

and risks of PPP.

PPP Features

The objectives of the Warsaw airport extension PPP were:

· for PPL as the public side to obtain a ready to use new terminal and examine alternative PPP

models for airport construction and financing.

· for the EIB to examine and test the optimal combination of private and E.U. financing concepts

for major PPP infrastructure projects.

It was considered that only an international consortium consisting of a large construction company as

general contractor with both international PPP experience and established relationships to experienced

subcontractors could manage the project and meet E.U. environmental and procurement standards to

avoid political and legal conflicts.

The loan repayment to involved private banks began in 1993 on a quarterly basis and was completed

by the end of 2000. According to the agreement between PPL and Citybank AG the latter is allowed

to collect all hard currency payments owed to PPL by the foreign flag carriers, interest on the loan and

other fees owed to Citibank AG. A fixed amount of money was calculated as a reserve in a collateral

account. Concerning the tariff fees as base for these contractual regulations Hochtief AG, Citybank

AG and PPL had agreed on a fixed model in the project framework contract.

A number of other positive elements have also assisted the success of the project. An independent

Environmental Impact Assessment (EI A) was undertaken. Regarding the results of this study the

public-private airport extension of the 90s is compliant with the Polish Environmental Protection Act

of 27 April 2001 and with E.U. environmental legislation. Furthermore the procurement process for

the design, finance and build contract comprised an open international tender competition between

pre-qualified consortia, following advertisement in the OJEC. The tenderers had been also asked to

propose the method of financing of the investment. Additionally the national Polish airline Lot

financed one-third of the private loan of DM 221.7m in a long term contract and that a HERMES

security was given by the German national export insurance company (with support of the national

Polish Government).

Lessons Learned

An international consortium consisting of a large construction company as general contractor and a

major bank can manage a successful 100% PPP model for the extension or construction of

international airports if several conditions are fulfilled:

· the volume of air traffic supports the planned investment and forecasts are realistic,

· the regional PPP knowledge transfer is accessible,

· the procurement process for the contract comprises an open international tender competition

between pre-qualified consortia,

· Independent Environmental Impact Assessments are undertaken to assist in the mitigation of

political conflicts.

Case 20. Wijkertunnel Randstad,The Netherlands

Background

As of 1980’s the circulation in the Randstad, the Netherlands central region, was made very difficult

by traffic congestion and car accidents. The economic costs of these transportation problems were

estimated at an annual amount of approximately Ђ180m in the early 80’s and a further increase was

forecast. The growing demand for public investment for the extension and modernisation of the

national transport infrastructure occurred in the middle of a structural crisis of the national economical

and political system, as recession, high rates of unemployment, budged deficits up to 6.7% of GDP hit

the country in 1983. In this situation, the proposal to mobilise private capital and know-how for major

infrastructure projects was part of the national government plan developed in 1983 which included a

privatisation programme and a PPP approach similar to the UK Private Finance Initiative (PFI).

A task force of the National Transportation Department (“Ministerie van Verkeer en Waterstaat)

developed a draft framework for the financing, risk allocation and contractual schemes for two urgent

major transportation projects in the Randstad: The “Noordtunnel” and the “Wijkertunnel”, presented

in this case study. The financing contract for the Noordtunnel was signed in 1988, while the

competitive tendering process for the Wijkertunnel started in 1991.

PPP Features

The main criteria for selection of the bidder were: financial liquidity, experience with major tunnel

construction programmes and the most economically advantageous bid. The last criteria however

could not be tested competitively because the ING BANK was the only bidder. Despite the missing

assessment of value for money, negotiations between ING BANK and the Dutch National Department

of Transportation took place between May 1991 and September 1992. The modified PPP toll contract

covered the following aspects:

· a private investment of Ђ183m (sales tax not included) for the period 1993 to 1996

· an operating concession of 30 years with a subsequent transfer of the tunnel to the National

Department of Transportation

· an option for the national government to buy out the contract earlier

· a shadow toll system that raised several subsequent concerns particularly as the minimum revenue

was set at the financial / traffic demand base case and maximum revenue was not capped but

related directly to actual usage.

In addition, ING was granted an EIB loan of around 93m Euros.

The national audit court examined both of the PPP projects Noordtunnel und Wijkertunnel in the mid

1990’s. As regards to the choice of the private partner, risk allocation and the public costs of the

projects, the examination underlined that:

· if a competitive tendering process only leads to one bid it should be repeated with modified

bidding documents

· interest rates for the involved bank grants should not be fixed for 30 years but adjusted regularly

to reflect changing capital market conditions

· the tariff fee should be fixed for all vehicles to guarantee long term calculable costs for the state

· a public sector comparator should be developed and integrated into the process of selecting both

the PPP alternative (as opposed to traditional public sector alternatives) and the private partner

because in both tunnel projects, the audit court calculated that the PPP solutions had been 34 to

41% more expensive than the public sector alternative.

These results of the audit court examination and general concern over the lack of value being derived

assisted in reshaping the national approach to PPP implementation. A major recognition was the lack

of national competence and analytical tools available for the analysis of options. The major

consequences of the review can be summarised as:

· establishment of a national PPP competence centre, founded in January 1999 in the framework of

the Department of Finance, with, as one of its objectives, the development of a Public

Sector/Public Private Comparator, standard contracts and to organise the knowledge transfer in

and between the departments participating in PPP projects

· establishment of a scientific study group to support the development of economic supervision

instruments (based on an economical cost effective analysis) in April 1993 as a forerunner to the

competence centre

· the need for a clear division of responsibilities between the State being responsible for policy

formulation, project preparation and procurement and the private sector for the long term delivery

of infrastructure and services.

Lessons Learned

The project is generally considered as having major structural deficiencies. It is interesting to note the

major changes that have been implemented in The Netherlands and which now drive the development

of new PPP projects.

· While the project partly transferred design and construction risk to the private party, demand risk

was borne by the public party and resulted in substantial costs to the State as maximum revenues

were not capped. Additionally no provision was made for including project life cycle costs in the

contract

· The inclusion of (potential) private partners during the preparation and planning of a PPP can

harness the problem solving potential of the private sector and PPP models. However this should

in no way negate the need for the public party to have a clear strategy, detailed understanding of

its needs, objectives, technical and financial details of a PPP approach; and a competitive

tendering process contributing to the creation of real value for money.

· The development of a national PPP competence centre is a clear advantage for the development

and application of analytical methodology, development of national know-how, provision of

assistance to local authorities and the general dissemination of experience and support.

· The project clearly demonstrates that project costs and overall value for money are affected by the

effectiveness of the procurement process in identifying the most cost effective solution. Also the

public party should clearly identify the financial and economic case for a PPP option beforehand

by comparing it to traditional public sector methods. Only if it clearly provides better value for

money should a PPP option be selected (as is now the case in most EU Member States). Similarly

the individual bids of the private sector should also be subjected to comparison to clearly identify

the costs and benefits of each. As stated above such analysis requires the development of skills

and know how at a national level together with standardised methodology.

· A modified toll model for public-private tunnel projects can be more expensive for the taxpayer

than a public solution if PPP experiences in transportation projects are missing

· In a country such as the Netherlands, with a strong SME sector, there is a restricted number of

potential private partners able to undertake major infrastructure projects. As a result the project

structure needs to be tailored accordingly. General opinion in the Netherlands suggests that such

a project would not be repeated given the overly generous terms accorded to the private party in

an attempt to attract the required financing.

Case 21. Perpignan – Figueras Rail Concession, France & Spain

Background

The Perpignan-Figueras rail line traces its origin from Spain’s efforts to develop a standardised UIC

gauge network, the European TEN-T network of rail connections and inter-state negotiations which

began in 1992 and resulted in a treaty in 1995 establishing the concept of developing the line under a

PPP / concession model.

The 50km long freight and high speed rail line will provide a vital link between the French and

Spanish rail systems and between the Spanish and European rail networks. It is anticipated that the

line will allow a reduction of 10 to 12 hours for freight and 2 hours for passenger traffic by

eliminating the rail gauge difference between the two countries. This is expected to have a significant

impact on the demand for rail usage. The technical parameters include 50km of line incorporating 5

bridges and an 8km long tunnel. The total investment is in the region of Euro 1 billion of which 32%

is related to the tunnel.

The project has been characterised by strong and effective inter-state cooperation which established a

unified implementation structure for the development and realisation of the tendering procedure.

Although the tendering process had to be re-started, all sides gained valuable experience and this was

put to effective use in concluding the second round. The BOT model and concession contract has

been borrowed from the motorway sector but has been successfully adapted to the requirements of

this rail project. The strong government support and allocation of resources was a major factor in the

successful conclusion of the tender.

PPP Features

The concept of applying a PPP model was fixed by an international treaty of 1995 and the contract is

granted through a bi-national tender process as defined by the EEC Directive 93/37 under the

supervision of the French and Spanish States. The project will be implemented through a BOT

approach including a 50 year operating concession. This is based essentially on the French motorway

concession principle. The main features of the approach include:

· Responsibility for design remains with the States.

· Construction and financing of the project will be the sole responsibility of the private party

although the construction costs will receive a Euro 540 million state subsidy shared equally

between France and Spain and which includes EU grants. This is provided to the private party in

10 semi-annual payments.

· The private party will be required to invest its own equity (estimated at Euro 103 million) and will

have to raise the remainder from private bank loans.

· The operating concession is for a period of 50 years after which the assets revert back to the

States.

· During the concession the private party will operate and manage the infrastructure making it

available to rail operating companies at fixed rates. The contract makes stringent requirements on

maintenance and availability performance (>99.9%) and sets penalties for non-performance.

· The tolls levied on the train operators have been publicly approved and indexed according to

usage type. The maximum tolls are defined in the contract and for the first three years of

operation the tolls will be imposed on a flat rate basis.

· Delivery of the infrastructure must occur within 60 months of contract signature and financial

close must occur within 1 year of contract signature.

The tender was launched in May 2003. The procedure imposed bidding on the basis of a non

negotiable contract, not allowing any alternative technical options and imposing a tight response

schedule.

Bids were received by October 2003 and by November 2003 negotiations were begun with the 2

leading consortia with a contract signed on February 17, 2004.

Given the project’s characteristics, the risk allocation profile can be considered as ambitious as most

of the construction and operating risk is placed on the private party. However a number of checks and

balances have reduced the risk. This includes, on the financial side, the considerable state subsidy

covering 57% of the construction cost and strong support of external financiers on the project and the

concession contract, including bank guarantees. Additionally, although there is a clear motivation on

the private party to maximise the rail users, the traffic assumptions are thought to be very realistic

providing an apparent stability in the financial model.

From the States perspective the contract provides for harsh penalties in case of non-performance and

the ability to use a real threat of contract termination. Successful implementation does however

require effective coordination and a good working relationship between the private party and the

existing infrastructure managers (RFF and GIF) / rail operators and continued effective inter-state

cooperation.

Lesson Learned

This project demonstrates the importance of careful planning and establishing effective oversight and

management structures. Additionally it clearly demonstrates that PPP principles can be applied on

difficult projects provided that the interests of all parties are identified and addressed. The main

lessons learned include:

· Existing PPP structures can be applied across sectors provided that they are correctly adapted to

the requirements of the sector.

· PPP in the rail sector is feasible and can include substantial risk transfer to the private party

provided that the compensation system is effective and sustainable in meeting the needs of all

parties. Additionally there must be a clear demand for the infrastructure providing clarity and

reliability in demand forecasts.

· Tendering procedures can be implemented rapidly provided that sufficient planning is undertaken

and that an effective oversight / management structure exists.

· The project clearly demonstrates the need for and value of committed political and State support

for such projects, particularly in pushing through the tendering and negotiating phases.

· The project also benefits from clarity and simplicity in the division of responsibilities. All

construction is the responsibility of the private party as are the operating and maintenance

requirements. These are clearly defined in the contract.

Case 22. Channel Tunnel Rail Link (CTRL), UK

Background

The Channel Tunnel Rail Link (CTRL) is a 110km twin-track high-speed railway that will link the

Channel Tunnel with a new international railway station at St Pancras in London. When it is

completed in 2006 it will provide continuous high-speed rail connections between London, Paris and

Brussels with trains travelling at speeds of up to 300kph.

It was originally envisaged that the PPP would design, build, finance and operate the CTRL for ninety

years. During the development of the project it was necessary to renegotiate the concession and the

original PPP is now designing, building and financing the project and then selling it to Network rail,

the UK national rail infrastructure company.

History of the Project

When the Channel Tunnel was under construction in the late 1980s the French and Belgian

Governments were already planning and constructing high speed rail links to enable trains to travel at

speeds of 300kph between Paris, Brussels and the tunnel. In contrast, British Rail maintained that the

Eurostar passenger services could be routed on existing tracks through to a new international terminal

at London’s Waterloo Station. This strategy not only added significantly to the journey times but also

increased congestion on the existing tracks in Kent and South-East London.

In August 1987 the UK Government’s Department of Transport published the Kent Impact Study

which demonstrated that if no new railway infrastructure was provided in Kent, the growth of rail

services in SE England would be constrained. This led British Rail to study options for a new rail link

from London to the Channel Tunnel and in 1998 they published five possible routes. At the time this

led to considerable difficulties in the housing market as people were reluctant to buy houses that

would be affected by construction on the five routes. Under pressure from the public and

Government, British Rail chose a single route in March 1989.

In the late 1980s the UK Government was promoting the involvement of the private sector in the

development of public infrastructure. This policy was partly driven by the need to finance the

provision of infrastructure but also by a strongly held belief that the private sector would be more

disciplined than the public sector in designing and constructing infrastructure and more commercial in

operating it. In December 1988 British Rail had invited six private sector consortia of engineering and

transport companies to submit proposals for designing and building the rail link.

Recognising the opportunities in the Government’s approach and the shortcomings of British Rail’s

proposals, the privately-owned consulting engineers Ove Arup & Partners decided to develop an

alternative route for the rail link and in March 1990 published their proposals. The Arup route had

several technical advantages over British Rail’s proposal. It followed existing transport corridors,

avoided many built-up areas and entered London from the East passing through a potential new

transport hub at Stratford. At the time this was seen as an opportunity to connect the rail link with the

London Cross Rail and Jubilee Line Extension projects that were then being planned for London.

Over the next two years there was intense activity as the Eurorail Consortium, which had won the

competition to build the British Rail route, and Arup developed their alternative proposals and lobbied

Government. In October 1991 the Government announced that they preferred the Arup Route and

Arup was invited to join the British Rail team to develop it. Finally in March 1993 the Government

announced that:

· The Channel Tunnel Rail Link would be developed as a joint venture between the public and

private sectors.

· Government would provide substantial financial support to the project.

· Following public consultation, the Government would introduce legislation to provide the

consortium with the planning permissions and other powers that it needed to construct the project.

· This approach would enable the CTRL to be opened by the end of the century.

As the project was now very different from British Rail’s original proposals, a new competition had to

be held to choose the private sector partner. Arup formed the London and Continental Railways

(LCR) consortium with six other companies with interests in construction, transport, property

development and banking and in August 1994 began to compete with three other consortia for the

project. Eighteen months later LCR was chosen by the Government to design, construct, finance and

operate the CTRL. As part of the agreement LCR took over control of the Government’s share in

Eurostar on the understanding that it would use revenues from the existing passenger services through

the Channel Tunnel to help finance the construction of the CTRL.

In 1996 LCR began work on the design and detailed planning of the project that would lead to

confirmation of the financing and to the start of construction. At the same time LCR established a

subsidiary company to design and build the project. Rail Link Engineering was owned by the

engineering and construction companies in the consortium and provided them with a considerable

amount of work in recognition of the investment that they had made in developing the project.

By 1998 it became clear that it would not be possible for LCR to finance the construction of the

CTRL under the existing agreement with Government. The principal reason for this was that the

Eurostar passenger services were carrying fewer passengers that had been predicted and LCR’s share

of the revenues were not forecast to meet the financing requirements of the project. By this time

British Rail had been privatised and Railtrack plc had been formed to own and operate the national

railway infrastructure. Furthermore, a new Government had been elected only a year before and it

had a long history of opposing the previous Government’s policies on PPPs.

Throughout the summer of 1998 there were intensive negotiations between the Government, LCR,

Railtrack and the financial institutions as the Government tried to save the project. The negotiations

were constrained by the legislative framework of the project. The legislation that provided planning

permission for the project named LCR as the promoter. Railtrack was now a privately-owned

company and was the only organisation apart from LCR that could operate the railway. Finally, any

increase in state aid to the project would have to be approved by the European Commission.

In October 1998 agreement was reached on a complex refinancing of the project. Under the

agreement LCR would finance and build the CTRL and then sell it to Railtrack who would take over

responsibility for the operation of the infrastructure. LCR would retain the right to develop the land

associated with the project and the Government would provide certain guarantees to enable LCR to

finance the design and construction work.

The final twist in the history of the project came in November 2001 when Railtrack plc was unable to

finance its operations and was taken into administration by the Government. A year later it was

reformed as Network Rail Ltd, a company limited by guarantee.

The first section of the CTRL was completed in 2003 on time and within budget reducing the journey

time between London and Paris to 2hrs 35mins. When the project is completed in 2006 the journey

time will be reduced to 2hrs 20mins. The total cost of the project will be more than Ј5bn and it will

be completed seven years later than originally envisaged.

PPP Features

Project Structure

One of the most interesting features of the CTRL project is the changes that have taken place amongst

the key participants over the twenty years since the project was originally conceived:

· Promoter – the promoter of the project is the UK Government through the Department for

Transport. When the project was conceived there was a Conservative Government with a

policy of privatising national infrastructure and developing infrastructure projects through

PPPs. In 1997, before construction began, the New Labour Government came to power and

took over responsibility for the project. In opposition they had been strongly opposed to

privatisation and to PPPs. In Government they supported the privatised railway and the

CTRL project. Over the life of the project there has been a total of seven Ministers of

Transport responsible for the project.

· Infrastructure Operator – when the project was conceived the national railway infrastructure

was owned and operated by British Rail. Under the concession that was granted to LCR, they

would operate the infrastructure for ninety years and it would then revert to BR. In 1995 BR

was privatised and Railtrack plc was formed to own and operate the national railway

infrastructure. Under the restructuring of the project in 1998 Railtrack became the operator of

the CTRL. In 2002, Railtrack was replaced by Network Rail.

· PPP Consortium – the idea for the route of the CTRL was developed and promoted by Ove

Arup & Partners at their own expense. When the route had been accepted by Government

Arup formed the LCR consortium to bid for the project. LCR are still responsible for the

design and construction of the project and for property development associated with it.

The PPP Process

The CTRL is a good example of what can be achieved through a pragmatic approach to developing

infrastructure projects through PPPs. From the start of the project there has been a commitment from

Government to use a PPP process to design, build and finance the CTRL. The process has been

changed and adapted along the way as new ideas have been put forward and as problems have had to

be overcome.

Actual Experience

The first section of the CTRL was completed on time and within budget in 1993 and the overall

project is on target to be completed in 2006. There is no doubt that the private sector has

demonstrated its ability to deliver a complex engineering project efficiently.

The numbers of passengers using the high speed train services between London and Paris and London

and Brussels are about half the number that was predicted when the project was in the planning

stages. CTRL has failed to replace the airlines as the mode of choice for passengers on these key

inter-city routes but has significantly contributed to increased market competition on these routes.

The principal reason for this seems to be that the airlines have competed effectively with the railway

and each other over these key routes by reducing fares and improving services. In contrast Eurostar

has been much less commercial than the airlines in developing and marketing its high-speed rail

product. This may however be a feature of rail transport as opposed to air which can be more

responsive to market demand.

When Arup promoted their alternative route for the CTRL in the early 1990s, they placed great

emphasis on the opportunities for high-speed domestic services from Kent and for high-speed freight.

They also stressed that the alignment of the Arup route would enable high-speed train services to be

extended to the north of London. The actual experience has been that very little progress has been

made with these proposals. One of the reasons for this is that the original team did not have

experience of operating a railway and tended to underestimate the operational problems of integrating

high-speed services into the national rail network.

Other UK Rail Projects

When the present Government came to power in 1997 they quickly accepted the privatised structure

of the railway and actively promoted PPPs as the means of financing and building major railway

projects. At the time the CTRL was held up as an example of how things should be done.

In practice nothing has come of these proposals. This is partly the result of other well publicised

problems on the UK rail network. However, the principal reason is that most of the other projects that

have been promoted are upgrades of existing routes and it is extremely difficult to separate these

projects from the ongoing operation of the railway so that a PPP can take responsibility for them.

Lessons Learned

· Major railway projects take many years to plan, design, approve and build. And over the years it

is inevitable that circumstances will change and unforeseen problems arise. The success of the

CTRL is the result of consistent Government support for the project and of a pragmatic approach

to modifying the PPP to suit the changing circumstances.

· While it is advocated that such infrastructure projects be developed in the context of a coherent

sector strategy there is also an inherent risk in linking projects too closely. As in this case CTRL

suffered from the equally poor performance of the Channel tunnel. While the two pieces of

infrastructure are obviously closely linked, provisions may have been necessary to assess the

projects in isolation and the degree of dependence each has for the other. Such analysis may have

allowed more robust financial provisions / safeguards to be developed.

· PPPs can deliver excellent infrastructure on time and within budget. There is consistent evidence

from the UK that PPPs are much more likely to deliver the infrastructure on time and within

budget than the public sector.

· The CTRL has not yet delivered the range of railway services that it committed to and it seems

unlikely that it will. This is partly due to a lack of realism about the problems of integrating a

high-speed railway into the rest of the network. It might also result from the fact that the PPP was

led by engineering and construction companies with a strong focus on building the infrastructure

rather than on developing and marketing the services.

· Even in the core Eurostar services passenger numbers are around half those predicted at the

planning stage. Overestimations of revenues are very common on railway projects (Ref.

“Megaprojects and Risk - an Anatomy of Ambition” by Flyvbjerg, Bruzelius and Rothengatter

Cambridge University press 2003) If the Government had known this at the start of the project, it

is questionable whether they would have supported it.

· It is very difficult to transfer the risks in major railway projects to the private sector. When such

projects get into difficulties, Governments have few options other than supporting the existing

team.

For that material has been used information from official sources which have been translated and formed.