Demand risk transfer should be always be considered with caution. Significant transfer of the risk, with no mitigation or sharing mechanisms, should only be considered when boosting demand is essential to the success of the project from the government’s perspective (see section 4.9). Another general rule for deciding the allocation of use/demand is the scope of the project. If the essence of the PPP is to operate institute tariffs or collect tolls, some exposure to risk should naturally be included in the contract. However, if the contract does not provide the necessary tools for managing the demand risk (basically, the ability to influence the management of the service provision to the user), the risk should not be transferred.
In social infrastructure projects, higher use of the facility is generally not a natural policy objective and volume/use risk should be removed from the contract.
In transport projects, if the transport service to the user is not included in the scope of the contract, but the contract relates only to the infrastructure, transferring demand risk does not provide Value for Money.
When the project contract is designed on the basis of user payments, it is understood that there is an explicit intention of the government to charge users, so the higher the use (the demand for the service) the better is the outcome[4]. An example is a road conceived to attract users from toll-free alternatives to lower congestion.In such situations and in general, when the higher utilization of the asset is a strategic objective for the government, demand risk should be transferred. But caution should be taken if the risk assessment evidences that uncertainty is highly significant. In such contexts, it is good practice to establish risk-sharing mechanisms, such as minimum traffic (or minimum revenue) guarantees in user-pays projects, or a system of bands in volume-linked payment mechanisms (see section 4).
In public transport projects, assuming a vertical integrated approach (i.e. service to the user is included in the scope of the infrastructure DBFOM), it is clear that higher utilization is a success in terms of public strategy. However, providing the public with a safe mobility option is essential.Most of the best PPP structures for large integrated transport infrastructure PPPs are based on a mixed revenue regime. Part of the payments are linked to volume/actual use, but with volume risk being tempered with a portion of payments based on quality or availability[5].
Demand risk may occur in a contradictory form: the higher the demand, the higher the risk. This happens in projects where the revenue is based on availability. In such contexts, a volume of use higher than anticipated by the government, in terms of the design of the facility, may seriously impact the service quality or even the availability. A compensation mechanism should be established in these cases so as to restore the economic equation of the project contract. This can be done by including in the payment mechanism a portion linked to the use of the service or other measures.
When limiting the private partner’s exposure to volume risk, the contract should provide access for the authority to the upside if demand is greater than expected.
Subsets of demand or volume risk: competing facilities and network risks
The common cause of lower demand is an economic down-turn which as a general business risk should be borne by the private partner. However, lower demand may also depend on competing facilities, network risks, or other subtle risk events.
If a competing facility promoted by the authority (or by the government in general), which was not announced or planned at the time of the tender, causes a down-turn in traffic compared to previous projections, this is commonly (or should be) considered a retained risk event. Competing facilities are the clearest case of network risks[6] that should be taken back by the authority.
An example of a subtle network risk is the risk related to traffic light priority in light rail transport (LRT) projects. Usually, a government will grant priority at intersections and traffic lights for the LRT vehicles to maintain the commercial speed levels as prescribed. So when the mobility authority does not provide traffic light priority to the light rail and this affects the commercial speed, the private partner should be given relief from punctuality obligations and an excuse for certain payment deductions.
[4] However, there may be situations where user payments are considered as a source of funds for the project, but where maximizing the use is not the highest priority of the authority (for example, some dynamic tolling aimed to manage traffic congestion). Therefore, the authority may decide to remove the demand risk and assume it by structuring the revenue regime under an availability payment scheme.
[5] In some light rail schemes based on volume payments, the risk is also shared by a system of bands as in some shadow toll roads. For example, this is the case for a number of light rail transport (LRT) PPPs in Spain.
[6] For a definition and deeper explanation of “network risks”, see Partnerships Victoria (Risk Allocation and Contractual Issues, 2001). Other examples of network risk, according to Partnerships Victoria are when a government agency controlling bulk water distribution may be unable or unwilling to supply raw water to the PPP water treatment facility in the necessary quantity or quality. A more abstract example of network risk is the risk that government will enter into other arrangements for accommodation services competing with those supplied under the contract.
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