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1.2.9 Other Operating Costs

General project company costs

General company costs include the permanent staff of the company, which is usually more of an administrative centre with limited personnel. For instance, it could include staff to manage the finance of the project and interact with the procuring authority and the lenders.

These costs include the current costs of the headquarters of the SPV and administration costs, such as accounting, financial, auditing, and so on. The most relevant current costs are allocated into the contract structure and passed through to contractors or second-level SPVs that handle operations and/or maintenance.

The cost of the performance guarantees may also be considered here. The risk associated with these costs is always borne by the private partner.

Utility costs

Utility costs, especially electricity/energy, as costs of the project (that is, costs necessary for, and directly linked to the service) are very significant, especially in rail and water projects, but also in facility-building PPPs.

This risk can be difficult for the private partner to control and manage, but by default, the general allocation is to transfer the risk to the private partner as an incentive for the private partner to manage the risk by negotiating appropriate arrangements with utility suppliers.

A shared approach may be considered in specific projects and contexts, basically when the utility cost item has a significant weighting in the O&M cost composition, and where volatility of the energy market is very significant. This avoids the private party building exaggerated contingencies into the service price that will not provide Value for Money.

In these cases, it is not uncommon to moderate the risk through a risk-sharing approach that may cap the total cost to be borne by the private partner, share extra costs above a threshold (and share upsides due to cost decreases), or a combination of the two.

The public partner should also analyze whether it can secure better terms by negotiating directly with utility providers. For example, the government may be able to secure lower pricing than the private partner due to the government’s ability to negotiate on a whole-of-sector or whole-of-government basis.

In some Design-Build-Finance-Manage (DBFM) PPPs in which the infrastructure is operated by the public sector (for example, a high-speed rail [HSR] system where the government remains as the administrator of the traffic system and/or the trains are operated by a state-owned enterprise [SOE]), the utility consumption is largely determined by the public sector’s operating activities. Therefore, it may be appropriate for the public partner to bear the entire utility cost risk, or to bear the risk of utility consumption departing from pre-agreed levels.

Soft services

This cost concept is generally relevant in social infrastructure projects, and it refers to services such as catering, cleaning, waste disposal, and others. For these services the risk of cost deviations that are not corrected or compensated for naturally by the general indexation adopted for the service payment is higher than for conventional maintenance costs.

This is due to the more specialized profile of the service providers and the higher volatility of this market in terms of labour costs, as well as the volatility of certain inputs (for example, food in the catering service, which may be significant in a hospital PPP or a school PPP).

As with any basic cost item related to works and maintenance, this risk may be handled by the SPV passing it through to an operator together with the obligation to render the service. However, soft service providers are more reluctant than other more conventional operators to accept long-term commitments in terms of price.

When there is strong evidence in the specific market of the inability of the private partner to manage this risk by transferring the cost variation to a contractor in the long term, the authority may consider risk sharing by means of market tests or benchmarking (see section 4.10[7])

Insurance costs

This risk refers to the risk of the price for the insurance developing in a different way than anticipated, such that it is not compensated for by the indexation of the service payment.

The most extensive approach worldwide is to transfer the risk to the private partner. However, when the cost item has a significant weighting (which will depend also on the insurance requirements defined in the project contract), this risk may be shared by the public partner. This may happen when and to the extent that the insurance costs become significantly different from what was reasonably expected. This is done under a benchmark type of approach.

The benchmark curve or baseline curve of premiums, against which the divergence of the actual cost is assessed, is built on the basis of the actual cost of premium contracted at the inception of the project, together with the assistance of advisors, so as to agree on the final benchmark. The benchmark will usually be indexed by the general CPI, and when the actual cost of the insurance premium diverges by more than a certain percentage (commonly in a range of 50 to 100 percent), the private partner is entitled to claim compensation equal to the extra cost above the threshold. Conversely, when the actual cost is symmetrically below the threshold, the public partner will have the credit for the unexpected benefit.

These type of provisions are complex to implement and require specialized insurance advice. Insurance premiums may suffer deviations related to the performance and/or the credit standing of the project company, its shareholders, or the contractors. Therefore, this effect should be excluded from the risk-sharing mechanism to the extent possible.

 

[7] Also, Standardization of PFI contracts, Version 4 (HMT 2007) provides a detailed explanation of market testing and benchmarking as alternative tools to deal with price/cost variations on services.

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