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Establishing a PPP Framework

21.6.2 Appraise the Project

Candidate projects that survive the “screening” are then developed and appraised. Again, this is an iterative, or multi-stage, process. The appraisal report, often called a “Business Case”, is typically the basis for approval to proceed with the PPP transaction.

In describing the framework in this PPP Guide, project and procurement decisions are considered as part of the same process. A two-stage process, however, is not always practical, as outlined in BOX 6.

BOX 2.6: Investment Decision versus a PPP Decision

It is desirable for governments to separate the investment decision from the procurement decision.

· Investment decision: Is it a good project? Is the government willing and able to provide the required funding?

· Procurement decision: What is the best way of buying the project? Does the PPP procurement offer better Value for Money than the best practicable public sector delivery model?

This two-stage process has a number of benefits, including:

  • All potential projects (regardless of procurement method) compete for the same finite funds, thus ensuring that projects are appropriately prioritized in terms of strategic importance;
  • The choice of procurement method is not prejudiced by the perceived budget impact, that is, the government dispels the common misconception that PPPs are an alternative to government borrowing; and
  • If Value for Money is not achieved through a PPP tender process, the investment can go ahead under a different procurement methodology.

However, in reality many governments do not develop comprehensive strategic planning processes in each sector, nor do they undertake systematic cost benefit and technical analysis of all projects. Therefore, a jurisdiction that does not routinely do such analysis can do one of two things.

  • Establish requirements for the systematic appraisal of all projects: While this is ideal, it requires wide-scale government support. Therefore it may not be achievable without a mandate or within a short period of time; and
  • Under the mandate of the PPP framework, establish a requirement for the appraisal of PPP projects: In this way, all PPP projects would have to be appraised to determine whether or not they are good projects (before being implemented as PPPs). A disadvantage of this approach is that PPP projects are made subject to stricter scrutiny than non-PPP projects. The main advantage of this approach is that it ensures that only worthwhile projects are implemented under the PPP program. However, it does not subject the PPP program to the kind of complexity and delays likely in trying to introduce proper project appraisals for all public sector projects. A further advantage is that project appraisal techniques that are shown to work for PPP projects could later be extended to other, non-PPP, projects.

Decision criteria

At this stage, the framework should ensure that only those projects which are ‘good projects’ and ‘suitable for PPPs’ proceed to development. Good projects can be defined as follows.

  • Economically, technically, environmentally and legally feasible: This feasibility assessment is not unique to PPPs. All government projects, regardless of the procurement method, should demonstrate that they are ‘good’ projects. Specialist skills are required to undertake such an appraisal, so when such skills are not available in-house, advisors should be appointed; and
  • Affordable: Affordability needs to be assessed from both the government and user perspectives. The government should only proceed when government liabilities, both direct and contingent, are within budgetary constraints. In addition, the services provided by the PPP need to be affordable to the users. False expectations of user willingness to pay may lead to underutilized infrastructure and financial trouble for the project.

Projects that are suitable for PPPs are those that can demonstrate the following.

  • Commercial viability (and bankability): PPPs require the participation of the private sector. If the project can not provide financial returns for the level of risk incurred by the private sector, then it will not be commercially viable. This means the project must be able to generate returns to the investor and enable investors to raise debt from lenders, while also meeting the requirement of affordability to the public sector; and
  • Value for Money: PPPs are just one form of procurement. A PPP is considered Value for Money if the project is expected to deliver higher net economic benefits if done as a PPP.

There are many ways of assessing Value for Money. The traditional approach developed in the UK and used in many Australian jurisdictions as well is to determine whether a PPP will have a lower (risk-adjusted) cost to the government than a conventional procurement. The assumption in this approach is that the private company can be incentivized to manage risks better than the public sector, thereby improving overall economic outcomes.

Another approach is to see which delivery option will maximize benefits for a given budget. In New Zealand, the test is which approach is likely to deliver greater net economic benefits.

Value for Money (VfM) is usually assessed in a qualitative way during an initial screening stage under what are sometimes called “PPP suitability tests” (see chapter 3.10), and it is then quantified if the project moves on to a full appraisal.

It is important to recognize the limitations of quantitative Value for Money analyses. They are necessarily based on assumptions and forecasts, so they will only indicate whether the chosen procurement method will deliver higher net economic benefits. Because of this, in Canada the outcomes of quantitative Value for Money analysis are treated as an estimate only and in some cases are used amongst other qualitative indicators to select a procurement option.

  • The ability to be ring-fenced: The project needs to be sufficiently separated from other government systems to ensure that accountability can be provided and interface risks[64] are limited;
  • Definable outputs: Clear, specific, and measurable outputs are essential in a PPP, so that the contract can be monitored and enforced. Designing the contract around outputs also has the benefit of giving the private party the freedom to design more efficient and innovative ways of delivering a service. This compares to more traditional contracts in which designs and inputs are specified; and
  • Sufficient information to be able to assess costs and risks: For the potential bidders to be willing to dedicate resources to developing a bid, they need to be able to calculate what the potential liability of the PPP might be. This is only possible if the risks of the project can be identified and then allocated to either party.

An appropriate procurement strategy should also be developed during this phase. A sound procurement strategy is needed to attract suitable private partners, and to make them compete to offer the government the best deal. The procurement strategy should engage potential bidders early in the process. In this way, the government can ensure the opportunity is one that suitable private firms will bid on. It will also allow their ideas to be incorporated in the contract design.

Procedures and institutional responsibility

The framework should create a principled, predictable way of selecting PPP projects. To do this, the PPP framework will need to specify the following:-

  • The required content of the PPP appraisal: This includes the studies that need to be done (for example, demand forecasts) and the questions that need to be answered to determine if a project is economically, financially, technically, environmentally, and legally feasible (the PPP appraisal is also called a business case or feasibility study); and
  • Who approves the PPP appraisal: As outlined in the previous section, any PPP project will require the support of numerous stakeholders to be successful. The PPP framework will need to identify the approval process needed for proceeding to the next phase. Many jurisdictions require a decision by the cabinet in favor of proceeding. Others delegate the decision to a government agency, perhaps with the assent of one or more central agencies or a PPP unit.

An example of PPP appraisal criteria is presented in BOX 7. Refer to chapter 4 for details as to how to undertake the project appraisal stage.

 

BOX 2.7: PPP Appraisal Criteria in Indonesia

The Indonesia Infrastructure Guarantee Fund (IIGF) assesses PPPs using the following appraisal criteria.

  • The project is viable, that is, it is technically, economically, and financially viable as well as environmentally and socially desirable;
  • Project risks are identified, allocated properly with effective mitigation plans;
  • The procurement process is sound as shown in the procurement plan;
  • The procuring authority has the capacity to manage the contract and risks; and
  • IIGF approval, based on these criteria, is required for projects that need government guarantee in any way.

Source: Indonesia Infrastructure Guarantee Fund (2012) Infrastructure Guarantee Provision Guidelines.

 

[64] The relationship with other contracts or activities of the government, or dependencies of the government, on the successful performance of the PPP contract.

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