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Appraising PPP Projects

45.1 Revenue Regime and Payment Mechanism

The revenue regime of PPPs refers to the source of revenues collected by the project company. This can be broadly divided into two major groups. The first is the user charges. The textbook examples are the tolls collected directly by the private partner in road concessions, or the fees paid to privately-operated metro trains. PPPs solely funded with user charges are known as user-pays PPPs.

The second group is the governmental payments during the contract (that is, service payments[3]), often used in PPPs for social infrastructure but also to reduce the need to charge users in economic infrastructure[4]. PPPs solely funded with public payments are known as government-pays PPPs.

User-pays PPPs are a popular revenue regime for governments due to the practically neutral budgetary impact of such projects. There is also a strong economic case for requiring users of infrastructure to pay the effective marginal cost of the infrastructure-based services that they use. This aligns incentives and avoids excessive use of infrastructure-based services, also reducing the common negative externalities of such use.

Some projects, based on the user-pays model can be regarded or estimated as being “over-feasible”, in the sense that the revenue is sufficient not only to meet the costs of the project, but also to meet a fee to be paid by the private partner to the contracting authority. Imposing “concession fees” should be carefully considered, and there are other ways to capture the potential excess of profit – see chapter 5.8.

Conversely, the total revenues generated by user charges might be insufficient to achieve the required levels of revenue, especially if the demand is very sensitive to price changes and, thus, marginal increases in price will reduce the total revenue. In this case, the government may choose to provide direct financial support to ensure commercial feasibility, as described in chapter 1. One of the most common types of support is the provision of direct government payments to the project company. This is a mixed revenue regime. The payments may be grants made during the Construction Phase (sometimes called co-financing) or complementary service payments made over the operational phase of the contract (a hybrid payment mechanism).

Another situation in which government payments are considered is a deliberate attempt to reduce the price paid by users for political reasons. There is a direct trade-off between the price charged to users and the government payments required to ensure the project is commercially feasible.

Government payments can also be the only source of revenue of the project company during the life of the contract. This is the government-pays revenue regime. It is typically used for social infrastructure, such as prisons, hospitals, and schools, but it can also be used for economic infrastructure such as roads without tolls. Government-pays PPPs are very common in sectors in which public policy indicates there should be service delivery without user charges.

Purely government-pays PPPs can also be used to allocate the demand risk to governments. The typical example is tolled roads in which the only revenue for the private partner comes from the government which, in turn, is responsible for collecting the tariffs. In this case, the total revenue of the project company does not change due to variations in demand, and the government obtains revenues that can be higher or lower than the payments made to the project company.

A choice needs to be made to define the revenue regime of the project contract. This decision should be made considering policy directives, as well as the results of several of the feasibility exercises during the Appraisal Phase (such as the legal due diligence, commercial feasibility, and affordability).

When projects include direct government payments, whether or not they are concurrent with user-paid revenues, their basic characteristics (such as the triggers, occurrence, and calculation) should be developed as part of the preliminary PPP structure. This is done in a payment mechanism.

The payment mechanism is detailed during the Structuring Phase. However, an outline of its key components must be assumed in the preliminary contract structure since it is key to an accurate financial model as well as to other assessments described below[5].

Generally speaking, the payment mechanism can assume triggers for the public payment based on different types of events such as the infrastructure availability, demand, or output.

The governmental payments can also vary in time. In all cases, they only begin once the service is operational and are usually regular during the contract. In other cases, they can be designed in different profiles over time to meet bankability requirements (see section 1.8 below). In some countries, it is also possible to see co-financing approaches in government–pays PPPs (usually in the form of up-front grant payments – see chapter 1.7.3).

During appraisal, at the very least, the general assumption on specific triggers and timing of the repayments must be made. This, albeit revisited in later phases, is required not only to test commercial feasibility, as described in the following sections, but also to evaluate affordability, the impact of the project on public debt, and Value for Money.

 

[3] Note that the PPP Guide refers here to payments for service as a source of operational revenue for the private partner, rather than other kinds of public payments (for example, those including construction or grant payments).

[4] In reality, there are also revenues that escape this broad grouping like financial revenues (for example, interest on working capital) and commercial revenues (for example, selling advertising space on the walls of a metro station or promoting the commercial use of land as a part of a transportation project). However, they generally represent a small proportion of the total revenues of the project company.

[5] The EPEC’s The Guide to Guidance: How to Prepare, Procure and Deliver PPP Projects, presents a useful summary, with examples, of payment mechanisms related to PPP projects, and refers to further guidance on the topic.

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