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Appraising PPP Projects

48.2 Assessing Commercial Feasibility in User-Pays PPPs

In user-pays PPPs, the exercise of commercial feasibility examines the capacity of the project to generate enough cash resources to meet its expenses. The exercise might consider several scenarios for the prices charged to users (if this is possible) or a given price that cannot be altered due to regulatory or legal standards. In either case, there are three possible outcomes.

The first is that the project revenue is expected to be sufficient to meet the commercial feasibility criteria discussed in the previous subsection, in which case the project is considered feasible.

Second, it is possible that the project is expected to be able to generate inflows much higher than those required for the project to be commercially feasible (that is, the project might be “over-feasible”). In this case, the government might consider reducing the reference price accordingly (if possible), or stipulating payments to be made by the private party to the procuring authority in order to balance the project’s financial equation.

Finally, the expected revenue may not be sufficient to verify that the project is feasible from a commercial perspective. This may be because the prospective demand is not enough even at the tariff that maximizes the revenue. For instance, in transportation, there is generally a maximum possible level of revenue after which an increase in price does not augment the total revenue because the elasticity of the demand is higher than one. Hence, the reduction in usage outweighs the increase in revenue from the remaining users. Or it may be because the user paid revenues can also be capped for policy reasons that stipulate desirable maximum prices, or by regulatory regimes that determine specific price ranges.

In these latter circumstances, the options open to governments are to cancel the project, revise the scope, adjust the technical requirements (that is, by reducing the responsibilities of the private sector or decreasing the size or capacity of the infrastructure), or provide government support, typically in the form of direct government payments to the project company (see viability gap funding in chapter 1 box 6).

 

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