By: Pinsent Masons Tue 13th November 2012
Under what circumstances is it suitable for the public sector to grant a company rights to exploit revenues of an infrastructure asset?
Description and overview
The concession model is a favoured model for infrastructure.
The concession model is similar to the Availability and Performance model except that instead of government cash flows attached to availability and performance, the concession involves cash flows from users/consumers (or a mixture of both).
The concession company is granted the exclusive right by the public sector to exploit the revenues of the asset.
The model is most prevalent where there is inherent demand and an intrinsic value in using the infrastructure.
They tend to be more "one off" projects since more industry based concessions would probably fall within the Regulated Asset Base Model.
The concession model is generally a design, build, finance and operate model with the concession company first constructing the piece of infrastructure and subsequently managing and operating it and retaining the revenues.
The model throws up similar risk issues for institutional funders as does the Availability and Performance model.
Construction risk is the most obvious where the PIP have stated they will not take the risk although progress on the "Early Stage Fund", which it is stated will take the risk, is as yet unknown.
Otherwise construction will need to be financed from a mix of equity and development finance or risks guaranteed in whole or in part by the public sector.
The current lending climate will probably require a greater loan to equity ratio than currently with the potential consequent increase in cost. If a separate development finance facility is used the development finance will need to be subsequently refinanced by the Infrastructure Fund.
It will be very difficult (particularly in volatile markets like the present) to tie down the cost of finance from the Infrastructure Fund.
There will therefore be a refinancing risk which either the public sector will need to meet or otherwise a significant contingency may be built into the overall cost of the project.
The main area of contention during the operational period is around assuming volume risk.
Concessions with multiple sources of income will be able to spread this risk. Single sources of income (eg road charging) give rise to the greatest risk and payment for this type of concession is often on a mixed income and availability basis.
Demand and volume risk will also be one of the primary determinants for balance sheet treatment.
The more risk transferred the more likely it will be off the public sector balance sheet. For other areas of risk such as compensation on termination it is likely that institutional investors will push for something close to a full return of capital (and returns where it is a public sector default).
- Design, build, finance and operation risk transferred;
- Incentives built into model to complete on time and to budget;
- Long term repairs and maintenance of the infrastructure over the length of contract together with lifecycle renewal;
- With appropriate development finance facility, contractor or public sector coverage the Infrastructure Fund will be de-risked from construction risk;
- It has potential to be off balance sheet;
- User fees can be hedged against inflation;
- Can act as "growth catalyst" for surrounding area.
- Demand and volume risk transferred to the concession company (may be only in part if part availability payment);
- Potential for statutory regulation of user charges;
- Potential for competition to impact on user charges;
- Risks deriving from ultimate contractor failure (eg latent defects) unless underwritten by third party;
- Absence of regulator creates less certainty.
The concession is a favoured model for complex "one off" pieces of infrastructure.
Whilst it has the benefits of strong user charges and the potential for inflation hedging enabling RPI indexed payments to the Infrastructure Fund it does have the draw backs of being green field and giving rise to demand and volume risks.
Although the latter may be mitigated in part institutional funders may look to public sector minimum guarantees on volume and user fees.