private and public partnerships move mainstream

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Private and Public Partnerships Move Mainstream

Greg FitchAugust 16, 2016



WPI Department of Civil Engineering ‘98Columbia University Department of Civil

Engineering – PhD Candidate


Project Controls Lead AnalystConstruction & Procurement in New York City


PUBLIC-PRIVATE-PARTNERSHIPS (PPP OR P3)

1. Characteristics of PPPs2. Overview of P3 Project Finance Structures3. Common Aspects P3 Project Agreements4. Project Risks & Project Procurement Process5. PPP Financial Markets, Structure & Model

Traditional and Alternative Procurement Methods Defined

Design-Build – Owner uses a competitive proposal process to contract with a

private entity to design and build a project.

Design-Build-Operate – Owner uses a competitive proposal process to

contract with a private entity to design and build a project but also adds

operations to the DB Foundation.

Design-Bid-Build – Traditional method in which the agency or owner

contracts with separate entities for the design and construction of a project.

CHARACTERISTICS OF PPPS

DBFO or Public-Private-Partnership Procurement Method Defined

Design-Build-Finance-Operate or Public-Private-Partnerships (PPP or

P3):

Owner uses a competitive proposal process to contract with a private

consortium to finance, design, construct, maintain and operate a

facility and / or build a project.

Congressional Budget Office (2012)

Variety of alternative arrangements for Projects that transfer more of the risk associated with control of the project to the private sector.

Dr. Michael J. Garvin (May – June 2011 edition of TR News)

Long-term contractual arrangements between public and private partners for the creation and enhancement of assets, bundled together with the provision of services and capital financing through a private entity.

FHWA – Office of Innovative Project Delivery

Contractual agreements between a public agency and a private entity that allow for greater private participation in the delivery of transportation projects. Participation involves the private sector taking on additional project risks, such as design, finance, long-term operation, and traffic revenue.

Why Public-Private Projects Relevant?• ALTERNATIVE PROJECT DELIVERY METHODS

─ Solution to Resolve Investment Deficits in Infrastructure

• CENTRAL GOAL OF P3 PROJECTS─ Alleviate Government Budgets with Funding Provided by External

Financiers. (Algarni et al. 2007)

• P3 PROJECTS INCLUDE EQUITY SPONSORS─ Most Capable of Managing Financial Risk & Owner-like Responsibility

w/out Actually Transferring Ownership. (Culp 2011)

PPP VS. TRADITIONAL DELIVERY

• Private Perspective • Public Perspective• Service-Oriented Delivery

Model• Large Scope & Long-term

Contracts• High Priority Projects• Optimize vs. Maximum Risk

Allocation• Opportunities for Stable

Investment

• Public Need & Benefits─ Local, Regional & State─ Reliable & Safe Infrastructure

Procurement─ Traffic Congestion Relief─ Electrical Power Demands─ Other Public Use Needs

• Financial Feasibility─ Alleviate Government

Budgets─ Better Value for Money─ Market Demand for Projects

CHARACTERISTICS OF PPPs

• PROJECT SPECIFIC CONTRACT INCLUDES:

─ Significant New Capital Expenditures [large EPC or DB contracts]─ Long-term O&M Responsibilities─ Private Financing Allows Public Funds To Be Used On Other Projects─ Project Specific Revenue Source

• PUBLIC PERCEPTION OF “PRIVATIZATION”:

─ Convey Ownership of Public Assets Transferred to Private Sector─ Rely on Private Sector to Provide Services Formerly Provided by

Public Owner or Agency─ Project May Not Require or Support Private Financing Based on

Generated Revenues

• Three Main Models for Project Agreements:

• Offtake Contract (i.e. Process-plant Project):─ The Project Company produces a product and sells it to an Offtaker.

• Concession Agreement (i.e. Toll Road Project):─ The Project Company provides a public service, and collects User

Charges.

• Availability-based Contract (i.e. PFI Model):─ Contracting Authority pays a Project Company for making a project

available for use.

OVERVIEW OF P3 PROJECT FINANCE STRUCTURES

Project-Finance Structures• Process-Plant Projects:

─ Projects where there is an input at one end of the project, which goes through a process within the project, and emerges as an output.

• Concession Projects:─ Construction or refurbishment of public infrastructure with revenues

derived from tolls, fairs, or similar payments from by users.

• Private Finance Initiative Model:─ Construction / Refurbishment of Public Buildings or other public

infrastructure with revenue derived from payments by a Contracting Authority (CA).

Example of Project-Finance StructuresProcess-plant ProjectInvestors

16 CE590 – P3 Project Financing

Finance

Lenders

Project-Finance DebtEquity

Government Electricity Distributor

Power Purchase AgreementOperating License

Project Company

Example of Project-Finance StructuresProcess-plant Project - Subcontracts


Project Company

EPC Contract Fuel Supply Contract

Operation & Maintenance Contract

Construction Contractor

Fuel Supplier

O&M Contractor

Process-Plant Project• SOLAR PLANT PROJECT - Roserock (Project Company) will sell

the energy, capacity and green attributes to the City of Austin based on the terms of the Power Purchase Agreement signed May 1, 2014.

KEY TERMS VALUES

Effective Date 5/01/2014

Delivery Term 20 years

Expected Capacity (which may not be modified by RE Roserock to change by +/- five percent) 150 MW

Maximum AC Output 150 MW

Minimum Capacity 140 MW

Contract Price ($/MWh) $44.95 (no escalation)

Process Plant Project

Holdings Company “A”

Short Term Credit

Agreement

Longer Term Credit Agreement

“ProjectCompany”

Project Sponsors

Holdings Company “B”

Project Completion

Engineering & Construction

Operations & Maintenance

Funding

Funding

Purchase Shares

Purchase & Sale Agreement Equity Related Contracts

Financial Lender & Debt Related

Contracts

Initial Investors Other Investors

Other Investors

100%

Example of Project-Finance StructuresToll-Road ConcessionInvestors


Finance

Lenders


Contracting Authority Road Users

TollsConcession Agreement

Project Company

Example of Project-Finance StructuresToll-Road Concession - Subcontracts


Project Agreement

Design & Build Contract

Toll Operation Contract

Maintenance Contract

Design & Build Contractor

Toll Operator

Maintenance Contractor

Concession Project• I-595 CORRIDOR ROADWAY IMPROVEMENTS

─ Located in Broward County Florida.

─ Opened to Traffic in 1989 – With Accelerated Traffic

─ Roadway Improvements includes Reconstruction and Widening of I-595

with various improvements to ramps, interchanges etc.

─ Private concessionaire designed, built, financed and will operate and

maintain project for 35 years.

─ $1.8 Billion (present value in 2009 dollars; a 5% discount Rate)

Example of Project-Finance StructuresPrivate Finance Initiative (PFI) Model

Investors


Finance

Lenders


Project Company

Contracting Authority

Project Agreement

Example of Project-Finance StructuresPFI Model - Subcontracts


Project Agreement

Design & Build Contract

Maintenance Contract

‘Soft’ Services Contract(s)

Design & Build Contractor

Service Provider(s)

Maintenance Contractor

Project Finance Initiative Model ProjectFargo Moorhead Flood Diversion Channel

Red River Basin surrounding Fargo, ND & Moorhead, MN

─ Red River Basin & Diversion Authority (includes counties in ND and MN)

─ Increased Frequency and Severity of Floods

─ 30 mile wide Diversion Channel in ND w/ 150,000 acre-feet of Upstream

Staging

─ Federally Authorized in February 2016

─ USACE as a Demonstration Split Project Delivery Model

Fargo Moorehead Flood Diversion Channel

• FINANCIAL OVERVIEW & SPLIT PROJECT DELIVERY MODEL

1. USACE will deliver Southern Embankment and Related projects with

Multiple Design-Bid-Build Projects.

2. Diversion Authority will Deliver Channel & Associated Infrastructure

with Locally-led P3 delivery includes a combination of public and

private financing, leveraging state and local funding sources

• FARGO MOORHEAD FLOOD DIVERSION P3 FINANCIAL OVERVIEW FOR DIVERSION CHANNEL

─ Project Delivery Method

• Design-Build-Finance-Operate-Maintain

─ Construction Funding

• Private financing (debt & equity) secured by P3 Consortium

• Diversion Authority will make Milestone Payments to P3 Consortium

─ Payment Structure for O&M Scope (30 -50 year term)

• Multiple Funding Sources to Meet Debt Service and O&M Payments include

State Appropriations, Sales Tax, Asses.

COMMON ASPECTS P3 PROJECT AGREEMENTS

Common Aspects of Project Agreements• Contract Term

─ Useful Life of the Project─ Term of Debt─ Equity Return

• Payment Mechanism─ Payment on Project Completion─ Level Payments─ Inflation Indexation

• Contract Monitoring by the Offtaker / Contracting Authority─ Design, Construction and Operation─ Subcontracts─ Financing

Common Aspects of Project Agreements• Performance Bonding and Other Guarantees

─ Offtaker / CA Requires a Performance Bond─ Duplicates Lenders’ Requirements of Project Company ─ Project Company Incentive is to Generate Revenue

• Compensation Events – “Time & Money”─ Project Company Receives Reimbursement from Offtaker/CA─ Breach of Obligation (e.g. provide access to site)─ Delays in Construction / Contract Variations by Offtaker/CA

• Excusing Causes─ Protects Project Company against penalties or deductions─ Temporary Closure of Project by Agreement with Offtaker/CA─ Implementation of a Contract Variation or Change of Law

Common Aspects of Project Agreements• Relief Events “Time No Money”

─ Force Majeure - No fault & Cannot be Controlled by Any Party─ Examples include Nat. Disasters, Embargos, Labor Strikes etc.

• Step-in by the Offtaker / Contracting Authority─ Offtaker / CA may have the right to operate the project itself─ Contract Payment to Financial Lenders Continue─ Investors & Lenders Uneasy about Terms when Step-in is Permitted

• Termination─ Default by Project Company or Offtaker / CA─ Force Majeure Events – Impossible to Complete or Continue─ Complicated Terms and Numerous Scenarios

Common Aspects of Project Agreements• Change of Ownership

─ Offtaker /CA May Restrict the Sale of Sponsor’s Share─ Restriction is generally Limited to Construction Phase─ Project Technology Dependent on Project Sponsor

• Dispute Resolution─ Preferable Dispute Resolution by Arbitration─ Avoid Disputes Related to Poor and Ambiguous Language─ Standard Construction Contracts not Suitable for P3 Projects

PROJECT RISKS &

PROJECT PROCUREMENT PROCESS

Risks & Selection of Project Delivery MethodCASE STUDY

─ Pima County Regional Wastewater Reclamation Department (PCRWRD)─ Wastewater treatment facilities & conveyance systems in Eastern Pima

County, Arizona─ Lower Effluent Limits from Roger Road Wastewater Treatment Facility

into the Santa Cruz River Required Construction of a New Wastewater Treatment Facility

─ Considered DBB for Conceptual Timeframe & Cost Estimates for Design & Construction

─ Recommended Alternative Procurement methods be considered including: DB, DBO, DBFO

(Regional Optimization Master Plan – Alternative Delivery Methods Final Report 2008ASCE Journal of Eng. Construction Management - Fitch et. al. Jan. 2015)

Risks & Selection of Project Delivery Method• OPTIMUM PROJECT DELIVERY METHOD

─ Effective Allocation of Risks Between Project Participants Best Able to Manage Particular Risks

─ Costs Associated with Each Risk & Total Project Cost are Lessened

• MODEL FOR SELECTING PROCUREMENT METHOD─ Optimize Risk Allocation─ Perform and Compare a Risk Adjusted PV Analysis For Each Delivery

Method Under Consideration (DB vs. DBO vs. DBFO)

Risks & Selection of Project Delivery Method

• RISK ADJUSTED PV ANALYSIS:

─ CC0 = Capital Costs for Design and Engineering in year 0;─ NCFt = Net Cash Flow in Year t; and ─ i = Discounted Rate for Both Interest and Inflation

Risks & Selection of Project Delivery MethodPCRWRD LIFECYCLE COSTS USED FOR PV ANALYSIS

New WRC Project DB DBO DBFOCapital Costs (Design, Construction)

$212,000,000 $206,000,000 $206,000,000

Yearly Operation & Maintenance Costs

$7,000,000 $5,000,000 $5,000,000

Risks & Selection of Project Delivery MethodPCRWRD ECONOMIC VARIABLES USED FOR TO SIMULATE THE

RISK ADJUSTED PV ANALYSISInterest Rates Rate & Term (yr)

Tax Exempt 5.0%Muni Bond Term 20Private Rates 6.0%Private Bond Term 30

Inflation Rates RateCapital Inflation Rates 5.0%O&M Inflation Rates 2.5%Energy Inflation Rate 3.0%Discount Rate 6.0%

COMPARISON BETWEEN THE RANGE OF PVs FOR THE NEW WRC USING DB VS. DBO USING CRYSTALBALL SOFTWARE:

COMPARISON BETWEEN THE RANGE OF PVs FOR THE NEW WRC USING DBO VS. DBFO USING CRYSTALBALL SOFTWARE :

Risks & Selection of Project Delivery MethodPCRWRD RISK ADJUSTED PV ANALYSIS RESULTS:

Procurement Process

Baseline PVRisk Adjusted

Mean PV 90% Certainty PVStandard Deviation

DBO $312,000,000 $350,000,000 $370,000,000 $12,000,000

DB $330,000,000 $369,000,000 $391,000,000$13,000,00

0

DBFO $332,000,000 $373,000,000 $394,000,000$12,000,00

0DBFO Risk Adjusted NPV Impacted by 6% Interest Rate and 30 Year Term

Risks & Selection of Project Delivery Method• PIMA COUNTY CONCLUSIONS:

─ Compared Project Delivery Methods (DB v DBO v DBFO)─ Risk Adjusted NPV for DBFO Higher than DB and DBO─ For PCRWRD

Longer Term with Higher Interest Rate (Economic Risk) IRS Rev. Proc. 97-13 (Commercial and Regulatory Risk)

• TYPES OF RISKS:─ Commercial ─ Macro-Economic ─ Regulatory and Political

PPP Risks – Commercial• Commercial Viability:

─ Does the Project Make Overall Commercial Sense for All Parties• Construction Risk:

─ Can the Project Be Built On Time and On Budget• Revenue Risk:

─ Will its Operating Revenues be as Projected• Operating Risk:

─ Is the Project able to Operate at the Anticipated Level and Cost• Input Supply Risk:

─ Can Materials or Other Inputs be Obtained at the Estimated Cost• Uninsured Risk:

─ Are there Significant Risks Not Covered by Insurance

PPP Risks – Commercial• Environmental Risks:

─ What effect will the project have on the Environment• Residual-Value Risk:

─ What happens to the project at the end of the Agreement• Contract Mismatch:

─ Do the Project Contracts Fit Together Properly• Sponsor Support:

─ Is there Proper Amount of Recourse to the Sponsors• Other Reasons for Failure:

─ Does the Project Display Any Common Reasons For Failure

PPP Risks – Macro-Economic• Macro-Economic Risks:

─ External Macro-Economic Risks aka Financial Risks include changes in:• Interest rates• Inflation• Currency Exchange–Rates

─ Are not project specific but relate to the Economic Environment in which it Operates.

PPP Risks – Macro-Economic• TIME VALUE OF MONEY

─ Analysis of Risks Discounted Cash Flow to Calculate the Net Present Value (NPV) of the P3 Project

─ Internal Rate of Return (IRR) – The Discount Rate Results in NPV = 0.

─ IRR is Used For Calculating:

• Overall Return on a Project• Investors’ Return on Investment in the Project• Compensation Sums under the Project Agreement• Early Termination Payments Under the Project Agreement• Benefits of Refinancing

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𝑇 𝑁𝐶𝐹 𝑡

(1+𝑖)𝑡

PPP Risks – Macro-Economic• Interest Rate Risks

─ Construction-Phase • During Construction the accrued interest is normally capitalized (i.e. added to

the loan amount) or paid by making a new drawing on the loan.• Interest Rate is part of the Project’s Capital Budget and a Higher Interest Rate

Than Originally Planned During Construction can Result in a Construction Cost Overruns.

─ Operating-Phase• During Operation a Higher Interest Rate means Lower Project Cash Flow and

Reduction in Lenders’ Cover Ratio and Lower Returns for Investors.

PPP Risks – Macro-Economic• Inflation

─ Construction Cost Overruns Related to Higher Inflation Rates─ Higher Operating Costs Reduces the Return for Investors ─ Mitigating Strategy Includes Indexation of Contract Payments

• Foreign-Exchange Risks─ Risks Resulting from movements in the Exchange Rate between Once

Currency and Another.• Refinancing Risks

─ Short-term Construction Loans can be Refinanced by Long-term Loans after Project Completion

─ Long-term Interest Rates may Be Higher than Originally Planned.

PPP Risks – Political & Regulatory• Change In Law

─ Legislation Allows for Private Ownership or Control of the Project and Protects Private Investment

─ Clear Legal and Regulatory Framework for the Project’s Operation─ Consistency of Legal and Regulatory Policies─ Ability for Lenders to Take and Enforce Security

• Investment Risks─ Currency Convertibility and Transfer─ Expropriation of the Project by the State─ Political Violence

• Wider Political Risks─ Contract Repudiation – Deliberate Failure by a Public-sector─ Creeping Expropriation – Cumulative Effect of Numerous Actions

FINANCIAL MARKETS STRUCTURE & MODEL

Project-Finance Markets & Lenders• Private-Sector Project-Finance Debt Provide by:

─ Commercial Banks─ Bondholders

• Commercial Banks─ Largest Providers of Project Finance─ 90% of Private–Sector Finance Debt in 2012─ Over $18 Billion in Loan Commitments in the U.S. in 2012

• Bonds─ Bondholders: Life-Insurance Companies and Pension Funds─ Aimed at the Non-Banking Markets─ Tradable Debt Instrument

Financial Structuring in P3 Projects• Investors’ Analysis and Equity Structure

─ Minimum Equity IRR used by Sponsors and Other Investors to Determine whether the Project is a Viable Investment.

─ Hurdle Rates for Equity IRR above which an Investment is Acceptable:

• Investor’s Own Weighted Cost of Capital• Additional Return Over Cost of Capital Required for Particular Risks• Market Competition• Project Viability

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𝑇 𝑁𝐶𝐹 𝑡

(1+𝑖)𝑡

Financial Structuring in P3 Projects• Main Elements For Project-Finance Structure:

1.Debt Cover Ratios

2.Debt:Equity Ratio

3.Debt Service Profile

4. Interest Rate and Fees

Financial Structuring in P3 Projects• Debt Cover Ratio

─ Level of Debt for a Project is based on Ability to Pay Interest & Principal with a Margin of Safety.

─ To Assess the Margin of Safety Lenders Calculate Debt Cover Ratios:

• Annual Debt Service Cover Ratio (ADSCR)• Loan-Life Cover Ratio (LLCR)• Averages of ADSCR and LLCR• Project-life Cover Ratio

Financial Structuring in P3 Projects• Debt:Equity Ratio (Ratio of Debt to Equity)

─ Based on Cover-Ratio Calculations and Reflect Project Risks

─ Greater Safety Margin Required by Lenders = Higher Debt Cover Ratio

─ Projects With Greater Risk have Lower Debt:Equity Ratios:

• 90:10 for and Accommodation-based Contract• 85:15 for a Process –plant project with an Offtake Contract• 80:20 for a Transport Concession• 70:30 for a Power Plant Project with no Offtake Contract• 50:50 for a Natural Resource Project

Financial Structuring in P3 Projects• Debt Service Profile

─ Loan Interest Payments and Principal Repayment─ Investors Look For Dividends Sooner than Later ─ Lenders Look to be Repaid as Rapidly as Possible─ Debt Repayment Schedule Based:

• Term of Financing – Project-Finance Debt is much longer in term (repayment period)

• Average Life (or Maximum Average Life) – How Rapid Risk Reduces Over the Term

• Repayment Schedule – Start Date and Frequency of Repayment• Flexibility in Repayment – “Target and Minimum” Repayment Structure

Financial Structuring in P3 Projects• Interest Rate and Fees

─ International Project-Finance Floating Loan Rates Typically 2 – 3.5 % over LIBOR (LIBOR stands for Intercontinental Exchange London Interbank Offered Rate)

─ Fees Include:• Arranging and Underwriting Fees• Commitment Fees Paid on the Available But Undrawn Portion of Bank Debt

During Construction• Agency Fees Payable to the Agent Bank or Security Trustee

The P3 Financial Model• Input or Main Building Blocks include:

─ Macro-economic Assumptions─ Project Costs and Funding─ Operating Revenues and Costs─ Accounting and Taxation Assumptions

• Outputs:─ Determine Viability of the Project from Investors’ Point of View─ Determine Viability of the Project from Offtaker’s / CA’s Point of View ─ Sensitivity and Risk Analysis for Lenders

The P3 Financial Model• Functions of the Financial Model

─ Pre-Financial Close / Development Phase• Evaluation & Reevaluation of Projects Financial Aspects and Sponsor’s

Economic Return• Structuring the Finance and Reviewing the Sponsors’ Benefits under Different

Financial Terms• Formulating Financial Provisions of the Project Contracts including LD Calc.’s• Part of the Lenders Due Diligence Process• Quantifying Critical Finance Issues• Offtaker / CA Confirm Financial Viability• Compare Proposals Submitted by Sponsors

The P3 Financial Model• Functions of the Financial Model

─ Post-Financial Close• Budgeting Tool• Enables Lenders to Review Long-term Changes• Enables Investors to Calculate the Value of their Investment• Used by Investors to Calculate Compensation Event Payments• Offtaker / CA Calculate Refinancing Gain• Offtaker / CA Calculate Termination Sum


Conclusions and Summary:1. Infrastructure Overhaul in the U.S.

2. Increased Number of Projects procured using Alternative Project Delivery Methods

3. Greater Frequency of P3 Procurement

4. Increased Participation For Civil Engineers

5. Greater Knowledge & Involvement with Project Finance

6. More Infrastructure Projects + Expanded Roles for Civil Engineers = Greater and More Value

Private and Public Partnerships Move MainstreamAcknowledgements:

Principles of Project FinanceBy E.R. Yescombe

Published by ElSevier Publishing

WPI will offer this Fall 2016On-Line &

Monday Evenings 6:00 – 8:50 p.m.

CE590 - Capital Facility Planning and Financing in Private and Public Partnerships

Email: [email protected]

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64

CE590 – P3 Project Financing

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