Helsinki Summer School in Transportation Rethinking the Transportation Planning Process – Executive Course Financing Alternatives: Budget, Road Funds, Public Private Partnerships Cesar Queiroz, Ph.D. Consultant, former World Bank Highways Adviser Aalto University, Espoo, Finland August 8-12, 2011

Presentation Outline Alternative road financing methods Sources of financing How to charge road users Private financing World Bank/PPIAF Toolkit for PPP in Roads and Highways Financial assessment of PPP projects 2

Alternative Road Finance Methods

Ultimate sources of financing Charge the users Charge the tax payers

Why User Charging Systems? Generate revenue Reduce congestion Increase investment in transport infrastructure Apply the “users pay” principle Provide “value for money” (VfM) to paying users

Ideally road user charges (or any other tax or fee) should be Economically efficient Equitable Collected at little cost Not easily evaded

Methods of Charging for Roads Fuel taxes (do not reflect the higher damage done to roads by heavy vehicles) Vehicle licences (not use related) Charges for non-standard and overweighted vehicles (hard to control, relatively easy to evade) Charges on the purchase of new vehicles (not use related)

Methods of Charging for Roads Sales taxes (not use related) Vignettes (do not reflect usage, relatively easy to evade) Direct user fees Vehicle-distance traveled fees (require substantial initial outlay, sophisticated administration) Tolls (require substantial capital and operating costs)

Fuel Taxes A fuel tax (or fuel duty) is an excise tax imposed on the sale of fuel intended for transportation Home heating oil and fuels used to power agricultural vehicles are taxed at (usually) lower rates In some countries part of the fuel tax is dedicated to transport projects (e.g., Road Funds); in others, fuel tax is a source of general revenue

More on road user charges: World Bank Transport Paper TP-23 “Road User Charges: Current Practice and Perspectives in Central and Eastern Europe,” by Cesar Queiroz, Barbara Rdzanowska, Robert Garbarczyk and Michel Audige Available on the World Bank website at: http://go.worldbank.org/6HDCYBMRT0 11

Private financing is not new Toll road at Wadesmill in Hertfordshire, UK, established in 1663 by Act of Parliament 19th century concessions: toll roads, bridges, tunnels in US; railways in France; subway in London Suez (1860) and Panama (1880) canals Decline around 1930 (great depression) Resurgence in the 1980s: worldwide

Private financing in Finland In the 19th century, private finance and expertise provided Helsinki with novelties such as gas (1860) piped water supply (1876) electricity (1884)

The Maysville Turnpike, USA, 1830

A toll house at the approach to a bridge U.S. 1 in South Carolina, 1921 A toll house at the approach to a bridge

Toll Backup Chesapeake Bay Bridge toll booths, beach-bound traffic August 1999 Source: The Washington Post

Riverside Freeway, SR 91, CA First fully automated toll road (free-flow system), 16-km long, opened on December 27, 1995 Serves commuters on Riverside Freeway (SR 91), Orange County, south of Los Angeles Original developer and operator: California Private Transportation Company Achieved cash flow break-even in mid-1998 (can pay operating and debt expenses from revenues)

SR 91: Toll lane information

SR 91: Toll rate information

SR 91: Two express toll lanes in each direction

SR 91 Express Toll Lanes Typical afternon peak

Private Finance Initiative (PFI) in the United Kingdom “In Britain, the private finance initiative has been used to build everything, from roads to hospitals. So far, projects worth GBP 53 bn have been signed.” Source: “Building debts for the future,” Financial Times Editorial Comment, August 8, 2011 (page 8), http://www.ft.com 22

Private Finance Initiative (PFI) in the United Kingdom (cont´d) Central claim made for PFI: It adds value for tax payers by transferring risks to the private sector, including the risks of construction and of running projects, while achieving greater efficiencies than possible under conventional procurement However, the Financial Times estimates an extra cost of GBP 20 bn above the government borrowing cost, which would require a very substantial amount of efficiency gain to make PFI worthwhile 23

Private Finance Initiative (PFI) in the United Kingdom (cont´d) A possible alternative to long term public debt: Charge the users (e.g., tolling) First tolled motorway in the UK: M6 near Birmingham, operated by Midland Expressway Limited Typical toll rates: cars, GBP 5.30; HGV, GBP 10.60 More info: http://www.m6toll.co.uk/ 24

Toolkit for PPP in Roads and Highways Assists in each stage of PPP preparation (e.g., TOR) Describes the PPP framework necessary to develop private sector interest Presents “most applicable practices” Helps practitioners to understand PPP Helps teaching PPPs in roads and highways 25

In summary, the Toolkit helps answer the question Where and under what conditions can a PPP be appropriate? Available on a CD-ROM and Internet: http://go.worldbank.org/P2XMGNYLD0 26

The Six Modules of the Toolkit                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   The Six Modules of the Toolkit Additional Tools: Glossary, Site Map Link to Toolkit Toolkit 27

The Six Modules of the Toolkit                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   The Six Modules of the Toolkit “Dance,” Henri Matisse, 1909, Oil on canvas, MOMA, N. York 28

English and Russian Versions English original available since 2009, including upgraded and audited financial models http://www.ppiaf.org/ppiaf/sites/ppiaf.org/files/documents/toolkits/highwaystoolkit/index.html Russian translation available since April 2011 (to be posted soon on the PPIAF/World Bank website) 29

Continuum of PPP Options The Toolkit presents a broad definition of PPP including performance-based contracts http://www.ppiaf.org/documents/toolkits/highwaystoolkit/ 1/1-13.html 30

Toolkit Financial Models Purpose Familiarization of non-financial specialists with the basics of project finance and financial simulations for a (highway) PPP project Better understanding of key parameters which affect the financial viability of a PPP project Preliminary scrutiny of PPP projects Limits Simplified financial models: graphical and numerical versions Specific project assessment requires detailed financial models prepared by experienced financial practitioners 31

Graphical Model The model represents the main financial features of a project company in graphic form and their sensitivity to a range of 14 key assumptions The graphs change according to the key project assumptions Cash Flow graph Debt graph Dividends graph Link to financial models Toolkit > Tools > Financial models 32

Numerical Model The model provides financial statements by a potential concessionaire to analyze the construction and operation of a highway concession under a Build-Operate-Transfer (BOT) scheme The Assumptions sheet of the model contains key parameters and data input as determined by the user The financial model is not a banking model and is not intended to provide project-specific financial modeling 33

Main Stages to Launch a PPP Project Stage 1: Identification, Prioritization and Selection of the PPP Project Stage 2: Due Diligence and Feasibility Studies: includes activities and studies to ensure the selected project is well designed and can be successfully tendered and implemented Stage 3: Procurement: includes prequalification of bidders and the bidding and bid evaluation processes, and a section on Unsolicited Bids

Main Stages to Launch a PPP Project (cont’d) Stage 4: Contract Award: gives advice on dealing with the preferred bidder(s) Stage 5: Contract Management: deals with the construction and operation periods of a project including transfer back if relevant – BOT, but not BOO Reference: Toolkit Module 5

PPP Project Development

Open competitive bidding selection of concessionaires Wide advertisement – press, road show, data room Prequalification of potential bidders – helps ensure quality bidders Bidding documents well prepared -- clear and non-discriminatory Clear procedures for bid submission Public bid opening Transparent bid evaluation criteria, which are well defined in the bidding documents 37

Open competitive bidding selection of concessionaires (cont’d) Negotiation of the final contract, if required, should be done only within the parameters defined in the bidding document Selection of the successful bidder based on the most economically advantageous offer Clear and effective complaint and appeal handling mechanisms in place http://www.ppiaf.org/ppiaf/sites/ppiaf.org/files/documents/toolkits/highwaystoolkit/5/5-4.html 38

Toolkit Case Studies Brazil – country case Chile – concessions in Santiago Croatia – A6 motorway France – country case Hungary - M1/M15 motorway India – country case Korea – country case Serbia – country case South Africa/Mozambique N4 toll road UK – M6 toll road US – country case Zambia – PBC contracts Indonesia – country http://www.ppiaf.org/ppiaf/sites/ppiaf.org/files/documents/toolkits/highwaystoolkit/6/case_studies/index.html 39 39

Traditional Procurement vs PPP Arrangements Project life: usually less than 5 years vs more than 20 years Completion and delivery of the facility vs long term service provision Input vs output orientation Contract signed with the contractor vs with a “special purpose vehicle” (SPV) Public financed vs user fees or tariffs (or some other arrangements) Better sharing of risks in PPP 40

Decreasing Public Risks, Increasing Private Risks Allocation of Risks High Force Account Traditional Outsourcing Performance-based Contracts Availability Payments Shadow Tolls RISK TO PUBLIC SECTOR Toll Road BOT BOO Decreasing Public Risks, Increasing Private Risks Low High RISK TO PRIVATE SECTOR

Cesar Queiroz Roads and transport infrastructure consultant, former World Bank Highways Adviser Tel +1 301 755 7591 queiroz.cesar@gmail.com Washington, DC, USA

Appendix Financial Modeling Exercise

Objectives of the Exercise This practical session will provide participants with an opportunity to learn how to use the graphical and numerical financial simulation models of the Toolkit for PPP in Roads and Highways Following completion of the exercise, the participants should be able to work on several PPP issues, such as the main factors defining the minimum tariff (e.g., toll rate), or minimum availability payment required for a PPP project to attract private investors

Instructions to Participants Please form teams with a few members each Teams will be numbered 1 to n Each team will be given basic data (or assumptions) for a proposed PPP project and will be asked questions on the financial assessment of the project Please choose the team member who will make a brief presentation of your team’s results, after deliberations Please assume that previous studies have shown that the project is economically justified, and socially and environmentally sound

Basic data to be used by each team Concession term: 30 years Construction Cost: US$210 million Road length: 40 km Four-year construction, with progress rates: Year 1: 15%; Year 2: 30%; Year 3: 30%; Year 4: 25% Operating expenses: $10 million per year (at opening year); no variable operating expenses Capital structure: Equity, 30%; Subsidies, 0% Nominal interest rate: 9% per year Loan grace period: 4 years Loan repayment period: 15 years Discount rate (real terms): 8%

Basic data to be used (cont’d) Initial daily traffic (opening year), vehicles/day: Team x: AADT = 7,500 + 2,500x, where x is the team number Traffic composition: cars, 70%; trucks, 25%; and buses, 5% Traffic growth: 3% per year Inflation: 4% per year Tax rate, VAT: 10%; Corporate tax: 11% Link to the Financial Model Link

Financial Indicator Targets Please assume that the following targets (or constraints) will have to be met for the project to attract private sponsors: Project Financial Internal Rate of Return: FIRR ≥ 12% Equity Internal Rate of Return (or Return on Equity): ROE ≥ 14% Annual Debt Service Cover Ratio: ADSCR ≥ 1.2

Main financial analysis indicators Project Internal Rate of Return (or Project IRR) Financial return or yield of the project regardless of the financing structure Project is considered to be financially viable when Project IRR is above a benchmark rate of return with respect to the country, sector and project characteristics (7% or more in real terms, depending upon countries and financial markets) OCFBF = Operating Cash-Flows Before Financing

Equity Internal Rate of Return (or Equity IRR) Yield of the project for the shareholders through the remuneration of their investment with dividends The project is profitable for the shareholders when Equity IRR is high. Generally, a minimum expected return rate (real return) is 10% (Shadow Toll) or 17% (Toll Roads). This Equity IRR minimum is called Hurdle Rate.

Annual Debt Service Cover Ratio (ADSCR) Represents the ability for the project company to cover/repay the debt Project estimated viable for the lenders when the ADSCR is greater than 1 for every year of the project life. Generally, the minimum ADSCR should be greater than 1.2. CAFDS = Cash Available For Debt Service (Debt Service)i,n = Principali,n + Interesti,n

Questions to each team Please estimate the minimum toll rate per average vehicle, in (a) $/veh, and (b) $/veh-km, for the project to be able to attract private investors. Note: The minimum toll rate ($/veh) can be obtained by trial and error using the “Cash Flow” sheet of the graphical financial simulation model (or the “Assumptions” sheet of the numerical model) of the Toolkit. After you have entered all the data applicable to your specific project, you can vary the toll rate so the financial indicators calculated by the model are just above the minimum required threshold. 53

Questions to each team (cont’d) 2. Please estimate the minimum car, truck and bus toll rates, in (a) $/veh, and (b) $/veh-km, for the project to be able to attract private sponsors. Please assume the following relationships between toll rates for different type of vehicles: Average truck toll rate = 3 x car toll rate Average bus toll rate = 2 x car toll rate The toll rate in the graphical model (WATR) is: WATR = (%C x TRc + %T x TRt + %B x TRb) / 100 where WATR is the weighted average toll rate per vehicle; %C, %T, and %B are the percentages of cars, trucks, and buses in the traffic flow; TRc, TRt, and TRb are the toll rates for cars, trucks, and buses

Toll rates for trucks and buses The example of Brazil: TRt = Number of axles x TRc; TRb = Number of axles x TRc

Questions to each team (cont’d) 3. Closing the affordability gap with government subsidies. If the toll rates estimated under Question 2 are above road users’ affordability (or willingness to pay), you may want to consider using government subsidies to reduce the toll rate required to attract private investors. Assuming that the Government is willing to contribute up to 25% of the construction cost (i.e., subsidies), please estimate the minimum required toll rate per average vehicle (in $/veh-km) that would be sufficient to attract private sponsors.

Notes regarding the solution to Question 3 (a) Changing the amount of Subsidies does not change the project’s financial Internal Rate of Return (IRR), which is independent of the project’s capital structure. Please disregard the minimum IRR requirement in this case. (b) A minimum amount of equity is usually specified to make sure the private sponsors have “their skin in the game.” Equity, in this example, is required to be not less than 30% (see slide no. 4). The sum of Equity, Loans and Subsidies is 100 percent. Consequently, the maximum amount of Subsidies that could be considered in this case is 70%.

Questions to each team (cont’d) 4. Using the toll rate computed under Question 1, what is the amount of subsidy that the government could provide for the project to be fiscally neutral to the government? 5. How does the project financial internal rate of return (IRR) vary with the amount of subsidies? Is IRR independent from the capital structure (i.e., proportion of subsidies, equity, and credit)? 6. Is the return on equity (ROE) directly influenced by subsidies? Ceteris paribus, what would be the impact on ROE of an increase in subsidies from 0 to 10%?

Questions to each team (cont’d) 7. In case there is no political support to charge actual tolls to road users, alternative approaches could include shadow tolls or availability fees. Assuming that there will be no capital grants (i.e., no subsidies during construction), please estimate the minimum annual required payment by the government (availability fee, or availability payment, or annuity) during the first year of operation. Please use the result from Question 1a in your calculations. Note: Availability payment = 365 * AADT * WATR 8. What financial criterion (or criteria) would you include in the bidding documents, so as to allow for an objective evaluation of financial proposals under a competitive selection of concessionaires?

Questions to each team (cont’d) 9. Bridging the affordability gap with shadow tolls. In case the toll rates estimated under Question 2 are higher than the affordable toll rates in your country (or in your province/state), the Government may want to consider providing a shadow toll payment to the concessionaire, so the actual toll rates can be kept within the road users’ affordability. Assuming that the maximum affordable toll rate is $0.04/car-km, and that there will be no capital grants (i.e., zero subsidies), please estimate the shadow toll payment by the government during the first year of operation, so as to complement the affordable toll rates.

Notes regarding Question 9 (a) Please use the information and results from Questions 1 and 2, as appropriate. (b) Affordable weighted average toll rate per vehicle (WATRa): WATRa = (%C x TRca + %T x TRta + %B x TRba) / 100 where %C, %T, and %B are the percentages of cars, trucks and buses in the traffic flow; TRca, TRta, and TRba are the affordable toll rates for cars, trucks, and buses, respectively. Note: TRca = 40 x 0.04 = $1.60/car (c) Annual shadow toll payment (ASTP): ASTP = 365 * AADT * (WATRr – WATRa) where WATRr is the required weighted average toll rate per vehicle as computed under Question 1a. The units of WATRr and WATRa should be $/veh. (d) Payment of an ASTP by the government is somewhat similar to a minimum revenue guarantee.

Questions to each team (cont’d) 10.Time permitting, please work with the numerical financial simulation model to answer the above questions. In your view, what are the pros and cons of the two models? 11. Module 5 of the Toolkit for PPP in Roads and Highways describes the five key stages to launch a PPP project. In which one (or ones) of these stages do you think it may be necessary to carry out a financial assessment of the project?

Questions to each team (cont’d) 12.Several assumptions have been made to run this numerical application of the Toolkit financial simulation models. Please describe the changes in assumptions that you would suggest to make this exercise more realistic for your country (or your province/state). 13.Toll rates (or availability fees) are a complex issue. The toll rate that will actually be charged to road users depends on many factors, such as the degree of competition, expected and actual traffic volume and composition, loan terms, government support (if any). Please discuss.

Elasticity – Toll rates and traffic volumes Inelastic Elastic D D TR2 TR2 Q2 TR1 Q2 Q1 D TR1 So, lets look at some further examples of elasticity of demand. The chart on the left shows a section of demand curve showing inelastic demand. What does that mean - inelastic demand means that for large changes in price there is only a small change in quantities demanded - typical examples of this are food, fuel and household durables - if the price of food goes up what are you going to do - cut back on unnecessary bits but more importantly, eat out less, one less cinema trip... On the right we have the opposite case - elastic demand. A small change in prices of foreign holidays might be enough to tip the balance in favour of holidaying abroad and so the price change brings a big change in quantities. Q Q1 Q [e.g., some types of commuting] [e.g., leisure travel] 64

Questions to each team (cont’d) 14. Please make a brief presentation summarizing your team’s results and discussions. Please focus your presentation on the non-numerical questions. Good luck!

Making Predictions “It's hard to make predictions - especially about the future.” Attributed to many people, including Yogi Berra, Niels Bohr, Samuel Goldwyn, Robert Storm Petersen, and Mark Twain “Heavier-than-air flying machines are impossible.” Lord Kelvin, British mathematician and physicist, president of the British Royal Society, 1895