The role of governments and international organizations in oil & gas Public-Private Partnerships Managing risks and seizing opportunities for local companies in the oil and gas sector Rio de Janeiro, 8-9 June 2004 Lamon Rutten Chief, Finance & energy UNCTAD NOT AN OFFICIAL UNCTAD RECORD

Overview Defining the scope Structuring energy sector PPPs Conclusion

The expression PPP is used in many different ways: As a catch-all term for any form of cooperation between investors and all the local stakeholders in a project As a term for certain types of Corporate Social Responsibility activities, e.g., community development or educational efforts As a term for projects in which public goods (e.g., water, electricity, security) are provided by private companies As a term for a specific form of investment project, in which the private sector is brought in to provide public goods, and the government carries part of the project risk. Defining the scope: what are PPPs? Focus of this presentation

Defining the scope PPPs have been used in many sectors, e.g.: road infrastructure, incl. bridges other transport infrastructure (railways, ports, airports) public transport energy sector projects schools, hospitals, prisons and courts telecommunications social housing, sanitation security There is generally one government framework policy for all kinds of PPPs, not separate policies for each sector.

PPPs are not new. Until the beginning of the 20 th century, most public infrastructure was built and financed by the private sector – e.g., think of the widespread issuance of railway bonds, or the private construction and financing of the Suez and Panama canals. Governments only took control less than a hundred years ago. And they kept control until recently… But the State is shrinking again, and since the mid-1990s, PPPs are back in fashion. Through PPPs, governments hope to: - expand public services beyond the wealthier groups - engage local communities in a more productive manner - provide a better quality of services at a lower cost to users - introduce user charges, e.g. to reflect the environmental costs of certain activities, in a manner that is accepted by the public - save money.

Defining the scope PPPs can harness some of the massive private investment flows for public purposes. The result should be more and better public services, at a better cost. But: this result does not happen automatically, but only if there is a proper framework for the PPP profits are OK, but excessive profits can lead to a public backlash there may be a public backlash anyway if the government was previously providing the service at a highly subsidized, unsustainable rate.

Structuring energy sector PPP – e.g., a power plant A common format would be an independent power plant (IPP) Power plant Govern- ment Private investors International organizations Parastatals Financiers Insurance companies Gas supply contract Electricity offtake contract Insurance Loans Frame- work Assets, equity Equity, loans Guarantees Equity, shareholder loans

PPPs in the energy sector usually concern large sums of money, and as the costs of capital in international markets tends to be a lot lower than in developing country financial partners, it generally makes sens to attract foreign capital. PPPs, then, will come with both commercial risks and country risks. And both need to be mitigated.

In PPPs, the allocation of risk is crucial Too little risk in private hands leads to rent-seeking and often, excessive profits. Too much risk in private hands results in under- investments, leading, in turn, to worsening services. It may also lead to large price rises. At times, PPPs have been borne out of desperation, and the framework put in place for the private companies that were brought in did not give them proper incentives to perform well and have a long-term vision. It’s this improper execution of PPPs which has often led to a bad image for PPPs.

The best way to ensure that both public and private interests are met in a PPP is by structuring the PPP as a stand-alone project, using the logic of a project finance. This makes it possible to explicitly formulate the objectives and conditions, and to optimize risk allocation. It also makes it much easier to bring in outside parties, e.g., international organizations. Government risk mitigants Public equity holders Private investors Commercial risk mitigants PPP International organizations Benchmarks and milestones

The structure of the project has to reflect the underlying activity, and there are many different formats – management contracts; leases; concession agreements (for 15 years to 99 years…), build-own-operate; build- own-operate-transfer; etc.

The government’s role in risk mitigation Governments should be willing to: Provide direct risk mitigation – e.g., undertakings on taxation regimes, currency convertibility Create a legal and regulatory environment in which the private sector can use proper risk mitigation tools – e.g., permit the use of offshore escrow accounts, or the use of foreign insurance companies. Assist the investors in reaching an understanding with the civil society partners in the project.

The international organizations’ role in risk mitigation International organizations are ready to provide: technical assistance and advice equity loans guarantees, especially on political risks

Conclusion Many crucial investments will only happen if there is a real partnership between the government and the private sector. This partnership works best if it is highly structured, through a project finance-type arrangement. Such an arrangement allows clear allocation of risks, and also leverages access to support from international organizations (finance, risk mitigation). Governments should not deal with PPPs on an ad-hoc basis, but should have a clear policy framework, a long- term plan, and good monitoring capacity.