1. Undertaking PPP Projects: Feasibility Stage
Vickram Cuttaree
The World Bank
St. Petersburg – May 23, 2008

2. Objectives of the Feasibility Phase
GET THE PROJECT READY FOR BIDDING STAGE
OBJECTIVE 2
ASSESS IF PROJECT IS VIABLE AND PPP RESULTS IN BETTER VALUE FOR MONEY

3. Lessons from International Experience
Several issues/delays during procurement/operations could have been avoided with a solid feasibility study.
Examples include:
Project failures during operations due to weak demand analysis and estimation of user willingness to pay
Delays in procurements often linked to important legal review not done prior to bidding stage

4. Key considerations in preparing a Feasibility Study
Feasibility stage should not be seen as a administrative step to obtain the necessary City approvals
Understanding and incorporating the objectives and constraints of all stakeholders (City, Federal, Users, Private partner) will ensure quality of PPP project
The use of consultants with strong expertise in PPP is essential, but the involvement of public sector officials (coordination, decision making, communication) should not be underestimated

5. Key steps in the Feasibility Stage
Needs Analysis
Value Assessment
Options Analysis
Economic Analysis
Due Diligence
Project Viability
Financial Analysis
Verification
and Sign-Off
Affordability
Assessment
Project
Management Plan

6. Needs Analysis Needs Analysis Value Assessment Options Analysis
Economic Analysis
Due Diligence
Project Viability
Financial Analysis
Verification
and Sign-Off
Affordability
Assessment
Project
Management Plan

7. Purpose of Needs Analysis
Define the service that the city needs to
deliver and specify the minimum standards for the output
An important objective is to ensure that the project is in line with the City’s strategic objectives
During this step, the available budget will be identified and analyzed (incl. potential savings resulting from the project)
On the basis of the needs assessment, strategic objectives and budget, the following will be determined
Output Specifications
Performance Indicators

8. Content of Needs Analysis
Output Specifications
Output specifications forms the basis of project preparation
Output specification define what the required services are, but they do not specify how they should be delivered
Ex: Defining a road in terms of routing, capacity and operational quality requirements
Performance Indicators
Performance indicators are defined to ensure that the service will be delivered to the desired level of performance
Performance indicators should be realistically set-up, as they will directly determine the cost of the service to the City and/or users

9. Options Analysis Needs Analysis Value Assessment Options Analysis
Economic Analysis
Due Diligence
Project Viability
Financial Analysis
Verification
and Sign-Off
Affordability
Assessment
Project
Management Plan

10. Rationale for Options Analysis
Examine the range of reasonable options for
meeting the City’s output specifications, reject
unviable options, and choose the best solution
for further examination
Consider all technical, legal and financial options that meet the output specifications
Options considered should include low-investment solutions that can meet the needs (ex. managing demand for services instead of building new capacity)
Option analysis does not tell whether PPP is the correct option or not – it identifies the most viable option for further analysis

11. Conducting the Options Analysis
Listing and Evaluation of
Options
List all reasonable options to be considered
Assess the advantages and disadvantages of each option based, for example, on:
- technical aspects
- funding and financial impacts
- market capability and demand
- environmental impacts and costs
- etc
Reject all options that are illegal, too expensive or too risky
Analyze and score each option in a matrix form against each of the abovementioned criteria
Select the preferred option with justifications
Selection of Best Option

12. Illustration of Option Analysis
Example of Options:
Build a new road vs. increase capacity of public transport
Develop current port or build a new one
Use of source of energy (coal, renewable, etc…)

13. Due Diligence Needs Analysis Value Assessment Options Analysis
Economic Analysis
Due Diligence
Project Viability
Financial Analysis
Verification
and Sign-Off
Affordability
Assessment
Project
Management Plan

14. Objective of Project Due Diligence
Identify and Analyze ALL
LEGAL, LAND AND SITE, TECHNICAL,
SOCIAL and ENVIRONMENTAL ISSUES
A thorough due diligence is expensive, but saves time and money down the road
Early identification of issues and quality of exercise is essential for future success
Importance of legal, social and environmental issues should not be underestimated

15. Scope of Project Due Diligence
Ensure compliance with all related City and Federal laws and regulations (at minimum)
Due diligence should go further and identify and mitigate any related issues that could raise concerns for the potential private partner
Environmental and Land
Revenue sources
and
Demand Analysis
Review should be professionally done and conservative
This analysis is the backbone of assessment of private sector interest and financial contribution from the State/City
Legal
Ensure that all foreseeable legal requirements are met for the project development (incl. sector laws)
Poor legal review will raise concerns from potential bidders and could lead to delays in bidding and negotiations

16. Scope of Project Due Diligence
Financing
Review the availability and cost of financing, financial instruments, hedging and risk mitigation products, insurances and applicable tax regime for the project
Market Analysis
Review should include number, size and capacity of sponsors, contractors and financiers, as well as known competing projects being prepared in other countries
Other Items
Due diligence is also project-specific and examples include:
Technical site analysis
Technical design analysis
Availability and quality of supporting infrastructure
Availability of raw material and fuel supply

17. Financial Analysis Needs Analysis Value Assessment Options Analysis
Economic Analysis
Due Diligence
Project Viability
Financial Analysis
Verification
and Sign-Off
Affordability
Assessment
Project
Management Plan

18. Objective of Financial Analysis
DEMONSTRATE THAT THE PROJECT WILL BE FINANCIALLY ATTRACTIVE TO THE PRIVATE SECTOR
OBJECTIVE 2
ASSESS THE LIKELY FINANCIAL CONTRIBUTION FROM THE CITY TO THE PROJECT
The central component of the financial analysis is the development of a financial model
The financial model represents the costs of delivering the preferred solution through a PPP arrangement and may be called the PPP model
The results of the financial analysis are highly dependent on the quality of assumptions and advice from experts is essential

19. Construction of Financial Model
Step 1: Technical definition
of project
Determine the technical parameters of the project construction and operation with their cost implications
Step 2: Identifying direct
costs
Direct capital costs are specifically associated with the construction of a new facility or the acquisition of a new asset.
Direct maintenance costs will include the full lice-cycle costs of maintaining the assets in the condition required to deliver the output specification (e.g. raw materials, equipment and labor)
Direct operating costs are associated with the daily operation of the service (incl. staff, raw materials, etc…)

20. Construction of Financial Model
Step 3: Identifying indirect
costs
Indirect costs will include that portion of any additional overhead costs related to the project (e.g. personnel, accounting, billing, legal, rent, communications)
Step 4: Identifying project
revenue
Revenue and demand study from due diligence is used as base case for revenue projection
Any assumption on revenue collected should reflect project’s ability to invoice and collect revenue – beware of revenue over-estimation

21. Construction of Financial Model
Step 5: Financing and
other assumptions
Assumptions regarding financing, project structure and tax should be tested with financial experts
Proposed source of funding (e.g. debt, equity and government contribution) should be identified
City should assume that cost of capital would rely on project’s own credit, and not on government bond yield
All relevant financial ratios should be set out in detail (e.g. annual debt service cover ratio, return on investment for equity holders, etc…)
Step 6: Calculation of
explicit government
financial support to
the project
Explicit government budget support will be required if base model with simple costs, revenues and financing assumptions will not meet required ratios
If budget support is needed, City can undertake measures to:
1) reduce costs in PPP model
2) increase revenue in PPP model
3) reduce amount of private financing

22. Construction of Financial Model
Step 7: The Base Case
model
The base case model is created based on the anticipated revenues, costs, assumptions, payment/subsidy mechanism and structure for this project
Step 8: Adjusting base
model for risk
The base model is then adjusted to take into consideration all risks likely to impact the project, with a estimation of their potential impact
City should pay attention to optimal risk transfer – in general, risks should be allocated to party best able to manage them

23. Construction of Financial Model
Step 9: Adjusting PPP
Model to reflect total cost
to City
The adjusted PPP Model includes “all-in” cost to City for undertaking project through PPP
City will still be responsible for some costs in PPP, such as costs of managing PPP agreement – these costs should be identified in Model
Step 10: Sensitivity
Analysis
Sensitivity analysis determines resilience of PPP Model to changes in assumptions
Sensitivity of following variables should be tested on key variables, including demand, financial terms, capex and opex
The City should learn how much its contribution to the project will change if key assumptions are different in reality

24. Illustration of Financial Model Output
Model used to determine project attractiveness to the private sector: Equity IRR Calculation
Note: Graph for illustrative purposes only – does not correspond to any existing project

25. Illustration of Financial Model Output
Model used to determine project attractiveness to the private sector: Financial sustainability
Note: Graph for illustrative purposes only – does not correspond to any existing project

26. Illustration of Financial Model Output
Model used to determine financial contribution by City
Note: Graph for illustrative purposes only – does not correspond to any existing project

27. Illustration of Financial Model Output
Example of output: assessment of minimum toll rate (US$ per km) for a highway PPP based on construction costs
$/km
5,000 vpd
10,000 vpd
15,000 vpd
20,000 vpd
Construction cost, $ million/km
Source: PPP in Highway Toolkit and Cesar Queiroz

28. Affordability Assessment
Needs Analysis
Value Assessment
Options Analysis
Economic Analysis
Due Diligence
Project Viability
Financial Analysis
Verification
and Sign-Off
Affordability
Assessment
Project
Management Plan

29. Objective of the Affordability Assessment
PPP projects should provide services that are affordable either to
USERS of the services (tariffs)
GOVERNMENT paying for the services (availability payment, subsidies)
Affordability for users is assessed by willingness to pay for the specific services provided
Affordability for Government is based of expected payments during life of project and budget assumptions during same period
Determination of project costs and available budget should be as accurate as possible
Collaboration with Budget preparation is essential

30. The Case of Demand Risk
Risk allocation based on principle that risk should be allocated to the party best able to manage it
In practice, demand risk is difficult to fully allocate to the private sector
In addition, demand for the services are often over-estimated (optimism bias)
S&P Survey of PPP projects showed that actual traffic on PPP projects are on average 70% of forecasted one
If not mitigated, demand risk can result in higher perceived project risk, increased cost to the City or reduced interest from the private sector

31. Case Study: Hungary M1/M15 Toll Project
Illustrates importance of traffic forecasts and difficulty in justifying high toll rates
First PPP motorway in Hungary to be fully financed by tolls
Financial close reached in November 1993 and construction of M1 completed in January 1995 on schedule and within budget
Traffic was 40% below expectations with no demand risk guarantees from Government
Tolls considered the highest in Europe contributed to accusation that Concessionaire was abusing its dominant position
Negotiations took years and resulted in Government taking a large part of the debt in 1998

32. Risks Associated with Guarantees
Minimum Revenue Guarantee (MRG) reduces the risk to the private partner of lower than forecasted revenue
Government contribution can be significant, especially given usually over-optimistic traffic forecasts
Affordability Calculation for Government should include sensitivity analysis on lower revenue’s impact on Government payments
Affordability Calculation for Government is therefore extremely sensitive to quality of demand forecasts and user willingness to pay
Revenue (Rubles)
Revenue shared with City
Minimum Revenue Guarantee
Payment by City

33. Risks Associated with Availability Payment
From a budget perspective, availability payments replace capital expenditure by recurrent ones
Moreover, traffic risk is transferred to Government, baring the cost of any downturn in traffic
Affordability assessment should include future payments and take into consideration the net cost of lower than expected traffic
Rubles
Capital Expenditure
Maintenance
Traditional Procurement
Rubles
PPP with Availability Payments

34. What if a Project is NOT Affordable?
A project not affordable for users means tariffs are too high and can result in
Negative social impact if users don’t have alternatives
Reduced benefits or even project failure if alternative exists (ex. use of parallel road)
A project not affordable to Government means available budget is not sufficient to pay commitments to private partner
If project is not affordable, Government has several options
Reducing the scope/quality of services
Abandon the project
Obtain more financing from Budget

35. Value Assessment Needs Analysis Value Assessment Options Analysis
Economic Analysis
Due Diligence
Project Viability
Financial Analysis
Verification
and Sign-Off
Affordability
Assessment
Project
Management Plan

36. Definition of Value for Money
Value for Money (VfM) describes a net benefit, both in quantitative (financial) and qualitative terms, from the outcomes of a PPP project compared to the same project delivered by the public sector over the entire lifespan of the project.
VfM is not the choice of the goods and services based on the lowest cost bid
Several factors directly influence the VfM
Risk allocation between City and Private Sector
Focus on whole life rather than upfront costs
Use of output specification approach
Sufficient flexibility in relation to design and service delivery

37. How to determine Value-for-Money
QUALITATIVE ASSESSMENT
Project has efficiencies that private sector can provide
There is a suitable competitive market
Risk can be transferred to the private sector
QUANTITATIVE ASSESSMENT
Development of Public Sector Comparator (PSC)

38. Illustration: Using PSC to Assess VfM
Rubles
A: Vfm at feasibility is difference with Risk-adjusted PPP
B: VfM at financial close is difference with Risk adjusted PPP A B
Full costs to the City (NPV) of delivering the required service according to the specified outputs using conventional public sector procurement
NPV of capital and operating costs associated with the project should it be procured and operated by the City
Best estimate (NPV) of the total (risk inclusive) cost of the project to the City with estimate of the risk retained by the City
Total cost (incl. risk) of the project to the City based on actual bid received
Risk Adjusted
PSC
PPP Model plus Retained Risk
Actual Bids plus retained Risk
PSC

39. Example of PSC Calculation: Base PSC
Note: Table for illustrative purposes only – does not correspond to any existing project

40. Example of PSC Calculation: Risk Valuation
Note: Table for illustrative purposes only – does not correspond to any existing project

41. Example of PSC Calculation: Risk Adjusted PSC Model
Note: Table for illustrative purposes only – does not correspond to any existing project

42. Benefits and Limitation of using PSC
Provides basis for selecting a PPP project, with very long and significant fiscal implication for the City
Provides City with credible alternative to deliver project should bidding/negotiations not provide an acceptable PPP solution
Limitation
Developing PSC brings additional cost and time in the preparation of the feasibility study
PSC is complex and requires institutional capacity that might not be available
PSC provides a tool to reconcile City decision to undertake a project with assessment of the PPP option

43. Overview of Risks related to PPP Project
Risk should be allocated to the party best able to manage it
If the private sector is asked to take over a risk it cannot manage (macro, demand…), it will either refuse or price it with a premium
Availability
Completion
Cost overrun
Design
Environmental
Exchange rate
Force majeure
Inflation
Insolvency
Insurance
Interest rate
Latent defect
Maintenance
Market, demand or volume
Operating
Planning
Political
Regulatory
Residual value
Resource or input
Subcontractor
Tax rate change
Technology utilities
Source: South Africa Treasury

44. Economic Analysis Needs Analysis Value Assessment Options Analysis
Due Diligence
Project Viability
Financial Analysis
Verification
and Sign-Off
Affordability
Assessment
Project
Management Plan

45. Objective of Economic Analysis
Estimate all economic costs and benefits of the project to ensure that it is the least-cost option and that all externalities to stakeholders have been considered
Economic analysis is required to calculate the incremental costs and benefits of the project to society as a whole – “with” or “without” project
This way the City understands the various economic costs and benefits to the project entity, private sector entity, government and local community
Changes may be necessary to the project design if negative externalities are large

46. Stages of Economic Analysis
Determine economic costs
of project
Determine major
assumptions for
economic analysis
Calculate EIRR and ENPV
Estimate economic
benefits

47. Project Viability Needs Analysis Value Assessment Options Analysis
Economic Analysis
Due Diligence
Project Viability
Financial Analysis
Verification
and Sign-Off
Affordability
Assessment
Project
Management Plan

48. Project Viability The project is viable if it is
Technically deliverable
Socially and Environmentally sustainable
Financially viable to investors
Affordable to users
Affordable to the City
Provides Value for Money to the City
Economically viable

49. Verification and Sign-Off
Needs Analysis
Value Assessment
Options Analysis
Economic Analysis
Due Diligence
Project Viability
Financial Analysis
Verification
and Sign-Off
Affordability
Assessment
Project
Management Plan

50. Verification and Sign-Off
City and transaction advisers expected to sign off the
feasibility study after all the analysis has been completed.
Description of
Assumptions
Description of how assumptions used in constructing financial model are realistic and appropriate
Explanation of
Methodologies
Obtain record of methodologies used for valuing various costs, including costs of key risks
Sign-Off on Accuracy
of Study
Ensure that all inputs into feasibility study are signed off as accurate and verifiable by Line Committee, PPP Support Unit and each of transaction advisor specialists

51. Project Management Plan
Needs Analysis
Value Assessment
Options Analysis
Economic Analysis
Due Diligence
Project Viability
Financial Analysis
Verification
and Sign-Off
Affordability
Assessment
Project
Management Plan

52. Project Management and Procurement Plan
The objective of the Project Management Plan is to summarize the key issues, institutional/approval arrangement and the schedule of activities until the completion of procurement
The plan should be part of the feasibility study and agreed by all the committees and agencies involved in the project
The plan should contain at least
Project timetable, with key milestones and approvals required
List of potential issues and how they will be tackle
Governance process to be used by the City (incl. decision making)
List of all required approvals from all committees and agencies
Bid evaluation process and teams, and quality assurance process for bud documentation

53. Feasibility Study: Key messages
The feasibility study is an essential component of project preparation and allocation of time, as well as human and financial resources, contributes to preventing issues later
The need to obtain City approval should not undermine the project attractiveness to the private sector
Feasibility study is broader than just a technical assessment
The decision to undertake a project as a PPP vs. traditional procurement should be based on value-for-money and affordability assessment
Optimal risk allocation contributes to increased Value for Money and does not mean maximum risk allocation to the private sector
Early identification of issues and planning of preparation (incl. necessary approvals) save time and money down the road

54. Undertaking PPP Projects: Feasibility Stage
THANK YOU !!!
Vickram Cuttaree
The World Bank