The Tendering Mechanism Based on the Least Present Value of the Revenues: Practical Evaluation in the Highway Concession Scheme in Chile



The Tendering Mechanism Based on the Least Present Value of the Revenues: Practical Evaluation in the Highway Concession Scheme in Chile

Authors

J M Vassallo, TRANSyT-UPM, ES

Description

This paper evaluates the reasons why the tendering mechanism for granting highway concessions based in the ?Least Present Value of the Revenues? has not been implemented as successfully as expected in the highway concession scheme in Chile.

Abstract

In the early 90?s a policy decision was taken to introduce private capital into the transport infrastructure sector in Chile, covering all kind of public infrastructure. The system adopted was the BOT mechanism regulated through a concession contract between the government and the promoter. Concessionaires would recover their investment basically from tariffs paid by users.
In 1991, this process was reinforced with the approval of a new Public Works Concession Law, which was subsequently extended and improved in 1996. This Law regulates concession tendering process, rights and obligations of concessionaires, length of contracts, expiration clauses, project monitoring by the public sector, guaranties which can be provided by the State, financial sources to be used in financing infrastructure concessions and so on.
One of the most interesting innovations introduced by the concession system in Chile, was the possibility of tendering projects under the so-called ?Least Present Value of the Revenues (LPVR)? mechanism. This mechanism consists basically of awarding the concession to the bidder which offers the least present value of the accumulated revenues?discounted according to a discount rate pre-fixed in the contract. The concession will finish automatically when the LPVR had been reached. Consequently if real traffic is ultimately higher than expected, the concession will finish earlier whereas if it is lower the concession will finish later. This way, traffic risk is substantially mitigated through either a reduction or an extension of the concession duration depending on the level of traffic. This mechanism adds two interesting points to some variable-term concession experiences implemented in Europe such as the ones introduced in the Severn Bridge in the United Kingdom and Lusoponte Bridge in Portugal. First, the revenues are discounted according to a discount rate that should reflect as better as possible the weighed average cost of capital (WACC) of the project. And second, the LPVR becomes the key economic variable so as to decide the winner of the tender.
This original idea came up in the Ministry of Public Works of Chile (MOP) when they were starting to implement the road concession program in this country. Three economists from the University of Chile?Engel, Fischer and Galetovic?developed most of the theoretical analysis concerning this mechanism, having had their results a big impact in the economic ground. In fact their contributions were successfully published in prestigious economic journals.
Until now the LPVR mechanism has basically been adopted in Chile. However, an analysis of the experiences concerning LPVR shows us that this mechanism has been much less successful in practice than it was in the academic arena. In fact, among the 26 road projects that were granted in Chile during the last decade, only 2 were successfully procured under the LPVR.
The main reason why this mechanism has not been applied as often as it could have been was the strong opposition to it coming from concession promoters. Three causes were given by promoters to criticize the LPVR. Fist, it limits concessionaire?s profitability always in the upside but not always in the downside. Second, even though LPVR improves the solvency of the project if traffic is ultimately lower than expected, it does not improve the capacity of the project to fulfil its commitments with the lenders every year. And third, the variable length of the duration makes concession operation difficult to organize since operation entails a lot of costs that have to be programmed in advance.
This paper analyses the practical experience of LPVR in Chile in order to determine the reasons why the success of this mechanism in practice does not correspond to the contributions provided by the economic theory. The analysis is particularly interesting since few years after the beginning of the operation of most of highway concessions in Chile, a economic crisis caused that traffic growths were much lower than expected, what obviously provide us a very interesting research scenario to test the performance of this mechanism.

Publisher

Association for European Transport