Contractual Flexibility in Transport Infrastructure P P Ps
Nominated for The Neil Mansfield Award
Sergio Domingues, University of Antwerp, Dejan Zlatkovic, University of Belgrade, Athena Roumboutsos, University of the Aegean
The aim of this paper is to propose a methodological framework where Real Options Analysis is used to identify and quantify risks associated with the development of port related infrastructures delivered by means of PPPs.
All major ports in the world have a continuous need for important port infrastructure investments, be it for replacement or expansion. It has been shown before how important transport infrastructure, and port infrastructure in particular, is to trade, the economy and society. However, the recent global financial crisis has stressed the perception of funding as scarce resource, also in the case of Public-Private-Partnerships (PPP).
In one hand, given the needs for transport infrastructure, the associated uncertainties in terms of demand and the current budgetary scarcity, governments need to take smart and balanced decisions on which projects to procure, which private partners to select and how to allocate risks. On the other hand, decision making processes and ex ante evaluation instruments, like the public sector comparator and cost-benefit analysis, are frequently suboptimal and are most often used in a rather formal way. Moreover, the financial crisis and Basel III regulations have affected the project financing market dramatically, making financial institutions reluctant to invest in high-risk projects or to grant long term loans. Lastly, project sponsors are facing a highly volatile investment environment, which stresses the need for a sound assessment of the economic and financial viability of infrastructure projects. This all strongly increases the complexity of both the setting in which funding can be developed, and of the required instruments that allow assessing the outcome of certain funding schemes.
Standard investment appraisal practice (based on discounted cash flow techniques) fails to recognize two routine features of large projects – 1) assumed conditions, such as price and demand, constantly change; 2) intelligent management eventually decides to change the system in response to new circumstances (de Neufville & Scholtes, 2011). Hence, to achieve the best results, investors and planners need to adapt to circumstances as they arise, by giving this infrastructure development the necessary flexibility to adapt to uncertainty. Optimally, such flexibility could be applied to risk management by building risks as options into projects (e.g. stepwise investment) or could be built into contracts by introducing special clauses which can be used to alter the timing and sequence of activities for achieving reduced risks (Floricel & Miller, 2001). Flexibility is thus the key to deal with the uncertain future. Notwithstanding, the procedures for creating effective flexibility in design are not well established in the current PPP theory nor practice.
From a methodological viewpoint, real options (RO) theory is an important tool to valuate such flexibility. For that purpose, tools such as simulation models, binomial lattices or decision analysis can provide useful input. However, RO has not been tested so far in realistic case studies, being PPP projects in maritime infrastructure. Moreover, only limited developmental work has been done about how to bring in such flexibility into the PPP risk allocation and management approaches as well as into PPP contracts in the transport sector.
The aim of this paper is therefore to propose a methodological framework where RO is used to identify and quantify risks associated with the development of port related infrastructures delivered by means of PPPs.
Association for European Transport