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2008/SOM3/EC/SEM/012 Agenda Item: 9
Cost “and” Benefit Analysis in Transport Infrastructure Public-Private Partnerships Projects
Submitted by: Chile
Seminar on Best Practices in Regulation and Promotion of Efficiency in Transport
Infrastructure Facilities Lima, Peru
15-16 August 2008
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Cost “and” Benefit Analysis in Transport Infrastructure
Public-Private Partnerships Projects
August 15-16, 2008Lima,Peru
Sergio A. Hinojosa
Seminar on Best Practices in Regulation & Promotion of Efficiencyin Transport Infrastructure Facilities
Cost “and” Benefit Analysis
1.Methodology2.General Approach
• Elegibility Criteria (Check List)
• Expanded SNPV (Real Options)• Value for Money (VFM) and Public
Sector Comparator• Multi-criteria Decision Making
Agenda
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Methodology
• Conceptual analysis based on literature review for i) cost-benefit analysis ii) real options and iii) PSC
• Pseudo “ Action Research”• In depth interviews• Principal component analysis [In progress]
Countries
1. Costa Rica2. Peru3. Chile4. Mexico
1. Tabasco2. Aguascalientes3. Chiapas4. Distrito Federal5. Yucatán6. Guanajuato7. Oaxaca8. Veracruz
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General approach to Cost “and”Benefit analysis methodology forDecision Making in PPPs projects
¿ privateNPV> 0?
Is not executable withpublic funds
YES
NO
Public Infrastructure Needs
¿ social NPV > 0?
Private Solution[ market]
¿ Is Eligiblefor PPP ?
NO¿ Expanded
socialNPV> 0?
NO
TraditionalPublic
Investment
NO
VFM = Public provision cost adjusted
by riskPrivate provision cost adjusted
by risk-
YES
YES
YES
Dec
isio
n-M
akin
gP
roce
ss
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¿VFM > 0? PPPPrivate Provision
NO
Costo de la provisión pública ajustado por riesgo
Costo de la provisión privada ajustado por riesgo-
¿User charges?
PartialPPP
NO PurePPP
Public Provision(RPP)
¿Multi-CriteriaDecisionAnalysis?
NO
VFM = Public provision cost adjustedby risk
Private provision cost adjustedby risk-
YES
YES
YES
Dec
isio
n-M
akin
gP
roce
ss
PPP Eligibility Criteria (25)
“Expanded” Cost-Benefit Analysis =NPV+Real Options
Development and execution of theproject under standard public
modality
Procurement modalityevaluation (VFM – PSC)
Multi-Criteria Decision Analysis
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2
3
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Development and execution of theproject under public-private partnerships
modality
Decision - Making Process
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Eligibility Criteria for PPP Schemes[25 Check List Criteria]
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Eligibility Criteriafor PPP projects
Institucionalidad
TechnicalAspects
Institutionality
Business TransactionModel
Public Finance andBancability
Competition andIndustrial
Organization
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8.Presence of a project leader
7.Existence of previuos studies at a feasibility level or an advancedprofile
6.The level of complexity of the engineering design of constructionsites and/or architecture of the building or facilities
Technical aspects of the project
5.Joined – Up in the public sector
4.Degree of institutional innovations that provoke
3.Probability of being reachable in political times [Lame Duck]
2.Making the federal, state or municipal government developmentplans suitable
1.Making the federal, state or municipal government strategies suitable
Institutional Aspects
25.The components of physique technology ( specialized equipment)
24.Existence of suppliers or the asset is very specific
23.Impact in the market structure and the need to regulate the “ natural” monopoly
Industrial organization and competitive strategy
22.Value for Money potential
21.Private atractibility for lenders and equity
20.Degree of impact in the public finances
Public finance and bancability
19.The degree to generate competition in the bidding process (Demsetz effect)
18.Posibility to apply User Charge (prices or tariff)
17.Social Impact
16.Capacity to be replicate due to structure soluction and business design
15.Capacity to the project to transfer risks to private sector
14.The size of stakeholders
13.The degree of risks of rejection towards stakeholders groups (involved)
12.Evidence of previous international experiences from other developed countries
11.Evidence of previous international experiences from other similar countries
10.Creation of a specific solution to a problem ( logical frame)
9.Reasonable size of the project ( 20 million of euros, realistic, dynamic) and time of realization ofconstructions
Business desing of the transaction
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Cost-Benefit Analysiswhith Real Options
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Project Evaluation
1. Social Project Appraisal
2. Economic project appraisal
3. Cost-Benefit Analysis
4. Benefit-Cost Analysis
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Differents Approach
•Consumer+Producer Surplus [Economic Surplus]
•Benefits and Cost ( SNPV, SIRR)
•Cost-effectiveness analysis
•Contingent Valuation
•Hedonic Prices
•Transport Cost
Real options appliedin Public Invesments
Public InvesmentAnalysis
Economic Growth Option Theory
ExogenousHarrod (1936)Domar (1936)Solow (1956)Swan (1956)Arrow (1962)Phelps (1963)
EndogenousRomer (1986)Lucas (1988)Barro (1990)
Rebelo (1991)Aghion y Howitt (1992)
EntrepeneurshipsSchumpeter (1911)
Baumol (1968)
Financial OptionsBlack y Scholes (1973)
Merton (1973)Merton (1974)
Cox, Ross y Rubinstein (1976)Boyle (1977)
Real OptionsMyers (1977)Kester (1984)
Brennan y Schwartz (1985)Majd y Pyndick (1985)
Mc Donald y Siegel (1986)
FlexibilitySapleton (1985)Acs et al (2004)
Guivernau (2005)
MethodologiesLuermanh (1998)
Amram y Kulatilaka (1999)Copeland y Antikarov (2003)
Mun (2006)
Cost-Benefit AnalysisKaldor (1939)Hicks (1939)
Little y Mirrlees (1963)Davis (1964)
Dasgupta, Marglin y Sen (1970)Arrow y Lind (1970)
Haberger (1975)Squire y Van der Tak (1975)
Hanemann (1984)Carson (1991)
Arrow, Solow, Portney, Leamer, Radner, Shuman (1993)Bishop y Welsh (1994)
National Public InvesmentSystem Applications
Fontaine (1973)ILPES (1994)Vizzio (2000)
HM Treasury (2003)Pacheco y Ortegón (2005)
Pearce et al (2007)
Infrastructure PublicInvestment
Aschauer (1989)Gramlich (1994)
Agénor y Moreno-Dodson (2006)
Literature Map
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flexibility
Private CapitalEntrepreneurship MarketCompleteness
PublicInfrastructure
Economic Growth
-Schumpeter (1911)-Baumol (1968)-Acs et al (2004)
-Sappleton (1985)
-Myers (1977)-Kester (1984)
-Brennan y Schwartz(1985)
-Majd y Pyndick(1985)
-Mc Donald y Siegel(1986)
- King y Levine (1993)-Arrow (1964) -Debreu (1959)
-Baidya y Brandão-(2000)
-Barro (1990)-Aschauer (1989a, -1989b y 1989c)-Munnell (1992)-Gramlich (1994)
-Romp y de Haan (2005)-,Agénor y
-Moreno-Dodson (2006)
flexibility
Capacidad Empresarial
PublicInfrastructure
Economic Growth
Public-PrivatePartnerships
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Definición
Flexibility represents owning the right but not the obligation toaccomplish an activity
Many assets, especially the opportunity of growth, can be seen as call options [Myers (1977), Kester (1984)]
Flexibility can be modeled as an OPTION
The right but not the obligation to buy an “S” asset at an “X” cost on a date
T. Max [ S-X,0] = Call
The right but not the obligation to sell an “S” asset at an “X” cost on a date
T . Max [ X-S,0] = Put
Real OptionsNPV and Discounted Cash Flow techniques implicitly assumes that firms hold real assets pasively. It ignores the options found and embedded in real assets- options that managers can act to take advantage of. NVP does not reflect the value ofmanagement, flexibility and options. What options?
The option to abandon a project
The option to make follow-on invesment if the immediate investment project succeeds
The option to wait and learn before investing
The option to change the firm´s output or its production methods
The option to deferThe option to growth when a early investment is a prerequisite or a link in a chain ofinterrelated projects, opening up future growth opportunities
Brealy and Myers (1999) and Trigeorgis (1996)
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Expanded (Strategic) social net present value (SNPV)= Standard (Static, passive or direct) NPV of expected
cash flows + Option Premium ( Value of operatingand strategic options from active management and
Interaction effects of competition, synergyand dependence ( Value of flexibility)
EvidenceEvidence in in thethe PrivatePrivate SectorSector
Energy IT and TelecomInvestment Banks
Fuente: Lisowski (2000)
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Real OptionTransport Infrastructure Project Example
AC
B
PT
10*(1.03)25+10+9+5+3-100FCF203720122011200920082007Years
NPV (10%) US$ -21.64 millions
Project: Road AB
Traditional main benefit:Travel time savings
Growth Option• The total net value discounted at a social 10% rate results in a value
of -21.64 million dollars. The traditional cost-benefit analysis advises us not to invest in the road. The NPV is negative and as a consequence it does not increase the wealth of society.
• Nevertheless, it is important to note that the project not only provides cash flows associated to the construction of the road, but it also creates a call option for developing the port (dock), whichconstitutes the real strategic value of the project for society. Once the road is built, and if the option from the society is exercised, it would be worthwhile to invest in the port, or in the worst case scenario, it would be better to abandon it. The question in matter is, what is the value of the purchase option?
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Growth Option• It is assumed that the port is projected for the year 2011, where
the initial investment is calculated at 150 million dollars and the future value of the cash flows expected in 2011 reaches 300 million dollars. The real value of that amount discounted at a rate of 10% is 205 million dollars. The analytical solution developed by Black and Scholes (1973) for a purchase option with an “X” price of exercise and an “S” spot price is denoted by:
• N(.) is the accumulated normal standard distribution, “r” is the risk free rate and “σ” is the volatility.
)()(),,( 21 dNXedSNXtSc rt−−=
Growth Option• Assuming that “S” has a value of 205, “X” has a value of 300, calculated
volatility is 30%, and “r” is 6%, then the value of the purchase option is equal to:
• The call option has a value for society of 37.40 million dollars, which exceedingly compensates the negative profitability of the highway. The total NPV, which includes the value of the option, goes up to 15.76 million dollars. Through this point of view, which takes into account the value of the call option of building the dock, it is concluded that the highway that connects locations “X” and “Y” should be constructed.
millionsUSdNedNXtSC 40.37$)(300)(205),,( 2406.1
1 =××−×= ×−
Expanded (Strategic) social net present value (ESNPV)
= -21.64 + + 37.40= USD15.76 millions
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EvidenceEvidencePublic Infrastructure
NationalNational InvesmentInvesment Public SystemsPublic Systems
NoNo requiredNo requiredFixeda) CBAb) Cost-Effectiveness
MEFPeru
NoNo requiredNo requiredFixeda) CBAb) Cost-Effectiveness
MIDEPLANChile
NoRequired in an specific matter
RequiredVariablea) CBAb) Cost-Effectiveness
HM TreasuryUK
NoRequired in general terms
RequiredVariablea) CBAb) Cost-Effectiveness
The White HouseUSA
Real Options
Risk andUncertainty
EquityImpacts
Social DiscountRate
PrincipalMethodologies
AdministrationCountry
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Value for Money and Public Sector Comparator
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Public Sector Comparator[Treasury Taskforce 1999]
“ A hypothetical risk-adjusted costing, by the public sector as a supplier, to an output specification produced as part of a PPP Project.
• It is expressed in net present value terms;• is based on the recent actual public sector
method of providing that defined output (including any reasonably foreseeable efficiencies the public sector could make); and
• takes full account of the risks which would be encountered by that style of procurement.”
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UK [1999]
Australia
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Canada
UK [2006]
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The Netherland
South Africa
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Chile
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Mexico
Value for Money (VFM)
Achieving VFM may be described in terms of the 'three Es' -economy,efficiency and effectiveness*:
a. Economy. Doing less with fewer resources, i.e. makingsavings.
b. Efficiency. Doing the same as before, but with fewerresources (money, staff, space).
c. Effectiveness. Doing more than before with the sameresources as now (or less).
*Imperial College of London
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Retained Risk Retained Risk
Base Costing
Transferred Risk
Cost of ServicePayments
PPPPRPPPPPublic Reference Project
Public Sector Comparator
Risk
Risk can be defined as the volatility of an expeted outcome
( )∑=
−−
=n
ii uu
n 1
2
11σ
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Risk Valuation Methodologies
• Historical Probabilities: Found σ using past data and simulate Bootstrap or Montecarlo analysis)– Quantitative
• State Probabilities: Found σ (over-cost and over-run) through expert panel and simulate with Bootstrap or Montecarlo Analysis Qualitative
• International Benchmark : Found σ taking into consideration international studies
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International Studies
• Probabilidades Históricas: Encontrar σ a travésde datos pasados y simular (Bootstrap o Montecarlo)– Inductivo cuantitativo
• Probablidades Declaradas: Encontrar σ los sobrecostos / sobreplazos a través de panel de expertos y simular (Bootstrap o Montecarlo –Inductivo cualitativo
• Benchmark Internacional: Encontrar σ a partir de estudios internacionales
Qualitative evaluation:• Not to be used for Information
Communication Technology projects• Or projects less than MMUSD 30• Or sufficient market interest for
competition• Or the public sector not be able to
finance the alternative
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Multi-Criteria Decision Making
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Analytical Hierarchy Process“ Analytical Hierarchy Process (AHP) is an approach to decision
making that involves structuring multiple choice criteria into ahierarchy, assessing the relative importance of these criteria, comparing alternatives for each criterion, and determining an
overall ranking of the alternatives“ Source: Decision Support System 2008
Evaluation phase is divided into four steps 1. Generate pairwise matrices2. Generate the weights of the measures3. Normalize weights to get the consistency among measures4. Calculate the overall ratings
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The Decision-Making Process
Develop DecisionCriteria
Allocate Weightsto Criteria
DevelopAlternatives
AnalyzeAlternatives
Select Alternative
ImplementAlternative
Evaluate Results
Identify Problem
Source: Adapted from Ibrahim Ozer - University of Ottawa 2005
Procurement Procurement MechanismMechanism
• Define the objective:Select Procurement Mechanism for the development of a public infrastructure project
• Alternatives:
1. Traditional2. PPP3. Traditional (B) + PPP (O&M) [ Unbundling]
• Criteria:
Value for Money (VFM), Oportunity, Competition, Institutionalexternality.
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Analytic Hierarchy Process
Select ProcurementMechanism
Tradicional PPP Traditional (B) + PPP (O&M)
VFM
Oportunity
Competition
InstitutionalExternality
VFM
Oportunity
Competition
InstitutionalExternality
VFM
Oportunidad
Competition
InstitutionalExternality
ALTERNATIVES
GENERAL CRITERIA
GOAL
PairwisePairwise Matrix Matrix ComparisonsComparisons[ [ SourceSource: : DecisionDecision andand RiskRisk AnalysisAnalysis by by SaatySaaty (2005)](2005)]
Traditional PPP Traditional +PPP
Traditional 1/1 1/2 3/1
PPP 2/1 1/1 4/1
Traditional + PPP 1/3 1/4 1/1
• Numerical representation• Relationship between two elements that share a common parent in the
hierarchy• Comparisons ask 2 questions:
– Which is more important with respect to the criterion?– How strongly?
• Matrix shows results of all such comparisons• Typically uses a 1-9 scale• Requires n(n-1)/2 judgments• Inconsistency may arise
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Many Thanks