EuropeanInvestmentBank

The PPP Premium in European Roads Projects

Hugh GoldsmithPPP Coordinator, Projects Directorate

Frederic Blanc-Brude & Timo Välilä

5th Conf. On Applied Infra Research (INFRADAY)Berlin, 6-7 October 2006

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A road, is a road, is a road… except when it’s a PPP!

Does it cost more to build infrastructure as a PPP than via traditional procurement?

Agenda:

1. Theory

2. Practice

3. Data

4. Analysis

5. Interpretation

6. Conclusions

3

Theory – Value for Money

Does PPP deliver VfM?

We’ll only know once large sample of projects have completed life-cycle

1. Full cost-benefit comparison

2. Ex-ante use of PUBLIC SECTOR COMPARATOR

Cost to Govt of PPP

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Cost to Govt of Traditional Procurement

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Theory- Benefits & Costs

Benefits

Bundling Life-cycle approach

Innovation Depends on scope in

tender dossier

Risk sharing Better risk management

Private asset ownership Cost saving innovation &

more efficient contracting

Costs Transaction costs

Bidding, negotiation, monitoring Renegotiation over life-cycle

Private finance costs

Pursuit of cost efficiency may impact service quality

Institutional and administrative capacity requirements in public sector

VfM VfM

Scope for VfM varies across sectorsScope for VfM varies across sectors

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Theory – Construction Costs

Ownership + Incentives + Bundling (Hart, 2005)[a(i*) - α(e*)] + [b(i*) + β(e*)] > i + e

Higher construction costs expected due to:+ Greater investment for Lifecycle cost savings+ Pricing of risks (more efficient contracting)+ Higher transaction costs for complex contractsLower construction costs expected due to: – Design innovation responding to output based

specification

Cost of making cost-saving investments

Improved productive efficiency benefit

Impact on allocative efficiency (quality)

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Practice - Contracting

SPVSPV

EPCEPC O&MO&M

GovtGovt

XX

GovtGovt

EngineerEngineer ContractorContractor

OperatorOperator

TraditionalTraditional PPPPPP

XX XX

Cost to buildCost to build

Ex-ante = Price of construction contractEx-ante = Price of construction contract

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Practice – Risk Allocation

Sponsors EquityDebt

Taxpayers

Design & Construction

Operating Risks

Force MajeureUninsurability

Payment Market rates

Sub-contractors SPV Public sector

““Allocate risks to the party best able to manage them”Allocate risks to the party best able to manage them”

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The Sample

EIB financed roads projects 1990-2005

Projects divided into “sections” or “lots”

Different technical characteristics (length, terrain, proportion bridges/tunnels, no. lanes)

Motorway & non-motorway standard roads

Both public & private projects

Large variety of procurement routes

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FI 6

FR 8

DE 12

GR 12

IR 4IT 5

NO 9PT 38

SP 23

SW 14

DK 16UK 12 BE 3

Data – Country Coverage

FR 6

DE 2

GR 3

IR 3

NL 4

PT 14

SP 22

FI 1AT 1UK 9

65 PPP162 Non-PPP

227 EIB-financed road sections in 15 countries

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At face value, cost of a PPP road higher and more variable

Construction cost/km, in millions of 1999 €

Full sample PPP non-PPP

Observations 227 65 162Mean 12.2 15.5 10.9Median 5.8 6.8 5.1St. deviation 19.6 25.9 16.3

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Outliers are mainly fixed links

0

20

40

60

80

100

120

140

NONPPP PPP

median

mid-50% ofobservations

Construction cost/km, in millions of 1999 €

most outliers are fixed links

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Unit costs vary with project characteristics

-1

0

1

2

3

4

5

6

-1 0 1 2 3 4 5 6

LogLength

Lo

gU

C19

99

road

motorway

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Estimation methodology

OLS Regression Dependent variable: Unit costs (1999 million €/km) Explanatory variables: Economic; Technical; Countries Dummy variables for:

PPP Urban terrain, Mountainous terrain No. lanes (avoiding dummy trap) Countries

General to specific methodology 10% significance threshold

Diagnostic & robustness testing

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Robustness Testing

Alternative samples Motorways only Cost range € 20 to 300 million Observations +/- 1.5 x Stdev Only countries with both PPP and non-PPP No fixed links (< 50% bridges or tunnels)

Alternative specifications With/without country dummies

Common sense: Sign & magnitude of coefficients Unit cost benchmark: 4.9 million €/km (1999 prices)

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Results

PPP dummy coefficient significant in all samples & specifications

Sample N PPP coefficient Adjusted R2 DiagnosticsMotorways

full sample 156 0.29 0.74 OKTotal cost (20, 300) Eur million 117 0.33 0.76 OKDependent variable w/in 1.5 stdev 138 0.29 0.64 OKOnly countries with both PPP and trad projects 120 0.23 0.77 1/

All roadsfull sample 227 0.31 0.82 OKTotal cost (20, 300) Eur million 168 0.33 0.80 OKDependent variable w/in 1.5 stdev 201 0.27 0.69 OKOnly countries with both PPP and trad projects 175 0.28 0.79 OK

1/ There is evidence of residual non-normality at 5% level.

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Sample Bias Adjustment

Different data quality due to timing of appraisal Ex-ante cost data:

PPP = EPC contract price Non-PPP = variable timing/quality

Adjustment:

PPP Premium = 100 x {exp(PPPcoef) –1} – 10%

Median estimate Sample bias

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PPP Premium estimates

31 estimates of PPP premium

Distribution of PPP Premium estimates

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

< 10% 10-15% 15-20% 20-25% 25-30% 30-35% 35-40% > 40

PPP Premium range

Re

lati

ve

fre

qu

en

cy

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Good fit for preferred modelMotorways without fixed links

0

5

10

15

20

25

30

35

40

0 5 10 15 20 25Observed unit construction cost (mill 1999€)

Pre

dic

ted

un

it c

on

stru

cti

on

co

st

(mill

19

99

€)

Perfect fit line

PPP Premium = 23%

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Cost Overruns in Traditional Procurement

Previous Studies: Flyvbjerg (2002) for European roads: + 22% Mott MacDonalds (2002) for UK roads: + 21%

Interpretation: Systematic “optimism bias” PPP Premium = Expected Cost Overrun under

traditional procurement Is there any additional investment for quality

enhancement & lifecycle cost savings?

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What are we getting for the PPP Premium?

Construction on-time and on-budget Higher transaction costs? Construction companies taking out profits

upfront? Better quality?

“The road was built to a higher standard than normal motorways (in the country), because the contractor new he was fully liable for maintenance over 20 years”

EIB. EV Report on PPPs June 2005  

Better lifecycle performance? … too early to tell !

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Conclusions

PPP Premium in European roads is 20 to 25% Significant and robustly estimated Close correspondence with “optimism bias” of

traditional procurement Rational construction risk pricing by contractors

PPP delivery success = cost + time certainty VfM: Too early to judge about long term lifecycle

costs & quality

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The road ahead …

PPP here to stay: Challenge is to do it well … … by learning from mistakes

& successes at EU level EIB public policy role:

Support the development of EU-wide best practice

On-going research Questions:

Why are some countries cheaper?

How to achieve Lifecycle VfM?

http://www.eib.org

Address : 100, Boulevard Konrad Adenauer, L-2950 LuxembourgContact : Hugh Goldsmith

Email : h.goldsmith@eib.orgTel : 00352-4379-2783Fax : 00352-4379-2860