Concessions

Concessions are a type of Public Private Partnership (PPP) model where the private sector operator (concessionaire) is responsible for the full delivery of services in a specified area, including construction, operation, maintenance, management, and rehabilitation of the system.
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Instrument Category

  • Public Private Partnership (PPP)

Other ınstruments ın the same Category

Build-operate-transfer (BOT)
Design-build-operate (DBO)

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Description

A Public Private Partnership (PPP) is a long-term contract between a government entity and a private entity for providing a publicly beneficial service or asset, where the private party bears some risk and responsibility. PPPs can be attractive for governments as they can transfer upfront costs to private partners, take advantage of external expertise, and open new financing options.
Concessions are a type of PPP model where the private sector operator (concessionaire) is responsible for the full delivery of services in a specified area, including construction, operation, maintenance, management, and rehabilitation of the system. The operator is responsible for all capital investment required to build, upgrade, or expand the system. Although the private sector operator is responsible for providing the assets, such assets are publicly owned during the concession period. The public sector is responsible for establishing performance standards and ensuring that the concessionaire meets them.
The concessionaire collects the tariff directly from the system users and a concession contract is typically valid for 25–30 years so that the operator has sufficient time to recover the capital invested. The public authority may contribute to the capital investment cost through an investment “subsidy” (viability gap financing) to achieve commercial viability of the concession. The government can be compensated for its contribution by receiving a proportional amount of the tariff collected.
Concessions are an output-based contract where the contractor is accountable for meeting the contract outputs. While concessions can be used for both greenfield and brownfield projects, they are predominantly used in greenfield projects due to the higher risk of cash flow and profitability issues in brownfield concession projects.

Enabling Conditions and Key Considerations

  • Legal and regulatory framework for PPPs. A robust legal and regulatory environment in the project’s country is crucial for structuring PPP projects, including BOT projects. This framework should define private sector investment rights, ensure transparent procurement, outline arbitration processes, and establish measures for bankruptcy/payment defaults. Clear delineation of enforcement capacities among institutions is essential. The regulatory framework not only creates business opportunities for private investors but also influences transaction speed, pricing decisions, and legal certainty in contractual arrangements and rule of law enforcement.
  • Public sector expertise in design and implementation. Successful PPP implementation relies on an effective institutional framework that clearly delineates roles and responsibilities across ministries and coordinating bodies. This enhances efficiency and ensures effective enforcement of PPP agreements, fostering the overall success and sustainability of collaborative ventures between the public and private sectors.
  • Competent private sector providers. PPP will only be successful if the private sector has the capabilities to add value to the delivery of public services. As such, PPP models should only be applied to projects where the private sector has the competencies to meet the service standards required by the government or the public. This is particularly important in a Concession model where the private sector operator entity needs to ensure the effective management and sustainable operation of the infrastructure over a long period of 25-30 years.

Potential Challenges

  • Lack of public sector capacity to formulate and implement PPP frameworks. Inadequate public sector capacity in policy formulation and regulatory management may hinder the creation of robust PPP legal or regulatory frameworks and discourage private sector investment and participation. Additionally, limited public sector capacity in planning and managing PPP projects may result in poorly structured contracts, unclear risk allocation, and diminished appeal for private investors. In particular, concession projects demand a high level of expertise and oversight from the public sector in contract design, risk management, negotiations with the private sector operator to ensure the project aligns with public interests.
  • Lack of private sector capacity for contractors to participate in PPP. Limited capacity within the private sector may pose challenges for contractors to adhere to legal and regulatory frameworks, leading to bottlenecks and delays in project implementation. This issue is particularly significant in a concession project where the operator, overseeing the entire project life cycle, may be unable to meet contractual obligations and regulations, and delay the construction and operation of the utility/facility. Concessions may face challenges in generating robust competition due to a limited number of qualified operators for major infrastructure networks, potentially impacting the benefits of market competition.
  • Risk of service discontinuity due to financial challenges faced by contractors. If the contractor faces financial challenges during the contract, service continuity might be compromised if the government/ alternative private providers are unable to take over and continue delivering the service. This challenge is particularly relevant for concession projects, where there are high costs of changing operators given the complex nature of transferring responsibilities and potential legal complexities.
  • Potentially complex bidding process and contract design. Defining the operator’s activities in concession contracts can be complex, posing a challenge in drafting comprehensive agreements that clearly outline roles and responsibilities. Furthermore, the necessity for long-term contracts to recover substantial investment costs adds complexity to the bidding process and contract design, with challenges in anticipating events over a 25-year period.
  • Risk of political controversy and organisational difficulty. Concession contracts, due to their long-term and comprehensive nature, can be politically contentious and challenging to organise. This poses difficulties in sustaining continued support from the public sector, particularly during transitions in political leadership.

Potential Benefits

  • Potential cost efficiencies. Private sector contractors, tasked with overseeing various project phases of design, build, maintenance, and operation, are incentivised to optimise lifecycle costs for long-term cost efficiency. This results in enhanced value for the public sector, as the private sector providers prioritise maintaining high-quality standards while minimising lifecycle costs. This is particularly pertinent in concession projects as there are strong incentives for the operator to increase efficiency since lower costs will lead to higher profits.
  • Private sector contractors are incentivised to deliver optimal outcomes. Private sector contractors are incentivised to deliver optimal outcomes as they seek to meet and exceed performance targets across various project phases. This results in enhanced service quality, timely project delivery, and the effective long-term management of public assets, ultimately benefiting both the public sector and end-users. In particular, the concession model encourages increased performance accountability and efficiency, as the operator is motivated to uphold high standards to ensure the continued success of the infrastructure throughout the concession period.
  • Risk transfer from the public sector. In a concession project, the private sector operator assumes responsibility for all the construction and operational risks during the concession period. This strategic risk transfer not only mitigates potential financial burdens on the public sector but also fosters a sense of accountability within the private sector, incentivising them to implement robust risk management strategies.
  • Effective means to attract private financing. Concessions are an effective way to attract private finance required to fund new construction or rehabilitate existing facilities. By leveraging private financing through concessions, governments can allocate their budgetary resources more efficiently and direct public funds toward other essential services.

Sources/Additional Information

Case Study

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