Paper of PSP

8/6/2019 Paper of PSP

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population in 2000 and it was not significantly improved up to 2007, hence it is aneed to find out an appropriate contract strategy to meet stakeholder objectives interms of project financing, sustainability operation and maintenance.

Pendulum Obligation Diagram (POD) and Assessment Criteria (AC) (developed by

the author) were use to assist decision-making process in selecting contract strategiesfor development (construction), operation and maintenance of the water supplyindustry in Indonesia, 2002. To what extend these approach may assist the selection

process of contract strategy suit to a water supply project was demonstrated in thispaper.

ObjectivesObjectivesThe objectives of this paper is to utilise of Pendulum Obligation Diagram (POD)and a set of Assessment Criteria (AC) in assisting process in selecting contractstrategies for development of a water supply projects. A case study in development ofwater supply project appraisal in Indonesia was also presented to demonstrate the use

of POD and AC.

Literature StudyLiterature Study

Private Sector Participation (PSP) has been promoted as necessary for obtainingfinancial resources for the development of the water supply sector in developingcountries for improving both service coverage and performance quality (Owen, 2001;Steklov, 2001; Wolfe, 2001; and Janssens, 1997).

Factors affecting the success, or failure, of private sector participation

This paper identified a range of factors influencing the success or failure of PSP inwater projects, but the emphasis is placed on seven (see Figure 1): Political will is required to support and accomplish PSP. An adequate legal framework must be in place before adoption of PSP. This

should be related to re-allocation of water, water transfer, water licences, water pricing, contractual arrangements ,and long-term industry structural aspects toensure a sustainable water industry.

An independent regulatory system is also necessary. This should encompass:environmental regulation, protection of river water and wetlands, water qualitystandards, level of service standards, financial performance, and water charges.

This will require: (i) technical standards, which are based on appropriate scientificcriteria; and (ii) competent staff, who are able to carry out operations andmaintenance (O&M) of the new, and systems.

An adequate database for: water resources management; the existing urbanwater systems; socio-economic conditions; and geographical conditions. Suchinformation is fundamental for private investors and project promoters to developfeasibility studies for water projects.

Acceptable elemental risk (external and internal risks) of the projects, such as:transferred project asset conditions; operational performance; market demand; andclimatic conditions.

Community acceptability of the principle of PSP in the water supply sector. The

community also needs to be committed to connecting to the water service, and

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accept economic water tariffs measured by willingness to pay (WTP) whichmust be linked to quality of service.

Acceptable global risk. These risks are essentially: political stability, which isessential to sustainable development (changes in the government regime shouldnot significantly affect the existing regulations and laws); access to capital

funding; a sufficiently large pool of skilled operations staff; and adequate revenuegeneration, enabling project promoters to service O&M costs, debt, and generate

profits.These seven significant factors were also reported in Sandhyavitri, 2002, Owen, 2001,and Janssens, 1997. Hence, it is a common sense that various factors above are alsoinherent in any water supply development projects in many countries.

Research MethodologyResearch MethodologyLiterature study was applied in the initial research activities. Field survey to the fieldwas also carryout together with interviewing various parties involving in the water

supply area in Padang, Indonesia (encompassing project managers level of Padangwater supply operators, consumers and regulatory body). The main objectives of thissurvey is to obtain information related to project financing issues, technical andadministration performance during project operation. The simulation of projecteconomic parameters uses Caspar Software package.

DiscussionDiscussion

Typical PSP contracts

This paper classifies PSP contracts in three major groups:Low degree of private participation this may include service contracts,

management contracts, and leasing. The private sector mainly provides theworking capital to carry out works as stated in the contracts. Government retainsthe ownership of water assets and pays the private sector investor usingcontractual mechanisms. Government is also able to take advantage of the privatesectors experience, and efficiency of performance and skills in the O&M of watersystems and service.

High degree of private participation this may include Build Operate Transfer(BOT) and concession contracts. In BOT contracts, public authorities pay privatefirms to treat a certain amount of water produced. To provide the basis for project

financing, the revenue stream is secured through a take-or-pay arrangement, orfixed payments are made irrespective of whether or not the service is used. Inconcession contracts the private sector (the concessionaire) has the overallresponsibility for financing the expansion of water systems, O&M facilities,delivery of services, and collecting revenues from the customers. The contract

period is negotiated to allow for retirement of debts, providing a return on equityfor investors, and a reasonable profit for the operators. The fixed assets remainthe property of the public authority (project principal), but the operation of allfacilities is entrusted to the concessionaire.

Full privatisation within this contract arrangement, the private sector(concessionaire) has overall responsibility for project finance, O&M facilities and

revenue generation. The existing assets are handed over from the publicauthority (project principal) to the concessionaire.

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within water treatment plants; and underLeasing Contract(LC), the private firm mayalso invest capital for the development of plants or distribution systems. Ultimately,underBOT (BC) and concession contracts (CC), the roles of the private entity arefurther extended to cover overall capital investment, O&M costs and efficiency tasks.

The shift in the balance of obligations from the public sector to the private sector inmoving from a service contract (SC) to concession contract (CC) may also beillustrated by a definition of the tasks which fall to both sectors, as shown in Figure 3.

Assessment Criteria

Seven assessment criteria, which may be used to assist the process of: (i)identification of strengths and weaknesses of PSP contract strategies; and (ii)selection of appropriate PSP contracts for water supply projects are identified. Thesecriteria (Table 2) are: Capital investmentidentifies which parties are responsible for providing capital

investment. Financing O&M indicates the allocation of O&M costs for water treatment

plant, distribution systems and management offices. The costs may include: (i)staff payments; (ii) electricity and fuel; (iii) chemical costs; (iv) financial cost; and(v) administration.

Obligations These may include overall descriptions of the private sectorcompanys responsibilities in either financing, operation or management of awater scheme. The roles of the water company may also be described in thisdiagram.

Efficiency of O&M The project operators have as their main objective toimprove efficiency of the O&M activities, such as efficiency in using electricity,chemical materials, equipment, staff, and reducing leakage2.

Commercial risk Commercial risk is inherent in any privately funded waterproject, thus the project principal or promoters should appreciate the degree ofcommercial risks, which have been passed to other parties, or indeed how riskshave been shared between their organisation and other parties; and what risks have

been retained in order to minimise the risk premium paid. Economic parameters - These are illustrated by the IRR, NPV, cash pay back

time (CPBT) and Maximum investment requirements of a project. Contract duration - Different contact lengts for different PSP options are

identified as being between 2 to 30 years.

Case Study

This paper undertaken a study of the development of a water supply scheme plannedfor Padang city in Indonesia, which had the main objectives of: (i) increasing servicecoverage from 54% of the population in 2000 to 67% of the population in 2007; (ii)

2Leakage reduction identifies which parties are responsible for leakage mitigation and control. These responsibilities

should be clearly stated in the contract. High levels of technical performance and professionalism are required to ensuresuccess of leakage reduction programmes. Billing and revenue collection higher billing efficiency usually needs to beachieved, as this will improve revenue generation. Quality the term quality is abstract and subjective. In order to makeit less subjective, there is a need to establish quality specifications against various parameters set by formal organisations.For example: (i) the water quality standards are referred to the standards of the World Health Organisation (WHO), or the

government of Indonesia; and (ii) the efficiency standards for O&M of the water utilities should comply with the standardsof the Public Works Department

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maintaining uninterrupted supply of 150 litres per capita per day (lcd) by 2005; and(iii) complying with the World Health Organisation (WHO) water quality standards.

The project duration is 25 years (January 2000 to December 2024), divided into 4 packages encompassing: (i) project finance, (ii) construction, (iii) operation and

maintenance (O&M) and (iv) revenue generation. The main aspects of project financeare loan resources, loan repayments, and the fluctuation of interest and exchangerates. The construction and operation phases have 35 activities. The plannedconstruction period was divided into 4 phases. Phase 1 of duration 49 months to becommissioned in January 2004, and Phase 2 taking 25 months to be commissioned inFebruary 2006, with Phases 3 and 4 to be commissioned in April 2008 and in April2009 respectively. Plant operation would be in 3 phases, related to increased waterdemand and production capacity. The main aspects of the revenue package are:establishment of tariffs, billing and revenue collection. These packages waresimulated using Caspar Software.

The requirement of stakeholdersThe main requirements of specific stakeholders were:1. Principal (Municipality) had to identify the financial resources for such a project

(e.g. private sector finance).2. Lenders (e.g. Asian Development Bank or ) require a punctual loan repayment

schedule, and high commercial viability for the project (i.e. commerciallyattractive project IRR and NPV figures).

3. Promoter and operator (water companies) have three main requirements: (i)generation of adequate revenue to cover O&M, service debts and yield profits; (ii)efficiency improvement; and (iii) gaining public esteem.

4. Consumers (domestic, commercial and industrial sectors) have the mainrequirements: (i) obtaining adequate water quality; (ii) reliability of water quantity(no disruption); and (iii) reasonable water bills.

Thus, for the selection of appropriate PSP options, these stakeholders' requirementshould be taken into account.

The main requirement of the project principal is a large capital investment to meetrapid increases in water demand within the city. Thus, Service Contract andManagement Contractstrategies were considered inappropriate for such a project, as

both of these contract strategies do not provide large capital investment. This can beseen at the magnitude of obligation of the private sector in Figure 2.

Hence the author investigated four contract strategies that could be appropriate forfinancing, developing and operating such a project in more detail. These encompass:(i) lease contract; (ii) BOT; (iii) partial concession contract; and (iv) full concessioncontract.

Lease Contract (Affermage)

Possible application: The private sector leases treatment plant (stage I). This wouldinclude: operation of water treatment plant facilities; and maintaining reservoirs,intakes and distribution systems in the southern and eastern areas of the city over a 20year contract period.

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Obligations of the private sector are to: Operate and manage a water treatmentplant (stage I) with the capacity of 160 l/s; supply clean water to an agreed number ofcustomers; commence staff training; read water meters and issue bills; collect revenuefrom the customers; transfer the collection fees to an Escrow account 3; develop theexisting plant from 160 l/s to 220 l/s; expand distribution systems to cover 6,200 new

connections; and at the end of the contract period return all facilities to governmentcontrol.

Financial analysis: The commercial data for such a contract strategy for the investorsis projected to be an IRR of 10.15%, with the NPV of Rp. 3.31 billion (US$ 0.47million) and a cash pay back time (CPBT) of 11.83 years.

Recommendation: Such an option would probably be commercially attractive to aninvestor as the economic parameters are relative high, but this option is notrecommended, as the type of contract attracts low capital investment, CPBT isrelatively long (compared to the 20 years project life cycle) and generates little

improvement of water treatment plant facilities and distribution systems (Figure 4).

BOT Contract

Possible application: The private sector finances, constructs and operates watertreatment plants (stages I and II, reservoirs and water intakes over a 20 year contract

period.

Obligations of the private sector are to: Finance and construct 2 new watertreatment plants (with capacities at stage I of 160 l/s, and stage II of 200 l/s). This alsoincludes the construction of reservoirs and intakes stated in the project plan; operateand manage the new facilities and supply bulk water to the existing water company;maintain agreed minimum water quality and quantity production, and achieve thestandard performance benchmarks agreed between the existing water company andBOT contractors; and at the end of the contract period return all facilities togovernment control.

Financial analysis: Project should yield an IRR of 14.42%, with an NPV of Rp.21.48 billion (US$ 3.07) and a CPBT of 10.41 years.

Commercial risks: A fixed-fee is set for treatment of water and maintenance of the

water treatment facilities. This is paid directly by the project promoter to the privatecontractor via an escrow account.

Recommendation: Such a contract may (i) improve treatment plant capacity; and (ii)be commercially attractive to an investor (the NPV and the IRR of the project arerelatively high); this option is not however recommended. This contract does not meetthe project principals requirements (that of fresh capital investment for theimprovement of water plants and extension of distribution systems). Moreover, theexisting infrastructure owner does not have the capability to provide adequate

3Escrow account is an account established by the Government and the private sector for collecting the revenue

from customers. The money within the escrow is then proportionally divided between these parties based on thecontract agreement.

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network distribution systems and to pay the fixed fee for the water produced by theprivate sector.

Concession Contract (Partial)

Possible application: The government authorises the total management of new

water supply systems (for example: the construction and operation of water treatmentplants, reservoirs, intakes and distribution systems) to a private sector investor in aspecified area of the city over a 25 years contract period.

Obligations of the private sector are to:provide capital investment of 31.71 billion(US$ 4.53 million) for financing and construction of new water treatment plants(stages I and II with the total capacity of 260 l/s) and distribution systems; supply653,000 m3 of clean water per month to cover 181,400 customers; operation of newtreatment plants with operation costs per m3 of water of Rp. 600 and a selling cost ofRp. 1,100; maintain distribution systems and all treatment plant facilities; read watermeters, issue bills and collect revenues from the customers; transfer the collected

revenues to the escrow account; and at the end of the contract period return allfacilities to government control.

Financial analysis Analysis indicates that the projected NPV of the project wouldbe Rp. 36.65 billion (US$ 5.23 million), with an IRR of 6.12% and a total investmentof Rp. 30.82 billion (US$ 4.40 million) with a CPBT of 17.97 years.

Recommendation: Although this option provides the overall facilities required tomeet an increase of water demand, such a contract is unattractive to investors as the

projected IRR is relatively low and CPBT is long. Thus, this option is notrecommended for application in this project.

Concession Contract (Full)

Possible application: The private sector takes over total management of water supplysystems (for example: the construction and operation of all of water plant facilities,reservoirs, intakes and distribution systems) for the entire city over a 25 year contract

period.

Obligations of the private sector are to: finance and construct new water facilitiesand distribution systems with agreed capital investment of Rp. 31.71 billion (US$4.53 million); operate and manage the entire water supply systems (both existing and

newly developed); read water meters, issue bills and collect revenues from thecustomers; transfer the collected revenues to the escrow account; and at the end of thecontract period return all facilities to the government control.

Financial analysis this arrangement woul yield an NPV of Rp. 102.76 billion (US$14.68 million), with the IRR of 14.27% and a CPBT of 12.99 years.

Recommendation: This option is recommended for such a project, as the type ofcontract would yield significant improvement of the water treatment plants anddistribution systems. This option would also best meet the requirements of the project

principal and the project promoters (i.e. to have an access to large capital investment

and working capital, and improve efficiency). Moreover, this contract should yield

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relatively high IRR and NPV, with a relatively short CPBT. Thus, this option wouldbe commercially attractive to investors.

Conclusion and recommendationConclusion and recommendationFor this case study the recommendations are that the first option would be a full

concession contract as such a contract will best meet most of the project requirements(on fresh capital investment and efficiency). This contract may also be attractive toinvestors as the projected IRR is relatively high (14.27%) and CPBT is relativelyshort (12.99 years).

The second option would be a BOT contract as this contract could meet partial project requirements on financing and operation of new water treatment plantfacilities. Such a contract may also yield good economic parameters (e.g. the IRR is14.42% and CPBT is 10.41 years). On the other hand, lease and partial concessioncontracts were not recommended.

The Authors have realised that the political and social environments would probablyresult in strong opposition if full management of water assets was given to the privatesector. Based on a willingness to pay (WTP) survey carried out in the city in 2000 theAuthors identified that only 20% of the water users were happy to have a fully

privatised water utility, 20% felt that partial privatisation of O&M of the water utilitywas acceptable. Hence it is likely that a full concession contract might proveunacceptable to the water consumers, and therefore a compromise recommendation ismade that the project principals and project promoters follow a BOT contract strategy.

This type of approach maybe used as a generic model that may assist project principals and managers in the selection of contract strategies, which best meetproject's requirements. By systematically assessing the requirements of the projectprincipal and promoter, and inputting this information to the figures, along with allthe other relevant data, the various contract strategy options may be prioritised inorder of maximum benefit to the parties to the contract.

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AppendixAppendix

.

10

POLITICALWILL

LEGALFRAMEWORK

REGULATORYSYSTEMS

EFFECTIVEPSP

Requirements

ACCEPTABLE GLOBAL RISK:Stable political environmentAccess to capitalAccess to capable operatorsAdequate revenue

Access to technology

ACCEPTABLEELEMENTAL RISK

Asset conditionsOperationalperformanceMarket/demandClimate

COMMUNITYACCEPTABILITYWillingness toconnectWillingness to pay(WTP)Water conservationmeasure

DATABASE ofthe existingwater supply

systems

Figure 1 Country conditions for effective PSP


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SCALE OF

OBLIGATIONSCAPITAL

INVESTMENTPlanning and

designWater resources, dams,

reservoirs and intakesMain trunksNetwork

systems and

water metersTreatment plants and

pumpsWORKING CAPITALQuality

managementCatchmentsBulk

waterTreatment of raw waterSupplying

waterRepairs and maintenanceAdmin.

and billingEFFICI-ENCYQuality

controlQuality of serviceTreatmentcostsBilling and revenue

collectionsLeakage rates

Public Sector(PS)

Service Contract(SC) Management

Contract (MC)

Leasing (LC)

BOT Contract(BC)

ConcessionContract (CC)

DEGREE OF PSP

Figure 2 Scale of Pendulum Obligations


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Figure 3 Change of the public obligation in financing and operation of water

sector from the public sector to the private sector

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Escrow

Account

Supply water andcarry out service

Operation fee

Government fee

Concession

Customers

Government

OwnershipRegulatorMonitoring

Government

OwnershipCatchment areasRegulatorDistribution/sell bulk ofwaterFinancing capital investmentO & MTreatment plants Development

facilities/ servicesDistribution systems, and water supplyCommercialrisksRepair, service and maintenanceAdministrationBilling and revenue

collection

PrivateSector

CustomersSupply waterand services

Pay bills

Carry out works/services

Paycontractors

Pay bills

Private Sector

Financing capital investmentDevelopment facilities

Catchment areas

Distribution/sell bulk of water

O&MWater treatment plants

Distribution systems, and water supply

Repair, service and maintenance

Administration

Billing and revenue collection

Commercial risks


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-60000

-40000

-20000

0

20000

40000

60000

80000

100000

120000

2000

2001

2002

2003

2005

2006

2007

2008

2010

2011

2012

2013

2015

2016

2017

2018

2020

2021

2022

2023

2025

year

NPV(Rp.) Lease contract

BOT contract

Partial Concession

contract

Full Concessioncontract

Figure 4 Comparison cash flows of four contract options


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Table 1. Range of private sector participation can play in water industryPrivate Sector Participation (PSP)

Low degree of

participation

High degree of participation Full privatised

Relatively low capitalworks

Private sector involved insupplying (as suppliers)and operating (as sub-contractors) of a water

utility. Government provides all

water supplyinfrastructure andfacilities, owns the assets,and controls and managesthe facilities.

Relatively high capital worksand investments.

Private sector invests,constructs and operates watersupply facilities.

Government as regulators and

sometimes also involved in someoperation and management offacilities.

Government owns thefacilities.

Divestiture ofthe government'sassets to privatesector.

Private sectorowns the overall

assets.

(Adopted from the Public Work Department of Indonesia, 1999).

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Table 2 Summary of the possible PSP features for the case study project

Criteria

Sub-criteria

Type of Contract Strategies

Lease BOT Concession

(partial)

Concession

(full)

Investment

Source ofinvestment

Shared betweenpublic andprivate sectors

Private sector Private sector Private sector

Scale ofcapitalinvestment

Small(Public sectorRp. 2.20 billion;Private Rp. 2.4

billion)

MediumRp. 8.30 billion

orUS$1.19million

LargeRp. 31.71 billion

orUS$ 4.53 million

LargeRp. 31.71 billion

orUS$ 4.53million

Size ofproject

Small(water treatment

plant facilities,WPs)

Medium(WPs)

Large(Overall new

water supplyfacilities)

LargeOverall facilities

(new and theexisting ones)

Manag-

ement

FinancingO&M

Operate WPsand develop itscapacity

Finance andoperate severalWPs

Finance andoperate new watersupply facilities

Finance andoperate overallfacilities

Obligations

Obligationsof the privatesector

Limited tooperate, manageand develop the

existing WPs

Limited tofinance, buildand operate

new WPs.

Complex(Finance, build,operate and

management ofwater supplyfacilities on a

partial basis)

Complex(Finance, build,operate and

management ofthe overall watersupply schemeswithin the city)

EfficiencyinO&M Efficiency in

O&MLimited towater treatment

plant facilities(WPs)

Limited toseveral WPs

Overall newwater supplyfacilities

Overall watersupply facilities(new and the oldones)

Leakage ratereduction

n.a. n.a. Partial network systems

Overall networksystems

Billing and

rev.collection

n.a. n.a. Limited

customers

Overall

customers

Quality Improved waterquality

Improvedwater qualityand quantity

Improved waterquality andquantity as wellas service

performance

Improved waterquality andquantity as wellas the overallservice

performance

Risks

Commercialrisks

Public sector(pays the

private operatorusing fixed rate

basis)

Public sector(pays the

private sectorusing fixed rate

basis)

Private sector Private sector

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Economic

Parameters

IRR 10.15% 14.42% 6.12% 14.27%

NPV Rp. 3.11 billionor

US$ 0.47million

Rp. 21.48billion orUS$ 3.07million

Rp. 36.65 billionor

US$ 5.24 million

Rp. 102.76 billion or

US$ 14.68million

CPBT 11.83 years 10.41 years 17.97 years 12.99 years

Contract period 20 years 20 years 25 years 25 years

Recommendation Notrecommended

Possiblyrecommended(as secondoption)

Notrecommended

Recommended(as first option)

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Paper of PSP