Public Private Partnership Analysis Business Essay

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Initially private finance initiative was emerged (PFI) to restore investment in public sector without increasing capital spending as the governments were facing the situation of financial crisis or budget constraints. Initially PFI which was then called Public Private Partnership (PPP), got popularity as leasing arrangements, a private sector company, and group of companies or consortium of companies were made contracted to finance and build assets and in many cases run and manage the assets and as well provision of services associated with assets, were entrusted to them for a fee or commission. The contracts made under this mechanism were all on long term basis. The assets could be transferred back to the government at the end of contract period. The initially developed system of PPP was applied to many areas of government service provision, example include roads, bridges, school buildings, office buildings for government departments, hospital buildings and other public structures.

There are main parts of PPP agreement, at the top is financing arrangement, the construction phase and the provision of services related to the asset built in order to keep asset in use. From the industry perspective i.e. for the companies in PPP industry, forth phase is also important in which they can sell the contract for future cash flows to another third party and take its profit. The sale of contract which is indeed very profitable but apart from that, companies that were at construction phase were not necessarily the right people for managing services that were associated with those assets.

These three elements of PPP agreement solved three main problems of governments. The element of financing arrangement postponed the government payments to future years, the construction element based on specifications and performance contract, removed the problem of managing large capital projects from the public sector, where as third element ongoing contracts transferred the problem of managing(running) the asset to private sector. This transfer of problems also transferred the risk of public sector to private sector or at least shared between them.

The initial idea behind the development of PPP was that instead of borrowing money and paying large amounts of interest and principle for capital expenditure, contracts would be made with private sector firms to provide the facility of services associated with a capital asset and pay a fee or commission for that. For simple example road, bridge or any other facility could be designed, financed, build and operated by a private company for an annual fee. This was the best alternative to government borrowings and the capital spending would not appear as public expenditure any more and government can maintain its borrowings and spending on a lower level. Apart from these structural strengths PPP is mostly used as a management tool and pursued for the following reasons including; reduction in life cycle costs, allocation of risk in an efficient manner, faster implementation strategies, improved service quality and cost reduction and used for additional revenue generation.

Risks involved in PPP contracts

Construction Risk

Construction risk is involved directly in design and construction stage of PPP, which may include the risk of poor project definition and its poor specifications, costs overrun, late delivery of the contracted facility.

Financial Risk of PPP

Financial risk is involved in financial matters of PPP contracts, which may include the variation in interest rates and exchange rate risks, financial risk can affect the costs of projects and as well can make hurdle sin finance generation for the facility.

Performance or Availability Risk of PPP

Performance or Availability Risk is the probability that the asset would not be according to the specification agreed in the contract, and the contracted party may fail to provide quality services according to the specifications and there might be no continuity in its provision.

Demand risk of PPP

The demand for the output of the facility may be over estimated by the parties which can contribute in the failure of PPP contract significantly, so the private firm may not be able to generate revenues to cover it initial costs.

Residual value Risk

The residual value risk is related to the future market price of the facility, this kind of risk is particularly related to the property.

Models of PPP

Service Model of PPP

In service model of PPP, which lasts from 2 to 5 years, private sectors companies are employed some narrowly defined tasks, the example may include the service of billing. The responsibilities of private sector in service contracts are limited to the specified service. Fixed fee is paid to contracted company for their services and risk transferred is minimum in service contracts.

Management Model of PPP

Management contract, which is basically the extension of service contract to the management of company as a whole, so the management risk is also transferred to private company along with the service risk, usually for a fixed fee or bonus. The duration of management model may be from 3 to 5 years.

Leasing Model of PPP

In leasing contract, which lasts usually from 10 to 12 years, the private sector operates the system for a specified period of time but in case of leasing assets remains the state property. The public sector is usually responsible for financing new investment and the private company is responsible for working capital, maintenance of the asset leased and for collecting revenues that would be used to fund its operations. The risk in leasing contract is completely transferred to private sector.

Concessions Model of PPP

In concession model of PPP, both the operation and new investment of the system comes under the responsibilities of private company. The private company will hand over the facility/ asset to government at the end of contract period, residual value is paid to the private company. The concession contract usually lasts from 15 to 30 years.

Greenfield Model of PPP

Green field investment model of PPP involves the development and operation of the built facility, generally for a long period of time ranging from 20 to 30 years. In green field investment construction risk and operating risk is transferred to the private sector. Construction and management of power generation plant is an example of green field investment. Following are the specialized types of green field investment contracts

BOT, Build, Operate and Transfer contract

BOO, Build, Own and Operate

BOLT, Build, Operate, Lease and Transfer contract

BLOT, Build, Lease, Operate and Transfer contract

DBFO, Design, Build, Finance and Operate contract

ROT, Rehabilitate, Operate and Transfer contract

Summary of the models

SERVICE CONTRACTS

MANAGEMENT

CONTRACTS

LEASE CONTRACTS

CONCESSIONS

BOT

Scope

Multiple contracts for a variety

of support services such as

meter reading, billing, etc

Management of entire operation

or a major component

Responsibility for management,

operations, and specific

renewals

Responsibility for all operations

and for financing and execution

of specific investments

Investment in and operation

of a specific major component,

such as a treatment plat

Asset Ownership

Public

Public

Public

Public/Private

Public/Private

Duration

1-3 years

2-5 Years

10-15 Years

25-30 years

Varies

O&M Responsibility

Public

Private

Private

Private

Private

Capital Investment

Public

Public

Public

Private

Private

Commercial Risk

Public

Public

Shared

Private

Private

Overall Level of Risk

Assumed by the private sector

Minimal

Minimal/moderate

Moderate

High

High

Compensation terms

Unit Price

Fixed fee, preferably with

performance incentives

Portion of tariff revenues

All or part of tariff revenues

Mostly fixed, part variable

related to production

parameters

Source: Heather Skilling and Kathleen Booth. 2007

PPP IN PAKISTAN

The Policy Framework for Public Private Partnerships for the development of infrastructure

Projects and other facilities in the country was approved by the Economic Coordination Committee (ECC) of the Cabinet, chaired by the Prime Minister on 13th November, 2007.The fundamental principle for the Policy Framework which was approved by the meeting, is the acknowledgment that private sector participation in infrastructure projects would require a combination of policy reforms, institutional support, incentives and credit enrichment modalities to encourage its participation in financing, constructing and managing of infrastructure projects or the built facility. The recognition of responsibilities, rights and liabilities was also important with in the government structure and as well in the new framework of public private partnership.

Objectives and Focus of Policy Framework:

The objectives of the Government behind the promotion of PPPs are to provide the following;

Large Scale Services

A lot of work needs to be done in the provision of basic services, demanding the need to catch up this backlog in basic services and as well to start building facilities for future needs. The areas of basic services containing backlog are transport, solid waste management, water and sanitation and rural electricity.

Enhanced Services

The quality of existing services is worsening due to lack of incentives and new investment funding for infrastructure maintenance and up-gradation, which resulted in unclean water, unhealthy living conditions and failure to provide appropriate health services and education.

Reasonably Priced Services

A large population of Pakistan lives under poverty line and cannot afford the cost recovery tariffs on the other side private service provider needs to recover costs in order to continue it operations, so the government will provide explicit subsidies for the maintenance of targeted performance levels. The provision of subsidies would be only on actual service delivery by the contracted parties.

On Demand Timely services

The Government does not have the capability or the financial space to meet the instant service demands of its citizens, so PPPs are selected to cope with this problem

Other objectives to be achieved include the following;

Faster project implementation

Leveraging public funds with private financing from local and international capital markets

Greater accountability in service deliverance

Public sector management will shift from budget expenditure to whole life cycle cost management

The evaluation of Public Private Partnership project would be focused on but not limited to the following public sectors.

Transport and logistics which include provincial and civic roads, seaports in Sindh and Baluchistan, railway, airports, fishing harbors and warehousing as well as cold storages,

Mass Urban Public Transport which include buses and intra and inter-city rail.

Civic Services which include water supply and sanitation, solid waste management, health and education sector and low cost housing facilities.

Small Scale Energy Projects which include hydroelectric and captive power generation projects other than those which are being facilitated PPIB and AEDB.

.

Applications on PPP models in Pakistan

Service model of PPP in Baluchistan

Service contract can be used in Pakistan in different sectors; one such application may be for leak reduction of water reservoirs in Baluchistan, Mirani dam and band khushdil khan in district Pashin. Mirani dam was destroyed by floods due to its leakages causing heavy damages to rural population and the leakages of band khushdil khan is destroying agricultural land in Pishin district. Government can make a service contract with any engineering firm like Malaysia did in its Sabah state in 2003. In 2003 Sabah water board made a contract with Salcon Engineering, and the project was successfully completed in July 2005, identifying and repairing about 2,100 leaks. Physical loses were reduced by almost 17.5 million liters per day against the targeted. Overall savings were of 20% of the total treated water produced. The contract was also paired with training program for the sustainability of the efforts which include the following activities; providing core technical personnel for different technical works such as pipe replacement, setting up of district metered zones, active leakage recognition, leak repair, pressure management, and network modeling in the area. This model can be applied to reduce the damages caused by Mirani dam and band Khushdil khan in Pishin district, the physical loses can be reduced and the saved water can be used for drinking and agricultural purposes in Turbat, Gavadar and Pishin. The saved water of Mirani can also be provided to near by areas of kech and mand, where as in case of band Khushdil khan, to tora sha, lalak karez and loi alizai. Government can increased the efficiency of these reservoirs by entering in to the service contracts for identifying, repairing of leaks and for the training of core technical personnel of the projects. Employees of the discussed facilities are not well trained, there is no management of water distribution, no facilities to save water in times zero inflow and the most important government revenue is negative from the above discussed facilities. Government can cope with all discussed problems associated with Mirani dam and band Khushdil khan. The potential problem that private companies may face in case Mirani dam, is the law and order situation, which is parity bad in Baloch populated areas of Baluchistan, so the project may result in high costs to government in case of Mirani dam, where as in case of Pishin, the private company would face batter working conditions and may produce the desired results in cost effective manner. The success of the project will increase the agricultural productivity and save water for other purposes in the areas discussed above, the revenues and the most important, the reputation of government would be enhanced with the success of the project.

Strengths of the model applied

Service contracts are generally most appropriate where the service can be undoubtedly defined in the agreement. So government should define each and every aspect of the contract to the private company. Responsibilities and rights should be clearly defined and provision of security in Baluchistan would be included in the core responsibilities of government. The level of demand is practically sure, and performance can be monitored and measured with out any problem. The service model provides a comparatively low-risk option for expanding the participation of private sector in a country. The Service model can have a rapid and sizeable impact on operations of the system and on its efficiency. Service contracts can provide grounds for technology transfer and development of extra capacity. Service contracts are short term so can enhance the level of competition. The process of repeated bidding maintains pressure on contracted private company to maintain low costs and there low entry barriers which further enhance the competition in the sector leading ultimately to low costs, efficiency and high quality.

Weaknesses of the model

The Service contracts are not suitable if capital attraction is one of its main objectives. The service contracts are only for the improvement of efficiency ant to result in release some revenues for other activities, its not included in the obligations of services contract to solve the financing problem of government. The efficiency of the service contract would be greatly reduced if other sources of finance do not become visible, i.e. from government and other donors. The reality that the private company's activities are separate and segregated from the broader operations of the company may mean that there is no broader or deeper impact on the system operations, only discrete and imperfect limited improvements.

Application of Management model of PPP in Balochistan

Government of Baluchistan can use management model of PPP in its health department by contracting out its basic health care to any private medical organization in pattern of Cambodia. The Cambodian government made a four year contract with a private organization for the provision of basic health care facilities in 12 districts. The full management responsibility was given to the private company and performance standards were set by the government. Performance targets included vaccination, family planning facilities to each village and provision of basic health care facilities to the poor. The project was successfully completed with greater efficiency and value. The set targets were achieved with in specified timeframe.

Government of Baluchistan can use this model by contracting out its basic health services to a nongovernment organization to provide the discussed facilities initially in 5 districts of Baluchistan including Kalat, Mastung, Pishin, Gulistan and Kila saifullah and for the management of Civil Hospital Quetta. Basic health care facilities in these areas of Baluchistan are very substandard, there are hospitals but no doctors, dispensaries but no staff and medicines. Mothers are dyeing on child birth with very high ratio and as well their new born babies due to the lake of maternity homes in these areas. Government medicines are sold on private medical stores. There is no family planning awareness in these areas and as well no vaccination facilities for new born babies which giving rise to polio and other diseases.

Government can use this model for the provision and management of basic health services in above discussed districts of Baluchistan. Performance targets would be set for the facilities provided by the private organization. Complete management responsibilities would be given and contracted organization would use existing setup of government, which would help organization to low down its cost to a compatible level. The organization must provide following services free or at very low cost emergency obstetrical services, minor surgery services, emergency primary care and treatment of serious illnesses. Usual payment would be made for other services of basic health care. The new contract would help poor people of the area in a batter way then direct government provision of services, which is complete failure till now and paving way to more substandard lives in these districts.

MANAGEMENT MODEL OF PPP FOR CONTRACTING BASIC HEALTH CARE AND CIVIL PROVISIONAL HOSPITAL QUETTA

GOVERNMENT

INVESTMENT&SUBSIDY APPROVAL

REGULATION

TARIFF SETTING

SERVICE & PERFORMANCE

STAODARDS

REPORTING

PUBLIC SERVICE PROVIDER

MANAGEMENT

TARIFF

PRIVATE OPERATOR

Source: Heather Skilling and Kathleen Booth. 2007.

The above mentioned model can be used for contracting out basic health facilities and as well for management contract of civil provisional hospital Quetta. The government remains the ultimate provider of service but the daily management and provision of facilities is fully transferred to a private organization for a certain contract fee. The basic capital investment would be the responsibility of government but working capital would be provided and managed by the contracted organization. Predetermined payments would by made for labor and other operating costs to the company. Contracted organization would be responsible for up-gradation of financial and management system of the hospital and other government health facilities in those discussed 5 districts of Baluchistan. Management contract would increase the efficiency and quality of the services provided. The new management would make doctors and medicines available for the people.

Civil hospital Quetta is situated on Jinnah road having well structured building for an ideal hospital, completely staffed. Civil hospital is made to provide health facilities to its nearby population on a very low cost, medicines are provided free of cost. But there is high level of absenteeism of doctors and paramedical staff. There is no stock management of medicines, resulting in empty stores, no medicines for patients because the medicines of the hospital are sold in private medical stores despite of the stamp, NOT FOR SALE. Facilities provided are very substandard. The private organization has to change the overall culture of civil hospital Quetta and other health facilities in those 5 districts, which seems to be very difficult and costly and the failure chances of the project are high due to this threat. They costs of the project may increase. There are some interest groups in health department of Baluchistan; including doctors, paramedical staff and people related to medical business. The new management has to make doctors available and reduce has to reduce the absenteeism, only then the new organization can make this contract work in a cost effective manner.

Strengths of the model

The most important advantage of this model is that operational gains that results from private organization's management, can be achieved with out transferring the asset to contracted organization. The contracts of the management model are easy to develop and operate. The contracts are simple, so less chance of conflicts between parties. The contract may result in low costs due to fewer work forces from the private contracted party. The management contract can be used in complex situations with few modifications.

Weaknesses of the model

The division between commitments for service & management and financing & expansion of the facility is too complicated to manage. The risk is involved in terms that the private organization may face difficulties in management of staff employed, for greater and successful changes in the structure to achieve efficiency. Incentive system should be developed and monitored in a way that copes with all its drawbacks.

Build-Operate-Transfer Model of PPP

Chaman is situated on Pak Afghan border and considered as trading and strategic hub to Afghanistan and central Asia. Supply to NATO and transit trade between Pakistan and Afghanistan is done through Chaman border. Majority of the population belongs to business community. There should be an international airport in Chaman which will facilitate trading and strategic activities in the area. Government can make a BOT contract for Chaman International Airport with any national or global firm, in this case national firm can produce better results. There is a well established demand so government can generate a lot of revenue from this facility. The mechanism and model of BOT is given billow.

Mechanism and Model

Build-Operate-Transfer model of PPP is a specialized type of concession contract in which private firm would be contracted to develop a facility according to the specified performance standards set by the government authority for Chaman airport, in accordance international standards. In BOT contract, the availability of the finance i.e. the new investment is the responsibility of private firm. The private owner owns the asset until the recovery of initial investment costs through user charges or fee. A minimum level of out put would be purchased by the government, agreed in contract. In this way demand risk is shared between government and private firm. A well developed financial mechanism would be there for BOT contract of Chaman airport. The ownership of the terminal would be transferred at the end of the contracted period, government may itself operate the facility, may contract the operating responsibility to original developer of the facility, or can enter into a new contract with a new private firm.

EVENTIONAL RETURN OF

INVESTMENT

PRIVATE CONTRACTOR

GOVERNMENT/ PUBLIC UTILITY

CAPITAL INVESTMENT

BOT

REVENUES

SERVICES TARIFFS

Source: Heather Skilling and Kathleen Booth. 2007.

CONSUMERS

Some facts about the BOT and its strengths

The main difference between traditional concession contract and BOT is that a concession contract usually involves extension and operating any existing facility, where in case of BOT, it involves large green field investment. A large out side finance is used in form of debt and equity. BOT may include development of new capacity as well as it extension. Demand risk is shared between government and private firm. The ownership of the asset is transferred at the end of the contracted period, government may itself operate the facility, may contract the operating responsibility to original developer of the facility, or can enter into a new contract with a new private firm. BOT may include development of new capacity as well as it extension. BOT reduces the commercial risk, as demand risk is shared by the government. Guaranteed demand reduces the risk of failure and loss to the private organization. BOT projects can be financed through both equity and debt, and there is an easy availability of both of them due to the shared risk of government and guaranteed demand. Direct user fees are charged to the customers.

Weaknesses of the Model

BOTs are usually project specific and do not have wide applications, only well for specific investment. Benefits of the competition are only limited to the early stage of bidding because the BOT contracts are usually renegotiated there after. The process and of documentation of the contract involves great care. Over estimation of demand would result in troubles and government would find it self in a situation of take or pay, so alternatively has to pay the capacity or it consumption charges. Demand risk is shared between government and private firm. Usually complicated financial mechanism is involved in BOT contract.

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