44397 noTE no. 32 ­ May 2008GRIDLINES Sharing knowledge, experiences, and innovations in public-private partnerships in infrastructure Are brownfield concessions poised for a comeback? New signs of life after a decade in decline James Leigland O nce expected to be the signature make needed investments, and recover all their contract of private participation in costs--plus make reasonable profits--over the infrastructure and for a time its fastest long term (20­30 years) of the contracts. Best growing form, the brownfield concession was of all, because of greater operational efficiency, hit hard by the Asian crisis and has never recov- carefully targeted and managed investments, ered. Because these contracts involve existing, and more realistic pricing, these operators would usually dilapidated government assets, brown- deliver better services while still recovering costs. field concessions tackled the toughest infra- Thus the new arrangements would be largely structure problems in the developing world. self-supporting, in dramatic contrast to the huge But the Asian crisis exposed the fragility of budget deficits that had resulted from public this mechanism, and its sudden unpopularity subsidies for inefficient service provision. almost single-handedly crashed the develop- ing world market for private participation in But the track record of brownfield concessions infrastructure. Why was so much expected of is one of boom and bust (figure 1). Indeed, the brownfield concessions, and what happened sudden unpopularity of the brownfield conces- to them? Why have they performed so poorly? sion almost single-handedly accounted for what is And what market signals suggest that a recov- normally thought of as a sharp decline in private ery in their use is now possible? participation in infrastructure (PPI) following the Asian crisis. Data from the PPI Project Database In 1990 brownfield infrastructure concessions show that if brownfield concessions are excluded, suddenly captured the attention of development the PPI market, buoyed by privatizations and professionals with a sevenfold increase in number greenfield projects, demonstrated few of the over the previous year. For public service provid- "crash" characteristics commonly associated with ers as well as private operators and financiers the aftermath of the Asian crisis. Other forms of brownfield concessions were an attractive option, PPI barely registered the effects of the crisis, and embodying almost all the most beneficial quali- all have long ago surpassed their precrisis invest- ties associated with public-private partnerships ment highs. in infrastructure. Perhaps most important, they were seen as a solution to one of the most diffi- Only brownfield concessions have never recovered. cult infrastructure problems facing the developing A 2006 surge in popularity pushed investment world--what to do with badly dilapidated infra- through brownfield concessions to about 40 structure service systems, such as water delivery percent of its 1997 peak. The surge (probably facilities and roads, that could not be shut down followed by another in 2007) suggests that some or sold off. kinds of brownfield concessions may finally be poised for recovery. The concept was simple: private companies would take over badly maintained government-owned PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY James Leigland is program leader for the Sub-National infrastructure service systems, improve efficiency, Technical Assistance program at PPIAF. Helping to eliminate poverty and achieve sustainable development through public-private partnerships in infrastructure PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY A second study looked at the profitability of infra- structure concessions in Latin America during Figure 1 the late 1990s, again using a broad definition Only brownfield concessions failed to recover from the Asian crisis of concession (Sirtaine and others 2004). The Investment in government-owned facilities in developing study suggests that, on average, projects became countries through private participation in infrastructure profitable only after about 10 years. Until then arrangements, 1990­2006 concession shareholders earned negative returns, even when such things as management fees, esti- US$ millions mated accumulated capital gains, and potential 90 investment markups were included. But this same 80 70 All PPI excluding study found that 40 percent of the concessions in 60 brownfield concessions the sample--and 50 percent of those in energy 50 and transport--did not appear to have the poten- 40 30 tial to ever become profitable. 20 Brownfield concessions 10 Problems with cash flows and long-term profitabil- 0 1990 1992 1994 1996 1998 2000 2002 2004 2006 ity were clearly among the most important reasons that brownfield concessions became so unpopular so quickly. These projects must be able to weather Source: World Bank and PPIAF, PPI Project Database. Note: The investment data refer to commitments and include years of negative cash flows and constant uncer- private and public contributions. tainty about long-term profitability. That so many contracts were renegotiated after only a few years, long before they could confirm their profitability, suggests that cash flow problems were probably critical in precipitating many renegotiations. Even What happened to brownfield if estimates of long-term profitability are positive, concessions? a project that early on generates cash flows too small to service debt is not viable without cash inflows from other sources or contract renegotia- No single factor accounts for the rise or decline tion to adjust existing flows. Cash flow and in the use of a PPI mechanism in all situations. In Latin America, for example, many of the most profitability attractive opportunities for brownfield concessions Why so susceptible to problems? problems were were taken up in the early 1990s. After the Asian crisis public opposition to privatization may have clearly among The PPI Project Database confirms that brown- combined with the eventual financial recovery of field concessions were far more likely to experience the most some governments to diminish the attractions of these kinds of contractual distress than other important turning infrastructure service provision over to forms of long-term PPI. In 1990­98 the share private operators. of brownfield concessions that were canceled or became distressed was 41 percent higher than that But Latin America is also the source of some of the for greenfield projects. most compelling empirical evidence on other key reasons for the steep decline in the use of brown- Why would brownfield concessions be more prone field concessions in the late 1990s. A recent study to problems with cash flows and profitability? The of concession contract renegotiations in Latin answer is simple: as business transactions, many America suggests that cash flow problems and low brownfield concessions turned out to be far less profitability were common in these arrangements profitable than expected. The assets were often (Guasch 2004). Using a definition of concession in much poorer condition than expected and that includes some greenfield projects and dives- required more basic rehabilitation and investment titures, the study shows that concessions in Latin before they could start generating higher revenue. America had a high incidence of renegotiation-- Concessionaires and governments often wanted to about 42 percent, with renegotiation happening start the investment programs as soon as possible, on average after only 2.2 years of operation. The to show early, dramatic results, but such invest- results tended to favor operators, mostly through ments often were not optimally targeted or timed improvements to cash flow and profitability. because the operators lacked experience with the Are brownfield concessions poised for a comeback? systems. And many of the real problems involved who put different amounts of time and resources sector and policy issues (tariffs, labor productivity, into feasibility studies and asset reviews, led to corruption) rather than day-to-day operations. bids that were often difficult to compare or based on incomplete or inaccurate views of invest- Many operators of retail operations faced severe ment needs. Perhaps the first notable example currency mismatch problems, with revenues in of the problem of low-cost preparation was the local currency and debt service payments in hard Buenos Aires water concession--one of the first currency. In addition, many governments required large brownfield concessions--signed in December Poor-quality brownfield concessions to pay debt service for 1992. A defining feature of the tender process was preparation outstanding loans used in initially developing the poor information. facilities. The need to pay off the initial invest- failed to bring ment on top of the new investment put more, and Second, even where one party or another was will- problems often unsustainable, pressure on cash flows. ing and able to undertake full feasibility studies, the task often turned out to be far more diffi- adequately On the other side of the ledger, revenues were cult and expensive than expected. Management to light often less than expected, particularly for retail information and basic record keeping were often service operations that were supposed to recover outdated or nonexistent. Historical performance full costs. Raising tariffs to cover the full costs of data were sometimes inaccurate or unavailable, operation turned out to be impossible, or at least and the condition of the infrastructure, such as wholly impractical, in many situations, particu- underground pipes, impossible to evaluate. Even larly in poor areas. Indeed, full cost recovery for customer records were often incomplete or miss- essential infrastructure services such as water ing. As a result, there was often no way to tell, for supply and sanitation is rarely attempted even in example, how many end users were connected to developed economies. water systems, much less paying their bills. Third, the preparation of brownfield concession Why weren't the problems better projects was probably affected by several weak- anticipated? nesses now widely recognized in the project appraisal techniques used to help anticipate and The potential for cash flow and profitability prob- avoid problems with cash flows and profitability. lems should have been apparent during project We now know that such techniques were often not appraisal and design. Why did so many contracts used at all because expensive analysis was thought reach financial closure before these weaknesses unnecessary in situations where remedial options were noticed? The quality of preparation often seemed obvious. When the techniques were used seems to have been very poor, for several reasons. by or on behalf of government partners, they often served to justify rather than independently assess First, governments, as well as donors and develop- projects. Other preparation techniques, such as ment agencies, often were unwilling to spend time economic cost-benefit analysis, seem to have been or money preparing brownfield concessions-- generally overwhelmed by bad data, complexi- doing feasibility studies, examining the true cost ties, public-private funding options, and "political of the services, assessing contracting options, and economy" issues. Quantitative estimates of the the like. For many of the contracts signed in the financial costs and benefits of these projects were early 1990s all this work was assumed to be the also often wildly inaccurate. In several studies of responsibility of potential private partners--part transport projects Flyvbjerg (2005) found massive of their normal due diligence--because if the proj- underestimation of costs and overestimation of ect failed, it would be at their sole cost. demand. We now know that for existing, poorly main- Fourth, the concessions often lacked settled regu- tained facilities, governments need independent, latory or contractual arrangements for increasing comprehensive assessments of the condition of tariffs or coping with unexpected changes. the infrastructure so that they can identify the Bidders were often prepared to commit to conces- objectives and the investments needed in brown- sions without such arrangements on the basis of field concessions and can evaluate bids on the government reassurances that such issues would basis of consistent operating and investment be readily resolved. Often the rhetoric failed to projections. Leaving such assessments to bidders match the reality, and concessionaires faced severe hurdles in securing, for example, a contractually Some governments are adopting hybrid arrange- mandated tariff increase. ments to mitigate risks. In high-risk sectors such as retailwaterdistributioninAfrica,projectsthatonce would have been implemented through brownfield What about risk mitigation? concessions are being unbundled. Private opera- tors implement management contracts and receive The emergence of cash flow and profitability compensation through a flat fee rather than from problems was supposed to trigger risk mitigation user fees. Operators issue and collect bills, fix mechanisms agreed to at the outset. The most leaks, or manage equipment. Governments and important risk mitigation instruments, structured donors supply funding for capital investment as off-take agreements and project guarantees, and take on the demand risk associated with user were to be provided by state-owned enterprises, payment for services. Under such an arrangement utilities, or the governments themselves. But the (generally captured by the PPI Project Database as Asian crisis in 1997 forced many governments to a management contract rather than a concession), recognize that they had an inaccurate understand- the government assumes most of the investment ing of how brownfield concession contracts, as and demand risks. well as other kinds of public-private partnerships, were supposed to work. Conclusion The contingent liabilities associated with the risk mitigation instruments had been ignored or The brownfield concession is not an inherently misunderstood by the governments. Whether flawed mechanism--its track record in developed they knew it or not, the public sector retained countries is reasonably successful. But many of massive contingent liabilities. But under the the conditions for success have proved difficult to intense pressure of the Asian crisis, governments achieve in developing countries, where prepara- simply repudiated these obligations, forcing many tion is especially time consuming and expensive projects into renegotiation or collapse. The PPI and the assets are in particularly poor condition. Project Database confirms that this happened But we now have a much better understanding more often with brownfield concessions than with of the risks and problems in dealing with exist- any other form of PPI contract. ing, dilapidated infrastructure assets in developing countries. Brownfield concessions as structured The future of brownfield concessions in the early 1990s may be an endangered species, but the needs that drove their initial widespread Data for 2006 from the PPI Project Database use still exist, and refinements to the concession suggest that some kinds of brownfield conces- mechanism--along with new investment arrange- sions are becoming more popular now because ments and hybrid contract forms--are emerging governments are more aggressively structuring to deal with these problems. the arrangements to reduce the risks for private References partners. In toll road projects, for example, govern- Flyvbjerg, Bent. 2005. "Policy and Planning for Large Infrastructure ments are reducing investment risk by providing Projects: Problems, Causes, Cures." Policy Research Working Paper capital grants or financing guarantees, and 3781, World Bank, Washington, DC. reducing demand risk by using shadow Guasch, J. Luis. 2004. Granting and Renegotiating Infrastructure GRIDLINES tolls or guaranteeing part of the revenue Concessions: Doing It Right. WBI Development Study. Washington, through minimum traffic assurances. DC: World Bank. Leigland, James. Forthcoming. The Rise and Fall of Brownfield Gridlines share emerging knowledge The key challenge in using these Concessions: But some signs of recovery after a decade of decline. Trends and on public-private partnership and give an contracting arrangements is to Policy Options series. Washington, DC: World Bank and PPIAF. overview of a wide selection of projects from find ways of maintaining perfor- Sirtaine, Sophie, Maria Elena Pinglo, J. Luis Guasch, and Vivien various regions of the world. Past notes can be mance incentives for the private Foster. 2004. How Profitable Are Infrastructure Concessions in Latin found at www.ppiaf.org/gridlines. Gridlines are a America? Empirical Evidence and Regulatory Implications. Trends and publication of PPIAF (Public-Private Infrastructure partners. PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY Policy Options series. Washington, DC: World Bank and PPIAF. Advisory Facility), a multidonor technical assistance facility. Through technical assistance and knowledge dissemination PPIAF supports the efforts of policy makers, nongovernmental organizations, research institutions, and others in designing and implementing strategies to tap the full potential of private involvement in c/o The World Bank, 1818 H St., N.W., Washington, DC 20433, USA infrastructure. The views are those of the authors and do PhOne (+1) 202 458 5588 FAX (+1) 202 522 7466 not necessarily reflect the views or the policy of PPIAF, PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY generAl eMAilppiaf@ppiaf.org WeB www.ppiaf.org the World Bank, or any other affiliated organization.