. , ~~~Iqq3'? Viewpoint riJit-. No. 183 April Rail and Subway Concessions in Rio de Janeiro Designing contracts and bidding processes Jorge M. Rebelo To help address a budgetary crisis in early 1995, the Rio de Janeiro state government began reforms aimed at selling or concessioning to the private sector loss-making state-owned enterprises. In the transport sector this meant selling or concessioning subway, commuter rail, bus, and ferry services, at the time requiring subsidies of US$363 million annually. This Note describes the concessioning of Rio's subway, the Metro, in December 1997 and its commuter rail service, Flumitrens, in July 1998. Together they accounted for 80 percent of the subsidies. The reform was expected to eliminate subsidies for the Metro and reduce them by two-thirds for Flumitrens, to improve service, and to clear the backlog of maintenance and investment. As a model and comparator for the Metro, the concessionaire wins the concession. The sched- state used the state-owned subway in Santiago, ule of subsidies must decline to zero by a certain Chile, which is about the same length, carries date, after which the concessionaire must start almost twice as many passengers at the same paying the government an annual concession average tariff, and has an operating surplus. For fee. Suburban rail concessions in Argentina xvere Flumitrens, it chose the Buenos Aires suburban initially granted for ten years, and the subway rail system, which has been operated by private concession for twenty years. in the event, the concessionaires since 1994 and has a productiv- model adopted in Rio differed from the one used ity three times that of Flumitrens. The Metro and in Buenos Aires. Flumitrens concessions were initially expected to follow the Argentine model. This model, used in In the Rio concessions, as initially planned, con- the concession of the Buenos Aires urban rail cessionaires would not be required to fund the systems, calls for bids to execute an investment investment plans because the state would assure plan defined and funded by the state and to be funding. But the funding for the two concessions implemented by the concessionaire. It requests was to come from different sources. The Metro a schedule of declining operating subsidies to be had already secured the funds for completing the paid by the state and of fees to be paid by the works required to double its ridership and concessionaire to the state for the concession increase its route length from 23 to 35 kilometers. rights. Finally, it stipulates a level of service to be These works, started ten years earlier, had been met by the concessionaire at a tariff set by the halted by the state's financial straits. The government. The bidder with the lowest net pre- investment (US$620 million) was financed by a sent value for the cost of the investment plan loan from Brazil's National Development Bank plus the subsidy to be paid by the government (BNDES). Flumitrens would receive funds under minus the concession fee to be paid by the the proposed Rio de Janeiro Mass Transit Project, LIU The World Bank Group - Finance, Private Sector, and Infrastructure Network 2 Rail and Subway Concessions in Rio de Janeiro under preparation for financing by the WVorld documents to the public and in some domestic Bank. The investment (US$373 million) would go road shows. mainl to rehabilitating rollinig stock, signalinig telecommunications, and stations judged neces- Strategy sary to reach a ridership of 1 million passengers a day by 2000. While the Metro investment was Despite the finding that an operating subsidv under way at the time of the concession, the Bank would be required for at least two tears, the pol- loan for the Flumitrens investment had been icymakers decided to go ahead with a positive negotiated but not yet signed, representing a risk concession-one in whichi no operating subsi- for potential concessionaires. dies would be paid by the state. Several factors influenced this decision. First, the concessionaire Metro would have no major investment funding oblig- ations because all the investment was being The state government commissioned two major financed by the state. Second, the concessionaire studies to help with the design of the concession would take over, by an agreed date and as contract and the bidding process. described in the concession contract, all the ongoing extensions financed by the state as well The first, funded by a World Bank loan, identi- as additional rolling stock already ordered by the fied the basic parameters to be included in the state. Third, the concessionaire was expected to bidding documents, undertook a demand analv- move more boldly in rationalizing staff than the sis of the system for different scenarios, prepared projections had assumed. And four:h, tariffs were financial projections, reviewed the legal and increased to account for inflation, in line with the institutional framework, and proposed actions government's policy. for dealing with redundant Metro staff who would not be absorbed by the potential conces- By contrast to the Argentine concessions, where sionaire. The study also looked at how the fed- the concessionaires carried out the works, in the eral concession law, w,ould affect the proposed Metro concession the state is implermenting all the concession. investment plans funded by the BNDES loan. The implementation of works started two years before The financial projections suggested that the sys- the concession and continued after the conces- tem wsould require an operating subsidy for one sion was signed. This was anotlher risk to be taken to two years before it would start producing an into account by the potential concessionaires, operating surplus. This subsidy estimate raised which wouldI project the reveniies on the assump- an important issue: the federal law did not seem tion that the line extensions and addlitional rolling to allow "negative concessions," like most of stock would be ready by a certain date. With the thosc in Buenos Aires. The state therefore had to state as implemcnting agent, the winining conces- approve a law that would permit such subsidies. sionaire would have no way to control delays other than bv exercising the penalties in the con- The second study, funded by the state under a cession contract. contract that included a success fee, was carried out by local consultants. The study helped pro- The state maintained part of the existing Metro duce a preliminary background memorandum, organization to handle issues relalied to redun- cash flow analysis, environmental and safety dant personnel not absorbed bv the concession- assessment, inventory of existing infrastructure aire, to assist the secretar-y of transport with and equipment, and procurement documents. extensions of the system, and to provide support The consultants were also responsible for run- to the Public Services Regulatory Agency in mon- ning the concession process, and they assisted itoring the performance and safety indicators in the state in the presentation of the concession the contract. The state indicated tha it had access The World Bank Group 3 TABLE 1 URBAN TRANSPORT CONCESSIONS IN THE RIO DE JANEIRO METROPOLITAN REGION Metro Flumitrens Package size 41-kilometer right-of-way extension. 200-kilometer right-of-way extension. Term of the concession 20 years, renewable once for 20 more years. 25 years, renewable once for 25 more years. Ownership of equipment Rio de Janeiro state government. Rio de Janeiro state government. and tracks Service quality Based on the performance targets for Based on the performance targets for frequency, specification frequency, reliability, safety, and comfort reliability, safety, and comfort established established in the concession contract. in the concession contract. Payments by the None. None. But proceeds of the Metro concession government fee will be made available to the concessionaire for investments. Award criterion Net present value of best offer above the Net present value of best offer above the mini- minimum price (US$25 million) plus mum price (US$28 million) plus materials in materials in stock (US$3.56 million). stock (US$8.25 million), plus the discount on cap- ital made available by the state, plus the cost of optional investments assumed by the bidder. Tariff renegotiation The flat tariff for a one-way trip was set by The flat tariff for a one-way trip was set by the conditions the state in the bidding documents and can state in the bidding documents and can be up- be updated only for inflation, according to a dated only for inflation, according to a formula. formula. For expansion and new investments The concessionaire will be allowed to increase under the present contract, the conces- the tariff by 50 percent if it installs air sionaire must submit a plan for approval by conditioning in the trains. For expansion and the state government. new investments under the present contract, the concessionaire must submit a plan for approval by the state government. Performance assurance Concession contract monitoring by the Concession contract monitoring by the Public Services Regulatory Agency of Public Services Regulatory Agency of Rio de Janeiro State. Rio de Janeiro State. Network planning The state will establish the conditions for The state will establish the conditions for operation of new lines. operation of new lines. Access to facilities The concessionaire of the freight railway system has access to Flumitrens lines and pays a track access fee. 4 Rail and Subway Concessions in Rio de Janeiro to funds to compensate redundant staff, but that * The net present value of the concession fee in turned out not to be the case. the vwrinning bid was about ten times the min- imum price set in the bidding documents. Bidding process * Unlike in earlier privatizations in Brazil, there were no official protests against the final The concession included 41 kilometers of right-of- awsard of the concession. There were initial way extension and the operational areas of the ter- legal injunctions against the concession, with minals and other operational buildings described the main ones filed by unions and the engi- in the contract (table 1). The concession was neers association. These opposed the conces- awarded in a twxo-step process: a prequalification sioning of the service to the private sector, in which the experience of the potential conces- arguing that the Metro was a state responsibil- sionaires was compared against the requirements ity. These injunctions were easily defeated. set out in the bidding documents, and a compari- The main unofficial protest came from the son of the bidders' cost proposals, containing the runners-up. They argued that the winner net present value of the offer over the term of the xvould be unable to cover its costs and make concession. a profit because of the high bid. They also claimed that there shouldl have been an inter- The proposals for each step were delivered to a mediate step in the bidding process calling for special commission of the Rio de Janeiro stock a business plan in which each bidder would exchange, which first verified that the candidates indicate how it would operate the system. met the prequalification conditions. Once bid- That, they argued, would have proved their ders prequalified, their cost proposals were point about the winner's bid. opened in a public session on the premises of x There were no strikes or destruction of inven- the exchange. (In the event of a tie between two ton' as there had been in other cases in the or more bidders the process allowed the tving region in which a state-owned company was bidders to bid in an open outcry auction during taken over by the private sector. the same session in which the cost proposals * Unlike the Flumitrens concession, the Metro were opened.) concession process was completed without postponements at either stage in the two-step Results process. The Rio Metro system wxas concessioned to the The main criticism after the conces,ion wxxas that private sector on December 23, 1997. The win- the minimum price set by the state had been too ning bidder was a consortium led by an low, as evidenced by the fact that the price Argentine company and a local investment bank. offered was ten times the minimum. Hindsight The concessioning process led to several inter- suggests that the state could have required addi- esting outcomes: tional investment as part of the corcessionaire's * A large number of bidders presented propos- obligations, such as additional trains or small line als, reflecting the private sector's confidence extensions. that the Metro's situation (the annual operat- ing subsidy had been about USS120 million) Flumitrens could be turned around. • A sizable number of foreign bidders partici- The Flumitrens concession process was more pated even though there had been no inter- complicated than the Metro's. Flumitrens was national road show, raising a question about seen as a risky concession nor onlb' because of whether the expensive international road its high projected operating subsidy require- shows often used for concessions are really ments but also because the concessioning was necessary. left to the end of the administration's political The World Bank Group 5 term, close to the start of the state governor's In addition, using Japanese funding, Flumitrens electoral period in April 1998. The decision- hired consultants to help the state review the makers were forced to rethink the process transaction report, to undertake a road show in twice as a result of hasty decisions and other Miami, to explain the process to potential con- factors. cessionaires, to hire procurement consultants, and to prepare the "data room." Flumitrens had been transferred to the state in 1995. benefiting from a World Bank loan sup- Strategy porting decentralization of the system from the federal to the state government. At the time of the Although the Metro concession had been a great transfer the federal government agreed to pay a success, the opposition party had harshly criti- full year of staff salaries to the state, which was cized the minimum price set for the concession expected to use those funds to reduce staff redun- and launched a media campaign aimed at show- dancies; instead, the state used the funds for ing that the administration was giving away state anotlher purpose. Tlhe investmIienits under the BaInk property. In respoinse to this criticismji, and loan, especially those in rehabilitating rolling despite the projections showing that Flumitrens stock, were expected to allow Flumitrens to main- would probably require an operating subsidy tain its ridership and prepare for the concession. over the first four years, the state decided against But because of poor decisions and delays in the a negative concession. rehabilitation of trains, train fleet availability decreased, passenger demand declined, and fare The state project team floated the idea of a for- evasion increased. In the second vear the state mula to provide the Flumitrens concession with started a rationalization program. But Flumitrens additional capital (from the concession fees paid continued to suffer from lack of train availability by the Metro concessionaire) and tariff increases hecause the companies that had won the train if improvements were made to the trains (such rehabilitation contracts in interinationlal coimpeti- as installiing air conditioning). The fuindinig fiom tive bidding failed to meet the proposed sched- the Metro would amount to a capital rather than ules, contributing to a further decline in ridership. an operating subsidy but would be risky because As a result the Bank agreed to finance another it assumed that the Metro's concessionaire would loan to rehabilitate the remaining fleet if the state not default on any of its payments. would concession Flumitrens. The rehabilitation of infrastructure and equip- The Flumitrens concession process produced ment financed by the Bank's decentralization two major studies similar to those for the Metro loan, the additional rehabilitation provided by concession. The first, funded by the Bank, the new loan, and the additional capital from the evaluated the options and the market for con- Metro were expected to be sufficient to attract cessioning the system. The second, funded by the private sector. the state under a contract with a success fee, prepared the preliminary background memo- The original aim was to include the Bank loan in randum, cash flow analysis, and bidding docu- the bidding documents, giving the winning bid- ments. The financial projections in the first study der the right to execute the investment program suggested that the system would require an financed by the loan without further procure- operating subsidy (of roughly US$150 million to ment. This would have the advantage of allow- US$250 million a year) for three to four years ing the concessionaire to implement its own before it would produce an operating surplus. works and to coordinate its operations with This led to the conclusion that Flumitrens would ongoing works, a task that becomes difficult have to be a negative concession, similar to the when the operator and the implementation agent ones in Buenos Aires. for the works are not the same. To include the 6 Rail and Subway Concessions in Rio de Janeiro Bank loan in the bidding documents, the state the rolling stock included in the bid, the cost of would have had to comply with the Bank's other works listed in the hid anid assumed by the guidelines for international competitive bidding. bidder, and the discount offered on the invest- Since the state did not comply with Bank pro- ment capital made available by the state. Finally, curement guidelines, it simply indicated in the the state would allow tariff increases if the win- bidding documents that it had obtained a loan of ning bidder introduced aIr conditioning in the USS186 million from the Bank to support the trains before a specified deadline. rehabilitation of infrastructure and equipment listed in the loan documents. The loan would be Results implemented by the state, not by the conces- sionaire as originally planned. This was another Five consortia submitted bids. The highest price risk to be taken into account by the potential wfas more than six times the minirnum price set. concessionaires. Some chose not to bid because The winning bid, awarded in January 1998, w as in their opinion implementation of the package from a Spanish-Brazilian consorlium. A good by the state would lead to unacceptable delays. number of the trains and works included in the investment package for the loan negotiated with Bidding process the Bank. and listed as optional investments in the bidding documents, will instead he financed by The concession included 200 kilometers of right- the concessionaire as part of its bid, leaving room of-way extension and the operational areas of the for additional investments excludeo during prepa- stations, main terminals, and other buildings indi- ration of the loan because of budget restrictions. cated in the contract. Contracts with rctail busi- nesses operating in the stations could be Unlike the Metro concessionaire, which will have renegotiated or terminated by the concessionaire. to pay the state the concession price agreed to in the contract, the Flumitrens concessionaire will The bidding process was similar to the two-step have an out-of-pocket cost equivalent only to the approach used in the Metro concession. The state minimum price and the materials in the inventory. administration prepared the concession docu- The rest of the bid consists of the cost for reha- ments according to Brazilian procurement law bilitating the fleet, the civil works assumecl, and and called for prequalifications. Five consortia the discount on the capital made available by the indicated that they would seek prequalification, state. The Flumitrens concessionaire must deliver btit at the last minute only one appeared ready the rehabilitated trains back to the state and com- to present the bid bond required. Suspecting a plete the civil works according to a specified cartel, the state canceled the first bid and set a deadline, but will not have to payr the state for new date for the bidding process. In the mean- these services. Thus the concession-ire's payment time the state revised the bidding documents to w-ill be in terms of trains made available and civil make the concession more attractive and the works completed. If the concessionaire is efficient process more transparent and to allow time for in procurement, it might be able to deliver those other bidders to enter. outputs for less than the cost quoted. The state must be strict in ensuring that the deliverables The state adopted the formula for providing a cap- meet the specifications in the concession contract. ital subsidy froiii the Metro concession fees. It called for new prequalifications and set the mini- Lessons mum price at US$28 million plus the cost of mate- rials in Flumitrens's inventory. The net present The Rio de Janeiro experience suggests that even value of the bid would include the net present in systems experiencing very high deficits as a value of the offer above the minimum price to be result of inefficient management, poor infrastruc paid over the concession period, the cost to repair ture, and inadequate equipment, concessions can The World Bank Group 7 be designed in such a way as to attract the pri- erance payments was a major flaw in the vate sector. Unlike Buenos Aires, which pio- process, and the state must quickly take steps to neered modern urban rail concessions, the state correct it. To realize the potential savings offered of Rio de Janeiro w as able to concession its sys- by the concessions, the state must either reallo- tems without providing operating subsidies. This cate the redundant personnel to agencies where was a major achievement, and a big factor in it they are needed or find funding for the sever- was political commitment. ance payments. A robust bidding process helped achieve this out- Another challenge for the new state administra- coniie. First, Rio ensured transparency in the tion that took over in 1999 will be to ensure that process. The use of the Rio stock exchange for there is true modal integration between subway, presentation of the bids (through a certified bro- rail, ferry, and bus services in a context in wlxich ker hired by the bidders), and their evaluation by all operators are private. Creating a multimodal a commission associated with the exchange, are ticket will require the introduction of special tick- not acceptable under Bank procurement guide- eting, such as a smart card, and an agreement on lines. But in Brazil these measures added to the revenue sharing through some sort of clearing- transparency of the process because the Rio stock house. The state must play the role of sector exchange is a highly respected institution. coordinator and regulator. Second, the state team was careful to prevent the Since the state and municipal administrations are formation of cartels. W7hen it suspected that a car- controlled by different political parties, care must tel was forming. it simply delayed the process and be taken to ensure that municipal buses do not provided time for other bidders to join. And to pre- engage in predatory pricing to undercut priva- vent monopolistic behavior, the Public Services tized buses or Flumitrens. Proposals during the Regulatory Agency prevented the Metro operator election campaign to impose a flat fare for inter- from bidding in the Flumitrens concession. city buses should be carefully examined to ensure that they wvould not have a major impact Third, the process was run by the secretary of on Flumitrens's ridership. These regulatory planning and finance rather than the secretarv of issues may be hard to deal with because the transport, who is generally too closely associated buses and trains are not regulated by the same with the operating agencies and subject to the agency. The bus lobby prevented bus regulation pressure of strong transportation lobbies. from being included in the mandate of the Public Services Regulatory Agency, arguing instead to Next steps retain the state transport ministry as regulator. The state administration must work hard to bring During preparation of the reforms, the state indi- the intercity buses under the same agenc-y that cated that it had access to a credit line with the regulates trains and to persuade the Rio munici- Federal Savings and Loan (Caixa Econoliica pality. which regulates the urban buses, to put Federal) to finance the severance payments of them under the same umbrella. Only in that way redundant staff not retained by the concession- can there be coherent regulation of the main aires. The state had planned to eliminate redun- urban transport modes. dancies through voluntary and involuntary staff reduction programs. But this goal was only par- The regulator must also be very strict in ensur- tially accomplished. Nine months after the rail ing compliance with the performance targets set concession was awarded nearly 3.000 redun- in the contracts signed by the concessionaires, dant staff remained (2,500 at Flumitrens and 500 applying the penalties set out in the contracts for at the Metro), at a monthly cost of US$6.3 mil- noncompliance. Without strict compliance with lion. Failing to make adequate provision for sev- agreed on targets, a point of failure in other 8 Rail and Subway Concessions in Rio de Janeiro urban rail concessions, it will he difficult to ensure the level of service that the state has promised to users. For a more detailed account of the concession process sec Jorge M.'. Rehelo, Reforming the Urban Transport Sector in the Rio deJaneiro Metropolitan Region: A Case Study on Concessions" (Policy Research Working Paper 2096. World Bank, Latin America and the Caribbean Region, Financc, Private Sector, and Infrastructure Department, WSashington, D.C., 1999). Murilo Junqueira, former Mlanaging Director of Flumitrens, and Regina Amelia Oliveira, frirmer Planning Coordinator if Flumitrens, provided data for this Note. Jorge M. Rebelo, Principal Transport Specialist, Latin America and the Caribbean Region The views published in this series are those of the authors and should not be attributed to the World Bank or any of its affiliated organizations. Nor do any of the con- clusions rapresent official policy of the World Bank or of its Executive Directors or the countries they represent. 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