Public Private Partnerships in Africa: The User-pays agreement to attract the private sector in infrastructure - Article 1/3

This is first publication (out of three). The article is analyzing the infrastructure gap in Africa and raise the discussion on the required actions to attract the private sector and to mitigate the risk revenue in user-pays PPPs projects.

Introduction

According to history researchers PPPs in an evolution of the concept of the concession contracts. In the 15th century in France, the states granted Louis de Barman with a concession related to waterway transport. This case can be considered as the first documented PPPs. we have an  Since the last two decades, this concept is taking an important role in the project management (especially for infrastructure) and in the complex financing arrangements involving government and private sector actors. Even if there is no an agreed definition, in most of the cases, the PPPs is first of all a collaboration between the private and the public sector for the implementation of projects and services (World Bank). The idea is to develop a mechanism using the strengths of both parties, increasing the efficiency for the most cost-effective way to achieve the goals. This partnership should be guided by a comprehensive agreement, explaining how the responsibilities, risks and rewards are managed and shared. Public Private Partnerships (PPP’s) can be defined as cooperation between public and private actors with a durable character in which actors develop mutual products and/or services and in which risk, costs and benefits are shared (Klijn, Teisman, 2003). The private party provides in that case a public service and at the end it receives a remuneration based on the performance.

The complexity of such agreements raises three main questions: What are the types of the assets, what are the expected functions from the private party and what is the mechanism for the payment of the private sector? The key challenges of this kind of partnerships came from the objectives of each of the parties. While public sector entities seek to provide services, regulate activities and enforce laws, private companies look mainly for financial profits. The PPPs agreement should protect the interest of both parties for the best interest of the final user.  

Considering the huge financing gap for green project and taking into account the available private financial stocks in the world, the PPPs is the best arrangement to attract the private sector and to advance the African agenda on infrastructures. The scarcity of the public resources creates a need of sound management system and resources allocation mainly based on the efficiency and the equity. It is a necessity to know the type of investment providing the highest impact and to link it with most deserving beneficiaries. This kind of choice go beyond economical and financial analysis but have social and political drivers. A new tendency can be a game changer: the capability and willingness of the beneficiaries to raise capital for infrastructure investments. The financing gap is huge and is not mainly due to the high overall investment needs, but mainly to the frameworks based on the traditional development aid. Providing sovereign loans and increasing the debt balance in the African countries, will not be the most efficient and effective way to close the gap. 

Infrastructures gap in Africa

The desertification and poverty create a situation where population fleeing the rural zones are creating the highest urban growth in earth. The African countries have limited resources to deal with the needs associated with this fast demographic growth in the cities. Looking at the quality, the size and number of the existing infrastructures in many African countries, we can conclude that the continent is far from closing the infrastructure gap. I tried in the paragraphs below to put on the loop the main infrastructure types and to provide a snapshot showing where we are in term of progress.    

Water and Sanitation

According to the Infrastructure Consortium for Africa, over 300 million people in Africa do not have access to safe and clear drinking water and ver 100 million people in Africa still rely on surface water to survive. This figures show how big the challenge is for the African leaders when we know that the economic growth is about 2.4% by year and the demographic growth is 2.7%. One of the main Sustainable Development Goals (SDG6) refers to water and sanitation with the aim to “Ensure availability and sustainable management of water and sanitation for all by 2030”. From 1.2 billion todays, the African population will reach 1.7 billion in 2030.

In 2015, the Official Development Assistance disbursements in the water sector totaled $8.6 billion, which represents an increase of 67 per cent in real terms since 2005 according to United Nations, while the annual investment needs are around US$22 billion. These uncovered needs have a real impact on the development of the African Countries as it has been translated for the sub-Saharan to loses reaching 5% of the GDP. In his 2016 report the Infrastructure Consortium for Africa stated that “40 billion hours of otherwise productive time is spent just collecting water”. The climate change will be a new challenge to consider as it will require greater resiliency in management of the water resources due to significant temperature increase and the progress of desertification in the Sahel region.       

Energy

630 million Africans leave without electricity. In 2015 the Africa Progress Panel Report made an analysis explaining how, fifteen years ago, per capita energy use in Sub-Saharan Africa was 30 per cent of the level in South Asia, now it is just 24 per cent and still falling. When looking deeply to the figures we can by extrapolation say that the electricity consumption of an American in one-year is as much as a Tanzanian around Eighty years. This lack of sufficient and reliable power generation capacity is hindering the industrialization and the development of the African countries. The production green and modern energy still the lowest in the world while the continent has many natural energy resources such as wind, water or sun.  

According to the Programme for Infrastructure Development in Africa (PIDA) that the demand for power will increase each year by 6% to 2040 reaching 700 Gigawatts. Only 20% of this need is covered by the current power generation estimated to 124 Gigawatts to close this gap. The attractiveness of the energy sector must be enhanced to show interest for more private funds managers as only 20% of the commitments (35 Billion) made to the development of Africa’s energy sector are coming from the private sector in 2015 (ICA Flagship Report 2016). APP estimated the same year the financing gap around $55 billion.

Transport

Foster & Briceno-Garmendia stated that Africa has the lowest national road density in the developing world, with only 204 kilometers per 1,000 square kilometers of land area when world average is 944 per 1,000 square kilometers. To meet Africa’s development goals, the World Bank estimates that over US$16.7bn by year need to be invested in transportation infrastructure for the next 15 years. This lack of transport infrastructure is highly impacting the development and the intra-regional trade. According to ICA this trade represents only 18% of the commercial exchanges in Africa while in Europe the rate is 69% and more than 50% in north America and Asia. The cities are rapidly growing in Africa creating a lot of challenges for the urban transport. The efficient management of the Intra-urban mobility and accessibility, will be a key element in building operational cities.

Telecommunications

The telecommunications sector is experiencing explosive growth but this hiding disparities between landlines, mobile phones and internet access.The number landlines in Africa is significantly lower than elsewhere in the world, with an average of less than 100 per 1,000 workers in 2001– 2005The growth of the mobile phone is most significant this millennium with a phone penetration rate of 63% in 2016 but in term internet access and usage the continent is left behind as three quarter of the Africa’s population are offline. The household internet access is only about 15% (Asia 46% and Europe 84%). Nevertheless, Africa has higher growth rates and greater digital mobile penetration than other developed countries do. Budget allocations made by African national governments reached US$705m in 2015 even if it was higher the year before (and China a, announced investments in 2015 of just over US$ and they committed 44% of all financing in 2015.

Risk sharing in PPPs  

It is a fact that the public spending is not anymore the only solution to finance infrastructures projects. Looking at 50 years practices we can conclude that the public sector even supported by the development agencies failed in many cases to develop the African infrastructures. The lack of domestic resources, the lack of transparency and good governance, the complexity and duration of the projects and, the huge amounts budgeted, the high and multiple risks associated with such projects are the main factors leading to the failure. Learning from that many public organizations started with the endorsement and facilitation of the World Bank to explore new frameworks to better manage and share the risks, through agreements such as Public Private Partnerships (PPPs). 

According to Grimsey and Lewis, sharing of risks is perhaps the most fundamental principle underlying the long-term infrastructure PPP model because it encourages the private investors to focus on lifecycle costs rather than optimization of short-term profit. The infrastructure projects are generally related to large investments with long amortization period, in that case sharing risks requests a balanced allocation taking into account the capacity of each partner. For an efficient implementation of the PPPs agreement the risk should be borne to the partner best equipped to manage the specific risks. This management will reduce the cost associated with the risk to a lower level increasing the efficiency of the project.

 Wilkinson (2014) noted that some risks are beyond the control of the private sector and those should be handled by the Government while those pertaining to project management expertise should be transferred to the private partners. The negotiation phase is crucial and the risk allocation is the main challenge of this step. Several experts argue based on an analysis of the existing projects that transferring the risk is not well handled between parties in the PPP contract. The main ex-ante risks are identified and mitigated as much as possible but the failure of negotiation in many projects happens when it comes to managing the ex-post risks, - those arising once the infrastructure has been built, such as revenue risks and operational risks. The revenue of a project can be affected by the fluctuation of the demand due to external factors, the legal environment which can impact the taxes, or political and social pressure reducing the output costs while the input costs still high. Identifying the financial mechanism for instance to build a toll road and manage typical risks in order to generate sound economic returns is a major challenge. When it comes to private investments, the financial return becomes one of the main drivers and a key element of the investment decision. The private sector is willing to take risks but it must be justified by the break-even point. To attract private partners, the public sector should provide sufficient insurance on the financial profitability of the project, moreover they must identify all the attendant risks to the profitability and propose mitigation measures. The complexity of the PPP contracts, their large project scale and their long lifecycle make it difficult to cover all the risks and to assess precisely the associated likelihood and impacts. This complexity is a source of mistakes where generally the risks are underestimated or the capacity of the project to handle risks can be overestimated. The private sector in the PPPs agreement takes more risks than in traditional projects due to principle of risks transfer from the public to the private sector. It has been demonstrated that in many PPP contracts the main objective of the Government was to transfer the maximum risks to the private sector exposing contractors to excessive risks that are not within their expertise to master, or out of their capability to undertake. For traditional projects the contracting period is usually less than 5 years while in the PPP projects with long-term contracts (20 to 30 years) raising new challenges to protect managers related to the ex-post risk management. Therefore, it is necessary to shift the ex-ante risk management to a trade-off between the ex-ante and the ex post way in PPP projects. Taking into account the high financial impact for the private sector, the financial return in a long term projected become one of the most relevant criteria for investors.

An effective risk mitigation plan combined with an efficient risk sharing agreement will increase the insurance of the private investors on the profitability of the PPPs projects. The private sector in the PPP agreement has one big fear and it is about being paid and how during the project. Answering to this question will be a first step of revamping the PPPs for the development of the African infrastructures.

The next publication will talk about the mitigation of risk revenue