BOT – Projects in Asia

Table of Contents

Acknowledgment

Table of Acronyms and Abbreviations

Table of Figures

1. Introduction
1.1 Motivation of the Thesis
1.2 Methodology and Containment of the Study

2. Private Participation in Infrastructure
2.1 Private Participation in Asia
2.2 Public Infrastructure
2.2.1 Transport Sector in Asia
2.2.2 Railways Segment in Asia
2.3 Forms of Private Participation

3. BOT Projects
3.1 General Definitions of BOT
3.2 Parties Involved in a BOT Project
3.2.1 Government Agency
3.2.2 Sponsors
3.2.3 Lenders
3.2.4 Multilateral, Bilateral and Export Credit Agencies
3.2.5 Project Company
3.2.6 Construction Contractor
3.2.7 Operation and Maintenance Contractor
3.2.8 Offtake Purchaser
3.2.9 Input Supplier
3.3 The Contractual Framework
3.3.1 Concession Agreement
3.3.2 Shareholders’ Agreement
3.3.3 Lending agreements
3.3.4 Construction Contract
3.3.5 Operation and Maintenance Agreement
3.3.6 Offtake Purchase Agreement
3.3.7 Input Supply Agreement
3.4 Phases of a BOT Project

4. Tendering Procedures
4.1 One-Stage Bidding Processes
4.2 Two-Stage Bidding Processes
4.3 Bid approaches
4.4 Issues Specific to Tender Procedures
4.4.1 Bid Bonds
4.4.2 Confidentiality of Intellectual Property
4.4.3 Competition during the Bid
4.4.4 Lack of Information

5. Project Finance
5.1 Typical Characteristics and Features
5.1.1 Cash Flow Related Lending
5.1.2 Risk Sharing
5.1.3 Limitation of Liability
5.1.4 Off Balance Sheet Financing
5.2 Financing Instruments
5.2.1 Project Finance-Based Debt
5.2.1.1 Commercial Bank Loan
5.2.1.2 Bond Finance
5.2.1.3 Mezzanine Finance
5.2.2 Equity
5.2.3 Other Sources
5.2.3.1 Value Capture
5.2.3.2 Project Leasing
5.3 Finance Structure

6. Risk Management
6.1 Risk Identification
6.1.1 Technology Risk
6.1.2 Completion Risk
6.1.3 Sales Risk
6.1.4 Financing Risks
6.1.5 Input Supply Risk
6.1.6 Operational and Management Risks
6.1.7 Political Risk
6.1.8 Legal Risks
6.1.9 Environmental Risk
6.1.10 Force-Majeure Risks
6.2 Risk Quantification
6.2.1 Static Risk Quantification Techniques
6.2.2 Dynamic Risk Quantification Techniques
6.3 Risk Reduction
6.4 Risk Spreading
6.5 Further Risk Allocation
6.5.1 Guarantees
6.5.2 Liquidated Damages and Indemnity Obligations
6.5.3 Insurances
6.5.4 Derivative Instruments
6.6 Risk Management Process
6.7 Risk Efficiency
6.8 Summary

7. Conclusion

Table of Enclosures

Enclosures

List of References

Table of Acronyms and Abbreviations

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Table of Figures

Figure 1 Annual Investment in Infrastructure Projects with Private Participation in Developing Countries

Figure 2 Annual Investment in Infrastructure Projects with Private Participation in East Asia and Pacific, and South Asia

Figure 3 Sectors and Segments of Infrastructure

Figure 4 Investment in Infrastructure Projects with Private Participation in Developing Countries by Sector 1990 - 2004

Figure 5 Cumulative Investment in Transport Projects by Sector in East Asia and Pacific and in South Asia, 1990 - 2004

Figure 6 Cumulative Investment in Transport Projects in East Asia and Pacific and in South Asia by Type, 1990 - 2004

Figure 7 Contractual Structure for a BOT Project

Figure 8 Phases of a BOT Project

Figure 9 Simplified Cashflow Calculation Formula

Figure 10 Schema of Project Risks

Figure 11 Cashflow Ratios

Figure 12 Cashflow Scenarios

Figure 13 Risk Management Process

1. Introduction

1.1 Motivation of the Thesis

The rapidly developing economies in Asia are undergoing unprecedented growth. This explosive development has placed incomparable demands on the existing infrastructure in many countries. Governments struggle with the challenge of providing modern, efficient, and affordable infrastructure services for their people; finding it difficult to finance what are often multimillion dollar projects on their own. Involving the private sector in the financing and operation of infrastructure promises several benefits for both parties.^[1]

“With a share of over eleven percent in German foreign trade, exports to Asia are – in terms of volume – now two percent higher than those to the USA. >…< “Many German companies have taken on public private partnerships as a form of cooperation and thus play a part in the sustainable development of the Asian economies.”^[2] To date the most common sub-type of private participation in infrastructure is the BOT (Build-Operate-Transfer) model, where a project company finances and constructs new infrastructure and operates that infrastructure over a long-term period, before it is transferred back to the government. But despite the long history of projects of this type, only a few are very successful and usually mean more costs than income to the companies.^[3]

Eurotrain, a joint venture between rail giants Alstom and Siemens, proved in May 1998 it was ready to build Taiwan’s US$ 14 billion high-speed rail (BOT) project, with a successful test-run of its integrated train system in Germany. The only problem was that after at least a two-year effort, the Taiwan High Speed Rail Corporation (THSRC) suddenly decided to give the core contracts to the Japanese Shinkansen Consortium. THSRC has yet to explain why Eurotrain was not given a chance to match Shinkansen’s offer. De facto ambassadors from Germany, France and even the CEO’s of the companies met with THSRC’s chairwoman Nita Ing, who failed to provide any explanation whatsoever for this change of plan.^[4]

BOT projects are extensive in nature, with the companies therefore always finding themselves in international competition and/or having to forge global partnerships to get the project done. They have to be aware of every single potential local and global risk which could threaten the whole project; not only to ensure that the project is won, but also to successfully complete it.

For companies, there is often the difficulty that risks are misjudged, meaning that projects are either canceled completely or, in case of overestimated risks, the bidding price is much higher than the competitors, which ultimately both lead to a loss of image and references.

On the other hand, there are more than enough examples of risks being severely underestimated, with the project turning out to be absolutely unprofitable and companies often have to face long and cost-intensive legal disputes^[5]. This turns especially fatal when construction companies are also under the sponsors/investors of the project.

Within companies, there are clearly differences in the perception of the risks. The goal of this thesis is to provide a better understanding of the most important risks during Build–Operate–Transfer Projects in Asia.

1.2 Methodology and Containment of the Study

Due to the specific employment of the authoress in Taiwan and the wide range of the umbrella term “infrastructure”, this study will concentrate on specific examples and statistics in Asia with specific reference to the subsector “transport” and the segment “railways” therein, while at the same time providing enough information to also offer a general overview of the other sectors.

This dissertation looks first at private participation in infrastructure. Chapter 2 introduces the idea of private participation and the development in Asia as well as the different forms of participation and the sectors of infrastructure. The researched form of private participation in this dissertation is the Build-Operate-Transfer model. This and the relationship between the parties to a BOT project and the relevant documents are discussed in Chapter 3. Tendering procedures are reviewed in Chapter 4 and Chapter 5 discusses issues specific to financing a project and its instruments. The emphasis of this dissertation on risk management is discussed in Chapter 6, with a focus on identification, quantification, reduction and allocation of risks.

2. Private Participation in Infrastructure

The coverage and quality of a country’s infrastructure plays a vital part in economic growth. From the 1950s until the 1990s, most developing countries relied on public sector monopolies to deliver electricity, telecommunications, transport infrastructure, and water and sewerage services. Progress in expanding service coverage has been slow. An estimated 1.2 billion people in the developing world have no access to electricity more than 1 billion lack access to clean water, and nearly 1.2 billion are without adequate sanitation. Moreover, inefficiency has been high. Technical inefficiencies in roads, railways, power and water alone caused losses estimated at US$ 55 billion a year in the early 1990s – equivalent to 1% of the GDP of all developing countries, a quarter of their annual investment in infrastructure, and twice the annual development finance for infrastructure in the developing world.^[6]

Disenchantment with past approaches to providing infrastructure services, coupled with tightening budget constraints, led governments to explore how to best harness the benefits of private participation. In doing so, governments also reexamined their own role and are seeking to transform it – moving away from being the exclusive financiers, managers, and operators of infrastructure to becoming facilitators and regulators of services provided by private firms.

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All of this launched a trend of liberalizing and privatizing infrastructure, beginning in a few countries in the 1980s. According to the World Bank’s Private Participation in Infrastructure (PPI) Project Database^[7], 26 developing countries awarded 72 infrastructure projects with private participation in 1984 – 89, attracting almost US$ 19 billion in investment commitments. In 1990 – 2001 developing countries transferred the operation risk for almost 2,500 infrastructure projects to the private sector, attracting investment commitments of more than US$ 750 billion. Annual allocation is shown below in Figure 1. Investment commitments for infrastructure declined in the wake of the East Asian financial crisis^[8] and subsequent crises in the developing world, starting in September 1997.

Figure 1 Annual Investment in Infrastructure Projects with Private Participation in Developing Countries^[9]

Those projects were implemented under schemes ranging from management contracts to divestitures to greenfield^[10] facilities under build-operate-own (BOO) contracts, BOT contracts, or merchant facilities.^[11]

In 2004 developing countries saw investment flows to infrastructure projects with private participation grow for the first time since 2000. Growth was driven by just one sector: telecommunications. Investment flows to other infrastructure sectors fell by 20 percent.^[12]

2.1 Private Participation in Asia

East Asia and Pacific, and South Asia together attracted more than US$ 250 billion in investment commitments for infrastructure projects with private participation. The annual allocation is shown below in Figure 2.

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Figure 2 Annual Investment in Infrastructure Projects with Private Participation in East Asia and Pacific, and South Asia ^[13]

Private activity in the region began early with major programs in Malaysia and the Philippines in the second half of the 1980s, and grew rapidly in the 1990s. In 1997, investment declined sharply as a result of the before-mentioned financial crisis in the region. The largest economies in the area – China, Malaysia, Thailand, Korea, the Philippines, Indonesia and India – drew the most investment in PPI projects. The region focused on creating new assets through greenfield projects that served or complemented investments by public sector providers.

In both regions, 978 infrastructure projects with private participation reached final closure between 1990 and 2004. Energy and Telecom were the most active sectors and greenfield projects were the most frequent form of private participation in these countries. In East Asia, some of those deals turned sour. 40 projects representing 12% of investment were either cancelled or running into problems by 2004.^[14]

Much of Asia continues to grow rapidly, driven to a considerable extent by China. Urbanization is proceeding at a rapid pace. Demand for infrastructure services is increasing massively, particularly in cities. Much of the demand comes from the newly-urbanized poor. Infrastructure has to meet the needs of this population.

2.2 Public Infrastructure

“The availability of infrastructure facilities is imperative for the overall development of any country. Infrastructure is but one part of the development challenge, but its impacts are among the most important.”^[15]

Yet a general definition for the term “infrastructure” is still missing. This interpretation should transcribe the fact, that the benefits of infrastructure are the key to the economic incentives of a national economy^[16]: to promote economic growth, to share the benefits of growth with poorer groups and communities, and to connect countries within the region and with the rest of the world^[17].

The term “infrastructure” first appeared in the 1960s and had economic-political reference. It is actually a military term of the NATO, which described fixed military and transport facilities.

Today, infrastructure facilities can be divided into the following main sectors and segments as shown in Figure 3 below:

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Figure 3 Sectors and Segments of Infrastructure ^[18]

But private participation has also been seen in developing single buildings, for example, the 101 Tower in Taipei. Currently the tallest building in the world, it was financed with a BOT model and is a very successful project.^[19]

Figure 4 below shows investment amounts by sector in the past years.

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Figure 4 Investment in Infrastructure Projects with Private Participation in Developing Countries by Sector 1990 - 2004^[20]

Telecommunications led the growth of private infrastructure in developing countries, which is confirmed also in 2004. The sector accounted for 70% of annual investment flows. This outcome is not surprising; around the world, mobile phone firms outperform other utilities in financial returns, service provision, and cost-recovering tariffs^[21].

Energy attracted the second largest share of investment. Most of the investment occurred between 1994 and 1997, during the boom in greenfield projects for independent power producers implemented through BOO or BOT contracts.

Private activity has lagged in transport and in water and sewerage, where technological change has been less pronounced, political barriers to reform can be strong. Transport accounted for 18% of the cumulative investment from 1990 to 2004. Much of this share went to toll roads. Countries introducing private participation in transport have focused on transferring existing assets through concessions and constructing toll roads through greenfield projects.^[22]

2.2.1 Transport Sector in Asia

Transportation projects, including airports, seaports, roads, railways, tunnels and bridges, have traditionally been financed by a combination of private and public funding. Below in Figure 5, the cumulative investment in the four main segments is shown.

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Figure 5 Cumulative Investment in Transport Projects by Sector in East Asia and Pacific and in South Asia, 1990 - 2004 ^[23]

Private activity in transport started in the 1980s with mainly tollroad projects in Malaysia, Indonesia and Thailand^[24].

The trend, of governments to privatizes new and already existing transportation schemes, has developed largely as a result of the tremendous expense the public sector has incurred in subsidizing transportation operations. Cost concern in the public sector is aggravated by the need to increase capacity in the near future. Developing economies have a particular need for increased capacity in their transportation services, yet the costs of such increases are prohibitive.^[25]

2.2.2 Railways Segment in Asia

Private investment in and financing of railways has had a long and illustrious history and a number of different structures and models are available for private sector involvement in rail projects. Historically the most common type has been concessions, but this is giving way to greenfield models.^[26]

One of the primary differences between a BOT railway project and, for example, a BOT power project is the absence of a universal offtake agreement (discussed in Chapter 3.3.6). Although commercial carriers may make contracts with the railway operator for long-term rail access, such contracts will generally not cover the entire period of the concession.

Further, just as with roadway and bridge projects, there is no guarantee that once the project has been completed private passengers will use the service. Even with market testing and traffic forecasts, the project company can be left bearing the majority of the project’s market risk. The traffic forecast in particular is one of the major weaknesses of transport projects. Such forecasts have proven to be unreliable in the past, often failing to take account of demographic changes, shift in demand, competition, cost increase and willingness to pay.^[27]

This also happened to be the main failure on the Bangkok Transit System (BTS) in Thailand (discussed in detail in chapter 7.2). The Skytrain is among the best technical local traffic solutions practiced today in the world, but the revenue from ticket fares is to date still not enough to repay the debts. To attract the BTS the government even granted cheaper fares, making the situation worse.

Looking at a number of countries in this region to assess where the most likely new rail projects will occur in the next few years suggests that a return to the heady days of rail investment in the 1980s and 1990s is unlikely. But there is no doubt that rail, particularly urban rail, will continue to play an important role again, especially in China.

Malaysia has seen major investment in both mainline and urban rail systems during the past 12 to 15 years, but this may not continue in the foreseeable future because the government will concentrate on expanding the highways, and will place less emphasis on large infrastructure projects.

The picture in Thailand, where national and urban rail developments are at the planning stage, if not actually underway, is more encouraging. The State Railway of Thailand (SRT) will participate in some exciting developments of the Bangkok suburban network, the first being the airport railway to serve the Second Bangkok International Airport Suvarnabhumi^[28] located about 30km east of the city. Design of the railway has been undertaken by Japanese consultants and bids for the construction contract were opened late 2004, with the Sino-Thai/Siemens group winning the contract even though the contentious issue of track gauge almost led to a Japanese victory. Of even more interest is the planning which is underway for extending both urban rail systems.

Singapore has been at the heart of rail development in Asia for more than 20 years, but given the slowdown of the economy in Singapore since 1997 - again due to the Asian crisis, the government consciously took a more relaxed view to the early completion of major projects.

To date, the Philippines have completed a couple of projects under the so-called Line 1 extension to Cavite which was the subject of a pre-emptive BOT bid by SNC Lavalin, Canada. This bid is now being subjected to the “Swiss Challenge” aspect of the Philippines BOT law under which other bidders have an opportunity to offer the government an alternative proposal.

The largest of the south-east Asian rail systems, Indonesia, fulfills a significant transport role. Despite limited funding, the Indonesian rail system has quietly, but effectively, undertaken considerable infrastructure upgrading over the past few years and is poised to build on that with further major investments.^[29]

2.3 Forms of Private Participation

The term Public-Private Partnership (PPP) has no precise meaning but is used to describe many forms of arrangement between the public and private sectors for providing public services.

The most important are:

Management and Lease Contracts:

A private entity takes over the management of a state-owned enterprise for a fixed period while ownership and investment decisions remain with the state.

1) Management contract:

The government pays a private operator to manage the facility. The operating risk remains with the government.

2) Lease contract:

The government leases the asset to a private operator for a fee. The private operator takes on the operational risk.

Concessions:

A private entity takes over the management of a state-owned enterprise for a given period during which it also assumes a significant investment risk. Every type described below has in common that the private sponsor operates and maintains the facility at its own risk for the contract period.

1) ROT (Rehabilitate, operate, and transfer)

A private sponsor rehabilitates an existing facility.

2) RLT (Rehabilitate, lease or rent, and transfer)

A private sponsor rehabilitates an existing facility at its own risk and leases or rents the facility from the government owner.

3) BROT (Build, rehabilitate, operate and transfer)

A private developer builds an add-on to an existing facility or completes a partially-built facility and rehabilitates existing assets.

Greenfield Projects:

A private entity or a public-private joint venture builds and operates a new facility for the period specified in the project contract. The facility may return to the public sector at the end of the concession period. Every type described below (except for merchant) has in common that the government usually provides revenue guarantees through long-term take-or-pay contracts for bulk supply facilities or minimum traffic revenue guarantees.

1) BLO, BLOT (Build, lease and own or Build, lease, own and transfer)

A private sponsor builds a new facility largely at its own risk, transfers ownership to the government, leases the facility from the government and operates it at its own risk, then receives full ownership of the facility at the end of the concession period.

2) BOT, BOOT (Build, operate, transfer or Build, own, operate, transfer)

A private sponsor builds a new facility at its own risk, owns and operates the facility at its own risk, then transfers ownership of the facility to the government at the end of the concession period.

3) BOO (Build, own and operate)

A private sponsor builds a new facility at its own risk, then owns and operates the facility at its own risk.

4) Merchant

A private sponsor builds a new facility in a liberalized market in which the government provides no revenue guarantees. The private developer assumes construction, operating, and market risks for the project (for example, a merchant power plant).

In addition to these common greenfield projects, there are some more uncommon versions like BOD (Build, operate, deliver), BOL (Build, operate, lease), BOOST (Build, own, operate, subsidise, transfer), BRT (Build, rent, transfer), DBOM (Design, build, operate, maintain), DBOT (Design, build operate, transfer) and FBOOT (Finance, build, own, operate, transfer)^[30]. But all of these versions are only possible variations of the four main greenfield projects mentioned above.

Divestitures:

A private entity buys an equity stake in a state-owned enterprise through an asset sale, public offering, or mass privatization program.

1) Full

The government transfers 100% of the equity in the state-owned company to private entities (operator, institutional investors and the like).

2) Partial

The government transfers part of the equity in the state-owned company to private entities (operator, institutional investors and the like). The private stake may or may not imply private management of the facility.^[31]

The boundaries between all these categories are not always clear, and some projects have features of more than one category.

In the 1990s the most common type of private participation varied across sectors and regions. But in the past few years, greenfield projects (specifically sub-types BOT and BOOT) have become the most common type across infrastructure sectors^[32].

[...]

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^[1] Cp. World Bank, (1996), p. 1

^[2] Pierer, (2004), p. 7f

^[3] Cp. Duff, (2002), pp. 2-5

^[4] Cp. Feliciano, (2000), p. 1ff

^[5] On Friday November 26th 2004, THSRC agreed to pay US$ 65 million to the Eurotrain consortium to settle the four-year dispute. The settlement sum was US$ 24 million less than what the International Chamber of Commerce (ICC) had demanded in a ruling made in March. (Cp. China Post, (2004), p. 5). For satisfaction of the Europeans the Japanese Consortium is currently one year behind schedule with its planned revenue service date.

^[6] Cp. World Bank PPI Database

^[7] For further information on this database please refer to the explanations in the bibliography

^[8] The Asian crisis started on July 2nd 1997 when the Thai Central bank floated the exchange rate of the local currency. The Thai currency promptly plummeted 20% against the US Dollar. Starting in Thailand the Asian crisis reached Indonesia, Malaysia and the Philippines in July and August, and South Korea in November. The year 1998 saw the crisis heighten, with it encroaching upon Russia and other emerging markets like Brazil and Mexico in August.

^[9] compiled by the authoress in dependence on the World Bank PPI Project Database

^[10] Means, by which users are provided with a new facility where none previously existed

^[11] Cp. World Bank, (2003), p. 1ff

^[12] Cp. Izaguirre, (2005), p.1

^[13] compiled by the authoress in dependence on the World Bank PPI Project Database

^[14] Cp. World Bank, (2004) p. 1

^[15] Asian Development Bank, (2005), p. xxi

^[16] Cp. Tytko (1999), p. 183

^[17] Cp. Asian Development Bank, (2005), p. xiii

^[18] compiled by the authoress in dependence on the World Bank PPI Project Database

^[19] Cp. Mei-Chun, (2005), p. 22

^[20] compiled by the authoress in dependence on the World Bank PPI Project Database

^[21] Cp. Izaguirre, (2005), p. 2

^[22] Cp. World Bank, (2003), p. 3-4

^[23] compiled by the authoress in dependence on the World Bank PPI Project Database

^[24] Cp. Gomez-Ibanez, (1993), p. 146

^[25] Cp. Delmon, (2005), p. 369

^[26] Cp. Tynan, (1999), p. 7

^[27] Cp. Delmon, (2005), p.372-375

^[28] SRT used the BOT-model for financing this project

^[29] Cp. Powell, (2005), p. 1ff

^[30] Cp. Tytko (1999), p. 177

^[31] Cp. World Bank PPI Project Database

^[32] Cp. Izaguirre, (2005), p. 3