Disincentivising overbidding for toll road concessions

3 │ TOLL ROAD CASE STUDIES
Discussion
The intellectual appeal of flexible-term concessions, and the LPVR approach specifically, is perhaps stronger than
their applicability. 97 They commonly incorporate asymmetries, which the private sector dislikes—for example, the buyout
call option which a government can exercise is not accompanied by a put option allowing the private sector to sell
the concession. Other parties, particularly equity providers, may be troubled by possible limited upside potential and
may have reservations about entering into a business where operating efficiency improvements do not translate into
higher rates of return. In addition, the fact that LPVR concessions are usually bounded by an absolute maximum term
(duration cap) means that, by term end, it may be possible that concessionaires with underperforming assets will
remain loss-making.
Various authors have suggested enhancements to address this latter asymmetry. 98 Typical solutions include the
specification of a minimum concession term or—less politically palatable—having unlimited term extensions. Neither
of these approaches appears to have enjoyed widespread acceptability. Other researchers have proposed the use
of least present value of net revenues to take account of the existence of fixed operations and maintenance (O&M)
costs in toll road operations. 99 However, this, too, remains conceptual. This international review of concession
mechanisms demonstrates that flexible-term concessions generally remain a minority application. That said, they
merit consideration if only as an example of a different approach to the twin issues of demand uncertainty and
overbidding.
On the other hand, flexible-term concessions (such as those based on the LPVR) are more likely to appeal to debt
providers, as the attractive bond pricing on some Chilean toll road deals suggests. Concession grantors may also
warm to this approach since it makes no direct call on government finances and places no upward pressure on
toll tariffs. Grantors can adjust tariffs (within reason) to reflect broader pricing policy objectives and, in terms of
aggregate revenue receipts, concessionaires will not be affected. The role of such mechanisms in limiting the
incentives for contract renegotiation is proven, especially in host jurisdictions with a propensity to renegotiate. A
recession in Chile prompted widespread contractual renegotiations for toll road concessions; the only contracts not
renegotiated were those based on the LPVR mechanism. By reducing renegotiating expectations, bidders have less
incentive to inflate their forecast from the outset.
3.4 Construct-then-concession
At its simplest, traffic forecasts comprise three components: opening-year demand, a ramp-up profile and a longerterm
growth trajectory. Analysis of the forecasting errors associated with greenfield projects repeatedly demonstrates
that the greatest contributor to such errors is getting the opening-year demand estimate wrong. Although departures
from the longer-term growth trajectory will have a cumulative effect over time, the most economically sensitive time
for toll road concessions tends to be the early years, which is when any project distress and/or default are most
typically observed. One practical way of mitigating traffic risk is therefore to expose the private sector to projects
once their opening-year and ramp-up periods have passed. In other words, the public sector would have the road
constructed, possibly through traditional procurement, and would steward it through its formative years before letting
(leasing) it to a concessionaire as a maturing ‘brownfield’ asset with a considerably reduced risk profile. 100 This is
effectively what happened with 407ETR in Toronto (see Box 3.5). 101
97 An international review for this study found only four, possibly five examples of toll road concessions employing the LPVR approach.
98 See, for example, Vassallo, J. (2010), ‘Flexible-Term Highway Concessions: How Can They Work Better’, Transportation Research Record:
Journal of the Transportation Research Board, 2187, 22–8.
99 See, for example, Nombela, G. and de Rus, G. (2003), ‘Flexible-Term Contracts for Road Franchising’, available at http://uctc.net/research/
papers/660.pdf
100 A variant on this model was used by the Queensland State Government, through the state-owned Queensland Motorways, to fund projects such
as the Logan Motorway and the Gateway Bridge Update.
101 This case study was compiled from publicly available reports and presentations, and—critically—through correspondence with several individuals
close to the project at the time. The authors are most grateful to those individuals who wished to remain anonymous.
39