Disincentivising overbidding for toll road concessions

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DISINCENTIVISING OVERBIDDING FOR TOLL ROAD CONCESSIONS Case studies from the toll roads sector •• The report examines a selection of case studies to illustrate the different approaches being taken around the world to toll road concessions, and their award. The traditional user-paid toll road model is discussed and contrasted with approaches that instead reward the concessionaire according to performance and/or asset availability. However, caution is sounded about constructs that rely on long-term state payments, since such arrangements can cause affordability problems. Furthermore, user charging may be desirable as part of a longerterm policy solution to the requirements for road investment or demand management—even in situations where user revenues cover only part of the overall project costs. •• The report looks at pass-through tolls, whereby the concessionaire collects tolls but passes them through directly to the concession grantor (who separately reimburses the concessionaire against performance or availability-based metrics). Such arrangements highlight the very real possibility of de-linking toll revenues from concessionaire reimbursement, and a number of circumstances are described in the report under which such arrangements could be beneficial to concession grantors. Such arrangements are fairly common under models of incentive regulation in infrastructure sectors. •• The role of flexible-term concessions is also considered. Traditionally, these concessions have been designed to terminate when a predefined absolute volume of revenue has been collected or a certain number of vehicles have used the facility. However, in some countries this model has evolved such that the concession terminates when a predefined present value of revenues has been received. Indeed, the concessions are awarded in the first place to the bidder requiring the least present value of revenues (known as the LPVR model). The pros and cons of such arrangements are considered from the alternative perspectives of different project stakeholders. •• There are international examples of toll roads that the public sector has constructed before being leased to the private sector as a mature brownfield project. One such example, 407 ETR in Canada, is taken in the report in order to walk through the advantages and disadvantages of such arrangements. Given that forecasting errors (and optimism bias) are commonly greatest when estimates of opening-year traffic have been critiqued, this model has an initial intuitive appeal. However, it brings private sector expertise late to the project and many studies (and much anecdotal evidence) point to the possibility that early private sector involvement can reduce project costs through design innovation, the employment of new techniques and materials, and so forth. •• The final toll road case study looks at bundling new construction obligations with the operation of an existing (possibly revenue-generating) asset. Particular developments in the USA with bundling arrangements have seen bidding teams becoming much more involved in the project specification, which is fine-tuned with their input, as concession grantors seek to contain or reduce project costs. In cost-conscious infrastructure investment environments generally, such approaches present interesting opportunities. • • None of toll road case studies presented in this report offers the perfect solution to concession design, contract award or the problems that stem from overbidding, and, importantly, all of them demonstrate the need for project and transaction design to respond appropriately to local objectives and circumstances. However, the case studies themselves demonstrate how individual features can be selected and combined to tailormake contractual arrangements that perhaps look beyond the traditional toll road concession model to new approaches that could be developed in the future. 2
EXECUTIVE SUMMARY Case studies from other sectors •• Turning from toll roads to other sectors, from which might be learned lessons about overbidding and procurement practice generally, attention in the report then focuses on the passenger rail sector in Great Britain. Since their privatisation back in the early 1990s, GB rail services have been delivered through competitively procured franchises. Of interest to this study: ◦◦ prequalification screening specifically includes assessments of any past failure to deliver on contractual commitments; ◦◦ service requirements are becoming less tightly specified, to promote delivery innovation and flexibility; ◦◦ bid appraisal pays detailed attention and gives a high weighting to the deliverability of the bids themselves. •• Of particular note, however, is the treatment of the bidders’ revenue forecasts. These are split into exogenous and endogenous revenue-affecting factors. Exogenous factors (outside of management control, such as GDP) are normalised (equalised across all bid submissions) and the detailed deliverability plans are used to evaluate the residual endogenous revenue-affecting assumptions. •• Other features of GB rail franchising include strong government commitment not to renegotiate contracts and the use of revenue risk-sharing arrangements, including revenue adjustment mechanisms linked specifically to GDP growth. This leads to a reward culture that directly reflects management actions, rather than positive or negative GDP fluctuations. A range of harsh financial penalties is triggered in the event of a franchisee default, providing incentives to structure bids in the first place that have low default risk exposure. •• The second non-toll road case study presented in the report examines third-generation spectrum licences auctioned for mobile phones in the UK. Here, the emphasis was placed on efficient, sustainable solutions that offered the highest economic value (rather than the highest revenue). The auction was based on an open, multi-round, ascending-bid design, with the bid prices being made public at the end of each round (revealing competitor behaviour). Bidders paid substantial deposits (linked to bid size) at the outset as insurance against default and to deter frivolous bidding (overbidding). •• Subsequent UK radio spectrum auctions have moderated the emphasis on revenue-raising more explicitly, with even greater priority being placed on efficient utilisation of the asset. •• The final case study looks at the ‘menu-based’ system used by Ofwat, the regulator of the water sector in England and Wales, to incentivise truthful revelation of business plan requirements. In short, water companies are required to submit business plans that detail their capital expenditure (CAPEX) projections, which are used in turn to set price caps (the higher the CAPEX, the higher the price cap). Water companies are subsequently rewarded if their outturn costs are equal or close to their original cost forecasts, or penalised otherwise. • • The mechanism itself is structured such that the reward from providing an accurate forecast is greater than the maximum reward from over- or understating the companies’ CAPEX requirements. This disincentivises the companies from overstating (gaming) their CAPEX projections simply to benefit from a higher price cap. Similar arrangements could be applied to toll roads, making truthful revelation of demand estimates incentivecompatible, possibly by rewarding companies for the accuracy of their forecasts. 3
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www.infrastructure.gov.au INFRA1452
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Disincentivising overbidding for toll road concessions

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