Caspian Business Journal

Beyond the Power Sector: PPP In The Caspian Region

Countries in the Caspian region are beginning to embrace public private partnerships with a new found enthusiasm, and no longer just in the power sector. Brien Desilets reveals some of the important principles of PPP, and takes a look at how the exciting trend has been picking up steam[1].Globally, public private partnerships (PPP) have expanded beyond their origins in the power sector to encompass projects in nearly every sector, from transportation to housing and even schools and hospitals. The Caspian region has begun to embrace this trend and has had some experience with PPP in sectors beyond the power sector, most notably in transportation. More importantly, the countries of the region are beginning to develop PPP programs like those found in the UK, Australia, India and South Africa.

The main road to Almaty (CC BY 2.0)Photo by Irene2005, Creative Commons Attribution

While these exciting initiatives have the potential to become fully fledged PPP programs with a significant deal flow over the course of several years, there are also reasons to be circumspect. The region has met with some major setbacks in PPPs, and governments are struggling to establish some of the main preconditions for successful PPP development.

This article reviews some of the principles of PPP, then highlights the experience with PPP beyond the power sector in the region with an eye toward future developments in this exciting and challenging area of business opportunities.

Principles of PPP

Public private partnership (PPP) is a method of project delivery that enables the public sector to tap the resources of the private sector for the provision of traditionally public services. The rationale for PPP includes harnessing private sector financing, technological innovation and management skills for the implementation of public projects.

While various forms of concession and private management of infrastructure existed in the 19th Century, we can trace the current PPP movement as an outgrowth or variation on the privatization wave of the 1980s. The US is behind the UK and many other countries in PPP in most sectors, however in the power sector, the US was an innovator. With the 1978 Public Utilities Regulatory Policies Act, the US created the Independent Power Producer (IPP) market. The motivation was to reduce reliance on foreign oil which helped to cripple the US economy during the oil price shocks of the 1970s. Along with restrictions on oil-based electricity generation, PURPA sanctioned private companies to build and operate power plants to supply the power grid with electricity. These projects are governed by a Purchase Power Agreement (PPA), a contract between the government (public utility) and the private company whereby the government agrees to purchase a certain amount of power from the private company over the course of a long term, usually 25 years, or the expected useful life of a power plant.

The flow of payments promised by the government in the PPA provides the financial justification for IPP projects. With this agreement in hand, private companies can arrange financing from banks and other investors to pay for the capital costs of a power project. Depending on the government’s credit rating, the lenders and investors know they can rely on a steady stream of payments coming out of the project for many years to come. The lenders and investors are then very concerned about the project, to ensure that it meets its contractual obligations to supply power to the government thereby guaranteeing the flow of payments from the government.

These projects are financed based on the expectation of cash flows under a project finance model. In corporate finance, a lender can evaluate a company’s financial history and assess the value of its assets. In project finance, the project is separated from the sponsoring company or companies. A Special Purpose Vehicle (SPV) is established whose only purpose is the implementation of the project. At the time of lending, the SPV has no assets and no financial history. It is only the expected future payments that justify lending to or investing in an SPV.

The PPAs include two types of payments to the SPV. The first is referred to as an availability payment, to cover the costs of the capacity of the power plant. The second is a usage payment to pay for actual electricity consumed. PPPs in sectors outside of the power sector have adopted these two payment methods: either the government pays the private company to provide the asset and related service or users pay directly for the service. Sometimes a combination of these two methods is employed. In addition to the payment methods, PPPs in other sectors have also adopted the general structure and other arrangements for project finance from the power sector. The UK has the largest PPP program in the world and the chart below shows the various sectors represented by its more than 900 projects worth more than $100 billion total.

UK PPP projects by sector

The concept of risk transfer is central to PPPs. By adopting PPP as a delivery method, the goal of the private sector is to transfer various project risks to the private sector. What is risk and how is it transferred? In one sense, risk is both responsibility and cost. Who is responsible for a specific aspect of a project and who will pay the cost associated with that aspect? Construction costs are a good example of a risk. Many public projects are plagued by cost overruns and time overruns. The public sector wants to minimize the risk of cost and time overruns on its projects. So it holds the private sector responsible for construction. How is this done? Fixed price contracts allow the government to lock in a price for construction and also a completion date. The private sector agrees in its fixed price contract with the government to complete construction of a given asset by a specific date and for a certain price. If the private company experiences cost overruns on the project, it must pay for these additional costs out of its own pocket because the government has locked in its price.

Another major risk is operations and maintenance (O&M) costs. Government may be interested in paying the least price for a certain asset, but paying the least price up front may result in much higher costs down the road in terms of replacing the asset or its components. By tying construction and O&M together, the government can take advantage of whole life costing. The motivation is to reduce the overall cost of construction and O&M instead of focusing just on the construction cost. By making the same company responsible for the construction and O&M of an asset, the government transfers this O&M risk to the private company. The combination of construction and O&M under a single contract is also one of the reasons PPPs are usually long-term contracts for 25 years or more. The contract and project parallel the life of the asset used to provide a service.

While there are a number of additional categories of risk, including political, economic, site risks, termination risk, etc., construction and O&M are the two major types transferred to the private sector under PPP projects.

PPP in the Caspian Region

The states of the Caspian region share a common legacy of infrastructure and service delivery with the other former Soviet states. Once adequate and well maintained, the infrastructure has suffered the neglect and deferred maintenance of the past 20 years and is now in a critical stage with urgent need for rehabilitation and renewal. The situation is the same in all sectors: energy, transportation, communal services, education, housing, etc. Common problems include a lack of funds, inadequate maintenance, low levels of service delivery, operating inefficiencies and users’ low willingness to pay.

In most cases, government funds are insufficient to cover the required investments. Where government funds are available, the use of PPP can leverage these funds to increase total investment. Increasing the amount of available finance allows governments to realize investments sooner instead of waiting years to accumulate the funds necessary for major capital costs. As described in the previous section, PPP also offers the technological innovation and managerial skills of the private sector. Increasingly, the states of the Caspian area are adopting the PPP approach as an answer to their infrastructure crises. Indeed, they already have significant experience with PPP in the power sector, where major international firms such as AES have come to run the electricity sector of Kazakhstan and other international investors have built power plants to supply electricity. The states of the region are now expanding the application of PPP to other sectors and increasingly looking to develop PPP programs that promise a flow of projects for interested operating companies and investors.

Kazakhstan has taken the lead in terms of making a serious commitment to developing a full PPP program. In compliance with its 2006 concession law, it established the Kazakhstan Public Private Partnership Company (KPPC) as the country’s PPP unit to assess PPP projects and develop the legal and institutional framework for project implementation. This leaves responsibility for the development of PPP projects with the individual line ministries.

This initiative builds on some previous success with PPP in Kazakhstan. Nurzhol Energy Ltd signed an agreement with Kazakhstan Tamir Zholy JSC to undertake the electrification and operation of the railway line section between Makat and Kandyagash. The project along this 392 km long railway line is estimated to cost $350 million. The contract was awarded to Nurzhol Energy Ltd in 2007 which signed an agreement with Kazakhstan Tamir Zholy JSC to manage the 23-year concession. Construction is to be completed by 2011.

On another railway line, a concession was awarded to Doszhar Tamir Zholy for the construction and operation of new railway infrastructure between Sher and Ust Kaengosrk in East Kazakhstan in July 2005. The railway section is 151km and the project cost is estimated at $169 million. The concession period is 2005-2028. The project aims to have cargo volume reach 16,300 tons and passengers reach 900,000 per year by 2028. The new railway came into operation in December 2008[2].

Also in the transportation sector, a concession agreement was signed with ATM Group Ulusiararasi Havalimani Yapin Yatirim ve Isletme Ltd Sti to construct a passenger terminal at the international airport in Aktau [3]. The concession agreement was signed with ATM Group Ulusiararasi Havalimani Yapin Yatirim ve Isletme Ltd. Sti. in December 2007 at a cost of $65.5 million. The concession period is from 2007 to 2037. Upon completion the terminal will have a capacity of 350 passengers per hour.

These successes have, however, been marred by some major setbacks in Kazakhstan’s PPP program, particularly recently after the establishment of the KPPC. In the road sector, procurement commended for four different road sections: Almaty-Korgos, Astana-Karaguda, Almaty-Kaphagay and the Almaty ring road. All four were put out to tender with a deadline of March 2009. Unfortunately the launch of the tenders was unsuccessful, largely as a result of poor planning of the tenders and the economic crisis. This initial failure has caused the government of Kazakhstan to rethink its PPP strategy, and the country is hoping to attract investment in other infrastructure projects.

Another major PPP failure in Kazakhstan was the Zhetygen-Khorgos Railway Line (China Gateway Project). This project is aimed at constructing a 300km single track railway line in south eastern Kazakhstan between Korgas (on the Kazakhstan/China border) and Zhetygen, with four intermediate stations, ten intersections and a loading complex. The project was estimated to cost $900 million. Eurasian Natural Resource Corporation[4] (ENRC Logistics), the transport division of the Kazakh minerals company, was awarded the contract in May 2008. Construction was scheduled to begin in July 2009 and be completed in 2010[5] while the concession period is 2008-2036[6]. Then at the end of July 2009 when construction was due to begin, ENRC pulled out of the project, citing differences with the government. The Kazakhstan Temir Zholy National Railway Company is now undertaking the project.

Armenia successfully employed a two-stage process to introduce PPP to its water sector. In 2000, it awarded a management contract for operation of the Yerevan Water and Sewerage Company. The contract was initially for four years but later extended to five years. An Italian consortium headed by Acea and including C. Lotti & Associates won the tender. Five years later, the government awarded a lease contract for the water company to Compagnie General des Eaux (Veolia). The water system has seen major improvements, including a reduction of energy consumption by 20%, an increase in collection efficiency by 20% and the installation of 20,000 meters. In addition, the supply of water has increased to 17.5 hrs per day, more than 37% of subscribers receive 24-hour water service and 5,000 illegal connections have been eliminated[7].

In Georgia, International Container Terminal Services Inc (ICTSI) is developing and operating a container terminal, ferry and dry bulk handling facility at the Port of Batumi. The concession was granted in September 2007 for 48 years. Lease payments to the government are valued at nearly $100 million. ICTSI is based in Manila, Philippines, and operates ports worldwide.

TAV Urban Georgia LLC, TAV was awarded an 11.5-year concession in 2006 to design, finance, construct, maintain, and operate Tbilisi International Airport (TIA). The total project cost of was $77 million. EBRD and IFC helped finance the project with loans of $25.9 million and $27 million respectively. TAV Georgia is jointly owned by four Turkish companies: Tepe İnşaat Sanayi A.Ş, Tepe, Akfen İnşaat Turizm ve Ticaret A.Ş, Akfen and Urban Insaat Sanayi ve Ticaret AS, Urban, with 30% each and Sera Yapı Endüstrisi ve Ticaret Ltd. Şti, Sera, a private investment company, holding the balance 10%.

Although water supply networks in Uzbekistan reach over 80% of the population, the reliability of water supplies is inadequate; in most areas of the country water is available for only three hrs per day. Last year the Asian Development Bank approved a $30 million loan for the Surkhandarya Water Supply and Sanitation (WSS) Project, which will increase access to water and improve utility efficiency in Surkhandarya Province. The project is being co-financed by the Multi-Donor Trust Fund under the Water Financing Partnership Facility. In addition to setting up a services model that can be expanded in other provinces later, it is hoped that this project will provide a framework for PPP that can be utilized in other sectors in Uzbekistan [8].

A glimpse of the future

This article has outlined some of the principle benefits of PPP and the methods used to harness private sector efficiency and financing for the provision of traditionally public services. It has also highlighted some of the region’s experience in PPP, both successes and failures. The benefits of successful PPP projects can be seen in the gleaming new infrastructure provided by some projects and experienced in the homes of many of the beneficiaries of other projects. However, some recent failures also highlight the need for improved approaches to PPP project preparation and procurement along with creative approaches for overcoming the difficulties raised by the current financial crisis.

Globally, the PPP trend has gained momentum over the long-term and the Caspian region is experiencing this trend. Looking to the future, PPP is likely to become a major mode of public service delivery and a major source of business opportunities.

Footnotes:

[1] The author would like to thank Melissa Lambert for her research assistance on this article.

[2] http://www.akimvko.gov.kz/eng/news.htm?id=0157

[3] USAID. (2009). PPP Country Fact Sheet: Kazakhstan.

[4] www.enrc.com

[5] http://capital-en.trend.az/transport/1474291.html

[6] http://silkroadintelligencer.com/2008/07/11/kazakh-rail-on-track-for-private-money/

[7] http://www.adb.org/Documents/Reports/Yerevan-Water-Supply/yerevan-water.pdf

[8] Ye, Yong. (2009). Cooperation with Uzbekistan in Water Supply and Sanitation Sector: A Strategic Change in Approach. Asian Development Bank. Retrieved September 26, 2009 from http://docs.google.com/gview?a=v&q=cache:3jQJ6sTJA_gJ:www.adb.org/Documents/Periodicals/Urban-eNews/2009/Uzbekistan-Water-Supply.pdf+public+private+partnerships+uzbekistan&hl=en&gl=us&sig=AFQjCNGjokLhIYz_FJfJ9sUByZw16-xVxA