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Home > Financing Best Practice > Public–Private Partnerships in Emerging Markets

Financing Best Practice

Public–Private Partnerships in Emerging Markets

by Peter Koveos and Pierre Yourougou

Executive Summary

  • A public–private partnership (PPP) is an “arrangement in which the private sector supplies infrastructure assets and services traditionally provided by governments.”

  • The public and private sectors have different goals and organizational philosophies and cultures. Reconciling these differences requires a strong commitment, and a clear vision regarding expectations and outcomes.

  • The essence of PPP is risk allocation—whether these operations add value depends primarily on how risk is identified, managed, and priced.

  • In emerging markets, international partners must address not only the project risk and country risk, but also the risks posed by the lack of local managerial skills, inadequacy of institutions, corruption, lack of transparency, and others.

  • Project financing can be used for PPP projects, thus clarifying a key element of the partnership financing structure.

  • One of the most significant and interesting global economic developments of the past few years is the emergence of Africa as a competitive region for business.

  • The Bujagali Hydropower Project represents the largest mobilization of private financing for a power project in Africa.

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Introduction

Given the poor state of public-sector resources around the world, made even worse by the global financial crisis, governments have been seeking to enhance resources by attracting private sector participation. Such participation may be somewhat unstructured, or more formal. The public–private partnership (PPP) is one of the formal approaches to cooperation. PPP, in various forms, is not a new construct. The current frailties of the global economy have forced governments to reduce costs and limit risks. This paper examines the nature of PPP, and describes some of the advantages and disadvantages of PPP. The discussion then focuses on the viability of PPP in emerging markets in general, and African countries in particular. A case study, Bujagali Hydropower Project in Uganda, illustrates many of the major concepts discussed throughout this paper.

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Definitions/Nature of PPP

There are many definitions of PPP. Most versions of PPP are very similar, although the degree of control shared by the partners, and several other characteristics of the partnership may receive different emphasis from definition to definition. Thus, PPP is an “arrangement in which the private sector supplies infrastructure assets and services traditionally provided by governments” (Michel, 2008). Other terms for PPP include: PPI (private participation in infrastructure); PSP (private sector participation); in the UK, the term used is PFI (private finance initiative); in Australia, the reference is to PFP (privately financed projects); and P3 is commonly used in the US (see Yescombe, 2007). Other variants include the build–transfer–lease (BTL) and build–own–operate–transfer (BOOT) options. In some cases, two or more of the above terms can be used in combination. For example, project financing can be used for PPP projects, thus clarifying a key element of the partnership, financing. Project financing schemes may involve a variety of instruments such as the special-purpose vehicle (SPV), a legal entity with its own assets and obligations. Creation of this joint venture among project sponsors enables the flow of funds. An SPV is a highly leveraged company, with typically limited-recourse debt and limited equity participation. PPP can indeed be very complicated, and requires thorough analysis of associated terms and conditions.

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PPP: Some Advantages and Disadvantages

PPP is part of the recent movement of “new public management.” PPP is a means through which the two sectors can become interdependent. Managers in each sector must independently answer some basic questions: Why are we participating in this partnership? Where are we going to operate? Who are our partners? How are we going to proceed? What is our exit strategy?

Specific benefits for the public sector include:

  • reduces project costs and time, while enhancing its overall efficiency and effectiveness;

  • enables access to and learning from private sector resources, technology, and managerial skills;

  • credit enhancement and, consequently, access to long-term financing;

  • shifts risk to the private sector;

  • pursues an integrated approach to project completion;

  • involves participation from various partners, and may legitimize the project in the eyes of the citizenry, and other stakeholders;

  • PPP may provide greater economic benefits than other forms of cooperation, such as public sector procurement. These extra benefits are usually referred to as value for money (VfM).

For the private sector participant, the analysis is based on the profitability of the project in terms of dollars and cents, and is usually more objective than that conducted by the public sector. Participation in a given project can be analyzed using standard finance tools. These projects usually involve a great deal of risk, but government backing and involvement of international financial institutions help mitigate risks. The limits of risk–return trade-offs, and the ensuing risk allocation, are even more crucial factors leading to project assessment. A great deal of emphasis is placed on risk management, including the formulation of an exit strategy.

PPP also involves potential disadvantages. PPP entails considerable agency costs, as it must be thoroughly cultivated and managed in terms of planning, monitoring, and acceptance of loss of some control. Private and public sectors often have different goals, and organizational philosophies and cultures. Reconciling these differences in order to bring about the desired project results requires a strong commitment, and a clear vision regarding expectations and outcomes.

The above are especially relevant to public authorities in emerging markets. As emerging markets are so diverse, the analysis must be adjusted to fit the particular country’s environment.

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Emerging Markets

The term “emerging market” is used to describe countries whose economies are undergoing a significant transition through a series of reforms.

For a private sector firm, operating in an emerging market can be an attractive prospect leading to profit generation, increased market share, and access to growing markets. The firm’s ability to access this opportunity depends on how risk is identified, managed, and priced. Business risks exist in every country. Operating in emerging markets, however, may make these risks even more prevalent. The potential risks include:

  • Political risk, defined as a change in government policy that affects foreign companies, is often associated with weak political, legal, and institutional infrastructures. To manage political risk, foreign organizations must be familiar with the political landscape, and learn how to operate in an uncertain and different environment. Property rights, a staple of Western economic institutions, can often be easily undermined. The heavy hand of government can also interfere with a firm’s plans and desired outcomes.

  • Economic risk. In general, emerging markets exhibit a higher degree of volatility than that shown by developed economies. Even assessing the state of the economy in many of these markets is challenging, as the “official statistics” may not be accurate. Partners, then, must rely on their own analysis of future market conditions for their services.

  • Financial risk, stemming from a country’s financial system weakness, may impact on the value of the currency and, subsequently, the company’s bottom line.

  • Other risks. The country’s immature economic infrastructure is vulnerable to a number of disruptions. International partners must address risks posed by the lack of local managerial skills, inadequacy of institutions, corruption, lack of transparency, social issues, income inequalities, pollution, and other elements in the operating environment.

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Africa

One of the most significant and interesting global economic developments of the past few years is the emergence of Africa as a competitive region for business. Africa is the fastest reformer in terms of easing business entry. It is now easier for private foreign firms to do business in Africa, due to recently simplified business regulations, strengthened property rights, eased tax burdens, increased access to credit, and other economic reforms. African countries are diverse with respect to their politics and economics. The risks of doing business may vary in their nature and intensity from country to country. These risks may emanate from the region’s poverty, numerous conflicts, corruption, and health problems, or from the lack of adequate infrastructure. Risks also present opportunities—for example, infrastructure projects are often open to foreign participation. Moreover, many risks can be mitigated through bilateral official insurers (for example, OPIC), multilateral insurers (for example, MIGA) and private risk insurers (for example, AIG). Africa has provided the stage for PPP in such sectors as utilities, energy, minerals, health, tourism, and others.

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Case Study

Bujagali Hydropower Project, Uganda

The Bujagali Project is a private power generation project. The 250 MW run-of-the-river hydroelectric power plant, comprised of five 50 MW turbines, was completed in June 2012. The project is located on the Victoria–Nile on Dumbbell Island, Jinja, Uganda, and it achieved its financial closing in December 2007. Bujagali is the first independent power project (IPP) in Uganda, and the largest mobilization of private financing for a power project in Africa. It was named “Africa Power Deal of the Year 2007” by Project Finance magazine. Bujagali is a good example of how various international financial institutions can work together with private sector project sponsors to address their financing and risk mitigation concerns, and meet the client country’s economic objectives.

Rationale for PPP

According to the World Bank, the severe shortage of electricity in Uganda contributed to a decline in GDP growth to around 5% in 2005/06. Bujagali is an essential part of Uganda’s energy-sector strategy to provide a sustainable and affordable source of electricity. The government of Uganda lacks, however, the necessary technical expertise and financing to complete the project on its own. Private sector participation was sought to fill the gap.

Project Partners

The Bujagali project has been described as a global story for bringing together partners from 37 countries. It is a public–private partnership between the private sector project sponsors represented by Bujagali Energy Ltd (BEL), the government of Uganda, including the Ministry of Energy and Mineral Development (MEMD) and Uganda Electricity Transmission Company Ltd (UETCL), multilateral and bilateral development financial institutions,1 and commercial lenders, including Absa Capital (South Africa) and Standard Chartered Bank (UK). BEL, a special-purpose company (SPC), is incorporated in Uganda, and is privately owned by Industrial Promotion Services (Kenya) Ltd (IPS (K)), the industrial development arm of the Aga Khan Fund for Economic Development (AKFED) and SG Bujagali Holdings Ltd (Mauritius), an affiliate of US-based Sithe Global Power LLC. The sponsors were selected through international competitive bidding procedures.

Project Description

The Bujagali project is developed, financed, constructed, and maintained by BEL on a BOOT basis. BEL also manages the construction of the Interconnection Project on behalf of UECTL, which will own and operate the project. The Interconnection Project involves the construction of about 100 km of high-voltage electrical transmission line to interconnect the power generation facility (the Bujagali project) to the national electric grid. Structured as IPP, BEL will sell the electricity to UETCL, Uganda’s national transmission company, under a 30-year power purchase agreement (PPA).

Financing

Finance for the project is structured as an integrated package for both the power plant and transmission components. The total cost for the integrated projects, about US$900 million, is mobilized on a limited-recourse basis, through equity and debt in the ratio of 22:78. The government of Uganda provided an in-kind equity contribution of US$20 million. The equity financing is shared by the sponsors, IPS (K) and SG Bujagali Holdings Ltd, on a pro rata basis. The equity structure of BEL is complex. Figure 1 provides a simplified description.

Data adapted from Bujagali Energy Limited for the Private Power Generation (Bujagali) project. “Project appraisal document.” World Bank/IFC/MIGA report no. 3 842 1 –UG, pp. 68, 72

The debt is being financed by loans from the group of lenders, the World Bank group providing a far more substantial amount of US$360 million (US$130 million loan from IFC, US$115 million partial-risk guarantee from International Development Association to commercial lenders, and US$115 investment guarantee from Multilateral Investment Guarantee (MIGA) to cover the equity position of SG Bujagali Holding Ltd). The project financing plan is described in Figure 2.

Data adapted from Bujagali Energy Limited for the Private Power Generation (Bujagali) project. “Project appraisal document.” World Bank/IFC/MIGA report no. 3 842 1 –UG, p. 16

Contractual Arrangements and Risk-Sharing Mechanism

Contractual agreements define the transactions and allocation of the commercial, technical, and political risks among the partners. The contractual structure of the Bujagali project is consistent with industry practice for limited-recourse project finance transactions (see Figure 3). The project implementation agreement (IA), also called the concession agreement, signed between the government of Uganda and BEL on December 13, 2005, defines the terms of the concession the government grants to BEL to design, finance, own, operate, and maintain the project. Under the 30-year PPA, BEL agrees to sell exclusively to UETCL all the production, and UETCL agrees to purchase the contracted capacity (i.e., 250 MW), with the government guaranteeing the UETCL’s payment obligations. In addition to the IA and PPA, BEL signed a fixed-price, date certain, turnkey engineering, procurement, and construction (EPC) contract with Salini Costruttori SpA (Italy), and Alsthom Power Hydraulique (France), and an operation and maintenance (O&M) agreement with affiliates of Sithe Global. The EPC contract requires the power plant to be commissioned within 44 months. The EPC contractors were selected through competitive bidding, in accordance with the EIB procurement rules. The O&M agreement reflects BEL’s commitments under the PPA.

Data adapted from “Project appraisal document” World Bank/IFC/MIGA report no. 38421–UG, p. 21

The contractual structure ensured that the project-related risks, including completion and operation, were borne by the project sponsors and commercial lenders. However, these risks were mitigated by contracts and various insurance arrangements. The risks related to supply/input (hydrology risk), market, political, and natural forces were borne by the government of Uganda under the government guarantee and implementation agreements. The participation of the IFC and the guarantees provided by the World Bank group (IDA and MIGA) are critical in mitigating the completion risk, and to provide Uganda with access to long-maturity commercial loans in favorable terms.

Reaction to the Project

A project as large in impact and scope as Bujagali is bound to generate considerable reaction and skepticism. Indeed, critics point out that construction proceeded prior to resolving a number of important issues regarding the impact of the project. Questions are still being asked about the cost of the project and its true impact on the Ugandan economy, lack of resolution of compensation and resettlement challenges, hydrological and climate risks, the project’s cumulative impact, and the consultation process.

Although some of these questions may never be completely answered, the Bujagali story should serve as a lesson for future PPP projects.

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Conclusion

Globalization has led to the emergence of new economies. With scarce resources, the public sector in many economies needs private sector partners. PPP is a unique opportunity for the two diverse sectors to learn how to work together. For the public sector, shifting risks and securing financing are important benefits. For the private sector, the environment represents an opportunity to add value to the organization, and act in a socially responsible manner. PPP involves complicated arrangements that require a great deal of expertise and flexibility. The essence of PPP is risk allocation—preparation, and proper risk management and pricing are a must.

Contract arrangements are very complex. For PPP to be successful, the contract must be well-designed to provide the private provider with compatible incentives and the public authority with monitoring mechanisms, and to channel private-profit-motivated objectives to attain the government’s broader social objectives.

Bujagali’s total impact is envisioned to be far wider than radically upgrading the country’s electricity production capacity. It is also expected to revamp Uganda’s social, environmental, economic, and education infrastructure. These additional effects make the Bujagali project, and PPPs in general, valuable contributors to a region’s business, economic, and social development.

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Making It Happen

  • Conduct a readiness analysis of your organization.

  • Know exactly what you want and expect.

  • Know what the various partners want and expect.

  • Work to build trust among partners.

  • Put together a solid risk management process, with clear accountability and understanding of the risks faced, how they are allocated, and how risk is to be priced.

  • Be as specific as possible about your role and responsibilities.

  • Familiarize yourself with the nature and operations of international financial institutions and agencies, such as the World Bank, its affiliated agencies (IFC, IDA, MIGA), and other cooperating organizations.

  • Make sure you do a feasibility study and conduct due diligence.

  • Go slow! Learning about PPP is important. Existing relationships could serve as an easier first step.

  • Decide on what valuation techniques would be appropriate (for example, internal rate of return, net present value, adjusted present value, and real options).

  • Analyze all possible scenarios.

  • Review and revise as appropriate.

  • Work towards a sustainable relationship, but have an exit strategy.

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Notes

1. The institutions include the African Development Bank (ADB), European Investment Bank (EIB), the World Bank Group, Agence Française de Développement (AFD), Proparco, Netherlands Development Finance Company (FMO), Kreditanstalt für Wiederaufbau (KfW), and Deutsche Investitions und Entwicklungsgesellschaft (DEG).

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Further reading

Books:

  • Akintoye, Akintola, Matthias Beck, and Cliff Hardcastle. Public–Private Partnerships: Managing Risks and Opportunities. Malden, MA: Blackwell Science, 2003.
  • Asian Development Bank (ADB). Public-Private Partnership Handbook. Manila: ADB, 2008. Online at: tinyurl.com/blbwxwv
  • Grimsey, Darrin, and Mervyn Lewis. Public Private Partnerships: The Worldwide Revolution in Infrastructure Provision and Project Finance. Northampton, MA: Edward Elgar, 2007.
  • Mobius, J. Mark. Mobius on Emerging Markets. New York: Irwin Professional, 1996.
  • Osborne, Stephen P. (ed). Public–Private Partnerships: Theory and Practice in International Perspective. London: Routledge, 2000.
  • Yescombe, E. R. Public–Private Partnerships: Principles of Policy and Finance. Oxford: Elsevier, 2007.

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