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How to set up PPP projects for success: Learnings from Latin America

Posted 13/10/2020 by Pedro A. Sousa

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In a PPP project, adequate allocation of risks is key to success. The party most capable of dealing with a certain risk should assume its responsibility as part of their contractual obligations.

This allows for the most effective and efficient mitigation of any project risk, as well as the remediation of any materialised risk, given the affected party is better placed in terms of experience, knowledge, and its ability to act.

Notwithstanding, the economical equilibrium of the project, from both the public party and the private party perspectives, is arguably the ultimate driver to assess the success of a PPP project. Surely the project won’t fulfil its purpose if it is either too expensive to be maintained by the public sector, or if it brings the private party into financial loss. While the public party must aim to achieve the best quality of service to users at the most competitive expenditure, the private party’s main driver is profit, thus focusing on minimizing overruns to the cost profile prepared at bidding stage. Even more so on an availability payment-based project where revenues are fixed.

The signing of the Concession Agreement is therefore a pivotal moment in the life of a PPP project. This is the moment when the parties effectively decide on both risk and economical positions. And there is no coming back from there, at least without significant time and money lost in long and weary disputes. As far as success on a PPP project is concerned, this is probably the most decisive moment in the life of the project.

Therefore, every step of the way leading on to the execution of the Concession Agreement, from structuring to formal award, is fundamental in designing the correct risk allocation and economical equilibrium of a PPP project, one which will effectively determine its success.

Ultimately this means that both the public bodies involved in the process since structuring and the private parties involved in the tender stage must be allowed enough time to diligently study the risks of the project. Easier said than done.

Across Latin America, there have been some recent examples whereby political pressures, caused mainly by election timescales, have rushed structuring and procurement processes of important PPP projects in the region, limiting the ability of the project to mature to a stage in which risks are clearly understood and accounted for.

It is good practice to provide bidding consortia with a sufficient window of time so that the due diligence is developed adequately to understand the risks they shall assume during the concession period.

Perhaps a good example is the risk of unforeseen geotechnical conditions developing during construction stage, which is often assumed by the private party. Although the structuring and procurement processes often rely on third-party studies to quantify the geotechnical parameters of the project, there is a possibility, however, that such studies are not well scoped, elaborated or interpreted, partly because the party undertaking this work might not be fully aligned with the long term drivers of the concession development. On the other hand, due to tight timescales or permitting complications, bidding consortia are often limited in the number of additional investigations they can undertake to validate these parameters. As a result, the party taking the risk during the execution of the project may be less prepared to deal with its materialization at a later stage.

While many countries in Latin America have taken significant steps in making the PPP model a successful tool to promote socio-economic growth, there is room for improvement in the way the project risks are studied and mitigated during structuring and procurement stages. Governmental procuring authorities should be granted greater independence from electoral cycles, for example. Of equal importance is the early stage engagement of the private sector, even during the structuring phase, as they can be invited to provide strategic inputs and challenge the authorities’ initial designs and investigations. This engagement is even more crucial during tender stage. The promotion of meaningful technical and commercial dialogue during this stage, across suitable timescales, has proven to be effective elsewhere.

To continue using PPP projects as an instrument to further national prosperity, politicians must be prepared to change the way these projects are used in their agendas, thereby maturing the models in the region, to ensure a successful legacy of their implementation in the years to come.