11/13/2008
Structuring Water and
Wastewater Projects
Through Public-Private
Partnerships
André Unger
Department of Earth and Environmental Sciences
University of Waterloo, Canada
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Project Finance Alternatives
• municipality needs to obtain funding to finance a water/wastewater project
• obtain funding by:
1. obtaining a government (federal/state) loan
2. issuing municipal bonds
3. engaging in a public-private partnership
• preference based on:
– controlling decisions during the evolution of the project
– sharing risk due to project uncertainties
– municipality owns infrastructure (i.e. not privatization)
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Government Loan
federal or state
government
principal principal
+ interest rRF principal + interest rRF + rLP
infrastructure loan municipal
program government
go ernment
principal
guarantee that water and
wastewater services comply user fees
with performance indicators
residents of
municipality
• rRF risk free interest rate (US Federal treasury bonds)
• rLP interest rate premium (on top of rRF ) required to operate
infrastructure loan program
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11/13/2008
Government Loan (cont.)
• control:
– municipal government specifies design of water/wastewater
– treatment plant
– municipal government tenders contracts to builders
• risk:
– all cost over-runs covered by residents through tax base and user fees
unless limited by contract and enforced by arbitration or
contract litigation
(labor strikes, equipment shortages, material costs,
– inflation uncertainty, force majeure, changing regulations, …)
• pros and cons:
– low cost of borrowing
– restrictions on the availability and timing of loans
– no cap on project delays or cost over-runs
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Municipal Bonds
principal + interest rRF + rMB + premium + no default guarantee
municipal bond
insurer
capital market municipal
investors bond rating government
agency
principal + credit rating
guarantee that water and
wastewater services comply user fees
with performance indicators
residents of
municipality
• rRF risk free interest rate (US Federal treasury bonds)
• rMB interest rate premium (on top of rRF) required to compensate
insurer for premium + no default guarantee based on credit rating
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Municipal Bonds (cont.)
• control / risk:
– same as government loans (traditional procurement)
• pros and cons:
– higher cost of borrowing rMB > rLP
– credit rating assigned by bond rating agency reflects debt/equity
– ratio of the municipalities portfolio of projects
– (not just the p p
( j proposed water/wastewater p j )project)
all risks covered by collective tax base / user revenue
possible risk of default on borrowed principal
– bond insurer provides no-default guarantee on borrowed principal
– with premium (services) provided by rMB
– timely arrival of adequate capital
– bond insurers are currently in dire straights (sub-prime mortgages)
– causing rMB » rLP
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Public Private Partnership
• special purpose vehicle (SPV) to manage infrastructure
municipal
government
guarantee that
infrastructure is
contract to build
the infrastructure performance constructed
on time/budget
bond subject to
principal + interest rRF + rP3 + premium + no default guarantee performance
principal +
p p
indicators
user fees
letter of credit
capital market
SPV trust
investors
principal principal +
user fees + investment income
guarantee that water and
wastewater services comply user fees
with performance indicators
residents of
• rRF risk free interest rate municipality
• rP3 interest rate premium (on top of rRF ) required to reserve capital
to issue letter of credit and post performance bond 7
Public-Private Partnership (cont.)
• control:
– municipality retains ownership of infrastructure (i.e. not privatization)
– SPV constructs infrastructure using design-build strategy
• risk:
– letter of credit provides no-default guarantee on loaned principal
– to capital market investors
– performance bond enforces fixed-price g
p p guarantee that SPV will
– manage all construction risks
– municipal government can adjust term of the project to ensure user
– fees compensate SPV for all project costs
• pros and cons:
– higher cost of borrowing rP3 > rLP but is rP3 > rMB ?
– scope of project limited to water/wastewater infrastructure, independent
– to the debt/equity ratio of the municipalities portfolio of projects
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How do you price risk?
• the project
– $30 million wastewater treatment plant, to be build over 3 years
– in even instalments of $10 million / year
– risk-free interest rate: rRF = 4.23%
• municipal bond: rMB = 1.02% • P3: rP3 = 1.2%
– appreciate costs at: rRF + rMB – appreciate costs at: rRF + rP3
– depreciate costs at: rRF – depreciate costs at: rRF
Year 1: $10,525,000 Year 1: $10,543,000
Year 2: $11,077,563 Year 2: $11,115,485
Year 3: $11,659,135 Year 3: $11,719,056
NPV: $30,591,003 NPV: $30,696,097
− $30,000,000 − $30,000,000
$591,000 $696,097
risk premium risk premium
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Cost Comparison
• P3 premium ( $696,097 − $591,000 ) × 100% = 0.35%
$30,000,000
• Question: How many municipal projects that are funded by traditional
• procurement exceed their budget by more than 0.35% ?
• project delivery evidence from the UK
traditional P3
procurement procurement
projects over 73% 20%
budget
projects delivered 70% 24%
late
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Summary
• whether project operates under a government loan, municipal bond, or P3:
– re-arrangement of same (or similar) partners in the deal,
– relationships dictated by desired level of control, and risk sharing,
– risk is worth $$$,
– and the municipality retains ownership of the infrastructure.
• private sector is highly effective a managing construction risk,
• especially after p
p y g performance bond
posting a p
– effective management of risk can easily compensate for higher
– cost of borrowing capital
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