Delivering PPP infrastructure

Public-Private Partnerships (PPPs) are shaping the future of South Africa’s infrastructure. But before shovels hit the ground, feasibility is key. PROF JOHN MALULEKE and ADV A.M. MATJILA explain further… 

In a previous issue, we discussed key steps towards the successful implementation of PPP projects utilising Special Purpose Entities (SPEs). The first step encompassed project conceptualisation, creating awareness about the project and registering it with the concession granting authority or contracting authority.

In this issue, we look at the next phase: assessing the feasibility of the project. This requires Treasury Approval 1 before the project can advance to the next stage.

Feasibility studies are undertaken to determine whether the proposed project will be in the best interest of the implementing authority, provide strategic and operational benefits to the community in which it will be established and – given that every country’s resources are limited – ensure that it does not amount to wasted resources.

There are five key assessment criteria that contracting authorities consider when deciding whether or not to pursue a project as a PPP.

1. Technical and economic feasibility

Irrespective of the procurement model, it must be confirmed that the project aligns with national development strategies, provincial strategies, policy priorities and infrastructure plans.

This involves feasibility studies to ensure that the project is technically feasible, that the technology to be used is readily available in the market and that it is unlikely to become obsolete in the medium term – thereby avoiding unreasonable technical risk.

Economic appraisal entails confirming that the project is justified following a cost–benefit analysis and represents the least-cost approach to delivering the expected benefits.

Many governments undertake a socio-economic viability study to decide whether a proposed project represents a sound use of public resources. A project is economically viable if its economic benefits exceed its economic costs when analysed from the perspective of society as a whole.

Economic costs or benefits are not the same as financial ones; economic benefits measure the value the project delivers to society, rather than the revenue it generates. It is important to consider externalities and the environmental impact the project will have on the communities where it is implemented. Externalities – whether positive or negative – are economic effects that impact persons who are not necessarily part of the project scope.

Economic benefits can therefore be much higher than the direct revenue a PPP generates. For example, the benefits of improved highways may far exceed the tolls paid, as they result in faster travel times, reduced congestion and accidents and lower vehicle maintenance costs.

Additionally, PPP projects may stimulate regional economic activity and improve the quality of life for people living nearby.

Stakeholder engagement

According to the International Finance Corporation’s (IFC’s) Stakeholder Handbook, Volume 4: 2017, many private operators begin their consultation process as early as the pre-feasibility stage of a PPP project. Stakeholders include communities, government entities and non-governmental organisations.

Early engagement helps introduce the project positively by setting out its developmental rationale and balancing promotion with the management of expectations and concerns. It also signals to stakeholders that their needs and views are being taken into account.

Legal, Environmental and Social Impact

Legal feasibility involves identifying any legal barriers to the project, including due diligence to highlight constraints preventing the contracting authority from entering into a PPP contract.

It must also be determined whether the project complies with national environmental legislation, spatial planning, land-use management and town-planning standards.

The success of a PPP depends on effectively managing environmental and social (E&S) risks. The key element of E&S risk management is the avoidance and minimisation of impact. Where relocation is unavoidable, compensation should be provided to support affected individuals and communities, or to mitigate environmental risks.

For example, if residents near a proposed construction site will be displaced, E&S impact studies should explore ways to minimise displacement and propose measures to compensate relocated persons. These studies should cover the entire lifecycle of the project: design, construction, operation and decommissioning.

Effective E&S risk management improves project quality; helps achieve political, social and environmental sustainability; prevents conflicts; and avoids delays. It also informs the development of terms of reference (ToR), enabling the contracting authority, bidders and other stakeholders to understand the key issues affecting the project. Furthermore, it identifies mitigation measures that need to be implemented, their costs and the responsibilities of the private party and the contracting authority before the project is awarded.

2. Commercial feasibility

For a PPP to be feasible, it must attract reputable sponsors and lenders who expect a reasonable financial return on their investment and are prepared to assume an appropriate level of risk.

Assessing returns typically involves detailed financial modelling, including the analysis of project cash flows and projected returns.

If revenue from user charges exceeds costs and yields sufficient returns to remunerate capital, the project will generally be commercially attractive – provided risks remain reasonable. Where user charges are inadequate, the contracting authority must determine whether fiscal contributions or subsidies are justified.

3. Value-for-money feasibility testing

This test determines whether implementing the project as a PPP will provide better value for money (VfM) than other procurement methods. Many PPPs require an assessment of whether they offer greater value than traditional public procurement.

VfM analysis typically combines qualitative and quantitative approaches to measure the usefulness, efficiency and effectiveness of expenditure.

Some PPPs also require the use of a public sector comparator (PSC) – a theoretical calculation of the total cost to the public sector of developing and operating a project through traditional procurement. The PSC estimates total lifecycle costs – capital and operational expenditure (CAPEX and OPEX) – while accounting for risks. These costs are compared to the PPP model’s projected costs. 

Alternatively, the two options can be compared using an economic cost–benefit analysis tool to measure the expected benefits of the PPP approach relative to its additional costs. A cost-benefit ratio (CBR) greater than 1.0 indicates a project expected to increase social welfare.

4. Assessment of fiscal feasibility

This analyses the ability of users to pay for services and the contracting authority’s capacity to finance the infrastructure. It covers both regular payments and fiscal risks. Even if a project is feasible, economically viable and offers value for money, it may still be unaffordable given the authority’s fiscal constraints.

PPP projects may require fiscal commitments in the form of direct and contingent liabilities:

• Direct liabilities: Payments that the contracting authority must make if the PPP proceeds (e.g. availability payments or upfront costs for tolling infrastructure).
• Contingent liabilities: Payments triggered only if specific events occur (e.g. compensation if passenger volumes on a commuter rail system fall below projections).

The contracting authority must assess the cost of these commitments against available fiscal resources to ensure affordability.

5. Project management feasibility

This feasibility assessment examines whether the contracting authority has the capacity and financial resources to prepare, tender and manage the contract throughout its term. It includes evaluating current and future capacity, drawing on expertise from other government agencies and appointing external experts and transaction advisors to strengthen project leadership.

The assessment should demonstrate that the project is properly resourced and governed. Transaction advisors should be appointed, a risk register compiled and mitigation strategies defined. A plan must also be established for evaluating and monitoring the project during its operational phase. Once this phase is complete, Treasury Approval 1 must be granted before proceeding to the procurement stage.

• This article draws in part on the International Bank for Reconstruction and Development’s Public–Private Partnership Reference Guide, Version 3 (2017).