Infrastructure Contracts

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INFRASTRUCTURE CONCESSION CONTRACTS: AN INTRODUCTION
#2/July 08

What is infrastructure concession contract? What are the advantages and disadvantages of concession contracts? This paper addresses these two questions. Also, it outlines the basics of infrastructure concession contracts.

I. Introduction Ownership of public assets is a sensitive issue for all governments. However, budgetary shortfalls as well as the repeated failure of governments all over the world to maintain these assets have forced them to change their attitude towards private ownership of such assets. As a result, policymakers have devised various ways in which the private sector can be brought in to maintain and operate public assets. Thus, concession contracts, through which ownership rights continue to reside with public authorities save operation rights and associated returns being transferred to private players, have been gaining popularity around the world. Under concession contract, private partner gets exclusive rights from the government to operate, maintain and sometimes even carry out investment in a public utility for a given period of time. In return, the private party pays either a fixed sum, a percentage of revenue from the utility or a combination of the two to the government for exclusive rights over a facility. Revenue to the private party comes from the user fee charged to users of the facility. There are different types of concession contracts, including: ex-leasing, franchise, buildoperate-transfer (BOT) etc. Private finance initiatives (PFIs) may also be considered similar to concessions. The major advantage of a concession is that it allows certain public assets, for which private ownership is economically inefficient and politically not possible, to be maintained and operated efficiently by private players. Bidding for concession contracts introduces competition into the industry, albeit in an artificial sense. Such competition often induces private players to minimise cost, as one of the criteria used for awarding a concession is price cap regulation, in which they need to state the minimum price they would charge for services provided. Finally, in concession, competition between firms occurs before investment commitment that generally creates enough space for optimal pricing.

On the negative side, concessions require complex design and monitoring systems: thus, they are difficult to implement. Moreover, it is not possible for a concession contract to cover all uncertainties involved; this implies that fixing one price over the period of contract often turns out to be unviable and creates space for renegotiation and its abuse. Furthermore, there are no incentives for the private party to maintain the facility well or undertake necessary investment towards the end of the contract period. 2. How Do Concessions Work? "Concession contracts are typically defined by the following four features: 1. The contract governs the relationship between the concession-granting authority and the private concessionaire. The concession-granting authority is the government, an inter-ministerial commission, or less common – and the least appropriate – the regulatory agency. 2. The concession is awarded for a limited but potentially renewable period, during which concessionaire enjoys the exclusive right to use the assets, exploit existing facilities, and develop new ones. The contract determines conditions under which concessionaire uses these facilities and the prices at which it provides the service. The facility continues to be publicly owned. 3. The concessionaire is responsible for all investments and for developing all new facilities – many of which are specified in the contract – under the supervision of state or regulator. The concessionaire retains control and use rights over the new assets until they are handed over at the expiration of the contract. The contract might contain a clause specifying compensation for investments not...
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