Christian Schempp Francesco Angelini - European Commissionec.europa.eu/regional_policy/sources/conferences/cba/schempp_angelini.pdf6. Economic Analysis: Climate Change mitigation &

Practical aspects and good practices for CBA of major projects

Christian Schempp&

Francesco AngeliniJASPERS

#CBAForum

Cost-Benefit Analysis of Investment ProjectsPractical aspects and good practices

Christian Schempp &

Francesco Angelini

Project economists, JASPERS

Scope of the presentation

• Share our view on special challenges and good practices in carrying out CBA

• Based on JASPERS experience in appraising CBA of major projects in the PP 2007–2013

• Not meant to be a detailed, exhaustive treatment of all topics of the CBA Guide (dedicated training required for that)

CBA: 7 steps of the appraisal

1. Presentation of the socio-economic, institutional and political context

2. Definition of objectives

3. Project identification

4. Technical feasibility & Environmental sustainability

5. Financial analysis

6. Economic analysis

7. Risk assessment

1. Presentation of the context

Main purpose

• Description of the existing situation and the overall reference framework as a basis to verify the relevance of the project

• Instrumental to subsequent steps: (i) assessment of needs and definition of project objectives, (ii) analysis of demand

Challenges and Good practice

• The context is presented with relevant information/statistics to the project (socio-economic, legal-institutional, technical, environmental, etc.)

• The existing infrastructure and service provision is presented with relevant statistics focusing on the shortcomings to be removed

• The sectorial and regional development plans relevant to the project are presented in sufficient detail (may even be an ex-ante conditionality)






7. Risk assessment


2. Definition of objectives• Needs assessment• Project relevance


Challenges and Good practice• Project objectives are identified in explicit relation to the needs, the needs are

derived from the description of the context

• Needs should be of specific and not generic nature and be properly explained

• Project objectives are quantified with a system of indicators, including baseline and targets (not to be confused with project outputs)

• Link to indicators defined in the OP and priority axis (in particular to result indicators). Expected contribution to OP target (in % of total target)

• If project is compliance driven, if country-wide target exists, the contribution of the project to achieving this wider target (in % of total target) is explained

• Project impact/effects monetised in CBA are identified in clear relation to the project objectives





7. Risk assessment




• Project scope/activities

• Body responsible for project implementation

• Who has standing?



• Where a project has several stages or phases, these are properly presented together with their respective costs (and benefits)

• Individual investment measures are bundled into one single project when these are: i) integral to the achievement of the intended objectives and complementary from a functional point of view; ii) implemented in the same impact area; iii) share the same project promoter; and iv) have similar implementation periods.

• The project impact area and the final beneficiaries are clearly identified (important for the quantification of economic benefits)

• The institutional set-up for project implementation and operations is clearly presented (important to correctly allocate financial cash-flows)




7. Risk assessment




4. Technical feasibility & Environmental sustainability• Demand analysis• Option analysis• Environmental considerations, including EIA and climate change• Technical design, cost estimates and implementation schedule

4. Feasibility Analysis: Interphase FS and CBA

Interphases between Feasibility Studies and CBA

FS CBA

Demand Analysis

Cost of environmental

protection, climate change mitigation and

adaptation

CAPEX OPEX estimates

Option Analysis

4. Feasibility Analysis: Demand Analysis


• Market analysis: analysis of supply / existing & planned competing alternatives is as important as analysis of demand

• Ensure optimal scale and utilisation of project

• Risk of oversizing the project (particularly when investment cost is financed by grants…)

• Thorough assessment of demand risk and related prevention / mitigating measures, for example:

• correct “optimism bias”• availability of complementary products/infrastructure • pricing strategy• promotional activities• embed option to expand capacity at a later stage

4. Feasibility Analysis: Options analysis

Special challenge: two-step approach

1. Comparison of strategic/generic options, normally based on Multi-Criteria Analysis, for the selection of best systemic solution / feasible options / location

2. Comparison of the short-listed options at the technological level, based on quantitative methods (least cost, ENPV)

Good practice

• Selection of options: ensure proper screening of options at the initial stage to make sure that no feasible option is left out

• Multi-Criteria Analysis: ensure selection of relevant criteria and an appropriate scoring and weighting system that does not automatically favour a certain solution

• Quantitative analysis: Least cost analysis where benefits/externalities are similar for all options compared, otherwise a “simplified CBA”

• Also rely on risk assessment results where options have similar ENPVs

4. Feasibility Analysis: CAPEX/OPEX estimation

Challenges and Good practice • CAPEX estimation:

• Comparison with recently procured projects in the same sector/country

• Thorough analysis of current market supply/demand, both for equipment/civil works

• Integration of CAPEX for environmental protection, CC mitigation/adaptation (also in OPEX!)

• OPEX estimation:• Thorough research to establish unit cost forecasts for most important consumables (eg. energy), but

also for sale/disposal of outputs, incl. transport cost

• Benchmarking exercises, in particular for staff and asset maintenance requirements (historic cost data for existing infrastructure is not always reliable!!)

• Reinvestment cost estimation:• Clear separation of periodic asset replacement cost from running maintenance/repair cost (=>OPEX!)

• Consideration of closure/decomissioning/dismantling costs for assets at the end of useful lifetime, where relevant



7. Risk assessment





5. Financial analysis• Cash-flows for project costs and revenues, incl. residual value

• Tariff and affordability analysis (where relevant)

• Sources of financing

• Financial profitability & Sustainability

5. General CBA Methodology: Incremental method


• Definition of the counterfactual scenario in case of pre-existing infrastructure:

• As a general rule, assume business-as-usual (BAU) scenario that ensures

• basic functionality of the assets … i.e. scenario without permanent service interruption

• service provision under similar quality levels … albeit slowly deteriorating over time

• limited asset replacements … i.e. only operational equipment and key parts of main assets with very short economic life, on top of “asset conform O&M”

• minimum cost recovery to ensure financial sustainability of operations … i.e. recovery of all O&M and replacement cost through user fees/tariffs (in sectors where relevant)

• In cases where service cannot be continued without a certain level of capital investment, assume do-minimum scenario, ensuring that it is

• realistic and no feasible alternative to the project

• does not cause unrealistically high costs or benefits

5. General CBA Methodology: Residual Value (RV)

New! For operations that generate net revenues: requirement to calculate the RV based on the net present value of cash flows in the remaining life years of the operation, both in the financial and economic analysis


• What is the useful life of a project?

General rule: weighted average of the life of the different asset components

Complex projects with more than one facility: useful life of the dominant facility

Projects dominated by technological assets: useful life of the main technological asset

• How to project cash-flows after the end of the reference period?

Simplification: keep all cash-flows constant at level attained at end of reference period

• How to appraise the economic analysis of a project where the RV has a decisive impact on the end result, e.g. makes ENPV switch from (-) to (+)?

Where a project is justified based on benefits mainly generated in the very long-term. particular focus is needed on risk assessment, ideally including a probabilistic analysis

5. Financial Analysis: Financial Discount Rate (FDR)

• New! FDR 4% real terms (07-13: 5%)

• Possibility to use a different FDR, e.g. based on a MS’s specific macroeconomic conditions, nature of the investor / sector concerned

For national CBA Guidelines

• When the Weighted Average Cost of Capital (WACC) is used as a proxy for FDR, it may be difficult to justify values > 4% (real) for projects / sectors mainly funded by EU + central national budget

EU 10y Gov. bond yields (%)(Source: ECB)

5. Financial Analysis: Modulation of eligible expenditure

Need for EU co-financing and modulation of eligible expenditure: the case of Revenue-generating projects

2007

-2013

Discounted Net Revenue

calculation

(“Funding-gap method”)

State aid

rules

Possible complexity In some cases, possible overcompensation

5. Financial Analysis: Modulation of eligible expenditure

2014 -

2020 1. Discounted Net Revenue

CPR Art. 61(3)(b)2. Flat revenue rate

CPR Art. 61(3)(a)3. Reduced co-financing rate

CPR Art. 61(5)

State aid

rules

Simplification / more flexibility

Applicable method fixed in advance for a given sector / subsector (according to national rules)

For non-SMEs, if no “individual verification of financing needs” under State aid rules, still need to apply CPR Art. 61 - as per Art 61(8)(c)

Clear State aid issues as early as possible!

(may impact Art. 61)

5. Financial Analysis: Profitability and determination of grant


• With “flat revenue rates”, potential over-compensation in some cases

Return on promoter’s capital: if more than one national financing source FRR(K) ≠ return on promoter’s capital -> also check FRR(Kp) and/or FRR(Kg) to ensure grant is proportionate

• If FRR(C) is significantly higher than FDR, a grant is in principle not needed, unless investment is “not bankable” (e.g. highly innovative projects)

Weigh FRR(C) against results of risk assessment / residual risk level

If possible, consider alternative form of finance (e.g. financial instruments)


7. Risk assessment







• Fiscal corrections

• From market to shadow prices

• Evaluation of non-market impacts

• Economic profitability

6. Economic Analysis: Economic costs

Evaluating project’s inputs


• Apply shadow prices / conversion factors (CF) to reflect opportunity costs

• Simplification: EU internal market + proper public procurement = many inputs can be assumed to be traded in “competitive market” -> CF=1

• However, three items usually deserve more attention

Labour (particularly “unskilled”, CF << 1 in case of high unemployment) Land (CF > 1 if land is made available below market price) Energy (taxes, regulated / subsidised prices, externalities, internal market

still fragmented)

6. Economic Analysis: Economic benefits

Evaluating project’s outputs

New! Specification of main categories of economic benefits per sector


• In most sectors (transport, environment, energy), ample and useful experience exists from projects approved in the past 2007 – 2013 period

• 7 JASPERS case studies in CBA Guide provide practical examples of benefit quantification

• In some sectors (e.g. RDI) practical experience with benefits monetisation remains scarce – still work in progress

• Further guidance to be developed in the framework of the CBA Forums / national guidelines on CBA – JASPERS can provide assistance

6. Economic Analysis: Climate Change mitigation & adaptation


• Benefits of CC mitigation: economic value of project incremental GHG emissions1. Quantify the amount (tons) of incremental GHG emissions avoided (or emitted)

2. Calculate total CO2eq with Global Warming Potential (1CH4 = 25CO2eq, 1N20 = 298CO2eq)

3. Monetization of externality using a unit cost of CO2 as estimated by the EIB

• Benefits of CC adaptation: economic cost of damage averted through the enhanced CC resilience of the infrastructure• Requires reliable data on probabilities of extreme events due to CC and valuation of averted

damage -> may be difficult to monetise!

• Where monetization is not possible, benefits should at least be described in qualitative terms

All values expressedin 2006 prices

Value 2010

(Euro/t-CO2eq)

Annual adders

2011 to 2030

High 40 2

Central 25 1Low 10 0.5








7. Risk assessment• Sensitivity analysis• Qualitative risk analysis• Probabilistic risk analysis

7. Risk Analysis: Qualitative Risk Analysis

Assumptions in risk matrix need to be consistent with results of sensitivity analysis (e.g. link “severity” – “switching values”)

Make the risk matrix a real tool for the risk management process: clear definition of person/function in charge of prevention & mitigation measures

Probability Risk levelSeverity

Prevention Mitigation

ResidualRisk level

SeverityProbability

Ris

k M

atr

ix

7. Risk Analysis: Probabilistic Risk Analysis


• Where residual risks are still significant -> probabilistic risk analysis is mandatory

JASPERS model for simplified probabilistic risk analysis on the key CBA results with Monte Carlo simulation (available at www.jaspersnetwork.org)

Assumptions - Triangular Probability Distributions

Base-case ENPV mEUR 60.0

Variables Investment O&M Benefits

Base-case (Present Value) mEUR 110.0 10.0 180.0

Minimum % 90% 90% 70%

Most Likely (Mode) % 100% 100% 100%

Maximum % 150% 110% 120%

Number of iterations # 10,000

Results of Monte Carlo Simulation - ENPV

Mean (Expected ENPV) mEUR 39.96 Minimum mEUR 37.73-

Median mEUR 41.09 Maximum mEUR 101.89

Standard Deviation mEUR 23.40 Prob. {ENPV>0} % 94.9%

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

-37.7

-29.2

-22.4

-15.6

-8.8

-2.0

4.8

11.6

18.5

25.3

32.1

38.9

45.7

52.5

59.3

66.1

72.9

79.8

86.6

93.4

101.9

ENPV cumulative probability distribution

0.00

0.01

0.02

0.03

0.04

0.05

0.06

-37.7

-29.2

-22.4

-15.6

-8.8

-2.0

4.8

11.6

18.5

25.3

32.1

38.9

45.7

52.5

59.3

66.1

72.9

79.8

86.6

93.4

101.9

ENPV probability distribution

http://www.jaspersnetwork.org/

Thank you for your attention!

[email protected]

mailto:[email protected]

Documents

Christian Schempp Francesco Angelini - European Commissionec.europa.eu/regional_policy/sources/conferences/cba/schempp_angelini.pdf6. Economic Analysis: Climate Change mitigation &