Strategic planning requirements for identifying infrastructure

opportunities

BY: PAUL WANUME

+256 782 349 670paulwanume@gmail.com

Key considerations in project identification

Feasibility stage should not be seen as an administrative step to obtain the necessary entity approvals

Understanding and incorporating the objectives and constraints of all stakeholders will ensure quality of PPP project

The use of consultants with strong expertise in PPP is essential, but the involvement of public sector officials (coordination, decision making, communication) should not be underestimated

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Key steps in project identification

Needs analysisOptions analysisDue diligenceFinancial analysisAffordability

assessmentValue assessment

Economic analysisProject viabilityVerification and

sign-offProject

management plan

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Purpose of Needs Analysis

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Define the service that the entity needs to deliver and

specify the minimum standards for the output

An important objective is to ensure that the project is in line with the entity’s strategic objectives

During this step, the available budget will be identified and analyzed (incl. potential savings resulting from the project)

On the basis of the needs assessment, strategic objectives and budget, the following will be determined– Output Specifications– Performance Indicators

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Content of Needs Analysis

Output Specifications

• Output specifications forms the basis of project preparation

• Output specification define what the required services are, but they do not specify how they should be delivered

• E.g Defining a road in terms of routing, capacity and operational quality requirements

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Performance Indicators

• Performance indicators are defined to ensure that the service will be delivered to the desired level of performance

• Performance indicators should be realistically set-up, as they will directly determine the cost of the service to the entity and/or users

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Rationale for Options Analysis

Examine the range of reasonable options for meeting the entity’s output specifications,

reject unviable options, and choose the best solution for further examination

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Consider all technical, legal and financial options that meet the output specifications

Options considered should include low-investment solutions that can meet the needs (e.g managing demand for services instead of building new capacity)

Option analysis does not tell whether PPP is the correct option or not – it identifies the most viable option for further analysis

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Conducting the Options Analysis

Listing and Evaluation of Options

• List all reasonable options to be considered

• Assess the advantages and disadvantages of each option based, for example, on: – technical aspects– funding and financial impacts– market capability and demand– environmental impacts and costs

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Selection of Best Option

• Reject all options that are illegal, too expensive or too risky

• Analyze and score each option in a matrix form against each of the above mentioned criteria

• Select the preferred option with justifications

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Illustration of Option Analysis

Example of Options:– Build a new road vs. increase capacity

of public transport– Develop current port or build a new

one– Use of source of energy (coal,

renewable, etc…)

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Objective of Project Due Diligence

Identify and analyze ALL – Legal, – Land and Site, – Technical, – Social Environmental Issues

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A thorough due diligence is expensive, but saves time and money down the road

Early identification of issues and quality of exercise is essential for future success

Importance of legal, social and environmental issues should not be underestimated

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Scope of Project Due Diligence

Environmental and Land

• Ensure compliance with all related government laws and regulations (at minimum)

• Due diligence should go further and identify and mitigate any related issues that could raise concerns for the potential private partner

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Revenue sources and Demand Analysis

• Review should be professionally done and conservative

• This analysis is the backbone of assessment of private sector interest and financial contribution from the entity

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• Legal

• Ensure that all foreseeable legal requirements are met for the project development (incl. sector laws)

• Poor legal review will raise concerns from potential bidders and could lead to delays in bidding and negotiations

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Scope ……

Financing: Review the availability and cost of financing, financial instruments, hedging and risk mitigation products, insurances and applicable tax regime for the project

Market analysis: Review should include number, size and capacity of sponsors, contractors and financiers, as well as known competing projects being prepared in other countries, districts etc

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• Other items: Due diligence is also project-specific and examples include:• Technical site analysis• Technical design analysis• Availability and quality of supporting

infrastructure• Availability of raw material and fuel supply

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Financial Analysis

ObjectivesDemonstrate that the project will be

financially attractive to the private sectorAssess the likely financial contribution

from the entity to the project

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The central component of the financial analysis is the development of a financial model

The financial model represents the costs of delivering the preferred solution through a PPP arrangement and may be called the PPP model

The results of the financial analysis are highly dependent on the quality of assumptions and advice from experts is essential

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Financial analysis……….

Step 1: Technical definition of project Determine the technical parameters of the

project construction and operation with their cost implications

Step 2: Identifying direct costs Direct capital costs are specifically

associated with the construction of a new facility or the acquisition of a new asset.

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• Direct maintenance costs will include the full lice-cycle costs of maintaining the assets in the condition required to deliver the output specification (e.g. raw materials, equipment and labor)

• Direct operating costs are associated with the daily operation of the service (incl. staff, raw materials, etc…)

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Step 3: Identifying indirect costs Indirect costs will include that portion of any

additional overhead costs related to the project (e.g. personnel, accounting, billing, legal, rent, communications)

Step 4: Identifying project revenue Revenue and demand study from due diligence

is used as base case for revenue projection

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Any assumption on revenue collected should reflect project’s ability to invoice and collect revenue – beware of revenue over-estimation

Step 5: Financing and other assumptions Assumptions regarding financing, project structure

and tax should be tested with financial experts Proposed source of funding (e.g. debt, equity and

government contribution) should be identified

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• Entity should assume that cost of capital would rely on project’s own credit, and not on government bond yield

• All relevant financial ratios should be set out in detail (e.g. annual debt service cover ratio, return on investment for equity holders, etc…)

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Step 6: Calculation of explicit government financial support to the project

Explicit government budget support will be required if base model with simple costs, revenues and financing assumptions will not meet required ratios

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If budget support is needed, entity can undertake measures to:

1) reduce costs in PPP model

2) increase revenue in PPP model

3) reduce amount of private financing

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Step 7: The Base Case model The base case model is created based on the

anticipated revenues, costs, assumptions, payment/subsidy mechanism and structure for this project

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Step 8: Adjusting base model for risk The base model is then adjusted to take into

consideration all risks likely to impact the project, with a estimation of their potential impact

Entity should pay attention to optimal risk transfer – in general, risks should be allocated to party best able to manage them

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Step 9: Adjusting PPP Model to reflect total cost to entity

The adjusted PPP Model includes “all-in” cost to entity for undertaking project through PPP

entity will still be responsible for some costs in PPP, such as costs of managing PPP agreement – these costs should be identified in Model

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Step 10: Sensitivity Analysis

Sensitivity analysis determines resilience of PPP Model to changes in assumptions

Sensitivity of following variables should be tested on key variables, including demand, financial terms, capex and opex

The entity should learn how much its contribution to the project will change if key assumptions are different in reality

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Affordability Assessment

Projects should provide services that are affordable either to– USERS of the services (tariffs)– GOVERNMENT paying for the

services (availability payment, subsidies)

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• Affordability for users is assessed by willingness to pay for the specific services provided

• Affordability for Government is based of expected payments during life of project and budget assumptions during same period

• Determination of project costs and available budget should be as accurate as possible

• Collaboration with Budget preparation is essential

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What if a Project is NOT Affordable?

A project not affordable for users means tariffs are too high and can result in– Negative social impact if users don’t have

alternatives– Reduced benefits or even project failure if

alternative exists (ex. use of parallel road) A project not affordable to Government means

available budget is not sufficient to pay commitments to private partner

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If project is not affordable, Government has several options– Reducing the scope/quality of services– Abandon the project– Obtain more financing from Budget

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Value Assessment (VfM)

Value for Money (VfM) describes a net benefit, both in quantitative (financial) and qualitative terms, from the outcomes of a PPP project compared to the same project delivered by the public sector over the entire lifespan of the project.

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• VfM is not the choice of the goods and services based on the lowest cost bid

• Several factors directly influence the VfM– Risk allocation between entity and Private

Sector– Focus on whole life rather than upfront costs– Use of output specification approach– Sufficient flexibility in relation to design and

service delivery

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Economic Analysis

Estimate all economic costs and benefits of the project to ensure that it is the least-cost option and that all externalities to stakeholders have been considered

Economic analysis is required to calculate the incremental costs and benefits of the project to society as a whole – “with” or “without” project

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• This way the entity understands the various economic costs and benefits to the project entity, private sector entity, government and local community

• Changes may be necessary to the project design if negative externalities are large

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Stages of Economic Analysis

1. Determine economic costs of project

2. Determine major assumptions for economic analysis

3. Calculate EIRR and ENPV

4. Estimate economic benefits

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Project Viability

The project is viable if it is

1. Technically deliverable

2. Socially and Environmentally sustainable

3. Financially viable to investors

4. Affordable to users

5. Affordable to the entity

6. Provides Value for Money to the entity

7. Economically viable

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Verification and Sign-Off

Entity and transaction advisers expected to sign off the feasibility study after all the analysis has been completed

Description of Assumptions– Description of how assumptions used in

constructing financial model are realistic and appropriate

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Explanation of Methodologies– Obtain record of methodologies used for valuing

various costs, including costs of key risks Sign-Off on Accuracy of Study

– Ensure that all inputs into feasibility study are signed off as accurate and verifiable by Line Committee, PPP Support Unit and each of transaction advisor specialists

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Project Management and Procurement Plan

The objective of the Project Management Plan is to summarize the key issues, institutional/approval arrangement and the schedule of activities until the completion of procurement

The plan should be part of the feasibility study and agreed by all the committees and agencies involved in the project

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• The plan should contain at least– Project timetable, with key milestones and

approvals required– List of potential issues and how they will be tackle– Governance process to be used by the entity (incl.

decision making)– List of all required approvals from all committees

and agencies– Bid evaluation process and teams, and quality

assurance process for bid documentation

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Project identification: Key messages

Project identification is an essential component of project preparation and allocation of time, as well as human and financial resources, contributes to preventing issues later

The need to obtain entity approval should not undermine the project attractiveness to the private sector

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THANK YOU