Over the last few years, there has been a strong trend toward the introduction of private management in the port domain in both industrialized and in developing countries. This privatization principally concerns the handling and storage of freight transiting via the port, and the funding and operation of the infrastructure, superstructures, and equipment required for these activities. This trend has involved the construction of complex, multidimensional partnerships between public port authorities and terminal operators. Module 5 presents an analytical framework for assessing the risks confronting port operators and with the goal of identifying principles for the equitable sharing of each risk between the public and private sector parties involved.
This analysis demonstrates that the scope of port terminal operator covers a range of different situations, depending on the type of traffic handled and the degree of competition surrounding the activity. This diversity substantially affects the degree of required regulation of the operator’s activity on the part of the port authority or other regulating body (see Module 6). This regulation, in turn, has major implications for the operator, both in terms of the level of risk carried and risk management capacity. Therefore, the principles adopted for sharing the risk between the port authority and the terminal operator must take this essential consideration into account.
Reducing the situation to its simplest terms, the terminal operator carries two fundamental risks: a cost risk, or a risk of exceeding initial cost estimates for the construction or operation of the project, and a revenue risk, or commercial risk, depending on traffic and revenue yields.
There is nothing extraordinary about this situation. Any enterprise operating in any field of activity has to carry these risks. However, the terminal operator conducts its activity largely in the public domain, and can have the support of public investment, supply a public service, and enjoy a de facto monopoly. Over and above the overarching legislative and statutory framework, some measure of regulation of its day-today activity is often deemed necessary. This regulation can cover a number of technical aspects (definition of the project, performance standards, standards relating to maintenance of the facilities, and so forth), economic aspects (public service obligations or field of activity restrictions), and financial aspects (control of prices, fees, or subsidies). Module 6 reviews in detail the aspects pertaining to economic and financial regulations.
What is the impact of regulation on the cost and revenue risks, and in what way does it condition the principles for sharing these risks?
The constraints imposed by technical regulation have an impact on the initial estimation of project cost (investment and operation). However, provided the rules of the game are established at the outset, and provided these rules are clear, stable, and complied with, they do not affect the excess cost risk, which then only depends (apart from cases of force majeure) on the ability of the operator to implement the project. Under such circumstances, it is reasonable to expect the operator to identify and assume the full cost of attendant risks.
Where risks and associated excess cost stem from changes in the regulatory system or legal framework established prior to signature of the contract, the principles of risk sharing must then depend on the very nature of the activity. Two situations are possible in this case:
The principles of risk sharing should be clearly defined on signature of the agreement, and can cover guarantees of stability or provide appropriate compensation (for example, lifting of pricing constraints, indemnities, or other considerations).
In contrast to the cost risk, regulation has a direct impact on the extent of the revenue risk for the operator and on its ability to manage this risk. The revenue risk is in fact the principal risk involved in a port project due to the uncertainty inherent in traffic and throughput level predictions.
As a general rule, it is desirable to assign the traffic risk to the operator. This is possible and justified in a case where the activity is not a public service. Sharing of profits between the port authority and operator can be envisaged under certain circumstances. This is also possible in the majority of cases where the activity is subject to genuine competition.
On the other hand, sharing of this risk is frequently necessary in the case of a public service monopoly. The substantial degree of regulation required in this case imposes such constraints on the operator that it has little means of managing the commercial risk. The port authority can then, as appropriate, provide the concessionaire with a guarantee of noncompetition, possibly temporary, or even implement a negative concession formula where the operator bids for the lowest level of subsidy required when the traffic is acknowledged to be too low to sustain commercial viability.
While the operator is then no longer fully at risk for meeting the project’s projected revenue level, it must continue to bear responsibility for the costs. The regulatory system therefore must not deviate from the principle of assigning the project risk to the operator. This is the case where the contract provides for a guaranteed minimum level of return, or adjustment of rates and charges according to costs.
Another risk for the operator is present in all cases. This is the political risk of noncompliance with the terms of the contract by the public authority, or the imposition of discriminatory measures affecting the project. This risk can be reduced by various methods, or hedged. The assessment of this risk nevertheless represents a major factor in the decision of the operator to proceed or not with the project. Political risk may manifest itself either as a revenue risk or a cost risk.
In the end, the principles of risk sharing between the public port authority and the operator depend, to a large extent, on the degree of public service accorded (or not) to the activity concerned by the national authority and the resultant regulation. The initial situation frequently is that of a stagnant public sector, with little means of clearly identifying among the various tasks in which it is engaged those which relate genuinely to the public service, and which, when delegated or franchised to an operator, demand strict regulation. While a form of partnership always exists between the port authority and the operator, the activities of the port terminal operator do not always embody the characteristics of a public service, and do not therefore require the same level of regulation in all cases. Note, however, that any form of regulation imposes costs, namely the cost of the additional risk imposed on the operator (reflected by a requirement for a higher rate of return), the cost of resultant considerations, or simply the cost of supervision. To minimize such costs, the objective should be to regulate only in those cases where it is clearly essential.
The port terminal operator has numerous partners in the provision of comprehensive port and transportation service, the most important of which is the port authority itself. The port authority therefore, is not often only a regulator, but also the primary partner of the terminal operator. From this point of view, the type of “horizontal” partnership between terminal operator and port authority does not differ from that which can exist between two companies. Of necessity, this partnership involves reciprocal obligations, with the port authority guaranteeing not only the services that it provides directly, but also those which it may be led to delegate to other entities operating within the port complex.
The involvement of private companies in port management leads to the introduction of a complex, multidimensional partnership with the port authority. This requires the establishment of a clearly defined, stable, contractual framework that enables the operator to quantify and manage the risks with which it will be confronted, and which is based on comprehensive legal procedures and techniques. However, no contract can provide for all eventualities. It is therefore necessary to include clauses that define the conditions and procedures for periodic reviews and negotiations for the purpose of making necessary adjustments. Apart from this renegotiation process, the option of issuing new calls for tender at periodic intervals during the lifetime of the project is a possibility, despite practical problems of implementation. In some cases, a clear division between infrastructure and equipment management and activities management may be desirable. See Module 4 for a full discussion of legal issues.
Once the risks have been distributed between the public and private partners, the private operator—the concessionaire—will seek to “quantify” and “rate” the residual risk it must bear. The risk valuation will be determined through country and project ratings. Tariff setting will be contingent upon a minimum financial break-even point, below which prospective concessionaires will be unwilling to participate. From the point of view of the concessionaire then, the riskier the project, the higher the requirement of expected returns.
A risk-return assessment is an integral part of a comprehensive profitability analysis of the project. Such analysis would help determine under what conditions and terms the project will succeed in meeting the needs of the market, given the ever changing nature of these needs. This is what is implied when analysts speak of “project bankability.” The operator is now faced with two compelling sets of parameters resulting from the profitability analysis and the cost-effectiveness analysis of the project, and their impact on the socioeconomic returns for the community at large. Because of these market-driven financial constraints and the fragile nature of the public-private partnership, there is as much a case for sharing financial obligations as there is for risk distribution between the port authority and the concessionaire. To reach agreement on an equitable distribution of risks, the difficult balance between socioeconomic returns of a project and financial profitability must first be achieved. This amounts to finding the optimal equilibrium within the framework of a regulatory system acceptable to both partners.
Part A of this module focuses on the issue of “financial engineering” and the effort to secure the best terms for financing and coverage of the project based on the risk analysis and the financial constraints. The key components are the structuring of the project equity and debt, and the management of “exogenous” and political financial risks. Financial engineering is a complex process given the constant introduction of new and more sophisticated financial tools; it is also a delicate process because financial partners commit to projects on a long-term basis. Since project funding is such a critical element of any significant port reform initiative, a solid understanding of financial engineering is essential. Part A takes a pragmatic view of the subject and seeks to establish a basic understanding of what is at stake. It does not attempt to undertake a comprehensive treatise on the more sophisticated mechanisms for coverage and financing.