noTE no. 54 ­ April 2010 GRIDLINES Sharing knowledge, experiences, and innovations in public-private partnerships in infrastructure Private sector participation in urban rail 56734 Getting the structure right Iain Menzies and Cledan Mandri-Perrott T here is growing interest in using rail tran- for different aspects of system development and sit--trams, metros, light rail--to solve operation. And accounting for urban growth will urban transportation problems, particu- require contractual flexibility to allow for network larly road congestion and air pollution. In devel- extensions. How these extensions are incorporated oping urban rail projects, a range of major cities in the private operator's contractual obligations around the world have turned to public-private needs careful consideration. partnership models, to leverage both public and private resources and expertise. Dissect- Another issue is the high capital costs of urban ing the successes and failures of public-private rail systems, suggesting that some form of public urban rail schemes, this note examines how support is likely. Yet the challenge for planners is policy makers can best deal with the main risks to avoid offering too much public support1 and to involved in designing, procuring, and imple- ensure good value for money.2 menting such schemes. It also draws lessons on best practice in developing and managing contractual arrangements that can help ensure Designing the structure to their success and sustainability. adequately manage risks New urban rail systems are complex, capital In allocating demand (or passenger ridership) intensive, and typically customized to a partic- risk in urban rail PPPs, a critical consideration is ular city or transportation corridor. Managing whether the public or private sector will exercise such complexity and the associated risks can be a control over such issues as fare setting, inter- daunting challenge for even the most experienced modal and ticketing integration, and licensing and sophisticated public authorities. of competing services. The public authority typi- cally has control over these factors. Alternatively, When an urban rail system is developed by a the authority may decide to allocate demand risk public-private partnership (PPP), a key factor entirely to the private operator, with the fares paid in determining the success of the scheme is how by passengers being the private operator's main or risk is allocated between the parties. Achieving sole source of income. But it is important that fares the right allocation of demand risk between the not only reflect customers' ability and willingness public and private sectors is critical. So is ensuring to pay but also are aligned with policy goals (such adequateApproved Logo Usage and integration PPIAF physical infrastructure as promoting a switch to public transportation, with other modes of public transportation, both managing traffic congestion, or improving urban of which have a direct effect on demand. air quality). Logo - Black In determining the contractual design, public authorities need to consider whether to use an integrated approach, with a single concession or PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY Iain Menzies and Cledan Mandri-Perrott are senior infra- build-operate-transfer (BOT) contract, or a layered structure specialists in the World Bank's Finance, Economics, approach, with separate contractual arrangements and Urban Development Department. Logo - 1-color usage (PMS 2955) Helping to eliminate poverty and achieve sustainable development PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FAC ILITY through public-private partnerships in infrastructure 2 Allocating all demand risk to private operators has tively cross-subsidize other parts of its network. In a poor track record. This is clear from experience the United Kingdom, phase 2 of the Manchester with urban rail PPPs worldwide but notably so Metrolink project showed how politically sensi- in the cases of the Skytrain project in Bangkok, tive fares can be as public outcry over higher fares Thailand, and the STAR and PUTRA projects contributed to the premature termination of the in Kuala Lumpur, Malaysia, where demand was concession. significantly lower than forecast (Halcrow Group 2004). The projects either were restructured (as Planning in advance the links with other modes of in Bangkok) or failed and were subsequently transportation--such as buses, metros, taxis, and nationalized (as in Kuala Lumpur). The authority private vehicles as well as other transit systems--is may prefer to share demand risk with the private also critical in designing a new urban rail system. operator through a minimum revenue guarantee Customers for the new system need convenient (as in South Africa, for Gautrain) or decide to links to start and complete journeys. So planners bear this risk itself and pay the operator an avail- need to consider how passengers will get from ability fee to cover the costs of investment and their homes to the new rail stations and from the delivery of passenger service (as in the United stations to their ultimate destinations (such as Kingdom, for the Nottingham Express Transit workplaces, shopping centers, and schools and tram system). Commercial best practice for such colleges)--and similarly for their return trips. fee payment would typically incorporate perfor- "Park and ride" and "kiss and ride" facilities, for mance incentives and penalties against defined example, will attract private vehicle commuters. (and contracted) service delivery targets. Public-private urban rail schemes have managed this intermodal integration risk in a range of ways, In some instances public authorities have decided including the following examples: to be responsible for fare setting. Great care needs to be taken in exercising this authority, especially ˇBangkok's Skytrain introduced new dedicated where the private operator's sole or principal feeder bus services in its bid to increase ridership source of revenue is the farebox. Kuala Lumpur's from the unexpectedly low levels at the start of STAR and PUTRA PPP projects suffered when operations (box 1). temporary discounts designed to increase rider- ship became politically impossible to reverse. In ˇForSouthAfrica'sGautrain,theprojectdesign other projects operators have had the freedom for the initial rail concession includes cobranded Allocating to set the fare structure so as to shape demand feeder buses. all demand or take advantage of higher-value or discretion- ary routes, such as airport connections. In South ˇThe Nottingham Express Transit tram system risk to private Africa, for example, the Gautrain concessionaire has introduced park-and-ride sites with more operators has substantial freedom to set fares on its link to the O. R. Tambo International Airport and can than 3,000 parking spaces as well as tram stops linked to national and commuter railway has a poor use the higher fare revenues from this link to effec- stations. track record Box 1 Integrating urban rail with other transport solutions In Bangkok during the development of Skytrain, several public institutions--including the Ministry of Transport, the Bangkok Metropolitan Authority, and the State Railway of Thailand--were implementing transportation solutions. Coordination among these entities was deficient, and little consideration was given to integrating the systems. This oversight contributed to disappointing ridership levels when Skytrain opened: 150,000 riders a day rather than the 600,000­700,000 that had been forecast. Revenues were so low that the concession company eventually became unable to meet its financial obligations. Skytrain's services offered clear value to customers by enabling them to avoid Bangkok's extreme traffic at a reasonable cost. But without supporting modes of transportation, many of the city's residents lacked easy access to the system. Later improvements in the integration of services, including the addition of feeder buses and new aerial walkways, helped to increase ridership to some 460,000 passengers per weekday. Source: Halcrow Group 2004; Spicer 2008. Private sector participation in urban rail 3 Physical integration with other transport systems, line or network extensions and the replacement such as buses and metros, also requires an inte- of operators. If extensions are needed, the public grated approach to ticketing. Many cities are authority can procure a new construction-only adopting transit smart cards to pay for multimodal concession contract and competitively procure and multitrip journeys, recognizing that a typical additional rolling stock or operational services. commute or journey might involve, for example, However, this approach poses substantial chal- catching a bus from home to the train or metro, lenges for the public authority in integrating and then riding the urban rail system to an office in the coordinating these contracts. The Docklands Light The center of town. Among such schemes are London's Railway in London, one entity that has adopted Oyster Card and Singapore's Ez-link systems. a layered contractual approach, has managed complexity Increasing passenger convenience in this way helps these challenges successfully (box 2). Many other of urban rail to both increase ridership and meet other policy authorities, however, have chosen the integrated objectives, such as reducing the number of private approach because of lack of capacity to coordi- contracts vehicles in urban centers. nate the multiple contracts involved in the layered demands approach. In addition, in some jurisdictions (such as the Russian Federation) the layered approach that they be Designing and implementing for PPP projects is incompatible with local public well managed contractual arrangements procurement legislation. Contractual arrangements for urban rail PPPs are Where cities envisage extensions to the new rail likely to be complex, encompassing arrangements system, some public authorities have opted to with government agencies and regulators, lenders include such extensions within the contractual and investors, landowners, utilities, contractors, arrangements, on a right-of-first-refusal and nego- rolling stock and system providers, and opera- tiated basis. This strategy brings risks, however: tors. Public authorities need to decide whether to parties may fail to reach agreement on extensions adopt an integrated contractual approach, with a within the first few years of the contract, when the single concession or BOT contract, or a layered operator is in a strong negotiating position and contractual approach, with separate contractual may have an incentive to cash out through early arrangements for design and construction, for termination (claiming its future profits). This situ- rolling stock and systems, and for operation and ation has arisen recently in both Manchester and maintenance. Nottingham and, in the case of the Manchester Metrolink, has been costly for the public authority. Proponents of the layered contractual approach Potential ways to mitigate this risk include speci- see it as offering more flexibility for dealing with fying a pricing regime for such extensions in the Box 2 Aligning incentives with factors under the concessionaire's control The Docklands Light Railway has used a layered contractual approach. It has implemented three infrastructure- only concessions for building and maintaining network extensions--for Lewisham, London City Airport, and Woolwich Arsenal--and has a fourth in development. A separate contractual arrangement provides for service delivery by a franchise operator. The concession for Lewisham was the first private finance initiative for transport in the United Kingdom. It was structured so that the concessionaire would be paid an availability fee for the first 10 years of the concession period, then take farebox risk for the last 11 years. Planners later realized that this approach to risk allocation failed to offer value for money because the concessionaire had little control over factors relating to ridership levels. The concessionaire was not involved in service operation and so could not influence the quality of service beyond ensuring that infrastructure assets were well maintained. Subsequent infrastructure-only concessions have been based on availability payments for the infrastructure. That approach to risk allocation aligns performance assessment and payment systems more closely with factors under the concessionaire's direct control. Source: Keep 2008. 4 contract, specifying reduced termination payments whether integrated or layered. The constant growth if the parties fail to agree on a price for an exten- and evolution of urban centers puts a premium sion, or moving away from integrated concession on contractual flexibility for dealing with network arrangements to letting contracts in smaller pieces extensions--and avoiding some of the associated or using layered contractual arrangements. pitfalls. Urban rail contracts, because of their complexity, Achieving the right balance of risk between require strong and effective management on behalf partners also requires that private partners have of the contracting authorities. Governments there- something to lose for nonperformance at every fore need to plan institutional arrangements for stage of project implementation. Accordingly, implementing contracts well in advance, to ensure contractual arrangements need to provide for the that contract performance is properly monitored government's own structures for contract moni- and managed. Well-designed incentives, created toring coupled with performance management through a sound performance management system systems linked to remuneration. linked to performance-related payments, can help ensure that the developer meets or exceeds the Experience has shown that there is no single best performance targets. The experience of the Dock- way to structure an urban rail PPP. Instead, each lands Light Railway shows the importance of city must find its own way, based on its unique aligning incentives with factors under the conces- history, politics, finances, and geography. Address- sionaire's control (see box 2). Gautrain and Canada ing the issues raised here will give policy makers Line provide examples of contractual structures more than a fighting chance of success. that allow private partners to share in the gains from growth in system ridership. Notes This note is based on Mandri-Perrott with Menzies (2010), which discusses the issues involved in urban rail PPPs in much greater detail. Conclusion 1. Public support can take many forms, including the provision of revenue guarantees, availability payments, financial guarantees and There has been growing interest in urban rail PPPs capital grants. over the past 10 years. Cities around the world-- 2. Value for money is used here in the broader sense to introduce the from Dublin to Jakarta, from Jerusalem to Lagos, rigor of a structured PPP approach that would satisfy both public from Mumbai to St. Petersburg--have recently and private objectives. embarked on such ventures. References Halcrow Group. 2004. "A Tale of Three Cities: Urban Rail The record of urban rail PPPs underscores the Concessions in Bangkok, Kuala Lumpur and Manila." Background importance of effectively allocating risk between paper for the Asian Development Bank, Japan Bank for International Cooperation, and World Bank East Asia and Pacific Infrastructure the public and private partners. Especially critical Study, Washington, DC. are how and by whom demand risk is managed and Keep, David (company secretary, Docklands Light Railway). 2008. how well the urban rail system is integrated with Interview by Iain Menzies, October 1. other transportation systems, not only physically Mandri-Perrott, Cledan, with Iain Menzies. 2010. Private Sector but also with respect to ticketing arrangements. Participation in Light Rail-Light Metro Transit Initiatives. Washington, The success of urban rail PPPs can also depend DC:PPIAFandWorldBank. on how governments provide financial support Spicer, Martin (chief credit officer, International Finance Corporation). 2008. Interview by Iain Menzies, September 17. and which contractual approach is chosen, GRIDLINES PPIAF Approved Logo Usage Gridlines share emerging knowledge on public-private partnership and give an Logo - Black overview of a wide selection of projects from various regions of the world. Past notes can be found at www.ppiaf.org/gridlines. Gridlines are a PUBLIC-PRIVATE IN F R A S T R U C T U R E A D V IS O RY FA C IL IT Y publication of PPIAF (Public-Private Infrastructure Advisory Facility), a multidonor technical assistance facility. Through technical assistance and knowledge dissemination PPIAF supports the efforts of policy makers, nongovernmental organizations, research institutions, and others in designing and implementing Logo - 1-color usage (PMS 2955) strategies to tap the full potential of private involvement in c/o The World Bank, 1818 H St., N.W., Washington, DC 20433, USA infrastructure. 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