Privatesector P U B L I C P O L I C Y F O R T H E The World Bank October 1995 Note No. 59 Concessions—The Way to Privatize Pierre Guislain and Michel Kerf Infrastructure Sector Monopolies Concession-type arrangements are well suited cluding operating and maintaining the infra- RANGE OF for privatizing sectors with monopolistic char- structure, typically against payment of a lease PRIVATE acteristics.1 Under this approach, the state (or fee. In the second, concession stricto sensu, SECTOR municipality or other public entity) delegates the private contractor is also responsible for OPTIONS to the private sector the right to provide a ser- building and financing new investments. At Private vice, yet retains some control over the sector the end of the concession term, the sector by incorporating in a concession contract or assets are returned to the state (or municipal- Divestiture license the terms and conditions—including the ity). The term BOT (build-operate-transfer) is by license rights and obligations of the service provider— often used to refer to greenfield concessions, that will govern the infrastructure project or and ROT is sometimes used to describe con- company. This Note outlines the concession- cessions in which investments entail prima- type approach and some of its operational rily rehabilitation (hence the “R”) rather than BOO implications. construction. Options for private sector provision BOO (build-own-operate) is a similar scheme, BOT and but does not involve transfer of the assets. Di- concession (stricto There is a continuum of options for involving vestiture, finally, involves the transfer to the sensu) the private sector in the provision of infra- private sector of the ownership of existing as- structure services, as illustrated by the figure sets and the responsibility for future expan- Leasing on the left.2 At the base (in white) are supply sion and upkeep. In both cases, the private (affermage) and service contracts, which tend to be of short company is responsible for financing and car- duration and require less private commitment rying out the investments required to meet the than the options higher in the continuum. The obligations specified in its license or by the private contractor is not directly responsible for regulator. Management contracts providing the service, but instead for perform- ing specified tasks, such as supplying inputs, In all these concession-type arrangements constructing works, maintaining facilities, or (hereafter, concessions), a public entity, typi- Sub- billing customers. In this first category, private cally the state or a municipality, grants the right contracting sector involvement is highest in management and the obligation to provide an infrastructure contracts. When these include mechanisms link- service to a private company (the concession- ing the contractor’s compensation to the per- aire).3 The service, whether gas, power, water, Technical formance of the utility it manages, they come transport, sanitation, or telecommunications, is assistance closer to the concession-type arrangements (in provided under terms and conditions specified contracts pink and purple in the figure) that are the fo- in a contract or license. The private sector takes cus of this Note. over operational responsibility and at least part Supply and of the commercial risk of service provision. The civil works The first of these arrangements is the lease- concessionaire is by and large held responsible contracts and-operate (or affermage ) contract, under for achieving specified results in service deliv- Public which the private contractor is responsible at ery and is given some freedom to choose the its own risk for provision of the service, in- means for meeting those targets. Private Sector Development Department ▪ Vice Presidency for Finance and Private Sector Development Concessions—The Way to Privatize Infrastructure Sector Monopolies Sizing up concessions The contracts’ duration tends to reflect the num- ber of years investors need to recoup their in- Despite these common features, important vestment. That is the case for French-style differences do exist between the different types concessions, under which assets return to the of concessions. These variations can have im- state at the end of the period free of charge or portant operational implications. for a nominal amount. Lease-and-operate con- tracts (affermages ), under which the public Responsibility for new investments authority remains responsible for financing most investments, are shorter (ten to fifteen Although the responsibility of the private sec- years) than greenfield BOTs or concessions tor under a concession always includes the op- stricto sensu requiring major up-front capital eration and maintenance of the system or expenditures; these can exceed thirty years. facilities and the supply of the infrastructure Similarly, the transfer of existing sector assets service, it may or may not include the design, (for example, a distribution network or a par- construction, and financing of the new infra- allel bridge) free of charge at the time of the structure. award not only reduces the relative size of new investments. It also provides a free cash flow Legal ownership for financing these investments, allowing a shorter payback period and a shorter contract The legal status of assets built and financed period. by the private operator may also vary. Under the traditional French concessions, for ex- Matching the contract term to the amortization ample, the state owns these assets from the of investments is not essential, however. The moment they are built, but the private opera- government generally reserves the right to ter- tor retains full control over them until the end minate the contract before the end of its nor- of the concession period. In other cases, in- mal term. In addition, infrastructure services cluding many BOT or ROT schemes and even require continuous investment that cannot be some French concessions, the legal owner- adequately predicted decades in advance. In- ship of assets built and financed by the pri- vestments will almost always have to be made vate operator will remain private until their toward the end of the concession that cannot transfer to the state at the end of the conces- reasonably be amortized before its expiration. sion term. Finally, under BOO contracts and Moreover, the true value of the business is in divestiture schemes, these assets remain pri- no way limited to the value of the unamortized vate. Private ownership may give investors assets built by the incumbent. It also includes more protection and facilitate the financing intangible assets, know-how, reputation, and of concessions by making these assets avail- billing and collection systems. able as collateral. Schemes should thus be designed with proper Duration incentives for maintenance of the facilities and for valuation of assets that have not been fully Leases, BOTs, and concessions stricto sensu (in amortized. For example, a payment might be pink in the figure) are generally granted for made by the public authority to the private op- fixed periods. At the end of the specified term, erator on the basis of an evaluation by inde- most assets (including those financed by the pendent experts. Another option would be to concessionaire), as well as the right to carry stipulate that the concessions awarded will be out the activity, return to the public entity. In rebid periodically—as the Argentines have done France and other countries with a long tradi- in the power distribution sector. Though the tion of using concessions, however, these con- Argentine concessions are for a period of tracts are often renewed or retendered. ninety-five years, they are rebid after the first fifteen years and every ten years thereafter. If Regulatory implications the incumbent bids the highest price, it retains the concession. If it doesn’t, the highest bid- Concession arrangements embody a regulatory der pays the amount of its bid to the incum- framework and should be seen as an integral bent, not to the public authority. In this way, part of economic regulation, rather than as a assets that are not fully amortized are valued substitute or alternative. The key elements of by the market, not at the discretion of the state the regulatory framework, including tariffs, de- or a regulator. gree of competition, interconnection regime, and performance targets, are defined in the con- In monopolistic sectors, even BOOs and full cession contract or operating license. Because divestiture do not imply permanence. The pri- of the element of monopoly, public service ob- vate company does have indefinite ownership ligations tend to include detailed specifications rights to the assets. To be allowed to provide on the service to be provided, the obligation the service, however, it typically also needs an to supply, equal treatment of users, continuity operating license, which the government can of service, and so on. In consideration of these withdraw, revoke, or not renew. In England obligations, concessions often grant certain ex- and Wales, for example, the privatized water clusive rights to the private operator. utilities have a license in perpetuity, but the government can terminate these licenses after These terms need to be monitored and enforced twenty-five years with ten years’ notice. In ad- and may need to be revised from time to time dition, licenses can be revoked at any time for to reflect changing conditions. Thus, concessions noncompliance. The difference between a tra- (or the legal framework that governs them) may ditional fixed term concession (in pink in the grant the public authority or a regulator a cer- figure) and an indefinite divestiture thus may tain amount of discretion and, at the same time, not be as big as it might at first appear. provide recourse against the decisions of the authority or regulator. In view of concessions’ Bulk or retail supply public service nature, public authorities will of- ten reserve the right to unilaterally modify some In its classical (or narrow) sense, a concession of the provider’s obligations or even to termi- is a public utility: it provides a public service nate a concession before its stipulated term.5 to end users. Direct payment of the conces- sionaire by the users, who are not party to the Whatever the approach, all concessions include concession contract, was seen as a defining some form of regulatory mechanism. Under the feature of this scheme. Examples of such con- French model, the concessionaire is regulated cessions include bridges, tunnels, toll roads, in part by the public authority that awarded and water and power distribution systems. the concession and to a lesser extent by that authority’s supervising agencies. The authority In the broader sense suggested by this Note, and agencies themselves are kept in check by concession-type arrangements also include the political process (including elections) and schemes under which an independent producer the courts. Concessions also may be regulated of, say, power or bulk water sells its product by independent regulatory bodies, as in Ar- to a single buyer, the public utility. Examples gentina. The selection mechanism can play an include the fifty-year bulk water supply BOT important regulatory role by awarding the con- in Casablanca signed in 1949 and the many cession initially on a competitive basis and by private power deals signed in recent years in putting it up for bid periodically thereafter. In- such countries as China, Indonesia, Pakistan, deed, repeatedly auctioning off the concession and the Philippines. The risks associated with right allows monopoly rents to be extracted a public utility and a bulk supply concession without discretionary intervention by the regu- differ significantly.4 lator or government.6 Self-regulation also may Concessions—The Way to Privatize Infrastructure Sector Monopolies play an important role: most concessionaires In sum, what matters most are the incentives are concerned with protecting their reputation built into a specific scheme, not whether it is (or their shareholder’s) in the market. labeled as a concession, a BOT, a privatiza- tion, or by any other name. A customized instrument 1 The concession technique is less suited to situations in which The concession is a flexible mechanism that competition can and should be introduced in the market—distinct can be designed to overcome a broad range of from competition for the market through competitive bidding for the exclusive right to provide a service. Where multiple firms obstacles to private participation in infrastruc- must compete with one another for the provision of services, ture. The option of leaving formal ownership competitive discipline tends to reduce the need for economic regu- of existing sector assets to the state makes it lation. Such firms should operate on a level playing field under a uniform regulatory framework (such as antitrust legislation), not particularly useful in countries in which the under the terms of individual regulatory deals that would dis- law or constitution excludes private ownership criminate among players. And, under normal circumstances, the of specific infrastructure assets. For the same state would no longer have the option to terminate the operator’s right to provide the service. reason, recourse to a concession is an elegant 2 With any of these schemes, private participation would be less solution when the sale of the infrastructure where the state or other public entities are shareholders of the company or assets would not fetch the “right 3 service provider. Concessions have also been granted to autonomous public enti- price” and would expose the government to ties, for example, ADM, the Moroccan toll road company. In accusations of a giveaway. Public ownership France, state-owned companies are concessionaires of toll roads may also provide tax advantages where tax laws and hold monopoly concessions in the gas, power, and railroad sectors. In other cases, the state is a minority shareholder of the treat public ownership more favorably—for ex- concession company (for example, SEEG, the Conakry, Guinea, ample, by allowing a concessionaire to depre- water company). 4 ciate investments faster than if it owned them. Collecting from hundreds of thousands of households, enterprises, and administrations may be more difficult, but in addition to strong incentives to collect, the concessionaire possesses the tools re- Because concession-type agreements can be quired to make users pay (including the right to cut off service in This series is published made as specific as required, they are well case of arrears). Exposure to a single buyer, by contrast, may to share ideas and invite require more government guarantees or comfort, especially when suited to situations in which more general and the buyer is a state enterprise that may be uncreditworthy and discussion. It covers financial and private vaguely defined regulatory approaches would protected from the concessionaire’s power to cut off service. In a sector development as deter investors. And they can be tailored to public utility concession, the private operator bears the market well as industry and risk directly, such as the risk of a drop in demand. With a single allocate risks in a variety of ways to give in- buyer, this risk is usually taken by the public utility through take- energy. The views expressed are those of vestors the comfort they need to venture their or-pay arrangements, although where the utility may limit its take the authors and are not capital in specific countries and markets. to a contractual minimum that is lower than capacity, the private intended to represent operator would still face a residual demand risk. 5 an official statement of Some form of compensation is usually called for when modifica- Bank policy or strategy. The flexibility of this mechanism is clearly one tions create more onerous operating conditions or in case of early of its main strengths, but it can also be per- 6 termination. Comments are welcome. See also the section above on duration of concessions and An- plexing. Designing a scheme that strikes the thony Dnes, “Franchising and Privatization,” Private Sector (March Please call the FPD Note line to leave a right balance between the interests of the in- 1995). The competitive award of a concession is a form of fran- message (202-458-1111) vestors, the consumers, and the public authori- chising, as this term is used in the economics literature. or contact Suzanne ties and that fits the conditions of the sector Smith, editor, Room G8105, The World Bank, and the country concerned is pivotal. It requires Pierre Guislain, Principal Private Sector 1818 H Street, NW, a clear identification of the objectives and of Development Specialist (email: pguislain@ Washington, D.C. 20433, the tradeoffs that must be taken into account worldbank.org), and Michel Kerf, Consultant or Internet address ssmith7@worldbank.org. to achieve them. Blueprints and model con- (email: mkerf@worldbank.org), Private Sector tracts can rarely be transposed from one coun- Development Department 9 Printed on recycled try and sector to another. With time, countries paper. will develop their own precedents, and the process will become easier. But each conces- sion is likely to remain a special case requiring special attention and unique features.