Finding Safe Habour: Port Concessions
Alessandro Borgogna and Ivan Jakovljevic, principals at Booz & Company look at the opportunities successful port concessions can generate.
Sea trade is a lifeline of the global economy. Ore from mines in Australia, corn from North America, and flashy new iPads from China all find their way through the world’s major ports. The simple harbours of centuries past are now complex systems that typically employ thousands of people and cost billions to build and maintain.
Traditionally, that burden has fallen on governments: port construction, financing, and operations were handled by the public sector because of their relatively high infrastructure and financing needs, long project life spans, and required economies of scale. However, since the early 1980s, public-private partnerships (PPPs) have frequently been used in port construction and operations.
In the Middle East, 17 public-private port projects valued at more than US$4 billion have been completed since the mid-1990s. Over the next 10 years, additional investments of $40 billion are expected in new ports and expansions. One of these, the New Doha Port, is projected to have capacity for more than six million container units when it is completed in 2030. At a cost of approximately $4 billion for its first phase alone, it will be one of the largest ports in the region.
Most of the new port capacity will likely be created by some form of partnership — often via concessions for port construction and operations, in which private companies build and operate facilities for the duration of a contract, essentially taking ownership during this period.
Despite their complexity, if structured properly, concessions can generate tremendous value for both the government and the private partner. For example, during recent negotiations over a concession for a regional port, the government’s negotiating team was able to extract more than $100 million of additional value compared to the original deal on the table, leaving that money to go back into public coffers for other projects. On the other hand, badly structured concessions can result in direct and indirect liabilities to the government in the range of hundreds of millions of dollars. Given the magnitude of these potential gains—or losses—concessions need to be carefully considered and implemented.
Designing and awarding a concession typically takes from four to nine months, though it can take significantly longer if the country does not have the necessary legislative framework in place. Both sides must ensure that the deal is in their best interests: governments select the concession model, quantify savings for the public, and evaluate and rank the offers. Meanwhile, bidders assess their expected returns and compensation to the concessionaire, as well as secure external financing.
There are a number of factors that must be agreed upon during the contract stage to ensure that both parties understand their obligations and rewards
Typically, the private partner collects revenues from operating the terminal and compensates the government for providing the assets and/or the opportunity. This compensation consists of a one-time, fixed, initial goodwill payment; royalties, determined by revenue or volume; and rental charges to offset the opportunity and cost of land development incurred by the government. Alternately, in situations when the private partner is unlikely to recoup its investment but the government needs to provide services to its citizens—for example, in public transport—the government may need to provide subsidies to the private partner.
The contract must define parameters for service to ensure that the operator provides all services necessary from the government’s perspective, rather than only those that are profitable. The contract should define metrics to track service and put penalties in place for any shortfall in performance.
The length of the relationship needs to be aligned with the operator’s level of investment and magnitude of risk to allow the company to recoup its cost and earn reasonable returns. For example, models in which companies accept only a limited amount of risk and offer a small amount of capital upfront should also have a relatively short contract duration, as a longer contract would offer them excessive returns compared to their investment and risk undertaken.
Prospective operators frequently request such rights to protect their investment and limit competition. These requests can range from the right of first refusal to an outright prohibition on future port expansion and the introduction of new terminal operators. In most cases, the government should resist these requests or try to limit their scope and duration.
These clauses are essential, especially for terminals with primarily local cargo with limited alternatives available. These terminals have the characteristics of a natural monopoly and captive users need to be protected from potential abuse. Customer protection clauses typically take the form of price caps and/or required approvals for price increases.
Regional governments have an opportunity to not only improve delivery and operations of their ports but ensure that they are getting their money’s worth from the operations. When properly executed, concessions are an efficient and transparent model for effective construction and operations that benefit national and regional economies.