Evaluating Public Sector’s Support Mechanisms for Project Companies Facing Revenue Risk of PPP Projects

Abstract

In PPP toll road projects, public sector supports project companies that face the risk of revenue, by different mechanisms. It is necessary for the public sector to evaluate these mechanisms before granting them to the private sector. This study evaluates the support mechanisms defined in the Iranian PPP toll road projects legislations by real options and compares them with a proposed mechanism. Additionally, the uncertainty of the project revenue during the concession is modeled by the options theory. The impacts of the revenue risk on public and private sectors is evaluated by Monte Carlo simulation in a Flexible-term mechanism, a Flexible-term mechanism alongside a Revenue Guarantee mechanism defined in the legislations, and a Flexible-term mechanism alongside a proposed Guarantee based on Barrier Option. Subsequently, the sensitivity of these impacts to the revenue projection errors is analysed. This process is implemented in a real PPP freeway project. The results show that the combining Flexible-term and Revenue Guarantee mechanisms improve the financial viability of the project, indicating the continuance of adequate yearly cash flows through the whole concession period. Adjusting the Revenue Guarantee defined in legislations by Barrier options reduces the public sector’s payment commitments. The analysis of the uncertainties of the project revenues reveals that the revenue projection errors have a great impact on the consequences of the revenue risk on both parties. Since the public sector often faces budgeting challenges to support projects, the proposed mechanism can help public sector decision-makers to better allocate financial resources by supporting the projects that struggle with financial viability. The sensitivity analysis of revenue projection errors on risk impacts in each mechanism provides public sector decision-makers with a broader and more realistic spectrum of the revenue risk impacts on pubic and private parties.

Keywords

• freeway projects
• public-private-partnership
• revenue risk
• project financial viability
• real options