Demand Risk in Transport Infrastructure Projects

The Demand risk of a PPP Rail Transport Infrastructure Project refers to the risk with regards to the number of passengers that is required in order to ensure adequate revenue generation to cover the project’s operational and maintenance costs. Merna and Owen ( Merna & Owen. 1998) noted that “demand risk is the greatest risk to the concessionaire under the payment mechanism”. The demand risk is key for a market-led service where revenue generation is critical to the ultimate success of the project. Brocklebank, Burnett, Ras & Walt(Brocklebank, Burnett, Ras & Walt . 2001) describes the demand forecasts or revenue generation as “vital to the development of a business case”. Mackie, Nellthrop and Laird (Mackie, Nellthrop and Laird. 2005) note that “demand forecasts are fundamental to an economic appraisal” for rail transport infrastructure projects.

The Concept of Demand Risk
Burger (Burger, P. 2006) noted that when a need for a service exist, with externality characteristics (demand side risk), the type of contract through which the infrastructure is constructed, managed and operated, depends on the ability of the government to transfer the demand risk to the concessionaire as well as the level of the competition in the open market. Grimsley and Lewis (Grimsley and Lewis, 2005) note that risk transfer and the level of competition during the tender process, is critical to ensure the concessionaire focuses on being “technically and X-efficient”. X-efficiency refers to the ability of the concessionaire to operate the service without wasteful inputs (Burger, P. 2006). Fourie and Burger (2000) conclude that the main drivers of efficiency and value for money in elastic demand based PPP Infrastructure projects is demand risk transfer. The demand risk associated with infrastructure projects are inherently higher than projects that deliver a product as the infrastructure projects are fixed assets that can’t easily move or follow the target market. The ability of a concessionaire to manage the demand risk for a rail transport infrastructure project is extremely limited and the demand risk is therefore historically transferred to the grantor of the project who is deemed to be in a better position to manage and mitigate the risk.

Demand Risk in Rail Transport Infrastructure projects
Demand risk forecasting is paramount to the success of a rail transport infrastructure project. Demand forecasting allows the grantor to identify the number of potential passengers, provide an estimate of possible revenue generation, establish feasibility and identify the requirements of the target market. Rail Transport projects are market-led projects and are usually highly reliant on the revenue generation. The ability of institutions to accurately calculate demand for a transport project over a long concession contract period remains highly controversial. The high number influences on the demand for a service is extremely difficult to predict.

Historic research of Public Private Partnerships (PPP’s) Transport infrastructure projects would suggest that the demand forecasting is grossly inaccurate. As a result the economic feasibility of rail transport infrastructure projects are questionable. Furthermore the demand forecasting requires a large amount of assumptions to be made, all of which can be easily manipulated to prove feasibility. The ultimate purpose of the demand forecasting is to prove profitability and feasibility in order to attract funders, investors and competitive tenders. Below is a list of factors associated with or that have an impact on demand risk for rail transport infrastructure projects:

Recession
Economic down turn
Quality of the service
Social acceptability
Consumer resistance to pay and use the system
Safety
Changes to demographic nodes surrounding the stations
Associated feeder or distribution systems to deliver the demand to the service
The ability to meet an increase in the demand
Competition of alternative methods of transport

Demand Risk Mitigation in Rail Transport Infrastructure projects

Merna and Owen ( Merna & Owen. 1998) noted that the success of a PPP project depends not only on the ability of the partners to transfer risk but to transfer to the risk to the party most suitable to mitigate the risk. Merna and Al-Thani ( Merna & Al-Thani, 2010) concluded that in order to manage demand risk effectively it is critical to ensure that the PPP contract promotes continues service delivery and productivity. Historically the preferred method of demand risk mitigation in a PPP Transport Infrastructure project is the introduction of a patronage guarantee, where the grantor guarantees the minimum patronage or revenue required to ensure maintenance and operational costs during the concession period is covered. However, the introduction of a patronage guarantee reduces or eliminates the incentives for a concessionaire to increase service quality and increase demand or passenger numbers. The ability of a rail transport infrastructure concessionaire to manage the demand risk is nearly impossible therefore demand risk is mostly transferred to the grantor.

Summary

Demand risk identification, transfer and mitigation are key to the feasibility and success of a PPP transport infrastructure project. The ability to accurately forecast the demand for a service and the revenue generated through the life cycle of the service is critical to the economic feasibility of a market-led infrastructure service. The introduction of a patronage guarantee offered by the grantor transfers the demand risk effectively to the public partner, albeit that it provides little incentive to the private party or concessionaire to improve service delivery and increase demand for the service. Historic literature would suggest that the demand risk is of utmost importance in a revenue or market-led infrastructure system.

References

Brocklebank, P., Burnett, S.L., Ras, N. & VD Walt, G. (2001) Gautrain: Demand and Revenue Forecast. 20th South African Transport Conference, “Meeting the Transport Challenges in Southern Africa”, 16-20 July 2001, Arcus GIBB, South
Africa. Grimsley, D and Lewis, M.K. 2005. Are public-private partnerships value for money? Evaluating Mackie, P., Nellthrop, J. & Laird, J. 2005a. Demand Forecasting Errors. Transport Note TRN-26 Transport Economics, Policy and Poverty Thematic Group, World Bank, Washington. Merna, A. & Owen (1998) Understanding the Private Finance Initiative: The New Dynamics of Project Finance. Hong Kong: Asia Law & Practise Ltd.