Wednesday, 19 December 2012

Disincentivising overbidding for toll road concessions

It was driven by the concerns over the list of Australian toll road concessions that appear to have been overbid with overly optimistic forecasts for traffic.  The latest being the Brisbane AirportLink, closely followed by Clem 7, the Lane Cove Tunnel and Cross City Tunnel.

I've finally had a chance to read the report, so here are some of the main points I found of interest (although it is recommended to read it thoroughly).

Six explanations were found from a literature review for possible overbidding:

- Strategic misrepresentation by the public sector:  Public sector comparators used to determine the expected costs and demand for the project get biased by political considerations demanding that the project proceed.  Bidders get caught along with this optimism.

- Strategic misrepresentation by the private sector:  Determination to because of prestige or strategic belief that winning is important in leading up to new contracts.

- Optimism Bias: A recognised flaw in forecasting of costs and benefits to take a more optimistic view of outcomes that dismisses negative influences.

- Renegotiation:  Providing an optimistic forecast to win on the basis that the contract can be renegotiated onto more favourable terms and conditions post award.

- "Winner's curse": The winner by definition will have lowered costs and have heightened expectations of demand and success, so the process self selects the one with the greatest bias from the market average.

- Technical error:  Inexperience in bidding results in bidders making a mistake that enables them to win/

It suggested various measures to minimise the risk of overbidding in future:

- In pre-procurement, subject proposed projects to economic efficiency appraisal so that only projects where there is commercial and economic viability proceed, rather than those driven by political expectations.

- Exposure to traffic risk should not be removed completely from concessions, partly to incentivise provision of higher quality service.  It is suggested that risk sharing mechanisms with the state for factors outside the control of concessionaires could be adopted, to cover factors such as GDP or population growth.   The concession should not incentivise excessive risk-taking.

- The downside risk of overbidding needs to be increased.  Options include bidding deposits that are used to cover costs if retendering is required, or to evaluate bids based on the guarantees and equity provided for the bid.

- Bid appraisal should avoid rewarding upfront premiums offered by bidders, it could also include assessment of assumptions on which demand and revenue forecasts are based.  This could also reassure investors by giving confidence that concessions are awarded to the most qualified group for appropriate reasons.

For me, the big issues are around the original viability of projects.  Governments should undertake robust commercial and economic appraisals that are allowed to say a project is not worth pursuing with.   This, at the very beginning, will mean those that proceed will be those with a reasonable chance of financial success.  An alternative would be to simply let the private sector approach government with propositions that do not involve taxpayers' money.

Beyond that is the concessioning policy framework that is set up in the first place.  It is important to note that the Queensland government has very little exposure in the Clem 7 and AirportLink toll road cases, so in that sense it hasn't been a failure.  However, if there is interest in having more of these, there needs to be a framework that allows for that.

Some ideas:

- When releasing a concession, incentivise the private sector to say if the project is not viable.  Don't make it a forgone conclusion that it will proceed.  If it is politically important then taxpayers can subsidise it, but it should be clear that bidders that are overly optimistic in forecasts wont be rescued.

- Private bidders should be required to get independent peer reviews undertaken of demand/revenue forecasts, the mere fact of this should incentivise more conservative behaviour by the primary modellers.

Beyond that, this should be more of a wake up to investors and banks that demand forecasting in this field is not something that can be done based mostly on assumptions used both on projects in other geographies and on untolled projects.  Motorists value the money they spend on tolls more than the value of time typically imputed by the public sector for transport capital projects.  It is time for investors to demand more scrutiny, and perhaps to treat the transport economics behind such forecasts as rather a bit more refined than has been undertaken by some consultants who spend most of their work dealing with untolled highway projects.

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