Appropriating the Value of Flexibility in PPP Megaproject Design

Abstract

Public–private partnerships afford governments the opportunity to build megaprojects that benefit the public but might be too expensive or risky for either the public or private entity to undertake alone. Concession contracts, which govern the behavior of the participants in the partnership, often contain a Right of First Action (RoFA) clause. The holder of this clause has the right, but not the obligation, to invest in altering the project in some way. The RoFA is linked to design flexibility, which can be built into the megaproject public–private partnership’s initial blueprint as a way to increase private-sector interest and preserve public-sector value for money. This research shows that the inclusion of a RoFA can create an additional stream of potential cash flows to the project; these cash flows constitute an asset that exists in addition to the primary revenues expected upon project completion. The additional asset can be offered to the private partner, augmenting the value of the project, or it can be held by the public sector until certain conditions are met. The value of the asset can be determined using a real options approach. To illustrate the approach, a case study on the Batoka Gorge Hydropower Dam, a 2,400-MW facility on the Zambezi River, which divides Zambia and Zimbabwe, is undertaken. The framework extends existing research on contract design to offer a specific valuation application that will be especially useful to government agencies that are seeking to enhance the competitiveness of their bidding processes and create durable contracts of lasting value.