Variation Negotiation in PPP Toll-Road Projects: Option Approach

Abstract

The literature on public-private partnership (PPP) agreements suggests that variation renegotiation places the public sector authority at a disadvantage, because the authority has to pay extra costs to claim its variation. This leads to the need for a PPP contract to incorporate flexibility, embedded with real options analysis (ROA), to deal with these variations. This paper proposes that PPP agreements should ideally contain an option for the authority to order variation as an effective response to changing circumstances in the postconstruction phase throughout the concession period of toll roads. Having the variation option, the authority sets a threshold on the concessionaire’s bargaining power via variation negotiation as the authority can order its variation at its favorably controlled price. The paper also presents the ROA, based on the probabilistic cash flow approach, that gives the financial value of flexibility for the authority to order variation. This approach is straightforward and provides a fair way forward for the implementation of PPP toll roads.