Demand risk

Heavy rail Heavy rail

Description (What is the Risk)

The availability by both volume and quality along with transportation of resource or inputs to a project or the demand for the product of service of a project by consumers/users

Risk Allocation (Who typically bears the risk)

Allocation: Public Private Shared
Rationale

Under a typical franchise agreement, this risk will largely be taken by the Operator but will be mitigated by the revenue share obligations imposed on the Operator and revenue support obligations imposed on the Contracting Authority.

Alternatively the Contracting Authority may decide to take this risk, in which case it will require the Operator to enter into a management contract.

Mitigation Measures (What can be done to minimize the risk)

Under a typical franchise agreement, the Operator will be required to share a proportion of its revenue exceeding a specified threshold with the Contracting Authority, and will be entitled to receive revenue support from the Contracting Authority if its revenue is below a specified threshold. Revenue share arrangements do not normally apply during the first 4 years of a franchise agreement.

Government Support Arrangements (What other government measures may be needed to be taken)

If the Contracting Authority will be retaining demand risk, it will need to ensure that it is comfortable (both politically and economically) with demand forecasts.

Comparison with Emerging Market

In developed markets, the Contracting Authority should have access to various data sources to develop realistic and attainable ridership and revenue forecasts, such that the Contracting Authority is well placed to manage demand and farebox risk. However, within certain parameters, the Contracting Authority may feel that the Operator should take a degree of this risk.

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Description (What is the Risk)

The availability by both volume and quality along with transportation of resource or inputs to a project or the demand for the product of service of a project by consumers/users.

Risk Allocation (Who typically bears the risk)

Allocation: Public Private Shared
Rationale

The default position for existing rail ROT projects in emerging markets is for the Private Partner to retain demand and tariff risk (risk of demand and total revenue receipt).

To the extent that tariff revenue may be insufficient to cover the cost of financing and operating the project in question, as well as meeting the likely project contingencies, then some form of taxation-based support within the payment structure will be required, and the Contracting Authority may need to retain an element of demand risk.

Mitigation Measures (What can be done to minimize the risk)

Both the Contracting Authority and Private Partner should do a full assessment of demand risk and should ensure that the concession agreement appropriately addresses and allocates the risk for everything that will impact on demand.

The parties should also develop a comprehensive market strategy to deal with the implementation of the project.

Government Support Arrangements (What other government measures may be needed to be taken)

There may need to be an element of subsidy from the Contracting Authority if demand falls below a certain amount. If this is structured as a 'cap and collar' arrangement then the Contracting Authority should also start to benefit from economic upsides above the Private Partner's base case. This is not universally included and does not necessarily reflect a market practice.

If there is high uncertainty over passenger projections and uncertainty over revenues (due to tariff limitations and/or currency volatility) then the project may need to be structured purely on the basis of an availability fee.

Comparison with Developed Market

Most demand risk rail projects in the world have over- estimated user and revenue forecasts, and restructurings have been common. This creates a difficulty for Contracting Authorities in emerging markets, particularly in the case of market first projects, where there is likely to be a lack of relevant comparative market data to begin with.

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