Demand 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 light rail projects in developed markets is for the Contracting Authority to retain demand and farebox risk (risk of passenger numbers and total revenue receipt).

Where the demand risk is allocated to the Private Partner, or the extent that farebox 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.

In a Dutch project, the demand risk remains with the Contracting Authority.

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

As it will be absorbing this demand risk, the Contracting Authority 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)

As 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.

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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.
Competing lines or modes of transport.

Risk Allocation (Who typically bears the risk)

Allocation: Public Private Shared
Rationale

The default position for light rail projects in emerging markets is for the Private Partner to retain demand and farebox risk (risk of passenger numbers and total revenue receipts).

To the extent that farebox 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.

The Contracting Authority could undertake for the duration of the term of the project not to permit the construction or operation of any parallel railway infrastructure which would compete substantially with the Private Partner's passenger transport services. This undertaking could also extend to other competing modes of transport (eg buses or trolleybuses) developed within a certain radius of the route which would result in the avoidance of passenger fares which would otherwise be paid to the Private Partner.

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.

Some projects now ask bidders to price their subsidy needs, developing a hybrid demand risk/availability model.

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 structure purely on the basis of an availability fee.

Comparison with Developed Market

Most demand risk light-rail projects in the world have over- estimated ridership 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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