Demand risk

Toll Road Toll Road

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 earlier projects placed demand risk on the Private Partner but in many developed markets (Europe and Australia) traffic forecasts fell short of expectation and there were a few insolvencies. Over recent years it has become more common for the default position for toll road projects in developed markets to provide for the Contracting Authority to retain demand and toll revenue risk (risk of traffic numbers and total revenue receipt).

Demand risk is unlikely to be accepted by the private sector in the absence of extensive traffic analysis and a regime that protects the Private Partner from 'material adverse changes' such as new competing transport options or changes to surrounding traffic and road conditions.

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

If it is absorbing 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.

Where a demand based project has a MAC regime, the parameters of the Private Partners' protection will need to be carefully negotiated to ensure the Contracting Authority and other relevant Government bodies retain sufficient flexibility to implement other necessary urban development over the term of the project.

Comparison with Emerging Market

In developed markets, the Contracting Authority should have access to various data sources to develop realistic and attainable traffic and revenue forecasts, such that the Contracting Authority is well placed to manage demand risk.

A number of developed markets tender gas stations and service stations separately and this removes additional potential revenue streams from the Private Partner who would become solely reliant on traffic volume.

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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 toll road projects in emerging markets has been for the Private Partner to retain demand and toll revenue risk (risk of traffic numbers and total revenue receipt). There are examples of some jurisdictions in Africa where there has been a push back on this.

To the extent that toll 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. (e.g. by the implementation of upper and lower limits of revenues or a minimum guarantee).

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.

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

If there is high uncertainty over traffic 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

It may be difficult 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.

In some emerging markets the lack of any other viable traffic solutions on a particular corridor may also give the Private Partner greater confidence to accept demand risk which may further explain the difference in approach between developed and emerging markets.

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