Performance-Based Contracts (PBC) for Improving Utilities Efficiency

Experiences and Perspectives

Jan Janssens, Didier Carron, Philippe Marin, Philip Giantris, Tom Williams

• Editore: IWA Publishing
• Anno: 2018
• ISBN:
  9781780409092
• Argomento: Tecnología e ingeniería
• Categoria: Ciencias aplicadas

Scientific and Technical Report No. 24Performance-Based Contracts (PBC) for Improving Utilities Efficiency: Experiences and Perspectives is a compendium of articles written by members of the PBC taskforce. It focuses on new approaches without delegated management to private operator i.e. service contracts, consulting contracts, Alliance approach, public-public partnership. It also mentions new design and generation of more traditional PPPs, (MC, lease, concession), where a larger proportion of performance-based design is being applied.List of Contents: Performance Based Contracts – Setting the scene; PBC and Results Based Financing: the inverse approach; PBC and Energy Efficiency; Internal Performance Contracts: A Case of the National Water and Sewerage Corporation in Uganda; Performance-Based Service Contracts in Navi Mumbai; Financial Comparison of PBCs and Conventional Approach; Tegucigalpa PBC Case Study; Performance Based Contracts – Key Design Issues; NRW Reduction Optimization Framework; How to improve water services performance? Performance Based Contracts (PBC) and Regulatory issues; Peer-to-Peer Partnerships Operational for sustainable water services; Performance Based Contracts in Malawi: Teamwork Works; Performance based affermage contracts; Performance based Contracts, The Aroona Integrated Alliance Experience; Experience from Eastern Europe; NRW Performance Contract – Kingdom of Bahrain; The way forward and perspectives/trends

© IWA Publishing 2018. Jan Janssens, Didier Carron, Philippe Marin, Philip Giantris and Tom Williams. Performance-Based Contracts (PBC) for Improving Utilities Efficiency: Experiences and Perspectives DOI: 10.2166/9781780405964_0001

Chapter 1

Performance-based contracts – setting the scene

Jan G. Janssens and Didier Carron

Performance-based contracts (PBCs) are a special case of public–private partnership (PPP) contracts and they widely differ from traditional public sector, input-based, contracting methods. The whole idea of PBCs is to make contracts more efficient, by optimizing incentives and allocating risks to the party more able to bear or mitigate it, so that better results can be expected. Designing PBCs is however less simple than designing conventional contracts, as it involves setting objectives, defining key performance indicators (KPIs) reflecting these objectives and selecting a remuneration formula based on these KPIs so as to become a win–win agreement for both the utility and its contractor. Such contracts should also comply with the existing legislations on public contracting.

1.1INTRODUCTION – PBCs AND PPPs

While traditional input-based contracts often bring disappointing results, delegating operations, or part of operations, to private management under a performance-based public–private partnership (PPP) offers a valuable solution, more efficient than traditional input-based contracts.

The whole idea of performance-based contracting (PBC) is to make contracts more efficient, by optimizing incentives and allocating risks to the party more able to bear or mitigate it. Properly designed, a performance-based contract can achieve better results than are normally achieved using traditional public sector, input-based, contracting methods. The advantage comes from a better alignment of incentives with output objectives, coupled with more contractor flexibility in design and implementation to facilitate innovation and encourage efficiency.

Performance-based contracts belong to two categories of contracts:

•Results-based financing contracts

Results-based financing (RBF) is an umbrella term linking payment to achieving a predetermined performance target.

RBFs have become common practice in highways and roads, healthcare and energy sectors.

In the water and sanitation sector, RBFs are still less well spread; the most common application is through output based aid (OBA), often and mainly targeted at increasing access to the urban poor.

Performance based contracting is an RBF where the remuneration of the contractor is directly related with its performance through quantified key performance indicators (KPIs).

•Public–private partnership contracts

PPP involves a contract between a public sector authority and a private party, in which the private party provides a public service or project and assumes substantial financial, technical and operational risk in the project.

In some types of PPP, the cost of using the service is borne exclusively by the users of the service and not by the taxpayer. In other types (notably the private finance initiative), capital investment is made by the private sector on the basis of a contract with government to provide agreed services and the cost of providing the service is borne wholly or in part by the government. Government contributions to a PPP may also be in kind (notably the transfer of existing assets).

There are usually two fundamental drivers for PPPs:

•First, PPPs are claimed to enable the public sector to harness the expertise and efficiencies that the private sector can bring to the delivery of certain facilities and services traditionally procured and delivered by the public sector.

•Second, a PPP is structured so that the public sector body seeking to make a capital investment does not incur any borrowing. Rather, the PPP borrowing is incurred by the private sector vehicle implementing the project. Generally, financing costs will be higher for a PPP than for traditional public financing, because of the private sector higher cost of capital. However, extra financing costs can be offset by private sector efficiency, savings resulting from a holistic approach to delivering the project or service, and from the better risk allocation in the long run.

By comparing both definitions, one can see that:

•PBCs are PPPs in the sense that PBCs clearly involve risk taken by the contractor, which is a major differentiation from a traditional service or works contract.

•However, as PBCs typically do not include much investment, PBCs are thus “light” PPPs which, for implementation, do not need all the tools used for typical PPPs such as special purpose vehicles (SPVs), complex guarantee schemes or complex financing schemes.

1.1.1Specificity of PBCs

It can be seen that PPPs, which are mainly service contracts, can be designed as performance-based contracts.

The design of a PBC includes thus three specific components which are not so much used in common PPPs:

•Defining objectives. These objectives should be both ambitious and realistic;

•Designing key performance indicators (KPIs) reflecting these objectives. The design of these KPIs is crucial as they will drive the remuneration of the contractor, and can be quite tricky;

•Correlatively finding the right balance between necessary empowerment of the contractor and control by the utility.

The implementation of a PBC also has much specificity, such as:

•The need to establish a validated baseline. This is an absolute precondition for an effective incentive structure with realistic time-bound performance targets – inaccuracy of baseline is an issue and a constraint.

•The overall target of improving performance and building capacity.

However there also exists some specific ways to develop PBCs, especially third party financing. Third-party financing (TPF) means that project financing comes from a third party, e.g. a finance institution, and not from internal funds of the contractor or of the customer. The finance institution may either assume the rights to the energy savings or may take a security interest in the project equipment.

This type of mechanism is quite often used for performance based energy efficiency contracts (PBEECs), where the contractor is an energy savings company (ESCO).

As described by the EU Commission, there are two conceptually different TPF arrangements associated with EPC; the key difference between them is which party borrows the money: the ESCO or the client.

•The first option is that the ESCO borrows the financial sources necessary for project implementation.

•The second option is that the energy user/customer takes a loan from a finance institution, backed by an energy savings guarantee agreement by the ESCO. The purpose of the savings guarantee is to demonstrate to the bank that the project for which the customer borrows will generate a positive cash flow, i.e. that the savings achieved will certainly cover the debt repayment. Thus, the energy savings guarantee reduces the risk perception of the bank, which has implications for the interest rates at which financing is acquired. The “cost of borrowing” is strongly influenced by the size and credit history of the borrower.

At a first glance, there are no good reasons why PBCs are so little favored, as PBCs have the potential to be more efficient contracts than the traditional, input-based contracts. Despite their potential, PBCs are not necessarily always the most appropriate mechanism to meet a utility’s objectives in a given situation. The following criteria will help determine whether the utility’s conditions are conducive to a successful PBC:

•Do potential benefits outweigh the costs? The utility needs to do a cost–benefit analysis, pondering especially whether there is real value in providing the contractor with flexibility on some tasks, and if this compensates for the higher price which the contractor shall probably require in exchange for taking more risks;

•Are quality baseline data available? This is essential for being able to properly measure performance improvements (comparing “before” and “after”). When no reliable baseline is in place, this may make the contract risky due to potential conflicts during implementation;

•Can the PBC be ring-fenced from utility management? To justify a bonus payment, performance improvement needs to be clearly linked to the sp...