Restructuring PPPs in the age of Covid-19: Some approaches

Nobody alive today will ever forget 2020. Even before the pandemic, the World Bank was raising red flags about debt transparency and other obstacles posed by state-owned enterprises (SOEs). In that context, I sometimes found myself in the uncomfortable position of explaining how best to reexamine existing commitments under public-private partnerships (PPPs) to give governments more fiscal space or allow SOEs to turn their balance sheets around.

Before joining the World Bank, I practiced law in the private sector specializing in large, complex, cross-border financing transactions. It’s no surprise that I’m often asked to shed light on the contractual implications of actions taken by a party to a PPP contract. But providing advice of this nature can be tricky. Conveying a position or advising on a course of action that could potentially lead to contractual friction can create exposure to reputational and even legal risks. This often leads to decision paralysis or to a client feeling abandoned at a time of great need.

The challenge

PPPs are typically pursued when the private sector’s commercial incentives mesh with the public sector’s development, economic, and political incentives. However, when challenges arise in PPPs, these two realities often collide, and there’s a need for help in navigating these contrasting perspectives.

In a crisis, stakeholders may hastily look for legal implications without first fully appreciating the underlying rationale that led to the contractual terms. Remembering the commercial underpinnings that drive the private sector and the development, economic, and political incentives that spur the public sector are critical in navigating contractual tension in PPPs. 

The first step in resolving any conflict is to understand each party’s position. Governments must understand the commercial arrangements that incentivized the private sector in the first place, and the private sector needs to assess public-sector incentives. And what about the World Bank in a situation like this? We need to understand both public and private perspectives and, critically, step up into our role as honest brokers.

An IPP case study

We recently hosted Cranmore Partners, a global advisory firm, for a World Bank webinar to examine these challenges from a non-legal, financial perspective. Using a government-backed power purchase agreement (PPA) for a gas-fired power plant in Sub-Saharan Africa as an example, the session examined the commercial challenges and financial implications of restructuring government-backed PPPs financed under long-term PPAs in U.S. dollars.

As the pandemic-driven economic crisis unfolded, some governments have found the payments (and the implied tariffs they are based on) increasingly difficult to bear, especially as fiscal positions weakened.  They wanted to understand how to reduce the costs of these contracts.

We discussed several potential restructuring solutions that might reduce the tariff burden. These, however, require the full cooperation of all relevant stakeholders to achieve a sustainable outcome. For instance:

1. Reduce the tariff. Cutting the existing tariff without adjusting other parameters is simple but usually results in an unsavory lower return for the investor. A lower tariff also means fewer revenues, which could potentially lead to a debt service default with termination payment implications for the government. This approach tends to have a chilling effect in the market and sends a negative message to investors considering future projects in the country if done hastily.
    
2. Increase the concession term. Here, the PPA/license is extended by five or ten years with a corresponding adjustment of tariffs so that the original (or other acceptable) equity return is reached by the end of the new contract period. While straightforward to implement, this approach locks in government for a longer period, which may not be desirable. Investor returns are also generated over a longer period.
    
3. Restructuring debt. In this scenario, lenders restructure the existing debt package through refinancing or contract amendments—for example, by lowering margins, extending the tenor, or refinancing in local currency. However, restructuring requires agreement among all existing lenders, which may be difficult to achieve. There may also be refinancing provisions in the PPA that need the offtaker’s cooperation to waive.
    
4. Tax breaks. Here, the government provides a tax holiday or reduces the corporate tax rate in exchange for a lower tariff. The lost tax revenues from the plant may be offset by the benefit of cheaper electricity to end-users.
    
5. Government buydown of debt. Government buys out a tranche of the senior debt, which could be funded on concessional terms. This debt is funded at the government level, where borrowing costs are assumed to be lower. This, of course, comes at an opportunity cost to the government.
    
6. Sharing the fuel cost burden. Fuel costs under a PPA are typically passed through in the tariff and borne by the offtaker. Often, the gas supplier is also government-owned. An option could be to decrease the fuel price by providing a tolling structure, which keeps it outside the PPA. “Real” fuel price considerations can occur behind the scenes outside the PPA context. This approach effectively provides a subsidy to the power plant by the government.

Most likely, the solution would involve a combination of some of the above, depending on a project’s unique situation. But what role should the World Bank play in helping governments and the private sector consider options such as these? Working with governments to help shed light on the private sector implications that come into play can go a long way to ensuring a mutually acceptable restructuring solution, which can materially reduce the burden to the state.

In my view, our role as honest brokers is to help governments better think through and understand public sector implications and private sector considerations.  We can also help governments identify and hire financial advisory firms to conduct analyses and help explore options.

There’s an important reason why we’re in this business in the first place: to ensure continuity of affordable and inclusive infrastructure service provision in moments of stress. The overarching reason for this is to ensure that vulnerable populations around the world have steady access to the power, transport, and connectivity they need to reduce poverty and increase shared prosperity.
 

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