PROJECT FINANCE WATER AND WASTE WATER SECTOR EXPERIENCE

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PFI for Waste Management Contracts Financial
Issues
21 November 2003
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Content

• 1. Analysis of financial status of contractors
• 2. Analysis of financial models
• 3. Developing a Payment Mechanism

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1. Analysis of financial status of contractors
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The Procurement Process - ELWA
BAFO
ITN Bid Stage
Prequalification/ISOP
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Pre Qualification Stage Analysis of Financial
Status

• Issues for the Authority
• In a consortium which party is doing what?
• Are the operational companies (not the
  contracting SPV) a good credit risk?
• Are the applicants experienced in raising finance
  for similar projects?
• Analysis based on
• Review of accounts
• Responses to questionnaire
• EU Directive restrictions
• Invitation to Submit Outline Proposals?

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Typical Limited Recourse Financing Structure
Local Authority
Public sector
Private sector
Project Finance
Equity
SPV
Investors
Construction Company
Operating Company

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2. Analysis of Financial Models
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Analysis of Financial Models - ITN Evaluation

• Price
• Base case
• Sensitivities e.g. waste growth
• Robustness
• Reliance on third party income?
• Cover Ratios
• Deliverability
• commitment of funders
• consistency of term sheet and model

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Analysis of Financial Models BAFO/Negotiation
Phase

• Negotiation on Risk Issues
• contingencies
• benchmarking
• Audit
• form of opinion
• to whom is it addressed?
• Interest Rate Risk
• optimisation
• hedging

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3. Developing a Payment Mechanism
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What is the Objective of the Payment Mechanism
A well designed payment mechanism should

• Optimise risk transfer and thereby
• Incentivise the contractor to deliver the
  specified services
• Allow the Authority to demonstrate Value for
  Money
• Contribute to an off-balance sheet opinion under
  FRS 5

• Design constraints include
• Commercial logic!
• Clarity - principles and drafting
• Resource cost of using the mechanism

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Features of Payment Mechanism in the Waste Sector
(1)

• The Unitary Charge is typically fragmented
  between
• Fees payable for receiving, handling,
  transporting, processing and disposing of waste
• Fees payable for managing sites
• Payments in respect of landfill tax
• Deductions for service failures
• Identification of the separate elements of
  Unitary Charge raises FRS5 issues but..
• Off balance sheet treatment has been achievable
  in the past

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Features of Payment Mechanisms in the Waste
Sector (2)

• For IWM contracts the mechanism typically
  incentivises the Contractor to
• accept all Contract Waste (within defined limits)
• recycle a defined percentage of contract waste
• divert a defined percentage of contract waste
• make CA sites available during specified opening
  hours
• Landfill tax - the mechanism typically leave the
  majority of the risk re changes in the rate with
  the Authority.
• Special provisions often apply for non-standard
  contract waste which is particularly expensive to
  manage

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The Formula
UC (BREN) C L (DMP)
Waste Management Fees
Deductions
C CA Site Payments L Landfill Tax Payment D
Unavailability Deductions M Mileage
Deductions P Performance Deductions
UC Unitary Charge B Baseline Payment R
Recycling Supplement E Diversion Supplement N
Non Standard Waste Supplements
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Baseline Payment Volume Related But Banded

• UAC (BREN) C L (DMP)

Band 2
Band 1
Band 4
Band 3
Debt Service and unavoidable operating costs
covered
Tonnage
0
Minimum Tonnage
Maximum Tonnage
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Recycling and Diversion - Contractual Targets
of Contract Waste
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Diversion Supplement Related to Achievement of
Targets

• UAC (BREN) C L (DMP)

Supplement above Target Rate linked to saving on
Landfill Tax
Expected Payment
Diversion Rate ()
0
100
Contracted Target Rate
Termination Trigger Rate
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Non Standard Waste Supplements
UAC (BREN) C L (DMP)

• What is Non Standard Waste ?
• Fridges ?
• Clinical waste ?
• A matter for negotiation but Authorities
  generally seek to minimise scope of carve-out
• Price and volume risk may be separated and
  allocated differently

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Site Payments
UAC (BRDN) C L (DMP)

• Which sites?
• CA sites only is a common approach but
• Could be extended to all sites with Works
• Could be characterised as availability payments
  and linked to UD
• Payments per period do not vary with volume
• May be subject to step changes (normally up) due
  to
• trigger dates e.g to manage affordability
• trigger events e.g. to incentivise completion of
  works

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Site Payments

• UAC (BRDN) C L (DMP)

Fee may be partially or 100 indexed
Time
0
Contract Expiry
Trigger Event/Date
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Landfill Tax Payment

• UAC (BRDN) C L (DMP)

• Tax paid by Contractor in first instance
• Contractor can re-charge the Council the
  prevailing rate of landfill tax on the lower of
  
• tonnage actually taken to landfill
• tonnage that should have taken to landfill (if
  Diversion Target had been met)
• Limits contractor exposure to changes in rate of
  tax but
• ..residual exposure exists as contractor not
  reimbursed for tax on waste that should have been
  diverted from landfill.

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Deductions
AUC (BRDN) C L (DMP)
Deductions

• Aggregate of
• Unavailability Deductions
• Mileage Deductions
• Performance Deductions
• Impact should be proportionate to nature of
  service failure
• Contractor given relief from deductions which
  arise due to specified events

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Issues Related to Payment Mechanism (1)

• Sharing specific excess revenues/gains
• Recyclate income
• Sale of electricity
• Third party waste
• Landfill permits
• Refinancing gains
• Operating costs e.g. due to technological
  innovation
• General excess profit or cashflow sharing
  arrangements

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Issues Related to the Payment Mechanism (2)

• Adjusting UAC for (unforeseen) variations
• Pre-priced (foreseen) variations
• Indexation
• In year payment arrangements
• Measuring waste flows

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Conclusions

• Consistency with output specification is vital
• Standardisation will not elimination negotiation!
• Landfill Allowances may shift focus
• Keep it simple

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Pwc