Article by Marcus Rodrigo de Senna, partner in our Infrastructure and Infrastructure Project Structuring practices.

The new models for concession contracts must acknowledge the state of uncertainty and, more than that, adjust contract obligations and charges to this situation

The dilemma is posed. Everyone agrees that it is necessary – of course at the right moment, in terms of public health – that the economy will accelerate again and, for this to take place with the necessary speed to avoid a serious recession, everyone converges as to the need for additional stimulus. That infrastructure will be key at that moment is also a consensus, due to the capillarity of the effects of investments trickling down to society.

At the Federal Government sphere, regardless the convergence in thinking there were signs of dissent as to the method to be used, with some ministers considering the application of large direct public investments (Pro-Brazil Plan, also called Marshall Plan, that received a great deal of attention from the media), others insisting on private investments. The situation has been apparently pacified in favour of the Minister of Economics and the Pro-Brazil plan, which at a certain point was even presented as a concept. It has been reclassified by the Minister as studies, something that could be used in the future. In the end, at least for now, the logic of attracting private investments has prevailed.

However, the difficulties for that are also posed. Attracting these private investments will not be a simple matter. Not for lack of interest, but for various difficulties ranging from funding issues, currency exchange rates, to more essential issues such as the difficulty private investors have in preparing minimally reliable projections as to the future behaviour of the variables involved in a large infrastructure contract. How to estimate traffic – be it of cargo or people – for the coming years? The graph for the economic slow-down/pick-up will have the shape of a V or a U? In this last case, how long will this U take, will it be months or years? And, more importantly, will the tip of the U that’s in the future return to the same levels of the initial tip, or will it be a perpetual lower-growth curve?

The specialists recognise that the lack of precedent makes it difficult to foretell the behaviour of the market after the pandemic dies down, also considering the uncertainty as to how long it will last. Will there be a second wave or not? And a third one? When a vaccine or an effective treatment will become available? Even the experience of China – and soon, that of the US and European countries – will not apply to Brazil because the economic, social, political conditions are very different.

To these uncertainties others are added, resulting from the effects of social isolation itself. Will virtual meetings affect the flow of travel on the various means of transportation? Will digital commerce accelerate its impact – which was already taking place – over the retail structure? Will it be convenient to diversify supply chains, for safety? However, will that be possible in an environment where competition is increased? Will these be the new variables to be considered when making economic calculations for projects? What will be their dimension or scope?

These are obviously reasonable possibilities and questions, but until now, every utterance in this regard has looked more like a bet or a wish than an effective response, and for a simple reason: there are no precedents that allow for a more precise analysis.

In the case of infrastructure, however, there is a point in favour of continuity: private agents are eagerly interested in taking part on nationwide infrastructure projects. The question is not so much as whether or not to take part, but quite another, more pragmatic one. It is how to factor the uncertainty that reigns today into a long-term contract set under rigid rules? And to do so in a Country where public agents have had no condition to act – in a legally safe manner – to rescue projects in jeopardy? The examples are many, and it isn’t necessary to list them here, of projects that could have been re-dimensioned and adjusted, but the Country has been debating this issue for years with no success.

In the current context, therefore, any infrastructure bids that may take place may reflect an enormous disparity with some bidders trying to shelter themselves from economic uncertainty, while others, without correctly gauging it – whether aware of this fact or not – will submit bids containing faults that may not be corrected over time – and we’ve been through this experience as well. The recent history of concessions in distress is disheartening, with some notable impasses in concessions for roads, ports, railways, electrical power, to name a few.

Which, then, would be the way to solve this dilemma where, on the one hand the Granting Powers are keenly interested in attracting private investments, and these private entities are keen as well to take part in bids, while on the other hand there is great insecurity in projections, which could lead private entities into making businesses with lower-than-expected results and the Granting Powers into another wave of contracts in jeopardy, thus harming public service?

Perhaps the answer is quite simple in essence. In order to provide a minimum of future security, one that would allow for healthy contracts and would avoid critical situations to be reached in a few short years, the best solution would be to change the concept underlying the models. Instead of the current focus – there’s no need to review it here, we’ve all seen the most recent invitations to bid – the new models should necessarily acknowledge this state of uncertainty and, more than that, adjust contract obligations and charges to this situation.

It doesn’t seem very logical to define a date for increasing the capacity for a project being bid at this moment if the future demand is unknown, whether it will or will not return to the previous levels, if it will increase or when this will take place. Any and all preestablished requirement in a volatile environment may become a superfluous investment, or worse than that, may make bidding for a project unfeasible.

Of course we are not defending that infrastructure bids wherein obligations are not defined, or that do not reflect the essence of concessions and PPPs, which is management by the private entity on their account and risk. What we are suggesting is that, in order to navigate these turbulent waters, new contracts could focus on the so-called “triggers,” whether based on volume, load, passengers, vehicles, etc., so that when the expected demand does take place – not in precisely X or Y years – the investment will take place, because at that moment, resources will be consequent. Without effective demand, the precocious implementation of investments would only serve as a sterile demonstration with no socially fair purpose, and consequently, the concessionaire would be hearing from the financier – whether this be a development or a commercial bank – that revenues from the project would not warrant such high investments.

On the other hand, with the models absorbing this degree of legal and economic uncertainty, contracts will become more fluid, precisely adequate to the effective demand. Revenues will be adjusted as well as any financing that may take place. The excessive risk is then averted, both the one resulting from the impossibility of making reliable projections and, to the Public Powers, that of seeing some recent failures be repeated.

It is always worth remembering that administrative contracts must be efficient. The exaggerated allocation of risks to private entities harms this efficiency, either because bids end up reflecting risks that are remote and hard to quantify, leading to proposing higher tariffs than they should be, or lower assignments, or because, if bidders cannot foresee or are unable to adequately quantify those improbable risks, and they do come to bear, contracts may become unfeasible.

The allocation of certain risks to the State, therefore, is not meant to favour private companies, but has the objective of attempting at contract efficiency, which is the result of a conjugation between the tariff modality and the security of an adequate fulfillment of the contract until the end. Those risks over which private entities have no control should be allocated to the State, so they can be written off from the bid (favouring the tariff modality), because only the Public Entity is capable of factoring it in.

Therefore, the dilemma is posed. It may be a false dilemma, however, because it can indeed be solved.