Colombia - Toll Road Concession Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 22931 PROJECT COMPLETION NOTE COLOMBIA TOLL ROAD CONCESSION PROJECT (LOAN 4370-CO) October 31, 2001 Finance, Private Sector and Infrastructure Department Country Management Unit - LCC1C Latin America and the Caribbean Regional Office This document has a restricted distribution and may be used by recipients only in the performance of their officials duties. Its contents may not otherwise be disclosed without World Bank authorization. l  CURRENCY EQUIVALENTS Current Unit = Colombian Pesos (Col$) Exchange Rate US$1.00 = Col$ 2,395.10 (October 29, 2001) FISCAL YEAR OF THE GOVERNMENT OF COLOMBIA January 1 - December 31 ABBREVIATIONS AND ACRONYMS Cc - Concession Contract GOC - Government of Colombia INVIAS - National Institute of Highways (Instituto Nacional de Vias) MOT - Ministry of Transport PPP - Private-Public Partnership PRG - Partial Risk Guarantee PPIAF - Public Private Infrastructure Advisory Facility Vice President: David de Ferranti Country Manager/Director: Olivier Lafourcade Sector Manager/Director: Danny Leipziger Task Teamn Leader/Task Manager: Jose Luis Irigoyen  FOR OFFICIAL USE ONLY PROJECT COMPLETION NOTE COLOMBIA TOLL ROAD CONCESSION PROJECT I. This is the Project Completion Note on a Loan in the amount of US$137.1 million to the Republic of Colombia for a Toll Road Concession Project. The Project was presented to and approved by the Board of Directors on July 2, 1998 (Report No. 17986-CO). The Bank loan was to support three government up-front capital contributions under a Concession contract entered into with a private concessionaire for the purpose of mobilizing part of the financing and so helping to implement the above mentioned Project. The Loan Agreement was signed on December 4, 1998 and became effective on December 23, 1998. A first contribution was disbursed into a Project Trust (about 26 percent of the loan amount) but no significant implementation of the Project was achieved (see paragraph 12) before the Loan Account was closed on April 30, 2001. This Project Completion Note has been issued instead of an Implementation Completion Report, in accordance with Paragraph 4 of OP 13.55, that deals with Implementation Completion Reporting, since the Project falls in one of the exceptional cases provided therein, as the Project was terminated before significant implementation could be initiated. 2. Project Objectives. The overall purpose of the Project was to improve transport conditions along a strategic highway corridor linking Bogota with Medellin and the ports on the north coast, through an effective and sustainable private-public partnership (PPP). The overarching aims were: (a) reducing transport costs and improving the level of service along that highway corridor by building and upgrading key sections; (b) attracting and maintaining adequate private sponsors and entrepreneurs to mobilize equity and debt through more favorable financing structures than those attained in previous road concessions in Colombia (those belonging to the so-called first generation), finance road improvements, and manage operations; and (c) strengthening the capacity of the national roads agency (INVIAS) to prepare future road concession projects and put into effect key polices for sustainable development of highway corridors. 3. These objectives were consistent with GOC's strategy and the Bank's Country Assistance Strategy dated October 15, 1997, which supported, among others, the objective of improving the quantity and quality of infrastructure services by encouraging and facilitating private sector participation. The Project was intended to contribute to this strategy and help enhance Government's position in private sector infrastructure deals by supporting its role in mitigating, at a reasonable cost, the risks that could not be covered by the private sector. 4. At the beginning of the nineties, Colombia had enjoyed an important advantage over its neighbors in accessing international capital due to its investment grade credit rating, although at the time of Project design only a limited number of road projects had attracted private financing, with maturities and interest rates that were costly for undertaking large road projects. Projects of the size of the Toll Road Concession Project would have to rely on both local and foreign capital markets to obtain the needed amounts and maturities of debt financing. The public-private partnership to be advanced with the Toll Road Concession Project was expected to allow INVIAS to expand the concession program to larger projects, not fully financeable by the private sector under the then prevailing financing terms. 5. Project Components. The Project consisted of: (a) the operation and maintenance of the existing road from El Vino to Villeta (Link 1, 51 km); (b) the rehabilitation, operation and maintenance of the existing, winding road from Villeta to Honda (Link 2, 72 km); (c) the construction, operation and maintenance of a new highway from Tobiagrande to Puerto Salgar, including about 15 tunnels and about This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  2 37 bridges and viaducts (Link 3, 68.4 km); and (d) the operation and maintenance of the existing road from Honda to San Alberto (Link 4, 380 km). The Project also included the transfer of the management of about 200 ha. of a sub-Andean land as a natural forest reserve, in order to preserve the environment along the right-of-way of the new road. 6. The execution and management of the Project, and the mobilization of part of the financing required, was to be done by a private concessionaire selected on the basis of International Competitive Bidding. Total cost was estimated at US$572.3 million (including contingencies). The Project's components were to be given in concession for a specified period of time (up to 20 years, including four for construction, with the possibility of extensions for another four years) and under the terms of a concession contract (CC). The construction works were to be undertaken by the concessionaire's Technical Assistant--a construction consortium formed by key shareholders of the concessionaire--under a fixed-term, fixed-price contract. 7. Innovative features in project design. The Project was among the first operations that contemplated Bank support to a privately funded project through credit enhancement instruments offered at the bidding stage. The driving principle was to address risk allocation issues through competitive bidding. Private investors have different attitudes towards country risk, project risks, and revenue potential associated with a project in a particular setting. Thus, the actual level of government support needed for the Project was subject to market testing through competitive bidding. Key elements of the support offered during the bidding process, and the rationale for offering them, were as follows: a) Government up-front capital contribution. The amount of government capital contribution would be decided through competitive bidding, so as to make the Project sufficiently attractive to private investors and compensate them for the externalities associated with the Project. GOC will partially finance the construction costs through a cash contribution, reimbursed in kind when the facility is returned to Government at the end of the concession term or as soon as cumulative Project revenues reached the revenue target set in the concessionaire's bid, whichever was earlier. Without this initial contribution, the Project would be unfinanceable by the private sector, though its economic worth was robust and positive. The toll rates determined by GOC (and to be paid to the Concessionaire during the Concession period) were deemed affordable to users and adequate to avoid excessive traffic diversion and consequent erosion of economic benefits accrued to road users as a result of building the Project. INVIAS included in the concession the operation of an existing contiguous tolled road section to allow economies of scale in Project operation, reduce its financial support, and enhance Project revenues. b) Government Minimum Revenue Support. Even with affordable toll rates, the uncertainty of traffic revenue has been one of the biggest issues hindering private financing of new roads. In order to address this issue, GOC designed a revenue support mechanism, limited in duration and size, to improve the bankability of the Project and reduce financial costs. Bidders were asked to bid on the minimum level of comfort, if any. This support would only be available during the first nine years (including a four-year construction period) out of the proposed 20-year concession. The actual level of GOC's support was expected to represent what the successful bidder assessed in its bid as the minimum revenue that such bidder required for each semester to convince lenders that project revenues would cover estimated debt service and operation and maintenance expenses during the first nine-year period. Revenues in excess of the minimum revenue support would be applied to cover any shortfall during unfavorable years. Thus, GOC's funds would only be used when there was still a shortfall to be filled. Any GOC compensation under this limited revenue obligation would be counted against the revenue target set in the concessionaire's bid. In the event of a revenue shortfall, such portion would have become available to the concessionaire through a Liquidity Mechanism to be funded by a Bank loan to ensure rapid payment.  3 c) Government Support to Tunnel Contingencies. INVIAS would share with the concessionaire contingency costs in tunnel construction, resulting from additional works which could not be foreseen at the design stage (such as changes in geologic or hydrologic conditions), through an incentive structure appropriately designed to contain cost overruns. Under this arrangement, the concessionaire would have absorbed the first 20% of such contingencies, while IINVAS would cover the additional works above that level. The arrangement was intended to lower the final cost of the tunnels to GOC and allow the private sponsors to manage the risk in a cost effective manner, thus improving the bankability of the Project. d) Bank Partial Risk Guarantee. Bidders were given the option to use a Bank Partial Risk Guarantee (PRG) to improve project borrowings. The PRG would protect project lenders or bond holders against debt service default due to INVIAS' inability to comply with its payment obligations in the Concession Contract (CC) in respect of: (i) MOT not authorizing the toll adjustments agreed in the CC; (ii) compensation for events of political force majeure ("Extraordinary Excusable Events"); and (iii) compensation for possible changes in the law (such as changes to environmental standards, imposition of taxes on the collection of tolls, or laws restricting contractual arrangements for toll collection) that could adversely affect the Project's ability to service its debt and lead to a default of the debt covered under the PRG. 8. Overall, compared with previous road concessions in Colombia, the structure offered would allocate risks to the various parties in a more cost effective manner, reduce GOC's exposure to contingent obligations throughout the concession period, and promote a more secure financing structure compared to the existing concessions, capable of tapping the intemational markets, since the conditions of the financing available in the local market were not commensurate with the size of this Project. The risks to be covered under the proposed PRG were restricted to political and regulatory risks over which GOC had direct control. Thus, the level of support subject to competitive bidding aimed at restricting residual risk- bearing by GOC.' 9. Within this framework, at pre-appraisal-ahead of the bidding process and of project approval by the Bank Board of Directors-the role anticipated for the Bank to support the Project and the concession scheme during the bidding stage was designed to both provide enhancement to the Project for increased competition at the bidding stage and more secured private financing; and ease Government cash management constraints through Bank backstopping of INVIAS contingent undertakings (as the budgetary arrangements that otherwise would support government payments might lack the credibility needed). The Bank package consisted of two instruments, namely: (i) one or two loans to INVIAS to backstop its contingent obligations in respect of eligible cost increases in tunnel construction and a Liquidity Mechanism to support revenue shortfall during the early years of the concession, and (ii) a Partial Risk Guarantee to improve project private borrowings. The market was to determine whether these instruments were needed, as bidders would bid on the size and availability period of the proposed Liquidity Mechanism-subject to specified caps-and choose whether or not to use the partial risk guarantee. Thus, the Bank instruments initially chosen to support the Project were selected to maximize the added value of Bank involvement. 10. INVIAS selected the Project sponsors/concessionaire through international competitive bidding, following procedures-for pre-qualification and final bidding-satisfactory to the Bank and before Infrastructure privatization has frequently been accompanied by extensive residual risk-bearing by govemments, which threatens to vitiate its efficiency benefits and confront future govemments with large financial liabilities. This issue was extensively discussed at an international conference organized by the Bank. The conference on "Dealing with Public Risk in Private Infrastructure" was held in Colombia in May 1997.  4 approval of the Project by the World Bank Board of Directors. The tender documents required that the CC be awarded to the bid that represented the least expected cost to the government. The successful bidder requested the lowest Government's capital contribution (about US$83 million short of the immediate competitor) and did not request the other instruments offered by Government and the Bank (which in varying sizes were requested by the other bidders). In contrast, the winning Concessionaire requested the highest expected revenue upon which the concession was to revert to government. The fact that two bidders out of the four who submitted bids, requested all of the instruments supported by the Bank in their bids and the third bidder requested one of the instruments backstopped by the Bank, reinforces the conclusion that the support offered was deemed necessary and critical to attracting competition for the Project. 11. Upon completion of the bidding stage, though the winning bidder had not requested the instruments supported by the Bank, GOC asked the Bank to remain involved in the Project and provide a loan to finance its capital contribution to the Project. The initial pre-appraisal instruments were changed accordingly, and a loan was made to the Republic of Colombia to help finance the budgetary transfers made or to be made to INVIAS. The Republic of Colombia would make available to INVIAS an amount identical, in the aggregate, to the amount of the Loan, the proceeds of which INVIAS would use to deposit in the applicable project Trust Account(s) the three capital contributions requested in the winning bid, subject to the provisions of the CC. This arrangement proved appropriate to shield the Bank loan from the contractual arrangements between the executing agency and the concessionaire. 12. Halted Project Implementation. The winning bidder entered into a CC with clear language restricting changes to key bidding parameters, such as the alignment defined by government for the new road. The CC established three stages -pre-construction, construction and operation-- defined by specific milestones to be met by both the Concessionaire and INVIAS before moving into the next stage 2. The Concessionaire and INVIAS were able to meet the milestones required in the CC for commencement of the Construction Stage. On the part of INVIAS, key events included: (i) completing the acquisition of more than 95 percent of the right-of-way needed for construction of Link 3; (ii) successful completion of a best-practice resettlement plan (for 38 vulnerable families) and the development of a land use plan following Bank guidelines as set forth in the project agreement; and (iii) transferring to the concessionaire the existing road links with the respective toll stations in operation that conform the concessioned network. On the part of the concessionaire, key events included finalizing the engineering designs and reaching financial closure. Regarding the latter, the Concessionaire was able to secured the financing through external borrowing. The size and terms of equity and debt financing committed by the concessionaire to the Project enjoyed a longer maturity and lower interest rates when compared to previous concession projects in Colombia. The resulting financial closure gave comfort to INVIAS and its financial advisors on the viability of the financial plan. Meeting the conditions for commencement of construction prompted the first (and, ultimately, only) Bank loan disbursement (about 26 percent of the loan amount). 13. Upon financial closure, the Concessionaire initiated the operation and maintenance of the existing road from El Vino to San Alberto and carried out the rehabilitation from Villeta to Honda, while collecting tolls on the existing roads and mobilizing resources from its shareholders and lNVIAS. In spite of the sound start-up, no significant implementation of the main construction component was achieved before the Loan Account was closed on April 30, 2001. The difficulties unfolded and escalated throughout 1999. The first notable difficulty arose with the expiration of the financial arrangements on which financial closure was reached, as the Concessionaire did not meet the conditions for a first draw- 2 These stages implied increasing levels of resources committed to the project (which in a manner would give the parties an opportunity to quit the project before incurring in additional' costs or liabilities, albeit subject to the compensation mechanisms stipulated in the CC).  5 down from the commercial loan stipulated in the agreement with the private financier (itself one of the shareholders of the Concessionaire) and did not request an extension. Moreover, the beginning of construction works along Link 3-the main physical component of the Project-was delayed as the Concessionaire was pushing forward a proposal to change substantially the road alignment, which INVIAS eventually rejected. 14. On June 2000 INVIAS gave notice to the Concessionaire that the latter's right to implement the Project had been forfeited, pointing out a number of situations which, in the view of INVIAS, constituted a breach of contract by the Concessionaire, and claiming the pecuniary compensations provided under applicable Colombian Law (which could become payable by the Concessionaire if it is determined by the appropriate Colombian court of law that there has been in fact a breach of contract). The Concessionaire and most of its associates have contested INVIAS' claims before the applicable Colombian courts. Legal proceedings are now under way, and, in the meantime, the object of the Concession has reverted to INVIAS and is thus back under government control and subject to the Colombian Courts' decision(s) on the aforesaid litigation. 15. The early termination of the concession has made impossible the attainment of the Project objectives in the manner and timeframe envisaged at appraisal. It also left the construction works along Link 3 incomplete. Although earthworks were done on some unconnected sections along the alignment, construction of tunnels and main viaducts--the bulk and more complex part of the investment--never begun. The Project road network reverted to INVIAS in December 2000. 16. INVIAS is presently implementing the following short-term actions, with some Bank assistance in the context of the continuous sectoral dialogue: (i) completing a final audit of the financial statements of the Project Trust Account from the beginning of the Project, as part of the liquidation/unilateral termination process 3; (ii) temporary works and preventive measures to ensure the environmental sustainability of those works along Link 3 which were left incomplete and without environmental protection due to the suspension of project activities. INVIAS has already identified the activities to be performed and their location and the preparation of respective bill of quantities and the ultimately contracting out the works is underway. The plan also addresses social issues, as INVIAS must engage in a dialogue with the affected rural communities to explain the nature of the problems encountered and the actions being considered to solve them and mitigate the social consequences of the interruption of the works. INVIAS allocated Col$56,000 million in its budget for 2001 to carry out environmental works along Link 3; and (iii) the continuity of the operational and maintenance services along the existing road network (Links 1, 2 and 4). Taking into consideration the existence of tolls, INVIAS needs to put in place appropriate schemes to maintain, and in certain sections improve, the level of service of the existing network and the delivery of operational services of at least the same quality of the ones offered by the concessionaire. At their current level, toll revenue will amount to about Col$24-26,000 million per year, which would be sufficient if allocated to this purpose. 3 All disbursed project funds (for an amount of about US$37 million) were channeled through a Project Trust Account and used for project-related expenditures. The CC contained some specific provisions limiting the use of public funds from INVIAS' capital contributions and toll revenues during construction stage. According to available information from the Trust Account (which is being audited fully within the context of the liquidation of the contract), the project mobilized resources amounting Col$214,461 million. The government capital contribution represented 53 percent of this amount, toll revenues about 23 percent, financial revenues about 23 percent and equity from the shareholders about 2 percent. Expenditures amounted to Col$123,500 million, allocated as follows: about 51.7 percent to construction works, about 11.4 percent to operation of existing road links, about 10.4 percent to design studies, and about 2.4 percent to road maintenance; the remaining (about 24.1 percent) was used to cover expenses such as administration, taxes, and others. The balance remaining in the Trust Account amounts to about Col$90,961 million. Those funds are currently "frozen", until the liquidation of the contract is completed.  6 17. For the long term, INVIAS has highlighted the strategic importance of the Project for the Colombian road system and its commitment to pursuing its implementation in spite of this initial drawback. An appropriate scheme for continuing project implementation has yet to be defined as the on- going litigation process imposes some constraints. The Colombian government continues-albeit at a much slower pace than expected-with its plan to expand the road concession program. The underlying principles behind a proposed third generation of concessions are in principle sound, but the issue remains how to best manage uncertainties and their consequences on project financial returns. The program would rely on the Fondo de Contingencias, created by legislation in 1998 but not yet operational, to partially fund government contingent obligations under concession contracts. 18. This sectoral dialogue on road concessions between the Bank and the INVIAS is being furthered through the Bank sector work on "Issues and Options for Enhancing the Sustainability of the Toll Road Program in Colombia", for which PPIAF approved a grant. This sector work would provide an opportunity to deepen the concepts advanced with the Toll Road Concession Project, and its possible application to a third generation of concessions to better evaluate their sustainability.