Indexing availability payments: where $179 million goes

Availability payments in PPPs are usually indexed once a year. A wrong indexation formula is barely visible in year one and very expensive by year fifteen.

What the payment covers

The annual payment pays for two different things:

• operations and maintenance: staff, materials, energy. These costs really do rise with inflation
• return of invested capital and debt service. This part is fixed in the loan agreements and does not move with inflation

Only the first part should be indexed. Index the whole payment and the state compensates inflation on costs that are not rising.

The numbers

Illustrative project: $10 million a year for 25 years. Operations 40%, capital and debt 60%. Inflation 6% a year.

Operating share indexed only:

• year-10 payment: $12.8 million
• total over 25 years: $369.5 million

Whole payment indexed:

• year-10 payment: $16.9 million
• total over 25 years: $548.6 million

That is $179 million in nominal terms, about $82 million in today's money at 4.5%.

Other places money leaks

Even with the right formula, overpayment happens in practice:

• the index does not match the cost base. UK Private Finance Initiative contracts long used the Retail Price Index, historically above the Consumer Price Index
• multi-index formulas with lags are calculated by hand and never reconciled
• the private partner's annual invoice is accepted without checking it against the financial close model

What the public partner can do

• split the payment into indexed and fixed components in the tender documents
• choose an index that reflects the actual cost structure
• reconcile every annual invoice with the financial model before paying, and record the differences

Inflation risk on operations reasonably sits with the state. Nothing in the contract requires it to pay more than that.

Illustrative calculation; real project parameters will differ.