Demand risk sharing mechanism to address changes in user behavior post-COVID-19

Context

Sao Paulo metropolitan train lines 8 and 9 carried more than 1 million passengers per day pre-COVID-19 from the Amador Bueno station in the city’s far north-west to Grajau station in the city’s south.
The concession contract for the lines was for the operation, maintenance, and upgrade of the network. It will lead to renovated stations, new rolling stock, and upgrades to electrical and signalling systems, with forecast capex of BRL3.2 billion (USD600 million).

COVID-induced restrictions had a significant impact on project structuring, as passenger usage of both lines fell to below 50% of pre-COVID levels.
Government fiscal tightening resulted in reduced long-term public credit to fund large infrastructure projects. Brazil’s infrastructure expenditure represented 2% of GDP, compared to 5.5% in India and 7% in China.
A new management model for the Brazilian Development Bank (BNDES) had resulted in less participation in financing of infrastructure projects.

Demand sharing mechanism under S.35.3 of the Contract spread the risk between the grantor and concessionaire. If demand was more than 15% lower or higher than forecast, this would trigger a financial rebalancing, based on the discrepancy between the forecast and actual figures.
If actual demand is 15-25% higher or lower than forecast figures, the government will take 60% of the extra proceeds or compensate the private partner for 60% of the reduced fares, respectively, within that range.
The risk sharing rate increases to 90% when demand is 25-40% higher or lower than forecast.

Greater private sector involvement in the bidding process: The auction took place on the Brazil stock exchange and set a record for the largest attendence at a concession tender in Brazil.
Downside risk protection: This led to greater interest and higher project valuation (the winning consortium paid a 202% premium to the minimum bid). Under the contract, private sector investors will be guaranteed a minimum IRR of 4.5%.
Improvements in rapid transit: The contract will lead to a new fleet of 34 trains, 4 new stations, and improved services through new signalling systems and maintenance capabilities.

A demand sharing mechanism can encourage private sector investment by providing an investment return floor and protection against poor asset performance or overly optimistic forecasts.
Extensive financial and technical studies in the pre-works phase, and transparent bidding processes, can increase private sector interest and lead to a premium being paid for concessions.