Another PPP in renegotiations - Mysore Water Project

The Mysore Municipal Corporation's Rs 164 Cr PPP project to provide 24X7 water supply is the latest to fall victim to the curse of contract renegotiations. The Tata owned Jusco won the tender in November 2008 for a three-stage project, financed under the JNNURM, to rehabilitate the existing supply network, reduce non-revenue water, manage operation and maintenance, and deliver 24X7 water to the entire Mysore city over a six year period.

The project had three phases - preparation (1 year), rehabilitation (3 years), and O&M (2 years) - with clearly defined performance clauses. But now with rehabilitation period deadline having passed in January, just 61000 out of the 117000 services have been connected to the rehabilitated network and of them only 13000 have 24X7 supply. Now Jusco is seeking renegotiations. Livemint writes about the reasons,

First, Jusco found problems with the scope of the work defined in the project agreement. When the tripartite agreement was signed, the work was for laying a network of pipelines over 910km with 117,000 connections. During the initial survey done by Jusco, the length of the pipeline network that needs to be rehabilitated was found to be 1,910km with 1.74 lakh connections... With changes in the scope of the work, the estimated cost of the project shot up, and renegotiating became messy. The government does not have money to increase the cost of the project, and even if they did, it would lead to litigation... Jusco is in talks with the government to resolve the discrepancies in the initial surveys... The Planning Commission working group conceded in its report that the risk of data gaps is high and that guaranteeing performance is difficult if a project design is flawed. 

I haven't read the Jusco contract document. But it is clear that Jusco is following the same script as the numerous failed or failing utility PPPs across the world. In all such PPPs, conventional wisdom would have it that the public agency should design the tender in a manner as to align incentives. The most favored design in such water supply rehabilitation and O&M contracts is Engineering Procurement Contracts (EPCs) where the bidders study the network and offer their quotes. These quotes are invariably based on an estimate of how much it would take to rehabilitate, operate and maintain the network for a period of time (Jusco may not be an exact form of this). It is reasoned that this project design will align incentives and encourage bidders to adopt the most optimal rehabilitation and O&M plans and leverage the latest technology, thereby lowering costs and raising efficiency.

However in the real world, this approach rarely ever works, especially for utilities where massive legacy systems dominate. Even with the most comprehensive upfront surveys, baseline information collection, and O&M plans, it is impossible to reliably estimate the cost of any such project. In all such projects, the rehabilitation costs generally emerge in unpredictable manner, as the project work starts. Tailoring an incentive compatible contract becomes an imposing challenge.

In the circumstances, and especially when faced with competition, a market failure ensues. The bidders, eager to be the first-mover in an emerging market with great long-term potential, invariably under-estimate the costs and bid aggressively. Renegotiations are a fait-accompli. In fact, the window of renegotiations serve to generate the moral hazard that drives aggressive bidding. I am not aware of even a single such project which has been successful.

There are no easy solutions. The legacy risks inherent in rehabilitation of existing networks cannot be borne by private operators. It has to be dealt separate from O&M. Its entrustment to private operators poses the aforementioned difficulties. However, once the rehabilitation is done, the performance contracts to monitor O&M is a much more tractable and realistic window to bring in private capital, management, and technology.