European

Commission


Guide to Cost-Benefit Analysis of Investment Projects

Economic appraisal tool for Cohesion Policy 2014-2020

December 2014

Regional and Urban Policy

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EUROPEAN COMMISSION

Directorate-General for Regional and Urban policy

REGIO DG 02 - Communication

Mrs Ana-Paula Laissy

Avenue de Beaulieu 1

1160 Brussels

BELGIUM

E-mail: regio-publication@ec.europa.eu

Internet: http://ec.europa.eu/regional_policy/index_en.cfm

More information on the European Union is available on the Internet (http://europa.eu). Luxembourg: Publications Office of the European Union, 2015

ISBN 978-92-79-34796-2 doi:10.2776/97516

© European Union, 2015

Reproduction is authorised provided the source is acknowledged.

Printed in Italy

PRiNTED on ELEMENTAL CHLORiNE-FREE BLEACHED paper (ECF)

Guide to Cost-Benefit Analysis of Investment Projects

Economic appraisal tool for Cohesion Policy 2014-2020

European Commission

Directorate-General for Regional and Urban policy

ACKNOWLEDGEMENTS AND DISCLAIMER

Authors: Davide Sartori (Centre for Industrial Studies [CSIL]), Lead author; Gelsomina Catalano, Mario Genco, Chiara Pancotti, Emanuela Sirtori, Silvia Vignetti (CSIL); Chiara Del Bo (Universita degli Studi di Milano).

Academic Panel Review: Massimo Florio (Universita degli Studi di Milano), Panel Coordinator; Per-Olov Johansson (Stockholm School of Economics), Susana Mourato (London School of Economics & Political Science), Arnold Picot (Ludwig-Maximilians-Universitat, Munich), Mateu Turró (Universitat Politecnica de Catalunya).

Technical advisory: JASPERS acted as technical advisor to DG REGIO for the preparation of this Guide, with a focus on the practical issues related to the CBA of major infrastructure projects. In particular, besides peer reviewing the early drafts of the Guide, JASPERS contributed by highlighting best practice and common mistakes in carrying out CBA as well as with the design and development of the seven case studies included in the Guide. The JASPERS team was composed of experts in all sectors covered by the Guide. It was led by Christian Schempp and Francesco Angelini and included Patrizia Fagiani, Joanna Knast-Braczkowska, Marko Kristl, Massimo Marra, Tudor Radu, Paul Riley, Robert Swerdlow, Dorothee Teichmann, Ken Valentine and Elisabet Vila Jorda.

The authors gratefully acknowledges very helpful comments by Witold Willak, Head of Sector, G.1 Major Project Team, the European Commission Directorate-General for Regional and Urban Policy, who has been in charge of the management of the service, by Mateusz Kujawa, European Commission Directorate-General for Regional and Urban Policy, by the members of the Academic Panel Review, by experts from JASPERS and the European Investment Bank (EIB), as well as participants in the Steering Committee meetings including desk officers from the European Commission Directorates-General for Communications Networks, Content and Technology, for Climate Action, for the Environment, for Energy, for Mobility and Transport, for Regional and Urban Policy and for Research and Innovation.

In some cases, constraints of space, of time, or scope of the Guide have limited the possibility by the authors to fully include all the suggested changes to earlier drafts. The usual disclaimer applies and the authors are responsible for any remaining omissions or errors.

The European Commission and the authors accept no responsibility or liability whatsoever with regard to this text. This material is:

•    information of general nature which is not intended to address the specific circumstances of any particular individual or entity;

•    not necessarily comprehensive, accurate or up to date. It is not meant to offer professional or legal advice.

Reproduction or translation is permitted, provided that the source is duly acknowledged and no modifications to the text are made.

Quotation is authorised as long as the source is acknowledged along with the fact that the results are provisional.

LIST OF ABBREVIATIONS

BAU    Business As Usual

CBA    Cost-Benefit Analysis

CF    Conversion Factor

DCF    Discounted Cash Flow

EC    European Commission

EIA    Environmental Impact Assessment

EIB    European    Investment Bank

ENPV    Economic    Net Present Value

ERDF    European    Regional Development    Fund

ERR    Economic    Rate of Return

ESI    European    and Structural Investment

EU    European    Union

FDR    Financial Discount Rate

FNPV    Financial Net Present Value

FRR(C)    Financial Rate of Return of the Investment

FRR(K) Financial Rate of Return on National Capital

GDP    Gross Domestic Product

GHG    Green House Gas

IWS    Integrated Water Supply

LRMC    Long Run Marginal Cost

MCA    Multi-Criteria Analysis

NACE Statistical classification of economic activities

MS    Member State

OP    Operational Programme

O&M    Operation & Maintenance

PPP    Public-Private Partnership

QALY    Quality-Adjusted Life Year

SCF    Standard Conversion Factor

SDR    Social Discount Rate

STPR    Social Time Preference Rate

VAT    Value Added Tax

VOSL    Value of Statistical Life

VOT    Value of Time

WTP    Willingness-to-pay

WTA    Willingness-to-accept

WWTP Waste Water Treatment Plant

Table of Contents

1.1    Introduction...........................................................................................................................................................................................................15

1.2    Definition and scope of ‘Major projects’...............................................................................................................................................15

1.3    Information required, roles and responsibility for the appraisal.............................................................................................17

1.4    Consistency with recent policy developments...................................................................................................................................21

2.1    Introduction...........................................................................................................................................................................................................25

2.2    Project appraisal steps...................................................................................................................................................................................27

2.3    Description of the context............................................................................................................................................................................29

2.4    Definition of objectives...................................................................................................................................................................................30

2.5    Identification of the project..........................................................................................................................................................................31

2.5.1    Physical elements and activities.....................................................................................................................................................31

2.5.2    The body responsible for project implementation.................................................................................................................32

2.5.3    Who has standing...................................................................................................................................................................................33

2.6    Technical feasibility and environmental sustainability.................................................................................................................34

2.6.1    Demand analysis....................................................................................................................................................................................35

2.6.2    Option analysis........................................................................................................................................................................................36

2.6.3    Environment and climate change considerations...................................................................................................................38

2.6.4    Technical design, cost estimates and implementation schedule...................................................................................40

2.7    Financial analysis..............................................................................................................................................................................................41

2.7.1    Introduction................................................................................................................................................................................................41

2.7.2    Methodology..............................................................................................................................................................................................41

2.7.3    Investment cost, replacement costs and residual value.....................................................................................................44

2.7.4    Operating costs and revenues..........................................................................................................................................................45

2.7.5    Sources of financing..............................................................................................................................................................................47

2.7.6    Financial profitability.............................................................................................................................................................................48

2.7.7    Financial sustainability.........................................................................................................................................................................50

2.7.8    Financial analysis in Public Private Partnership (PPP) ..........................................................................................................52

2.8    Economic analysis.............................................................................................................................................................................................54

2.8.1    Introduction................................................................................................................................................................................................54

2.8.2    Fiscal corrections.....................................................................................................................................................................................55

2.8.3    From market to shadow prices.........................................................................................................................................................56

2.8.4    Application of Conversion Factors to project inputs..............................................................................................................58

2.8.5    The shadow wage................................................................................................................................................................................... 58

2.8.6    Evaluation of direct benefits.............................................................................................................................................................59

2.8.7    Evaluation of non-market impacts and correction for externalities..............................................................................61

2.8.8    Evaluation of GHG emissions............................................................................................................................................................62

2.8.9    The residual value..................................................................................................................................................................................63

2.8.10    Indirect and distributional effects...................................................................................................................................................64

2.8.11    Economic performance........................................................................................................................................................................65

2.9    Risk assessment.................................................................................................................................................................................................67

2.9.1    Sensitivity analysis.................................................................................................................................................................................67

2.9.2    Qualitative risk analysis ......................................................................................................................................................................69

2.9.3    Probabilistic risk analysis....................................................................................................................................................................71

2.9.4    Risk prevention and mitigation........................................................................................................................................................73

2.10 Checklist..................................................................................................................................................................................................................75

3.1    Introduction...........................................................................................................................................................................................................77

3.2    Description of the context............................................................................................................................................................................79

3.3    Definition of objectives...................................................................................................................................................................................79

3.4    Project identification........................................................................................................................................................................................80

3.5    Forecasting traffic volume............................................................................................................................................................................81

3.5.1    Factors influencing demand analysis............................................................................................................................................81

3.5.2    Hypotheses, methods and input......................................................................................................................................................82

3.5.3    Outputs of the traffic forecast..........................................................................................................................................................83

3.6    Option analysis...................................................................................................................................................................................................84

3.7    Financial analysis ..............................................................................................................................................................................................84

3.7.1    Investment costs.....................................................................................................................................................................................84

3.7.2    Operation and Maintenance (O&M) costs..................................................................................................................................85

3.7.3    Revenue projections..............................................................................................................................................................................85

3.8    Economic analysis.............................................................................................................................................................................................87

3.8.1    Travel time.................................................................................................................................................................................................90

3.8.2    Road users Vehicle Operating Costs.............................................................................................................................................. 94

3.8.3    Operating costs for service carriers ...............................................................................................................................................95

3.8.4    Accidents.....................................................................................................................................................................................................95

3.8.5    Noise .............................................................................................................................................................................................................97

3.8.6    Air pollution................................................................................................................................................................................................98

3.8.7    Climate change ........................................................................................................................................................................................99

3.9    Risk assessment.................................................................................................................................................................................................99

Case study - Road Project....................................................................................................................................................................................101

Case study - Railway...............................................................................................................................................................................................113

Case study - Urban Transport............................................................................................................................................................................127

4.1 Water supply and sanitation....................................................................................................................................................................145

4.1.1    Description of the context...............................................................................................................................................................147

4.1.2    Definition of objectives.....................................................................................................................................................................148

4.1.3    Project identification...........................................................................................................................................................................148

4.1.4    Demand analysis.................................................................................................................................................................................149

4.1.4.1    Factors influencing water demand.......................................................................................................................149

4.1.4.2    Hypotheses, methods and input data................................................................................................................149

4.1.4.3    Output of demand forecasting..............................................................................................................................150

4.1.5    Option analysis.....................................................................................................................................................................................151

4.1.6    Financial analysis.................................................................................................................................................................................151

4.1.6.1    Investment cost............................................................................................................................................................. 151

4.1.6.2    Operation and Maintenance (O&M) costs........................................................................................................ 152

4.1.6.3    Revenues projections.................................................................................................................................................. 152

4.1.7    Economic analysis ............................................................................................................................................................................... 153

4.1.7.1    Increased availability of drinking water    supply and/or sewer services.............................................153

4.1.7.2    Improved reliability of water sources and water supply service..........................................................154

4.1.7.3    Improved quality of drinking water......................................................................................................................154

4.1.7.4    Improved quality of surface water bodies and preservation of ecosystem services.................155

4.1.7.5    Water preserved for other uses.............................................................................................................................155

4.1.7.6    Health impacts...............................................................................................................................................................156

4.1.7.7    Reduced congestion....................................................................................................................................................156

4.1.7.8    Variation in GHG emissions......................................................................................................................................157

4.1.8    Risk assessment...................................................................................................................................................................................157

4.2    Waste    management......................................................................................................................................................................................158

4.2.1    Description of the context...............................................................................................................................................................159

4.2.2    Definition of objectives.....................................................................................................................................................................160

4.2.3    Project identification...........................................................................................................................................................................160

4.2.4    Demand analysis.................................................................................................................................................................................161

4.2.4.1    Factors influencing waste demand......................................................................................................................161

4.2.4.2    Hypotheses, methods and input    data................................................................................................................161

4.2.5    Option analysis.....................................................................................................................................................................................162

4.2.6    Financial analysis.................................................................................................................................................................................163

4.2.6.1    Investment cost.............................................................................................................................................................163

4.2.6.2    Operation and Maintenance costs.......................................................................................................................163

4.2.6.3    Revenues projections..................................................................................................................................................164

4.2.7    Economic analysis...............................................................................................................................................................................165

4.2.7.1    Resource savings: avoided waste to landfill...................................................................................................165

4.2.7.2    Resource savings: recovery of recyclable materials and production of compost.........................166

4.2.7.3    Resource savings: energy recovered...................................................................................................................166

4.2.7.4    Visual disamenities, noise and odours...............................................................................................................166

4.2.7.5    GHG emissions...............................................................................................................................................................167

4.2.7.6    Health and environmental hazards.....................................................................................................................168

4.2.8    Risk assessment...................................................................................................................................................................................168

4.3    Environment remediation, protection and risk prevention......................................................................................................170

4.3.1    Introduction.............................................................................................................................................................................................170

4.3.2    Description of the context...............................................................................................................................................................171

4.3.3    Definition of objectives.....................................................................................................................................................................171

4.3.4    Project identification........................................................................................................................................................................... 172

4.3.5    Demand analysis.................................................................................................................................................................................173

4.3.6    Financial analysis.................................................................................................................................................................................173

4.3.6.1    Investment and operating costs...........................................................................................................................173

4.3.6.2    Revenue projections....................................................................................................................................................173

4.3.7    Economic analysis...............................................................................................................................................................................173

4.3.7.1    Improved health conditions.....................................................................................................................................174

4.3.7.2    Productive use of land...............................................................................................................................................175

4.3.7.3    Increased recreational value................................................................................................................................... 175

4.3.7.4    Ecosystem and biodiversity preservation ......................................................................................................... 175

4.3.7.5    Reduction of damages    to properties .................................................................................................................. 176

4.3.7.6    Increase in property values ..................................................................................................................................... 176

4.3.8    Risk assessment................................................................................................................................................................................... 177

Case Study    - Water and Waste Water Infrastructure..........................................................................................................................179

Case Study    - Waste Incinerator with Energy    Recovery.......................................................................................................................191

5.1    Introduction........................................................................................................................................................................................................211

5.2    Description of the context.........................................................................................................................................................................213

5.3    Definition of objectives................................................................................................................................................................................213

5.4    Project identification.....................................................................................................................................................................................214

5.5    Forecasting energy demand and supply............................................................................................................................................215

5.5.1    Factors influencing energy demand............................................................................................................................................ 215

5.5.2    Input data for demand analysis...................................................................................................................................................216

5.5.3    Factors influencing    energy supply...............................................................................................................................................216

5.5.4    Input data for supply analysis.......................................................................................................................................................217

5.6    Option analysis................................................................................................................................................................................................217

5.7    Financial analysis...........................................................................................................................................................................................218

5.7.1    Investment cost .................................................................................................................................................................................... 218

5.7.2    Operation and maintenance    costs .............................................................................................................................................. 218

5.7.3    Revenues.................................................................................................................................................................................................. 219

5.8    Economic analysis..........................................................................................................................................................................................219

5.8.1    Energy production, storage, transport, transmission and distribution........................................................................220

5.8.1.1    Increase and diversification of energy supply to meet    increasing demand....................................221

5.8.1.2    Increase of security and reliability of supply..................................................................................................222

5.8.1.3    Reduction of energy costs for substitution of the energy source.........................................................223

5.8.1.4    Market integration........................................................................................................................................................224

5.8.1.5    Improved efficiency......................................................................................................................................................224

5.8.1.6    Variation of GHG and air pollutant emissions................................................................................................225

5.8.2    Energy-efficient consumption for buildings and productive systems........................................................................226

5.8.2.1    Increase of efficiency for consumption..............................................................................................................226

5.8.2.2    Increase of comfort.....................................................................................................................................................227

5.8.2.3    Reduction of GHGs and pollutant emissions..................................................................................................227

5.9    Risk assessment..............................................................................................................................................................................................228

Case Study - Natural gas transmission pipeline.....................................................................................................................................231

6.1    Introduction........................................................................................................................................................................................................241

6.2    Description of the context.........................................................................................................................................................................242

6.3    Definition of objectives................................................................................................................................................................................243

6.4    Project identification.....................................................................................................................................................................................244

6.5    Demand analysis ............................................................................................................................................................................................245

6.5.1    Factors influencing demand............................................................................................................................................................246

6.5.2    Hypotheses, methods and input data.......................................................................................................................................246

6.5.3    Output of the forecasting exercise.............................................................................................................................................247

6.6    Option analysis................................................................................................................................................................................................247

6.7    Financial analysis...........................................................................................................................................................................................248

6.7.1    Investment and operating    costs................................................................................................................................................... 248

6.7.2    Revenue projections...........................................................................................................................................................................248

6.8    Economic analysis..........................................................................................................................................................................................249

6.8.1    Typical benefits and valuation methods..................................................................................................................................249

6.8.2    Increased take-up of digital services for households and businesses......................................................................250

6.8.3    Improved quality of digital    services for households and businesses........................................................................251

6.8.4    Improved provision of digital services for public administrations...............................................................................251

6.9    Risk assessment..............................................................................................................................................................................................252

Case Study - Broadband infrastructure.......................................................................................................................................................255

7.1    Introduction........................................................................................................................................................................................................269

7.1.1    RDI projects in the EU policy agenda.........................................................................................................................................269

7.1.2    Definitions of RDI infrastructures and the focus of the cohesion policy's intervention....................................270

7.2    Description of the context.........................................................................................................................................................................271

7.3    Definition of objectives................................................................................................................................................................................273

7.4    Project identification .....................................................................................................................................................................................273

7.5    Demand analysis ............................................................................................................................................................................................275

7.6    Option analysis ................................................................................................................................................................................................277

7.7    Financial analysis ...........................................................................................................................................................................................278

7.7.1    Investment, operation and maintenance costs .................................................................................................................... 278

7.7.2    Revenues and financing sources.................................................................................................................................................. 278

7.8    Economic analysis..........................................................................................................................................................................................280

7.8.1    Structure of the section .................................................................................................................................................................... 280

7.8.2    Typical benefits..................................................................................................................................................................................... 280

7.8.3    Valuation of benefits to    businesses ........................................................................................................................................... 282

7.8.4 Valuation of benefits to researchers and students............................................................................................................. 287

7.8.5 Valuation of benefits to target population and the general public ............................................................................ 290

7.8.6    Benefit and costs of RDI    infrastructures in a regional perspective............................................................................. 292

7.8.7    Future methodological developments ...................................................................................................................................... 294

7.9    Risk assessment..............................................................................................................................................................................................295

Annex I.    The financial discount rate.........................................................................................................................................................299

Annex II.    The social discount rate...............................................................................................................................................................301

Annex III.    Approaches for empirical estimation of conversion factors...................................................................................305

Annex IV.    The shadow wage...........................................................................................................................................................................313

Annex V.    Tariff setting, polluter-pays principle and affordability analysis..........................................................................317

Annex VI.    Willingness-to-pay approach to evaluate direct and external impacts............................................................321

Annex VII.    Project performance indicators...............................................................................................................................................333

Annex VIII.    Probabilistic risk analysis............................................................................................................................................................337

Annex IX.    Other appraisal tools.....................................................................................................................................................................345

349


Bibliography

Foreword

Evidence-based and successful policy requires making investment decisions based on objective and verifiable methods. This is why the Commission has been continuously promoting the use of Cost-Benefit Analyses (CBA) for major infrastructure projects above €50 million. For the first time, in the 2014-2020 period, the basic rules of conducting CBAs are included in the secondary legislation and are binding for all beneficiaries. In general, the Member States plan to implement over five hundred major projects in the 2014-2020 period.

CBA - that is about measuring in “money terms” all the benefits and costs of the project to society - should become a real management tool for national and regional authorities and therefore we have focused on practical elements in the Guide while keeping abreast of recent developments in the scientific world of welfare economics.


In addition, DG Regional and Urban Policy - together with JASPERS - will establish regular CBA forums for exchanging best practices and experience in carrying out CBAs so that we can continue to improve stakeholders' knowledge and its effective application to specific investment projects. For the sake of creating growth and jobs, Member States' projects financed by the European Structural and Investment Funds need to be completed on time and have to provide expected results to our citizens and enterprises.

I am looking forward to the successful use of EU funding in the coming years to show its added value and role in delivering the Europe 2020 strategy.

Corina Cretu,

European Commissioner for Regional Policy

Introduction

The present guide to Cost-Benefit Analysis (CBA) of investment projects updates and expands the previous edition of 2008. The guide has been revised with consideration for the recent developments in EU polices and methodology for cost benefit analysis and international best practice, and builds on the considerable experience gained in project preparation and appraisal during the previous programming periods of the cohesion policy.

The objective of the guide reflects a specific requirement for the European Commission to offer practical guidance on major project appraisals, as embodied in the cohesion policy legislation for 2014-2020. As with previous versions, however, the guide should be seen primarily as a contribution to a shared European-wide evaluation culture in the field of project appraisal. Its main objective is to illustrate common principles and rules for application of the CBA approach into the practice of different sectors.

The guide targets a wide range of users, including desk officers in the European Commission, civil servants in the Member States (MS) and in candidate countries, staff of financial institutions and consultants involved in the preparation or evaluation of investment projects. The text is relatively self-contained and does not require a specific background in financial and economic analysis of capital investments. The main change with respect to the previous edition concerns a reinforced operational approach and a stronger focus on the investment priorities of the cohesion policy.

The structure of the guide is as follows.

Chapter one presents the regulatory requirements for the project appraisal process and the related decision on a major project. The project appraisal activity is discussed within the more comprehensive framework of the multi-level governance planning exercise of the cohesion policy and its recent policy developments.

Chapter two discusses the CBA guiding principles, working rules and analytical steps that shall be considered for investment appraisal under EU funds. The proposed methodological framework is structured as a suggested agenda and check-list, both from the standpoint of the investment proposer, who is involved in assessing or preparing a project dossier, and the project examiner involved in project appraisals.

Chapters three to seven include outlines of project analysis by sector, focusing on transport, environment, energy, broadband and research & innovation sectors. The aim is to make explicit those aspects of the CBA that are sector-specific, such as typical economic costs and benefits, evaluation methods, reference periods, etc.

To facilitate the understanding and practical application of CBA in the different sectors covered by the Guide, a number of cases studies are provided. The case studies are solely intended as worked examples of the general methodology described in Chapter 2 and the sector specific methodologies. Although the project examples used in the case studies may be partially based on real projects, these have been simplified and modified in many ways to fit the intended purpose, which is why they are not necessarily representative of the complexity of any real project. Also, the projects selected are only illustrative examples of a vast variety of possible project types within each infrastructure sector and should not be seen as a standard project for the given sector. Similarly, none of the specific assumptions featured in any of the case studies are meant to be seen as representative or standard for any other project, in any sector or country, but rather as illustrative examples. Finally, it should also be noted that for reasons of space limitations in this Guide, the case studies have been generally kept as short as possible and thus many details had to be left out in many ways.

A set of annexes cover the following topics: financial discount rate; social discount rate; approaches for empirical estimation of conversion factors; shadow wage; tariff setting, polluter pays principle and affordability; willingness to pay approach; project performance indicators; probabilistic risk analysis; other appraisal tools. The text is completed by a bibliography.

1. CBA in the framework of the EU funds

1.1 Introduction

The EU cohesion policy aims to deliver growth and jobs together with the targets and objectives contained within the Europe 2020 strategy. Choosing the best quality projects which offer best value for money and which impact significantly on jobs and growth is a key ingredient of the overall strategy. In this framework, Cost Benefit Analysis (CBA) is explicitly required, among other elements, as a basis for decision making on the co-financing of major projects included in operational programmes (OPs) of the European Regional Development Fund (ERDF) and the Cohesion Fund.

CBA is an analytical tool to be used to appraise an investment decision in order to assess the welfare change attributable to it and, in so doing, the contribution to EU cohesion policy objectives. The purpose of CBA is to facilitate a more efficient allocation of resources, demonstrating the convenience for society of a particular intervention rather than possible alternatives.

This chapter describes the legal requirements and scope of the CBA in the appraisal of investment projects within the EU cohesion policy, according to the EU regulations and other European Commission documents (see box below). In addition, the role of CBA in the broader framework of EU policy is discussed in light of the EU 2020 Strategy, the targets and objectives of the flagship initiatives and the main sectorial policies and cross cutting issues, including climate change and resource efficiency, in addition to synergies with other EU funding instruments such as the Connecting Europe Facility. The key contents of the chapter are:

•    definition and scope of ‘major projects';

•    information required, roles and responsibility for the appraisal; and

•    consistency with recent policy development and cross cutting issues.

1.2 Definition and scope of 'Major projects’

According to Article 100 (Major projects) of Regulation (EU) No 1303/2013, a major project is an investment operation comprising ‘a series of works, activities or services intended to accomplish an indivisible task of a precise economic and technical nature which has clearly identified goals and for which the total eligible cost exceeds EUR 50 million.' The total eligible cost is the part of the investment cost that is eligible for EU co-financing.1 In the case of operations falling under Article 9(7) (Thematic objectives) of Regulation (EU) No 1303/2013, the financial threshold for the identification of major project is set at EUR 75 million.

THE LEGAL BASIS FOR MAJOR PROJECTS APPRAISAL

•    Regulation (EU) No 1303/2013 of the European Parliament and of the Council of 17 December 2013 laying down common provisions on the European Regional Development Fund, the European Social Fund, the Cohesion Fund, the European Agricultural Fund for Rural Development and the European Maritime and Fisheries Fund and laying down general provisions on the European Regional Development Fund, the European Social Fund, the Cohesion Fund and the European Maritime and Fisheries Fund and repealing Council Regulation (EC) No 1083/2006.

•    Commission Delegated Regulation (EU) No 480/2014 of 3 March 2014 supplementing Regulation (EU) No 1303/2013.

•    Commission Implementing Regulation (EU) No 1011/2014 of 22 September 2014 laying down detailed rules for implementing Regulation (EU) No 1303/2013 of the European Parliament and of the Council as regards the models for submission of certain information to the Commission and the detailed rules concerning the exchanges of information between beneficiaries and managing authorities, certifying authorities, audit authorities and intermediate bodies (hereinafter called IR on notification procedure and IQR)

•    Commission Implementing Regulation (EU) laying down detailed rules implementing Regulation (EU) No 1303/2013 of the European Parliament and of the Council as regards the models for the progress report, submission of the information on a major project, the joint action plan, the implementation reports for the Investment for growth and jobs goal, the management declaration, the audit strategy, the audit opinion and the annual control report and the methodology for carrying out the cost-benefit analysis and pursuant to Regulation (EU) No 1299/2013 of the European Parliament and of the Council as regards the model for the implementation reports for the European territorial cooperation goal (hereinafter called IR on application form and CBA methodology)

The definition of a major project does not apply to the operation of setting up a financial instrument, as defined by Article 37 (Financial instrument) of Regulation (EU) No 1303/20 1 32, which should undergo a specific procedure3. In the same vein, a Joint Action Plan, as defined by Article 104 (Joint action plan) of Regulation (EU) No 1303/20134 is not a major project. Major projects may be financially supported by the ERDF and Cohesion Fund (hereafter the Funds) as part of an OP or more than one OP (see box below). While the ERDF focuses on investments linked to the context in which firms operate (infrastructure, business services, support for business, innovation, information and communication technologies [ICT] and research applications) and the provision of services to citizens (energy, online services, education, health, social and research infrastructures, accessibility, quality of the environment)5, the Cohesion Fund supports interventions within the area of transport and environment. In the environment field, the Cohesion Fund specifically supports investment in climate change adaptation and risk prevention, investment in the water and waste sectors and the urban environment. Investments in energy efficiency and renewable energy are also eligible for support, provided it has positive environmental benefits. In the field of transport the Cohesion Fund contributes to investments in the Trans-European Transport Network, as well as low-carbon transport systems and sustainable urban transport6.

THE INCLUSION OF MAJOR PROJECTS IN AN OPERATIONAL PROGRAMME

According to Article 96 (Content, adoption and amendment of operational programmes under the Investment for growth and jobs goal) of Regulation (EU) No 1303/2013, an operational programme shall set out (...) ‘a description of the type and examples of actions to be supported under each investment priority and their expected contribution to the specific objectives referred to in point (i), including the guiding principles for the selection of operations and, where appropriate, the identification of main target groups, specific territories targeted, types of beneficiaries, the planned use of financial instruments and major projects.’

As part of the operational programme(s), the implementation of major projects should be examined by the Monitoring Committee appointed for the specific programme(s) (Article 110). Progress on their preparation and implementation shall be reported in the Annual Implementation Report (Article 111), which Member States are asked to submit annually, from 2016 to 2023.

Financial instruments can be set up to finance major projects, even in combination with ERDF or Cohesion Fund grants. In the latter case separate records must be maintained for each form of financing. In addition, the applicant is asked to specify the type of financial instruments used for financing the project.

1.3 Information required, roles and responsibility for the appraisal

In order to get the approval for the co-financing of the major project, the managing authority (MA) of the programme(s) which submits the project is asked to make available the information referred to in Article 101 (Information necessary for the approval of a major project) of Regulation (EU) No 1303/2013 (see box).

INFORMATION REQUIRED

(a)    Details concerning the body responsible for implementation of the major project, and its capacity.

(b)    A description of the investment and its location.

(c)    The total cost and total eligible cost, taking account of the requirements set out in Article 61.

(d)    Feasibility studies carried out, including options analysis, and the results.

(e)    A CBA, including an economic and a financial analysis, and a risk assessment.

(f)    An analysis of the environmental impact, taking into account climate change mitigation and adaptation needs, and disaster resilience.

(g)    An explanation as to how the major project is consistent with the relevant priority axes of the OP or OPs concerned, and its expected contribution to achieving the specific objectives of those priority axes and the expected contribution to socio-economic development.

(h)    The financing plan showing the total planned financial resources and the planned support from the Funds, the EIB, and all other sources of financing, together with physical and financial indicators for monitoring progress, taking account of the identified risks.

(i)    The timetable for implementing the major project and, where the implementation period is expected to be longer than the programming period, the phases for which support from the Funds is requested during the programming period.

The information in Article 101(a to i) represents the basis for appraising the major project and determining whether

support from the Funds is justified.

According to Article 102 (Decision on a major project) of Regulation (EU) No 1303/2013, the appraisal procedure can take two different forms. It is up to the Member State to decide which of the two forms to apply for specific major projects under its OPs:

•    the first option is an assessment of the major project by independent experts followed by a notification to the Commission by the MA of the major project selected. According to this procedure, the independent experts will assess the information provided on the major project according to Article 101;

•    the second option is to send the major project documentation directly to the Commission, in line with the procedure of the 2007-2013 programming period. In this case, the MS shall submit to the Commission the information set out in Article 101, which will be assessed by the Commission.

Regardless of the procedure adopted, the aim is to check that:

•    the project dossier is complete, i.e. all the necessary information required by Article 101 is made available and is of sufficient quality;

•    the CBA analysis is of good quality, i.e. it is coherent with the Commission methodology; and

•    the results of the CBA analysis justify the contribution of the Funds.

The results of the analysis should, in particular, demonstrate that the project is the following:

   consistent with the OP. This is demonstrated by checking that the result(s) produced by the project (e.g. in terms of employment generation, carbon dioxide reduction, etc.) contribute to the specific objective(s) of the priority axis of the programme and policy goals;

   in need of co-financing. This is assessed by the financial analysis and, particularly, with the calculation of the Financial Net Present Value and the Financial Rate of Return of the Investment (FNPV(C) and FRR(C) respectively). To gain a contribution from the Funds, the FNPV(C) should be negative and the FRR(C) should be lower than the discount rate used for the analysis (except for some projects falling under State Aid rules for which this may not be relevant7);

   desirable from a socio-economic perspective. This is demonstrated by the economic analysis result and particularly by a positive Economic Net Present Value (ENPV)8.

In order to assess if the results of the CBA actually support a case for the major project approval, the CBA dossier should demonstrate that the methodology is sound and consistent. To this end, it is of paramount importance that all the information related to the CBA is made easily available and is discussed convincingly by the project beneficiary in the form of a quality CBA report, that refers to methods and tools used (including the model(s) used for calculations) as well as all the working hypotheses underpinning the analysis and especially the forecasts of future values, in addition to their sources. A quality CBA report should therefore be: self-contained (results of previous studies should be briefly recalled and illustrated); transparent (a complete set of data and sources of evidence should be made easily available); verifiable (assumptions and methods used to calculate forecast values should be made available so that the analysis can be replicated by the reviewer); and credible (based on well-documented and internationally accepted theoretical approaches and practices).

Figure 1.1 Role and responsibilities in the Major Project’s appraisal


Selection of the appraisal procedure

1

l

1

/ N X N

S

s

s

N

Li'

\

Art. 102 (1)

Art. 102 (2)

procedure

i

procedure

i

y

I

y






Makes available information referred to in Art.101 to the independent experts

1

1

Makes available information referred to in Art. 101 and submits an Application Form to the Commission services

1

]

1

1

y

1

Assess the project on the basis of the information referred to in Art. 101 and produce an Independent Quality Review report

|

|

|

|

|

|

|

1

|

i

]

y

]

]

]

r

Submits a notification of the selected project to the Commission services

|

T

y

1

]

V

Assesses the project on the basis of the Independent Quality Review report

Assesses the project on the basis of the information referred to in Art. 101 with the support of the EIB (if necessary)

]

]

V

]

V


The project is approved/rejected


Source: Authors


Figure 1.2 The role of CBA in the appraisal of the major project

* With exceptions, as set out in Annex III to the Implementing Regulation on application form and CBA methodology. Source: Authors

Where the major project has received a positive appraisal in a quality review by independent experts, according to Article 102(1) (Decision on a major project) of Regulation (EU) No 1303/2013, the Member State may proceed with the selection of the major project and shall notify the Commission. The Commission has 3 months to agree with the independent experts, or adopt the Commission decision refusing the financial contribution to the major project.

If the Commission appraises the major project in accordance with Article 102(2), the Commission shall adopt its decision on the approval (or rejection) of the financial contribution to the selected major project, by means of an implementing act, no later than three months from the date of submission of the information referred to in Article 101.

The co-financing rate for the priority axis, under which the major project is included, shall be fixed by the Commission when adopting the OP [Article 120 (Determination of co-financing rates) of Regulation (EU) No 1303/2013]. For each priority axis, the Commission shall set out whether the co-financing rate for the priority axis is to be applied to the total eligible expenditure (including public and private expenditure) or to the public eligible expenditure. As stated in Article 65 (Eligibility) of Regulation (EU) No 1303/2013, the eligible expenditure of an operation, including major projects, is determined on the basis of national rules ‘except where specific rules are laid down in, or on the basis of, this Regulation or the Fund-specific rules'. Also, specific provisions apply in the case of revenue-generating projects (see box).

The financing method and appraisal procedure of major projects has therefore changed with respect to the 2007-2013 programming period. Table 1.3, displayed at the end of the chapter, highlights the main differences introduced by the new regulations as compared to the Council Regulation 1083/2006.

REVENUE-GENERATING PROJECTS

Revenue-generating projects are investment operations in which discounted revenues are higher than discounted operating costs. According to Article 61 (Operations generating net revenue after completion) of Regulation (EU)

No 1303/2013, the eligible expenditure to be co-financed from the Funds shall be reduced, taking into account the potential of the operation to generate net revenue over a specific reference period that covers both implementation of the operation and the period after completion. The potential net revenue of the operation shall be determined in advance by one of the following methods:

1)    Application of a flat rate for the net revenue percentage. It is a simplified approach as compared to the previous programming period.

2)    Calculation of discounted net revenue of the operation. This is the method used in the 2007-2013 programming period, in accordance with Article 55 of the Council Regulation 1083/2006.

3)    Application of reduced co-financing rates for particular priority axes.

Where it is not objectively possible to determine the revenue in advance according to these methods, Article 61 states that ‘the net revenue generated within three years of the completion of an operation [...] shall be deducted from the expenditure declared to the Commission.’

It should be noted that Article 61 does not apply to operations for which support under the programme constitutes:

(a) de minimis aid; (b) compatible State aid to small and medium-sized businesses (SMEs), where an aid intensity or an aid amount limit is applied in relation to State aid; or (c) compatible State aid, where an individual verification of financing needs in accordance with the applicable State aid rules has been carried out.

1.4 Consistency with recent policy developments

For the 2014-2020 programming period, cohesion policy and its Funds are deemed to be a key delivery mechanism to achieve the objectives of Europe 2020 strategy9' As stated in Article 18 (Thematic concentration) of Regulation (EU) No 1303/2013, Member States shall concentrate the EU support (in accordance with the Fund's-specific rules) on actions that bring the greatest added value in relation to the Europe 2020 priorities of smart growth, sustainable growth and inclusive growth.

The EU has set five ambitious targets - in the fields of employment, innovation, education, social inclusion and climate/ energy - which are to be achieved at EU level by 2020. To meet these targets, the Commission proposed a Europe 2020 agenda consisting of seven flagship initiatives representing the investment areas supporting the Europe 2020 priorities. These include: innovation; digital economy; employment; youth; industrial policy; and poverty and resource efficiency.

Actions under the smart growth priority will require investments aimed at strengthening research performance, promoting innovation and knowledge transfer throughout the Union, making full use of ICTs, ensuring that innovative ideas can be turned into products and services that create growth, improving education quality. Investments in specific sectors, such as R&D, ICT and education are considered to be of major strategic importance in the promotion of this objective;

To achieve sustainable growth, it is necessary to invest in operations aimed at limiting emissions and improving resource efficiency. All sectors of the economy, not just emission-intensive ones, are concerned. Environmental measures in water and waste management, investments related to transport and energy infrastructures, as well as instruments based on the use of ICT, are expected to contribute to the shift towards a resource efficient and low-carbon economy. A further step towards sustainable growth will be achieved by supporting manufacturing and service industries (such as tourism) in seizing the opportunities presented by globalisation and the green economy;

Inclusive growth priority requires actions aimed at modernising and strengthening the employment and social protection systems. In particular, this priority specifically addresses the challenge of demographic change by increasing labour participation and reducing structural unemployment (especially for women, young people and older workers). In addition, it will address the challenges of a low skilled workforce and marginalisation (e.g. children and elderly who are particularly exposed to the risk of poverty). In this regard, investments in social infrastructure, including childcare, healthcare, culture and education facilities, will help improve skills. This will enable citizens to balance work with their private lives, and will reduce social exclusion and health inequalities, thus ensuring that the benefits gained from growth can be enjoyed by everyone;

Table 1.1. shows how specific investment sectors are related to the Europe 2020 priorities, flagship initiatives and targets. Within this context, major projects play a key role and their appraisal should be seen as part of a larger planning exercise aimed at identifying the contribution of the project to the achievement of the Europe 2020 strategy. In addition, the projects must comply with EU legislation (e.g. public procurement, competition and State-aid) and sectorial policies.

Finally, all sectors and investments are required to comply with EU climate policy. Climate change issues, both mitigation and adaptation aspects, must be taken into account during the preparation, design and implementation of major projects. That is, major projects shall contribute to the progressive achievement of emissions reduction targets by 2050. Accordingly, in the context of the co-financing request, MAs are required to explain how mitigation and adaptation needs have been taken into account when preparing and designing the project. Second, major projects should be climate-resilient: the possible impacts of the changing climate have to be assessed and addressed at all stages of their development. In the context of the co-funding request, MAs are required to explain which measures have been adopted in order to ensure resilience to current climate variability and future climate change.

Overall, the CBA provides key support in assessing the contribution of the projects to the achievement of Europe 2020 targets. Table 1.2 below shows how certain effects may be identified and quantified through the CBA.

Table 1.1 Matching Investment sectors and Europe 2020 priorities/flagships/targets

Europe 2020 priorities

Europe 2020 flagship initiatives

Sector/investments

Europe 2020 targets

Employment

Innovation

Climate change

Education

Poverty

Smart

Growth

Innovation Union

- Research, Technological Development and Innovation

V

V

V

Youth on the move

- Education

V

V

Digital Agenda for Europe

- ICT

V

V

Sustainable

Growth

Resource efficient Europe

-    Environment

-    Energy

-    Transport

V

V

V

An industrial policy for the globalisation era

-    Entrepreneurship

-    Industry

V

V

V

Inclusive

Growth

An agenda for new skills and jobs

-    Culture

-    Childcare

V

V

European Platform against poverty

-    Health

-    Housi ng

V

Source: Authors

Table 1.2 The role of the CBA in contributing towards the achievement of the EU objectives

Europe 2020 Targets

Effects quantifiable through the CBA

Guide Section

Employment

The effect, in terms of employment used by the project, is captured by applying the Shadow Wage Conversion Factor to labour cost. The effect, in terms of employment spilling over from the project, is captured by the additional profit created, e.g. by new spin-off companies.

Par. 2.8.5 Annex IV Par. 7.8.3

Innovation

The contribution to the innovation objective is assessed by:

-    the economic returns generated by license deals; and

-    the technological progress generated by the project.

Par. 7.8.3

Climate change

The responses to climate change are assessed by estimating costs and benefits of integrating:

-    climate change mitigation measures, by measuring the economic value of greenhouse gas (GHG) emissions emitted in the atmosphere and the opportunity cost of the energy supply savings;

-    climate change adaptation measures, resulting from the assessment of the project’s risk-exposure and vulnerability to climate change impacts.

Par. 2.6.3 Par. 2.8.8

Education

The contribution to a higher level of education is assessed by estimating the expected increased income of students and researchers due to better positioning on the job market, as well as the economic value of knowledge outputs (e.g. scientific articles).

Par. 7.8.4

Poverty

Effects on poverty reduction may be assessed by evaluating the equity dimension of the project through the consideration of the households affordability (ability-to-pay), in particular the less wealthy, to access a given public service and the computation of a set of welfare weights.

Annex V

Source: Authors

Table 1.3 Main changes compared to the 2007-2013 programming period

2007 - 2013

(Regulation 1083/2006)

2014 - 2020

(Regulation 1303/2013)

Major project threshold

Operations where the total cost exceeds EUR 50 million (Art. 39).

Operations where the eligible cost exceeds EUR 50 million and, in the case of operations contributing to the thematic objective under Article 9(7), EUR 75 million (Art. 100).

Inclusion of

major projects in the OP

The major project is financed as part of an OP or OPs (Art. 39). The list of major projects contained in the OP is indicative.

The major project is financed as part of an OP or OPs. In addition it can be supported by more than 1 priority axis within the OP. Major projects notified to the Commission under paragraph 1, or submitted for approval under paragraph 2, shall be contained in the list of major projects in an OP (Art. 102).

Project appraisal and decision process

-    Submission: MS submits a major project application to the EC. The COM appraises the major project application on the basis of the information referred in Art. 40 and, if necessary, consulting outside experts including the EIB.

-    Decision: The Commission adopts a decision within three months. If the Commission appraises the major project and it does not comply with the Regulations, the MS is requested to withdraw the application. Alternatively, the Commission may adopt a negative decision.

(Art. 41)

-    Article 102 (1) procedure: at the level of the MS, if the MS decides, the major project is assessed by independent experts supported by technical assistance or, in agreement with the Commission, by other independent experts. The MS notifies the Commission about the results by presenting the information required in Article 101. The Commission approves or refuses the MS’s selection of the major project within three months. In the absence of a decision, the project is deemed approved after three months from its notification (Art. 101).

-    Article 102 (2) procedure:

o The MS sends major project application to the Commission. The Commission appraises and adopts a decision approving or refusing the MS selection of the major project within three months (Art.102).

o For an operation which consists of the second or subsequent phase of a major project for which the preceding phase was approved by the Commission and there are no substantial changes compared to the information provided for the major project application submitted in the previous period, in particular as regards the total eligible cost, the MS may proceed with the selection of the major project in accordance with Art. 125(3) and submit the notification containing all the elements, together with confirmation that there are no substantial changes in the major project. No assessment of the information by independent experts is required (Art. 103)

Payment

applications

Expenditure relating to major projects can be included in payment applications before the project has been approved by a Commission decision.

Expenditure relating to major projects may be included in payment applications only after the MA notifies to the Commission of the major project decision or following the submission for major project application approval.

Validity of

Commission

approval

A Commission decision on a major project is valid for the entire programming period.

Approval by the Commission shall be conditional on the first works/PPP contract being concluded within three years of the date of the approval of the project by the Commission. The deadline could be extended in duly motivated cases by not more than two years.

Calculation of net revenue

One possibility:

- Calculation of discounted net revenues (Art. 55).

Three possibilities:

-    Calculation of discounted net revenues

-    Flat rate net revenue percentage

-    Decreasing co-financing rate for a chosen priority axis (Art. 61).

Source: Authors


KJ

4^


GUIDE TO COST-BENEFIT ANALYSIS OF INVESTMENT PROJECTS


2.    General principles for carrying out cost benefit

analysis

2.1    Introduction

Cost-Benefit Analysis (CBA) is an analytical tool for judging the economic advantages or disadvantages of an investment decision by assessing its costs and benefits in order to assess the welfare change attributable to it.

The analytical framework of CBA refers to a list of underlying concepts which is as follows:

   Opportunity cost. The opportunity cost of a good or service is defined as the potential gain from the best alternative forgone, when a choice needs to be made between several mutually exclusive alternatives. The rationale of CBA lies in the observation that investment decisions taken on the basis of profit motivations and price mechanisms lead, in some circumstances (e.g. market failures such as asymmetry of information, externalities, public goods, etc.), to socially undesirable outcomes. On the contrary, if input, output (including intangible ones) and external effects of an investment project are valued at their social opportunity costs, the return calculated is a proper measure of the project's contribution to social welfare.

   Long-term perspective. A long-term outlook is adopted, ranging from a minimum of 10 to a maximum of 30 years or more, depending on the sector of intervention. Hence the need to:

-    set a proper time horizon;

-    forecast future costs and benefits (looking forward);

-    adopt appropriate discount rates to calculate the present value of future costs and benefits;

-    take into account uncertainty by assessing the project's risks.

Although, traditionally, the main application is for project appraisal in the ex-ante phase, CBA can also be used for in medias res and ex post evaluation10.

   Calculation of economic performance indicators expressed in monetary terms. CBA is based on a set of

predetermined project objectives, giving a monetary value to all the positive (benefits) and negative (costs) welfare effects of the intervention. These values are discounted and then totalled in order to calculate a net total benefit. The project overall performance is measured by indicators, namely the Economic Net Present Value (ENPV), expressed in monetary values, and the Economic Rate of Return (ERR), allowing comparability and ranking for competing projects or alternatives.

   Microeconomic approach. CBA is typically a microeconomic approach enabling the assessment of the project's impact on society as a whole via the calculation of economic performance indicators, thereby providing an assessment of expected welfare changes. While direct employment or external environmental effects realised by the project are reflected in the ENPV, indirect (i.e. on secondary markets) and wider effects (i.e. on public funds, employment, regional growth, etc.) should be excluded. This is for two main reasons:

-    most indirect and/or wider effects are usually transformed, redistributed and capitalised forms of direct effects; thus, the need to limit the potential for benefits double-counting;

-    there remains little practice on how to translate them into robust techniques for project appraisal, thus the need to avoid the analysis relies on assumptions whose reliability is difficult to check.

It is recommended, however, to provide a qualitative description of these impacts to better explain the contribution of the project to the EU regional policy goals.11

Incremental approach. CBA compares a scenario with-the-project with a counterfactual baseline scenario

without-the-project. The incremental approach requires that:

-    a counterfactual scenario is defined as what would happen in the absence of the project. For this scenario, projections are made of all cash flows related to the operations in the project area for each year during the project lifetime. In cases where a project consists of a completely new asset, e.g. there is no pre-existing service or infrastructure, the without-the-project scenario is one with no operations. In cases of investments aimed at improving an already existing facility, it should include the costs and the revenues/benefits to operate and maintain the service at a level that it is still operable (Business As Usual12 (BAU)) or even small adaptation investments that were programmed to take place anyway (do-minimum13). In particular, it is recommended to carry out an analysis of the promoter's historical cash-flows (at least previous three years) as a basis for projections, where relevant. The choice between BAU or do-minimum as counterfactual should be made case by case, on the basis of the evidence about the most feasible, and likely, situation. If uncertainty exists, the BAU scenario shall be adopted as a rule of thumb. If do-minimum is used as counterfactual, this scenario should be both feasible and credible, and not cause undue and unrealistic additional benefits or costs. As illustrated in the box below the choice made may have important implications on the results of the analysis;

-    secondly, projections of cash-flows are made for the situation with the proposed project. This takes into account all the investment, financial and economic costs and benefits resulting from the project. In cases of pre-existing infrastructure, it is recommended to carry out an analysis of historical costs and revenues of the beneficiary (at least three previous years) as a basis for the financial projections of the with-project scenario and as a reference for the without-project scenario, otherwise the incremental analysis is very vulnerable to manipulation;

-    finally, the CBA only considers the difference between the cash flows in the with-the-project and the counterfactual scenarios. The financial and economic performance indicators are calculated on the incremental cash flows only14.

The rest of the chapter presents the conceptual framework of a standard CBA15, i.e. the ‘steps' for project appraisal, enriched with focuses, didactical examples or shortcuts, presented in boxes, to support the comprehension and practical application of the steps proposed. At the end of each section, a review of good practices and common mistakes drawn from empirical literature, ex post evaluations and experience gained from major projects funded during the 2007-13 programming period, is also illustrated. A checklist that can be used as useful tool for checking the quality of a CBA closes the chapter. 11 12 13 14 15

THE CHOICE OF THE COUNTERFACTUAL SCENARIO

The following example, adapted from EIB (2013)16, illustrates the issue of the project performance in relation to what scenario is selected as counterfactual.

The proposed project, which consists of rehabilitating and expanding existing infrastructure capacity, involves investing EUR 450 million and will result in benefits growing by 5 % per year. The ‘do-minimum’ scenario, which consists of only rehabilitating existing capacity, involves investing EUR 30 million, followed by constant benefits. The BAU involves no investment at all, which, in turn, will affect the amount of output the facility can produce, causing a fall in net benefits of 5 % per year.

As shown below, the results of the CBA change significantly if different scenarios are adopted as counterfactual. By comparing the proposed project with the ‘do-minimum’ scenario, the ERR equals 3 %. If the BAU is taken as a reference, the ERR increases to 6 %. Thus, any choice should be duly justified by the project promoter on the basis of clear evidence about the most feasible situation that would occur in the absence of the project.

Scenarios

EUR m

NPV

1

2

10

21

1

Proposed project

Net benefit

1,058

45

47

70

119

Investment

435

450

2

Do-minimum

Net benefit

661

45

45

45

45

Investment

29

30

3

Business As Usual

Net benefit

442

45

43

28

16

Investment

0

Results

1-2

Proposed project net of Do-minimum

Net flows

-9

-420

2

25

74

ERR

3%

1-3

Proposed project net of Business As Usual

Net flows

182

-450

4

42

103

ERR

6%

Source: EIB (2013)

2.2    Project appraisal steps

Standard CBA is structured in seven steps:

1.    Description of the context

2.    Definition of objectives

3.    Identification of the    project

4.    Technical feasibility    & Environmental sustainability

5.    Financial analysis

6.    Economic analysis

7.    Risk assessment.

The following sections illustrate, in detail, the scope of each step.

Figure 2.1 The steps of the appraisal

Source: Authors

2.3 Description of the context

The first step of the project appraisal aims to describe the social, economic, political and institutional context in which the project will be implemented. The key features to be described relate to:

•    the socio-economic conditions of the country/region that are relevant for the project, including e.g. demographic dynamics, expected GDP growth, labour market conditions, unemployment trend, etc.;

•    the policy and institutional aspects, including existing economic policies and development plans, organisation and management of services to be provided/developed by the project, as well as capacity and quality of the institutions involved;

•    the current infrastructure endowment and service provision, including indicators/data on coverage and quality of services provided, current operating costs and tariffs/fees/charges paid by users, if any17;

•    other information and statistics that are relevant to better qualify the context, for instance, existence of environmental issues, environmental authorities likely to be involved, etc.;

•    the perception and expectations of the population with relation to the service to be provided, including, when relevant, the positions adopted by civil society organisations.

The presentation of the context is instrumental to forecast future trends, especially for demand analysis. In fact, the possibility of achieving credible forecasts about users, benefits and costs often relies on the assessment's accuracy of the macro-economic and social conditions of the region. In this regard, an obvious recommendation is to check that the assumptions made, for instance on GDP or demographic growth, are consistent with data provided in the corresponding OP or other sectorial and/or regional plans of the Member State.

Also, this exercise aims to verify that the project is appropriate to the context in which it takes place. Any

project is integrated in pre-existing systems with its own rules and features, and this is an imminent complexity that cannot be disregarded. Investments to provide services to citizens can achieve their goals through the integration of either new or renewed facilities into already existing infrastructures. Partnership with the various stakeholders intervening in the system is thus a necessity. Also, sound economic policy, quality institutions and strong political commitment can help the implementation and management of the projects, and the achievement of larger benefits. In short, investments are easier to carry out where the context is more favourable. For this reason, the specific context characteristics need to be taken into due consideration starting from the project design and appraisal phase. In some cases, improvements in the institutional set up might be needed to ensure an adequate project performance.

GOOD PRACTICES

✓    The context is presented including all sectors that are relevant to the project and avoiding unnecessary discussions on sectors that are unrelated to the project.

✓    The existing infrastructure endowment and service provision is presented with relevant statistics.

✓    The sectorial and regional characteristics of the service to be provided are presented in light of the existing development plans.

COMMON MISTAKES

X Socio-economic context and statistics are presented without explaining their relevance for the project.

X Socio-economic statistics and forecasts are not based on readily available official data and forecasts.

X The political and institutional aspects are considered irrelevant and not adequately analysed and discussed.


2.4 Definition of objectives

The second step of the project appraisal aims to define the objectives of the project.

From the analysis of all the contextual elements listed in the previous section, the regional and/or sectorial needs that can be addressed by the project must be assessed, in compliance with the sectorial strategy prepared by the MS and accepted by the European Commission. The project objectives should then be defined in explicit relation to needs18. In other words, the needs assessment builds upon the description of the context and provides the basis for the objective's definition.

As far as possible, objectives should be quantified through indicators and targeted19, in line with the result orientation principle of the Cohesion Policy. They may relate, for example, to improvement of the output quality, to better accessibility to the service, to the increase of existing capacity, etc. For a detailed illustration of the typical objectives per sector see chapters three to seven.

A clear definition of the project objectives is necessary to:

   identify the effects of the project to be further evaluated in the CBA. The identification of effects should be linked to the project's objectives in order to measure the impact on welfare. The clearer the definition of the objectives, the easier the identification of the project and its effects. Objectives are highly relevant for the CBA, which should reveal to what extent they are met;

   verify the project’s relevance. Evidence should be provided that the project's rationale responds to a priority for the territory. This is achieved by checking that the project contributes to reaching the EU policy goals and national/regional long-term development plans in the specific sector of assistance. Reference to these strategic plans should demonstrate that the problems are recognised and that there is a plan in place to resolve them.

Whenever possible, the relationship or, better, the relative contribution of the project objectives to achieve the specific targets of the OPs should be clearly quantified. Such identification will also enable the linking of the project objectives with the monitoring and evaluation system. This is particularly important for reporting the progress of major projects in the annual implementation reports, as requested by Article 111 (Implementation reports for the Investment for growth and jobs goal) of Regulation (EU) No 1303/2013. In addition, according to the most recent policy development of the European and Structural

Investment (ESI) Funds, the promoter should also show how and to what extent the project will contribute to achieving the targets of any national or regional sectorial programme.

GOOD PRACTICES

✓    Project effects are identified in clear relation to the project objectives.

✓    The general objectives of the project are quantified with a system of indicators and targets.

✓ Target values are established and compared to the situations with- and without-the-project.

✓ Project indicators are linked to those defined in the respective OP and priority axis. Where the indicators set at the level of the OP are inappropriate to measure the impact of specific projects, additional project-specific indicators, are set up.

✓    If a region or country-wide target exists (e.g. 100 % coverage of water supply in a given service area, diversion of minimum 50 % of biodegradable waste from landfill, etc.), the contribution of the project to achieving this wider target (in % of total target) is explained.

✓    Source and values of indicators are explained.


COMMON MISTAKES

X The economic effects considered in the CBA are not well aligned with the specific objectives of the project.

X Project objectives are confused with its outputs. For instance, if the main objective of the project is to improve the accessibility of a peripheral area, the construction of a new road or the modernisation of the existing network are not objectives, but the means through which the objective of improving the area’s accessibility will be accomplished.

X Where the investment is compliance driven (e.g. UWWTD20), the extent to which the project contributes to achieve such compliance is not shown. If the required standards are not attained by the project, evidence of what other measures are planned and how they will be financed must be provided.


2.5 Identification of the project

Section 1.2 has presented the legal basis for the definition of a project. Here, some analytical issues involved in project identification are developed. In particular, a project is clearly identified when:

•    the physical elements and the activities that will be implemented to provide a given good or service, and to achieve a well-defined set of objectives, consist of a self-sufficient unit of analysis;

• the body responsible for implementation (often referred to as ‘project promoter' or ‘beneficiary') is identified and its technical, financial and institutional capacities analysed; and

•    the impact area, the final beneficiaries and all relevant stakeholders are duly identified (‘who has standing?').

2.5.1 Physical elements and activities

A project is defined as ‘as a series of works, activities or services intended in itself to accomplish an indivisible task of a precise economic or technical nature which has clearly identified goals' (Article 100 (Content) of Regulation (EU) No 1303/2013). These works, activities or services should be instrumental in the achievement of the previously defined objectives. A description of the type of infrastructure (railway line, power plant, broadband, waste water treatment plant, etc.), type of intervention (new construction, rehabilitation, upgrade, etc.), service provided (cargo traffic, urban solid waste management, access to broadband for businesses, cultural activities, etc.) and location should be provided in order to define the project activities.

In this regard, the key aspect is that appraisal needs to focus on the whole project as a self-sufficient unit of analysis, which is to say that no essential feature or component is left outside the scope of the appraisal (under-scaling). For example, if there are no connecting roads for waste delivery, a new landfill will not be operational. In that case, both the landfill and the connecting roads are to be considered as a unique project. In general, a project can be defined as technically self-sufficient if it is possible to produce a functionally complete infrastructure and put a service into operation without dependence on other new investments. At the same time, including components in the project that are not essential to provide the service under consideration should be avoided (over-scaling).

The application of this principle requires that:

   partitions of project for financing, administrative or engineering reasons are not appropriate objects of appraisal (‘half a bridge is not a bridge'). A typical case might be that of a request for EU financial support for the first phase of an investment, whose success hinges on the completion of the project as a whole. Or, a request for EU financial support for only a part of a project because the remaining will be financed by other sponsors. In these cases, the whole investment should be considered in CBA. The appraisal should focus on all the parts that are logically connected to the attainment of the objectives, regardless of what the aim of the EU assistance is.

   inter-related but relatively self-standing components, whose costs and benefits are largely independent, should be appraised independently. Sometimes a project consists of several inter-related elements. For example, the construction of a green park area including solid waste management and recreational facilities. Appraising such a project involves, firstly, the consideration of each component independently and, secondly, the assessment of possible combinations of components. The measurement of the economic benefits of individual project components is particularly relevant in the context of large multifaceted projects (see box below). As a whole these projects may present a net positive economic benefit (i.e. a positive ENPV). However, this positive ENPV may include one or more project components that have a negative ENPV. If this component(s) is not integral to the overall project, then excluding it will increase the ENPV for the rest of the project.

•    future planned investments should be considered in the CBA if they are critical for ensuring the operations of the original investment. For example, in the case of wastewater treatment, a capacity upgrade of the original plant shall be factored in at a certain point of the project's life cycle, if it is needed to comply with an expected population increase, in order to continue to meet the original project's objectives.

PROJECT IDENTIFICATION: EXAMPLES

The main driver of the improvement of a railway line is its electrification in order to improve its performance and its integration into the electrified network. Given that the construction works will generate some service disruptions, the project incorporates other actions on the line such as alignment improvements, track reconstruction and the adoption of the ERMTS signalling system. The CBA should consider all these investments and their effects.

EU assistance can be designed to co-finance the reorganisation of some water subnets as part of a broader intervention financed with several sponsors and concerning the entire municipality’s water supply network. The larger intervention should be considered as the unit of the analysis.

A system of integrated environmental regeneration which envisages the construction of several waste water treatment plants and the installation of sewage pipelines and pumping stations in different municipalities can be considered as one integrated project if the single components are integral to the achievement of the environmental regeneration of the impact area.

In the context of urban development, the rehabilitation of city walls and streets in the historical centre of a town should be appraised independently from the rehabilitation and adaptation of buildings for commercial activities in the same area.

2.5.2 The body responsible for project implementation

The project owner, i.e. the body responsible for project implementation, should be identified and described in terms of its technical, financial and institutional capacity. The technical capacity refers to the relevant staff resources and staff expertise available within the organisation of the project promoter and allocated to the project to manage its implementation and subsequent operation. In the case of the need to recruit additional staff, evidence should be provided that no constraints exist to find the necessary skills on the local labour market. The financial capacity refers to the financial standing of the body, which should demonstrate that it is able to guarantee adequate funding both during implementation and operations. This is particularly important when the project is expected to require substantial cash inflow for working capital or other financial imbalances (e.g. medium-long term loan, clearing cycle of VAT, etc.). The institutional capacity refers to all the institutional arrangements needed to implement and operate the project [e.g. set up of a Project Implementation Unit (PIU)] including the legal and contractual issues for project licensing. Where necessary, special external technical assistance may need to be foreseen and included in the project.

When the infrastructure owner and its operator are different, a description of the operating company or agency who will manage the infrastructure (if already known) and its legal status, the criteria used for its selection, and the contractual arrangements foreseen between the partners, including the funding mechanisms (e.g. collection of tariffs/service fees, presence of government subsides), should be provided.

2.5.3 Who has standing

After having described the project activities and the body responsible for project implementation, the boundaries of the analysis should be defined. The territorial area affected by the project effects is defined as the impact area. This can be of local, regional or national (or even EU) interest, depending on the size and scope of the investment, and the capacity of the effects to unfold. Although generalisations should be avoided, projects typically belonging to some sectors have a common scope of effects. For example, transport investments such as a new motorway (the same does not usually apply to urban transport), even if implemented within a regional framework, should be analysed from a broader perspective since they usually form part of an integrated network that may extend beyond the geographical scope of the analysis. The same can be said for an energy plant serving a delimited territory but belonging to a wider system. In contrast, water supply and waste management projects are more frequently of local interest. However, all projects must incorporate a wider perspective when dealing with environmental issues related to CO2 and other greenhouse gas (GHG) emissions with effects on climate change, which are intrinsically non-local.

A good description of the impact area requires the identification of the project's final beneficiaries, i.e. the population that benefits directly from the project. These may include, for example, motorway users, households exposed to a natural risk, companies using a science park, etc. It is recommended to explain what type of benefits will be enjoyed and to quantify them as much as possible. The identification of the final beneficiaries should be consistent with the assumptions of the demand analysis (see section 2.7.1).

In addition, all bodies, public and private, that are affected by the project need to be described. Large infrastructure investment does not usually only affect the producer and the direct consumers of the service, but can generate larger effects (or ‘reactions') e.g. on partners, suppliers, competitors, public administrations, local communities, etc. For instance, in the case of a high speed train linking two major cities, local communities along the train layout may be affected by negative environmental impacts, while the benefits of the project are accrued by the inhabitants of the larger areas. The identification of ‘who has standing’ should account for all the stakeholders who are significantly affected by the costs and benefits of the project. For a more detailed discussion about how to integrate distributional effects in the CBA see section 2.9.11.

16


GOOD PRACTICES

✓    Where a project has several stages or phases, these are properly presented together with their respective costs and benefits.

✓    Individual investment measures are bundled into one single project when these are: i) integral to the achievement of the intended objectives and complementary from a functional point of view; ii) implemented in the same impact area; iii) share the same project owner; and iv) have similar implementation periods.


COMMON MISTAKES

X An artificial splitting of the project is adopted to reduce the project investment cost in order to fit under the major projects threshold.

X Project over-scaling: investments which are functionally independent of each other are packaged together

without a preliminary verification of the economic viability of each investment and of possible combinations and without a clear functional and strategic link among them.

X Project under-scaling: a request for assistance is presented for financing a portion of a project which cannot be justified in isolation from other functional elements.

X Project over-sizing due to over-optimistic assessment of the impact area, e.g. on the basis of unrealistic assumptions of demographic growth.

X The institutional set-up for project operations is presented unclearly.This will make it difficult to verify that financial cash flows are properly accounted for in the financial analysis.

X Benefits of a second phase of a project are included in the economic analysis of the first phase without also including the additional costs, thus making the first phase look economically and/or financially more attractive.


2.6 Technical feasibility and environmental sustainability

Technical feasibility and environmental sustainability are among the elements of information to be provided in the funding request for major projects (Article 101 (Information necessary for the approval of a major project) of Regulation (EU) No 1303/2013). Although both analyses are not formally part of the CBA, their results must be concisely reported and used as a main data source within the CBA (see box). Detailed information should be provided on:

•    demand analysis;

•    options analysis;

•    environment and climate change considerations;

•    technical design, cost estimates and implementation schedule.

In the following, a review of the key information that needs to be summarised in the CBA, in order to understand the overall justification of the project solution sought, is provided. Although they are presented consecutively, they should be viewed as parts of an integrated process of project preparation, where each piece of information and analysis feed each other into a mutual-learning exercise (see box).

TIMING OF CBA: AN ONGOING PROCESS

The CBA principles should be adopted in the project design process as soon as possible. The CBA should be understood as an ongoing, multi-disciplinary, exercise performed throughout the project preparation in parallel with other technical and environmental considerations. Prerequisites for the CBA of the proposed project solution are, however, the finalisation of a detailed demand analysis and the availability of investment and operational and management (O&M) cost estimates, including costs for environmental mitigation and adaptation measures. These are based on the preliminary project design, which are centrepieces of the ‘technical’ feasibility study and the EIA.

This does not necessarily mean that the analysts responsible for preparing the CBA should start working after the engineers complete the preliminary technical design and deliver the cost estimates, but rather in parallel. In fact, analysts preparing the CBA should adopt an interdisciplinary approach to project preparation from an early stage and are usually involved in preliminary, simplified CBAs for comparisons of different technical and environmental options. Their involvement in the preparation of the demand analysis and options analysis is useful (and often decisive) in achieving the best results for the project.

Once the optimal project solution is identified, a full-scale CBA is usually performed at the end of the preliminary design stage. The aim is to provide confirmation to the project planner(s) of the adequacy and economic convenience of the proposed solution to meet the pre-established project objectives. The results of the full-scale CBA, based on the most recent cost estimates, shall be presented in the EU request for co-financing.

2.6.1 Demand analysis

Demand analysis identifies the need for an investment by assessing:

   current demand (based on statistics provided by service suppliers/ regulators/ ministries/ national and regional statistical offices for the various types of users);

   future demand (based on reliable demand forecasting models that take into consideration macro- and socio-economic forecasts, alternative sources of supply, elasticity of demand to relevant prices and income, etc.) in both the scenarios with- and without-the-project.

Both quantifications are essential to formulate demand projections, including generated/induced demand where relevant21, and to design a project with the appropriate productive capacity. For example, it is necessary to investigate which share of the demand for public services, rail transport, or disposal of waste material can be expected to be satisfied by the project. Demand hypotheses should be tested by analysing the conditions of both the present and future supply, which may be affected by actions that are independent from the project.

For a detailed discussion about the main factors affecting demand, methods and outputs of demand analysis in the different fields of intervention see chapters three to seven.

PROJECTS BELONGING TO LARGER, TRANSBOUNDARY NETWORKS

Particular attention should be paid to identifying whether the project under consideration belongs to networks. This is particularly the case for transport and energy infrastructures, which always form part of networks, but also for ICT and telecommunication projects.

When projects belong to networks, their demand (and consequently their financial and economic performance) is highly influenced by issues of mutual dependency (projects might compete with each other or be complementary) and accessibility (ease of reaching the facility).

Several techniques (e.g. multiple regression models, trend extrapolations, interviewing experts, etc.) can be used for demand forecasting, depending on the data available, the resources that can be dedicated to the estimates and the sector involved. The selection of the most appropriate technique will depend, amongst other factors, on the nature of the good or service, the characteristics of the market and the reliability of the available data. In some case, e.g. transport, sophisticated forecast models are required.

Transparency in the main assumptions, as well in the main parameters, values, trends and coefficients used in the forecasting exercise, are matters of considerable importance for assessing the accuracy of the estimates. Assumptions concerning the policy and regulatory framework evolutions, including norms and standards, should also be clearly expressed. Furthermore, any uncertainty in the prediction of future demand must be clearly stated and appropriately treated in risk analysis (see section 2.10). The method used for forecasting, the data source and the working hypotheses must be clearly explained and documented in order to facilitate the understanding of the consistency and realism of the forecasts. Even the information about the mathematical models used, the tools that support them and their qualification, are fundamental elements of transparency.

GOOD PRACTICES

✓    Use is made of appropriate modelling tools to forecast future demand.

✓    Where macro-economic/socio-economic data/forecasts are available from official national sources, consistent use of them is made across all projects/sectors within the country.

✓    Demand is appraised separately for all distinct groups of users/consumers relevant to the project.

✓    Effects of current or planned policy measures and economic instruments that could influence the project are taken into account for demand analysis. Also, all parallel investments potentially affecting the demand for services delivered by the project are identified, described and assessed.


COMMON MISTAKES

X The methodology and parameters used for estimation of current and future demand are not explicitly presented nor justified, or they deviate from national standards and/or official forecasts for the region/country.

X Users’ growth rates ‘automatically’ assumed throughout the entire reference period of the project are

overoptimistic. Where uncertainty exists, it is wise to assume a stabilisation of demand after the first e.g. 3-to-X years of operation.

X Insufficient or incomplete market analysis often leads to an overestimation of revenues. In particular, a full assessment of the competition in the market (projects providing similar products and/or surrogates) and quality requirements for project outputs are often neglected.

X The link between demand analysis and design capacity of the project (supply) is missing or unclear. The design capacity of the project should always refer to the year in which demand is highest.


2.6.2 Option analysis

Undertaking a project entails the simultaneous decision of not undertaking any of the other feasible options. Therefore, in order to assess the technical, economic and environmental convenience of a project, an adequate range of options should be considered for comparison.

Thus, it is recommended to undertake, as a first step, a strategic options analysis, typically carried out at pre-feasibility stage and which may require multiple criteria analysis (see box). The approach for option selection should be as follows:

•    establish a list of alternative strategies to achieve the intended objectives;

•    screen the identified list against some qualitative criteria, e.g. multi-criteria analysis based on a set of scores22, and identify the most suitable strategy.

STRATEGIC OPTIONS: EXAMPLES

-    Different routes or construction timing in transport projects (roads/rails).

-    Centralised vs. decentralised systems for water supply or wastewater treatment projects.

-    A new gravity sewer main and a new wastewater treatment plant vs. a pumping station and pressure pipes that pump the wastewater towards an existing treatment plant, but with a capacity which has to be increased;

-    Different locations for a centralised landfill in a regional waste management project.

-    Retrofitting an old power plant or building a new one.

-    Different peak-load arrangements for energy supply.

-    Construction of underground gas storage facilities vs. new LNG terminal.

-    Large hospital structures rather than a more widespread offer of health services through local clinics.

-    Possible re-use of existing infrastructure (e.g. ducts, poles, sewerage networks) or possible co-deployment with other sectors (energy, transport) to reduce the cost of broadband deployment projects23 24 25 26.

-    Different procurement (classic public procurement vs. PPP) and user charging methods for large infrastructures.

Once the strategic option is identified, a comparison of the specific technological solutions is typically carried out at feasibility stage. In some circumstances, it is useful to consider, as a first technological option, a ‘do-minimum' solution. As mentioned, this assumes incurring certain investment outlays, for example for partial modernisation of an existing infrastructure, beyond the current operational and maintenance costs. Hence, this option includes a certain amount of costs for necessary improvements, in order to avoid deterioration of infrastructure or sanctions24. Synergies in infrastructure deployment (e.g. transport/energy and high-speed broadband infrastructure) should also be considered, in view of better use of public funds, higher socio-economic impact, and lower environmental impact.

Once all potential technological solutions are identified, also in the context of the Environmental Impact Assessment (EIA)/ the Strategic Environmental assessment (SEA) procedures and their results (see next paragraph), they need to be assessed and the optimal solution selected as the subject of the financial and economic appraisal. The following criteria shall be applied:

•    if different alternatives have the same, unique, objective (e.g. in the case of compliance-driven projects with predetermined policy objectives or targets) and similar externalities, the selection can be based on the least cost solution25 per unit of output produced;

•    if outputs and/or externalities, especially environmental impacts, are different in different options (assuming all share the same objective), it is recommended to undertake a simplified CBA for all main options in order to select the best alternative. A simplified CBA usually implies focusing on first qualified estimates of demand and rough estimates of the key financial and economic parameters, including investment and operating costs, the main direct benefit(s) and externalities26. The calculation of the financial and economic performance indicators in the simplified CBA must be made, as usual, with the incremental technique.

The criteria considered in selecting the best solution, with ranking of their importance and the method used in the evaluation, shall always be presented by the project promoter as a justification for the option chosen.

GOOD PRACTICES

✓    The options analysis is based on a common baseline (i.e. a common counterfactual scenario and consistent demand analysis are adopted across the options).

✓    The options analysis starts from a more strategic point of view (i.e. general type of infrastructure and/or location/alignment for the project) and continues with an assessment of specific technological variants for the type of infrastructure/site selected. New alternative technologies are accompanied by a thorough assessment of their technological, financial, managerial risks, climate risk and environmental impacts.

✓    For comparisons based on costs, all assumptions on unit costs of investment, O&M and replacement should be disclosed and explained separately for each option to facilitate their appraisal. Unit costs of common consumables (e.g. labour, energy, etc.) are the same for all options.

✓    Options are compared using the same reference period.


COMMON MISTAKES

X The various project options are discussed and analysed in detail, but they are not assessed against a counterfactual scenario which forms the basis of the incremental approach.

X The identification of possible alternatives is done rather ‘artificially’, e.g. alternatives are not genuine solutions but simply constructed to show they are worse than the preferred (pre-decided) alternative.

X There is lack of ‘strategic thinking’: project options are considered only in terms of alternative routes (for

transport projects) or alternative technologies of a pre-selected solution, but not in terms of possible alternative means to achieve the intended objectives.

X Too many or irrelevant criteria, or inappropriate scoring, are used in multi-criteria analysis for shortlisting the project options.


2.6.3 Environment and climate change considerations

Some requirements on the project's environmental sustainability should be fulfilled in parallel with the technical considerations and contribute to the selection of the best project option.

In particular, the project promoter shall demonstrate to which extent the project: a) contributes to achieve the resource efficiency and climate change targets for 2020; b) complies with the Directive on the prevention and remedying of environmental damage (2004/35/EC); c) respects the ‘polluter pays' principle, the principle of preventive action and the principle that environmental damage should be rectified at source; d) complies with protection of the Natura 2000 sites and protection of species covered by the Habitats Directive (92/43/EEC) and the Birds Directive (2009/147/EC); e) is implemented as a result of a plan or programme falling within the scope of the Strategic Environmental Assessment (SEA) (2001/42/EC); f) is compliant with the Council Directive 2014/52/EU on the Environment Impact Assessment (EIA)27, as well as any other legislation requiring an environmental assessment to be carried out. In addition, environmental investments, e.g. water supply, wastewater and solid waste management, have to comply with other sector-specific Directives, as further illustrated in chapter 4.

When appropriate, an EIA must be carried out to identify, describe and assess the direct and indirect effects of the project on human beings and the environment. While the EIA is a formally distinct and self-standing procedure, its outcomes need to be integrated in the CBA and be in the balance when choosing the final project option. The costs of any environmental integration measures resulting from the EIA procedure (including measures for protection of biodiversity) are treated as input in the assessment of the financial and economic viability of the project. On the other hand, the benefits resulting from such measures are estimated, as far as possible, when valuing the non-market impacts generated by the project (see section 2.9.8).

Impacts of the project on climate, in terms of reduction of GHG emissions, are referred to as climate change mitigation and must be included in the EIA. The following emission sources must be taken into account when assessing the impact of the project on climate:

•    direct GHG emissions caused by the construction, operation, and possible decommissioning of the proposed project, including from land use, land-use change and forestry;

•    indirect GHG emissions due to increased demand for energy;

•    indirect GHG emissions caused by any additional supporting activity or infrastructure which is directly linked to the implementation of the proposed project (e.g. transport, waste management).

On the other hand, the impacts of climate change on the project, referred to as climate change adaptation or resilience to climate change, must also to be addressed during the project design process, when necessary.28 Climate change adaptation is a process aimed to reduce the vulnerability of natural and human systems against actual or expected climate change effects. The main threats to infrastructure assets include damage or destruction caused by extreme weather events, which climate change may exacerbate; coastal flooding and inundation from sea level rise; changes in patterns of water availability; and effects of higher temperature on operating costs, including effects in temperate and/or permafrost29 The following phenomena need to be screened:

•    heat waves (including impact on human health, damage to crops, forest fires, etc.);

•    droughts (including decreased water availability and quality and increased water demand);

•    extreme rainfall, riverine flooding and flash floods;

•    storms and high winds (including damage to infrastructure, buildings, crops and forests);

•    landslides;

•    rising sea levels, storm surges, coastal erosion and saline intrusion;

•    cold spells;

•    freeze-thaw damage.

To support resilience to climate change in infrastructure investments, the Commission encourages project promoters to assess the project's risk-exposure and vulnerability to climate change impacts. The ‘Guidelines for project managers: Making vulnerable investment climate resilient'30 include a methodology to systematically assess the sustainability and viability of infrastructure projects in changing climate conditions. These guidelines are not intended as a substitute for EIA or CBA, but as a complement to the existing project appraisal tools and development procedures.

Costs and benefits resulting from the integration of both mitigation and adaptation measures in the project design are used in the appraisal of the project's financial and economic performance.

GOOD PRACTICES

✓    Environment and climate change considerations, including impact assessment on Natura 2000, are incorporated into the project design and preparation at an early stage, i.e. during project screening and scoping. Climate change adaptation and/or mitigation measures are integrated into the EIA procedure together with other environmental impacts.

✓    Cost of measures taken for correcting negative environmental impacts are included in the investment cost considered in the CBA.

✓    Early dialogue between the developer and the authorities/nature experts is carried out to run procedures smoothly and to enable better and faster decisions, which in turn could reduce costs and avoid delays.


COMMON MISTAKES

X There is no consistency between options analysed in the CBA and options analysed in the EIA. In particular, the option selected in the CBA must have been fully analysed in the EIA.

X Project cost does not incorporate cost of measures related to climate change mitigation, adaptation and other environmental impacts.

X The benefits of mitigation measures are not properly taken into account.


2.6.4 Technical design, cost estimates and implementation schedule

A summary of the proposed project solution shall be presented with the following headings.

   Location: description of the location of the project including a graphical illustration (map). Availability of land is a key aspect: evidence should be provided that the land is owned (or can be accessed) by the beneficiary, who has the full title to use it, or has to be purchased (or rented) through an acquisition process. In the latter case, the conditions of acquisition should be described. The administrative process and the availability of the relevant permits to carry out the works should also be explained.

   Technical design: description of the main works components, technology adopted, design standards and specifications. Key output indicators, defined as the main physical quantities produced (e.g. kilometres of pipeline, number of overpasses, number of trees planted, etc.), should be provided.

   Production plan: description of the infrastructure capacity and the expected utilisation rate. These elements describe the service provision from the supply side. Project scope and size should be justified in the context of the forecasted demand.

   Costs estimates: estimation of the financial needs for project realisation and operations are imported in the CBA as a key input for the financial analysis (see section 2.8). Evidence should be provided as to whether cost estimations are investor estimates, tender prices or out-turn costs.

   Implementation timing: a realistic project timetable together with the implementation schedule should be provided including, for example, a Gantt chart (or equivalent) with the works planned. A reasonable degree of detail is needed in order to enable an assessment of the proposed schedule.

GOOD PRACTICES

✓    A concise summary of the results of the feasibility study(ies) is included in the CBA report to explain the justification of the selected solution. Input data from the technical studies are duly used in the CBA. Should the FS include a section on CBA, consistency with the main CBA report is ensured or major differences explained.

✓    The technical description of investment and operating cost components provides sufficient detail to allow for cost benchmarking.


2.7 Financial analysis

2.7.1    Introduction

As set out in Article 101 (Information necessary for the approval of a major project) of Regulation (EU) No 1303/2013, a financial analysis must be included in the CBA to compute the project's financial performance indicators. Financial analysis is carried out in order to:

•    assess the consolidated project profitability;

•    assess the project profitability for the project owner and some key stakeholders;

•    verify the project financial sustainability, a key feasibility condition for any typology of project;

•    outline the cash flows which underpin the calculation of the socio-economic costs and benefits (see section 2.9).

The cash inflows and outflows to be considered are described in detail below. The methods to reduce the eligible expenditure of the operation and calculate the Union assistance (taking into account the potential to generate net revenue) are not discussed in this Guide. Please refer to Art. 61 (operations generating net revenue after completion) of (EU) Regulation 1303/2013 and Article 15 (Method for calculating discounted net revenue) of Commission Delegated Regulation (EU) No 480/2014.

2.7.2    Methodology

The financial analysis methodology used in this guide is the Discounted Cash Flow (DCF) method, in compliance with section III (Method for calculating the discounted net revenue of operations generating net revenue) of Commission Delegated Regulation (EU) No 480/2014. The following rules should be adopted:

•    Only cash inflows and outflows are considered in the analysis, i.e. depreciation, reserves, price and technical contingencies and other accounting items which do not correspond to actual flows are disregarded.

•    Financial analysis should, as a general rule, be carried out from the point of view of the infrastructure owner. If, in the provision of a general interest service, owner and operator are not the same entity, a consolidated financial analysis, which excludes the cash flows between the owner and the operator, should be carried out to assess the actual profitability of the investment, independent of the internal payments. This is particularly feasible when there is only one operator, which provides the service on behalf of the owner usually by means of a concession contract.31

•    An appropriate Financial Discount Rate (FDR) is adopted in order to calculate the present value of the future cash flows. The financial discount rate reflects the opportunity cost of capital. The practical ways of estimating the reference rate to use for discounting are discussed in Annex I, while the box below reminds the European Commission's reference parameter suggested for the programming period 2014-2020.

•    Project cash-flow forecasts should cover a period appropriate to the project's economically useful life and its likely long term impacts. The number of years for which forecasts are provided should correspond to the project's time horizon (or reference period). The choice of time horizon affects the appraisal results. In practice, it is therefore helpful to refer to a standard benchmark, differentiated by sector and based on internationally accepted practice. The Commission-proposed reference periods are shown in table 2.1. These values should be considered as including the implementation period. In the case of unusually long construction periods, longer values can be adopted.

•    The financial analysis should usually be carried out in constant (real) prices, i.e. with prices fixed at a base-year. The use of current (nominal) prices [i.e. prices adjusted by the Consumer Price Index (CPI)] would involve a forecast of CPI that does not seem always necessary. When a different rate of change of relative prices is envisaged for specific key items, this differential should be taken into account in the corresponding cash flow forecasts.

On the other hand, when there are many operators, the consolidation of the analysis might not be feasible. In this case, the analysis perspective should be that of the project promoter, either owner or operator, depending on the investment typology (see for example section 3.7.3 in the Transport chapter).

•    When the analysis is carried out at constant prices, the FDR will be expressed in real terms. When the analysis is carried out at current prices, a nominal FDR will be used31.

•    The analysis should be carried out net of VAT, both on purchase (cost) and sales (revenues), if this is recoverable by the project promoter. On the contrary, when VAT is not recoverable, it must be included.32

•    Direct taxes (on capital, income or other) are considered only for the financial sustainability verification and not for the calculation of the financial profitability, which is calculated before such tax deductions. The rationale is to avoid capital income tax rules complexity and variability across time and countries.

FINANCIAL DISCOUNT RATE: THE EC BENCHMARK

According to Article 19 (Discounting of cash flows) of Commission Delegated Regulation (EU) No 480/2014, for the programming period 2014-2020, the European Commission recommends that a 4 % discount rate in real terms is considered as the reference parameter for the real opportunity cost of capital in the long term. Values differing from the 4 % benchmark may, however, be justified on the grounds of international macroeconomic trends and conjunctures, the Member State’s specific macroeconomic conditions and the nature of the investor and/or the sector concerned. To ensure consistency amongst the discount rates used for similar projects in the same country, the Commission encourages the Member States to provide their own benchmark for the financial discount rate in their guidance documents and then to apply it consistently in project appraisal at national level.

Table 2.1 European Commission’s reference periods by sector

Sector

Reference period

(years)

Railways

30

Roads

25-30

Ports and airports

25

Urban transport

25-30

Water supply/sanitation

30

Waste management

25-30

Energy

15-25

Broadband

15-20

Research and Innovation

15-25

Business infrastructure

10-15

Other sectors

10-15

Source: ANNEX I to Commission Delegated Regulation (EU) No 480/2014.

The financial analysis is carried out by a set of accounting tables, as illustrated in Figure 2.2. and in table 2.2, and, in more detail, in the following sections.

Figure 2.2 Structure of financial analysis


Financial return on investment - FNPV(C)


Financial sustainability


Financial return on capital - FNPV(K)


Table 2.2 Financial analysis at a glance

FNPV(C)

SUSTAINABILITY

FNPV(K)

Investment costs

Start-up and technical costs

-

-

Land

-

-

Buildings

-

-

Equipment

-

-

Machinery

-

-

Replacement costs

-

-

-*

Residual value

+

+

Operating costs

Personnel

-

-

-

Energy

-

-

-

General expenditure

-

-

-

Intermediate services

-

-

-

Raw materials

-

-

-

Other outflows

Loan repayments

-

-

Interests

-

-

Taxes

-

Inflows

Revenues

+

+

+

Operating subsidies

+

Sources of financing

Union assistance

+

Public contribution

+

_**

Private equity

+

-

Private loan

+

* Only if they are self-financed by the project revenues. Otherwise, if new sources of financing (either equity or debt) are needed to sustain them, these sources must be displayed within the outflows at the time they are disbursed.

** Operating subsidies shall not be accounted in order to avoid double counting with the operating costs outflow.

Source: Adapted from EC CBA Guide 2008.

2.7.3 Investment cost, replacement costs and residual value

The first step in the financial analysis is the analysis of the amount and breakdown over the years of the total investment costs. Investment costs are classified by:

   Initial investment: it includes the capital costs of all the fixed assets (e.g. land, constructions buildings, plant and machinery, equipment, etc.) and non-fixed assets (e.g. start up and technical costs such as design/planning, project management and technical assistance, construction supervision, publicity, etc.). Where appropriate, changes in net working capital should also be included. Information must be taken from the technical feasibility study(ies)33 and the data to consider are the incremental cash disbursements encountered in the single accounting periods (usually years) to acquire the various types of assets (see box). Cost breakdown over the years should be consistent with the physical realisations envisaged and the time-plan for implementation (see section 2.7.4)34. Where relevant, the initial investment shall also include environmental and/or climate change mitigating costs during the construction, as usually defined in the EIA or in other appraisal procedures.

   Replacement costs: includes costs occurring during the reference period to replace short-life machinery and/or equipment, e.g. engineering plants, filters and instruments, vehicles, furniture, office and IT equipment, etc.35 36 37

It is preferable not to compute cash-flows for large replacements close to the end of the reference period. When a specific project asset needs to be replaced shortly before the end of the reference period, the following alternatives should be considered:

•    shorten the reference period to match the end of the design lifetime of the large asset that needs replacing;

•    postpone the replacement until after the end of the reference period and assume an increase of the annual maintenance and repair cost for the specific asset until the end of the reference period.

AVOIDED CAPITAL INVESTMENT COST IN THE COUNTERFACTUAL SCENARIO

According to the incremental approach, investment costs should be considered net of possible avoided capital costs in the counterfactual scenario. The latter costs are based on the assumption that, without the investment, there is no longer a feasible situation so that it is in any case necessary to implement other interventions, at least in a way to guarantee a minimum level of service provision. This is the assumption of taking the do-minimum as the reference scenario (see section 2.2). For example, in the electrical sector, a new substation could be needed to satisfy the load increase in the absence of a new line. This cost must be included in the counterfactual scenario.

A residual value of the fixed investments must be included within the investment costs account for the end-year. The residual value reflects the capacity of the remaining service potential of fixed assets whose economic life is not yet completely exhausted.37 The latter will be zero or negligible if a time horizon equal to the economic lifetime of the asset has been selected.

According to Article 18 (Residual value of the investment) of Commission Delegated Regulation (EU) No 480/2014, for project assets with economic lifetimes in excess of reference period, their residual value shall be determined by ‘computing the net present value of cash flows in the remaining life years of the operation'38 Other residual value calculation methods may be used in duly justified circumstances. For instance, in the case of non-revenue generating projects38, by computing the value of all assets and liabilities based on a standard accounting depreciation formula39 40 41 or considering the residual market value of the fixed asset as if it were to be sold at the end of the time horizon. Also, the depreciation formula should be used in the special case of projects with very long design lifetimes, (usually in the transport sector), whose residual value will be so large as to distort the analysis if calculated with the net present value method.

The residual value can be singled out either within the project inflows or within the investment costs but with negative sign (see table 2.3 for an example).

Table 2.3 Total investment costs. EUR thousands

Years

Total

1

2

3

4-9

10

11-29

30

Start-up and technical costs

6,980

1,816

Land

1,485

757

Buildings

37,342

17,801

Equipment

11,355

23,273

Machinery

25,722

Initial Investment

126,531

8,465

75,176

42,890

Replacement costs

1

11,890

9,760

Residual value

i

f

-4,265

Total Investment costs

152,655

8,465

75,176

42,890

_L

11,890

9,760

-4,265

These can include also costs, e.g. for feasibility studies, borne before the start of the evaluation period, although not eligible for EU funding.

In the example, expenditures of EUR 11.9 and 9.8 million are expected in year 10 and 20, respectively, to replace short life equipment and machinery.

The residual value is considered with negative sign because it is an inflow.

2.7.4 Operating costs and revenues

The second step in financial analysis is the calculation of the total operating costs and revenues (if any).

Operating costs41 include all the costs to operate and maintain (O&M) the new or upgraded service. Cost forecasts can be based on historic unit costs, when patterns of expenditures on operations and maintenance ensured adequate quality standards.42 Although the actual composition is project-specific, typical O&M costs include: labour costs for the employer; materials needed for maintenance and repair of assets; consumption of raw materials, fuel, energy, and other process consumables; services purchased from third parties, rent of buildings or sheds, rental of machinery; general management and administration; insurance cost; quality control; waste disposal costs; and emission charges (including. environmental taxes, if applicable).

These costs are usually distinguished between fixed (for a given capacity, they do not vary with the volume of good/service provided) and variable (they depend on the volume).

Cost of financing (i.e. interest payments) follow a different course and must not be included within the O&M costs.

CHANGE OF RELATIVE PRICES

The change of relative prices is defined as the total nominal increase (decrease) rate net of the inflation (deflation) factor, as defined by the CPI.

When the prices of some input and output items are expected to change significantly, above or below the average inflation rate, this differential should be taken into account in the corresponding cash flow forecasts.

Since there is high uncertainty over price evolution in the long term, the application of changes of relative prices should, however, be the result of proper analysis and supporting evidence should be provided in the CBA. For example, increase rates applied across all O&M costs and of the same magnitude must be avoided. In particular, high real increases of unit costs of both energy (e.g. fuel and electricity) and labour are not plausible as these together determine an large amount of average inflation. Also, with regards to labour costs, any assumed increase in real salaries and wages can be partially offset by increases in labour productivity throughout the time horizon.

The project revenues are defined as the ‘cash in-flows directly paid by users for the goods or services provided by the operation, such as charges borne directly by users for the use of infrastructure, sale or rent of land or buildings, or payments for services' (Article 61 (Operations generating net revenue after completion) of (EU) Regulation 1303/2013).

These revenues will be determined by the quantities forecasts of goods/services provided and by their prices. Incremental revenues may come from increases in quantities sold, in the level of prices, or both.

Transfers or subsidies (e.g. transfers from state or regional budgets or national health insurance), as well as other financial income (e.g. interests from bank deposits) shall not be included within the operating revenues for the calculations of financial profitability because they are not directly attributable to the project operations42. On the contrary, they shall be computed for the financial sustainability verification.

When the contribution of the state or other public authority (PA) is, however, in exchange for a good or service directly provided to it by the project (i.e. the state is the user), this shall be generally considered a project revenue and included in the financial profitability analysis. In other words, it is not relevant how the state or PA pays for the goods or services (i.e. through tariffs, shadow tolls, availability payments, etc.) because the contribution to the project originates from a direct relation to the use of the project infrastructure.

For compliance with the regulatory requirements, where relevant tariffs shall be fixed in compliance with the polluter-pays and the full-cost recovery principles. In particular, compliance with the polluter-pays principle requires that:

•    applied user charges and fees recover the full cost, including capital costs, of environmental services;

•    the environmental costs of pollution, costs of resource depletion, and preventive measures are borne by those who cause pollution/ depletion;

•    charging systems are proportional to the social marginal production costs which include the full costs, including capital costs, of environmental services, the environmental costs of pollution and the preventive measures implemented and the costs linked to the scarcity of the resources used.

Compliance with the full-cost recovery principle includes that:

•    tariffs aim to recover the capital cost, the operating and maintenance cost, including environmental and resource costs;

•    the tariff structure maximises the project's revenues before public subsidies, while taking affordability into account.

However, when relevant, e.g. for a project supplying a public service in the environmental sector, affordability considerations should be taken into account in the application of the polluter-pays and the full-cost recovery principles. Key aspects regarding their application and the relative affordability implications are discussed in Annex V.

As shown in table 2.4, the cash outflows of operating costs deducted from the cash flows of revenues determine the net revenues of the project. These are calculated for each year until the time horizon. According to Article 61 Reg. 1303/2013, for the purpose of the EU contribution calculation ‘operating cost-savings generated by the operation shall be treated as net revenue unless they are offset by an equal reduction in operating subsidies'.

Table 2.4 Operating Revenues and Costs. EUR thousands

Years

Total

1-3

4

5

6

29

30

Service 1

0

11,355

11,423

11,492

11,979

11,979

Service 2

0

243

243

243

243

243

Total revenues

407,862

0

11,598

11,666

11,735

12,222

12,222

Personnel

0

1,685

1,685

1,685

1,685

1,685

Energy

0

620

623

626

648

648

General expenditure

0

260

260

260

260

260

Intermediate services

0

299

299

299

299

299

Raw materials

0

2,697

2,710

2,724

2,821

2,821

Total operating costs

153,487

0

5,561

5,577

5,594

5,713

5,713

Net revenues

254,375

0

6,037

6,089

6,140

6,509

6,509

During the construction phase no operating revenues and costs usually occur.

ms

Personnel costs are assumed to be fixed along the reference period, while energy requirements are variable and follow the expected production growth.

2.7.5 Sources of financing

The next step is the identification of the different sources of financing that cover the investment costs. Within the framework of EU co-financed projects, the main sources can be:

•    Union assistance (the EU grant);

•    national public contribution (including, always, the counterpart funding from the OP plus additional grants or capital subsidies at central, regional or local government level, if any);

•    project promoter's contribution (loans or equity), if any;

•    private contribution under a PPP, (equity and loans) if any.

Here, the loan is an inflow and it is treated as a financial resource coming from third parties. Table 2.5 below provides an illustrative example including contributions from private investors.

Table 2.5 Sources of financing. EUR thousands

Years

Total

1

2

3

4

5

6

7-30

Union assistance

47,054

3,148

27,956

15,950

-

-

-

-

Public contribution

47,054

3,148

27,956

15,950

-

-

-

-

Private equity

16,212

1,085

9,632

5,495

-

-

-

-

Private loan

16,212

1,085

9,632

5,495

-

-

-

-

Total resources

126,531

8,465

75,176

42,890

0

0

0

0

The Union assistance is calculated in line with the provisions of Art. 61 of Reg. 1303/2012 and by applying a 50 % maximum co-financing rate of the priority axis.

In the example, the private financing is given by 50 % equity and 50 % loan.

The total sources of financing should always match the initial investment cost.

2.7.6 Financial profitability

Determination of investment costs, operating costs, revenues and sources of financing enables the assessment of the project profitability, which is measured by the following key indicators:

• financial net present value - FNPV(C) - and financial rate of return - FRR(C) - on investment;

• financial net present value - FNPV (K) - and the financial rate of return - FRR (K) - on national capital.

Return on investment

The financial net present value of investment (FNPV(C)) and the financial rate of return of the investment (FRR(C)) compare investment costs to net revenues and measure the extent to which the project net revenues are able to repay the investment, regardless of the sources or methods of financing.

The Financial net present value on investment is defined as the sum that results when the expected investment and operating costs of the project (discounted) are deducted from the discounted value of the expected revenues:

n


FNPV(C) =    =

t=o


Ą |

(1+0° (l+O1


Sn

0+0"


where: St is the balance of cash flow at time t, at is the financial discount factor chosen for discounting at time t and i is the financial discount rate.

The financial rate of return on investment is defined as the discount rate that produces a zero FNPV, i.e. FRR is given by the solution of the following equation43:

o=y—®—

*-i(i+frr)‘

The FNPV(C) is expressed in money terms (EUR), and must be related to the scale of the project. The FRR(C) is a pure number, and is scale-invariant. Mainly, the examiner uses the FRR(C) in order to judge the future performance of the investment in comparison to other projects, or to a benchmark required rate of return. This calculation also contributes to deciding if the project requires EU financial support: when the FRR(C) is lower than the applied discount rate (or the FNPV(C) is negative), then the revenues generated will not cover the costs and the project needs EU assistance. This is often the case for public infrastructures, partly because of the tariff structure of these sectors.

43


The return on investment is calculated considering:

•    (incremental) investment costs and operating costs as outflows;

•    (incremental) revenues and residual value as inflows.

Thus, cost of financing is not included in the calculation of the performance of the investment FNPV(C) (but is included in the table for the analysis of the return on capital FNPV (K), see below).

Moreover, as mentioned above, capital, income or other direct taxes are included only in the financial sustainability table (see below) and not considered for the calculation of the financial profitability, which is calculated before deductions.

Table 2.6 Calculation of the return on investment. EUR thousands

Years

1

2

3

4

5-9

10

11-29

30

Total revenues

11,598

12,011

12,222

Residual value

4,265

Total inflows

0

0

0

11,598

12,011

16,487

Total operating costs

5,561

5,662

5,713

Initial Investment

8,465

75,176

42,890

Replacement costs

11,890

9,760

Total outflows

8,465

75,176

42,890

5,561

17,552

5,713

Net cash flow

-8,465

-75,176

-42,890

6,037

-5,540

10,774

FNPV(C)

- 34.284

FRR(C)

1.4%

A financial discount rate of 4 % has been applied to calculate this value.

Return on national capital

The objective of the return on national capital calculation is to examine the project performance from the perspective of the assisted public, and possibly private, entities in the MS (‘after the EU grant').

The return on national capital is calculated considering as outflows: the operating costs; the national (public and private) capital contributions to the project; the financial resources from loans at the time in which they are reimbursed; the related interest on loans. As far as replacement costs are concerned, if they are self-financed with the project revenues, they will be treated as operating costs (as in table 2.7). Otherwise, if new sources of financing (either equity or debt) are needed to sustain them, these sources will be displayed within the outlays at the time they are disbursed. The inflows are the operating revenues only (if any) and the residual value. Subsidies granted to cover operating costs shall be excluded because they are transfers from one to another national source44. Table 2.9 shows this account and readers may see, by comparison with table 2.6 that the former focuses on sources of national funds, while the latter focuses on total investment costs, with the remaining items being identical.

The financial net present value of capital, FNPV(K), in this case, is the sum of the net discounted cash flows that accrue to the national beneficiaries (public and private combined) due to the implementation of the project. The corresponding financial rate of return on capital, FRR(K), of these flows determines the return in percentage points.

When computing FNPV(K) and FRR(K), all sources of financing are taken into account, except for the EU contribution. These sources are taken as outflows (they are inflows in the financial sustainability account), instead of investment costs (as it forms part of the financial return on investment calculation).

While the FRR(C) is expected to be very low, or negative for the public investments to be financed with EU funds, the FRR (K) will be higher and, in some cases, even positive. On the other hand, for public infrastructure, a negative FNPV(K) after EU assistance does not mean that the project is not desirable from the operator's or the public's perspective and should be cancelled. It just means that it does not provide an adequate financial return on national capital employed, based on the benchmark applied (i.e. 4 % in real terms). This is actually a quite common result, even for revenue generating projects receiving EU assistance. In such cases it is particularly important to ensure the financial sustainability of the project.

When relevant, the return on the project promoter's capital (either public or private) can also be calculated45. This compares the net revenues of the investment with the resources provided by the promoter: i.e. the investment cost minus the non-reimbursable grants received from the EU or the national/regional authorities. This exercise can be particularly useful in the context of state aid in order to verify that the intensity of the aid (EU and national assistance) provides the best value for-money with the objective of limiting public financial support to the amount necessary for the project to be financially viable. In fact, when the project expects a substantial positive return (i.e. significantly above the national benchmarks on expected profitability in the given sector) it shows that the grants received would bring supra-normal profits to the beneficiary.

Table 2.7 Calculation of the return on national capital. EUR thousands

Years

1

2

3

4

5-9

10

11-29

30

Total revenues

11,598

12,011

12,222

Residual value

4,265

Total inflows

0

0

0

11,598

12,011

16,487

Public contribution

3,148

27,956

15,950

Private equity

1,085

9,632

5,495

Loan repayment (including interest)

1,789

1,789

1,789

Total operating & replacement costs

5,561

17,552

5,713

Total outflows

4,233

37,588

21,445

5561

19,341

5,713

Net cash flow

-4,233

-37,588

-21,445

6,037

-7,329

10,774

FNPV(K)

11,198

FRR(K)

5.4 %

The loan is here an outflow and is only included when reimbursed. In this example, it is assumed to be paid back in ten constant payments starting in year 5.

In this example, replacement costs are self-financed with the project revenues. Accordingly, they are treated as operating costs.

2.7.7 Financial sustainability

The project is financially sustainable when the risk of running out of cash in the future, both during the investment and the operational stages, is expected to be nil. Project promoters should show how the sources of financing available (both internal and external) will consistently match disbursements year-by-year. In the case of non-revenue generating projects (i.e. not subject to the requirements set out in Article 61 of Regulation (EU) No 1303/2013), or whenever negative-cash-flows are projected in the future (i.e. in years in which large capital investments are required for asset replacements), a clear long-term commitment to cover these negative cash flows must be provided46.

The difference between inflows and outflows will show the deficit or surplus that will be accumulated each year. Sustainability occurs if the cumulated generated cash flow is positive for all the years considered (table 2.8). The inflows include:

•    sources of financing;

•    operating revenues from the provision of goods and services; and

•    transfer, subsidies and other financial gains not stemming from charges paid by users for the use of the infrastructure. The residual value should not be taken into account unless the asset is actually liquidated in the last year of the analysis. The dynamics of the inflows are measured against the outflows. These relate to the following:

•    initial investment

•    replacement costs

•    operating costs

•    reimbursement of loans and interest payments

•    taxes on capital/income and other direct taxes.

It is important to ensure that the project, even if assisted by EU co-financing, does not risk suffering from a shortage of capital. In particular, in the case of significant reinvestments/upgrades, proof of disposal of sufficient resources to cover these future costs should be provided in the sustainability analysis. In this sense it is recommended to carry out a risk analysis that takes into account the possibility of the key factors in the analysis (usually construction costs and demand) being worse than expected (see Annex VIII).

Table 2.8 Financial sustainability. EUR thousands

Years

1

2

3

4

5-9

10

11-29

30

Sources of financing

8,465

75,176

42,890

Total revenues

11,598

12,011

12,222

Total inflows

8,465

75,176

42,890

11,598

12,011

12,222

Initial investment

8,465

75,176

42,890

Replacement costs

11,890

9,760

Loan repayment (including interest)

1,789

1,789

1,789

Total operating costs

5,561

5,662

5,713

Taxes

604

-733

651

Total outflows

8,465

75,176

42,890

5,561

19,341

5,713

Net cash flow

0

0

0

6,037

-7,329

6,509

Cumulated net cash flow

0

0

0

6,037

...

20,726

133,835

Financial sustainability is verified if the cumulated net cash flow row is greater than zero for all the years considered.

The cumulated cash flow should be zero (or positive) during the construction phase

FINANCIAL SUSTAINABILTY FOR INFRASTRUCTURE UPGRADE

If projects fall within an already existing infrastructure, such as capacity extension projects, the overall financial sustainability of the infrastructure operator, including the project (more than that of the single extended segment), should be checked after the project (i.e. in the scenario ‘with the project’), even if the analysis of incremental cash-flows shows that the project will not run out of cash-flow. This is to ensure that not only the project but also the operator will not run out of cash-flow, or possibly experience negative cash flows, after implementation of the project, and is particularly relevant in the case of infrastructure that has previously suffered from severe underfunding.

2.7.8 Financial analysis in Public Private Partnership (PPP)

EU co-financed investment projects may be partly financed by private investors. PPP may be an important tool for financing investment projects when there is appropriate scope to involve the private sector. In order to attract private investors, who generally have different aims, aspirations and a higher aversion to risk than public bodies, proper incentives should be provided, but up to an amount which is not granting an unduly high revenue.

Many types of PPP exist, usually dependent on the specificities and characteristics of each project. The most common PPP models are: Private Operation and Maintenance; Design Build Operate (DBO); Parallel Co-finance of capex; Design, Build, Finance and Operate (DBFO)47. Attention should be paid to the structure of the PPP as it may affect the project's eligible expenditure. In particular, the degree of risk transfer to the private sector changes under each model project type, ranging from models with limited risk transfer (e.g. operation and maintenance risk) through to models with higher risk transfer (e.g. design, construction, financing and operations risk). The following steps shall be considered in the financial analysis of major projects implemented as a PPP:

•    Under PPP, the public partner is usually, but not always, the owner of the infrastructure and the private partner is the operator obtaining revenues through tariff payments. A consolidated analysis should first be carried out in order to calculate the overall investment profitability.

•    The return on capital shall then be calculated separately for the private partner and public partner:

-    in order to check profitability of the private capital to avoid unduly high profit generated by the EU support, the rate of return on private equity - FRR(Kp) - shall be calculated comparing all the revenues accrued by the private partner, net of the operational costs48 borne, including the concession fee (if any), with the financial resources provided during investment (either through equity or loans) (see table 2.9). The results shall be compared with national benchmarks on expected profitability in the given sector. Whenever the private partner is selected on the basis of the most economically advantageous tender criterion, through open public procurement, it is expected that such alignment with national benchmarks is automatically fulfilled;

-    a similar exercise can be replicated to calculate the rate of return on public equity - FRR(Kg) - which compares the revenues accrued by the public partner, usually coming from the concession fee, net of the managerial costs of the contract, with the resources provided during investment (either through equity or loans). The result should be compared with the financial discount rate in order to ensure the project is not over-financed.

Table 2.9 Calculation of the return on private equity. EUR thousands

Years

1

2

3

4

5-9

10

11-29

30

Total revenues

11,598

12,011

12,222

Total inflows

0

0

0

11,598

12,011

12,222

Private equity

1,085

9,632

5,495

Loan repayment (including interest)

1,789

1,789

1,789

Total operating & replacement costs

5,561

17,552

5,713

Concession fee

1,800

1,800

1,800

Total outflows

1,085

9,632

5,495

7,361

21,141

7,513

Net cash flow

-1,085

-9,632

-5,495

4,237

-9,129

4,709

FNPV(Kp)

26,806

FRR(Kp)

14.2%


A concession fee is usually included within the costs borne by the private operator.


The residual value is excluded because in many PPP contracts the infrastructure is returned to the public sector at the end of the period.


GOOD PRACTICES

✓    Price and technical contingencies are excluded from the investment cost for the financial profitability calculation, although they are eligible costs (up to 10 % of the initial investment cost).

✓    The inflation rate is based on official national projections of the Consumer Price Index (CPI).

✓    For O&M costs fixed and variable components are calculated separately.

✓    In the counterfactual case, the chosen regime of regular and periodic maintenance and operations does not lead to disproportionate losses of operational performance. Any predicted change of operational performance is shown to realistically correspond to the chosen maintenance and operations regime and to related incremental benefits calculations (such as time savings and modal shift).

✓    Fixed maintenance costs are expressed in % of the net cost of the assets for both civil works and plant components. Variable maintenance costs are expressed in unit cost per output of assets (e.g. EUR/ton, EUR/km, etc.).

✓    When a project adds new assets to complement a pre-existing service or infrastructure, both additional contributions from existing users and contributions from new users of the new service/infrastructure are taken into account to determine the project revenues.


COMMON MISTAKES

X Replacement costs are not considered in the calculation of residual values.

X The total investment cost in the CBA or its individual elements is inconsistent with the values presented in the feasibility study or in other more advanced engineering design documents, if available.

X Costs for protection of archaeological remains in the project site, as well as environmental and/or climate change integration measures are not included in the project cost.

X VAT is included in the financial analysis even though it is recoverable.

X Asset depreciation, interest and loan repayments, VAT and income tax, and dividends paid to shareholders are included within the O&M costs.

X Subsides received to cover (part of) the operating costs are included in the calculation of the EU contribution as revenues.

X Charges levied by governments in exchange for the goods or services rendered are confused with transfer payments and excluded from the operating revenues. For instance, a charge paid by farmers to the irrigation authority. Although the charge is called ‘tax’, this is not a transfer but a charge directly paid by users in exchange for the use of water. Accordingly, it must be considered as a project’s revenue. Another example is the ‘taxes’ paid by the citizens for waste collection and disposal services.

X In the FRR(K) calculation, cash-flows relative to replacement costs are computed twice: as operating outlays and as equity contribution from the project promoter.

X In the case of loans involved in project financing, loan conditions are not explained.

X Nominal interest rates are used to calculate the interest payments, where the analysis is carried out at constant prices.


2.8 Economic analysis

2.8.1 Introduction

As set out in Article 101 (Information necessary for the approval of a major project) of Regulation (EU) No 1303/2013, an economic analysis must be carried out to appraise the project's contribution to welfare49. The key concept is the use of shadow prices to reflect the social opportunity cost of goods and services, instead of prices observed in the market, which may be distorted. Sources of market distortions are manifold (see also Annex III):

•    non-efficient markets where the public sector and/or operators exercise their power (e.g. subsidies for energy generation from renewable sources, prices including a mark-up over the marginal cost in the case of monopoly, etc.);

•    administered tariffs for utilities may fail to reflect the opportunity cost of inputs due to affordability and equity reasons;

•    some prices include fiscal requirements (e.g. duties on import, excises, VAT and other indirect taxes, income taxation on wages, etc.);

•    for some effects no market (and prices) are available (e.g. reduction of air pollution, time savings).

The standard approach suggested in this guide, consistent with international practice, is to move from financial to economic analysis. Starting from the account for the return on investment calculation, the following adjustments should be:

•    fiscal corrections;

•    conversion from market to shadow prices;

•    evaluation of non-market impacts and correction for externalities.

After market prices adjustment and non-market impacts estimation, costs and benefits occurring at different times must be discounted. The discount rate in the economic analysis of investment projects, the Social Discount Rate (SDR), reflects the social view on how future benefits and costs should be valued against present ones. Annex II discusses the empirical approaches used for SDR estimation and provides examples of estimates at country level.

SOCIAL DISCOUNT RATE: THE EUROPEAN COMMISSION BENCHMARK

According to Annex III to the Implementing Regulation on application form and CBA methodology, for the programming period 2014-2020 the European Commission recommends that for the social discount rate 5 % is used for major projects in Cohesion countries and 3 % for the other Member States. Member States may establish a benchmark for the SDR which is different from 5% or 3 %, on the condition that: i) justification is provided for this reference on the basis of an economic growth forecast and other parameters; ii) their consistent application is ensured across similar projects in the same country, region or sector. The Commission encourages MSs to provide their own benchmarks for the SDR in their guidance documents, possibly at the start of the operational programmes and then to apply it consistently in project appraisal at national level.

Source: EC (2014)

After the use of the appropriate SDR, it is possible to calculate the project economic performance measured by the following indicators: Economic Net Present Value (ENPV), Economic Rate of Return (ERR) and benefit/cost ratio (B/C ratio). In the following sections the steps to move from financial to economic analysis are described.

2.8.2 Fiscal corrections

Taxes and subsidies are transfer payments that do not represent real economic costs or benefits for society as they involve merely a transfer of control over certain resources from one group in society to another. Some general rules can be established to correct such distortions:

•    prices for input and output must be considered net of VAT;

•    prices for input should be considered net of direct50 and indirect taxes;

•    prices (e.g. tariffs) used as a proxy for the value of outputs should be considered net of any subsidy and other transfer granted by a public entity51.

As concerns the methods of eliminating transfer payments, if it is possible to determine their exact value, they should be directly eliminated from the cash flows. For example, VAT payments on construction costs can be simply dropped off in the economic analysis. If it is not possible to determine their exact value, they should be eliminated from the project cash flows using conversion factors (see section 2.8.4).

In some projects the fiscal impact can be significant because, for example, the revenues generated by the project may decrease the need to finance budgetary deficits by public debt or taxation.52

Despite the general rule, in some cases indirect taxes (or subsidies) are intended as a correction for externalities.

For example, taxes on NOx emissions to discourage negative environmental externalities. In this and in similar cases, it is justified to include these taxes (subsidies) in project costs (benefits), provided that they adequately reflect the underlying marginal cost (Willingness-To-Pay (WTP)), but the appraisal should avoid double counting (e.g. including both energy taxes and estimates of full external environmental costs).

2.8.3 From market to shadow prices

When market prices do not reflect the opportunity cost of inputs and outputs, the usual approach is to convert them into shadow prices to be applied to the items of the financial analysis. A simplified operational approach for the estimation of the shadow prices is presented in the Figure below.

Figure 2.3 From market to shadow prices

i

Shadow prices

i___________|

Source: Adapted from Saerbeck (1990)

In practice, the following (simplified) operational approach can be applied to convert financial items into shadow prices. Project inputs:

   if they are tradable goods, border prices are used54. If a project uses an imported input, e.g. gas and oil, the shadow price is the import cost plus insurance and freight (CIF) in more liberalised (i.e. competitive and undistorted) markets, thus excluding any custom duties or taxes applied once the good enters the national market. Border prices can be expressed as a percentage of the price of the goods, as a fixed amount per unit or as a minimum price applied as soon as the good passes the border. Where the relevant economic border lies is a matter to be ascertained on a case-by-case basis. In the context of the EU funds, the external border of the EU may be considered relevant for most goods.

•    If they are non-tradable goods:

- the Standard Conversion Factor, which measures the average difference between world and domestic prices of a given economy (see box for an example) is applied in the case of ‘minor' items, e.g. administrative costs, intermediate services, etc.; 53

-    ad hoc assumptions, depending on the specific hypotheses made on market conditions, should be undertaken in the case of ‘major' items, e.g. land54, civil works, machinery, equipment, etc. to reflect their long run marginal cost55;

-    for manpower, the Shadow Wage is calculated.

The method generally used to operationally put into practice the different techniques presented above is to apply a set of conversion factors to the project financial costs. Section 2.9.5 below briefly presents the implications of this practice, while for a more detailed discussion about the existing empirical approaches to convert project inputs into shadow prices see Annex III. The shadow wage is treated separately in section 2.9.6 and in Annex IV.

Project outputs:

• Users' marginal Willingness-To-Pay (WTP), which measures the maximum amount consumers are willing to pay for a unit of a given good, is used to estimate the direct benefit(s) related to the use of the goods or services rendered by the project.

Section 2.9.7 shows the operational approach that should be followed to quantify the project outputs at users' WTP. Annex VI discusses, in detail, the current techniques to estimate WTP and the scope for application.

EXAMPLE: APPLICATION OF THE SCF

An illustrative computation of the Standard Conversion Factor (SCF) for a hypothetical country is hereby presented. As shown in Annex III, the simplified formula for the estimation of the SCF is:

SCF = (M+X)/ (M+X+TM)

where: M is the total value of import at shadow prices, i.e. CIF prices; X is the total value of export at shadow prices, i.e. FOB prices; TM is the total value of duties on import.

It is assumed that the total value of export at FOB prices and of import at CIF prices, in a given year, including both intra-EU and extra-EU trade of all products and services, are respectively EUR 25,000 million and EUR 20,000 million.

In the same year, the national general government and the EU collect EUR 500 million as taxes and duties on imports, excluding VAT. Export taxes, duties and other monetary compensatory amounts on exports are nil, as well as import and export subsidies.

International trade detailed data and main national accounts tax aggregates are provided both by Eurostat and national statistics institutes. Hence, in this example:

M= EUR 25,000 million

X= EUR 20,000 million

TM= EUR 500 million.

25,000+20,000

SCF    0.989

The SCF formula leads to the following result:    25,000+20,000+500

The variables in the SCF formula generally do not undergo significant variations on a yearly basis. For this reason the SCF could be either computed for a single year, or as an average of a number of years.

2.8.4 Application of Conversion Factors to project inputs

Transforming inputs market prices into shadow prices is completed, in practice, through the application of Conversion Factors. These are defined as the ratio between shadow prices and market prices. They represent the factor at which market prices have to be multiplied to obtain inflows valued at shadow price. Formally:

vi

ki= — ^Vi = Jii-Pi

where: pi are market prices for the good i, v are shadow prices for the same good and k are the conversion factors.

If the conversion factor for one good is higher than one, then the observed price is lower than the shadow price, meaning that the opportunity cost of that good is higher than that captured by the market. Conversely, if the conversion factor is lower than one, then the observed price is higher than the shadow price, due to taxes or other market distortions which add to the marginal social value of a good and determine a higher market price.

In principle, Conversion Factors should be made available by a planning office and not calculated on a project-by-project basis. When national parameters are not available, project-specific calculations can be made but these must then be consistent across projects56. At least, corrections should be applied to depurate market prices from fiscal factors, e.g. an excise tax on import. The following box provides an example.

In the absence of evidence of market failures, the CFs should be set equal to 1.

EXAMPLE: CONVERSION FACTOR FOR MATERIALS

As an example, let us assume that concrete is an input cost of the investment project. If the unit price of concrete used for the project is EUR 10,000, of which 20 % is VAT57 and import tax rate is 7 % (regardless of the country of origin), a simplified way to estimate the shadow price is to use the conversion factor (CF) computed as follows:

CF = U-/m-VAT)

where / is the import tax rate of the input good entering the CBA. Thus, the shadow price (SP) can be estimated by multiplying the CF by the observed market price (MP) of this good:

SP = (1-/m-VAT)*MP

The CF will amount to CF= (1-0.07)*(1-0.2) =0.93*0.8 =0.744 and the shadow price would be equal to SP=0.744*10,000=7,440.

Since the import tax rate could differ depending on the type of good considered, in order to compute the shadow price of the aggregated item ‘materials’ the project appraiser could use the average tax rate applying to those materials which are more commonly used in investment projects, such as bricks, iron, tubes, concrete, bituminous materials, plastics and other chemical products (e.g. paints), wood, etc. The same approach can also be applied for other cost items. As suggested in Annex III, the Input-Output matrix or the Use Table of a given economy can be used to breakdown aggregated input factors such as civil works, equipment, materials, etc. into their main sub-components, in order to disentangle the traded components to which the border price rule applies, and then compute the conversion factor as a weighted average.

2.8.5 The shadow wage

Current wages may be a distorted social indicator of the opportunity cost of labour because labour markets are imperfect, or there are macroeconomic imbalances, as revealed particularly by high and persistent unemployment or by dualism and segmentation of labour conditions (e.g. when there is an extensive informal or illegal economy). The project promoter, in such cases, may resort to a correction of observed wages and to the use of conversion factors for computing shadow wages.

WAGE DISTORTION: EXAMPLES

-    In the private sector, labour costs for a private company may be lower than the social opportunity cost because the State gives special subsidies to employment in some areas.

-    There may be legislation fixing a minimum legal wage, even if due to heavy unemployment there may be people willing to work for less.

-    There are informal or illegal sectors with no formal wage or income, but with a positive opportunity cost of labour.

The shadow wage measures the opportunity cost of labour. Typically, in an economy characterised by extensive unemployment or underemployment, this may be less than the actual wage rates paid. In particular:

•    for skilled workers previously employed in similar activities, the shadow wage can be assumed equal or close to the market wage;

•    for unskilled workers drawn to the project from unemployment, it can be assumed equal to or not less than the value of unemployment benefits or other proxies when unemployment benefits do not exist;

•    for unskilled workers drawn to the project from informal activities, it should be equal to the value of the output forgone in these activities.

The methodology to estimate the shadow wage at the national/regional level is illustrated in Annex IV, providing an example of computation which refers to year 2011. Member States are encouraged to develop their own national/regional benchmarks following the approach depicted in the Annex. In the absence of national/regional data, a shortcut formula for determination of the shadow wage is illustrated in the box below.

SHADOW WAGE: SHORTCUT FOR ESTIMATION

A practical solution to determine the shadow wage can be the reduction of unit labour costs by a percentage determined by the share of income taxation: SW = W*(l-t)

where: SW is the shadow wage, W is the market wage and t is the income taxation.

If a country is suffering from a high unemployment rate, the shadow wage may be inversely correlated to the level of unemployment. The following formula might be adopted for unskilled manpower used on project construction sites in order to take into account an ‘unemployment effect’, i.e. the excess supply of labour compared to the market clearing level in the case of a persistently high unemployment: SW = W*(1-t)*(1-u)

where: u is the unemployment rate of the region.

For more detailed SW formulas at regional level see Del Bo et al. (2011).

2.8.6 Evaluation of direct benefits

The concept of marginal WTP is commonly used to estimate the shadow price of the project output. In other words, to evaluate the project direct benefits, related to the use of the goods or services rendered. The WTP measures the maximum amount of people who would be willing to pay for a given outcome that they view as desirable. Different techniques, including revealed preference, stated preference and benefit transfer methods, exist to empirically estimate the WTP. The adoption of one or another method depends on both the nature of the effect considered and the availability of data. For a detailed discussion of the methods to estimate the WTP and some examples of practical application see Annex VI.

In absence of WTP estimates derived directly from users, or in the impossibility to adopt a benefit transfer, other proxies of WTP can be used. A commonly accepted practice is to calculate the avoided cost for users to consume the same good from an alternative source of production. For example, in the case of water supply projects, the avoided cost of water transported in tank lorries; in wastewater, the avoided cost of building and operating individual septic tanks; in energy, the avoided cost of substitute fuels (e.g. gas vs. coal) or alternative generation technologies (e.g. renewable energy sources vs. fossil fuels). The following box provides an empirical example of the application of this methodology.

EXAMPLE: AVERTIVE EXPENDITURE METHOD TO VALUE THE RELIABILITY OF WATER SUPPLY

Within the study ‘Ex-post evaluation of investment projects co-financed by the ERDF/CF in the period 1994-1999’ the EC evaluated the impact of a water supply investment aimed at solving the problem of water shortages and rationing affecting the citizens of Palermo during the 1970s and the 1980s. The project involved the partial substitution of the water distribution network, representing 50 % of the overall network and serving about 60 % of Palermo inhabitants. Before the project, water was rationed so that inhabitants were forced to equip themselves with domestic tanks and electric devices for collecting and pumping water into the house water systems with adequate pressure. After the project, in most cases, this equipment is no longer needed, especially where water is supplied 24 hours per day and at a high pressure. The WTP of improved service delivery was monetised in terms of avoided costs of maintaining and operating the electric pumps. These include the investment costs for purchasing the pump, the energy costs, the maintenance costs and time spent by users for the self-provision of water during the rationing periods. For about 73,000 users supplied by the renovated network, the net present value of the service costs avoided over the 2003-2027 period is estimated at almost EUR 67 million (2011 prices).

Source: EC (2012)

In practice, the economic analysis evaluation of the project's direct benefits is carried out by replacing the financial revenues, in the form of user fees, charges or tariffs, with the estimation of the users WTP for project outputs less changes in supply costs58. This operation is grounded on the following reasons:

•    in sectors not exposed to market competition, regulated, or influenced by public sector decisions, the charges paid by the users may not adequately reflect the social value of actually or potentially using a given good. A typical example is a publicly provided good, e.g. health care, for which a administered tariff is paid by users;

•    in addition, the use of a good or service may generate additional social benefits for which a market does not exist and therefore no price is observed. For example, time savings and prevention of accidents for the users of a new, safer, transport service.

For both reasons, the WTP provides a better estimate for the social value of the good or service than the observed tariffs. Also, the WTP is used for the projects providing outputs that are not subject to charges (e.g. a free recreational area). For a review of the typical direct benefits per sector see chapters 3 to 7.

For the evaluation of some outputs, when the WTP approach is not possible or relevant, long-run marginal cost (LRMC) can be the default accounting rule. Usually WTP is higher than LRMC in empirical estimates, and sometimes an average of the two is appropriate.

2.8.7 Evaluation of non-market impacts and correction for externalities

Impacts generated on project users due to the use of a new or improved good or service, which are relevant for society, but for which a market value is not available, should be included as project direct benefits (see section 2.8.6) in the economic analysis of project appraisal. In principle, the WTP estimated for the use of the service should capture these effects and facilitate its integration in the analysis. Examples of (positive) non-market impacts are: savings in travel time; increased life expectancy or quality of life; prevention of fatalities; injuries or accidents; improvement of landscape; noise reduction; increased resilience to current and future climate change and reduced vulnerability and risk59, etc.

When they do not occur in the transactions between the producer and the direct users of the project services but fall on uncompensated third parties, these impacts are defined as externalities. In other words, an externality is any cost or benefit that spills over from the project towards other parties without monetary compensation. Environmental effects are typical externalities in the context of CBA60 (see box for some examples). For a review of the typical external costs and benefits per sector see chapter 3.

Due to their nature, externalities are not captured with the evaluation of the project direct benefits and they need to be evaluated separately. Again, a WTP (or willingness-to-accept (WTA)61) approach should be adopted to include these effects into the appraisal.

Valuing externalities can sometimes be difficult even though they may be easily identified. For some specific effects, however, studies available in the literature provide reference values to be used in given contexts. This is, for example, the case of the ExternE62, HEATCO63or DG Move ‘Handbook on estimation of external costs in the transport sector'64, which provide some reference unit costs for emissions of carbon dioxide, noise and air pollutants. With this data, assessment of externalities becomes relatively straightforward: this requires an estimate of the externality volume (e.g. increase in decibels of noise to the exposed population) to be multiplied by the appropriate unit price (e.g. Euro per decibel per person). The inter-temporal elasticity of environmental externalities to GDP per capita growth could be used to take into account that their unit prices, which are usually expressed for a given base-year, should have increasing values over the life cycle of the project.

Significant progress has been made in recent years in refining the estimates of unit values of non-market impacts and improving methods to integrate such values into economic analysis. Developments in this field, both empirical and theoretical are, however, still needed, in order to broaden the range of externalities considered, such as the conservation of ecosystem services. Considering that ecosystem services change is one of the vital aspects of welfare, this should be always taken into account as potential for any project65.

Whenever money quantification is not possible, environmental impacts should at least be identified in physical terms for a qualitative appraisal in order to give to decision-makers more elements to make a considered decision. CBA and EIA are both required by EU regulations and should be considered in parallel and, whenever possible, should be integrated and consistent.

ENVIRONMENT EXTERNALITIES: EXAMPLES

Noise. Any increase or decrease of noise emissions affects activities and health. It is mainly relevant for infrastructures crossing or near densely populated areas.

Air pollution. Emissions of localised air pollutants such as nitrous oxide, sulphur dioxide, or small particulate matter, etc. have negative impacts on human health, generate material damage and loss of crops and affect ecosystems. It is relevant to all infrastructures which significantly modify the energy consumption mix of a given region.

Greenhouse gases emissions. Projects can emit greenhouse gases (GHG) into the atmosphere either directly, e.g. fuel combustion or production process emissions, or indirectly through purchased electricity and/or heat. GHG emissions have a worldwide impact due to the global scale of the damage caused, thus there is no difference in where the GHG emissions take place. On the other hand, some projects may lead to reduction of GHG emissions throughout their life cycle, which means that those GHG-related externalities can be positive.

Soil contamination. This is caused by the presence of human-made chemicals or other alterations in the natural soil environment, typically as consequence of industrial activity, agricultural chemicals or improper disposal of waste. Its effects on production, consumption and human health can be deferred over time.

Water pollution. Water pollution is the contamination of water bodies, e.g. lakes, rivers, oceans, aquifers and groundwater. This occurs when pollutants are discharged directly or indirectly into water bodies without adequate treatment to remove harmful compounds.

Ecosystem degradation. New infrastructure projects can deplete water sources, increase habitat fragmentation and contribute to deterioration of biodiversity, loss of habitats and species. The economic costs come in the form of lost services when an ecosystem is degraded and loses its functions.

Landscape deterioration. This usually involves a loss of recreational or aesthetic value.

Vibrations. Mainly from transport projects, these affect the quality of urban life and can interfere with certain production and consumption activities.

2.8.8 Evaluation of GHG emissions

Climate change impacts occupy a special position in the externalities assessment because:

•    climate change is a global issue, so the impact of emissions is not dependent on the location of the emissions;

• GHGs, especially carbon dioxide (CO2), but also nitrous oxide (N2O) and methane (CH4) have a long lifetime in the atmosphere so that present emissions contribute to impacts in the distant future;

•    the long-term impacts of continued emissions of greenhouse gases are difficult to predict but potentially catastrophic;

•    scientific evidence on the causes and future paths of climate change is becoming increasingly consolidated. In particular, scientists are now able to attach probabilities to the temperature outcomes and impacts on the natural environment associated with different levels of stabilisation of GHGs in the atmosphere.

The proposed approach to integrate climate change externalities into the economic appraisal is based, in part, on the EIB Carbon

Footprint Methodology66 and is consistent with the EU Decarbonisation Roadmap 2050. It consists of the following steps:

   quantification of the volume of emissions additionally emitted, or saved, in the atmosphere because of the project. Emissions are quantified on the basis of project-specific emission factors (e.g. t-CO2 per unit of fuel burnt, kg-COper kilometre travelled, etc.) and are expressed in tonnes per year. In the absence of project-specific data, default emission factors from the economic literature can be used. The sectorial chapters provides instructions on where to find data sources to be used as a benchmark;

   calculation of total CO2-equivalent (CO2e)emissions using Global Warming Potentials (GWP). GHGs other than COare converted into CO2e by multiplying the amount of emissions of the specific GHG with a factor equivalent to its GWP.

For example, set the GWP of CO2 equal to unity (=1), the GWP for CH4 and N2O are 25 and 298 respectively, indicating that their climate impact is 25 and 298 times larger than the impact of the same amount of CO2 emissions (IPPC, 2007);

evaluation of externality using a unit cost of CO2-equivalent. Total tonnes of CO2e emissions are multiplied by a unit cost expressed in Euro/tonne. It is suggested to use the values illustrated in table 2.10, for the central scenario, going from EUR 25 per tonne of CO2e in 2010 and then assuming a gradual increase to EUR 45 per tonne of CO2e until 203068 Due to the global effect of global warming, there is no difference between how and where in Europe GHG emissions take place. For this reason, the same unit cost factor applies to all countries. However, the cost factor is time-dependent in the sense that emissions in future years will have greater impacts than emissions today.

Table 2.10 Unit cost of GHG emissions

Value 2010 (Euro/t-CO2e)

Annual adders 2011 to 2 0 3 067 68

High

40

2

Central

25

1

Low

10

0.5

Source: EIB (2013).

Finally, if the change in carbon content of the project is significant, it is recommended that a carbon switching price is calculated, which is the price for carbon at which a decision-maker is indifferent between two (or more) specified project options69' This would offer another perspective on the impact of a given project on GHG emissions and the way in which this might inform project selection.

COST OF GHG EMISSIONS: APPLICATION RULES

In order to determine the external cost of climate change emissions, the following simplified formula must be applied:

Cost of GHG emission = V * Crur

GHG GHG

where:

-    VGHG is the incremental volume of GHG emissions produced by the project, expressed in CO2 equivalents;

CGHG is the unit shadow price (damage cost) of CO2 actualised and expressed at prices of the year at which the analysis is carried out.

As outlined in section 2.9.2, GHG emissions in future time periods should be discounted at the social discount rate applied to the project as a whole, reflecting the marginal impact of the project. However, it should be noted that the unit cost for GHG emissions may implicitly include a different social discount rate which reflects the impact of non-marginal GHG policy on the long term and uncertain damage from emission pathways. This is discussed further in Annex II.

2.8.9 The residual value

In economic analysis, the shadow price of the project's residual value must be estimated. This may be done in two mutually exclusive ways:

• by computing the present value of economic benefits, net of economic costs, in the remaining life-years of the project. This approach shall be adopted when the residual value is calculated in the financial analysis with the net present value of future cash flows method (see section 2.8.3);

• by applying an ad hoc conversion factor to its financial price. This is calculated as an average of the CFs of the single cost components, weighted by the relative share of each component in the total investment. This approach shall be adopted when the depreciation formula has been used in the financial analysis.

2.8.10 Indirect and distributional effects

Shadow pricing of project inputs and outputs, and monetisation of externalities, already account for the main relevant impacts of a project on welfare. Accordingly, indirect effects occurring in secondary markets (e.g. impacts on the tourism industry) should not be included in the evaluation of the project’s costs and benefits. The main reason for not including indirect effects is not because they are more difficult to identify and quantify than direct effects, but because - if the secondary markets are efficient70 - they are irrelevant in a general equilibrium setting, as they are already captured by the shadow prices. Adding these effects to the costs and benefits already measured in primary markets usually results in double-counting (see box).

BENEFIT DOUBLE-COUNTING: EXAMPLES

Double Counting of Benefits. In considering the value of an irrigation project, both the increase in value of the land and the present value of the increase in income from farming are counted as benefits. Only one of these should be counted because one could either sell the land or keep it and get the gains as a stream of income.

Counting Secondary Benefits. If a road is constructed, one might count the additional trade along the road as a benefit. However, under equilibrium conditions in competitive markets the new road may be displacing commercial activity elsewhere, so the net gain to society may be small or zero. People forget to count the lost benefits elsewhere (e.g. for newly generated traffic).

Counting Labour as a Benefit. In arguing for ‘pork barrel’ projects, some politicians often talk about the jobs created by the project as a benefit. But wages are part of the cost of the project, not the benefits. The social benefit of employment is already given by using shadow wages. However, a separate analysis of labour market impact can be helpful in some circumstances and is required by the Funds regulations.

On the other hand, shadow prices do not capture well, with a numeraire-based quantification, the distribution of the project costs and benefits across users and other stakeholders. Thus, the need for distinct analysis of the project impact on the welfare of specific target groups.

The distributional analysis requires the identification of a list of relevant effects and stakeholders that will be affected in a noticeable way by the implementation of the project. Typical effects refer to charges, time, reliability of service, comfort, convenience, safety, as well as environmental and territorial impacts. Typical stakeholders are users, operators, infrastructure managers, contractors, suppliers, and government (but the identification of stakeholders may differ across countries).

In operational terms, in order to summarise all the effects that are encountered by the project, a matrix can be developed linking each project effect with the sectors and the stakeholders affected by that impact. This methodology draws from the approaches of the SE Matrix suggested in the RAILPAG Guide71 (see box), as well as the BIT table (Benefit Incidence Table, even called Morisugi table from the name of its inventor) used in Japan for the appraisal of transport projects.

Alternatively, another method of analysing distributional issues consists of deriving explicit welfare weights from social inequality aversion estimates to be attached to the project winners and losers. This approach is illustrated in Annex V.

STAKEHOLDER MATRIX

The stakeholders matrix enables the presentation of the overall project in a way that relates effects (in the rows) and stakeholders (in columns) summarising the main economic and financial implications of the project, showing the transfers between stakeholders and the distribution of costs and benefits. It enables to estimate ‘net’ contributions, by cancelling out negative effects (for example displaced employment, displaced output) with positive effects. It also enables equity considerations if welfare weights are incorporated into the analysis.

Stakeholders

Users

(by category)

Non users (or alternative service users)

Service

operating

companies

Contracting & supplying companies

Tax payers

(local/regional/national/EU)

Firms (by sector)

Effects

External/internal

Effect 1

Effect 2

Effect 3

Source: adapted from RAILPAG

2.8.11 Economic performance

Once all project cost and benefits have been quantified and valued in money terms, it is possible to measure the economic performance of the project by calculating the following indicators (table 2.11):

•    Economic Net Present Value (ENPV): the difference between the discounted total social benefits and costs;

•    Economic Rate of Return (ERR): the rate that produces a zero value for the ENPV;

•    B/C ratio, i.e. the ratio between discounted economic benefits and costs.

ECONOMIC PERFORMANCE INDICATORS

The difference between ENPV and FNPV is that the former uses accounting prices or the opportunity cost of goods and services instead of imperfect market prices, and it includes as far as possible any social and environmental externalities. This is because the analysis is done from the point of view of society, not just the project owner. Because externalities and shadow prices are considered, some projects with low or negative FNPV(C) may show positive ENPV.

The ENPV is the most important and reliable social CBA indicator and should be used as the main reference economic performance signal for project appraisal. Although ERR and B/C are meaningful because they are independent of the project size, they may sometimes be problematic. In particular cases, for example, the ERR may be multiple or not defined, while the B/C ratio may be affected by considering a given flow as either a benefit or a cost reduction.

Table 2.11 Economic rate of return. EUR thousands

CF

Years

1

2

3

4

5

6-15

16

17-29

30

Willingness to pay 1

0

0

0

19,304

19,419

20,365

20,365

Willingness to pay 2

0

0

0

437

437

437

437

Reduced noise emission

0

0

0

4,200

4,200

4,200

4,200

Reduced air pollution

0

0

0

1,900

1,900

1,900

1,900

Total Benefits

0

0

0

25,841

25,957

26,902

26,902

Total operating costs

0.88

0

0

0

4,882

4,897

5,016

5,016

Initial Investment

V

0.97

8,228

73,071

41,689

0

0

0

0

Replacement costs

\

0.98

0

0

0

0

0

11.664

0

9.575

0

Residual value

0.97

0

0

0

0

0

0

-4,146

Total costs

\

8,228

73,071

41,689

4,882

4,897

23,428

871

Net economic benefits

\

-8,228

-73,071

-41,689

20,959

21,060

3,474

26,032

ENPV

\

212,128

ERR

>

14.8%

B/C ratio

2.04


(5

This CF is lower than CFs for

Financial Revenues have

These are positive

The application of a CF lower

investment because it includes

been replaced with user

externalities.

than 1 to the project inputs

a shadow wage correction

willingness to pay for

has the effect of reducing

for labour in a context of

the use of the service

the social cost and improving

unemployment.

rendered.

the economic performance.


GOOD PRACTICES

✓    Cost savings in O&M or investment are accounted for and included on the cost side as a negative, i.e. as decreasing costs and with appropriate conversion factors.

✓    Project positive impacts on employment are captured by applying the Shadow Wage Conversion Factor to (unskilled) labour cost and not including job creations as a direct benefit of the project.

✓    Project impacts on the overall economy (i.e. GDP growth) are excluded from the analysis of the project benefits.

✓    If specific indirect taxes are intended to correct for externalities, then these are included in economic analysis to reflect the social marginal value of the related externalities, provided that they adequately reflect the underlying WTP or marginal damage cost and there is no double-counting with other economic costs.


COMMON MISTAKES

X In the economic analysis a nil cost is given to the opportunity cost of land owned by a local municipality, although it may have value in other uses (e.g. it may be rented to local farmers).

X Conversion factors are ‘borrowed’ from other countries without justification.

X Revenues from tariffs are included as an economic benefit in addition to consumers’ marginal willingness to pay for the service rendered.

X Failure to isolate the ‘incremental’ economic benefits of the project, i.e. the benefits which are not displaced from other markets. This is especially evident in cases where it is attempted to measure secondary indirect impacts.

X Together with the application of the shadow wage on the cost side, benefits from job creation are included on the benefit side.

X Revenues from the sale of green certificates are included together with the external benefit of avoided GHG emissions.


2.9 Risk assessment

As set out in Article 101 (Information necessary for the approval of a major project) of Regulation (EU) No 1303/2013, a risk assessment must be included in the CBA. This is required to deal with the uncertainty that always permeates investment projects, including the risk that the adverse impacts of climate change may have on the project. The recommended steps for assessing the project risks are as follows:

•    sensitivity analysis;

•    qualitative risk analysis;

•    probabilistic risk analysis;

•    risk prevention and mitigation.

The rest of the section presents the aforementioned steps.

2.9.1 Sensitivity analysis

Sensitivity analysis enables the identification of the ‘critical' variables of the project. Such variables are those whose variations, be they positive or negative, have the largest impact on the project's financial and/or economic performance. The analysis is carried out by varying one variable at a time and determining the effect of that change on the NPV. As a guiding criterion, the recommendation is to consider ‘critical' those variables for which a variation of ±1 % of the value adopted in the base case gives rise to a variation of more than 1 % in the value of the NPV.The tested variables should be deterministically independent and as disaggregated as possible. Correlated variables would give rise to distortions in the results and double-counting. Therefore, before proceeding to the sensitivity analysis, the CBA model should be reviewed with the aim of isolating the independent variables and eliminating the deterministic interdependencies (e.g. splitting a variable in its independent components). For example, ‘revenue' is a compound variable, which depends on the two independent items ‘quantity' and ‘tariff', both of which should be analysed. Table 2.12 gives an illustrative example.

Table 2.12 Sensitivity analysis. Example

Variable

Variation of the FNPV due to a ± 1 % variation

Criticality

judgement

Variation of the ENPV due to a ± 1 % variation

Criticality

judgement

Yearly population growth

0.5 %

Not critical

2.2 %

Critical

Per capita consumption

3.8 %

Critical

4.9 %

Critical

Unit tariff

2.6 %

Critical

N/A

N/A

Total investment cost

8.0 %

Critical

8.2 %

Critical

Yearly maintenance cost

0.7 %

Not critical

0.6 %

Not critical

Per capita willingness to pay

Not applicable

-

12.3 %

Critical

Annual noise emissions

Not applicable

-

0.8 %

Not critical

Source: Authors

A particularly relevant component of the sensitivity analysis is the calculation of the switching values. This is the value that the analysed variable would have to take in order for the NPV of the project to become zero, or more generally, for the outcome of the project to fall below the minimum level of acceptability (see table 2.13). The use of switching values in sensitivity analysis allows making some judgements on the risk of the project and the opportunity of undertaking risk-preventing actions. For instance, in the example below, one must assess if a 19 % investment cost increase which would make the ENPV equal to zero thereby means that the project is too risky. Thus, the need to further investigate the causes of this risk, the probability of occurrence and identify possible corrective measures (see next section).

Table 2.13 Switching values. Example

Variable

Switching values

Benefits/revenues

Yearly Population growth

Minimum increase before the FNPV equals 0

104 %

Maximum decrease before the ENPV equals 0

47 %

Per capita consumption

Minimum increase before the FNPV equals 0

41 %

Maximum decrease before the ENPV equals 0

33 %

Tariff

Minimum increase before the FNPV equals 0

60 %

Maximum decrease before the ENPV equals 0

Not applicable

Per capita willingness to pay

Minimum increase before the FNPV equals 0

Not applicable

Maximum decrease before the ENPV equals 0

55 %

Costs

Investment cost

Maximum decrease before the FNPV equals 0

82 %

Minimum increase before the ENPV equals 0

19 %

Yearly maintenance cost

Maximum decrease before the FNPV equals 0

95 %

Minimum increase before the ENPV equals 0

132 %

Annual noise emissions

Maximum decrease before the FNPV equals 0

Not applicable

Minimum increase before the ENPV equals 0

221 %

Source: Authors

Finally, the sensitivity analysis must be completed with a scenario analysis, which studies the impact of combinations of values taken by the critical variables. In particular, combinations of ‘optimistic' and ‘pessimistic' values of the critical variables could be useful to build different realistic scenarios, which might hold under certain hypotheses. In order to define the optimistic and pessimistic scenarios it is necessary to choose for each variable the extreme (lower and upper) values (within a range defined as realistic). Incremental project performance indicators are then calculated for each combination.

Again, some judgments on the project risks can be made on the basis of the results of the analysis. For example, if the ENPV remains positive, even in the pessimistic scenario, the project risk can be assessed as low.

2.9.2 Qualitative risk analysis

The qualitative risk analysis aims shall include the following elements:

•    a list of adverse events to which the project is exposed;

•    a risk matrix for each adverse event indicating:

-    the possible causes of occurrence;

-    the link with the sensitivity analysis, where applicable;

-    the negative effects generated on the project;

-    the (ranked) levels of probability of occurrence and of the severity of impact;

-    the risk level.

   an interpretation of the risk matrix including the assessment of acceptable levels of risk;

•    a description of mitigation and/or prevention measures for the main risks, indicating who is responsible for the applicable measures to reduce risk exposure, when they are considered necessary.

To carry out the qualitative risk analysis, the first step involves the identification of adverse events that the project may face. Building a list of potential adverse events is a good exercise to understand the complexities of the project. Examples of events and situations with negative implications in the implementation of the project and, in particular, generating cost overruns and delays in its commissioning, are very varied and depend on the project specificities: landslides; adverse impacts of extreme weather events; non-obtainment of permits; public opposition; litigation; etc.

Once the potential adverse events have been identified, the corresponding risk matrix may be built. These are some brief instructions on how to operationally build it:

First, it is necessary to look at the possible causes of the risk materialising. These are the primary hazards that could occur during the life of the project. All causes of each adverse event must be identified and analysed, taking into account that several weaknesses of forecasting, planning and/or management may have similar consequences over the project. The identification of the causes of potential dangers can be based on ad hoc analyses or looking at similar problems that have been documented in the past. In general the occurrence of a disaster is looked upon as a design weakness, in the broadest possible sense, and therefore it is expected that all the potential causes of failure are properly identified and documented. Examples can be: low contractor capacity; inadequate design cost estimates; inadequate site investigation; low political commitment; inadequate market strategy, etc.

When appropriate, the link with the results of the sensitivity analysis should be made explicit by showing which critical variables are affected by the adverse events. For example, for the adverse event ‘unexpected geological conditions' the corresponding critical variable is ‘investment cost', and so on. However, depending on the nature of the event considered this is not always applicable (for example no variable corresponds to qualitative events such as public opposition).

For each adverse event, the general effect(s) generated on the project and the relative consequences on the cash flows should be described. For example, delays in the construction time will postpone the operational phase, which in turn, could threaten the financial sustainability of the project. It is convenient to describe these effects in terms of what the project promoter (or the infrastructure manager and services provider) might experience in terms of functional or business impacts. Each effect should also be characterised by its consequences over the project calendar (short vs. long term implications), relevant for both the prediction of the effect on the cash flows and the determination of appropriate risk mitigation measures.

A Probability (P) or likelihood of occurrence is attributed to each adverse event. Below, a recommended classification is given72, although in principle other classifications are possible:

A.    Very unlikely (0-10 % probability)

B.    Unlikely (10-33 % probability)

C.    About as likely as not (33-66 % probability)

D.    Likely (66-90 % probability)

E.    Very likely (90-100 % probability)

To each effect a Severity (S) impact from, say, I (no effect) to VI (catastrophic), based on cost and/or loss of social welfare generated by the project, is given. These numbers enable a classification of risks, associated with their probability of occurrence. Below a typical classification is given (table 2.14).

Table 2.14 Risk severity classification.

Rating

Meaning

I

No relevant effect on social welfare, even without remedial actions.

II

Minor loss of the social welfare generated by the project, minimally affecting the project long run effects- However, remedial or corrective actions are needed.

III

Moderate: social welfare loss generated by the project, mostly financial damage, even in the medium-long run. Remedial actions may correct the problem.

IV

Critical: High social welfare loss generated by the project; the occurrence of the risk causes a loss of the primary function(s) of the project. Remedial actions, even large in scope, are not enough to avoid serious damage.

V

Catastrophic: Project failure that may result in serious or even total loss of the project functions. Main project effects in the medium-long term do not materialise.

Source: Authors

The Risk level is the combination of Probability and Severity (P*S). Four risk levels can be defined as follows with the associated colours:

Risk level

Colour

Severity / Probability

I

II

III

IV

V

Low

A

Low

Low

Low

Low

Moderate

Moderate

B

Low

Low

Moderate

Moderate

High

High

C

Low

Moderate

Moderate

High

High

Unacceptable

D

Low

Moderate

High

Very High

Very High

E

Moderate

High

Very High

Very High

Very High

This exercise must be carried out during the planning phase so that decision makers can decide what is the acceptable level and thus what mitigation measures must be adopted. During the risk analysis included in the CBA, the remaining risks in the final design of the project are analysed. In principle no unacceptable risks should remain. The classification is useful, however, to identify the potential problems that the project might be confronted with.

Once the level of the remaining risks (P and S) is established, it is important to identify the mitigation and/or prevention measures foreseen.73 The diagram below shows, in a qualitative way, the kinds of measures or combinations of measures to reduce the project risk prevailing in the various areas of the above defined risk matrix. The identification of these measures requires a thorough knowledge of the causes of risk and of the nature and the timing of the end effects.

Severity / Probability

I II

III IV V

A

Prevention or mitigation

Mitigation

B

C

D

Prevention

Prevention and mitigation

E

The ‘intensity' of the measure should be commensurate to the level of risk. For risks with high level of impact and probability, a stronger response and a higher level of commitment to managing them shall be implemented. On the other hand, for low level risks, close monitoring could be sufficient. When the risk level becomes unacceptable (a situation that should never materialise, in principle) the entire project design and preparation must be revised. When identifying measures to mitigate existing risks, it is mandatory to define who is responsible for their execution and in what stage of the project cycle this will happen (planning, tendering, implementation, operation).

Finally, the impacts of the risk prevention and/or mitigation measures on the project's resilience and the remaining exposure to risk need to be assessed. For each adverse event, it is suggested to assess the residual risk after the implementation of the measures. If risk exposure is assessed to be acceptable (i.e. there are no longer high or very high risk levels), the proposed qualitative risk strategy can be adopted. If a substantial risk remains, it is required to move to a probabilistic quantitative analysis to further investigate the project risks (see next section).

Table 2.16 at the end of the section provides a simplified example of a risk prevention matrix for illustrative purposes.

2.9.3 Probabilistic risk analysis

According to the CBA methodology, as described in Annex III to the Implementing Regulation on application form and CBA methodology, the probabilistic risk analysis is required where the residual risk exposure is still significant. In other cases it may be carried out where appropriate, depending on project size and data availability.

This type of analysis assigns a probability distribution to each of the critical variables of the sensitivity analysis, defined in a precise range of values around the best estimate, used as the base case, in order to recalculate the expected values of financial and economic performance indicators.

The probability distribution for each variable may be derived from different sources, such as experimental data, distributions found in the literature for similar cases, consultation with experts. Obviously, if the process of generating the distributions is unreliable, the risk assessment is unreliable as well. However, in its simplest design (e.g. triangular distribution, see Annex VII) this step is always feasible and represents an important improvement in the understanding of the project's strengths and weaknesses as compared with the base case.

Having established the probability distributions for the critical variables, it is possible to proceed with the calculation of the probability distribution of the FRR or net present value (NPV) of the project. For this purpose, the use of the Monte Carlo method is suggested, which requires a simple computation software The method consists of the repeated random extraction of a set of values for the critical variables, taken within the respective defined intervals, and then the calculation of the performance indices for the project (FRR or NPV) resulting from each set of extracted values. By repeating this procedure for a large enough number of extractions, one can obtain a pre-defined convergence of the calculation as the probability distribution of the IRR or NPV.

The values obtained enable the analyst to infer significant judgments about the level of risk of the project. In the example shown in the table 2.15, ENPV can result in negative values (or ERR lower than the SDR) with a probability of 5.3 %, disclosing a project with a low risk level. In other cases, however, a mean (and/or median) value significantly below the base value can indicate future difficulties in the materialisation of the expected project benefits.

Table 2.15 Results of Monte Carlo simulation. Example

Expected values

ENPV

ERR

Base case

36,649,663

7.56 %

Mean

41,267,454

7.70 %

Median

37,746,137

7.64 %

Standard deviation

28,647,933

1.41 %

Minimum value

-25,895,645

3.65 %

Central value

55,205,591

7.66 %

Maximum value

136,306,827

11.66 %

Probability of the ENPV being lower than zero or ERR being lower than the reference discount rate

0.053

0.053

Source: Authors

The result of the Monte Carlo drawings, expressed in terms of the probability distribution or cumulated probability of the IRR or the NPV in the resulting interval of values, provide more comprehensive information about the risk profile of a project. Figure 2.3 provides a graphical example.

Figure 2.4 Example of cumulated and punctual probability distribution of the ENPV

-26,000,000    24,000,000    74,000,000    124,000,000

ENPV


Punctual probability

ENPV


Source: Authors


The cumulated probability curve (or a table of values) assesses the project risk, for example verifying whether the cumulative probability for a given value of NPV or IRR is higher or lower than a reference value that is considered to be critical. In the example shown in the above figure, the cumulative probability of an ENPV value of EUR 18,824,851, which is set at 50 % of the base value, is 0.225, a value high enough to recommend taking preventive and mitigation measures against the project risk. For a more detailed illustration of how to perform a probabilistic risk analysis and how results should be interpreted see Annex VIII.

2.9.4 Risk prevention and mitigation

The implementation of the steps described above defines the risk prevention and mitigation strategy of the project. Generally, a neutral attitude towards risks is recommended because the public sector might be able to pool the risks of a large number of projects. In such cases, the assessment of the switching values and of the scenario analysis results, followed by a well-established risk matrix (plus, a probabilistic risk analysis if necessary) will summarise the risk assessment. In some cases, however, the evaluator or the project promoter can deviate from neutrality and prefer to risk more (risk-taker) or less (risk-adverse) for the expected rate of return. However, there must be a clear justification for this choice.

Risk assessment should be the basis for risk management, which is the identification of strategies to reduce risks, including how to allocate them to the parties involved and which risks to transfer to professional risk management institutions such as insurance companies. Risk management is a complex function, requiring a variety of competences and resources, and it can be considered as a role for professionals, under the responsibility of the managing authority and the beneficiary. The project promoter should, however, following the risk assessment, at least identify specific measures (including responsibilities for their application) for the mitigation and/or prevention of the identified risks, according to international good practice. For a more detailed discussion about the assessment of acceptable risk levels and the definition of risk prevention and mitigation strategies see Annex VIII.

GOOD PRACTICES

✓    The sensitivity analysis is extended to all the independent variables of the project and, among them, the critical variables are identified.

✓    A large enough numerical scale (i.e. a scale of 1-5) is used for adequate differentiation of probability of occurrence and impact levels of the adverse effects.

✓    The cost of prevention/mitigation measures is included within the investment and/or O&M costs. This includes risks linked to natural disasters or other similarly unforeseeable events which need to be either covered in the technical design of the project and/or adequately insured (if possible).

✓    The switching values for critical variables are calculated also when projects show a negative FNPV(K) after EU assistance. The necessary variation of a key variable to reach the benchmark is valuable information for the appraiser.

✓    If, after all prevention/mitigation measures, there is still a considerable risk in the project, a probabilistic analysis is carried out in addition to the qualitative assessment to quantify the probability of risk occurrence.

✓    Probability distributions of the input variables are adequately determined, for example on the basis of collected experience in past projects.


COMMON MISTAKES

X Risks that are out of the control of the project promoter or other stakeholders (i.e. change of legislation) are neglected in the analysis, although they may substantially contribute to the success/failure of the project.

X Too aggregated variables (e. g. benefits as a whole) are taken into account in the sensitivity and risk analysis. As a consequence, it is not possible to identify which parameters the prevention/mitigation measures have focused on.

X Independently from the type of analysis, risk prevention/mitigation measures are not identified.

X A too generic discussion on risk causes and prevention measures is carried out with no mention of their likelihood of occurrence and/or identification of impacts.

X There is no identification of the risk ‘manager’, i.e. the function responsible for the implementation of the identified risk prevention/mitigation measures.


Table 2.16 Risk prevention matrix. Example

Adverse

event

Variable

Causes

Effect

Timing

Effect on cash flows

Probability

(P)

Severity

(S)

Risk

Level

Prevention and/or Mitigation measures

Residual

risk

Construction

delays

Investment

cost

Low contractor capacity

Delay in

service

starting

Medium

Delay in establishing a positive cash flow including benefits materialisation

C

III

Moderate

Set up of a Project Implementation Unit to be assisted by technical assistance for project management during implementation.

Low

Project cost overrun

Investment

cost

Inadequate design cost estimates

Investment costs higher than expected

Short

Higher (social) costs in the first phase of the project

D

V

Very high

The design of the project must be revised.

Moderate

Landslides

Not

applicable

Inadequate site investigation

Interruption of the service

Long

Extra costs to rehabilitate the service

A

III

Low

Close monitoring

Low

Delayed obtainment of permits

Not

applicable

Low political commitment;

Mismanagement of the licensing procedures process

Delay in commencement of works

Short

Delay in establishing a positive cash flow including benefits materialisation

A

II

Low

Close monitoring

Low

Public

opposition

Not

applicable

Inadequate market strategy

Underestimation of threats

Demand lower than expected

Medium

Lower revenues and social benefits

C

V

High

Early definition of an appropriate social plan; Awareness-raising activities and campaigns to raise the level of social acceptance

Moderate

Source: Authors


GUIDE TO COST-BENEFIT ANALYSIS OF INVESTMENT PROJECTS


2.10 Checklist

The following checklist closes the chapter. It is intended as a suggested agenda both from the standpoint of the project promoter, who is involved in preparing the project dossier, and from that of the project examiner, who is involved in reviewing the quality of the appraisal.

Step

Question

General

•    Has an incremental approach been adopted?

•    Is the counterfactual scenario credible?

•    Has an appropriate time horizon been selected?

•    Have project effects been identified and monetised?

•    Have appropriate financial and social discount rates been adopted?

•    Does the economic analysis build on the financial analysis?

•    Is the methodology adopted consistent with the Commission’s or Member States’ own guidance?

Presentation of the context

•    Is the social, institutional and economic context clearly described?

•    Have all the most important socio-economic effects of the project been considered in the context of the region, sector or country concerned?

•    Are these effects actually attainable given the context?

•    Are there any major potential constraints to project implementation?

Definition of objectives

•    Does the project have clearly defined objectives stemming from a clear assessment of the needs?

•    Is the project relevant in light of the needs?

•    Are the project objectives quantitatively identified by means of indicators and target values?

•    Is the project coherent with the objectives of the Funds and the EU operational programmes?

•    Is the project coherent with the national and regional strategies and priorities, as defined in their development plans?

•    Are the means of measuring the attainment of objectives and their relationship, if any, with the targets of the operational programmes indicated?

Identification of the project

•    Does the project constitute a clearly identified self-sufficient unit of analysis?

•    Have combinations of self-standing components been appraised independently?

•    Has the technical, financial and institutional capacity of the promoter been analysed?

•    Has the impact area been identified?

•    Have the final beneficiaries eventually profiting from the project been identified?

•    If the project is implemented by a PPP, is the PPP arrangement well described, are the public and private parties clearly identified?

•    Whose costs and benefits are going to be considered in the economic welfare calculation?

•    Are all the potentially affected parties considered?

Technical feasibility and environmental sustainability

•    Has current demand for services been analysed?

•    Has future demand for services been forecasted?

•    Are the demand forecasting method and assumptions appropriate?

•    Does the application dossier contain sufficient evidence of the project’s feasibility (from a technical point of view)?

•    Has the applicant demonstrated that other alternative feasible options have been adequately considered?

•    On what criteria was the project optimal option selected? Are these criteria appropriate for the type of project?

•    Is cost of measures taken for correcting negative environmental impacts included in the cash flows considered in the CBA?

•    Is the technical design appropriate to the achievement of the objectives?

•    Is capacity utilisation rate in line with demand expectations?

•    Are the project cost estimates (investment and O&M) adequately explained and sufficiently disaggregated to allow for their assessment?

Step

Question

Financial

analysis

•    Have depreciation, reserves, and other accounting items which do not correspond to actual cash flows been excluded from the analysis?

•    Has the residual value of the investment been properly calculated and included in the analysis?

•    In the case of using current prices, has a nominal financial discount rate been adopted?

•    Has VAT, if recoverable by the beneficiary, been excluded from the analysis?

•    Have transfers and subsides been excluded from the computation of the project revenues?

•    If tariffs are levied from users, how has the polluter-pays-principle been applied, what is their cost recovery level in the short, medium and long-term?

•    If an affordability cap is applied to tariffs, has an affordability analysis been carried out?

•    Is the financial sustainability analysed at project and, where appropriate, operator level?

•    If the project is not financially sustainable by itself (produces negative cash-flows at some point), is it explained how the required funds will be ensured?

•    Have the main financial performance indicators been calculated (FNPV(C), FRR(C), FNPV(K), FRR(K)) considering the right cash-flow categories?

•    If private partners are involved, do they earn normal profits as compared with financial benchmarks in the sector?

Economic

analysis

•    In the case of market distortions, have shadow prices been used to better reflect the social opportunity cost of the resources consumed?

•    Is the Standard Conversion Factor calculated and applied to all minor non-traded items?

•    In the case of major non-traded items, have sector-specific conversion factors been applied?

•    Has the appropriate shadow wage been chosen for the labour market?

•    If cash-flows present fiscal requirements, have market prices been corrected?

•    Have non-market impacts been considered for the evaluation of the project economic performance?

•    Have externalities been included in the analysis, including climate change effects?

•    Are the unit values for quantification of economic benefits and externalities and their real growth over time adequately presented/explained?

•    Have the main economic performance indicators been calculated (ENPV, ERR and B/C ratio) considering the right categories of cost and benefits? Is there any risk of benefit double counting?

•    Is the economic net present value positive? If not, are there important non-monetised benefits to be considered?

Risk

assessment

•    Is the sensitivity analysis carried out variable by variable and possibly using switching values?

•    Has the scenario analysis been carried out?

•    What is the proposed risk prevention and mitigation strategy?

•    Has a full risk prevention matrix been built?

•    Have risk mitigation or prevention measures been identified?

•    If the project appears to be still exposed to risk, has a probabilistic risk analysis been carried out?

•    What is the overall assessment about the project risk?

3. Transport

3.1 Introduction

The EU transport infrastructure strategy, as defined in the TEN-T74 Guidelines, focuses on improving transport infrastructure quality through new investment and the efficient use of pre-existing infrastructure in order to improve accessibility, mobility and safety, as well as to match transport demand. Related investments priorities are defined under the thematic objective 7 ‘Promoting sustainable transport and removing bottlenecks in key network infrastructures', which focuses on:

•    supporting a multimodal Single European Transport Area by investing in the trans-European transport network (TEN-T) network (investment priority 7a);

•    enhancing regional mobility through connecting secondary and tertiary nodes to TEN-T infrastructure (7b);

•    developing and improving environmentally-friendly and low-carbon transport systems, including inland-waterways and maritime transport, ports and multimodal links, and promoting sustainable regional and local mobility75 (7c);

•    developing and rehabilitating a comprehensive, high quality and interoperable railway system (7d).

According to the Common Strategic Framework, actions financed under the ERDF and the Cohesion Fund in the transport field shall be planned in close cooperation with the Connecting Europe Facility (CEF), which is a directly managed fund created in 2012 for accelerating cross-border investments in the field of trans-European networks, maximising the synergies between transport, energy and telecommunications policies, and ensuring funding from both the public and private sectors.

The CEF will concentrate on projects with a high EU added value, in particular in the core network for cross-border infrastructure (as pre-identified in the Annex of the CEF Regulation) and for railway, while the Cohesion Fund and the ERDF will concentrate on high EU added-value projects to remove bottlenecks in transport networks by supporting TEN-T infrastructure, for both the core and the comprehensive network.

In addition, transport investments must be closely linked to the needs identified in national transport plans (cf. thematic ex-ante conditionality 7.1), based on a rigorous assessment of transport demand (both for passengers and for freight). These plans should identify missing links and bottlenecks and should set out a realistic and mature pipeline for projects envisaged for support from the ERDF and Cohesion Fund. The aim is to ensure a better interoperable integration between transport modes and a stronger focus towards the Trans-European Networks in 2020 and beyond.

As illustrated in the box below, EU policies and interventions have mainly focused on: development of the infrastructure network; regulation and competition among and between modes intended to open up the national markets and make transport services more competitive and interoperable at the EU level; setting prices correctly (including charging for infrastructure use and internalisation of external costs); and providing safe infrastructure and/or improving safety conditions.

THE EU POLICY FRAMEWORK

Strategies

White Paper on Transport (March 2011)

Proposal from the Commission for a European Parliament and Council regulation on Union guidelines for the development of the trans-European transport network (COM/2011/0650)

Roadmap to a Single European Transport Area -Towards a competitive and resource efficient transport system - White Paper (COM/2011/144)

Keep Europe moving - Sustainable mobility for our continent, Mid-term review of the European Commission’s 2001 Transport - White Paper (COM/2006/314)

European transport policy for 2010: Time to decide - White Paper ( COM/2001/370)

Roadmap to a Single European Transport Area: Facts and figures Urban public transport policy Connecting Europe Facility

Trans European Network - Transport (TEN-T)

European Commission 2014, Building the Transport Core Network: Core Network Corridors and Connecting Europe Facility, COM(2013) 940 final

European Commission, 2013, The Fourth Railway Package - Completing the Single European Railway Area to Foster European Competitiveness and Growth

European Commission, 2011, Regulation of the European Parliament and the Council establishing the Connecting Europe facility

TEN-T: A policy review - ‘Towards a better integrated trans-European transport network at the service of the common transport policy’, Green Paper

Decision 661/2010/EU of the European Parliament and the Council of 7 July 2010 on Union guidelines for the development of the trans-European transport network

Trans-European Networks: Towards an integrated approach, COM/2007/0135

Competition and pricing

European Commission, 2007, Regulation of the European Parliament and the Council N. 1370 on public passenger transport services by rail and by road

Road Tolling Directive 2004/52/EC and Decision 2009/750/EC

Directive 2006/38/EC ‘Euro-vignette’ amending Directive 1999/62/EC on the charging of heavy goods vehicles for the use of certain infrastructures (see following box)

Directive 2004/49/EC amending Directive 2001/14/EC on the allocation of railway infrastructure capacity and the levying of charges for the use of railway infrastructure and safety certification

Directive 2011/76/EU amending Directive 1999/62/EC on the charging of heavy goods vehicles for the use of certain infrastructures

Rail Interoperability

Directive 2008/57/EC of the European Parliament and the Council of 17 June 2008 on the interoperability of the rail system within the Community: OJ L 191/1 of 18 July 2008

Commission Decision of 25 January 2012 on the technical specification for interoperability relating to the control-command and signalling subsystems of the trans-European rail system

3.2 Description of the context

The objectives of a transport project, namely the specific functions the infrastructure has to perform, must be consistent with the territorial context of the region or country (or cross-border area) where the project is built. As a minimum, the following information should be presented in order to outline the baseline elements.

Table 3.1 Presentation of the context. Transport sector

Assumptions

Socio-economic

trend

-    National and regional GDP growth

-    Demographic change

-    Industrial and logistics structure and developments (freight transport)

-    Forecasts in employment

-    Forecast in indices of specific economic sectors in which the area covered by the infrastructure is suited (e.g. value added growth in tourism)

Political, Institutional and Regulatory

-    Reference to EU directives and sector policy documents

-    Reference to the long-term national, regional and local planning documents and strategies, including, for example, the General Transport Development Plan and the Public Transport Development Plan

-    Reference to the priority axis and the intervention areas of the OP

-    Any pre-existing planning authorisations and decisions

Existing service conditions

-    Detailed information about the existing transport infrastructure in the area

-    Information about competition from alternative transport modes

-    Planned and/or recently executed investments that may affect the project performance

-    Information about historic and present traffic patterns

-    Statistics in motorisation, mobility and accessibility of the area

-    Technical characteristics of the service currently provided

-    Service quality, frequency and safety

-    Infrastructure capacity

Source: Authors

3.3 Definition of objectives

The next step is to clearly state the main objectives of the transport project. These are generally related to the improvement in travel conditions for goods and passengers both inside the impact area and to and from the impact area (accessibility), as well as improvements in both the quality of the environment and the wellbeing of the population served. In more detail, projects will typically deal with the following objectives:

•    reduction of congestion within a network, link or node by resolving capacity constraints;

•    improvement of the capacity and/or performance of a network, link or node by increasing travel speeds and by reducing operating costs and accidents;

•    improvement of the reliability and safety of a network, link or node;

•    minimisation of GHG emissions, pollution and limitation of the environmental impact (important examples are projects supporting the shift from individual, i.e. cars, to collective transport);

•    adjustment to EU standards and completion of missing links or poorly linked networks: transport networks have often been created on a national and/or regional basis, which may no longer meet the transport requirements of the single market (this is mainly the case with railways);

• improvement of accessibility in peripheral areas or regions.

Objectives must be aligned with the priorities identified in the OP and Transport Master Plan/Strategy in the context of ex ante conditionality. When feasible, they should be quantified and targeted with the use of indicators, logically linked to the project benefits (see section 3.7). For example, indicators including expected traffic volumes, travel times, average speeds, etc., can be used to show the link between the materialisation of the project benefits and the achievement of the stated objectives.

3.4 Project identification

A good starting point for briefly, but clearly, identifying the infrastructure is to state its functions, which should be coherent with the investment objectives. This should be followed by a description of the project typology, that is whether it is a completely new facility, or a link to a larger infrastructure, or an extension/upgrade of a pre-existing one77 (see box). Finally, a detailed list of the physical realisations must be included.

INVESTMENT TYPOLOGIES

New infrastructures to satisfy increasing transport demand Completion of existing networks (missing links)

Extension/renovation of existing infrastructures Investment in safety measures on existing links or networks

Improved use of the existing networks (i.e. better use of under-utilised network capacity) Improvement in inter-modality (e.g. interchange nodes)

Improvement in networks interoperability

Improvement in the management of the infrastructure investment

The identification of the project as a self-sufficient unit of analysis is usually a challenging issue in the transport sector. This is because most transport projects belong to a wider network and any investment decisions and implementation are not isolated, but are part of a larger system of public interventions, as well as the need to be physically integrated with other complementary infrastructures. In project identification, the basic principle is that its scope must always be a stand-alone socio-economic and technical unit: i.e. it should generally be functional and independently useful from a transport perspective without depending on the construction of other projects (which may however provide synergies). That considered, the following basic rules can be applied (see also section 2.6):

•    when the project consists of realising a given section, sub-portion or phase of a well identified transport investment, the CBA (and the supporting feasibility study) should be focused on the entire investment, regardless of the object of the EDRF/Cohesion Fund assistance;

•    when the project contributes to implementing a larger investment strategy or plan, encompassing a set of interventions all aimed at achieving the same priority, each intervention should undergo a CBA. For example, a project may consist of the completion of a trans-national link under the TEN-T. Here, the economic appraisal should not focus on the entire link, but only on the project's section where different options are available.

For example, the construction of a third lane for a two-lane motorway, the laying of a second track or the electrification and automation of an existing rail line.

3.5 Forecasting traffic volume

3.5.1 Factors influencing demand analysis

When developing a demand analysis for transport investments, particular attention should be paid to the sensitivity of traffic to some critical variables such as:

   demographic changes, including, amongst others, the number of people split into age structure, level of education and number of people of productive and non-productive age;

   socio-economic changes, including, amongst others, GDP level in analysed area, incomes, level of unemployment, economic structure of regions being served currently or in the future by the transport infrastructure;

   industrial and logistics structure and developments: location of concentrated industrial activities, natural resources, main transport hubs (ports and airports), logistics structure, and expected developments in supply chain organisation (clustering, unitisation, change in distribution patterns);

   elasticity with respect to quality, time and price (see box): travel demand characteristics, structure and elasticity are particularly important in those projects related to charged infrastructures, since the expected traffic volumes are determined by fare levels and the transport conditions;

   capacity constraints on competing modes and strategies in place, for example in terms of investments foreseen. This point is particularly relevant for long term investments: in the time span required to complete the intervention, the traffic that may be potentially acquired by the new infrastructure may shift to other modes and, if so, then it may be difficult to move it back.

   spatial changes leading to changes in the distribution of traffic potential;

   change of traffic management policies, e.g. existence of constraints in using the car in determined areas (this is particularly the case of urban public transport) or establishment of taxes or subsidies for competing modes;

   technological changes impacting the cost structure for the project and its alternatives through changes in e.g. fuel efficiency, fleet composition or productivity.

Given the uncertainty of the future trends of these variables, it is generally recommended to develop, as a minimum, three traffic scenarios (high, most likely and low), which should further feed into risk analysis. These should be based on different developments of both exogenous (e.g. GDP growth) and endogenous (e.g. pricing policy) variables. Demand forecasting should be completed for the scenario without-the-project, and for each project option (see below).

PRICING POLICIES

Fares, tolls and other pricing policies will influence the expected volume of demand and the distribution of demand across transport modes. It is therefore important, whenever a different pricing hypothesis is introduced, to reconsider the demand estimates and allocate the correct traffic volumes to each mode. With regard to pricing criteria, it is important to distinguish between:

-    fares which maximise the proceeds for the managers/constructors of infrastructures: these kinds of fares maximise the capacity for self-financing;

-    efficiency fares: these take into consideration the social surplus and also consider the external costs (congestion as well as the environmental and safety costs).

Efficient pricing should, in principle, be based on social marginal costs and requires the ‘internalisation of external costs’ (polluter pays principle), including congestion and environment costs. Social efficiency requires that users pay both the marginal private or internal and external costs that they impose on society. An efficient structure of charges confronts users with the marginal social costs of their decisions.

3.5.2 Hypotheses, methods and input

In order to develop traffic forecasting, some justified specific assumptions should be adopted with regard to:

•    the project’s impact area, in order to limit the traffic study and the related economic impacts. It is important to identify the demand without the project and the impact of the new infrastructure, as well as identify other transport modes potentially involved;

•    the degree of complementarity and competition among transport modes. In particular, competing modes and alternative routes, fares and costs for users, pricing and regulation policies, congestion and capacity constraints and expected new investments should be assessed;

•    the deviations from past trends, including changes in tax regime, energy prices or toll collection policy;

•    the relative sensitivity of demand patterns (such as modal share or volume of traffic) to changes in the transport supply.

Traffic modelling78 is usually required for demand analysis, which enables the simulation of traffic distribution on the network thereby providing indication of how trips will respond, over time, to changes in transport supply and demand. Trip developments may be the consequence of changes in the demand for transport and/or in the transport network itself (i.e. the building of new transport infrastructure and/or provision of operated services).

Different models exist, ranging from the development of relatively simple spreadsheet models79 (which are generally bespoke and constructed by users for a particular calculation) to network models that describe a defined impact area and are generally more complex since they can involve ‘feedback loops', where the resulting state of the network can impact on user decisions. These complex models incorporate significant volumes of information on the demand structure, the transport network and its dynamics (e.g. timetables, interconnections, etc.) to describe large numbers of transport movements over a specified period. Data is typically coded in the form of attributes for each transport link in the network, including speed, quality, and the travel modes that use each link.

The choice of the appropriate model depends on a large number of factors, including the nature of the options to be tested, geographical location, scope, size and likely key impacts so that is not liable to adopt a ‘one size fits all' approach to developing transport models in order to assess this range of issues. In general, the larger the project framework complexity, the higher the need for more sophisticated and complex models. Complex transport modelling is considered compulsory in large projects, e.g. if its size can significantly influence other traffic services or regional transport pattern.

Although there is currently no detailed guidance at EU level for the development and application of transport models, basic principles and features of modelling can be derived from national guidance, which the project promoter should always refer to. These include:

•    traffic modelling is used to predict the travel choice made by users travelling through the network, and to load the resulting trip movements to the modelled network based on a selection of the most likely routing for each trip. The model then describes the loaded transport network after this process has been completed;

•    the state of the transport network in future years on the basis of growth in travel demand, committed network changes and changes in socio-economic data can also be defined. Future years usually coincide at least with the opening year and a distant forecast year which is used for assessment of long-term capacity needs or is the end year of economic evaluation;

•    many transport models require substantial input data derived from standard statistics and special surveys for building a model of trips, a model of the network and for understanding current traffic flows and demand structure for the purpose of model calibration. This is essential for the model to be sufficiently accurate and have credibility for planning and decision making;

•    the output from the transport model is used to design adequate sizing and features of the investment, to verify the appropriateness of planned infrastructure capacity, and provides quantitative information that informs the scheme design, the CBA and the EIA. 76 77

Whatever model and modelling process is adopted, all hypotheses and assumptions applied to estimated existing and future demand should be made explicit by the project promoter. Although the analysis of the input data for traffic modelling is not a task of the CBA, nevertheless, there should be the source should be given of all quoted demographic, spatial and economic data.

3.5.3 Outputs of the traffic forecast

Taking into account the requirements for economic analysis, traffic forecast outputs are developed for passenger and/or cargo traffic. Outputs shall include all information necessary for further technical analyses as well as financial and economic analyses. Although each subsector has its own indicators of traffic forecasts, the following demand parameters are usually collected to feed the CBA model:

•    number of vehicles (cars, trains, buses, airplanes, ships, etc.) in absolute value, per unit of time (e.g. Annual Average Daily Traffic (AADT), trains per day, etc.) and/or per average trip length (e.g. vehicles-km, trains-km, etc.);

•    number of vehicles broken down by category, speed class and road category;

•    number of passengers, passenger-hours and passenger-km78;

•    cargo traffic in tons, ton-hour and ton-km;

•    travel times and other network performance indicators.

Types of traffic response

Traffic types can be divided according to their behavioural response to a project. This qualification will become relevant when it comes to the assessment of the socio-economic impacts of the project. The classification proposed in this guide is as follows79:

   existing traffic: current traffic on the network of reference (new projects) or on the infrastructure to be upgraded/ reconstructed;

   diverted traffic: traffic which is attracted to the project from other routes or transport modes;

   generated/induced traffic: additional traffic flows that result from a transportation infrastructure improvement due to new users attracted by better conditions of transport80.

Depending on the traffic system perspective, and on the actual availability of data on generalised costs from the traffic model, the assessment of socio-economic benefits for each of these categories can be performed differently (see section 3.8 below).81

Also, for the purpose of the economic assessment, the traffic surveys should also provide information on the share of trips by travel purpose, for instance business, commuting and leisure trips. An additional distinction by short and long distance trips can be relevant for road and railways trips.

3.6 Option analysis

The project should be identified after the assessment of all promising strategic and technical alternatives on the basis of physical circumstances and available technologies. The main potential for distorting the evaluation is the risk of neglecting relevant alternatives, in particular low-cost solutions, such as managing and pricing solutions, infrastructure interventions that are considered as not ‘decisive' by designers and promoters, etc.

Possible design options in transport include: i) mode; ii) location/route; iii) alignment, iv) technical solutions; v) interchanges; etc. Different options may have different demand, costs and impacts.

Options might include synergies in co-deployment of transport and NGA infrastructure, in line with the Directive 2014/61/ EU, in view of smartening the transport systems, improving efficiency in the use of public funds, and significantly increasing the socio-economic impact of projects.

For option selection, the suggested approach is generally to use Multi-Criteria Analysis for shortlisting the alternatives, then CBA to compare the results of the shortlisted options and consequently select the most promising one. It is worth stressing that option analysis should be developed standardly in concept stage feasibility studies prior to design and funding application preparation. In this case, the promoter should properly describe the options analysis in the feasibility study, in order to demonstrate that the available options have been subject to a robust assessment and that the selected option was the best from a socio-economic perspective. Otherwise, if the appropriate analysis was not formerly completed, it would then form part of the feasibility study, which is an annex to the project application.

Finally, option analysis can also be used later to review the efficiency of previous designs, especially when socio-economic circumstances have changed. This can lead to project re-design.

3.7 Financial analysis

3.7.1 Investment costs

Investment costs disaggregation is project-specific, although the transport sub-sectors are usually characterised by common cost categories for both initial investment and renewals82. For an illustrative list of investment outlays in the road and railway sectors, see the case studies at the end of the chapter. As general remarks valid for any transport investment, the following can be highlighted:

•    estimates must be based on appropriate benchmarks with projects of comparable characteristics, based on best available technologies, etc.;

•    it is recommended to present both the total cost of the project and the unit value (e.g. cost per km, cost per unit of rolling stock, etc.);

•    costly engineering structures (tunnels, bridges, overpasses, etc.) should always be shown separately in a cost statement to allow for benchmarking;

•    it is necessary to ensure that the project will include all the works required for its functioning (for example, links to the existing networks, technological plants, stations with related services, urban renewal works adjacent to public transport investments, etc.);

•    cost of land83 and costs for environmental protection, including e.g. noise barriers and other noise protection, drainage, greenery, animal passages, etc., and/or for the integration of the works in the territory (e.g. for the preservation of the landscape integrity, etc.) are usually main items to be included in the investment costs.

3.7.2    Operation and Maintenance (O&M) costs

In the transport sector, O&M costs can be generally grouped into the following categories:

•    infrastructure operations, e.g. repairs, current maintenance, materials, energy, Traffic Management System;

•    services operations, e.g. staff cost, traffic management expenses, energy consumption, materials, consumables, rolling stocks maintenance, insurance, etc.;

•    services management, e.g. services management itself, fare/tolls collection, company overheads, buildings, administration, etc.

As for the timing of the expenditure, O&M costs should cover (and is usually distinguished in):

   routine maintenance: yearly work required to keep the infrastructure technically safe and ready for day to day operation as well as to prevent deterioration of the infrastructure assets;

   periodic maintenance: all activities intended to restore the original condition of the infrastructure.

In financial analysis, O&M costs should be estimated in both the with and without project scenarios. Significant difference may, however, exist between the two scenarios, especially when maintenance and repair have been neglected in the past. For the estimation of O&M costs in the counterfactual scenario, in particular, periodic and routine maintenance costs should correspond to reaching the target without the project standard of operations with minimal investments. All assumptions taken should be carefully documented in the project dossier.

3.7.3    Revenue projections

Financial inflows will be represented by the proceeds from the charges applied to users for the access to the infrastructure or the sale of transport services, or related to sale or rent of land or buildings. The estimate for the proceeds must be consistent with the demand elasticity and trends of explanatory variables and, in a more general sense, with traffic modelling output.

The estimation of revenues should be based on the following elements:

•    traffic volume forecast (changes of passenger and cargo traffic);

•    projection of changes in charge system and pricing policy;

•    traffic forecast for each projection of charge system;

•    subsidy/compensation projection.

An indicative list of typical revenues to be considered for calculation of the financial profitability is provided in the table below.

Table 3.2 Typical sources of revenue by transport mode

Revenues from transport activities

Revenues from non-transport activities

Road

Tolls and/or other users charges

Value of scrap material Rental of service stations Advertisement on service stations

Railway

Access charges to railway line

Advertisement on trains and/or in railway stations

(in the case of infrastructure projects) Tickets (in the case of roiling stock projects)

Commercial premises in railway stations

Urban

Tickets and subscriptions

Commercial premises in stations

transport

Advertisement on vehicles and/or on stations or bus stops

Airports

Take-off or landing charge

Commercial services

Passenger charge

Real estate rental

Parking charge

Food services

Cargo charge

Transport services Advertising services Car parks

Seaports

Basin, berth dues, etc.

Commercial premises

and inland waterways

Tariff for inland cargo ship

Logistics

Advertising on vessels

Intermodal

Access charges to railway line

Commercial premises

facilities

Tariff/fee for cargo storage and transhipment

Logistics

Source: Authors

If the situation on a given transport service is such that revenues from transport and non-transport activities do not fully cover the cost of operation, the gap must be filled with other sources to avoid the closure of the service. This usually implies that an operating subsidy or compensation is provided from public funds. Under such circumstances, this type of inflow must be separated from the overall revenue projection because, as highlighted in chapter 2, they do not concur for the calculation of the EU contribution and the financial performance indicators (but they count for sustainability).

As a result of the revenue analysis, the projection of the total revenues for the entire time horizon of the analysis should be prepared in both with and without-the-project scenarios.

PERSPECTIVE OF THE ANALYSIS AND REVENUES

As mentioned in chapter 2, it is recommended to carry out the financial analysis at a consolidated (owner + operator) level. This is particularly feasible when there is only one operator, which provides the transport service on behalf of the owner, usually by means of a concession contract. This is often the case of road and urban transport services.

In other cases, on the contrary, the consolidation of the analysis cannot be feasible. In liberalised markets, the number of operators can be very large, e.g. in airports but, to some extent, also in seaports and railways. Given the high number of data that would be required, together with legal and information protection issues, the financial analysis of these investments is more frequently carried out from the viewpoint of the infrastructure owner. In such a case, the revenues to be accounted for in the CBA are those originating from the operators or from third parties (e.g. tenants of commercial spaces, etc.) to the owner for the use of the infrastructure (usually access charges, see below). Conversely, in the case of projects implemented by operators (e.g. rolling stock renovation in urban transport), the revenues are those originating from the sale of the service to final users, as well as any other operating revenues accruing to the operator for the use of the infrastructure by third parties.

3.8 Economic analysis

In transport projects the main direct benefits are measured by the change of the following measurable.

•    The consumer surplus, defined as the excess of users' willingness-to-pay over the prevailing generalised cost of transport for a specific trip. The generalised cost of transport expresses the overall inconvenience to the user of travelling between a particular origin (i) and destination (j) using a specific mode of transport. In practice, it is usually computed as the sum of monetary costs borne (e.g. tariff, toll, fuel, etc.) plus the value of the travel time (and/or travel time equivalents, such as the inconvenience of long intervals) calculated in equivalent monetary units. Any reduction of the generalised cost of transport for the movement of goods and people determines an increase in the consumer surplus. The main items to be considered for the estimation of the consumer surplus are:

-    fares paid by users;

-    travel time;

-    road users Vehicle Operating Costs.

•    The producer surplus, defined as the revenues accrued by the producer (i.e. owner and operators together) minus the costs borne. The change in the producer surplus is calculated as the difference between the change in the producer revenue (e.g. rail ticket income increase) less the change in the producer costs (e.g. train operating costs increase). This might be particularly relevant for public transport projects or toll road projects, especially if the project is expected to feature significant traffic (generated or induced) or a substantial change in fares. The main items to be considered for the estimation of the consumer surplus are:

-    fares paid by users (and received by the producer); and

-    producer operating costs.

It must be noted that fares paid by users for the use of the infrastructure appear in the economic analysis as a cost to the user in the estimation of the consumer surplus and as a revenue to the producer in the estimation of the producer surplus. Thus, for existing traffic (see section 5.5.3 above for definitions), this implies that fares are always cancelled out in the analysis. However, this is never the case for the calculation of benefits to generated/induced traffic, which are generally approximated via the Rule of Half (see box), and would also not apply in the cases where the benefits to the diverted traffic are also estimated via the Rule of Half (see section 3.8.1). In such cases, the producer revenues and associated user charge costs will not be cancelled out.84

This implies that the economic analysis of transport projects can be structured differently depending on two main situations:

•    in cases where the project is not expected to change traffic volumes, there is no need to estimate the changes of the consumer and producer surplus because the fares paid by users will always be cancelled out. A simplified approach can therefore be adopted and the analysis will just rely on the estimation of the net effects on users, in terms of travel time savings and, for road projects, Vehicle Operating Cost savings85. The case study on road investment, at the end of this chapter, provides an example of this approach;

•    in cases where the project is expected to change traffic volumes or when transport pricing strategies are introduced or expected to be changed, the fares paid by users will not be cancelled out. The analysis will therefore consist of estimating the net impacts on both the consumer and producer surplus. This implies that fares need to be separately accounted for, as well as all the changes in the producer operating costs (if not already captured in the financial analysis - as it happens when the analysis is not consolidated). The case study on rail investment provides an example of this approach.

In addition, any transport project may generate relevant non-market impacts on safety and the environment that always need to be evaluated.

Table 3.3 reviews the main effects and the relative evaluation methods to be considered for the economic appraisal of transport infrastructure projects. Fares are not included since they have already been discussed in section 3.7.3.

Table 3.3 Typical economic benefits (costs) of transport project

Effect

Valuation method

Travel time savings

-    Stated preferences

-    Revealed preferences (multi-purpose household/business surveys)

-    Cost saving approach

Vehicle Operating Costs savings

- Market value

Operating costs of carriers

- Market value

Accidents savings

-    Stated preferences

-    Revealed preferences (hedonic wage method)

-    Human capital approach

Variation in noise emissions

-    WTP//WTA compensation

-    Hedonic price method

Variation in air pollution

- Shadow price of air pollutants

Variation in GHG emissions

- Shadow price of GHG emissions

Source: Authors

In what follows, the main information needed and the practical instructions to evaluate the benefits (costs) illustrated above are presented. It is worth noting that economic effects other than those listed in table 5.3 can be generated. This pertains mainly to the wider impact on regional development, which is frequently associated with large transport investments. For instance, the improvement of an airport can influence socio-economic growth by activating the job market, developing local businesses, increasing community activity and boosting tourism.

As previously mentioned, the approach of the Guide is to exclude indirect and wider impacts from the CBA (see section 2.9.11). It is recommended, however, to provide a qualitative description of these wider impacts on secondary markets, public funds, employment, GDP, etc. in order to better explain the contribution of the project to the EU regional policy goals.

THE RULE OF HALF

The Rule of Half (RoH) relies on the consideration that, without the project, non-travelling users Willingness To Pay (WTP) is lower than the (prior) generalised cost of transport. After project implementation the (new) generalised cost of transport is lowered so that some previously non-travelling people decide to travel.

Although the absolute WTP is not known, the average change in consumer surplus of the generated traffic can be estimated as half of the difference between the original and the new generalised costs of transport on the improved mode for a given origin-destination (O-D) relation. It is half because a linear demand/cost graph is assumed where new users are spread evenly between two extremes: those requiring marginal motivation to start travelling (their WTP is already on the cusp between travelling and not travelling, so they get the full benefit of the change in generalised costs) and those requiring the full benefit of the change to the transport system to be motivated to travel (they get marginal net benefit). The RoH can be therefore expressed by the following formula:

gc = p+z+vz

where: p is the amount paid for the trip by the user (tariff, toll); z is the perceived operating costs for road vehicles (for public transport is equal to zero);r is the total time for the trip; v in the unit value of travel time.

Total consumer’s surplus (CS0) for a particular i and j in the Business As Usual (BAU) scenario is shown diagrammatically in the first figure. It is represented by the area beneath the demand curve and above the equilibrium generalised cost, area CS0.

User benefit = Consumer’s surplus^ - Consumer’s surplus^ where: 1 is the do-something scenario and 0 is the BAU scenario.



If there is an improvement in supply conditions the consumer’s surplus will increase by an amount of ACS, due to a reduction in equilibrium generalised cost and the total user benefit (for existing and new users) can be approximated by the following function, known as the rule of a half:

GCo    i

ACS= JD(GC)dGC = Rule of one Half (RoH) = -(GCo - GCi)(To + Ti)

GCi    2

For the generated demand only (i.e. for new users), the benefits may be approximated by the following formula :

ACS(generated) = 1/2*(GC0-GC1)*(T1-T0)’

In the case of a totally new infrastructure, the RoH will not be directly applicable and the measurement of the benefits depends on the nature of the new mode, its placement in the mode hierarchy and transport network, and will often need to be derived from the users’ WTP or calculated with other approaches. For example see various integration and other methods suggested in World Bank Transport Note No. TRN-11 2005.

Source: Authors

3.8.1 Travel time

Travel time saving is one of the most significant benefits that can arise from the construction of new, or improvement of, existing transport infrastructure.

Passengers traffic time savings

In carrying out CBA, different methods are possible to value time for passengers, whilst a distinction is usually made between the estimation of work and non-work travel time (including commuting).

The first method is to carry out specific empirical research and/or surveys in that country to estimate both work and non-work travel time. The approach consists of interviewing individuals using the stated preference method or conducting multi-purpose household/business surveys using the revealed preference method and then to estimate a discrete choice model on these data.

As a second option, value of time can be estimated adopting the cost saving approach88. The underlying logic is that time spent for work-related trips is a cost to the employer, who could have used the employee in an alternative productive way. The recommended process for valuing work time with the cost savings approach is as below.

•    Establishing wage rates for a given country or region: the gross hourly labour cost (Euro per hour) must be derived from observed (or, in absence, from average national) wage rates. The main data source should be the national statistical office;

•    Adjustment to reflect additional employee related costs: this would include paid holidays; employment taxes; other compulsory contributions (e.g. employer pension contributions) and an allowance for overheads required to keep someone employed. Social security payments and overheads paid by the employer shall therefore be computed and added to the estimated hourly labour cost.

The cost saving method is a simple approach to estimate a single value of work-time in a given country or region. This can, however, be enriched with further considerations and analysis, if necessary and feasible, as illustrated in the box below.

The preferred source from where to obtain value(s) of time at country level should be official national data, based on local research, provided that the methodology used is sound, robust and follows the general prescriptions illustrated above.89

For non-work travel time, the economic value of time savings is given by the difference between the marginal valuation of time associated with travelling and that associated with leisure. The implication is that there is no theoretical basis for deriving the economic value of non-work trips from the wage rate; instead the values have to be inferred from behaviour.

In the absence of national data using stated or revealed preference methods, the usual solution to this problem is to evaluate non-work travel time at a national average rate rather than at the rate the travellers appear to value their time themselves. In other words, non-work time can be assumed as a share of the work-related value. The review of the economic literature about value of time in specific countries suggests that non-working time usually ranges between 25 % and 40 % of the work time.90 86 87 88

FACTORS AFFECTING VALUE OF TIME

-    Labour market. The cost savings approach assumes that the gross wage rate in the labour market equals the marginal value product which the labour yields. However, this is not the case whenever distortions of the labour market exist. Thus, adjustments to reflect the level of unemployment in the country/region can be applied and the estimated value of time corrected by the shadow wage rate.

-    Industrial sector. Under the cost savings approach the economic value of work time savings is the marginal productivity of the person making the saving; thus different workers will have different time valuations. Ideally, values of time (VOT) should be developed for each worker classification. However, for the economic appraisal to operate at this level of disaggregation also requires the demand forecasting to occur at the same level.

-    Mode. Considering the relative qualities and comforts of one mode compared to the other modes (all other conditions being equivalent), value of travel time can be related to the mode of transport. For example, when considering average VOT associated with travellers using a certain transport mode, the average value of time of a bus traveller is usually lower than that of a car traveller. This is a characteristic of the fact that people with lower income will select slower and cheaper modes of transport (e.g. the bus) than richer people. Thus, it can be useful to differentiate the value of time by transport modes according to different people income level groups (where air and high speed rail transport are associated with higher income groups).

-    Walking and waiting time. All other things being equal, an individual typically prefers travelling within a vehicle to spending time walking, waiting or transferring between services. This is borne out from evidence, as such the value of non-working time saved walking and waiting is higher than time saved whilst travelling within a vehicle. The exact magnitude of the difference between non-working in-vehicle time and walking and waiting time is dependent upon national cultures and characteristics. For example, Mackie et al (2003) have found within the UK walking time savings are valued at double in-vehicle time savings. Such variations may be explained by a range of cultural, racial and economic factors which drive personal preferences. In this regard, the World Bank recommends a weight of 1.5 for waiting and access time when national research is missing.

-    Trip distance. The relationship between the value of (non-work) travel time and journey length includes increasing marginal disutility of travel time with journey length, greater significance of time constraints in longer distance journeys and differences in the trip purpose mix at long, relative to short distances. However, in practice it is expected that such situations will be rare so that a single value for travel time is used irrespective of trip distance. However, in cases where robust local or national specific data indicates that the values of non-work travel time savings increase with journey distance, data from revealed or stated travel behaviour can be used to adjust the value of time.

-    Travel conditions. The comfort associated with travelling conditions, including the ability of the traveller to take advantage of the time spent travelling, also affects value of time. For example, VOT savings in congested car driving situations exhibit higher values than those in uncongested situations. This reflects both the value of reducing the variability of travel time and the unpleasantness of driving in congested conditions. In urban public transport, the availability of air conditioning, less crowded busses, etc. are very important to justify certain expenditures. Another critical aspect is the capacity to work during the trip, which is a key advantage of rail transport with regard to road and (short haul) air travel and explains the behaviour of many travellers.

Freight traffic time savings

Reduction in travel times will benefit freight traffic in the following ways:

•    reduced driver (and any other persons necessarily travelling with the load,) wage costs per trip;

•    reduced vehicle operating costs per trip;

•    improved reliability, i.e. timely delivery of transported goods.

The valuation of the first benefit follows the same logic of passenger's traffic so that time savings for truck drivers (or rail carriers' crew members) is evaluated with the cost savings approach, whilst the valuation of the second is discussed below in section 3.8.2.

The last benefit item may arise through a number of mechanisms. If travel and transport times become more predictable, travellers and agents in freight transport would find it easier to arrive at the destination at the preferred moment and therefore reduce their safety margins in departure time. Also, in the case of perishables products, arriving at market earlier and in better condition thereby attract better prices; and reduced stockholding required through re-structuring of logistics and the supply sector. Its evaluation and inclusion within the economic benefits of a project is a complex issue which will require detailed case by case analysis. The following aspects should be taken into account when deciding whether to include time savings for freight:

•    such analysis shall be considered only where large step changes in transport infrastructure are under consideration;

•    benefit associated with reliability depends very much on the market segment in question as well as the time value of the commodity89;

•    owing to specific conditions of the market, logistics chain and general service, benefits from time savings can be lost elsewhere. For instance, benefit from improved speeds is realised only if they are not lost in other parts of the logistics chain. The situation and risks should be analysed and demonstrated in any CBA. Key elements of the logistics chain influencing potential time losses are the priority given, and capacity available to, the type of freight traffic on the line, issues at transfer/marshalling/loading/unloading points and the administration at border points;

•    care is needed to avoid double counting with vehicle operating costs savings calculations (for example distance reducing effects on operating costs should not be counted in travel time savings).

The methodology for the estimation of time value for freight should be based on the capital lock-up approach. This is based on the concept that value of time related to the movement of goods includes the interest costs on the capital invested in the goods during the time that the transport takes (important for high-value goods,), a reduction in the value of perishable goods during transit, but also the possibility that the production process is disrupted by missing inputs or that customers cannot be supplied due to lack of stock.

The valuation of the freight's value of time requires therefore an in-depth analysis of the MS's transport and logistic and supply sectors90. In a context of limited resources, it is suggested to refer to the economic literature where it is possible to find country-specific default values. The literature shows that reference unit values of time for freight vary significantly across countries: from over 1 EUR/tonne-hour to zero, and from small to large differentiation between commodities. For a review of the main studies and reports see the Bibliography section.

In this regard, HEATCO provides a framework with reference values for the EU-25. However, these values, particularly for rail freight, are relatively high as compared to other national-based studies because they include a full set of potential benefits (e.g. potential carrier company efficiency improvements). Thus, it is suggested to adopt them as a last resort and, in case, to include a scaling-down factor (e.g. low escalation elasticity against GDP).

In any case, the methodology used by the project promoter should be clearly presented, with all underlying assumptions and calculations made explicit. In general, since the values attributed to time are critical, the recommendation is to clearly report the VOT adopted and to check for consistency. In particular, MSs are encouraged to develop their own national guidance in order to propose unit reference VOT for both passengers and freight, provided that the methodology is complaint with the principles indicated in this guide.

TIME TRENDS IN THE VALUE OF TIME

The real value of work time is directly related to the real wage rate. Thus, it will grow with the projected wage rate, which is typically assumed to equal the growth in GDP per capita. The economic literature suggests escalating value of time for future years across the time horizon based on a default inter-temporal elasticity to GDP per capita growth of 0.7 to 1.0. This elasticity is expected to vary very little across market segments and to be stable over time. The value of non-work time is not related to the wage rate and as such there is no theoretical justification for linking it to wage rate growth. However, its value is related to income and any changes in income will affect that value. Studies in the UK91 and the Netherlands92 have indicated elasticity of value of time with respect to income of approximately 0.5 to 0.8.

It is generally recommended that value of both work and non-work time be treated as increasing over time in proportion to GDP per capita, unless there is local evidence to the contrary. For the sake of prudency, it is however recommended to use the lower elasticity values illustrated above: 0.7 and 0.5 for, respectively, work and non-work time. If HEATCO values are adopted as a last resort, the use of lower elasticity is recommended. In line with the use of constant prices, the inflation effect must not be taken into account for escalation.

Application rules

Once unit VOT are determined, benefit from time savings needs to be calculated separately, for:

   Already existing traffic of passengers and goods. For benefit calculation, the following procedure shall be adopted:

-    take the forecast of existing traffic considering number of passengers/goods for each origin-destination (O-D) pair and for each year across the time horizon;

-    take the travel time for each pair (O-D), on the basis of estimated average travel speed, for both with and without-the-project scenarios;

-    split passenger traffic into motivations: work and non-work related trips93;

-    calculate the time saving as the difference between travel time in the two scenarios;

-    calculate the benefit for each traffic class using the unit values available.

   Passengers and goods diverted from other transport modes or routes. When calculating time costs for passengers diverted from other routes or means of transport, practice across Europe varies and yet there is no consensus on the correct approach to take. Several methods can be used reflecting different approaches followed in different countries. The treatment of diverted traffic would in particular depend on project-specific circumstances, including whether there is an increase in capacity, the degree of congestion that can occur as the infrastructure approaches full capacity, and the availability of alternative modes with sufficient capacity to accommodate traffic that cannot be accommodated in the without-the-project scenario. In this guide the following, simplified, approach is suggested:

-    the Rule of Half should be applied to the travel cost change to the shifted mode whenever there is poor or no knowledge of the overall average generalised costs on O-D trips of either the transferred from, or transferred to, mode. Its application requires an estimate of mode shifted O-D movements;

-    if there is good and sufficiently detailed and calibrated knowledge of average travel costs between origins and destinations on all considered modes, the full difference between travel costs on the switched to mode and switched from mode should be applied94. Time savings are thus calculated as the difference between the estimated travel speed in the with-the-project scenario and the travel speed in the alternative transport mode/route from which traffic is diverted;

- in the case of a totally new infrastructure, the Rule of Half will not be directly applicable and the measurement of the benefits depends on the nature of the new mode, its placement in the mode hierarchy and transport network and it will often need to be derived from the users' willingness-to-pay.

Generated traffic. In order to calculate time savings for generated passengers and goods it is recommended to estimate only a half time savings calculated for existing traffic, according to the Rule of Half. On the basis of the forecast of generated traffic for every pair target-point, a half of time savings per existing user will be assigned for the generated user for the same pair target-point.

As for the practical use of travel time savings in the CBA, it is worth reminding that value of time must be applied to passengers (or to tonnes, in case of cargo) and not to vehicles. If data from traffic modelling is available per vehicle only, data on average vehicle occupancy rates will need to be used in the calculations.

3.8.2 Road users Vehicle Operating Costs

Vehicle Operating Costs (VOCs) are defined as the costs borne by owners of road vehicles to operate them, including fuel consumption, lubricants consumption, tires deterioration, repair and maintenance costs, insurance, overheads, administration, etc. In fact, VOCs are correlated with type of vehicle and average travel speed, but are also characteristics of roads such as design standards and surface conditions.

Savings owing to VOCs reduction are a typical benefit of road transport projects. For example, the rehabilitation/upgrade of an existing road typically implies better surface conditions and lower congestion, which, in turn, mean higher average speed and lower VOCs under a certain speed range.

Nevertheless, projects in fields other than road may also affect VOCs. For example, a railway investment attracting passengers from the road network. Passengers that that thus far have used the road mode will benefit from not operating their vehicles any longer. And, in case of significant traffic diversion, passengers that eventually decide to remain in the alternative road network may also benefit from lower congestion and, consequently, from VOCs savings. Thus, VOCs are treated here as general economic costs of transport.

EMPIRICAL ESTIMATION OF VOCs

A number of off-the-shelf models and computer software exists for the empirical estimation of VOCs. In some traffic models, the output already contains project effects on VOCs, with- and without the intervention.

As regards price escalation over time, VOCs mainly depends on the (very difficult to predict) fuel cost evolution. On the other hand, an evolution of the efficiency on the vehicles’ consumption shall also be taken into account. Thus, considering these two effects being compensated each other, no price escalation is suggested.

Application rules

As with travel time, benefits from VOCs savings need to be calculated separately, for the following factors.

Pre-existing traffic. The following procedure shall be adopted:

-    take the forecast for existing traffic in terms of number and types of vehicles (passenger cars, commercial vehicles, trucks and buses) for each origin-destination pair and for each year across the time horizon;

-    use unit VOCs (preferably from national studies, when available) estimated for each type of vehicle depending on speed, road condition and road geometry;

-    calculate the costs of vehicle operation in each scenario, by multiplying the quantity of transport for set road categories, speed classes and vehicle types by the average costs of operation for these classes and types;

-    calculate the VOCs saving as the difference between the two scenarios.

   Existing passengers who used the road mode. Diversion of existing users of the road system (either passengers or freight) to rail or air transport modes will result in changes to vehicles operating costs. VOCs of users who thus far have used the road mode are calculated in the same way as travel time savings.

   Generated/induced traffic. Again, in order to calculate VOCs savings for generated/induced traffic, the same approach as for travel time is used. Thus, on the basis of the forecast of generated traffic, half of VOCs savings per existing vehicle will be assigned to the generated traffic.

3.8.3    Operating costs for service carriers

In railway, airport and port investments, typically, the first ‘users' of the infrastructure are the companies (carriers) that, in turn, operate the service for final users (passengers and cargo).

For example, as a result of an infrastructure upgrade, operating costs for railway carriers may change due to greater effectiveness, such as power effectiveness, staff productivity or a shorter route. If significant, this effect could be taken into account and included as a project benefit. For example, savings may be estimated as a percentage reduction of vehicle operating costs per train-km or faster ‘asset rotation' (i.e. better use of owned rolling stock)95.

Application rules

If the financial analysis is carried out at consolidated level, any variation in the operating costs borne by the infrastructure owner and/or the service carriers (in other words, the ‘producer' of the transport service) will be already captured in the financial analysis and its economic valuation consists of applying the conversions factors to the relative, previously estimated, cash flows.

However, as shown above, in some cases the consolidation of the analysis is not feasible, so the point of view of the project owner is adopted. In such cases, changes in operating costs on carriers could be calculated and added to the economic appraisal where appropriate (see discussion on producer surplus in section 5.8). Their estimation should be based on data coming from the carriers who offer services within the analysis area. Their inclusion in the economic appraisal is however optional, for two main reasons: i) usually, their contribution to the project results is relatively marginal, and ii) the obtainment of data from companies can prove cumbersome.

3.8.4    Accidents

Given their nature, all transport activities imply a risk for the users of suffering an accident. Either by mechanical failure or, more commonly, by the influence of human errors, accidents involving vehicles are events that occur in all transport modes. The completeness, quality and integration of the signalling (road, rail, etc.) and safety (rail, mainly) systems greatly contributes to reduce the accident rates, and this should be taken into account in the economic analysis.

Safety benefits are (mainly) related to road traffic. However, the economic benefit arises not only as a result of directly improving the road safety conditions, but also indirectly, e.g. by diverting passengers to other, statistically safer means, such as rail and air transport. In both cases, this benefit should be computed in the economic analysis, possibly distinguishing between fatalities, severe injuries96 and slight injuries97 avoided.

According to the academic literature, the economic cost of accidents is mainly ascertained by the following two components98:

   direct costs: these costs consist of medical rehabilitation costs, both incurred in the year of the accident and future cost over the remaining lifetime for some injury types, plus administrative costs for police, the court, private crash investigations, the emergency service, costs of insurances, etc.;

• indirect costs: these costs consist of the net production loss to society, i.e. the value of goods and services that could have been produced by the person, if the accident had not occurred. The losses of one year's accident will continue over time up to the retirement age of the youngest victim.

In the case of fatalities, the evaluation of the ‘production loss' (i.e. the indirect cost component) is associated with the concept of Value of Statistical Life (VOSL), defined as the value that society deems economically efficient to spend on avoiding the death of an undefined individual.

The preferred method for the estimation of the economic cost of accidents is the use of stated preference or revealed preference techniques based on the concepts of willingness to pay/willingness to accept (i.e. either survey based techniques or the hedonic wage method).

In absence of this, the human capital approach can be adopted. The basic idea is that an individual is ‘worth' to the society what he/she would have produced in the remainder of their lifetime. The definition of the VOSL in this setting becomes ‘the discounted sum of the individual's future (marginal) contributions to the social product, which corresponds to future labour income, provided the wage is equal to the value marginal product'. In other words, the (marginal) value of a person's production is assumed to be equal to the gross labour cost. The box below provides the formula to be applied for practical calculation, while examples of empirical estimations are illustrated in Annex V.

VALUE OF STATISTICAL LIFE

It is common to include estimates of VOSL into the analysis of projects that affect mortality risks. The VOSL is an estimate of the economic value society places on reducing the average number of deaths by one. Estimating the VOSL involves assessing the rate at which people are prepared to trade off income for a reduction in the risk of dying. According to the hedonic wage method, the computation of the VOSL is as follows:

VOSL =


y T Lt (1+i)t


where: T is remaining lifetime; L is labour income; and i is the social discount rate.

Evidence from the literature shows that, by convention, the VOSL is usually assumed to be the life of a young adult with at least 40 years of life ahead. For labour income, the annual gross wage rate can be taken as a reference. Also, this approach assumes that the gross wage rate in the labour market equals the marginal value product which the labour yields. However, this is not the case when distortions of the market exist. Thus, in situations of severe unemployment, it is suggested to correct the gross wage rate by the Shadow Wage, calculated for that given country or region.

Application rules

Once unit values for different accidents types have been obtained, the physical impact of the project on safety (i.e. the accident risk reduction) has to be estimated from national functions/data. The following input data are needed:

•    statistics on the average number of light injuries, serious injuries and fatalities per accident;

•    accident rates per billion vehicle-km, using actual project specific values, or, in their absence, standardised road-type specific accident rates;

•    vehicle-km forecast on the road network per year with and without project.

On this basis, the decrease in the number of fatalities and injuries can be calculated and the relative benefit valued making use of the country-specific unit costs.

3.8.5 Noise

Noise pollution can be defined as the ‘unwanted or harmful outdoor sound created by human activities, including noise emitted by means of transport, road traffic, rail traffic, air traffic, and from sites of industrial activity' (see Directive 2002/49/ EC). The economic cost of noise is given by:

•    the annoyance that results in any restrictions on enjoyment of desired activities;

•    negative effects on human health, e.g. risk of cardiovascular diseases (heart and blood circulation), that can be caused by noise levels above 50 dB(A);

•    given the noise emissions have a local impact, the magnitude of the effect is related to the distance from infrastructure location: the closer to the project site, the higher the discomfort from noise emission.

There are several methods to evaluate the effects (either a reduction or an increase) generated by transport projects on noise.

The recommended method is stated preferences for a direct measurement of WTA compensation or WTP for noise reductions (see box). Noise costs vary depending on the time of the day, population density near the noise source and existing noise level.

Alternatively, a commonly used approach is the hedonic price method, which measures the economic cost of additional noise exposure with the (lower) market value of real estate (see Annex VII). Given the amount of houses affected by noise and the average house price a total cost can be calculated. In particular, the sensitivity of real estate prices to changes in noise level is measured by the noise Depreciation Sensitivity Index99.

As concerns price escalation, the same approach suggested for the value of time can be applied.

VALUE OF NOISE: DATA SOURCES

Based on a stated preference methodology (i.e. WTP for reducing annoyance and health damages), the HEATCO study provides EU-25 country-specific unit marginal costs per person exposed to a certain noise level. To evaluate the economic cost of noise using unit default values, the assessment requires estimating the increase/decrease of noise to the exposed population, to be multiplied by the appropriate unit value. In particular, the following input data must be available, as resulting from the EIA process and the relative production of noise maps:

-    exposed people: number of people living in each of the areas identified in the noise maps and their evolution over time;

-    expected change in noise exposure, i.e. the volume of noise (dB(A)) additionally generated or avoided to exposed people because of the project.

Building from HEATCO, the IMPACT ‘Handbook on estimation of external costs in the transport sector’ provides unit values of marginal cost of noise for different network types for road and rail traffic. In this case, unit costs are provided per vehicle-km (€ct/vkm) and the cost of noise is directly calculated as the amount of traffic (cars, trains, ships, etc.) additionally added or avoided to the transport network.100

3.8.6 Air pollution

Transport investments can considerably affect air quality either by reducing or increasing the level of air pollutant emissions. Effects on air pollution largely depend on the type of investment, where the variation in emissions can be either positive or negative, as compared to a baseline scenario. Any CBA should integrate the economic cost of air pollution, which consists of the following elements:

   health effects: the aspiration of air transport emissions increases the risk of respiratory and cardiovascular diseases. The main source of disease is particles (PM10, PM25);

   building and material damages: air pollutants can cause damage to buildings and materials in two ways: i) soiling of building surfaces by particles and dust; ii) degradation of facades and materials through corrosive processes due to acidifying pollutants (NOx, SO2);

   crop losses: ozone as a secondary air pollutant (formed due to the emission of CO, VOC and NOx) and acidifying substances (NOx, SO2) cause crop damage. This means an enhanced concentration of these substances leads to a decrease in the amount of crop;

   impacts on ecosystems and biodiversity: ecosystem damage is caused by air pollutants leading to acidification (NOx, SO2) and eutrophication (NOx, NH3). Acidification and eutrophication have a mainly negative impact on biodiversity.

To calculate the external costs caused by air pollution, the bottom-up approach is regarded as the most elaborated and best practice methodology, above all for calculating site-specific external environmental costs.101 This approach is based on an impact-pathway method, which requires the following methodological steps:

   Estimation of the volume of air pollutants additionally emitted or avoided. Emissions should be calculated based on national emission factors per type of vehicle involved, taking into account national vehicle fleet composition, multiplied by transport volume (mileage).102 If national data is not available, default emission factors can be taken from the following sources:

-    ‘EMEP/EEA air pollutant emission inventory guidebook 2013'103, which provides detailed literature on air pollutant emissions to different economic sectors, including transport; or

-    TREMOVE database, where emission data are available per vehicle category and region type (metropolitan, other urban, non-urban).

Evaluation of the total air pollution costs. Estimated quantity of emissions should be multiplied by unit costs per pollutant (by region type and taking into account population density), as available from international sources. The IMPACT study listing unit cost values for the main relevant air pollutants (in Euro per ton), based on HEATCO and CAFE104 CBA reports, can be taken as reference. In addition, the most recent study applying this approach for air pollution cost is the European research project NEEDS105, which is one of the first studies that gives reliable cost factors, also for ecosystem and biodiversity damage, due to air pollution.

If available national guidelines providing unit economic costs for emissions are available (based on clear and adequate assumptions and methodology), it will be also possible to calculate the impact as a cost per vehicle-km or ton-km. In this case, air pollution costs are evaluated based on traffic volumes, speeds and road types at analysed road sections.

3.8.7 Climate change

Any CBA should integrate the economic cost of climate change resulting from positive or negative variations of GHG emissions. With respect to transport, the main GHG emissions are carbon dioxide (CO2), nitrous oxide (N2O) and methane (CH4). These emissions contribute to global warming resulting in various effects such as rising sea levels, agricultural, health, ecosystems and biodiversity impacts, increase in extreme weather effects, etc. Climate change has therefore a global impact and thus the related cost is not dependent on the investment location (as instead happens for air pollutants).

The transport infrastructure GHG emissions assessment will mainly refer to consequences of the project activities (vehicles using transport infrastructure including modal shift effects). In order to estimate the total volume of emissions generated or avoided by type of vehicle for the various modes, this should be calculated by multiplying the emission factors by the transport volume data, taking into account considerations such as relationships between demand and capacity (speed flow), as well as fuel consumption and speed relationships (in the case of road). Again, default emission factors can be taken from ‘EMEP/EEA air pollutant emission inventory guidebook' or the TREMOVE database. Once the emissions volume is obtained, the methodology for valuing climate change costs follows the general approach illustrated in section 2.9.9.

3.9 Risk assessment

Due to their criticality, it is advisable to carry out a sensitivity analysis of the money values assigned to the goods without any market, especially values of time saving and accidents. In fact, in transport projects very often the value of time savings can represent more than 70 % of all benefits. It is therefore a parameter that must always be analysed and tested carefully. Other sensitivity tests may be focused on investment and operating costs or on the expected demand, in particular the generated traffic.

It is recommended to test at least the following variables:

•    value of time;

•    accident costs;

•    assumptions on GDP and other economic variables trend;

•    rate of increase of traffic over time;

•    number of years necessary for the realisation of the infrastructure;

•    investment and maintenance costs (as disaggregated as possible);

•    fare/tariff/toll.

Following the sensitivity analysis, a risk assessment must be carried out which typically includes the following risk typologies.

Table 3.4 Typical risks in transport

Stage

Risk

Regulatory

- Changes in environmental requirements

Demand analysis

- Traffic forecasts different than predicted

Design

-    Inadequate site surveys and investigation

-    Inadequate design cost estimates

Administrative

-    Building permits

-    Utility approvals

Land acquisition

-    Land costs higher than predicted

-    Procedural delays

Procurement

- Procedural delays

Construction

-    Project cost overruns

-    Flooding, landslides, etc.

-    Archaeological findings

-    Contractor related (bankruptcy, lack of resources)

Operation & Financial

-    Tolls collection lower than expected

-    O&M costs higher than expected

Other

- Public opposition

Source: Adapted from Annex III to the Implementing Regulation on application form and CBA methodology.

Case study - Road Project

I Project Description

The project consists of the construction of a new 16.4 km of tolled106 motorway, which constitutes a missing section on a TEN-T Corridor. The new motorway will reduce traffic on an existing road which carries annual daily traffic of more than 18,000 vehicles, most of which is transit traffic, and has reached its capacity limit. The current road leads traffic through several smaller settlements and one middle-sized town located in a valley, causing nuisance to residents through high levels of pollution in the form of noise and exhaust gases, and intersects with a number of lower category roads which adds to congestion, separation effect, and poor traffic safety. It is further characterised by a huge increase of traffic over the last 10 years (annual growth rate was 4.5 %) and a high share of freight vehicles (current share of goods vehicles is around 35 %).

Given the difficult characteristics of the terrain, the new motorway will need to include several bridges and overpasses as well as one tunnel. The technical description of the project and its components is as follows:

Component

Description

Motorway:

2x2 lanes (plus emergency lanes), width 27.5 m, length 16.4 km

Feeder road:

2x1 lane, width 11 m

Junctions:

3

Structures:

3    motorway bridges, total length 2,200 m

4    overpasses, total length 800 m, average width 8 m 1 tunnel, two tubes, length 2,200 m

The project promoter is the National Motorways Company which owns and operates the infrastructure.

II Project objectives

The objectives of the project are to:

•    provide fast and reliable travel for the long distance and transiting traffic;

•    improve traffic safety;

•    reduce impact of traffic on settlements.

The project is consistent with the existing strategic national transportation plan and is also included in the operational programme for Transport. In particular, the investment will contribute to the following OP indicators.

Indicator

OP 2020 target

Project (% of OP target)

Length of new motorways (km)

120

16.4 (14 %)

III Demand and option analysis

A detailed demand analysis included in a feasibility study completed in 2013 was used as a basis for the selection and final design of the preferred option. An options analysis also contained in this study compared two modified versions of a basic project solution that had emerged from a previously conducted pre-feasibility study. The pre-feasibility study had analysed a range of options regarding:

•    alignment;

•    technical solutions and design parameters (bypass road, new 2 lane road, 4 lane express road or motorway);

•    number, location and type of junctions;

•    phased implementation (including construction of half profile express road).

While the pre-feasibility study appraised more general project solutions based on multiple criteria taking into consideration the economic, engineering, traffic, environmental and social perspectives, the feasibility analysis compared only two remaining modified options107 based on cost-benefit analysis, where the highest ENPV dictated the preferred option.

The figures below depict the traffic forecast in the ‘with-the-project' scenario (figures on the right) and the counterfactual ‘without-the-project' scenario (figures on the left) for years 1 and 20 of the operational stage of the project. A single mode traffic model was used, covering only road traffic. It covers the impact area of the project, with a sufficiently disaggregated zoning system. It includes the national road network and most of the relevant lower category roads. Future improvements of the network (most importantly, the construction of the motorway which includes this project) are also included in the network model. Origin-destination matrices are based on an origin-destination survey from 2005. The assignment is based on minimising the cost of travel (including time, distance and toll cost). The traffic model was calibrated with traffic count data from 2010, and validity tests show that the model is sufficiently good in replicating the actual travel patterns. Future state matrices were multiplied by growth rates, which are based on assumed changes in population, economic activity, car ownership and transport cost. It was assumed that the traffic growth rate between 2015 and 2025 will be around 2 % per year, and around 1 % after year 2025. It should be noted that no generated/induced traffic or switch from other modes is expected, since the project is not located in a major urban area and no specific changes in population, employment and land use pattern are expected. In the opening year of the project, it is forecasted that 11,350 vehicles per day will shift from the existing road to section N1 of the new road (9,650 vehicles per day on section N2). As a consequence, the traffic load on the different sections of the existing road will be notably reduced (7,000 vehicles per day in section E3 compared to 18,400 in the without-project scenario).

Year 1

Year 20

Legend: blue - existing sections, red - new sections. Section name, a.a.d.t. cars, a.a.d.t. LGV+HGV.



The level of service (LOS) is estimated according to the HCM methodology. Currently, LOS is D and E on some sections, which will deteriorate to F in near future. Once the motorway is constructed, the LOS on the existing road will improve to B and C, and will remain sufficient until year 20. The LOS on the motorway will reach C in year 20, which is an indication for adequate capacity.108

IV Project Costs and Revenues of the selected Option

Investment Cost

The cost estimate for works and supervision of the selected option is based on detailed design, as the works have not been tendered yet. Land purchase is partially completed. The cost estimate is based on constant prices of 2013.

Investment cost component

Total cost

Planning/design fees, technical assistance

3,000,000

Land purchase

12,000,000

Building and construction, of which:

248,350,000

Earthworks

12,500,000

Vegetation

800,000

Road

48,000,000

Bridges

77,000,000

Tunnel

80,000,000

retaining walls

5,800,000

noise and safety barriers

7,500,000

public utilities

8,500,000

motorway information system

1,250,000

Buildings

1,000,000

other

5,940,000

Plant and machinery

0

Publicity

60,000

Supervision

5,000,000

Total Investment cost excl. contingencies

268,350,000

Contingencies (10% of construction cost)109

24,835,000

Total Investment cost incl. contingencies

293,185,000

VAT (recoverable)

56,630,055

Total Investment cost including VAT

349,815,055

The total project investment cost shown in the table above is considered eligible except the VAT, which is recoverable.

Estimates include all costs incurred for planning at feasibility stage and during the implementation period of the project, while the cost of all preliminary activities (pre-feasibility studies, surveys carried out before the feasibility study) are treated as a sunk cost and are thus not included.

Toll from freight vehicles is collected on behalf of the National Motorway Company by a toll collection company, through the pre-existing electronic toll collection system based on a combination of GPS and GSM technology. There is no physical investment necessary to extend the tolling on new sections, the motorway operator pays a fee for each toll transaction made on his road and receives the collected toll.

The following average unit costs were calculated to appraise the cost estimates of the most significant investment components, which were found to be well within the cost range of other comparable projects:

Investment component

Unit cost

Motorway, total

EUR 16.3 million/km

Motorway, excluding bridges and tunnels

EUR 6.8 million/km

Bridges

EUR 1,151/m2

Tunnel

EUR 18.2 million/km

Operation and maintenance cost

Routine maintenance cost for the new road is estimated on the basis of average maintenance requirements on the existing motorway network in the country and current maintenance practice of the motorway operator. Average routine maintenance cost is thus assumed to be EUR 34,000 per km of motorway110.

Routine maintenance cost for the existing road is assumed to be the same in the with and without-project scenarios and is thus excluded from the assessment.

Periodic maintenance of the new road is estimated on the basis of the expected schedule of periodic maintenance works. The timing of the works was determined on the basis of the observed maintenance cycle in the network of existing motorways in the country (e.g. re-pavement after 10 years, bridge repair after 15 years, retaining walls repair after 20 years, etc.); average cost of these works is also based on cost observed in the past.

Periodic maintenance of the existing road is excluded from the analysis. The decrease of traffic will extend the life of the infrastructure elements by a few years and consequently the maintenance cycle will be longer, however, it is assumed that maintenance measures will remain the same.

Operating cost of road includes toll collection cost; traffic management of the new section will be done from the existing traffic control centre without any additional cost and is thus excluded from the assessment. It is assumed that toll collection cost is EUR 0.12 per transaction (i.e. passage of a motorway section between the two junctions).

Revenue

A toll is only collected from goods vehicles: for light goods vehicles (including buses) EUR 0.10 /km; for heavy goods vehicles EUR 0.20 /km. The assumed share of light goods vehicles (including buses) is 55 %, for heavy goods vehicles it is 45 %.

V Financial and Economic Analysis

The analysis is performed using a 30-year reference period which is common for road projects. A residual value of the investment is considered at the end of the reference period; the residual value is EUR 13 million in the financial analysis which is calculated on the basis of the net present value of cash flows generated after the reference period (based on the perpetuity formula) and EUR 150 million in the economic analysis (based on the depreciation formula and corrected by the conversion factor). The financial and economic analyses use constant prices. A real discount rate of 4 % is used in the financial calculations, while a 5.0 % social discount rate is used in the economic analysis, in line with EU wide benchmark set by the Commission. VAT is reimbursable and thus excluded from the analysis.

Financial analysis

The cash-flows for the financial analysis are shown in the following table, including the calculation of the relevant financial performance indicators of the project.

The markedly negative financial net present value of the investment (FNPV(C) = -EUR 248 million) shows that the project requires EU assistance to make it viable.

The project is a net revenue generating operation in the meaning of Article 61 of Regulation (EU) 1303/2013. In this case, the contribution from the EU Cohesion Fund to the project has been determined using the method based on the calculation of the discounted net revenue111. The resulting pro-rata application of discounted net revenue is 93.4 %. This, multiplied with the eligible cost shown in section IV above (EUR 293.2 million) and with the co-financing rate of the relevant priority axis of the OP (85 %), gives a EU grant for the project of EUR 232.7 million.

The remainder of the investment is provided by the promoter entirely from equity, without the need to contract loans. The equity contribution will be financed through additional paid-in capital from the State, for which a formal commitment exists.

EU GRANT

1

2

3

4

5

6

7

8

9

10

15

20

25

30

Construction

Operation

Calculation of Discounted Investment Cost (DIC)

NPV 4 %

Investment cost (excluding contingencies)

mEUR

259.7

103.6

101.8

63.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

DIC / Investment cost cash-flow

mEUR

259.7

103.6

101.8

63.0

0.0

0.0

0.0

O

d

O

b

O

d

0.0

0.0

0.0

0.0

0.0

Calculation of Discounted Net Revenues (DNR)

NPV 4 %

Revenue

mEUR

40.9

0.0

0.0

0.0

2.2

2.3

2.3

2.4

2.4

2.5

2.5

2.7

2.9

3.1

3.4

O&M costs

mEUR

27.9

0.0

0.0

0.0

0.9

0.9

0.9

0.9

0.9

0.9

0.9

7.8

0.9

1.0

1.0

Residual value of investments

mEUR

4.2

0

0

0

0

0

0

0

0

0

0

0

0

0

13

DNR / Net revenue cash-flow

mEUR

17.2

0.0

0.0

0.0

1.4

1.4

1.5

1.5

1.5

1.6

1.6

-5.1

2.0

2.2

15.6

ELIGIBLE COST (EC)

mEUR

293.2

Pro-rata application of DNR = (DIC - DNR) / DIC

93.4%

CO-FINANCING RATE OF PRIORITY AXIS (CF)

85.0%

EU GRANT ( = EC x PRO-RATA x CF)

mEUR

232.7

FRR(C)

1

2

3

4

5

6

7

8

9

10

15|

20

25

30

Construction

Operation

Calculation of the Return on Investment

NPV 4 %

Investment cost (excluding contingencies)

mEUR

-259.7

-103.6

-101.8

-63.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

O&M cost

mEUR

-27.9

0.0

0.0

0.0

-0.9

-0.9

-0.9

-0.9

-0.9

-0.9

-0.9

-7.8

-0.9

-1.0

-1.0

Revenue

mEUR

40.9

0.0

0.0

0.0

2.2

2.3

2.3

2.4

2.4

2.5

2.5

2.7

2.9

3.1

3.4

Residual value of investments

mEUR

4.2

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

13.2

FNPV(C) - before EU grant / Net cash-flow

mEUR

-248.2

-103.6

-101.8

-63.0

1.4

1.4

1.5

1.5

1.5

1.6

1.6

-5.1

2.0

2.2

15.6

FRR(C) - before EU grant    -8.8%

FRR(K)

12 3

4 5 6 7 8 9 10 15 20 25 30

Construction

Operation

National Financing Sources

Promoter's contribution

mEUR

24.0 22.5 13.9 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Calculation of the Return on National Capital

NPV 4 %

Promoter's contribution

mEUR

-58.6

-24.0

-22.5

-13.9

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

O&M cost

mEUR

-27.9

0.0

0.0

0.0

-0.9

-0.9

-0.9

-0.9

-0.9

-0.9

-0.9

-7.8

-0.9

-1.0

-1.0

Revenue

mEUR

40.9

0.0

0.0

0.0

2.2

2.3

2.3

2.4

2.4

2.5

2.5

2.7

2.9

3.1

3.4

Residual value of investments

mEUR

4.2

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

13.2

FNPV(K) - after EU grant / Net cash-flow

mEUR

-41.4

-24.0

-22.5

-13.9

1.4

1.4

1.5

1.5

1.5

1.6

1.6

-5.1

2.0

2.2

15.6

FRR(K) - after EU grant    -2.9%

Note that the FNPV(K) on national capital remains negative because the EU grant is covering only 85 % of the gap, while the remainder is covered by a national public grant.

The project appears to be financially sustainable, as the investment cost during implementation is covered by an equal amount in financing sources and its cumulated net cash flow during operations is positive during the entire evaluation period.

FINANCIAL SUSTAINABILITY


12 3

4 5 6 7 8 9 10 15 20 25 30

Construction

Operation


Verification of the Financial Sustainability of the Project

EU grant

mEUR

Promoter's contribution

mEUR

Revenue

mEUR

Total cash inflows

mEUR

Investment cost (including contingencies)

mEUR

O&M cost

mEUR

Total cash outflows

mEUR

Net cash-flow

mEUR

Cumulated net cash-flow

mEUR


88.4

89.2

55.1

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

24.0

22.5

13.9

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

2.2

2.3

2.3

2.4

2.4

2.5

2.5

2.7

2.9

3.1

3.4

112.4

111.7

69.0

2.2

2.3

2.3

2.4

2.4

2.5

2.5

2.7

2.9

3.1

3.4

-112.4

-111.7

-69.1

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

-0.9

-0.9

-0.9

-0.9

-0.9

-0.9

-0.9

-7.8

-0.9

-1.0

-1.0

-112.4

-111.7

-69.1

-0.9

-0.9

-0.9

-0.9

-0.9

-0.9

-0.9

-7.8

-0.9

-1.0

-1.0

0.0

0.0

0.0

1.4

1.4

1.5

1.5

1.5

1.6

1.6

-5.1

2.0

2.2

2.4

0.0

0.0

0.0

1.4

2.8

4.3

5.8

7.3

8.9

10.5

12.3

14.3

15.6

20.3


Economic analysis

For the purpose of socio-economic assessment, the investment cost estimate was corrected for fiscal effects by factor 0.91 (excl. cost of land which was not subject to fiscal correction). The routine maintenance cost was corrected by factor 0.88. Fiscal correction factors are based on share of transfer payments in labour and energy cost and their respective share in overall cost.

The socio-economic analysis includes following monetised benefits, which are consistent with the project objectives, i.e. faster travel on a safer road with separated carriageways, travel time savings, vehicle operating cost savings, accident cost savings.

Project benefits, related to the reduction of negative impacts (pollution and noise) within settlements were not quantified, given that these were not considered to be of importance in monetary terms, but the socio-economic analysis does include project impact on the emission of CO2 as the main global environmental impact of transport.

Travel time savings (in minutes saved per person) are quantified with the help of the traffic model on the basis of average speeds achieved by cars and goods vehicles on the existing and new road links (see table below), their length and assumed traffic volumes. As a consequence of the project, it is estimated that the average car using the full length of the new motorway will save around 12 minutes in year 1, while goods vehicles will save around nine minutes. Time savings for vehicles remaining on existing road are around four minutes per vehicle.

Average speed (km/h)

Section

Length

(km)

Without project

With project

Year 1

Year 20

Year 1

Year 20

Cars

LGV+

HGV

Cars

LGV+

HGV

Cars

LGV+

HGV

Cars

LGV+

HGV

E2

1.7

51.4

46.5

41.0

40.2

64.7

53.8

62.5

53.4

E3

3.6

35.2

35.2

31.9

31.9

38.8

38.6

32.5

32.4

E4

3.1

42.7

42.1

32.3

31.8

57.2

53.0

52.9

49.6

E5

3.7

40.6

39.3

34.5

33.9

54.8

51.0

53.9

50.2

E6

5.6

69.0

57.6

55.1

47.5

79.1

63.6

78.7

63.6

N1

5.7

104.8

75.2

98.4

72.4

N2

10.7

113.0

74.5

107.7

72.5

N3

2.0

79.7

70.0

78.6

69.6

To monetise the benefit of VOT savings, the following additional assumptions114 were made:

Variable

Assumption

Comment

Average occupancy, cars

1.8 persons

Based on different surveys carried out in the country

Average occupancy, goods vehicles

1.2 persons

Trip purpose mix, cars

20 % work trips 80 % non-work trips

Trip purpose mix, goods vehicles

100 % work trips

Unit value of time, work trips

EUR 12.90 per hour

Estimate based on average wage in the country (EUR 9 per hour) and assumed labour related overhead (33 %)

Unit value of time, non-work trips

EUR 4.30 per hour

Estimated at 1/3 of value of time for work trips

Escalation factor for VOT

GDP per capita growth, with elasticity factor of 0.7

Vehicle operating costs (VOC) savings are calculated for different types of vehicles taking into consideration national vehicle fleet, speed and road capacity, road condition and road geometry. The software used applies nationally calibrated values and crew cost has been excluded to avoid double-counting.

Accident cost savings are related to the fact that the majority of the traffic will be diverted to a safer motorway, with separated carriageways for each direction and grade-separated crossings with lower category roads. Analyses of traffic safety revealed that the traffic fatality risk on the existing road is 10.7 fatalities per one billion vehicle-km, whereas on a motorway it is 3.1 fatalities per one billion vehicle-km. It was estimated that the construction of the new road will save around 0.6 fatalities in the opening year and around 0.9 fatalities in the final year of analysis.

A prevented road fatality in the country is estimated at EUR 677,500 (estimate based on values derived from a literature review). It is assumed that this value will grow at the same rate as real GDP per capita, with an elasticity factor of 1.0.

CO2 savings are related to the fact that due to the more favourable alignment the distance travelled for the majority of the traffic will reduce, while the traffic flow remaining on the existing road will be smoother. The assumed unit cost is EUR 31 per tonne of CO2 (in 2013 prices), with an annual growth of EUR 1.

The resulting cash flows and their ENPVs are shown in the following table. 112

ERR

12 3

4 5 6 7 8 9 10 15 20 25 30

Construction

Operation

Calculation of the Economic Rate of Return

NPV 5.0 %

Project investment cost

mEUR

-234.3

-94.9

-92.1

-57.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

Project O&M costs

mEUR

-21.0

0.0

0.0

0.0

-0.8

-0.8

-0.8

-0.8

-0.8

-0.8

-0.8

-6.9

-0.8

-0.8

-0.9

Residual value of investments

mEUR

44.6

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

151.0

Total economic costs

mEUR

-210.7

-94.9

-92.1

-57.0

-0.8

-0.8

-0.8

-0.8

-0.8

-0.8

-0.8

-6.9

-0.8

-0.8

150.2

B1. Time savings

mEUR

266.7

0.0

0.0

0.0

10.7

11.5

12.3

13.2

14.1

15.0

16.0

20.7

25.4

30.5

37.7

B2. VOC savings

mEUR

26.5

0.0

0.0

0.0

1.3

1.4

1.5

1.5

1.6

1.7

1.8

2.1

2.4

2.7

3.0

B3. Accident savings

mEUR

9.2

0.0

0.0

0.0

0.4

0.4

0.5

0.5

0.5

0.5

0.6

0.7

0.9

1.0

1.2

B4. CO2 savings

mEUR

3.1

0.0

0.0

0.0

0.1

0.1

0.1

0.1

0.1

0.2

0.2

0.2

0.3

0.4

0.5

Total economic benefits (B1+B2+B3+B4)

mEUR

305.5

0.0

0.0

0.0

12.5

13.5

14.4

15.4

16.3

17.4

18.5

23.7

28.9

34.6

42.3

ENPV / Net benefits

mEUR

87.0

-94.9

-92.1

-57.0

11.8

12.8

13.7

14.6

15.5

16.6

17.7

16.8

28.1

33.7

192.5

ERR    7.1 %

B/C RATIO    1.45

In terms of ENPV, the main benefit of the project are travel time savings (87 % of total), followed only distantly by vehicle operating cost savings (9 %), accident cost savings (3 %), and CO2 savings (1 %). All in all, the results of the socio-economic analysis (ERR: 7.1 %, ENPV: EUR 87.0 million) show that the project generates a positive welfare change and is thus worthy of receiving EU assistance.

VI Sensitivity analysis

This is performed by calculating the percentage change of the FNPV(C) and the ENPV as a consequence of a 1 % change in key costs and benefits. If the absolute percentage change in ENPV is higher than 1 %, then the respective variable is deemed to be critical.

Variable tested

FNPV(C) elasticity

ENPV elasticity

Investment cost +1 %

-1.07 %

-2.70 %

Traffic on new road +1 %

+ 0.27 %

+ 2.04 %

O&M cost +1 %

-0.12 %

-0.24 %

Toll revenue +1 %

+ 0.17 %

n.a.

VOT +1 %

n.a.

+ 3.08 %

VOC +1 %

n.a.

+ 0.31 %

Accident saving +1 %

n.a.

+ 0.11 %

CO2 saving +1 %

n.a.

+ 0.03 %

The sensitivity analysis reveals that the project's financial performance is not very sensitive to any change in the input variables.

On the other hand, the economic performance is quite sensitive to changes in assumed investment cost and demand and value of travel time savings, which are considered critical variables. This is also reflected in their switching values (i.e. necessary changes in the variables for the ENPV to become negative), which are +37 % for the investment cost and -32 % for the VOT savings (as compared to the base case assumptions). Given that these values are, broadly speaking, within realistic possibilities, it was decided to carry out a probabilistic risk analysis in addition to the standard qualitative risk analysis.

VII Risk analysis

Given that the sensitivity analysis revealed no critical variables for the financial analysis, the risk analysis concentrates - for the sake of simplicity - solely on the economic analysis of the project and is done in both qualitative and quantitative terms.

The qualitative risk analysis is presented in the following risk matrix. It takes into account uncertainties related to all aspects of the project. Note that prevention and mitigation measures are only defined for the remaining risks of the highest level.

Risk

Effect

Probability

(P)

Severity

(S)

Risk

level

Causes

Prevention/mitigation

measures

PLANNING AND ADMINISTRATIVE RISKS

Building permit acquisition

delay

A

III

Low

EIA completed, documentation for building permit is ready.

Utilities (and other) approvals

delay

A

I

Low

Approvals obtained, coordination on-going, spatial plan is prepared and approved.

Changes in

environmental

requirements

A

I

Low

EIA procedure carried out.

LAND ACQUISITION

Cost of land

cost

B

III

Low

Land purchase partially completed.

Delays of land purchasing

delay

B

IV

moderate

Land purchase partially completed.

Additional

requirements

cost

A

I

Low

No additional requirements appeared so far.

Land for temporary access to the site

A

I

Low

Construction site accessible, no need for temporary access.

DESIGN

Inadequate site surveys and investigation

cost

A

III

Low

Surveys were undertaken during design, conditions known.

Changes in the requirements

cost

A

III

low

All infrastructure components/ parameters agreed.

Inadequate design cost estimates

cost

B

III

low

Design mainly completed.

CONSTRUCTION RISKS

Inadequate construction cost estimates (compared to received bids)

cost

D

IV

high

Tender price not yet known.

Decision to submit the application for EU funds depending on tender results, contingencies included in the budget, credit line for additional funding is available

Cost overruns

(during

construction)

cost

D

IV

high

Project implementation did not start yet, it includes a tunnel construction which involves geological risks.

Surveys were undertaken during design, design was audited

Inadequate construction quality

cost

C

III

moderate

Estimate based on experience.

Flooding, landslides and similar

cost

A

III

low

Archaeological

findings

cost

B

I

low

No known archaeological findings in adjacent areas.

Inadequate supervision cost estimates

cost

C

I

low

Tender price not yet known.

Inadequate temporary works cost estimates

cost

C

I

low

Project implementation did not start yet, cost compared to total cost is low.

Contractor’s

bankruptcy

delay

B

III

low

Possible, adequate requirements concerning financial strength will be included in tender dossier.

Risk

Effect

Probability

(P)

Severity

(S)

Risk

level

Causes

Prevention/mitigation

measures

Contractor’s

resources

delay

B

III

low

Financial situation may affect contractor’s ability to finance works and the stock of materials.

Public procurement

delay

C

III

moderate

Could be delayed by a year (experience).

OTHER RISKS

Protester action

cost

A

I

low

Master plan approved, no civil initiatives active.

Change of strategy

cost

A

I

low

High priority project for the country, international commitments, low cost invested so far.

Introduction of direct tolls (toll evasion)

%

traffic

B

III

low

Vignette system, no intention to introduce direct tolling of the cars at the moment, transiting trucks will be prohibited to use lower category roads.

Lack of national finance

delay

A

IV

moderate

Reduced capacity to fund projects, but project remains high priority.

Traffic (demand) risk

%

traffic

C

IV

high

Traffic study available, uncertainties regarding long term forecast.

Audit the traffic model.

Evaluation scale: Probability: A. Very Unlikely; B. Unlikely; C. About as likely as not; D. Likely; E. Very likely.

Severity:    I. No effect; II. Minor; III. Moderate; IV. Critical; V. Catastrophic.

Risk level:    Low; Moderate; High; Unacceptable.

The qualitative risk analysis basically displays two critical risks: i) construction cost risk (increase of contract price compared to designer's estimate; increase of out-turn cost compared to contract price, amongst others due to considerable geological risk); and ii) demand risk.

These two risks were therefore subject to a quantitative risk analysis.

A Monte Carlo risk simulation was used to assess the probability distribution of the project's socio-economic performance indicators (ENPV), repeated in 4,000 iterations. An asymmetrical triangular probability distribution was applied113, with the following assumptions concerning possible ranges for investment cost and traffic benefits (min., max.):

•    investment cost (-5 %; +20 %);

•    traffic on the new road (-30 %; +15 %).

The assumed range of investment cost is based on ex-post evaluation of motorway projects in the past which analysed cost development during the project cycle, and which found that for standard project final out-turn cost is in the range of -5 % to +20 % compared to the designer's estimate.

Monte Carlo analysis simulates the variation of the traffic on the new road which affects the related benefits (time savings, vehicle operating cost, accident savings). The parameters (min., max.) were derived through panel assessment which considered sporadic evidence for some of the projects and published articles. Probability density and cumulative probability distributions for the ENPV are shown below. In the base scenario the ENPV is around EUR 87 million, the most likely risk adjusted ENPV is around EUR 77 million. The probability of negative ENPV is 15 %.

Probability density of ENPV

12%

10%

8%

6%

4%

2%

0%

<-°> , Jo Jo Jb JV o°> q\ JV Jo Jo Jb Jb \ o. <p Jo Jb

p- P' p p' } y P' p Py P P' <o>' P P P'jP'jP'jP'


0%


Cumulative probability distribution

12%

10%

8%

6%

4%

2%

0%


The risk analysis suggests that there is a probability for a negative ENPV due to residual risks that are outside of the project promoter’s control, namely geological conditions where a tunnel is to be built (geological survey cannot exclude all risks), construction market prices (tender prices not always following the experience of previous projects) and demand (traffic behaviour not always following foreseeable patterns). All necessary risk prevention measures have already been undertaken during project design, such as detailed geological and hydrological surveys, and the elaboration of a traffic model which provided parameters for dimensioning of the road elements. As a mitigation measure regarding traffic forecast, a recommendation is to audit the traffic model and continuously improve it, if and where necessary, e.g. by obtaining the latest input data to feed into the model.

Considering the careful project preparation process thus far (incl. risk prevention measures) and the positive expected ENPV, the calculated risk of negative ENPV is deemed acceptable and the project should be released for the next stage (tendering). Nevertheless, the final approval of the project and application for EU funding are not forthcoming until the results of tender are known. If the tender would result in significantly higher prices than estimated (i.e. more than 10 %) it is recommended repeating the CBA and risk analysis with new inputs and reconsidering the further project development and implementation.

Case study - Railway

I Project Description

The project consists of the upgrading of a double-track railway section, part of the TEN-T Priority axis Y. The existing line is 94.75 km long (from the Y end of station A to the X end of station B), all double tracked, electrified and equipped with automatic line block, and is used for both passenger and freight traffic114.

Current traffic averages approximately 40 pairs of trains per day. The average technical speed allowed by the current condition of the line is about 81 km/h (design speed equivalent, commercial speed is lower). The line is not interoperable as it is not equipped with ERTMS (European Rail Traffic Management System). The main performance problems of the existing line are caused by the speed limiting alignment parameters and by the significant lack of past maintenance.

Further to the realignments (speed upgrade variants) provided under the project, the section length shall be reduced from 94.75 km to 89.5 km. The project works include notably:

•    renewal of 63.464 double track km on the existing alignment and construction of 26.036 double track km on a new alignment. Upon upgrading, approximately 60 % of the line section will allow a maximum speed of 160 km/h;

•    construction of two single pipe tunnels of 1,260 m total length;

•    construction of 13.705 km retaining walls and 1.260 km slope protection and river bed correction.

•    renewal or repair of 32 bridges, construction or repair of 106 culverts;

•    rehabilitation of passenger buildings in four stations and six halts (about 14,725 m2);

•    enlargement and protection of station platforms, construction of 6 pedestrian tunnels and repair of a grade crossings;

•    reduction or re-arrangement of station tracks, replacement of 144 turnouts, extension of freight siding to 750 m length;

•    installation of 7 Electronic Interlockings, ERTMS Level 2 including GSM-R and rehabilitation of the existing Automatic Train Protection (INDUSI/PZB type) system as fall-back;

•    closure of 7 existing level crossings, replacement of two level crossing by overpasses and installation of automatic protection systems with four half barriers for the remaining 33 level crossings;

•    rehabilitation/installation of the electric traction system on the entire length of 89.5 km;

•    rehabilitation of telecommunication systems (voice and data communication, passenger information equipment, two transmission lines based on optic fibre).

The following design parameters were applied in consideration of the applicable standards/targets:

Criteria

Parameter

Maximum speed of passenger trains

160 km/h (on approx. 60 % of line length), 120 km/h on the rest

Maximum speed of freight trains

120 km/h

Clearance

UIC - B.

Maximum axle load

22.5 t

Maximum gradient

12.5 %o (within this section the max. gradient will be only 3%o).

Minimum length of sidings

750 m

Distance between axis in open line

4.20 m

Distance between axis in stations

At least 4.75 m (Article 29(3) RET), but regularly 5.00 m.

Height of platforms in stations

55 cm

Level crossings

Automatic 4 half barriers + CCTV

Compatibility of signal equipment

ERTMS Level 2 with LS/Indusi ATP as fall-back

II Project Objectives

Fundamentally the project aims to improve the level of railway service on an important corridor, in particular by reducing travel times, increasing capacity and improving safety, thereby contributing to the overall attractiveness of the rail transport mode within the country and also at trans-European level.

Specifically, the upgrade towards the target speed of 160 km/h for passenger and 120 km/h for freight trains (within ERTMS Level 2 environment) will allow a travel time reduction from the current approximately 96 to 55 minutes journey time for long distance passenger trains.

The main results expected are:

•    reducing the travel time for the existing rail users;

•    reducing operating costs for service providers;

•    diverting traffic from road to rail with benefits for travellers as well as for society through a reduction of external costs and attracting new traffic to rail; and

•    improving traffic safety.

The project is consistent with both the existing strategic national and EU (TEN-T) plans and the priorities of the Operational Programme Transport (OPT). It contributes to the achievement of the following OPT indicators:

Indicator

Unit

Target 2015

Output

Total length of reconstructed or upgraded railway lines

km

209.18

Result

Value of time savings for passengers and freight transported by upgraded railways

M EUR/year

86.93

III Options and Demand Analysis

The following main alternatives have been studied within the feasibility study:

Baseline (‘without project') scenario

Assumes the business as usual scenario, under which the railway infrastructure company continues to operate the line following current trends, i.e. with the current level of both routine and periodic maintenance (slightly lower than required) -with the effect of continuing the slight trend of lowering the average speed (by approx. 0.5 % per year) of the line in time.

With-Project Alternatives:

   Alternative 1: Online rehabilitation of the line to the initial design speed (120 km/h) without any new upgrades/new alignments.

   Alternative 2: Moderate speed upgrade to 160 km/h on approx. 60 % of the line by 2020 - where this could be achieved with low to moderate investment costs (avoiding very costly structures such as long tunnels and bridges).

   Alternative 3: Maximal speed upgrade to 160 km/h on approx. 80 % of the line by 2020.

The alternatives have been compared within the feasibility study on the basis of CBA, as well as other considerations (such as environmental impact including on Natura 2000 areas) and Alternative 2, providing the best economic return (highest ERR and B/C ratio), was selected as the preferred option115 - which was taken forward to detailed design and is the subject of this analysis.

Demand116

The current traffic volumes (average between A and B) are approximately:

•    30 pairs of passengers trains/day (approx. 4,900 pax/day);

•    9 pairs of freight trains/day (approx. 12,000 ton/day).

The forecast is derived from a model based on the impact of exogenous (GDP growth, population growth, motorisation, travel time by road, fuel cost growth) and endogenous (travel time by rail, rail fare growth) factors - with appropriate calibration.

During implementation the impact of the project is negative,reflecting the disruptions over the construction period, then gradually positive after adding operation of the corridor. The positive effect reflects additional traffic mainly diverting from roads - as a result of travel time savings.

Overall, the forecast results in an average incremental growth of the railway traffic, roughly equivalent to 1.1 % per annum. for passengers and 0.4 % per annum for freight over the appraisal period. The traffic forecast results without and with - project are illustrated in the graphics below:

IV Project Costs for the Selected Option

Investment Cost

Passengers traffic


-without project

-with project


-without project

-with project

1    4 7 10 13 16 19 22 25 28


Freight traffic

The cost estimate for works and supervision of the selected option is based on a detailed design estimate (broken down transparently into quantities and unit costs per components). The works have not been tendered yet and land purchase is partially completed. The cost estimate is made at constant prices of year Y.

In EUR

Total Project costs

Ineligible costs

Eligible costs

(A)

(B)

(C)=(AHB)

1

Planning/design fees

14,024,673,

,

14,024,673,

2

Land purchase

12,756,615

,

12,756,615

3

Building and construction

648,131,978

,

648,131,978

4

Plant and machinery

38,354,080

,

38,354,080

5

Contingencies

51,721,770

,

51,721,770

6

Price adjustment (if applicable)

0

,

0

7

Technical assistance

0

,

0

8

Publicity

125,747

,

125,747

9.1

Supervision

13,111,376

3,255,491117

12,855,885

9.2

Other costs

922,259

922,259

10

Sub-TOTAL

779,148,498

255,491

778,893,007

11

VAT

186,995,640

186,995,640

0

12

TOTAL

966,144,137

187,251,131

778,893,007

The average cost per (double-track) km of the project, including ancillary investments in stations, etc. is approx. EUR 8.7 million (ex-VAT), which is in line with similar projects in the country.

Infrastructure Operation and Maintenance (O&M) cost

The average maintenance unit costs for the railway line used in the analysis are:

•    for the ‘without project' scenario - EUR 29,717 per track km per year (as per actual costs incurred over the last 5 years -reflecting the business as usual assumptions);

•    for the ‘with project' scenario - EUR 37,500 per track km per year, as estimated for good maintenance standards based on local costs

Another factor influencing the overall O&M expenditure of the project is the reduction in the length of the rail section. Overall, however, there would be an increase in the O&M costs in the ‘with' project scenario as compared to the ‘without' project scenario.

The diversion of traffic from roads may have a marginal impact (reduction) on the road O&M, but this is usually considered not significant enough for appraisal and is therefore ignored.

Residual value

The residual value has been calculated as the net present value of the financial/economic flows118 over the remaining lifetime (52 years) outside the reference period (30 years). This method is considered to reflect more realistically the actual value of the assets than the traditional ‘accounting' method based on linear depreciation.

V Financial and Economic Analysis

General

The analysis is performed using a 30-year reference period which is common for railway projects.

The financial and economic analyses use constant prices (year Y). A 4 % discount rate in real terms is used in the financial calculations, while a 5 % social discount rate is used in the economic analysis, in line with EU wide benchmark set by the Commission. VAT is excluded from the analysis since it is recoverable.

Financial Analysis

Since the line is operated by more than one operator the financial analysis is done from the perspective of the infrastructure owner/manager; therefore the relevant revenues are the track access charges (TAC) paid by the freight and passengers operators.

Additional revenues are generated by the project as a result of the incremental traffic (trains-km) forecasted within the traffic analysis. The calculation is based on the current level of the track access charges (i.e. average EUR 2.11 /train-km for passengers and EUR 3.29 /train-km for freight), which is assumed not to change in real terms over the appraisal period. The choice of not raising the level of the TAC following the line upgrading was made on the basis of the policy line taken in terms of transferring maximum benefits of the upgrade to the end users (rather than trying to recover part of it) - in view of improving the attractiveness of the rail mode and thus contributing to the mode shift objective. Note also a temporary drop in revenues during the three years of the construction period as a result of the disruptions inherent to the works under operation (track capacity limitations, delays, etc.).

The project is a net revenue generating operation in the meaning of Article 61 of Regulation (EU) 1303/2013. To determine the contribution of the Cohesion Fund to the project, the method based on the calculation of the discounted net revenue was applied119, which is shown in the following table. The analysis shows that the project is not able to repay around 95 % of the invested capital.

12 3

4 5 6 7 8 9 10 15 20 25 30

Construction

Operation

EU GRANT

Calculation of the

Discounted Investment Cost (DIC)

NPV 4%

Investment cost (excluding contingencies)

mEUR

670.8

227.2

214.4

285.9

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

DIC / Investment cost cash-flow

mEUR

670.8

227.2

214.4

285.9

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

Calculation of the Discounted Net Revenues (DNR)

NPV 4%

Revenue (track access charges)

mEUR

35.1

-0.1

-0.1

-0.2

0.2

0.4

0.8

1.2

1.5

2.3

2.4

2.8

3.2

3.7

4.1

O&M cost

mEUR

-15.7

0.0

0.0

0.0

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

Residual value of investments

mEUR

13.7

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

44.3

DNR / Net revenue cash-flow

mEUR

33.1

-0.1

-0.1

-0.2

-0.9

-0.7

-0.3

0.1

0.5

1.2

1.3

1.7

2.2

2.6

47.4

ELIGIBLE COST (EC)

mEUR

778.9

Pro-rata application of DNR = (DIC - DNR) / DIC

95.1%

CO-FINANCING RATE OF THE PRIORITY AXIS (CF)

85.0%

EU GRANT ( = EC x PRO-RATA x CF)    mEUR 629.4

In this case, the EU grant has been calculated by multiplying the eligible cost shown in section IV above (EUR 778.9 million) by the pro-rata application of discounted net revenue (95.1 %) and the co-financing rate of the relevant priority axis of the OP (85 %) - resulting in EUR 629.4 million. The remainder of the investment is co-financed out of national (state-budget and railway company120) funds. No loans are planned.

The following profitability indicators (before-tax, real) are calculated - see cash flow tables below:

1 2 3

4 5 6 7 8 9 10 15 20 25 30

Construction

Operation

Calculation of the Return on Investment

NPV 4%

Investment cost (excluding contingencies)

mEUR

-670.8

-227.2

-214.4

-285.9

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

O&M cost

mEUR

-15.7

0.0

0.0

0.0

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

Revenue

mEUR

35.1

-0.1

-0.1

-0.2

0.2

0.4

0.8

1.2

1.5

2.3

2.4

2.8

3.2

3.7

4.1

Residual value of investments

mEUR

13.7

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

44.3

FNPV(C) - before EU grant / Net cash-flow

mEUR

-637.7

-227.3

-214.5

-286.1

-0.9

-0.7

-0.3

0.1

0.5

1.2

1.3

1.7

2.2

2.6

47.4

FRR(C) - before EU grant |    -8.1%

1 2 3

4 5 6 7 8 9 10 15 20 25 30

Construction

Operation

National Financing Sources

National public grant

mEUR

34.6

32.8

43.7

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

Promoter's contribution

mEUR

12.0

11.4

15.2

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

Calculation of the Return on National Capital

NPV 4%

National public grant

mEUR

-106.5

-34.6

-32.8

-43.7

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

Promoter's contribution

mEUR

-37.1

-12.0

-11.4

-15.2

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

O&M cost

mEUR

-16.3

0.0

0.0

0.0

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

Revenue

mEUR

36.5

-0.1

-0.1

-0.2

0.2

0.4

0.8

1.2

1.5

2.3

2.4

2.8

3.2

3.7

4.1

Residual value of investments

mEUR

13.7

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

44.3

FNPV(K) - after EU grant / Net cash-flow

mEUR

-109.7

-46.7

-44.3

-59.1

-0.9

-0.7

-0.3

0.1

0.5

1.2

1.3

1.7

2.2

2.6

47.4

FRR(K) - after EU grant    Q-2.1 %

Note that the FNPV(K) remains negative because the EU grant is not covering the entire gap but only 85 % of it.

To ensure overall sustainability, increased operational subsidies from the state are necessary to cover the negative operating cash flow over the construction period and the first three years of operation (which is a consequence of (i) the initial drop in revenues and (ii) the increased O&M costs required for good operation.

FINANCIAL SUSTAINABILITY


12 3

4 5 6 7 8 9 10 15 20 25 30

Construction

Operation


Verification of the Financial Sustainability of the Project

EU grant

mEUR

National public grant

mEUR

Promoter's contribution

mEUR

Revenue

mEUR

Total cash inflows

mEUR

Investment cost (including contingencies)

mEUR

O&M cost

mEUR

Total cash outflows

mEUR

Net operating cash-flow

|mEUR

Tax*

mEUR

Operating cost subsidies

mEUR

Cumulated net cash-flow

mEUR


196.0

185.7

247.6

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

34.6

32.8

43.7

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

12.0

11.4

15.2

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

-0.1

-0.1

-0.2

0.2

0.4

0.8

1.2

1.5

2.3

2.4

2.8

3.2

3.7

4.1

242.6

229.8

306.3

0.2

0.4

0.8

1.2

1.5

2.3

2.4

2.8

3.2

3.7

4.1

-242.7

-229.9

-306.6

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-242.7

-229.9

-306.6

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-1.1

-0.1

-0.1

-0.2

-0.9

-0.7

-0.3

0.1

0.5

1.2

1.3

1.7

2.2

2.6

3.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.1

0.1

0.2

0.9

0.7

0.3

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.1

0.6

1.8

3.1

10.9

20.8

32.9

47.1


* The tax line is 0 over the entire period because taxation is completed at the level of the whole company (rail infrastructure manager) - where the overall costs are actually higher than the revenues and the break-even is reached through subsidies covering the operating loss.

Economic Analysis

The following general assumptions are noted:

Parameters

Assumption121

Average occupancy, cars

1.6 persons

Average occupancy, goods vehicles

1.2 persons

Trip purpose mix, cars

15 % business

30 % commuting

55 % other

Trip purpose mix, rail

10 % business

30 % commuting

60 % other

Average train load (pax)

120 persons

Average train load (freight)

640 tons

Average track-access charge passengers trains

EUR 2.1 / train-km

Average track-access charge freight trains

EUR 3.29 /train-km

Average fare per passenger-km train

EUR 0.07

Average fare per passenger-km bus

EUR 0.05

Value of time (passengers)

EUR 12.6 /h for business

EUR 6.2 /h for commuting

EUR 5.2 /h for other purposes

Vehicle operating costs per vehicle-km (roads)

EUR 0.2 for cars

EUR 0.27 for minibus

EUR 0.95 for trucks

Train operation costs per train-km

EUR 3.95 for long-distance passengers

EUR 3.3 for short-distance passengers

EUR 4.01 for freight trains

Parameters

Assumption123

Train operation costs per hour-train

EUR 348.3 for long-distance passengers

EUR 200.3 for short-distance passengers

EUR 93.4 for freight trains

Average conversion factors to investment cost (shadow prices)

0.91 for investment cost

0.88 for O&M costs

The economic analysis looks to monetise the project impact on three levels:

•    consumers Surplus (rail users);

•    producers Surplus (rail and bus operators);

•    externalities (emissions and accidents).

Consumers Surplus

For the existing rail users, the consumer surplus is given by the change in the generalised user cost, namely in the time and fare cost.

Since the fares are assumed not to change in result of the project, the relevant impact is the time saving. The travel time (with project) was determined based on a train running simulation considering the profile of the upgraded line. For the scenario ‘without-the-project' the estimation was based on the current running times, adjusted over time according to the maintenance profile assumptions made for this scenario.

Calculation of benefits related to reduction of pollution and noise within settlements was not undertaken.

For the new rail users (diverting from roads122 - bus and car users respectively - and new demand generated), the consumer surplus was estimated following the ‘rule of half' formula - which essentially assumes half of the savings in the generalised cost of the existing users. Since the fares are not changing, this means half of the travel time savings.

For the users remaining on the road the marginal benefit from reducing the traffic volumes is considered not significant enough to be included in the appraisal (in particular since the respective road is not congested) and is therefore ignored.

Producers Surplus

The producers surplus is given by the project impact (mainly as a result of the new rail traffic mostly diverted from roads but also as a result of the change in train operating costs for the existing rail users) on:

•    the rail operators, namely the change in:

-    the train operating costs (savings)123;

-    the rail fare revenues (additional gains).

• The road operators, namely the change in:

-    the vehicle (bus) operating costs (savings)124;

-    the (bus) fare revenues (losses).

The cost impact on the infrastructure manager is quantified under the project costs (investment, residual value and O&M), whilst the revenues change impact (track access charges) is ignored as it represents a transfer (of equivalent value) from the rail operators surplus.

Externalities

Accidents cost savings result essentially from the traffic shifted from roads to rail, knowing the accident costs (measured in aggregate costs per vehicle-km based on previous research in the country) are substantially lower on rail than on roads. Additional safety benefits are brought by the improved protection of the line (elimination of some level crossings, full barrier protection at the others).

Fatalities number/ 100 million vehicles-km

Fatalities number/ 100 million passengers-km

Roads

5.80

3.6

Rail

10.50

0.1

Emissions cost savings (air pollution and climate change costs) are also a result of the mode shift from road to rail.

The unit costs per passenger-km and ton-km presented in the following table are based on a national study of external costs in the transport sector and are adjusted to base year constant prices. Escalation rates were applied to reflect the increase of damage costs of CO2 and air pollutant emissions over time, which is in line with the recommendation made in this guide and other international studies on the matter.

Passengers (pax-km)

Road cost

EUR/pax-km

0.015

Rail Cost

EUR/pax- km

0.007

Freight (ton-km)

Road cost

EUR/ton-km

0.026

Rail Cost

EUR/ton-km

0.006

Noise impacts are considered marginal and thus ignored given the rural environment (mostly outside inhabited areas).

The resulting cash flows and their present values are shown in the following table.

ERR

12 3

4 5 6 7 8 9 10 15 20 25 30

Construction

Operation

Calculation of the Economic Rate of Return

NPV 5 %

Investment cost

mEUR

641

220.8

209.2

279.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

O&M cost

mEUR

12

0.0

0.0

0.0

1.0

1.0

1.0

1.0

1.0

1.0

1.0

1.0

1.0

1.0

1.0

Residual value of investments

mEUR

-71

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

-305.2

Total economic costs

mEUR

582

220.8

209.2

279.0

1.0

1.0

1.0

1.0

1.0

1.0

1.0

1.0

1.0

1.0

-304.3

CONSUMERS (USERS) SURPLUS

mEUR

857

-2.0

-1.8

-3.0

7.2

10.4

13.6

17.7

23.9

40.1

44.0

66.1

98.8

143.7

207.1

RAIL EXISTING USERS

mEUR

801

-2.0

-1.8

-3.0

7.0

10.0

13.0

17.0

22.8

37.2

40.8

61.9

92.5

134.2

193.3

Value of time savings

mEUR

801

-2.0

-1.8

-3.0

7.0

10.0

13.0

17.0

22.8

37.2

40.8

61.9

92.5

134.2

193.3

Value of train fares change

mEUR

0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

NEW RAIL USERS

mEUR

56

0.0

0.0

0.0

0.2

0.4

0.5

0.7

1.1

3.0

3.2

4.2

6.3

9.4

13.9

Generalised users cost surplus (half of the change in time and fare cost)

mEUR

56

0.0

0.0

0.0

0.2

0.4

0.5

0.7

1.1

3.0

3.2

4.2

6.3

9.4

13.9

PRODUCERS SURPLUS

mEUR

466

-1.6

-1.4

-2.5

2.8

5.2

11.5

14.2

19.3

33.8

35.5

43.4

52.4

61.4

71.7

Train operating costs savings

mEUR

93

-0.4

-0.3

-0.5

-0.3

-0.2

2.3

2.6

3.4

6.1

6.5

8.4

10.9

13.7

17.2

Vehicle operating costs savings (road)

mEUR

284

-1.0

-0.9

-1.6

2.9

5.1

7.2

9.1

12.3

20.9

22.0

26.8

31.6

36.0

40.9

Rail fare revenues increase

mEUR

254

-0.7

-0.6

-1.1

1.7

3.2

5.7

7.3

10.1

19.2

20.1

23.4

28.2

33.2

38.9

Bus fare revenue loss

mEUR

-166

0.5

0.4

0.7

-1.5

-2.9

-3.7

-4.8

-6.6

-12.5

-13.0

-15.2

-18.3

-21.6

-25.2

EXTERNALITIES

mEUR

140

-0.3

-0.3

-0.4

0.5

1.5

2.1

2.7

4.0

7.5

8.1

11.7

16.3

22.3

30.3

Accidents

mEUR

24

-0.1

-0.1

-0.1

0.1

0.3

0.4

0.5

0.7

1.4

1.5

2.0

2.8

3.8

5.1

Emissions

mEUR

116

-0.2

-0.2

-0.3

0.4

1.2

1.7

2.2

3.3

6.1

6.6

9.7

13.5

18.5

25.3

Total economic benefits

mEUR

1,462

-3.8

-3.5

-5.9

10.5

17.0

27.2

34.7

47.2

81.4

87.6

121.2

167.5

227.4

309.2

ENPV / Net benefits

mEUR

880

-224.7

-212.7

-284.9

9.5

16.1

26.2

33.7

46.3

80.4

86.7

120.3

166.6

226.4

613.5

ERR    10.6%


B/C RATIO    2.51

The economic rate of return (ERR) is 10.6 %, and economic net present value (ENPV) is EUR 880 million. The following chart illustrates the weight of the benefit categories in the overall impact.


■    Value of time savings

■    Train operating costs savings

■    Vehicle operating costs savings (road)

■    Net fare revenues increase (rail-bus)

■    Accidents

Emissions

VI Risk Assessment

Sensitivity analysis

The main purpose of the sensitivity analysis is to determine the ‘critical' variables of the model. Such variables are those whose variations, positive or negative, have the greatest impact upon the project's economic results.125

The ‘critical' variables are conventionally considered those for which an absolute variation of 1 % gives rise to a corresponding variation of not less than 1 % in the ENPV - elasticity is unitary or greater.

VARIABLES

Variation of ENPV + 1 % of variable -1 % of variable

Investment costs

-1.01 %

1.01 %

Maintenance costs

-0.02 %

0.02 %

Baseline traffic (without project)

1.3 %

-1.3 %

Incremental traffic (induced by project)

0.2 %

-0.2 %

Time savings

1.03 %

-1.03 %

Savings of road VOC

0.5 %

-0.5 %

Accident savings

Externalities

TOC savings

0.10 %

-0.10 %

The variables identified as critical are thus (i) the traffic, (ii) the investment costs and (iii) the time savings. These three variables are taken further to the switching value calculation and risk analysis.

Switching Values

For each critical variable a switching value has been computed, i.e. the value for which the ENPV becomes zero, or in other words the maximum (negative) variation range over which the project would be still breaking-even economically. The results are summarized in the following table.

CRITICAL VARIABLES

Value for which ENPV = 0

Investment cost

137%

Baseline traffic

- 36%

Time savings

-110%

The above values essentially confirm the economic case of the project is quite solid.

Although not very relevant for the financial indicators, given their highly negative profile, switching values were calculated for the FNPV(C) to show the variation range required to reach financial break-even.

CRITICAL VARIABLES

Value for which FNPV(C) = 0

Investment cost

-95%

Revenues

+ 1,816%

O&M costs

-4,067%

The above results confirm the very negative financial profile of the project - which would require huge variations of the parameters - completely outside the realistic range - to reach break-even.

Risk analysis

Considering the particulars of the project, the following specific risks are considered.

Construction

The construction includes some technical challenges, e.g. replacement of existing tracks under railway operation, construction/ repair of 32 bridges, construction of 1.26 km of new tunnels. Works will require the employment of technical expertise and capacity, as well as proper co-ordination and supervision of activities.

Land acquisition

Land acquisition is an issue as the project includes some 26km of new alignment. However, the work plan (to be included in the tender documents) provides for a staged handing-over of the site, starting with the online sectors, whilst the expropriation procedure would be carried out in parallel. The procedure should be also eased by the recent new expropriation law.

Maintenance

Maintenance is a key issue for the long and short term sustainability of the investment. Regular maintenance is required in order to maintain the upgraded line in its design parameters (e.g. 160 km/h speed). Failure to ensure this would lead to speed restrictions which in turn would cancel out the benefits of the investment.

Demand

A traffic risk is inherent to any transport infrastructure project. This is equally true for the baseline traffic (without project) assumptions and for the incremental traffic (with project) forecasted.

The traffic risk also relates to the above factors as the improved level of service and efficiency gains for users (and in turn the demand reaction) depends on the operators' ability (both for passengers and freight) to exploit the potential provided by the improved infrastructure for enhancing the level of service provided.

The following matrix summarises the qualitative assessment of the above risks in terms of significance and probability of occurrence.

Risk

Probability

Impact

Overall risk

Mitigation measures

Residual risk

Construction

risks

D

III

High

Contracting experienced supervision services; improving the staffing and training of PMU

Medium

Land

acquisition

D

III

High

Staged handing-over of site starting with the online sections, in parallel with finalising land acquisition

Low

Operation -maintenance

C

III

Medium

Maintenance budget for the line to be increased, within a wider network reform programme

Low

Demand

risk

C

IV

High

A parallel service improvement programme to be planned, including a more competitive passengers timetable, new rolling stock, etc.

Medium

Evaluation scale: Probability: A. Very Unlikely; B. Unlikely; C. About as likely as not; D. Likely; E. Very likely. Severity:    I. No effect; II. Minor; III. Moderate; IV. Critical; V. Catastrophic.

Risk level:    Low; Moderate; High; Unacceptable.

The project promoter will need to carefully assess the above risks and plan appropriate mitigation measures.

However, even with the assumed mitigation, the risk of construction cost overruns. In addition, the risk of time savings not actually materialising cannot be excluded, therefore a quantitative risk analysis was considered to add useful information.

Quantitative risk analysis

The quantitative risk analysis was performed using the following steps:

•    assigning the probability distributions to the critical variables identified above;

•    running a Monte Carlo simulation;

•    interpreting the results.

Probability distribution

Since no studies have been performed in the country thus far concerning the distribution of variables such as investment costs, O&M expenses, traffic etc., the probability distributions of the critical variables have been assigned based on a review of the international literature and practice.

Construction costs

Flyvberg et al. (2003) has investigated cost overruns for 167 large-scale transport infrastructure projects. The tendency is clearly right skewed, where cost overruns are commonly occurring. In fact, an average of 20 % cost overrun among the 167 road projects is calculated with the worst project having a 223 % cost overrun and -33.6 % cost under-run.

Time savings

A triangular distribution with a minimum of -50 % of the variable, a most likely value of 0 % changes in estimated value and a maximum value of +5 % was assumed.

Baseline traffic

A Gauss profile distribution was assumed ranging from -50 % to +50 % with the mean of 0 % changes in estimated value.

The risk analysis has been performed with a specialised software for 5,000 simulations. The technique used is Monte Carlo simulation which involves a random sampling method of each different probability distribution selected for the actual model set-up. The three variables are considered independent of each other, so each ‘extraction' takes a random value for each variable to compute the corresponding ERR. The distribution of the ERRs obtained is presented below:

The above chart indicates that there is a 99.8 % probability for the ERR to be higher than 5.5 %, from a range of possible values starting from 4.4 % to 14.2 %.

The most likely value of ERR is 9.4 % with a standard deviation (quantifying the variation of the results from the expected value) of 1.4 %.

The results of the risk analysis clearly reconfirm the strong economic case of the project.

Case study - Urban Transport

I Project Description

City X is a medium sized city of 300,000 inhabitants. The motorised mobility in the city is ensured by private transport as well as an extended bus network. The modal share in the city is 45 % public transport (bus) and 55 % individual transport.

The residential area Y, 7 km North-East of the city centre, is rapidly expanding. Mobility demand is increasing rapidly and the road connecting the residential area Y to the city centre/business area is heavily congested at peak hours. To ease this situation, the City Transport Authority is proposing to improve public transport connections to the city centre and implement a package of measures to promote public transport and encourage modal shift, including:

•    Construction of 9 km of tram line (double track), with accompanying infrastructure (traffic signalling, traction infrastructure, necessary road works), as well as a new tram depot;

•    Purchase of 15 new tram sets;

•    Implementation of a Traffic Management System (TMS), including Passenger Information System at stops, integrated electronic ticketing, automatic vehicle location systems for public transport, public transport priority.

In addition, existing bus services in the area will be redefined with a feeder function to the new line. The public transport modal share is expected to improve, passing from the current 45 % to 47 %.

In this case study, time savings are expected in the transport system, due to the introduction of the new tram system and the reorganisation of the bus services, for the traffic diverted from the bus services and the individual cars to the tram. In addition, the impact of the shift to tram usage and the re-organisation of bus services will also translate into lower pollutants emissions from traffic, thus contributing to climate change mitigation126.

The institutional set up, in terms of relations between entities involved in project implementation and operations, is briefly described below. The implications of this institutional set-up for the analysis of cash flows, financial sustainability and assessment of State aid are duly taken into account in the rest of the analysis and will be highlighted when relevant in this case study127.

The City is the project beneficiary. As beneficiary, the City will receive the EU grant, and also draw a loan from an International Financing Institution (IFI) to co-finance the implementation of the project. In addition, it will co-finance the remaining part with own resources.

The City holds the strategic management of the public transport system through the Transport Authority, which is the budget unit of the City in charge of overall mobility policy128.

The City has entered a Public Service Contract (PSC) with the in-house Transport Operator. The PSC establishes the responsibilities, modalities for operation and compensations for public transport services. The contract is compliant with national and EU legislation regulating the provision of public service obligations129.

According to the PSC, the City will remain the owner of all the project assets (infrastructure, rolling stock and TMS), which will be made available for use to the public Transport Operator against payment of a lease. The City will also bear expenditures on replacements of project assets.

The Transport Operator holds the responsibility of operating and maintaining the project assets and bears all associated expenditures.

II Project objectives

The general objective of the project is to ensure an efficient public transport service in the urbanised areas of the City. Specific objectives include:

•    reducing road traffic congestion, accidents and negative environmental impacts, positively influencing the quality of urban life and the environment;

•    improving the quality of the public transport travel experience, through increased quality standards;

•    shortening travel time of public transport of vehicles and passengers without worsening traffic conditions.

As a secondary effect, it is expected that the project will also increase the attractiveness of the area around the planned investment through increased public transport availability.

The project objectives are in line with the national, regional and municipal strategies related to the overall territorial and spatial development as well as those related to the transport sector. In particular, the project responds to a priority defined in the City's multi-modal Mobility Plan, namely identifying needs and solutions for urban mobility. The objectives of the project are also coherent with the policies of the Commission on urban mobility130 and are well aligned with the objectives of the Operational Programme Transport. In particular, the project will contribute to the achievement of the following OP indicators:

Indicator

OP

2023 target

Project

(% of OP target)

Output indicators

Total length of new or improved tram lines (km)

32

8 (40 %)

Result indicators

Incremental number of passengers using urban public transport (M passengers/year)

40

10 (25 %)

III Demand and Options Analysis

Options analysis

In most transport projects different project options can generate different levels of traffic, so that a detailed definition of project options precedes the demand analysis estimating and forecasting the level of traffic for each of the project options.

The multi-modal Mobility Plan identified the need for improving the connections between residential area Y and the city centre as a priority, given the current heavily congested conditions and the foreseeable worsening of the traffic burden due to the fact that residential area Y is expanding.

In the Mobility Plan, a first screening of available options, with a multi-modal perspective, was done based on a Multi-Criteria Analysis (MCA). Selection criteria included technical feasibility, costs, environmental impacts and social acceptability131. Based on this screening, alternative project options such as the increase of road capacity by enlarging road infrastructure and the construction of an alternative road connecting the area Y and the city centre were discarded. The public transport option was considered the most effective and the number of alternatives was narrowed down to three, as follows.

•    Option 1: strengthening of bus services with implementation of bus lanes and fleet renewal, as well as implementation of TMSs with public transport priority.

•    Option 2: new tram line (7.5 km, along Alignment A running along the existing road) with tram rolling stock purchase, re-organisation of bus services with a feeder function, as well as implementation of TMSs with public transport priority.

•    Option 3: new tram line (9 km, along Alignment B, mostly along the existing road, but with a small detour to allow another residential area along the way to be served) with tram rolling stock purchase, reorganisation of bus services with a feeder function, as well as implementation of TMSs with public transport priority.

The without-the-project (counterfactual) scenario, against which the project options are compared, assumes a continuation of business as usual, maintaining the level of expenditures which would guarantee the basic functionality of assets. This implies a slight worsening of the modal share of public transport.

In the feasibility study a full CBA on all three project options was performed. Traffic forecasting was done separately for each of the three options, and implications in terms of investment costs, O&M, renewals, as well as benefits, were assessed separately. Option 3 was selected as it scored the highest economic internal rate of return. This case study shows the CBA carried out for the selected option only.

Transport demand

The demand analysis is carried out based on a multi-modal network traffic model (traffic diagnostic and forecasting) owned by the City. The model is calibrated with data from the most recent comprehensive traffic study (the Transport Authority carries out traffic surveys every 5 years). Model results are used to inform both the financial and the economic analyses. Traffic forecasts were carried out separately for the without-the-project scenario and for each of the three project options. Forecasts were made for three years (year 4 - first full year of operations, year 15 and year 25) and linear interpolation was used to forecast the remaining years. This case study shows the traffic forecasts carried out for the selected option only.

It is assumed that the city is congested and with a high level of suburban living. The average trip length is 7 km for buses and trams and 8 km for cars, while the average speed is 14 km/h for buses and 20 km/h for cars in the scenario without-the-project; and 14.3 km/h for buses, 19 km/h for trams and 20 km/h for cars in the scenario with-the-project (unchanged, since it is assumed that possible congestion relief effects will be counterbalanced by the implementation of TMS with public transport priority).

The traffic, after the traffic stabilisation and the corresponding shifts following project completion, shows a moderate traffic growth rate of 2 % from the opening (year 4) to year 10, 1 % up to year 15 and no growth afterwards132. Demand data for the without-the-project scenario and for the selected option are summarised in the following table. All data are expressed in millions (m) passengers or passengers-hours (h) per year.

Year 1 (start of construction)

Year 4 (first full year of operation)

Year 10

Year 15

Year 25

Without-the-project scenario

Passengers

Bus

42.4

45.0

50.2

52.7

52.7

Trams

-

-

-

-

-

Private transport

52.0

55.2

61.6

64.7

64.7

Passenger-h

Bus

21.2

22.5

25.1

26.4

26.4

Trams

-

-

-

-

-

Private transport

20.8

22.1

24.6

25.9

25.9

With-the-project scenario

Passengers

Bus

42.4

37.0

41.3

43.4

43.4

Trams

-

10.0

11.2

11.7

11.7

Private transport

52.0

53.7

59.9

62.9

62.9

Passenger-h

Bus

21.2

18.1

20.2

21.2

21.2

Trams

-

3.7

T-1

'ST

4.3

4.3

Private transport

20.8

21.5

24.0

25.2

25.2

Based on the traffic model results, demand in the with-the-project scenario has been qualified as existing (i.e. passengers already travelling in the without-the-project scenario), diverted (i.e. passengers diverted from bus and private cars to tram) and generated (i.e. passengers who were not travelling in the without-the-project scenario). The model shows that, in the with-the-project scenario, the incremental traffic (tram) is diverted from bus for 80 % of the total, diverted from individual transport for 15 % and newly generated for 5 %.

Transport supply

The information on current transport supply and foreseeable changes as a consequence of the project is provided by the Transport Operator and is compliant with the provisions on transport production as laid out in the Public Service Contract signed between the Transport Authority and the Operator. The planned supply is also compliant with the assumptions of the traffic model.

The following table summarises the main information about the current and planned public transport supply (bus and trams) and the expected private transport production. All data are expressed in millions (m) vehicles-km per year.

Year 1 (start of construction)

Year 4 (first year of operation)

Year 10

Year 15

Year 25

Without-the-project scenario

Bus

9.6

9.6

9.6

9.6

9.6

Trams

-

-

-

-

Private transport

346.4

368.0

410.4

431.3

431.3

With-the-project scenario

Bus

9.6

8.0

8.0

8.0

8.0

Trams

-

1.0

1.0

1.0

1.0

Private transport

346.4

358.0

399.2

419.6

419.6

IV Project Costs and Revenues of selected option

Investment Cost

The total cost of the project is estimated at EUR 160 million net of VAT (EUR 197 million gross), based on tender prices (the tenders for the construction works and the rolling stock purchase have all been awarded).

Total project costs (A)

Ineligible costs (B)

Eligible costs (C)=(AHB)

Planning/design fees

3.0

-

3.0

Land purchase

5.0

-

5.0

Building and construction

73.0

-

73.0

Tram infrastructure (incl. tracks and traction)

630

-

63.0

Tram depot

100

-

100

Plant and machinery or equipment

57.5

-

57.5

Tram rolling stock

37.5

-

37.5

Traffic Management System

200

-

200

Contingencies

14.5

-

14.5

Technical assistance

-

-

-

Information and promotion

0.3

-

0.3

Contract supervision

6.5

-

6.5

Sub-TOTAL

159.9

-

159.9

VAT

36.8

36.8

-

TOTAL

196.6

36.8

159.9

The beneficiary completed the land purchase procedures (EUR 5 million)133. Contract supervision is set at 5 % of construction and equipment expenditures (EUR 6.5 million).

Contingencies are set at 10 % of project cost, which seems reasonable given the type of project, its state of advancement (tender awarded, works not started yet) and the associated residual risks.

The unit cost per km of tram line constructed (double track) appears reasonable if benchmarked with that of similar projects in cities with comparable network conditions.

The unit cost of the tram rolling stock appears reasonable, taking into account the technical specifications of the rolling stock purchased.

Unit costs are specified below.

Investment component

Unit cost

Total cost

Tram infrastructure (9 km)

EUR 7 m/km (double track)

EUR 63 m

Tram rolling stock (15 tram sets)

EUR 2.5 m/tram set

EUR 37.5 m

VAT is set at 23 % and is fully recoverable for the City under national legislation.134 For this reason, VAT is a non-eligible cost for the project.

Operation and maintenance cost

The O&M costs are borne by the Transport Operator. The following O&M unit costs have been used in the analysis:

Project component

O&M unit cost

Tram (infrastructure* and rolling stock)

EUR 6 /tram vehicle-km

Bus rolling stock

EUR 3/bus vehicle-km

* Including tracks and overhead line system.

Unit costs include traction (including a yearly amount earmarked for replacement of overhead lines), maintenance and repair (including spare parts and excluding replacements), staff and other administrative costs (including the lease for the use of project assets).

No real growth of costs has been considered (see section 2.8.4 of the guide).

The impacts of different project components on the O&M have been assessed separately, taking into account O&M savings due to the reorganisation of the supply of bus services and the incremental O&M due to the new tram system. Savings due to reduction of the supply of bus veh-km do not counterbalance the increase of costs due to operating the new tram line and new rolling stock.

The project results in an overall increase in the O&M expenditures of EUR 1.2 million/year, resulting from additional O&M costs of EUR 6 million/ year for the tram system and a reduction of O&M costs of EUR 1.2 million/year for the bus system.

Replacements

The necessary replacements of the new infrastructure, rolling stock and TMS have been considered during the reference period of the project (25 years), based on the economic life of the individual project assets, which were assumed to be as follows:

Investment component

Economic life

Replacement during reference period in % of initial investment

Tram infrastructure

30 years

-

Tram rolling stock

20 years

33 % every 10 years

TMS

8 years

100 %

Based on the provisions of the PSC, the replacement costs are borne by the City (project beneficiary)137.

Residual value

The project does not generate net revenues (operating costs higher than operating revenues). The residual value of the investment is hence calculated based on the net book accounting method. The depreciation rates of the various investment components (taking into account the replacements) are as follows: 135

Investment component

Depreciation rate

Tram infrastructure

3.5 %

Tram rolling stock

5.5 %

TMS

13 %

Revenues

Project revenues stem from user fares and, based on the existing institutional set-up, accrue to the Transport Operator. The public transport ticketing system is integrated between buses and trams.

The average ticket per passenger is EUR 0.33 /passenger, which in the first year of operations results in an incremental inflow of EUR 0.7 million. The pricing policy will not change, i.e. tariffs will remain at the same level with and without the project136. Traffic diverted from bus will not contribute to increase of revenues, since the users were already paying a ticket before. The increased revenues come from road users diverted to public transport and from generated users.

Unit

Year 4 (first year of operation)

Year 10

Year 15

Year 25

Traffic diverted from road

m EUR

0.5

0.6

0.6

0.6

Generated traffic

m EUR

0.2

0.2

0.2

0.2

Total revenues

m EUR

0.7

0.7

0.8

0.8

The fare-box recovery ratio, i.e. the share of operating expenses recovered through user fares, is expected to be around 52 % in the first year of operations.

Compensations for public service obligations

Compensations are provided by the Transport Authority to the Operator in the framework of the PSC. The contract is on a net basis, i.e. the Operator bears both the cost risk and the revenue risk. The Transport Authority pays compensations to the Transport Operator as a price per vehicle-km produced (bus and tram), net of the revenues collected from user fares137. The existing PSC has been found compliant with European Commission Regulations on the provisions of services of general economic interest, so that the operating State aid, if granted according to the PSC provisions, can be considered compatible with market rules138.

Compensations are not a cash flow in the consolidated financial analysis (inflow for the Operator, outflow for the Transport Authority). However, they will be used in the financial sustainability assessment.

Loan conditions

The beneficiary negotiated a loan with an IFI of EUR 15 million. The conditions agreed for the loan include a maturity period of 15 years (including three years grace period during construction and 15 years for principal repayment, which starts in the first year of operation) and an interest rate of 3.5 % in real terms. The cash flows related to the debt service are used in the calculation of the financial return on national capital (FNPV(K)).

V Financial and Economic Analyses

The financial and economic CBA is done in conformity with European and national guidelines for the preparation of the cost-benefit analysis of major investment projects.

The following key assumptions have been used in the analysis:

•    the CBA is based on an incremental approach;

•    the analysis consolidates cash flows between the Transport Authority (owner of all project assets and bearing replacement cost) and the Transport Operator (using project assets against payment of a lease and bearing O&M costs);

•    contingencies are excluded from the financial and economic analyses and only considered in the assessment of the financial sustainability.

•    the reference period for the analysis has been set at 25 years based on the average life of assets, including both implementation (three years) and operations (22 years);

•    the financial and economic analyses are carried out at constant prices. For cash flows in real terms, a 4 % discount rate in real terms is used in the financial analysis and 5 % in the economic analysis;

•    VAT is fully refundable under national legislation and therefore not eligible. Thus, the financial analysis is carried out on cash flows net of VAT;

•    the residual value is calculated on the basis of the residual non-depreciated accounting value;

•    the most recent macroeconomic forecasts were adopted, based on national statistics;

•    the necessary expenditure on assets renewal has been properly recognised in the future project cash flows as operating costs, also for the purposes of the calculation of the pro-rata application of discounted net revenue..

Financial analysis

The assessment of the PSC and the financial impacts of the project highlight compliance with European Commission Regulations on the provisions of services of general economic interest139 and that aid provided in the form of compensation to the in-house Transport Operator will remain a compatible State aid, thus not requiring notification to the European Commission's DG Competition.

Even if the project generates revenues paid by users (in the form of user fares), the project's net revenue (difference between the incremental operating revenues and O&M costs) is negative, which is why Article 61 of Regulation (EU) No 1303/2013 does not apply here.

EU GRANT

Calculation of Discounted Investment Cost (DIC)

NPV 4%

Investment cost (excluding contingencies)

mEUR

139.8

48.8

48.3

48.3

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

DIC / Investment cost cash-flow

mEUR

139.8

48.8

48.3

48.3

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

Calculation of Discounted Net Revenues (DNR)

NPV 4%

Revenue

mEUR

9.9

0.0

0.0

0.0

0.7

0.7

0.7

0.7

0.7

0.7

0.7

0.7

0.8

0.8

0.8

0.8

0.8

0.8

O&M cost

mEUR

-16.0

0.0

0.0

0.0

-1.2

-1.2

-1.2

-1.2

-1.2

-1.2

-1.2

-1.2

-1.2

-1.2

-1.2

-1.2

-1.2

-1.2

Replacement cost

mEUR

-38.6

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

-20.0

0.0

-12.5

0.0

0.0

0.0

0.0

0.0

Residual value of investments

mEUR

11.7

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

30.1

DNR / Net revenue cash-flow

mEUR

-33.0

0.0

0.0

0.0

-0.5

-0.5

-0.5

-0.5

-0.5

-0.5

-20.5

-0.5

-12.9

-0.4

-0.4

-0.4

-0.4

29.7

ELIGIBLE COST (EC)

mEUR

159.9

CO-FINANCING RATE OF PRIORITY AXIS (CF)

85%

EU GRANT ( = EC x CF)

mEUR

135.9

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

20

25

Construction

Operation


In this case, the EU contribution has been calculated by multiplying the eligible costs shown in section IV above (EUR 159.9 million) by the co-financing rate of the relevant priority axis (85%), which results in an EU grant of EUR 135.9 million. In addition to the EU grant, the beneficiary will contract a loan of EUR 15 million and will contribute with own funds with EUR 45.7 million. The beneficiary will also ensure the pre-financing of the VAT (EUR 36.8 million), which is however recoverable. The financing structure of the project is described below:

Financing Sources

m EUR

% share

EU grant

135.9

69 %

IFI loan

15.0

8 %

Project beneficiary’s contribution

45.7

23 %

of which VAT

36.8

19 %

Total

196.6

100 %

The financial profitability of the investment (as indicated by FNPV(C) and FNPV(K)) is negative, as expected for a project where project operating revenues are lower than the operating expenditures (including renewals and maintenance), which is typical in the urban public transport sector. The table that follows shows the results of the financial analysis.

12 3

4 5 6 7 8 9 10 11 12 13 14 15 20 25

Construction

Operation

Calculation of the Return on Investment

NPV 4%

Investment cost (excluding contingencies)

mEUR

-139.8

-48.8

-48.3

-48.3

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

Revenue

mEUR

9.9

0.0

0.0

0.0

0.7

0.7

0.7

0.7

0.7

0.7

0.7

0.7

0.8

0.8

0.8

0.8

0.8

0.8

O&M cost

(including replacement cost)

mEUR

-54.6

0.0

0.0

0.0

-1.2

-1.2

-1.2

-1.2

-1.2

-1.2

-21.2

-1.2

-13.7

-1.2

-1.2

-1.2

-1.2

-1.2

Residual value of investments

mEUR

11.7

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

30.1

FNPV(C) - before EU grant / Net cash-flow

mEUR

-172.8

-48.8

-48.3

-48.3

-0.5

-0.5

-0.5

-0.5

-0.5

-0.5

-20.5

-0.5

-12.9

-0.4

-0.4

-0.4

-0.4

29.7

FRR(C) - before EU grant    -12.26%

Verification of the Financial Sustainability of the Project

EU grant

mEUR

Project beneficiary's contribution to investment costs

mEUR

Project beneficiary's contribution to loan repayment

mEUR

Loan disbursement

mEUR

Revenues

mEUR

Incremental compensations under Public Service Contract

mEUR

Total cash inflows

mEUR

Investment cost (including contingencies)

mEUR

O&M cost

(including replacement cost)

mEUR

Interest payments

mEUR

Principal repayments

mEUR

Total cash outflows

mEUR

Net cash-flow

mEUR

Cumulated net cash-flow

mEUR


45.3

45.3

45.3

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

3.4

2.8

2.8

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.2

0.4

1.3

1.3

1.3

1.3

1.3

1.3

1.3

1.3

1.3

1.3

1.3

1.3

0.0

0.0

5.0

5.0

5.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.7

0.7

0.7

0.7

0.7

0.7

0.7

0.7

0.8

0.8

0.8

0.8

0.8

0.8

0.0

0.0

0.0

0.5

0.5

0.5

0.5

0.5

0.5

20.5

0.5

12.9

0.4

0.4

0.4

0.4

0.4

53.7

53.3

53.5

2.5

2.5

2.5

2.5

2.5

2.5

22.5

2.5

15.0

2.5

2.5

2.5

1.2

1.2

-53.7

-53.1

-53.1

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

-1.2

-1.2

-1.2

-1.2

-1.2

-1.2

-21.2

-1.2

-13.7

-1.2

-1.2

-1.2

-1.2

-1.2

0.0

-0.2

-0.4

-0.5

-0.5

-0.5

-0.4

-0.4

-0.4

-0.3

-0.3

-0.3

-0.2

-0.2

-0.2

0.0

0.0

0.0

0.0

0.0

-0.8

-0.8

-0.8

-0.9

-0.9

-0.9

-1.0

-1.0

-1.0

-1.1

-1.1

-1.1

0.0

0.0

-53.7

-53.3

-53.5

-2.5

-2.5

-2.5

-2.5

-2.5

-2.5

-22.5

-2.5

-15.0

-2.5

-2.5

-2.5

-1.2

-1.2

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0


i~r2~r3 4~r5~r6~r7~ts~t9T10Tii~ri2~r13T14T15T20T25

Construction    Operation


FRR(K)

National Financing Sources

Project beneficiary's contribution to investment costs

mEUR

Loan

mEUR


Loan Balance

Beginning balance

mEUR

Loan disbursements

mEUR

Interest payments

mEUR

Principal repayments

mEUR

Ending balance

mEUR


3.4

2.8

2.8

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

5.0

5.0

5.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0


0.0

5.0

10.0

15.0

14.2

13.4

12.6

11.7

10.8

9.9

9.0

8.0

6.9

5.9

4.8

-0.0

-0.0

5.0

5.0

5.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.2

0.4

0.5

0.5

0.5

0.4

0.4

0.4

0.3

0.3

0.3

0.2

0.2

0.2

0.0

0.0

0.0

0.0

0.0

0.8

0.8

0.8

0.9

0.9

0.9

1.0

1.0

1.0

1.1

1.1

1.1

0.0

0.0

5.0

10.0

15.0

14.2

13.4

12.6

11.7

10.8

9.9

9.0

8.0

6.9

5.9

4.8

3.6

-0.0

-0.0


Calculation of the Return on National Capital

NPV 4%

Project beneficiary's contribution to investment costs

mEUR

-8.7

-3.4

-2.8

-2.8

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

Interest payments

mEUR

-3.9

0.0

-0.2

-0.4

-0.5

-0.5

-0.5

-0.4

-0.4

-0.4

-0.3

-0.3

-0.3

-0.2

-0.2

-0.2

0.0

0.0

Principal repayments

mEUR

-10.0

0.0

0.0

0.0

-0.8

-0.8

-0.8

-0.9

-0.9

-0.9

-1.0

-1.0

-1.0

-1.1

-1.1

-1.1

0.0

0.0

O&M costs (incl. replacements)

mEUR

-54.6

0.0

0.0

0.0

-1.2

-1.2

-1.2

-1.2

-1.2

-1.2

-21.2

-1.2

-13.7

-1.2

-1.2

-1.2

-1.2

-1.2

Revenues

mEUR

9.9

0.0

0.0

0.0

0.7

0.7

0.7

0.7

0.7

0.7

0.7

0.7

0.8

0.8

0.8

0.8

0.8

0.8

Residual value of investments

mEUR

11.7

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

30.1

FNPV(K) - after EU grant / Net cash-flow

mEUR

-55.5

-3.4

-3.0

-3.2

-1.8

-1.8

-1.8

-1.8

-1.8

-1.8

-21.8

-1.8

-14.3

-1.7

-1.7

-1.7

-0.4

29.7

FRR(K) - after EU grant

-11.16%


The analysis of the financial sustainability at the project level aims to assess whether the project is able to balance out its positive and negative cash flows during the reference period. The analysis shows that the project implementation costs are covered by means of the EU grant, a loan and the beneficiary's own contribution. As can be expected for such projects, negative cash flows will be generated during project operations. In order for the project to be sustainable, the balance between inflows and outflows must be reached by means of increased compensation by the City within the framework of the PSC. As can be seen below, in its financial plans the city committed to increase compensation to the extent that it covers the expected operating losses of the transport operator, so that there is robust evidence that the financial sustainability of the project can be ensured.


FINANCIAL SUSTAINABILITY -PROJECT


1 12 1 3    4~r5~r6~r?~rs~r9~rio~r 11Ti2~r 15Ti4~ri5~r20T25

Construction    Operation


The assessment of the financial sustainability of the project for the beneficiary aims to understand whether the City will have sufficient funds for financing the own capital contribution to project costs, the repayment of the loan and the planned amount of compensation in the framework of the PSC. The City of X explicitly allocated in the multi-annual financial forecasts a sufficient amount of funds to cover own contribution, including capital expenditures, the debt service for the project loan

and the pre-financing of the VAT140. In addition, the payment of yearly compensation under the PSC is explicitly mentioned as a long-term financial commitment in the multi-annual financial forecasts, with a specific yearly financial allocation. Under these conditions, the financial sustainability of the project for the beneficiary is secured.

The assessment of the financial sustainability of the project for the Transport Operator aims to understand whether the operator will have sufficient funds to operate the project asset, ensuring an adequate level of service and standard of maintenance. Total inflows and outflows for the Transport Operator after the implementation of the project have been compared and are shown in the table below.

1    2    3    4    5    6    7    8    9    10    11    12    13    14    15    20    25

Construction    Operation


FINANCIAL SUSTAINABILITY -TRANSPORT OPERATOR

Verification of the Financial Sustainability of the Transport Operator

Revenue

mEUR

Compensations under Public Service Contract

mEUR

Total cash inflows

mEUR

O&M cost

(excluding replacement cost)

mEUR

Total cash outflows

mEUR

Net cash-flow

mEUR

Cumulated net cash-flow

mEUR


14.0

14.3

14.6

15.5

15.8

16.1

16.5

16.8

17.1

17.3

17.5

17.6

17.8

18.0

18.2

18.2

18.2

14.8

14.5

14.2

14.5

14.2

13.9

13.5

13.2

12.9

12.7

12.5

12.4

12.2

12.0

11.8

11.8

11.8

28.8

28.8

28.8

30.0

30.0

30.0

30.0

30.0

30.0

30.0

30.0

30.0

30.0

30.0

30.0

30.0

30.0

-28.8

-28.8

-28.8

-30.0

-30.0

-30.0

-30.0

-30.0

-30.0

-30.0

-30.0

-30.0

-30.0

-30.0

-30.0

-30.0

-30.0

-28.8

-28.8

-28.8

-30.0

-30.0

-30.0

-30.0

-30.0

-30.0

-30.0

-30.0

-30.0

-30.0

-30.0

-30.0

-30.0

-30.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0


Based on the assumptions made concerning the expected inflows and outflows, the table above clearly shows that the project operations will be sustainable for the Transport Operator thanks to the provision of compensation under the PSC. As described before, the inflow of operating compensation is reasonably secured in the long-term financial forecasts of the City. Under these conditions, the financial sustainability of the project for the Transport Operator is secured.

Socio-economic analysis

The socio-economic analysis includes the following impacts:

Costs (-)

Benefits (+)

Investment costs

Consumer surplus:

Replacements (paid by the City)

- Travel time savings

Producer surplus (-):

- Vehicle operating costs savings (road users)

- O&M (paid by the Transport Operator)

- Fares

- Fares

Externalities

- Operating costs (tram)

- Accidents savings

- Air pollution reduction

- Reduction of impact on climate change

- Noise impacts reduction

Conversion factors were estimated based on national statistics on the average composition of project costs and shadow wage (for labour costs) and share of taxation (for energy costs). The correction factors are 0.9 for investment costs and 0.85 for O&M.

As described in section III on demand analysis, the multi-modal traffic model provides information on the generalised costs for users of public transport and individual cars, without and with the project. It is therefore possible to calculate the consumer surplus as the difference in generalised costs of the trip (including time savings and fares) for both existing traffic and traffic diverted from the origin mode (private car, bus) to the destination mode (tram). Benefits to generated traffic are calculated via the Rule of Half141. The main assumptions and parameters used for the calculation of the costs and benefits are summarised below.

Investment costs and replacements.

Investment costs and replacements are included in the economic analysis at their economic value, i.e. conversion factors are applied to net financial cash flows to correct for the opportunity cost of labour142.

Producer surplus.

For the calculation of the producer surplus, the revenues accruing to the Operator have been compared to the Operator's O&M costs. In this case study, the producer surplus is negative and therefore a cost to the project, since the incremental revenues are lower than the incremental costs.

Consumer surplus

Travel time

Impacts on travel time are calculated based on the information provided by the traffic model on door-to-door travel time143.

The project results in an overall decrease in travel time in the transport system (reduction of passenger/h), mainly due to time savings for bus users and car drivers diverting to the newly introduced tram mode. In this project, existing car users remaining in the road mode will not experience time savings, since it is expected that the project will not generate any significant increase in road capacity (the possible reduction of road congestion and increase of car speed due to traffic diversion to tram will be counterbalanced by the limitation of road capacity due to the implementation of a new surface transport mode, such as the tramway, as well as the implementation of the Traffic Management System, heavily oriented towards the public transport priority).

The table below summarises the impact on travel time, in million passenger/h.

Year 4 (first year of operation)

Year 10

Year 15

Year 20

Year 25

Existing traffic

-0.4

-0.4

-0.5

-0.5

-0.5

Bus

-0.4

-0.4

-0.5

-0.5

-0.5

Private transport

-

-

-

-

-

Diverted traffic

-1.1

-1.2

-1.3

-1.3

-1.3

Bus to tram

-1.1

-1.2

-1.2

-1.2

-1.2

Private transport to tram

0.0

-0.1

-0.1

-0.1

-0.1

Total

-1.5

-1.7

-1.7

-1.7

-1.7

The following parameters have been adopted for the estimation of value of time:

Travel purpose

Share of trips by travel purpose

Value of time (EUR/h)

Public transport

Private transport

Public transport

Private transport

Work

35 %

45 %

9

11

Non-work

65 %

55 %

3.6

4.4

The cost saving approach has been adopted to estimate the unit VOT for work trips. Labour costs have been estimated based on national statistics. Unit VOT for non-work travel time has been calculated applying ratios respectively of 0.4 to work VOT. The share of trips by travel purposes is based on the most recent traffic surveys.

Unit values escalate over time with an elasticity of 0.7 to GDP growth per capita.

Vehicle operating costs savings (VOC)

The avoided VOC for the users switching from cars to public transport due to the project (diverted users) are counted as a benefit.

The adopted unit VOC is EUR 0.3 /car veh-km, based on national statistics and taking into account fuel costs (depending on road alignment and traffic conditions) and wear and tear of vehicles (oil, tyres, vehicle maintenance and depreciation). The unit VOC is applied to the amount of cars (vehicle-km) saved in the project option.

The VOC savings associated with the reorganisation of bus services (resulting in a reduction of the bus supply in vehicle-km) are accounted for in the Operator's O&M costs.

Benefits to generated traffic

The traffic model shows that 5 % of the incremental tram trips will be newly generated in the transport system. This will represent an increase of 2 % of the total motorised mobility in the city (including public and private transport).

The benefits to generated traffic have been estimated according to the Rule of Half144. The half of the generalised costs for existing users has been taken (including VOT and fares) and multiplied by the amount of generated users.

Externalities

Accidents

The traffic diversion from cars to public transport is expected to reduce the number of accidents on the roads, via the reduction of distance travelled by road (reduction of vehicle-km).

The adopted probability of accidents, number of casualties, fatalities and injuries are taken from national studies and statistics.

Based on national statistics, the Value of Statistical Life (VOSL) has been estimated at EUR 400,000 per fatality and EUR 65,000 per injury. In addition, a value of EUR 13,500 per casualty has been estimated to cover direct medical and administrative costs associated with accidents.

Unit values escalate with GDP growth per capita, with an elasticity of 0.7.

Noise

Noise costs associated with the project have been estimated, taking into account the difference in noise levels due to transport activity related to tram, bus and individual cars. The number of people exposed to noise and the level of exposure with and without the project were assessed based on the noise maps produced during the environmental impact assessment. This estimation takes into account the type of noise source, the morphology of the territory, building patterns and the expected transport activity changes.

Based on the assessment, the project is expected to reduce overall noise levels. This, on the one hand, is due to the fact that the newly introduced tram mode will adopt anti-noise construction techniques on both the tram tracks and the trams, thus limiting noise emission and, on the other hand is due to the reduced level of traffic on roads (reduction of cars and buses).

The unit cost (EUR/year/person exposed) is identified based on national stated preference surveys and is related to the level of annoyance generated by a given level of sound emission and escalates with GDP growth per capita, with an elasticity of 0.7.

The differential noise cost is estimated multiplying the amount of persons exposed in the without and with-the-project scenario by the unit cost corresponding to the levels of noise in the without and with-the-project scenario.

Air pollution

A reduction of the environmental burden is expected due to traffic diversion from road-based modes (cars and buses) to trams, which generate a reduction of fuel consumption and hence lower air pollutant emissions. Tram operations are not expected to generate air pollution at the point of use. The indirect environmental impacts of the upstream process of energy production are taken into account in the assessment of climate change (see below).

It is assumed that there are national guidelines, based on clear assumptions and methodology, providing unit monetary costs of air pollution145 per vehicle-km, disaggregated by mode of transport and speed. In this case, the calculation of the impact was made based on the following steps146:

•    quantification of the incremental transport production, in vehicle-km, by mode (tram, bus, individual transport);

•    multiplication by a unit cost (EUR/vehicle-km).

The following monetary values per vehicle-km were taken into account for the calculation of air pollution impacts (based on national studies):

•    for bus transport, EUR 0.37 /vehicle-km (for speed between 11 and 20 km/h, in urban area);

•    for road transport, EUR 0.03 /vehicle-km (for speed between 21 and 30 km/h, in urban area).

Unit values escalate with GDP growth per capita, with an elasticity of 0.7.

Climate change

The variation of CO2 emissions due to the project is calculated, as well as its economic value.

Emissions for tramways, which are electrically powered, are assessed in relation to the upstream process of production of the required increase in electric energy. These emissions do not happen at the point of use of the tramway, but at the point of production of energy and depend on the national energy mix.

In summary, although a small increase of CO2 emissions is expected due to the increase of electricity consumption for tram operations (emissions related to energy production), the project will lead to an overall (incremental) reduction of CO2 emissions,

The calculation of the economic impact of CO2 emissions for road based modes was made based on the following steps:

•    quantification of the incremental transport production, in vehicle-km, by mode;

•    multiplication of the incremental vehicle-km by an emission factor (gCO2/v-km) to calculate the incremental emission of CO2;

•    multiplication of the total amount of CO2 emitted by a unit cost (EUR/tonne);

The calculation of the economic impact of CO2 emissions for tramways was made based on the following steps:

•    quantification of the marginal energy consumption (KWh/train-km);

•    multiplication of the total incremental energy consumption (in KWh) by a national average emission factor (gCO2/KWh) to calculate the incremental emission of CO2;

•    multiplication of the total amount of CO2 emitted by a unit cost (EUR/tonne).

The following emission factors were taken into account for the calculation of the economic impacts of CO2 emissions for road based modes and tramways (respectively, based on national studies and on international research):

•    for bus transport, 1,133.2 gCO2/v-km (corresponding to a Euro III bus);

•    for road transport, 347.4 gCO2/v-km (corresponding to Euro III 1.4 cc gasoline unleaded);

• for tram transport, 5 KWh/train-km and 496 gCO2/KWh (energy consumption per train-km and CO2 emissions per KWh depend on, respectively, project specific and country data).

The adopted unit costs per tonne of CO2 are in line with the ‘central' values suggested in the general part of this guide. Following the recommendations made in section 2.9.9, the 2010 value and the annual adders are first converted to constant 2013 prices and for the years beyond 2030, the adders are continued at the 2011 to 2030 rate.

The results of the economic analysis are described below:

12 3

4 5 6 7 8 9 10 11 12 13 14 15 20 25

Construction

Operation

Calculation of the Economic Rate of Return

NPV 5%

C1. Investment cost (excluding contingencies)

mEUR

-118.3

-43.4

-43.4

-43.4

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

C2. Replacements (City)

mEUR

-27.6

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

-17.0

0.0

-10.6

0.0

0.0

0.0

0.0

0.0

C3. Producer surplus (Transport Operator)

mEUR

-3.2

0.0

0.0

0.0

-0.4

-0.3

-0.3

-0.3

-0.3

-0.3

-0.3

-0.3

-0.3

-0.3

-0.3

-0.2

-0.2

-0.2

C3a. Fares

mEUR

8.4

0.0

0.0

0.0

0.7

0.7

0.7

0.7

0.7

0.7

0.7

0.7

0.8

0.8

0.8

0.8

0.8

0.8

C3b. O&M cost

mEUR

-11.6

0.0

0.0

0.0

-1.0

-1.0

-1.0

-1.0

-1.0

-1.0

-1.0

-1.0

-1.0

-1.0

-1.0

-1.0

-1.0

-1.0

C4. Residual value of investments

mEUR

8.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

27.1

Total economic costs (C1 + C2+C3+C4)

mEUR

-141.1

-43.4

-43.4

-43.4

-0.4

-0.3

-0.3

-0.3

-0.3

-0.3

-17.3

-0.3

-10.9

-0.3

-0.3

-0.2

-0.2

26.8

Consumer surplus

B1. Value of time

mEUR

115.2

0.0

0.0

0.0

8.3

8.5

8.8

9.0

9.3

9.6

9.8

10.0

10.2

10.4

10.6

10.9

11.4

12.1

B2. Vehicle Operating Costs (individual transport)

mEUR

40.7

0.0

0.0

0.0

3.2

3.3

3.3

3.4

3.5

3.5

3.6

3.6

3.6

3.7

3.7

3.8

3.8

3.8

B3. Fares

mEUR

-8.4

0.0

0.0

0.0

-0.7

-0.7

-0.7

-0.7

-0.7

-0.7

-0.7

-0.7

-0.8

-0.8

-0.8

-0.8

-0.8

-0.8

B4. Benefits to generated traffic

mEUR

23.0

0.0

0.0

0.0

1.7

1.7

1.8

1.8

1.9

1.9

2.0

2.0

2.0

2.1

2.1

2.2

2.3

2.4

Externalities

B5. Accidents

mEUR

2.8

0.0

0.0

0.0

0.2

0.2

0.2

0.2

0.2

0.2

0.2

0.2

0.3

0.3

0.3

0.3

0.3

0.3

B6. Environment

mEUR

12.9

0.0

0.0

0.0

1.0

1.0

1.0

1.0

1.1

1.1

1.1

1.1

1.1

1.1

1.2

1.2

1.3

1.3

B6a. Air pollution

mEUR

11.2

0.0

0.0

0.0

0.9

0.9

0.9

0.9

0.9

0.9

1.0

1.0

1.0

1.0

1.0

1.0

1.1

1.1

B6b. Climate change

mEUR

1.6

0.0

0.0

0.0

0.1

0.1

0.1

0.1

0.1

0.1

0.1

0.1

0.1

0.1

0.2

0.2

0.2

0.2

B7. Noise

mEUR

3.6

0.0

0.0

0.0

0.3

0.3

0.3

0.3

0.3

0.3

0.3

0.3

0.3

0.3

0.3

0.3

0.3

0.4

Total economic benefits (B1+B2+B3+B4+B5+B6+B7)

mEUR

189.8

0.0

0.0

0.0

13.9

14.3

14.7

15.1

15.5

16.0

16.2

16.5

16.8

17.2

17.5

17.8

18.6

19.4

ENPV / Net benefits

mEUR

48.7

-43.4

-43.4

-43.4

13.5

14.0

14.4

14.8

15.2

15.7

-1.0

16.3

6.0

16.9

17.2

17.5

18.3

46.3

ERR    8.3%

B/C RATIO    1.35

VII Risk Assessment

Sensitivity analysis

A sensitivity analysis of the economic and financial profitability was carried out in order to identify under which circumstances the project becomes, respectively, economically unprofitable, if any, or financially profitable, if any. The analysis is carried out using disaggregated variables (i.e. demand and prices separately) to better identify possible critical variables.

The sensitivity analysis was carried out for the following variables:

Sensitivity of financial profitability

Sensitivity of economic profitability

Investment costs

Investment costs

O&M unit costs

O&M unit costs

Traffic demand - incremental

Traffic demand - incremental

Revenues (unit tariff)

Value of Time (unit cost)

Vehicle operating costs (unit cost)

Air pollution (unit costs)

Climate change (CO2 emissions) (unit cost)

Accidents (unit costs)

Noise (unit cost)

Critical variables are defined as critical if a 1% change leads to a change of FNPV/ENPV equal to or higher than 1% (elasticity higher than 1). The estimated elasticity of the ENPV and FNPV(C) with respect to a 1% increase of the critical project variables is shown in the table below:

Variable

ENPV elasticity

FNPV(C) elasticity

Investment costs ±1%

±2.8%

-1.0%

Traffic demand (incremental) ±1%

±3.1%

-

Value of Time (unit cost) ±1%

±2.8%

-

Based on the analysis, only investment costs were found to be critical for the sensitivity of financial profitability. Regarding sensitivity testing of the economic profitability, the following variables were found to be critical: incremental traffic demand, investment costs and unit Value of Time. Switching values are calculated as follows:

Variables

Switching value (ENPV = 0)

Investment costs

+ 35%

Traffic demand

-32%

Value of Time

-36%

Spider diagrams illustrating the elasticity (line gradients) and switching values (line intersection with X axis) for the above mentioned variables are depicted below.

Change in the variable

—    Investment cost

—    O&M unit costs

—    Traffic (incremental)

—    Unit fare


Change in the variable


—    Investment cost

—    O&M unit costs

—    Traffic (incremental)

—    Unit value of time

—    Unit VOC

—    Unit air pollution cost

—    Unit climate change cost

—    Unit accident cost

None of the above switching values seem to realistically threaten the assessment of the project financial and economic profitability. The risk analysis below analyses the main risk factors related to traffic forecasts and to investment costs, identifying the risk prevention/mitigation measures implemented (or to be implemented) by the beneficiary. Concerning VoT, a reduction of such an entity as to make the NPV null (-36%) is considered not realistic, given the macro-economic forecasts adopted for the project (it is here reminded that, in this case study, the VoT is calculated based on resource costs, i.e. labour cost).

Risk analysis

A qualitative risk analysis has been carried out by the Beneficiary, with the aim to identify the main risks related to project implementation as well as operations. In addition, the main risk prevention and mitigation strategies are described.

Risk description

Probability

(P)

Severity

(S)

Risk level (=P*S)

Risk prevention / mitigation measures

Residual

risk

Administrative risks

Problems with land purchase and acquisition of rights of way

B

II

Low

The need for land purchase is reduced to a minimum since the new line will mostly run on the existing road. The needed expropriation procedures are completed.

Function in charge: Beneficiary.

None

Delays due to administrative procedures (permits, tenders, etc.)

B

II

Low

Establishment of a Project Implementation Unit with adequate resources within the Beneficiary structure, in charge of timely liaising with the relevant institutions/departments for timely finalisation of the needed procedures.

Function in charge: Beneficiary.

Low

Late availability of EU grant co-financing

B

II

Low

Involve JASPERS technical assistance early in the project cycle. Negotiation of a loan available as of 1st year of construction

Function in charge: managing authority and Beneficiary.

Low

Construction risks

Investment cost overrun

C

III

Moderate

Cost budget compared with relevant benchmarking to correct possible optimism bias. Publication of contract notices in the Official Journal of the EU to ensure wider competition. Selection of a professional external Construction Supervisor, with adequate budget.

Function in charge: Beneficiary.

Low

Delays due to contractors (failure to meet contractual deadlines, withdrawal, bankruptcy, etc.). For rolling stock and equipment, this relates to both construction and provision.

C

III

Moderate

Selection of contractors in line with procurement legislation, including quality in the awarding criteria (not only lowest price).

Close monitoring of contracts by PIU and by means of an external professional Construction Supervisor, with adequate budget.

Function in charge: Beneficiary.

Low

Risk description

Probability

(P)

Severity

(S)

Risk level (=P*S)

Risk prevention / mitigation measures

Residual

risk

Environmental and social risks

Impacts on air pollution, noise and climate change exceeding expectations.

B

III

Moderate

The environmental procedure has been completed according to high quality standards and can be reasonably considered comprehensive and complete. Mitigation Measures have been identified in the EIA, applying especially to the construction phase, and will be implemented by the Beneficiary.

Function in charge: Beneficiary.

Low

Public opposition

A

II

Low

The public has been duly involved during the development of the EIA procedure and public notice has been given of all relevant decisions.

Function in charge: Beneficiary

Low

Operational risks

Increase of operating costs higher than planned compensations, leading to liquidity problems for the operator

B

III

Moderate

The operating costs forecasts have been made based on the company historic costs as well as reasonable benchmarks, in order to reduce optimism bias.

The PSC provisions are based on these forecasts, and provide for mechanisms of adjustment to changes of operating costs.

Function in charge: Beneficiary and Operator in charge of ensuring correct functioning of PSC

Low

Significant shortfall in expected incremental public transport demand (implies lower benefits, lower revenues, need for higher compensations)

B

IV

Moderate

Adequate information and promotion measures to support modal shift.

Conservative demand forecasts, also factoring in the impacts of the current economic downturn.

Function in charge: Beneficiary.

Low

Transport supply not provided according to forecasted levels

B

III

Moderate

The Transport Authority and the Operator have signed a Public Service Contract, providing a clear framework for the provision of transport services, including planned production, quality standards and penalties for non-performance.

In addition, the Operator is implementing management tools to monitor the quality of services and the level of user satisfaction (e.g. via user satisfaction surveys).

Function in charge: Beneficiary (Transport Authority)

Low

Evaluation scale:    Probability: A. Very Unlikely; B. Unlikely; C. About as likely as not; D. Likely; E. Very likely.

Severity:    I. No effect; II. Minor; III. Moderate; IV Critical; V. Catastrophic.

Risk level:    Low; Moderate; High; Unacceptable.

The results of the sensitivity and risk analyses indicate that the project overall risk level is low to moderate. The planned strategies to prevent the occurrence of the identified risks and/or mitigate their adverse impact are expected to bring project risk to a lower level. The residual project risks can be considered acceptable.

4. Environment

The flagship initiative for a resource-efficient Europe establishes the importance of using all types of natural resources efficiently and provides a general framework for policy actions for the European economy and environment for the next decade. Under the flagship initiative, a roadmap to a resource-efficient Europe was published in September 2011 defining the milestones to be met by 2020147.

In addition to the flagship initiative, a new Environment Action Programme (EAP) ‘Living well, within the limits of our planet' was adopted in November 2013 and will guide EU policy action on environment and climate policy for the next seven years. The aim is to guide Europe towards a resource-efficient, low-carbon and environmentally friendly economy in which natural capital is protected and enhanced, and citizens' health and well-being are safeguarded.

The implementation of this programme, however, will require the continued commitment of the Member States. In this respect, major projects supported by the ERDF and the Cohesion Fund can play a pivotal role in ‘protecting the environment and promoting resource efficiency' (thematic objective 6), as well as in ‘promoting adaptation to climate change, risk prevention and management' (thematic objective 5). The main expected areas of intervention for major projects are:

•    water supply and sanitation;

•    waste management;

•    environment remediation, protection and risk prevention.

While being closely interrelated in many aspects, each sub-sector is characterised by different logics of intervention so that the Chapter is structured along these typologies of intervention, which are presented separately.

4.1 Water supply and sanitation

The EU water policy is largely based on the Water Framework Directive148 that sets up ambitious objectives for the quality and protection of all waters bodies (ecological status, quantitative status, chemical status and protected area objectives) and includes the key element of the River Basin Management Plans. The RBMPs provide the overall context for water management in a certain territory (the River Basin District, RBD) of the Union, including gaps, measures and objectives. In this respect the Cohesion Policy investments should take place within the context of the relevant RBMPs, including the preparation of programmes of measures at basin level, as well as within relevant implementation plans for the provision of particular services linked to other relevant EU water legislation (see box below).

In line with the results orientation of the new legislative framework of the cohesion policy, the principles for investments in the water sector are as follows:

   integrating the management of water resources on a river district scale. The river basin district' is the territorial unit basis for the management of water from all points of view and is defined as a set of terrestrial and marine areas, which include one or more neighbouring basins. In addition, water investments can be financed if River Basin Management Plans are adopted and are meeting minimum requirements set up in WFD (cf. thematic ex-ante conditionality 6.1, criterion 2);

   integrating economics into water management and water policy decision-making. To achieve its environmental objectives and promote integrated river basin management, the Water Framework Directive calls for the application of economic principles and requires an economic analysis of the different uses of resources and water services;

•    polluter-pays principle151. The tariff policies for attaining the goal of economically and environmentally sustainable use of water resources must recover the cost of water services, including financial costs, environmental costs and resource costs, while taking into account social, economic and environmental effects of the recovery, as well as geographic and climatic conditions. In this regard, Member States are encouraged to define their pricing policy frameworks at national/ regional level;

•    water efficiency152. Reducing water usage helps to preserve the available resources and prevent future droughts and also contributes to improving the competitiveness of an economy. It encompasses in particular water pricing providing incentives for users to use water resources efficiently, leakage reduction in distribution networks and, in areas where water deficit is structural, water reuse systems.

The following investment typologies are discussed in the rest of the section:

•    renovation/development of infrastructure for water supply;

•    renovation/development of infrastructure for wastewater collection and treatment.

Natural capital enhancing projects (e.g. green infrastructure) are not specifically treated in this section because usually associated to objectives of environment protection and ecosystem preservation (see section 4.3). However, in some cases, these projects can also achieve some of the water- (but also waste-) related benefits that are typical of the traditional engineering solutions. For example, preserving the Natura 2000 network is likely to have benefits ranging from regulating services, such as water resource savings, to cultural services, such as recreation. Vice-versa, development of infrastructure in the Integrated Water Supply service can also achieve benefits of environment preservation. That considered, both project typologies (i.e. infrastructure and natural capital investments) share the same methods for benefit evaluation. For this reason, the methodology presented below can be understood as a flexible framework for project appraisal, where a given benefit can be achieved through different investment types.

A selective list of policy and regulatory documents for the water sector is provided in the box below.

THE EU POLICY FRAMEWORK

Blueprint to Safeguard Europe’s Water Resources

The Water Framework Directive (or Directive 2000/60/EC)

The Drinking Water Directive (or Directive 98/83/EC)

The Urban Waste Water Treatment Directive (or Directive 91/271/EEC)

The Bathing Water Directive (or Directive 2006/7/EC)

The Nitrates Directive (or Directive 91/676/EEC)

Directive 2008/105/EC on environmental quality standards in the field of water policy Directive 2009/54/EC on the exploitation and marketing of natural mineral waters Directive 2006/118/EC on the protection of groundwater against pollution and deterioration Directive 2001/83/EC on the Community code relating to medicinal products for human use Commission Staff Working Document ‘Climate Change and Water, Coasts and Marine Issues’ 149 150

4.1.1 Description of the context

For water projects, besides the traditional information in the socio-economic context, there are specific baseline features that

should be analysed more carefully when performing the context analysis:

•    territorial planning framework. The project promoter should describe the existing national and regional sector policies (mainly for the use of water for human purposes, the treatment of sewage and the protection of water bodies elements) to ascertain the project's relevance. Also, clear and explicit links needs to be made between the water-related priorities in the operational programme and the relevant RMBPs;

•    institutional context. Reference should be given to the institutional organisation of the water and sanitation services, including information on the capacity of the service provider (utility), the level of service integration, the role of the planning and/or control authority bodies, etc.;

•    coverage and quality of the services in the area concerned by the project. The context analysis should describe: the current extension and population coverage of the water and wastewater systems151; levels of water consumption for civil, industrial, public and/or irrigation uses; level of physical and administrative water losses, both at production and in the distribution systems; reliability of the water supply and continuity of service; scarcity /abundance of the water sources; polluting loads on surface water bodies, including rivers, lakes, transition waters, estuaries and coastal seawaters;

•    pricing policy. The project promoter should present the current pricing policy and level of charges paid by the users, as well as analysing the scope and implications of tariff increases or change in the pricing system following project implementation, taking into account considerations of equity linked to the relative prosperity of the Member State, or the region concerned.

Table 4.1 Presentation of the context. Water sector

Main information

Socio-economic

trend

-    Population dynamics

-    National and regional GDP growth

-    Disposable income by population groups

Environmental

conditions

-    Reference to relevant river basin district

-    Current status of water bodies affected by the project, both as sources of water and as receptors of wastewater discharges

-    Planned qualitative and quantitative objectives on the status of the affected water bodies

-    Current amount of water drawn from natural sources and targets for future (increasing or decreasing)

-    Other uses, existing and planned, of the concerned water bodies: bathing, other recreational, productive uses, etc.

General political, institutional and regulatory framework

-    Reference to EU directives and sector policy documents (see above)

-    Reference to national and regional strategies, including the River Basin Management Plans, any national implementation plan and accompanying programmes of measures

-    Reference to the priority axis and the interventions areas of the OP

Water service institutional, regulatory and operational framework

-    Reference to the institutional organisation of the service: the level of the service integration, planning and/or control authority bodies, planning documents, etc.

-    Reference to the service control system

-    Reference to the operational organisation of the service and to the modes of supply

-    Service provider (utility): who will take over the operation and maintenance of the project infrastructure, and its capacity to implement (where relevant) and manage the infrastructure

Main information

Existing service conditions

-    Service categories: drinking water, irrigation, industrial uses, sewers, wastewater treatment

-    Service catchment area (or areas) and population served

-    Specific water consumption and historic demand development by category of customers (domestic, public, industrial and others)

-    Connection rates, metering rate

-    Water physical losses and administrative losses

-    Infiltration to the sewerage network

-    Frequency and duration of water supply interruptions

-    Pricing policies and affordability ratios

Source: Authors

4.1.2    Definition of objectives

The main general objectives of water investments are to increase the coverage or to improve the quality, effectiveness and efficiency of existing water supply and wastewater treatment services. Both logics of intervention can be driven by the need of the Member States to comply with the EU environmental acquis, as set out in the relative EU directives, but not exclusively.

The main motivations underlying the need for intervention are:

•    increasing the number of households connected to centralised drinking water supply and/or wastewater networks152;

•    improving the quality of drinking water;

•    improving the quality of the surface water bodies and preserving ecosystems and biodiversity dependent on these surface water bodies;

•    improving the reliability of the water sources and the water supply service;

•    increasing efficiency in water production and/or distribution, e.g. through detection, measurement and reduction of water losses or management asset measures aimed at operating costs reduction;

•    increasing efficiency in wastewater collection, removal, purification and elimination, e.g. with a strategy for disposal of sludge from urban wastewater treatment;

•    replacing the use of wa