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All You Need to Know About BOT (Build Operate Transfer) Project

Build Operate Transfer model or Build Own Operate Transfer model is an investment model and a project delivery method, usually used for large-scale infrastructure projects. In such projects, a private entity receives a concession from the government, directly or indirectly, to design and construct a facility stated in the concession contract or MoU.



The private company also invests at its own risk during the construction phase. In return, the private firm gets the exclusive right to operate the public project for a limited time. As per the concession agreement, the private company can collect tolls as revenue to recover its capital investment and other costs, including operation & maintenance. Once the concession period is over, the ownership of the built facility is transferred back to the owner/public entity.



Due to the long-term nature of the arrangement, the BOT model is a preferred method in public-private partnerships, where the private sector collaborates with the public sector/government agency to bring private investment to build needed infrastructure projects, especially in developing countries. The BOT agreement often employs an integrated project delivery method where the same contract governs the design, construction, operations, maintenance, and financing of the BOT project.



This article attempts to understand the BOT concept and model by looking into the various elements of the model. The article covers the following sections:



Understanding the BOT concept

Financing method in BOT projects

The risks associated with BOT projects

Financial risks in BOT projects
Political risks in BOT projects
Construction risks in BOT projects
Operation and Maintenance risks in BOT projects
How to attract more private sector participation in public infrastructure projects?

Parties involved in a BOT project

Role of different stakeholders in a Build Operate Transfer contract

Host Government
Project Company/Sponsor Consortium
Lenders/Banks
EPC contractor
Independent checking engineers
Which projects are suitable for the BOT model?

How BOT model differs from PPP model?

The bottom line



Understanding the BOT concept
The government of a developing country (where the project is developed) grants a concession to a private entity or private consortium to develop a public project in a BOT arrangement. The consortium then develops, operates, and manages the infrastructure facility for a specific period after completion, recovering its construction expenses and profiting from the project's operation and revenue generation. Thereafter, the BOT project is given back to the government.



As per most BOT contracts, the government does not guarantee loan repayments or returns on investment in the BOT project. Instead, the repayments and returns on investment are determined by the project's revenue.



Since the government does not allocate its public budget, it faces fewer fiscal constraints. Meanwhile, the BOT agreement also transfers the risks and need to employ innovative technology to the private sector. Furthermore, the involvement of the private sector ensures a better quality infrastructure for the public.



The host government may occasionally provide some or all of the land needed for a large project, or it may give some type of partial tax relief during the project period. The inflow of foreign investment often depends upon the degree of governmental participation in the project. For large infrastructure projects in developing nations, foreign investors prefer the government to have at least 25% equity to ensure political commitment to the project.



Financing method in BOT projects
Most BOT infrastructure projects are supported through the project finance model, which is either non-recourse or limited recourse in nature. An SPV (special purpose vehicle) is often created, which acts as the project company. The non-recourse nature of project financing allows the sponsoring consortium to stay immune from giving up their own personal assets if the project generates less revenue than anticipated. In such cases, the private investors have little recourse against the project sponsors and can claim only the given project assets of the SPV.



The risks associated with BOT projects
The government does not guarantee the loans to finance the project. This necessitates the non-traditional distribution of risks between a high number of contractually interrelated parties. This multiplicity of parties and their interrelated contractual relationships give rise to complex and time-consuming negotiations.



Financial risks in BOT projects
The financial risks in projects undertaker in the BOT scheme are classified into many categories, such as Equity Risk, Foreign Exchange Rate Risk, Currency Risk, and Interest Rate Risk.



Equity risk is associated with the equity share price of the sponsoring company. Equity is a determinant in raising capital for BOT projects. The share price reflects the promotor company's ability to raise cash for the BOT project. It is believed that equity investors and other long-term investors will only agree to give finance for a BOT project when the promoter has demonstrated the project's financial capability for its full duration. Nonetheless, the promoter's ability to conduct a rigorous and comprehensive feasibility study and economic risk assessment puts him in a better position to attract domestic equity finance to fund the BOT project.



Interest rate risks, on the other hand, involve the volatility in changing interest rates in the market. The change in interest rates impacts the project in terms of borrowing and debt payments. The lenders and project participants should agree upon an acceptable interest rate. The host government can lure more international investors and domestic private investors with interest rate guarantees.



Political risks in BOT projects
The political risks are classified into two categories: Sovereign and Country.



Sovereign risk is associated with an unstable political scenario. The political risk impacts the country where the investment takes place, specifically the location of the BOT project. Furthermore, a BOT project may face substantial risks if government policy and laws change due to changes in the ruling government. Changes in the bureaucracy may also impact the decision-making process, affecting the BOT contract.



Country risk, on the other hand, is not the same as sovereign risk. It is related to a certain country's overall investment climate. Socioeconomic factors, internal or external wars, and ethnic tensions all contribute to country risk. Before beginning any BOT project, the promoter should have a credible third-party risk assessment consortium to undertake a complete country risk assessment and budgetary procedures.



Political risks pose a severe threat to the foreign investment inflow into the country where the BOT projects are built. Thus, to mitigate such risks and have contingency plans ready, project promoters should hire reputed Engineering Procurement and Construction (EPC) Contractors and Operation and Maintenance (O&M) contractors to carry out the feasibility study before proceeding with the final investment decision.



Thus, well reputed and established consultant, together with an experienced contractor, should be hired to implement the BOT project without any tolerance to the standard codes and practices.



Construction risks in BOT projects
Construction risks include unknown ground conditions and delays in procuring construction materials. The risks can also include an increase in the price of construction raw materials. These are the issues that arise during the construction process. Furthermore, faulty design reports, extended schedules, and changes in the work order, production factors, and project scope all contribute to construction risk. Such risks often lead to substantial cost overruns.



Operation and Maintenance risks in BOT projects
O&M risk occurs when the facility needs to generate more revenue due to technical problems. The facility's operation and maintenance crew require particular technical skills and competencies. Inefficient teams would result in needlessly high operating costs and lower revenue for the consortium. It is critical that a good agreement be drafted to protect the operator's interests. The efficiency of the facility's operation could be improved by providing a maintenance handbook that is regularly updated, along with standard operating procedures.



How to attract more private sector participation in public infrastructure projects?
First and foremost, a stable and conducive political environment is necessary to attract private sector entities.
An explicit national development policy in which the host government pledges to encourage private sector participation in infrastructure projects.
To facilitate a BOT approach, a credible legal and regulatory environment is required.
A reliable administrative framework to accelerate the implementation of BOT projects. Also, a support mechanism for such projects when they experience complexities during the pre-construction, construction, and post-construction phase, regardless of how they are funded.
Various incentives in the form of government assistance, tax cut, Special Economic Zone, and fast-track regulatory approval processes stimulate private sector participation in BOT projects.
A fair and pragmatic approach to the risk-reward system should be implemented.
A clear government commitment to completing BOT deals in a stipulated time frame.
As part of national BOT policy, a fair and transparent BOT procurement system must be implemented.


Parties involved in a BOT project
BOT projects include multiple parties that must all work together in coordination for success. The stakeholders in a typical BOT project structure and their interrelationships are shown in the below diagram.



BOT Project & BOT Model Structure



Role of different stakeholders in a Build Operate Transfer contract
Host Government
The BOT model necessitates variable levels of government support based on the project's kind, size, and complexity. It depends upon the host country's economic and regulatory constraints. The government may need to provide specific legislation or exemptions in taxation, labor law, immigration, customs, currency convertibility, profit repatriation, and foreign investment protection to enable the project. Therefore, the host government should focus on implementing a legal and regulatory framework that governs the BOT project throughout its lifespan.



To undertake a major infrastructure project, the government may need to conduct a preliminary feasibility assessment to ensure the project's economic viability and a FEED study to know the technological requirements to shortlist prospective bidders. Most governments have discovered that drafting an RFP (Request for Proposal) is crucial for implementing a well-defined tender and bidding procedure.



Furthermore, the host government should select a specific organization for the BOT project. The agency should have considerable authority to guide the project through administrative, regulatory, and legislative hurdles. Moreover, the government and the private sponsor must be adaptable and ready to accommodate their different interests in a fair and balanced manner.



Project Company/Sponsor Consortium
A private company often acts as the concessionaire of the BOT project. The concession agreement or BOT project contract with the host government defines its rights and obligations. To analyze the RFP, study the feasibility report, and submit a bid, a consortium of private sector sponsors is often formed as per the BOT scheme.



The chosen sponsor or sponsors normally forms either a special purpose LLP (Limited Liability Company) known as the "Project Company," "Joint Venture Company," or SPV Company.



A sponsor consortium mostly consists of partners interested in entering into one or more project contracts or a part of the contract. These parties may include large EPC companies and subcontractors such as large equipment suppliers and O&M firms. These parties offer equity to the project in the form of cash, labor, or materials.



Lenders/Banks
Lenders/banks play a significant role in BOT projects. They can either provide the debt, invest through equity shares, or offer financial consultancy services for the given project. On some occasions, the host government may also become one of the investors or lenders.



EPC contractor
The project's construction may be undertaken by either the project company itself or by a third-party EPC contractor. Sometimes the EPC company also becomes the project operating company after the completion of the project. This company operates the facility and collects the revenue or toll tax in case it operates on behalf of a public agency.



Independent checking engineers
Given the size of many BOT projects, it may be advantageous for the project company to retain the services of an independent party to supervise construction, evaluate quality, and authorize payment during the project's execution.



Which projects are suitable for the BOT model?
The BOT model is suitable for large public projects in power, transport, roads, and bridges. Other BOT projects include tunnels, airports, ports, canals, water treatment plants, communication infrastructure, government buildings, and railways. Sometimes sewerage systems and housing units are also included in the scope of the BOT model.



How BOT model differs from PPP model?
PPP (Public Private Partnership) is a contractual arrangement between a public entity and a private entity. The private sector entity constructs a public infrastructure like large-scale public transportation networks, parks, and hospitals with its own finance and risks. The government may be a minority stakeholder in the project. It recovers the investment from the revenue generated from the facility's operation.



On the other hand, a BOT contract is simply one of several possible PPP contracts. The other PPP contracts can be Build-and-Transfer (BT), Build-Lease-and-Transfer (BLT), and Build-Own-and-Operate (BOO).



The bottom line
BOT contracts can be quite beneficial for both public and private sector entities. They let governments offload the cost and risk of large, essential infrastructure projects to a specialized private company with the potential to make a profit from the project.



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