After the 2014 Lok Sabha elections, road players were the first get some relief. Changes in rules governing the sector — such as, extending the time for starting premium payment to three years from the completion of the project, compensation for delayed projects and the 5:25 rule for refinancing projects — have helped ease the fund crunch that crippled them. The speed of execution of road projects has improved from around 4 km per day to 8 km per day and is well on track to reach 15 km per day or more, next fiscal year. Additionally, the Centre’s allocation of ₹55,000 crore to construct 10,000 km of road for the current fiscal year is being successfully implemented.
But for someone trying to understand the business of road construction companies, the barrage of technical terms such as EPC, BOT, HAM and so on, might throw them off. Here’s a closer look at the models used by road construction players:
Engineering, Procurement and Construction (EPC)
This is a traditional construction contract where the government body pays money to a private developer to construct a road or a highway. An infrastructure project, especially a road project, is considered a public good and is expected to have long-term positive multiplier benefits on the surrounding region. Thus, all the projects proposed by the government may not have a motive to make profit. Such projects are undertaken through the EPC format.
EPC contracts are classified into an item rate and turnkey contracts. In an item rate contract, the contractor submits the bill of materials to the government agency for executing the contract from time to time. The government body then repays the billed amount. Though this de-risks the contractor from the price fluctuation of various raw materials used, it leads to back and forth negotiations to identify the right cost that the government body needs to pay the contractor. This problem is mitigated in turnkey contracts. Here, the contractor undertakes the entire project for a fixed sum of money, thus managing the fluctuations in the raw material costs.
In an EPC project, the contractor is liable for any damages to the road during the contractually defined defect liability period. This period usually extends from three to five years after the project completion date. Major players in this segment are Dilip Buildcon, Larsen & Toubro, J Kumar Infrastructure and Ashoka Buildcon.
Build, Operate and Transfer (BOT)
Build, Operate and Transfer projects, or BOT projects, are those that are expected to have a return on investment commensurate to the risk assumed by the developer. The developer bids for the project and on successful selection, the bidder builds, operates, maintains and finally transfers the road to the project grantor after the tenure period of the contract comes to an end. During the contractual period, the bidder is responsible for the maintenance of the road. BOT projects are also operated under two main domains: BOT – Toll and BOT – Annuity.
The revenue for the road project is collected from the traffic flow and it is the fluctuation in the actual traffic flow compared to what is initially estimated that creates the revenue uncertainty. When the bidder decides to assume the traffic risk in the project, it is a toll form of BOT project. In case of annuity project, the grantor assumes the project risk and pays the operator a defined sum of money semi-annually or annually. Some of the major players in this segment are IRB Infrastructure, Larsen & Toubro and Ashoka Buildcon.
Hybrid Annuity Model (HAM)
Estimating traffic on a long term basis continues to be a major problem, both for grantor as well as the bidder. A very low traffic flow coupled with a heavy debt burden has brought many projects to a standstill. To mitigate this problem, the Centre decided to follow a hybrid annuity model, where 40 per cent of the project will be built on an EPC format while the rest will be built on BOT — the annuity format. Over the next few fiscal years, the Centre is expected to follow HAM for a significant number of new projects.
But through HAM, the Centre assumes the traffic-risk and the commensurate revenue-risk for a large number of projects while simultaneously paying the bidder a pre-defined contractual amount on a semi-annual or annual basis. This short term bias to increase the length of highway construction may pinch the pockets of the exchequer on a long term basis. Some of the major players in these segments are Larsen & Toubro, Ashoka Buildcon and Dilip Buildcon.
Toll Operate Transfer (TOT)
The number of highway projects operated by the Centre is more than a hundred. Most of these projects are able earn decent revenue; close to 40 per cent of the Centre’s projects earn annual revenue equivalent to 10 per cent of their project cost, while about 20 per cent of the projects earn anywhere between five and ten per cent of the total project cost. The incrementally increasing lengths of highway network envisioned by the Centre through Bharat Mala and port connectivity projects can be expected to be partly financed through TOT model.
Through this TOT model, the Centre transfers the road asset to a private player for a period that can span anywhere from 25 to 50 years for a one-time upfront premium payment. The private player operates, maintains, and collects toll revenue. This TOT framework, which is still in the process of discussion, may seem very attractive for some private players, but the success or failure of this model depends on the contractual conditions that are expected to be applied when the actual traffic flow deviates from the projected traffic. MEP Infrastructure is expected to gain from this model.