Tariff Policy and Sustainable PPPs in the Port Sector – Case Study of the Container Terminal Sector

1. Tariff Policy and Sustainable PPPs in the Port Sector – Case Study of the Container Terminal Sector Presentation To The Tariff Commission by Indian Private Ports & Terminals Association (IPPTA) September 12, 2007

2. Although this presentation discusses the case study of the container terminal sector, the basic principles vis-à-vis alternatives suggested by IPPTA in the area of tariff fixation and bidding model can also be applied to the bulk cargo terminal operators

3. The Context • 95% of existing trade is through Sea Ports • Growth of trade-intensive manufacturing will be facilitated only if terminals within Ports function efficiently, productively and profitably • Indian Ports are predominantly ‘origin-destination’ Ports; they will therefore, require state-of-the-art equipment, know-how and technology, to enhance competitiveness of the manufacturing sector • Healthy Ports will require healthy and sustained investors who will continue to reinvest their earnings in augmenting efficiency and productivity of terminals • According to Committee on Infrastructure: • Containerized cargo is expected to grow at 15.5% per annum every year • Trade handled by Indian ports is estimated to reach 877 million by 2011-12 • Investment required to handle such traffic: US$ 13.5 billion in major ports and US$ 4.5 billion for minorports, under National Maritime Development Programme • 64% of the proposed investment under NMDP expected to be sourced from Private Sector

4. This Presentation… • Discusses IPPTA’s understanding on the Strategic Role of Tariff in the Port Sector • Showcases the benefits of privatization in the port sector • Explains Features and Impacts of the existing Bidding Process and Tariff Model • Expounds the deleterious macroeconomic impact of existing tariff framework applicable to terminal operators on Indian trade • Sheds light on the alternatives that IPPTA has already put forward to the Ministry of Shipping and Planning Commission towards redressing problems of existing and prospective terminal operators in the Indian port sector

5. Benefits of Privatization in spite of Miniscule Contribution to Total Logistic Costs

6. Growing Strategic importance of Private Terminals • During 1995-96, the entire container terminal traffic of India was being handled by Ports • ‘Public-Private-Partnership’ in Port Sector induced private participation • Post 2000, private operators due to state-of-the-art technology and their investments started increasing their share in total container traffic handled by their respective ports • According to IPPTA estimates by the end of 2006, out of 7 million TEUs of container throughput, an estimated 5 million or 71% of the container throughput was being handled by private container terminal operators

7. Privatization has enhanced connectivity FELIXTOWE HAMBURG ROTTERDAM ANTWERP NEW YORK NORFOLK QUINGDAO DAMIETTA ALEXANDRIA CHARLESTON PORTSAID LOS ANGELES JEBEL ALI KARACHI JEDDAH SALALAH KANDLA SHANGHAI MUMBAI / JNPT SUDAN NINGBAO HODEIDAH YEDAN KINGSTON XIAMEN PINANG SUDAN CHI WAN DJIBOUTI COCHIN TUTICORIN KUANTAN PORT KLANG SINGAPORE Dar-Es-Salam COLOMBO Mombasaa

8. Container Handling Charges account for miniscule share of Total Logistic Costs

9. Benefits derived from Privatization exceed contribution to logistics cost-basket JNPT

10. The Strategic Role of Tariff

11. The Strategic Role of Tariff in the Port Sector SUPER STRUCTURE Magnitude of after tax cash flows = Just and fair returns to Port operators BASE Tariff

12. Long Term Objectives of any Tariff Model According to IPPTA any tariff model in the long run must • Ensure a sustained supply of services to trade by providing a healthy investment climate to service suppliers • Encourage Competitiveness • Provide a climate for creation of additional capacity which can fuel growth Make current PPP-investments unviable and future investments unattractive And Not

13. Efforts of IPPTA till date to ensure this long term goal • Presentation before the Ministry of Shipping with a focus on: • Problems associated with the existing Tariff Policy; and • Alternative Tariff Framework based on a ‘Floor and Ceiling’ approach that would ensure efficient and sustained supply curve of terminal operating services • Presentation and submission of a paper to the Planning Commission articulating the alternative bidding model that could be made applicable to future bids in the sector

14. Features and Impacts of Existing Bidding Process and Tariff Model

15. Existing Bidding Process: Features & Impact • Has created a dis-connect between the Bidding Process and Tariff Setting Principle • Private Operator offering the highest revenue share/royalty gets to operate the terminal • Private Operators keen on getting their foot into the Indian port sector due to growing importance of trade in India’s and region’s growth have been forced into a ‘Opportunity-Risk’ evaluation as against ‘Project-Viability’ evaluation • Private Operators are investing with the belief that best practices can be instituted within the system by participating in it rather than staying outside • High revenue share/royalty figures continue being quoted as Port Trusts compete amongst each other on creating better benchmarks vis-à-vis royalty/revenue share price quotes • Bidding process has become a process to extract rents and completely neglects concerns of trade • Port Trusts have become pure profit generators and have abdicated their role as trade facilitator

16. Existing Tariff Model: Features & Impact • Cost plus approach excludes certain cost increases (e.g. inflationary adjustments are being restricted to WPI vis-à-vis fuel, labour) • Terminals not allowed to charge tariffs that are driven by ‘market forces’ Tariff Regime Does not cover all recurring costs Places a cap on rate of return Result Rewards inefficient operators and encourages over-investment and underutilization Denies efficient terminal operators the opportunity to generate investible resources Compresses the supply curve

17. Existing Tariff Model: Flawed By Design 1 2 3 4 Excludes some costs from total costs Caps the permissible return on capital Writes down value of assets employed Generates tariffs that systematically decline even as costs rise 6 7 8 5 Rising costs include royalty to Ports Terminal operator uses capital to cover rising costs Elimination of terminal operator from ‘market’ sooner than later Capacity gets curtailed and competition diminished; This defeats the purpose of PPP; Cost to Trade increases 16% is much lower than what other corporate sectors earn

18. Impending Macroeconomic Disaster as a result of existing Tariff Model

19. Shrinking Capacities – An Example • Tuticorin Container Terminal: PSA SICAL • Started Operations on December 21, 1999 • Improved Efficiency and Productivity • High Vessel and Crane Productivity: VR 230% (from 15 to 50 moves/hour); GCR 180% (from 10 to 28 moves/hour • Quick turnaround of Vessels, Trucks and Containers: Vessel Port Stay 80% (from 2 days to 12 hrs) • Integrated Services • Use of Advanced IT Systems • Reduction in dependency of liners on Colombo as a trans-shipment hub • Tariff Order of September 2006 fixed tariff at Rs. 980/TEU against industry norm of Rs. 2500 per/TEU • Tariff fixed does not reward efficiency as well as productivity achieved • PSA SICAL was forced to seek the intervention of the Chennai High Court • High Court in its order in August 2007 has asked the Hon. Ministry and TAMP to give PSA SICAL a personal hearing and pass orders on merit

20. Simulating Disaster: Nhava Sheva International Container Terminal (NSICT) • MGT of NSICT = 0.6 million TEU • At present traffic handled = 1.32 million TEU • Value of the goods handled @ US$ 10,0001 per TEU = US$ 13.2 billion • Assuming that NSCT decides to operate at MGT: • Estimated loss of direct and indirect employment = 6,000 • Total value of trade that will suffer = US$ 6.6 billion • Loss to the Port at present royalty = Rs. (1.32-0.60) X 1150 million = Rs. 828 million • Liners will continue to charge a peak season tariff surcharge of US$ 100 per TEU based on demand and supply 1 Industry estimate

21. Solutions Provided by IPPTA vis-à-vis Tariff Model – Applicable to Existing Container Terminal Operators

22. IPPTA’s Suggestion – A ‘Floor’ and ‘Ceiling’ Model Highest tariff that an operator shall charge Protects the users Ceiling The ceiling and floor enable terminals and their customers to work within a range of competitive and feasible tariff plans Lowest tariff that an operator may charge Facilitates sustained supply of quality service Floor

23. Three Guiding Principles Tariff-setting model must protect users - the export and import trade – and investors Businesses must be able to recover costs and get viable returns on capital Tariffs must trigger competitiveness and increased supply

24. The Six Elements of the Proposed Tariff Framework • Normative capacity • Actual volume • Operating and administration costs • Royalty at minimum guaranteed throughput • Gross assets deployed • 16% return on gross assets deployed

25. Normative Capacity: Example in the Case of Container Terminals Normative Capacity = 113,100 TEU per crane Source: Report by National Working Group on Normative Cost based Tariff for Container Related Charges, July 2005

26. Minimum Guaranteed Container Volume: The Significance Minimum guaranteed container volume or throughput is annual level of cargo guaranteed by the terminal operator while signing the concession agreement

27. Royalty at Minimum Guaranteed Throughput: Why? • Since minimum guaranteed cargo or throughput is a committed throughput, the royalty payable on this throughput is a guaranteed cost that the terminal operator has to incur each year to be in the business of providing quality services to users • Royalty, thus incurred, is not a capital expenditure as: • it is incurred with annual periodicity; and • it does not augment available capacity

28. Royalty for Tariff Fixation and Payment to Ports: The Scenarios Royalty would be a 100% pass-through up to the maximum of (1) the minimum guaranteed royalty for tariff fixation and (2) what is payable to the port, provided the latter is payable on account of non-achievement of volumes Actual volumes are lower than minimum guaranteed throughput Actual volumes are higher than minimum guaranteed throughput but are below normative capacity To the extent of the difference in minimum guaranteed royalty and royalty on actual volume, royalty will not be payable to the port and will also not be a pass-through When there is no committed or minimum guaranteed throughput Royalty payable to the port and royalty pass-through will be at actual Benefit to the Trade

29. Ports’ Share of Excellence Slab One: If the actual volume exceeds normative capacity in a range of 1% to 15% then the terminal operator shall pay a royalty worth 15% of the royalty/TEU, which it pays on guaranteed volumes, on the excess (excess = actual volume – normative capacity) Slab Two: If the actual volume exceeds normative capacity in a range of 16% to 30% then the terminal operator shall pay a royalty worth 10% of the royalty/TEU, which it pays on guaranteed volumes, on the excess Slab Three: If the actual volume exceeds normative capacity by more than 31% then the terminal operator shall pay a royalty worth 5% of the royalty/TEU it pays on guaranteed volumes, on the excess Payment to port Actual volumes are higher than normative capacity Payment to port Payment to port

30. Ports can directly subsidize trade Ports can exhaust their right to subsidize trade directly, in stead of penalizing the terminal operator, if they believe that tariffs are high

31. Royalty, Payment to Ports and Trade The royalty pass-through at the minimum guaranteed throughput respects the spirit and letter of public-private-partnership Merit 1 Trade does not bear the cost of lower throughput when the actual volume is between minimum guaranteed throughput and normative capacity Merit 2 With the proposed slab rates operative, when actual volumes exceed normative capacity, terminal operators’ share gains from higher throughput with ports and trade Merit 3 Benefit to Trade

32. Extreme, Adverse Case • When a terminal functions below 60% of its normative capacity then its actual volumes will be used for determining its tariff • This will imply that such a terminal will effectively have only one tariff • A floor or a ceiling will not exist for such a terminal

33. Floor is ----------------------------------------------------------- Operating and administration costs including depreciation at actual volumes Royalty at minimum guaranteed throughput under concession agreement Return on gross assets deployed + + 100% of normative capacity

34. Ceiling is ----------------------------------------------------------- Operating and administration costs including depreciation at actual volumes Royalty at minimum guaranteed throughput under concession agreement Return on gross assets deployed + + 60% of normative capacity

35. Operational Outcomes of Tariff Band: A Virtuous Circle of Stability, Reliability and Competitiveness Four One Floor and ceiling Three Two

36. Utilizing the Bidding Framework to Rectify Anomalies in Tariff Model – Applicable to Future Bidders

37. Basic Model of the Bid Royalty/Revenue Share to be paid by the Operator over the life of the Concession Period shall be made public before inviting Bids Operators shall be asked to submit Bids based on tariffs Operator quoting the lowest tariff throughout the life of the Concession Period wins the Bid

38. Mandatory Information that must be disclosed with royalty/revenue share in the Bid Document • Outline the quantum and quality of the civil and port infrastructure, which the Port would be handing over to the Operator • Normative Capacity of the Terminal and Norms utilized to arrive at Normative Capacity • Services the Port shall provide to the Operator and the charges thereof • Volumes expected to be handled by the Operator for the first five years • Incorporation of a non-compete clause (IPPTA has made detailed suggestions in this regard in its submission to the Planning Commission)

39. Royalty expectation by Port and Norms Terminal Operators should only be charged either royalty as a % of net revenue or a lease rent or an upfront fee and not a combination resulting from any of these three elements if the Operator is only handed a water body and is expected to create a terminal on the same to handle prescribed normative capacity Royalty rate up to 5% if the Operator is provided with land, which is completely under developed (e.g. barren land) and he is expected to transform it into a full-fledged terminal with the prescribed normative capacity Royalty rate bet. 5.1% – 7.5% if the Operator is provided with semi-developed/developed land with certain limited amenities such as a water connection, power connection, a semi-finished road connecting the terminal to the Port entrance et al Royalty rate bet. 7.6% – 10% if the Operator is being handed over a full fledged terminal Royalty rate of 15%

40. Definition of Consolidated Tariff and Tariff Norms Consolidated Tariff = charges incurred towards movement of origin & destination (O&D) containers from ship to yard and yard to ship + charges incurred towards movement O&D containers from terminal yard to railway depot (in case of rail boxes) and vice versa + charges incurred towards movement O&D containers from yard to trucks and vice versa. Transshipment containers are excluded from this definition Specific Tariff Norms have also been conceptualized by IPPTA

41. Bid Evaluation Basis • Bidders will quote consolidated base tariffs for the first five years based on their subjective estimations of tariff • Bids will have to be evaluated only on the basis of the volumes-expectations figures made public before the bid • Operator with the lowest weighted average consolidated tariff per TEU for the first five years will be awarded the Terminal The natural question is, what will be the Tariff scenario after five years?

42. Tariff Adjustment Factor + = + + 15/100 X (L1/L0) Adjustment Factor 15/100 15/100 X (F1/F0) + 10/100 X (E1/E0) 45/100 X (WP1/WP0) L1 = All India average consumer price index for industrial workers on the date of Adjustment LO = All India average consumer price index for industrial workers on the base date F1 = Whole sale price index for fuel on the date of Adjustment F0 = Whole sale price index for fuel on the base date EI = Whole sale price index for electricity on the date of Adjustment E0 = Whole sale price index for electricity on the base date WPI1 = Whole sale price index on the date of Adjustment WPI 0 = Whole sale price index on the base date • Share of factors of production (excluding royalty) in the cost structure of the Operator • Labour Cost – 15% • Fuel Cost – 15% • Electricity cost – 10% • Other Expenses – 45%

43. Use of Tariff Adjustment Factor Tn-1 = x Adjustment Factor Tn The Operator will be allowed to increase the tariff throughout the life of the concession period by using this Tariff Adjustment Factor

44. Benefits of IPPTA’s Model • Reduces information asymmetry within the bidding model; • Provides the right climate for creating capacities thereby benefiting trade • Tries to make the Bid model ‘pure’ tariff based. • Benefits the Trade with the lowest tariff and with a transparent mechanism of how the tariff will scale during the life of the concession period. • Compels the Operator to internalize, future efficiency gains, traffic risk, and most importantly the impact of royalty, while quoting tariff figures. • Creates a competitive obligation on the Operator to bring in the best equipment to serve trade efficiently. • Does not compel the Operator to introduce equipment to generate idle capacities. • Allows the Operator retain efficiency gains. • Reduces un-necessary regulatory interference

45. THANK YOU