In emerging markets, climate change threatens infrastructure that is critical for development. Roads, airports, water systems, and power plants are vulnerable to weather changes. Severe storms and major droughts can disrupt economic activity. Because private companies and investors in emerging markets often manage infrastructure projects through public-private partnerships, they will now need to address climate change risks when planning and building these projects. The uncertainty of such risks has made incorporating them into project planning a challenge, but new tools and approaches, including insurance, are helping PPPs better respond to climate risks.
Well-functioning infrastructure, such as roads, airports, water systems, and power plants, is a pre-requisite to economic development. Yet in many emerging economies, weak governance, regulatory uncertainty, poor public credit ratings, and a shortage of bankable projects have hampered investment in infrastructure. As a result, emerging-market governments have long turned to partnerships with private companies to help fill the gap in infrastructure financing.
These public-private partnerships have evolved over the years with public and private entities shouldering various levels of financial and management responsibility. Some are long-term partnerships with defined roles and responsibilities, while others are more fluid with private enterprises receiving performance or output-based payments.
In emerging markets, climate change is now one more challenge that these projects face in designing, operating, and maintaining infrastructure crucial to growth. Water related projects are especially at risk. Water systems, hydropower plants, and coastal infrastructure will need to be overhauled to withstand the strain of storms, floods, and droughts. But the changing climate and warming temperatures will affect all types of infrastructure projects. Extremely hot days, for example, are cutting construction workdays short and high winds and severe storms threaten cell phone towers. As a result, public-private partnerships will need to account for climate risks in infrastructure planning, making sure that projects are resilient to the effects of climate change.
The lack of certainty about how temperatures and precipitation will change makes planning for long-term projects and designing public-private partnerships even more problematic. Historically PPP contracts have allocated risks to the party in the best position to manage them, but ambiguity about the timing and severity of climate risks presents major challenges for designing and pricing PPP contracts that promote economic development in emerging markets.
In particular, private players have little incentive to account for climate risks in project planning. Often private players in PPP contracts are only paid for the life of the contract, not for the life of the project. As a result of that compensation structure, a private player may not make decisions in the design and planning phase that increase a project’s longevity if they also increase costs. Public entities reinforce this behavior because they often choose less expensive proposals and resilience measures can be costly. Finally, if the private player does want additional compensation to manage climate change risks, the PPP structure might not be cost effective for emerging-market governments.
In general, the challenge of incorporating climate risks into PPP contracts is that these contracts are ill suited to managing unpredictability. Uncertain and rare events outside the contract, such as political unrest or floods, are often handled through force majeure provisions and insurance. With such provisions, “both parties get equitable rights to terminate a PPP contract after a prolonged risk event, perhaps lasting 180 days or longer. In a typical [force majeure] termination, both parties share the financial impact; the public sector pays out debt obligations of lenders, paid-in equity including any breakage costs of investors (who forego future profits) in lieu of an affected infrastructure asset,” according to a 2016 World Bank report.