The effect of asphalt maintenance regimes on inflation correction in Dutch DBFM contracts

Abstract

Inflation is a worldwide phenomenon that influences future investment decisions. Inflation is the devaluation of money, causing a reduction of purchasing power and price level rise. Nobody knows how high inflation will be, and thus price levels in the future a uncertain. In long-term projects with expenses in the future, it is important to take price level development into account. At the beginning of the project an investor wants to know the size of his expenses in the future to be able to estimate the profit of an investment. Inflation rates over the short term can be estimated, but over the long term, estimates introduce a big risk. Too low estimates of price rise result in higher cost than expected, resulting in financially unsuccessful projects. Too high estimates result in an offer that is not competitive. In modern large-scale road infrastructure projects in the Netherlands, Rijkswaterstaat and contractors enter into long-term contracts. These contracts span over 20 to 30 years and include maintenance expenses that are subject to inflation. In order to maximize Value for Money, Rijkswaterstaat relieves the private parties of estimating price level rise during the contract period. This is done by an index formula. The index formula escalates the payments from Rijkswaterstaat according to the price level rise of the expenses of the contractor. Independent organization publicize measurements of the price level at specific points in time. These objective index figures are input for the index formula. But the formula itself is a model and has, inherently, its imperfections. These imperfections originate from the workability of the formula, and cause a mismatch between the extra cost due to price level rise, and extra income due to inflation correction payments. The largest component in the design of the maintenance plan of road infrastructure is the maintenance regime of asphalt. Typically asphalt pavement lasts for 8-10 years, so it must be replaced during the contract period in order to keep the required motorway available. The contractor has a number of possible maintenance regimes to choose from to maintain the required availability. These regimes have a different cashflow and react differently on the imperfection of the index formula and thus have a different mismatch between inflation cost and inflation correction. This research aims on finding out what maintenance regime has the best performance on this mismatch because there is a lack of knowledge of the mismatch between a DBFM project’s inflation cost and its inflation correction payments. Furthermore, the effect of different maintenance plans on this mismatch is unknown as well. The most influential component of the maintenance budget is the pavement resurfacing because of its financial weight, numerous maintenance strategies, planning uncertainty and unstable product prices. It would be valuable to know how the resurfacing strategies perform on inflation correction in different scenario’s. This is important because inflation correction influences the tenderbid as well as the profitability for the private party. When the parties in DBFM projects are more aware of the gap and how it can be influenced, the projects will result in a higher value for money for the government. The research question is: Which resurfacing strategy minimizes the net present value mismatch between inflation correction and actual inflation cost in DBFM road projects in The Netherlands? To answer the research question, four different maintenance regimes are tested in a model simulating six variable price level developments relevant to the maintenance of asphalt. For this price level development simulation, an Autoregressive Integrated Moving Average (ARIMA) modelling technique is used. Besides the price level simulation, the model varies the timing of the maintenance activities in each calculation. The timing varies according to data of maintenance intervals in existing road sections. The research shows there are two types of mismatches. The first is already taken into account by the private parties in current DBFM projects. This first mismatch can be exposed by means of a deterministic base case. The second mismatch is not yet incorporated in the mismatch, this type is exposed with the probabilistic analysis of this research. The research concludes that the maintenance regime with the best behaving inflation correction is a regime that uses rejuvenating measures to postpone traditional resurfacing peaks. Furthermore, the differences of the mismatch between the maintenance regimes is relevant to the project’s financial success. The choice of maintenance regime has an impact of over 2% of the asphalt maintenance budget. With the understanding of the mismatch in inflation correction, the contractor is better able to mitigate this risk and create an offer with better value for money. This is beneficial to the efficient use of tax money by the government. Even though the index formula allows for this mismatch, the index formula works as well as possible within the constraints of workability.