Contractual Structuring for Road as a Service (RaaS)
In the Netherlands, the regulatory requirement is that the surface layer of asphalt roads have a whole-of-life span of six years. Currently, 60% of rubble from broke-up old roads can be reused in the construction of new roads, however increasing that percentage of reuse is mostly improbable due to stability and safety concerns.
Dura Vermeer, a Dutch construction, infrastructure, and engineering business, has developed the technology to create top layer asphalt which can last up to 15 years (twice as long as current asphalt roads), but costs 10% more than regular asphalt roads.
- Contractor: Dura Vermeer
- Client: Overijssel Province
- Dutch governmental budgeting structures have proved a barrier to investing in Dura Vermeer’s proposition as local provincial governments will often opt for the least expensive option.
- Under a traditional finite-period construction and maintenance contract, a contractor has no incentive to make roads last as they will “sweat” the asset and do the bare minimum to meet handover requirements, meaning that a new contractor will have to bring the road back into shape.
- Under a Circular Service Contract (CSC), the provincial government will maintain legal ownership of the road and Dura Vermeer will retain economic ownership of the road while providing use of the road. Both parties enter into a contractual obligation for the specified use period of the road, and Dura Vermeer receives the residual value at the end of contract term.
- The road stays a fixed asset on their balance sheet while the government (province) pays a recurring quarterly fee for use of the road.
- Dura Vermeer is responsible for the construction, maintenance, and operation of the road, and will receive residual value payout, creating an incentive to construct the highest quality and most durable asphalt to minimise maintenance costs, and optimise residual value.
Results and impact
- Discussions and negotiations between Overijssel Province authority and Dura Vermeer regarding the scope of the functional requirements of the road are underway. They have been in the process of co-developing the road and requirements for the contract. The current presumption is that the contract will have a tenor of 10 years and a value of EUR5m (USD 6 million) (Dutch procurement law only allows direct awarding of contract without competition if the monetary value is below 5 million).
- Forecasted reduction in road turnover and asphalt waste: Due to the extended durability of the road beyond the standard six years, this avoids the unnecessary waste and costly disposal of non reusable rubble from broken-up roads. If the pilot is successful, the road will require less replacement, and less asphalt will need to be used over a long period of time. The reduction in road closures due to maintenance will also facilitate reduction in traffic.
- Rebel, a Dutch consultancy firm is preparing a memo on how to determine the residual value of the road with further review required from members of a Dutch bank, another accountancy firm, and an engineering firm. The preliminary judgement is that the residual value of the road will not only consist of the material value of the road but also the future value which will be a function of the avoided expenditure from public authority on additional maintenance after the contract period. This approach ensures public benefits as the road is always in a good condition.
Key lessons learnt
- Creating financial incentive for circularity: The contractual agreement should consider the distribution of risk vs reward to incentivise circularity. If at the end of the contract, economic ownership is transferred to the client (ex. Overijssel Province), it still appears on their balance sheet from the start as it would in a ‘normal’ sale. The alternative is to specify explicitly the ongoing nature of the agreement, which excludes a transfer. The ownership has implications for the reuse of the road and its materials at the end-of-life. The owner of the road and ultimate beneficiary of residual value payout is incentivised to optimize the durability of the road, its maintenance and (re) use of raw materials, with potential effects such as a longer lifespan, lower overall maintenance costs, leading to a higher residual value. These incentives ensure public benefits as the road is always in a good condition.
- Combination of financing features: Roads are traditionally procured on a project finance basis. Project financing/lending is based on long term contracted cash flows. On the other hand, corporate lending provides financing based on the balance sheet of a company. Because the contract foresees a residual value that Dura Vermeer owns, ownership could also be viewed as an asset that is relevant for the company’s solvency. This is a theoretical shift to a combination of project financing and corporate lending as the road can be seen as asset to be held as secondary collateral, and the expected high residual value of the road improves the contractor's financial position.