A real options approach of managing public-private partnerships projects under high uncertainty

When future operating conditions are highly uncertain, revenues and costs of a long-term project may significantly deviate from the original projections. Such uncertainty raises problems for projects authorized by governmental agencies. This paper presents a real options approach to resolving such problems for public projects involving private entities. In a public-private partnerships project, a governmental agency offers a private entity an option to continue operating the project after the concession term. The private entity, if it has exercised the option, can choose to abandon the operation later. The private entity will pay a premium to the governmental agency for acquiring the options. The governmental agency prices the options with considerations of a variety of objectives, including maximizing public benefit from the project, increasing the probability of self-liquidity in the project, and maintaining the profitability of the private entity. The approach proposed here effectively alleviates the pressure on the governmental agency if unfavorable future conditions of operation occur, increases the private entity's expected utility, and improves the general social welfare.