Assessing the role of term extension clauses in mitigating disruptive events in infrastructure concessions

Infrastructure concessions, especially for transportation projects, are long-term investments subject to demand volatility. Yet disruptive events, such as the COVID-19 pandemic but not limited to it, may negatively affect demand for traffic infrastructure, thus impacting the returns and the attractiveness of the project to the private investor and result in lengthy and costly contract renegotiations. While historical demand series indicate that such events, some with localized effects and others with more global consequences, occur more frequent than might initially be perceived, their impacts are usually transitory in nature. We propose an innovative supporting mechanism called Minimum Demand Guarantee (MDG) with the Term Extension Clause (MDG-TEC) to hedge the effects of such disruptive events and minimize the need to contract renegotiations. This model combines an MDG with a concession time-term extension proportional to the observed reduction in the demand and the length of this reduction, which are modeled as European call options under the real options approach. In a novel approach, traffic demand is modeled as a mean reversion diffusion process with drift to which negative Poison jumps are added to simulate such disturbances. The results show that this model can be effective in minimizing demand risk and the need for renegotiations, without creating additional fiscal liabilities for the government.Infrastructure concessions for transport projects are long-term and risk demand shiftsDisruptive events like Covid-19 are rising and significantly impact demand and cash flowsWe propose a real options method using a Minimum Demand Guarantee with Term ExtensionThis combines MDG with a term extension proportional to demand reduction and durationThis model lets governments honor MDG without extra treasury cost or legal renegotiation