What Is a Build-Operate-Transfer (BOT) Contract?
A build-operate-transfer (BOT) contract is a model used to finance large projects, typically infrastructure projects developed through public-private partnerships.
The BOT scheme refers to the initial concession by a public entity such as a local government to a private firm to both build and operate the project in question. After a set time frame, typically two or three decades, control of the project is returned to the public entity.
- A build-operate-transfer (BOT) contract is a model used to finance large projects, typically infrastructure projects developed through public-private partnerships.
- BOT projects are normally large-scale, greenfield infrastructure projects that would otherwise be financed, built, and operated solely by the government.
- Under a build-operate-transfer (BOT) contract, an entity—usually a government—grants a concession to a private company to finance, build, and operate a project for a period of 20 to 30 years, hoping to earn a profit.
- After that period, the project is returned to the public entity that originally granted the concession.
How Build-Operate-Transfer (BOT) Contracts Work
Under a build-operate-transfer (BOT) contract, an entity—usually a government—grants a concession to a private company to finance, build, and operate a project. The company operates the project for a period of time (typically 20 or 30 years) with the goal of recouping its investment, then transfers control of the project back to the public entity.
BOT projects are normally large-scale, greenfield infrastructure projects that would otherwise be financed, built, and operated solely by the government. Examples include a highway in Pakistan, a wastewater treatment facility in China, and a power plant in the Philippines.
In general, BOT contractors are special-purpose companies formed specifically for a given project. During the project period—when the contractor is operating the project it has built—revenues usually come from a single source, an offtake purchaser with a binding agreement. This may be a government or state-owned enterprise.
Power purchase agreements, in which a government utility acts as offtaker and purchases electricity from a privately owned plant, are an example of this arrangement. Under a traditional concession, the company would sell directly to consumers without a government intermediary.
BOT agreements often stipulate minimum prices the offtaker must pay.
Variations on the Build-Operate-Transfer (BOT) Contract
A number of variations on the basic BOT model exist.
Under build-own-operate-transfer (BOOT) contracts, the contractor owns the project during the project period. Meanwhile, under build-lease-transfer (BLT) contracts, the government leases the project from the contractor during the project period and takes charge of the operation.
Other variations have the contractor design as well as build the project. One example is a design-build-operate-transfer (DBOT) contract.
The BOT approach was developed in the late 1970s against a backdrop of constrained budgets in developing countries and a downturn in work for international construction firms.
Example of a Build-Operate-Transfer (BOT) Contract
The elevated train system in Bangkok, Thailand, known as the Bangkok Mass Transit System (BTS) or BTS Skytrain, was created from a 30-year BOT concession agreement between the Bangkok Metropolitan Administration, the government entity that owns the line, and Thai transport firm Bangkok Mass Transit System (BMTS) Public Company Limited.
Under the terms of the agreement, BMTS was given the job of designing, financing, building, and operating the transit system out of its own pocket in exchange for collecting all fares and advertising revenue when the train line went live.
Based on its projections, BMTS figured it would recoup its costs within a decade, with at least a 16% rate of return. However, it didn’t pan out that way. BTSC ran into financial trouble after the number of people using the service fell way below its original prediction.
BOT contracts are generally more prevalent in developing economies, helping cash-strapped local governments to finance large, complicated infrastructure projects that they might otherwise be unable to manage and afford.
What Is the Basic Framework of a BOT Contract?
A BOT can be broken down into three distinct phases:
- Build: A private company agrees to build a public infrastructure project for the government.
- Operate: It then proceeds to operate and manage the facility for an agreed-upon period, during which it should recoup its outlay and start making money.
- Transfer: After the concessionary period, the company transfers ownership back to the public entity.
What Are the Risks of BOT Contracts?
One of the biggest risks is that the contract ends up losing money. To be a success for all parties, the project should provide a sufficient return on investment for the private entity, while also benefiting the public entity financially and beating other available alternative options. Unfortunately, this doesn’t always happen. Big projects come with great risk and the finances can be under or overestimated.
What Is the Difference Between BOT and PPP?
A public-private partnership (PPP) is when a private entity takes over, finances, and operates large-scale government projects, such as public transportation networks, parks, and hospitals. A BOT contract is just one of a series of potential PPP agreements.
The Bottom Line
BOT contracts can make a lot of sense. In theory, they enable governments to transfer the cost and risk of big, important infrastructure projects to a specialist private entity, which has the potential to make lots of money from it if it turns into a success before handing it back. Sounds like a win-win, right? In theory, yes, though sadly there are lots of variables that can turn what appears to be a dream arrangement into a complete nightmare, especially for the risk-bearing private company.