Public Private Partnerships have had their issues but are back in vogue with government. Marie Sansom surveys their different forms, the projects they suit – and where there’s room for improvement on both sides.
It’s easy to get lost in the alphabet soup of acronyms that immerse Public Private Partnerships (PPPs), but Queensland University’s Professor of Economics Flavio Menezes has a useful and basic definition of their fundamentals.
“A public private partnership is an arrangement whereby construction, operation and private financing are bundled in one long-term contract awarded through a tender,” Prof Menezes says.
But there’s a robust debate between experts over when they deliver value to taxpayers, industry and investors.
Usually aimed at larger projects over $100 million, PPPs differ from traditional publicly financed procurement because construction and/or operation are contracted out to the private sector.
Infrastructure Australia’s website lists more than 30 PPPs contracted since October 2014 and 12 PPPs on the market since November last year, yet the agency’s Chief Executive, John Fitzgerald says the number of PPPs in Australia is fairly low – at around 10 to 15 per cent of all projects – compared to Canada and the UK.
He believes the reasons for this are several: lack of political will, state governments and bureaucracies with differing ideologies and a lack of government officers experienced in administering PPPs.
“The current Australian federal government certainly has an agenda to try and use PPP arrangements to a much greater degree and they’re looking for avenues to increase their use,” Mr Fitzgerald says.
He notes a lack of experience dealing with PPPs at state level may have hampered their development.
“There’s a tendency for inexperienced public servants to want to transfer as much risk to the private sector as they can. If you’re transferring too much risk, you end up paying a premium.”
Mr Fitzgerald says NSW and Victoria have led the way so far but Queensland is catching up. There seems less appetite in other states.
What makes a successful PPP?
For a contract to work, it has to suit both sides in terms of what is what is being built or delivered.
Mr Fitzgerald says a successful PPP requires a program where risk can be quite clearly delineated, for example, like roads, schools, prisons and hospitals, and where there are well-defined, measurable performance targets to help both parties understand their obligations.
Highly technical projects don’t thrive under PPPs because risk is hard to quantify and manage; nor do agreements involving more than two sponsoring parties because it is “hard to get clarity of transferred risks: a three-way argument.”
Prof Menezes says PPPs are ideal where controlling cost overruns is important, but cautions contract format is critical and should vary according to the nature of the infrastructure.
“It makes little sense to expose a road concessionaire to demand risk. First, the private parties bearing demand risk do so in exchange for a risk premium … to the extent that [the private sector] cannot influence demand, the government may be the best party to hold the risk,” he says.
In this case, availability payments could be used and contracts renegotiated, e.g. extending a contract’s length until a private company recovers their costs, rather than leaving the company reliant on user pays tolls. There’s no shortage of hard lessons.
“In Australia most of the recent failures (AustralAsia, Adelaide-Darwin railway projects, Cross City Tunnel, Clem7 tunnel, Airport Link) are due to design: the combination of a fixed duration for the concession and the transfer of demand risk to the private operator was not an optimal design,” Professor Menezes says.
Partners in advantage
Prof Menezes says efficiency gains, where the same company or consortium is building, operating and/or maintaining a project, are one main advantage of PPPs.
“When bundling occurs (and as long as tender process is well designed), the winning firm should minimise the total of construction and maintenance/operating costs,” says Prof Menezes.
“Bundling also avoids a government’s temptation to save on maintenance in later years.”
Private financing can also avoid the construction of politically motivated white elephants.
“Private parties will find it difficult to obtain financing for a project that is not commercially sound.”
But there are differences over whether shifting risk to the private sector is a benefit of PPPs and the extent to which this shift occurs.
Mr Fitzgerald sees risk transference as one of the key benefits of PPPs but points out the higher premiums charged can mitigate this benefit.
“The biggest advantage is transferring risk for the life of the asset, so over 25 to 40 years you’re transferring the risk, not just the built asset but the risk of the services that asset provides over a period of time,” Mr Fitzgerald says.
Prof Menezes argues that governments often end up absorbing some of this risk when private companies flounder because of cost blowouts, debt servicing problems and, in some cases like toll roads, low patronage.
When projects fail governments may step in to renegotiate contracts or make transfer payments to shore up private companies and keep the PPP going.
Pushing too much risk onto the private sector can mean projects fail, thereby discouraging future investors. Private companies can also demand higher returns or submit less competitive bids. The effect is that project costs increase and the public pays more to use future infrastructure.
One of the disadvantages for governments of PPPs can be a loss of control over the design and building of an asset and the service provided, says Mr Fitzgerald, but he argues that this may not necessarily be a bad thing.
“That control often leads to overruns of projects or poor service delivery. “
Since PPP contracts are usually long-term, sometimes 25 years or more, they can mean a loss of flexibility compared with delivering assets and services in-house.
“If you want to change an asset or how it operates, you can’t do it unilaterally. You have to do it with the private sector and there are many examples of where this has been done successfully,” Mr Fitzgerald says.
He says PPPs tend to be more costly because governments are negotiating more complicated contracts than traditional public tendering, but this can pay-off.
“There’s more discipline around them because you really have to understand the risks and how it’s transferred and all the financing arrangements. If you saw that rigour around traditional design/construct contracts then government would get better outcomes than they have in the past.”
And of course, PPPs can go horribly wrong and cost both parties dearly. Construction companies can incur significant losses and special purpose vehicles can go bankrupt.
Witness the failure of Brisbane’s Clem7 tunnel, sold in 2013 for a fraction of what it cost to build or Sydney’s troubled Cross City Tunnel, which sold in 2014 for one-quarter of what it cost to build.
Both experts argue for proper evaluation of PPPs once they’re built and operating to improve understanding of their benefits and outcomes to build on successful projects and avoid future failures. Examining comparable PPPs in other countries also helps.
Prof Menezes says capacity building in the public sector is also important.
“We just need to spend more time thinking through and developing that institutional knowledge and innovation, looking back at what we’ve done and being a bit more confident and then we can use variable contracts or availability payments. We need to be a bit more creative,” he says.
Prof Menezes says allocating risk appropriately through the tender process and putting more thought into contract design would go a long way to delivering better outcomes for PPPs.
One way to do this is to ask companies to bid for the revenue they need in order to enter into a PPP, for example, to build and operate infrastructure such as a tunnel or highway. This bid would be based on estimates of how much it might cost to build and operate infrastructure and to service the debt incurred.
Take a new tunnel for example; the government announces a discount rate and uses it to calculate current revenue and tolls. That discount factors-in that $100 million today will not be worth the same as $100 million in ten years. The firm submitting what is called the lowest present value of revenue wins the tender.
“The innovation of this process is that the duration of the concession is variable. The contract only expires when the winner of the tender recovers the amount of revenue bid. The risk of demand is born by the government while competition for the contract ensures that society gets value for money from the PPP,” Prof Menezes says.
He adds the firm with the lowest construction and operating costs wins the tender, rather than the firm with the most optimistic view of demand.
Contracts could contain renegotiation trigger clauses so that a company can recover their costs, for instance, in the event of currency devaluation or a natural disaster.
In Chile, for example, a panel tries to secure PPPs by providing guidance on what happens in the event of contract renegotiation. This could involve going to an arbitration panel.
“It’s never going to be perfect. You’re trying to anticipate what the major risks are,” Prof Menezes says.
This story first appeared in Government News Feb/March 2015.