The Myths and Facts about Public Private Partnerships 2

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Monday, March 28th, 2016
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Ask 10 people on the street how they feel about public private partnerships (PPPs) in Australia today and you will most likely encounter a variety of sentiments and responses.

Amid requirements to cater for growing infrastructure demands in an environment of constrained public finances, however, the level of private sector involvement in public infrastructure and service delivery including through PPPs will no doubt continue to grow.

In this environment, it is important to look at common perceptions surrounding PPPs and evaluate whether or not these indeed hold true in reality or are the product of fallacies or misconceptions. According to leaders who work closely on the structuring of PPP related arrangements, common notions which fall into the latter category exist in a number of areas.

First, there is cost. Owen Hayford, a Sydney-based construction lawyer and partner at Clayton Utz, says there is a perception that the use of private sector financing which typically occurs through PPP type projects essentially represents a form of ‘free’ money from the point of view of taxpayers.

To show how this is not correct, Hayford says PPPs can broadly be broken down into two distinct categories: user-funded PPPs and government-funded PPPs. Under the user funded PPP model – which has been used on some road projects in the past but has not been adopted on more recent projects – the special purpose vehicle (SPV) set up by the PPP equity partners finances, builds and operates the asset in question and derives its return on investment not from taxpayers but instead through user charging methods such as road tolls. When projects are fully funded in this manner, assets are indeed paid for using private sector money (and subsequently, through user charges) at no cost to the taxpayer.

More common, however, are government funded PPPs, where private capital finances, builds, maintains and sometimes operates the asset in question. In these cases, the private backer earns its return on investment not through user charges but instead through availability or service charges paid by the government over the life of the asset as compensation for making the asset available for public use.

These types of arrangements are commonly used in PPPs which relate to social assets such as schools, hospitals or correctional facilities, and have been used on some of the more recent PPPs relating to transport assets. Under this type of PPP, the cost of building, operating and maintaining such assets ultimately falls on the taxpayer through the availability or service charges, and the private sector capital which is advanced up-front to build and operate the asset is not indeed ‘ free money’ but merely a form of project financing.

“That revenue or that money is coming out of government funds,” Hayford said, referring to the money charged by the SPV in return for making the asset available for public use. “It’s not free money, it’s taxpayer money.”

“If they (the government) do a user-funded PPP, they can get those who benefit by using the infrastructure to pay for it. But if they are doing government funded PPPs, then it is government that is paying for the infrastructure via that service charge.”

A second area of misconception which Hayford says is commonplace revolves around a belief that public private partnerships are more expensive compared with traditional government funded projects. This notion arises out of the fact that the special purpose private sector vehicle, which might have a credit rating of perhaps A- or BBB+, must pay a higher level of interest in order to borrow the necessary funds to finance building of the relevant asset compared with what governments with their AAA credit rating would have to pay in order to do likewise.

Whilst governments are indeed able to use the strength of their credit rating to borrow more cheaply, Hayford says it is important to take into account the risk transfer which takes place in a PPP type of arrangement.

Where equity partners involved in a PPP borrow to finance their investment, the recourse available to the lender if things go wrong is typically limited to the assets held by the SPV. By contrast, governments borrow on a non-limited recourse basis and taxpayers are forced to cover money owed to the lender irrespective of the success or failure of the project in question. Accordingly, the higher rate of interest charged by lenders in a PPP situation compared with that of direct loans to government simply reflects the fact that lenders assume a much greater portion of the risk under a PPP type arrangement.

Moreover, while the financing costs of a PPP are notionally more expensive from a taxpayer viewpoint compared with traditional government borrowing, this is largely offset by the fact that it is equity holders and lenders rather than taxpayers under a PPP who generally assume the risk where the project does not succeed.

Stan Stavros, head of infrastructure and projects at KPMG, agrees, adding that a broader view needs to be adopted when thinking about cost. Apart from the financing mechanism itself, PPPs generally have a good record of delivering projects on time and within budget, Stavros says, as well as unlocking greater potential for innovation and better outcomes when compared with traditional procurement approaches.

Furthermore, Stavros says, another myth revolves around the notion of their being a singular static model for PPPs. Whereas the traditional early model of PPPs in the 2000s often saw the private sector finance, build and maintain assets while core services were provided by government, he says a number of arrangements being entered into today are moving beyond this.

In the case of the Ravenhall Prison project in Melbourne’s outer western suburbs, for example, the GEO consortium has been contracted not only to build and maintain the facility but will also be responsible for its operations including the provision of custodial services. In the case of the Northern Beaches Hospital project in Sydney, meanwhile, the building of the hospital is actually taking place on a turnkey basis, with the successful Healthscope-led consortium receiving payment upon practical completion of construction. A subsequent provision of operating and maintenance services over the following 20 years will be paid for via a service charge.

Beyond that, innovative arrangements are happening involving the bundling of large numbers of smaller projects together into singular PPPs. Overseas in Pennsylvania, for example, the job of repairing no fewer than 558 aging bridges (primarily small bridges on major highways in rural areas) has been bundled together under a singular PPP. The Plenary Walsh Keystone Partners consortium is completing the work over three years and will maintain the assets over a subsequent 25 year period.

A fourth area in which misconceptions abound revolves around the idea that projects which have involved the insolvency of the SPV vehicle are necessarily ‘failed’ projects. While he acknowledges that a number of projects involving insolvency have indeed seen disastrous outcomes in which the government has had to step in, Hayford argued in a 2013 paper that some projects which have seen the SPV go belly up have indeed not been failed projects at all.

In the case of Sydney’s Cross City Tunnel, for example, the receiver appointed by the lenders was able to on-sell the project and the government did not have to bail out the project or fork out any additional money. The road remained open at all times (there were even periods where the tolls were in fact reduced) and the public received a significant piece of infrastructure at a lower cost than what would have been the case under a publicly funded delivery model, Hayford argues. The sale price for the project, meanwhile, was sufficient to ensure lenders were paid in full. Contractors, too, were fully paid.

Finally, Initiative Capital executive director Gerard Paynter says there are sometimes differing beliefs from different camps about who should provide services. While many on one side feel that services are generally delivered in a more compassionate manner by the public service, Paynter says, others feel that private sector participants who involve themselves in PPPs can have margins squeezed by a public sector which some see as being suspicious of the notion of profit.

He says there are in fact some services which are suitable for private sector delivery and others which are better delivered by the public sector – the latter of which generally relate to services where the creation of a competitive environment is difficult and where there may not be a clear ability for the private sector to deliver an adequate return on investment.

“I think there are two (misconceptions) and they go in different directions,” Paynter said. “The first is from the public sector culture which feels that the public sector delivers everything in the best, most complete and most compassionate manner. That’s a very pro-public service area which is quite suspicious of private sector involvement.

“Conversely, on the private side, there is a belief that the public sector looks on activities that make a profit with suspicion and therefore they typically try to squeeze profit out of private sector rather than just focusing on the outcome.”

As for why misconceptions may be propagated, Stavros says that while the nature of PPPs is well understood within industry and government, broader community awareness about PPPs, how they actually work and the benefits they deliver is limited. The benefits of PPPs were well-explained early on, he says, but some of the major benefits may not have been articulated as actively in recent years. This includes the whole-of-life benefits associated with PPP type arrangements which arise out of the fact that PPP type arrangements bundle maintenance, and sometimes operations, of the asset with design and construction.

Paynter, meanwhile, feels that some of the misconceptions surrounding PPPs arise out of their transactional nature and some of the different viewpoints which might originate according to different sides of the fence within the transaction. He says it is important to adopt a genuine partnership model and to be open and transparent with regard to tender processes and information about the true nature of costs, as they vary between public sector provision of services as opposed to that delivered by the private sector.

Around Australia, the number of public private partnerships going through looks set to increase over time.

Whether or not this will happen in an environment of informed debate will depend largely upon whether or not ideas or perceptions surrounding PPPs are subject to sufficient levels of scrutiny to ensure that those which do indeed play out in reality are separated from those which perhaps may not.

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2
  1. Barry B

    User paid PPP is the way to go in future – the only effective means of properly leveraging market incentives to produce first-rate infrastructure.

  2. Roger Jones PEng FEC

    Public service staff (bureaucrats, management, builders and operators), are paid 20% to 30% more than their equivalents in the private sector – this finds its way into the total cost of the project to the taxpayer. Additionally, bidding on a "government job" attracts higher prices from suppliers. I sense that PPP goes some way to remedying this problem as I don't see how we will ever get the public service to be competitive. There is no effective marketplace and politicians are always spending "other people's money", even if borrowed (but that's another problem.)