30 May 2011

Let the private sector improve Sydney ferry services

The commitment of the new NSW Liberal Government to involve the private sector in the operation, maintenance and leasing of the Sydney ferry fleet is good public policy.

Indeed, the Special Commission of Inquiry into the Sydney Ferries Corporation commissioned in 2007 by the then NSW Labor Government concluded as much. The Commissioner, Bret Walker SC, observed that there was an "urgent need for an entirely new fleet of ferries for Sydney", and that "the replacement of the fleet is an opportunity to reinvigorate ferry services, provide better services that customers want, and permit expansion". Walker recommended that a comprehensive services contract, including fleet replacement responsibilities, be offered to the market.

Almost 12 months after receiving the Walker report, the former Government called for private sector bids to provide ferry services under a services contract, with which it could compare the financial and quality performance of the Sydney Ferries Corporation (SFC). Curiously, however, the former Government called for bids on the basis that fleet replacement responsibilities would be excluded from the initial services contract.

Ultimately, the former Government decided in April 2010 that the service contract would remain with the government-owned SFC. "Overall, the government is confident that taking into account the individual merits of each bid, the significant improvements made by Sydney Ferries, as well as considering public opinion, the best decision for the community was to retain ferry services in public hands", said the then Transport Minister. Just how much weight it placed on the latter two factors in arriving at this decision - as opposed to the merits of each bid - remains a matter of speculation.

Reinvigorating Sydney's ferry services through a service contract

The new Liberal Government in NSW has a large task ahead of it in prioritising and embarking on much-needed infrastructure building and public transport reform. Outsourcing the operation of Sydney's ferry services is an obvious and easy place to start. So it's no surprise that the new Government has announced that it is seeking registrations of interest to operate Sydney's ferries.

So what form should a 'best practice' services contract to provide ferry services take? At its essence, such a contract should require the operator to provide specified passenger ferry services in return for a service fee paid by the Government.

Why should a service fee be paid? Because it is not possible to recover the cost of providing comprehensive passenger ferry services on Sydney Harbour from farebox revenues alone. The fee should include performance based components, to motivate the operator to continuously improve its performance and service levels. The Government should retain the ability to vary the level and/or quality of services required by the contract, with the operator being entitled to an adjustment to the fee if such variations increase the operator's costs.

Within this basic structure for the service contract, there are many variants which the Government should consider. For example:

  • Multiple operators - Should there one contract with a single operator, or multiple contracts with multiple operators? Multiple operators would enable cost and performance benchmarking, and provide a competitive environment in which Government could seek quotes for additional services. It would also lead to greater innovation, allow each operator to focus on route specific issues, and reduce the risk to Government if an operator defaults on its contract or falls into financial difficulty. Offsetting these benefits, however, are the additional costs and complications of multiple operators (e.g. facility sharing arrangements, claims of interference, sharing of farebox revenues etc).
  • Farebox revenue - Passing full farebox revenue risk to the operator is unlikely to deliver value for money, as patronage levels will be influenced by many factors outside the operator's control (such as macroeconomic growth, road congestion, changes to other public transport modes and fare levels). However, the Government may wish to calculate a portion of the operator's fee by reference to farebox revenue, to encourage the operator to develop strategies to maximise patronage growth, and to minimise fare evasion.
  • Exclusivity - If the Government wants the private sector operator to invest significant capital in a replacement fleet and upgraded or new shore based facilities, it will almost certainly need to provide some level of assurance that it will not act in a manner inconsistent with any key assumptions regarding future government action which underpin the private sector's business case. If the payment regime is structured in a way that a significant portion of the operator's revenue is determined by reference to farebox revenue, such assumptions may include that the government won't award another contract to a second operator who would compete for that farebox revenue.

Why fleet replacement should be included in the initial contract

The Walker report concluded that the primary constraint on SFC's operations is the age and complexity of its fleet. Walker found that SFC operates 12 distinct classes of vessel from an operational perspective and 14 from an engineering perspective. This imposes significant and unnecessary maintenance and training burdens on the operator. Further, several of the vessels have been designed for use on a particular routes and cannot be used on others, making it difficult for the operator to deal with breakdowns or surges in demand. Walker also found that most of the vessels in the fleet had passed their optimal economic life, resulting in unacceptable reliability and maintenance costs.

It was therefore surprising that the former Government decided to exclude fleet replacement responsibilities from the proposed initial term of the services contract. While the exclusion of fleet replacement responsibilities from the initial term of a services contract might provide more time for the Government to determine an optimal fleet and network structure in consultation with the new operator, selecting a private sector operator in advance of a replacement fleet constrains the Government's ability to procure the supply and maintenance of the replacement fleet in a contested environment and thereby achieve the best value for money outcome.

There are significant risks associated with building and owning a replacement fleet. There may be cost blowouts during the design and manufacture of the replacement fleet. The manufacture of the replacement feet may be delayed, resulting in higher maintenance and operating costs due to longer use of existing vessels. Operating and maintenance costs may be higher than expected due to design flaws, the use of inappropriate materials or manufacturing methods, or lower than expected productivity gains. All of these risks can be passed to the private sector. The private sector will build an amount into its pricing on account of the transfer of such risks. However, this additional amount is likely to represent value for money to government when weighed up against the likelihood of the risk materialising if the Government assumes responsibility for the management of the risk, the costs of managing the risk, and the additional costs it would could expect to incur if the risk materialises.

The significant capital expenditure required to replace the existing fleet and upgrade wharves and other shore based facilities, and the long economic life of these assets, also provides an opportunity to utilise private sector capital and free-up government funding for other government projects and services. While the Government can raise capital at a lower cost than the private sector, the additional cost to Government of utilising private sector capital is likely to be a reasonable premium to pay for the transfer of risk to the private sector.

SFC could bid for the contract

There is no reason why SFC could not bid alongside private sector operators for the role of the operator. If SFC was to bid for the role, it could do so on the basis that it would subcontract responsibility for the financing, design, building and maintenance of the replacement fleet to a private sector boat builder/maintainer.

Other possible outsourcing models

Some alternative contractual models for outsourcing Sydney ferry activities include:

  • Keep operations in-house and only outsource fleet replacement and maintenance - Under this model, the Government owned SFC would retain responsibility for operating the ferry services but SFC would call for private sector bids for a contract to finance, design, build and maintain the replacement fleet.

This model would still enable the Government to access private sector capital and to transfer the risks associated with the design, building, ownership and maintenance of the replacement fleet to the private sector.

The main disadvantage of this model is that it wouldn't enable Government to capture cost savings which private sector innovation in the operation of the ferry services would likely deliver. It also creates an interface between the Government owned operator and the private sector boat builder/maintainer which wouldn't exist under the fully outsourced model.

This model could be adopted if SFC won the tender to operate Sydney's ferries.

  • Brisbane Ferries model - Under this model, the Brisbane City Council has entered into a 7+3 year contract under which:
  • the Council is responsible for designing and building new ferries and terminals, and generally retains ownership of these assets;
  • a private sector operator is responsible for the operation of the vessels, vessel and infrastructure maintenance, marketing and fare collection; and
  • the Council retains the farebox and pays the operator a fixed operating fee and performance incentives.

This model avoids an interface between the operator and the maintainer. However, it introduces an interface between the boat builder and the maintainer. This is likely to give rise to disputes on whether service failures are due to poor maintenance for which the operator is responsible, or poor design/building for which (as between the operator and the Government) the Government is responsible. This will limit the Government's ability to effectively transfer risk to the private sector.

The way forward

The present need to replace SFC's entire fleet provides a rare opportunity to restructure the arrangements under which Sydney ferry services are provided with a view to:

  • improving service levels and reducing the associated cost to the Government; and
  • transferring risks associated with the provision of the services from the Government to the private sector.

The full outsourcing model offers the greatest opportunity to capture these potential benefits, but other models could also deliver substantial benefits to commuters and the Government.

 

This article was originally published in the Infrastructure Journal,20 May 2011

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.
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