PPPs - Considering all the options

By Owen Hayford and Doug Jones AM RFD.

Key Points:
A number of Australian PPP policies focus on privately financed PPPs, but to ensure the best value for money outcome is achieved, all possible PPP delivery models should be considered. Governments should consider allowing bidders to form their own view about the right PPP model when preparing their bids, so that competitively bid prices for those delivery models which the market considers best meet the Government's requirements can be compared.

The use of private sector finance to fund the provision of public infrastructure has become increasing common in Australia and internationally over recent decades. Since 1989, private spending on infrastructure in NSW has totalled over $5.5 billion. The NSW Government forecast that over the next decade, the private sector will finance $29 billion worth of infrastructure projects. Internationally, in 2003 privately financed infrastructure deals in the UK totalled over £11.5 billion. With a view to harnessing private sector involvement in public infrastructure development, all Australian States and Territories now have policies of differing levels of sophistication governing what have now been termed Public Private Partnerships, or PPPs for short. Indeed, the current NSW policy is now in its third generation, building on the policies previously published by the NSW Government in 1990 and 1995.

While many Australian PPP policies define PPPs broadly to include any relationship between a Government party and a private party to deliver public infrastructure or facilities and related ancillary services, a number of the policies and associated guidance materials focus on privately financed PPPs, as opposed to publicly financed PPPs. For example, the NSW Government's Working with Government – Guidelines for Privately Financed Projects apply only to privately financed PPPs. Others, such as Partnerships Victoria and the Queensland PPP policy, while more inclusive on their face, are also primarily directed at privately financed PPPs (as evidenced by their encouragement of long term service based payment structures). Indeed, all of the eight projects reviewed as part of the recent Fitzgerald review of the Partnerships Victoria policy are privately financed projects.

One question which is frequently asked in relation to privately financed PPP projects is how it is possible for such projects to be delivered at a lower overall cost to Government than publicly financed projects, given Government can borrow finance at a lower cost than the private sector.

The simple answer is, assuming all things are equal, that it is not possible. However, the better answer is that all other things are usually not equal, and that there are other differences between privately financed and publicly financed projects which can enable a privately financed delivery model to provide a better value for money outcome than a publicly funded alternative. In this regard, the value for money drivers for privately financed PPPs are typically said to be:

• Risk transfer – PPPs allow Government to transfer risks to the privately sector which the private sector party is better able to manage at a lower cost than Government, thereby reducing the overall cost of the project to Government.
• Whole-of-life costing – The long term nature of PPPs often requires the private sector party to assume responsibility not only for the design and construction of a facility, but also for its operation, maintenance and refurbishment. This provides a commercial incentive for the private sector to adopt design and construction methodologies which will minimise the overall cost of building, operating and maintaining the facility through life.
• Innovation – PPP projects focus on output specifications, thereby providing private sector bidders with the opportunity to develop innovative design and other solutions so as to meet Government's requirements at lower cost.
• Asset utilisation – Some PPP projects provide opportunities for third party use of the facility, thereby generating revenues which would not be derived if the facility were built, owned and operated by Government (due to absence of commercial motivation). These third party revenues can reduce the cost Government would otherwise pay as sole user of the asset, or alternatively open up opportunities for upside revenue sharing.

But are the above value for money drivers limited to privately financed PPP projects? Put another way, is it possible to develop a project utilising a project delivery model which captures these value for money drivers, but which uses public sector funding instead of more expensive private sector finance, thereby further reducing the overall cost of the project to Government?

The answer, for many projects, is probably yes.

Consider, for example, the $2.2 billion Pacific Highway Upgrading Program on the Central and Northern coasts of New South Wales. These upgrades are being delivered using a design, construct and maintain (DCM) delivery model. The NSW Roads and Traffic Authority (RTA) enters into a single contract with the private sector for the design, construction and, for a 10 year period, maintenance of the upgrade. This delivery model has enabled the RTA to:

• transfer to the private sector risks which the private sector was willing to manage at lower cost than the RTA, thereby reducing the overall cost of the projects to the RTA;
• provide the commercial motivation (via a lump sum maintenance fee) required to encourage the private sector to adopt a whole-of-life approach to the design, construction and maintenance of each project; and
• provide the private sector with an opportunity to develop innovative solutions which satisfy the RTA's output focused requirements for each project.

Furthermore, all of the above value for money drivers are being achieved without the utilisation of private sector finance.

There is also no reason why the DCM or design, construct, maintain and operate (DCMO) delivery models cannot provide opportunities for third party revenues, for suitable projects.

Of course, the above example does not necessarily demonstrate that all road projects can be delivered at a lower cost to Government by utilising a publicly financed delivery model (such as the DCM/O model), rather than a privately financed delivery model such as the build own operate and transfer (BOOT) model which has been adopted for Sydney's tollroad projects. Each project, and its risks, needs to be considered on its merits so as to identify the project delivery model which best achieves Government's objectives for that project. For example, most rural highway projects would be unlikely to generate the traffic revenues required to support a traditional user pays BOOT delivery model.

Consider also the National Museum of Australia project in Canberra, delivered by the private sector under a public sector financed project alliance delivery model. By most accounts, this project achieved high levels of innovation, with resultant time and cost savings for Government which would not have been achievable under a traditional public delivery model.

What the above examples do demonstrate is that a project does not necessarily need to be privately financed in order for Government to capture the benefits which a Public Private Partnership can deliver. To ensure the best value for money outcome is achieved, all possible PPP delivery models need to be considered.

A stated objective of some of the current generation of Government PPP policies is the maximisation of value for money, as opposed to overcoming fiscal constraints and Australian Loan Council borrowing limits. To this end, the policies generally require all privately financed PPP projects to be measured against a Public Sector Comparator (PSC) – a theoretical benchmark reflecting the cost of Government delivering the required project outputs based on the relevant Government agency's assessment of the most efficient alternative delivery method. The PSC may be based on a delivery option involving private sector participation. Indeed, for many large-scale infrastructure projects, delivery by the private sector is now the only realistic option.

A deficiency, however, in the current PPP policies is that they do not allow the market to determine which delivery model will best achieve Government's objectives (including the achievement of best value for money). Rather, they require Government agencies to:

• call for bids based on the PPP delivery model which the Government agency (rather than the market) considers will best achieve Government's objectives; and
• test the value for money of bids against a PSC encapsulating the agency's (rather than the market's) best estimate of what the project would cost under what the agency considers to be the most efficient alternative delivery model (which may or may not also involve some private sector participation).

Accordingly, it is possible that the Government agency may choose a sub-optimal delivery model for purposes of calling for bids, and/or may choose a sub-optimal delivery model for the purposes of building the PSC. Optimism bias in determining the risk-adjusted project cost under the PSC delivery model is also an ongoing issue.

As an alternative, it is suggested that Governments should consider allowing bidders to form their own view as to the most suitable delivery model (perhaps within defined parameters). This would allow the market to determine which delivery model best meets Government's requirements and objectives, and enable Government to compare competitively bid prices for the delivery models proposed by bidders. Such a process should provide Government with even greater certainty that the project delivery model selected represents the best value for money outcome for Government. At the very least, Government agencies should consider and assess the full range of PPP delivery models (including those not involving private sector finance) before proceeding to call for bids based on a privately financed delivery model.

Adopting such an approach would also address the concerns being expressed by some stakeholders regarding the involvement of the private sector in the development of infrastructure, based on an objection to the private sector's higher cost of funding it.

For further information, please contact Owen Hayford and Doug Jones AM RFD.