Building Australia with Ppps

The number of public-private partnerships (PPPs) in Australia has grown steadily in recent years. Australian States were among the first in the world to privately fund roads based on the collection of tolls. Nine private toll roads have been built since 1987 (starting with the Sydney Harbour Tunnel) with total funds raised of around $10.5 billion. Another $5 billion worth is now proposed or in procurement, including the politically controversial $2 billion Mitcham-Frankston toll road in Victoria. The trend towards using similar structures to fund social infrastructure like schools and hospitals, with the State committing to payments over time, has been encouraged by the influential example of the Blair Government in the UK.

According to the 2001 Infrastructure Report Card prepared by Engineers Australia and other groups including the Australian Council for Infrastructure Development (AusCID), an estimated $150 billion of additional investment is required to repair, upgrade and complete Australia’s water, energy, road and rail infrastructure. That sum alone would mean spending another one per cent of GDP annually for at least 20 years before any investment in schools, hospitals and other assets.

Victoria is at the forefront of policy development for PPPs which are now central to the Victorian Government’s policy through a formal PPP program. The Bracks-led Labor Government was behind the creation of a national PPP council to encourage best practice.

Earlier this year strategy consultant Peter Fitzgerald, of the Growth Solutions Group consultancy, finalised a review of the deals then completed under the Partnerships Victoria policy. While these projects can only be finally judged over the long term, the review found that policy to date was generally “on track”.

Fitzgerald singled out the Victorian County Court, which was built in less than two years, as “a case study of the timeliness of delivery and the quality of finish that can be obtained from a PPP”. He also referred to the smaller, still incomplete Echuca/Rochester and Wodonga water plants for their innovative engineering technology and good value for money.

According to Fitzgerald, Spencer Street Station in Melbourne, one of the largest State projects to date, is also a model PPP. He strongly doubts that the Government would have been able to design and build such a complex project in the short time required. “The PPP gives it the advantage of cost certainty,” he says. However, several commentators say the problems that Leighton Contractors has reported on the construction contract show that such risk transfer can come at a cost, and may not be repeatable.

The review noted there is room for improvement. For example, Fitzgerald recommends more streamlined tendering to cut costs and encourage competition, measures that have the support of government as well as the private sector. He advised that the PPP program should generally cover only larger projects worth over $100 million and focus on non-standard schemes where the private sector can innovate more. In Fitzgerald’s view the private sector had clearly shown it could add value on these larger projects - so much so that he believes bid costs as high as $3 million are justified, although this point has been contentious. He also suggests that we follow the lead in the UK and spend more time thinking about what it would cost to complete schemes in the public sector.

Tony Poulter of PricewaterhouseCoopers, one of the leading advisers on PPPs globally, thinks there is a clear case for more PPPs in Australia. “The money that needs to be spent on infrastructure cannot be afforded within State budgets without making every effort to get best value and spread the cost,” he says.

“Getting the private sector to provide the expertise in an integrated package, and only paying companies as they perform the service adequately, meets both these objectives.

“Yes, it costs more to raise money privately, but if you have a structure that creates incentives to do the work better and reduce costs or improve quality, it can still give better value for money.” According to Poulter, the key now for States and the Commonwealth is to bring projects forward with the right structure and then take the right approach to long-term deals. “The problem,” he adds, “is that if they don’t do that, some of the bidders are going to become disillusioned with the process and the level of interest and competition will reduce.”

The shift to social infrastructure

There are now more schemes being planned for social infrastructure like schools and hospitals. The leaders of most of these projects a year ago were investment banks, most notably ABN Amro, which won and closed four PPP deals in succession with an approach that is unprecedented worldwide - the Victorian County Court, Berwick Community Hospital, Spencer Street and the NSW Schools project. The bank took 100 per cent of the equity and underwrote capital market issues (PwC advised the States on all four). It then negotiated fixed-price contracts with construction, transport, retail and maintenance companies to carry out the work.

“There is no secret about why ABN Amro was such an effective deal maker,” says Poulter. “The bank thought about what the State wanted, and responded intelligently and with keen pricing. Now other banks think they can do the same. The not-so-good thing about this is that it’s not the banks’ core business to think about how public assets are provided. Their natural role is to focus on financial engineering, not how the long-term partnerships with the public sector are going to be managed. The next wave of socially-oriented projects needs to get more interest from contractors and service providers leading the consortia. They can bring innovative thinking about the best way to design and operate an asset over its lifecycle.”

State governments are thinking hard about the implications of structures like ABN’s. The bank has reportedly sold its equity stakes in the Spencer Street, Wodonga Waste Water and NSW Schools projects to Development Australia Fund Management, owned by four industry superfunds. Fitzgerald says this creates a new challenge for governments: they can no longer assume PPPs will be long-term partnerships.

However, the development of a secondary market in equity stakes in infrastructure also holds out an attractive prospect, he says: the possibility of a marriage between infrastructure investment and superannuation, which both depend on stable, long-term revenue streams.

Poulter agrees that a secondary market is a good thing for long-term liquidity and stability. “It helps the efficiency of the market,” he says, “because if you can trade your equity, you’re more likely to be willing to invest initially at lower rates of return. But there are still questions to be asked about whether banks are the right leaders of these deals.”



Competition

Limited competition was one concern raised by the Fitzgerald review. The Leighton Group is strong in construction in Australia, but it faces a number of competitors with good PPP experience, including Bilfinger and Berger, Multiplex and Barclay Mowlem.

In facilities management, Serco can compete against the services arms of the construction companies and specialists such as Honeywell. And in the banking market European lenders like Royal Bank of Scotland, Bank of Scotland and Credit Agricole have led the way in offering competitive long-term loans, encouraging domestic banks to do the same. This will make it easier for projects to get efficient long-term financing, and offers a challenge to the previous dominance of bond finance in the sector.

AusCID CEO Dennis O’Neill is adamant that there is now more competition than the current depth of the market requires. “There’s plenty of money out there, which is creating a competitive edge and shaving margins, which is good for taxpayers,” he says.

Fitzgerald is not so sure government is always getting value for money. “Governments have to be more savvy about what value for money looks like,” he says. He believes that margins for risk granted by governments to their private sector partners should be more rigorously tested and evidence-based, and that further study is needed to establish pricing benchmarks. He also recommends a cut in the rate at which the Victorian Government discounts long-term payment streams to private sector partners from 8.65 per cent to the rate paid on CPI bonds.

Poulter notes that the Victorian Government did not accept this recommendation to cut its discount rate, as a pragmatic approach to price seemed to be working. He also believes that public sector benchmarking of risk would in several cases justify not lower but higher prices for PPPs.

Property development

One innovative feature of PPPs in Australia is the emphasis on property through development companies with construction expertise, like Multiplex and Bovis Lend Lease. Europe has fewer such companies.

“If you’re looking to develop an asset that provides public services, it makes sense to ask whether there is a real estate development opportunity that has genuine synergy with the project,” says Poulter. The Darwin Convention Centre, Brisbane’s Southport TAFE project, and the Showgrounds site in Melbourne are cases in point.

Property development can also play an important part in socially-oriented projects. NSW is looking at using PPPs to build affordable housing. Calls for expressions of interest on affordable housing projects are expected later this year, though it’s not yet known how many sites will be involved. The aim is to combine private and public housing with other facilities to create a more sustainable community.

“There are opportunities in NSW to release value by increasing the density of housing,” Poulter says. “Projects elsewhere around the world typically have not offered that prospect: in London or Glasgow, for example, affordable housing is already fairly dense.

“The challenge is to ensure that the potential for property proceeds does not obscure or skew the service objectives of the PPP. What the public sector really needs is a functioning service or a well maintained asset, not just a cheque.”

Breadth of potential

One consistent comment from industry is that government needs greater skills in conceiving, structuring and assessing deals to achieve its aims. Dennis O’Neill says there will be better outcomes with equivalent skills on both sides of the table, adding that the skills gap is narrowing.

In his view the gap will be further reduced when the States have a few more deals under their belts. He believes several in NSW - the Sydney Airport rail link; the controversial $700 million Oasis development by Macquarie Bank and Liverpool City Council; and Port Macquarie Hospital - have given PPPs a bad name in some quarters because some governments lacked experience in deal-making.

The biggest obstacles to a national market, says Denis O’Neill, remain the expense and complications in tendering. The high formal probity standards of some State procurement teams have hindered deals, requiring legal drafting at early bid stages.

Poulter is only cautiously optimistic. “The effort to develop standardised contract terms is continuing and will help to reduce bid costs,” he says. “And there are more projects in the pipeline than a year ago. But the next 12 months is going to be critical in determining whether we have a robust market.”

While the debate continues, the national pipeline of PPP projects certainly points to the breadth of potential for this innovative form of procurement.

The national PPP pipeline (excludes roads)