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My issue with the Transmission Gully PPP

Whether or not transport public-private partnerships (PPPs) are a good idea has once again reared its head in recent times – due to discussion about the Transmission Gully project near Wellington. The Transmission Gully project (which is a decidedly dodgy project regardless of how it’s funded) will cost around $1 billion to build, but because the construction will be done through a PPP the amount of money that will eventually be paid by NZTA is more like $3 billion.

This is what the Green Party noted, after a Select Committee meeting where the figures were discussed:

NZTA head Geoff Dangerfield conceded at the Transport and Industrial Relation Select Committee that it would cost the Government $1 billion to build the Transmission Gully motorway, but that service payments under the preferred PPP approach will be triple that over a twenty five year timeframe.

“The Government is locking tax payers into long-term payments for an expensive and unnecessary motorway that will be very profitable for the private consortium building it,” said Green Party transport spokesperson Julie Anne Genter.

“Public-Private Partnerships are just an expensive form of borrowing, and borrowing to build an uneconomic highway is an irresponsible use of taxpayer money.

In response, the NZ Council for Infrastructure Development last week highlighted that the much larger figure needs to be taken in context to reflect the inclusion of financing costs and maintenance of the motorway, as well as the level of risk taken on by the private partner:

The benefit under a PPP contract is that, in so far as possible, risk is assessed up front and allocated to the party that is in the best position to manage the risk. When risk is not assessed correctly the party making a mistake is the party that pays for it.

“This is exactly what we have seen in Australia, where several PPPs have underestimated the risk that traffic demand will not be as good as expected. A common misconception is that these PPPs have failed. In fact the opposite is true. In passing demand risk onto private parties, the government, and the tax payer, have not had to carry this cost. It has almost fully fallen on the investors and the financiers who have put their money at risk. Under conventional procurement, we often don’t see these sorts of failures accounted for because the tax payer’s deep pockets keep poorly designed projects afloat and hide the real costs to taxpayers.

“Limited Knowledge also plagues understanding about the total costs of PPPs. In the case of Transmission Gully, it is easy to make headlines by saying the total cost of the project will be three times its $1billion construction cost.

“Again, what is poorly understood is what that $3 billion represents. It includes the cost of construction plus the operation and maintenance of the motorway over 30 years plus repayment of debt plus interest and transfer of construction and operating risk to the private sector. Cost blow-outs or failures do not sit with tax payers and if the road is not open and to standard every day for 30 years, the public withholds payments. The PPP will only proceed if a successful private sector bid to design, build, finance, maintain and operate the new road provides a better overall outcome than more traditional procurement methods.

“This will require bidders to develop innovative solutions to constructing and maintaining the road for the duration of the 30 year concession period, and beyond, maximising the value for every dollar spent.

“Although debt funding will incur capital and interest repayments into the future, the benefit is that people using the corridor in the future will also contribute to its cost.

“The purchase of a home provides a helpful analogy to understanding the structure of a PPP. Before you even bid at an auction or build a home, you may well spend several thousand dollars on lawyers, builders reports, designers, bank loan applications and engineers. These are comparable to the $60 million on Transmission Gully, with the notable exception that the upfront costs for Transmission Gully include sophisticated analyses which must always show that the public is getting best value for money, or the project does not proceed as a PPP.

“After you’ve bought your house, as any homeowner knows, the spending doesn’t stop. Sometimes you find there’s something wrong that needs fixing. That risk sits with you, which is why smart buyers pay for builders and inspections before they buy. Then there are the lawns that need mowing, the drains that need clearing, the repaint, the new roof, a replacement hot water cylinder and all that sort of thing.

“Once you collate all these expenses and add them to the debt repayment over 30 years, whatever you have in total paid for your house looks nothing like the figure you paid for the home. This is the equivalent of the $3 billion figure associated with the Transmission Gully project.

I understand the logic behind borrowing for infrastructure investment – even if it means that you end up paying much more for the project in the form of long-term repayments. This means that those who benefit from the project end up paying for it and can smooth out the cost of paying for large pieces of infrastructure. It’s essentially a larger form of buying your house with a mortgage.

However, it’s pretty easy to borrow money without needing to involve a private partner. Furthermore public agencies are generally able to borrow at lower interest rates than the private sector so there’s actually a disadvantage from the beginning from going with a private partner – if you set the issue of risk aside. And it is that issue of risk that becomes clearly the important issue here: as NZCID note the failed Australian PPPs aren’t actually failures in terms of the public partner, they have actually been quite successful in getting the piece of infrastructure built and it’s the private sector which has worn the messy results of terrible demand risk estimates.

The failure of Australian PPPs on the demand risk issue (i.e. projecting far higher traffic demand than what actually eventuated – a familiar story!) has had a huge impact on the structure of transport PPPs, with the Transmission Gully PPP being structured in a way that doesn’t actually transfer any of the demand risk onto the private sector. In effect, it sounds like NZTA will pay the private partner a set fee each year regardless of how many people actually use the road.

In effect this leaves the only risk for the private partner to take on being related to standard things like construction and maintenance. As far as I know these are things which NZTA already undertakes a lot of ‘risk-sharing’ on – which might sit behind why it’s incredibly rare for motorway projects these days to go over budget.

So to summarise I can’t actually understand what the advantage is from having Transmission Gully as a PPP if there isn’t going to be any demand risk in the deal allocated to the private sector. NZTA might as well just borrow the money themselves at a much lower rate, cut out the middle-man of the PPP’s private partner and undertake a normal risk-sharing arrangement in the construction and operation of the road itself. Of course an even better thing to do would be to simply not build the road because it’s a stupid waste of money – but the PPP arrangement seems to be turning a stupid waste of money into a REALLY BIG stupid waste of money, for pretty much no gain whatsoever (except to the private partner who basically gets a risk-free investment at the taxpayer’s cost).

26 comments to My issue with the Transmission Gully PPP

  • Brendan

    Isn’t the gain the ability to incur debt that doesn’t show up on your balance sheet? Off balance sheet debt worked really well for Greece for many years.

    • Mr Anderson

      Yeah I think the whole “accounting trick” remains the only benefit of a PPP once you take away transferal of demand risk.

    • Stu Donovan

      Exactly – and the first government that moves from “paygo” to “debt funding” will be in a position where they can effectively lock future governments into paying for the former’s pet projects. National’s being very clever in a way: Build the highways that they want on their watch, but set them up so that the costs are still being paid for by governments 20 years from now. Allows you to build much more!

      Given that the “debt” National is assuming through these PPPs on the behalf of future governments is not (as far as I know) recorded under normal budget processes, then I’d go as far to say that these PPPs are contrary to the spirit of accountable and transparent government.

      From the outside it seems that National is blowing a billion dollar hole in the transport budget that is deliberately designed to lock future generations into particular transport projects, but at the same time doing it in a way that keeps it off the books. “Shameful smoke and mirrors accounting tricks” is the word that springs to my mind when someone mentions these PPPs.

  • BD

    Public transport news gets even better, even the trams face cutbacks, the stupid thing is they had 2 years to get them to go all the way to britomart which would have been successful and generate a lot of patronage but instead the might consider scraping them altogether, so much for a country that invests in public transport, go to hell National I really hope you loose the 2014 election.

    • Mr Anderson

      That’s got nothing to do with the govt and is irrelevant to this topic. We may have a post up on that issue later today.

  • Pierre

    it’s incredibly rare for motorway projects these days to go over budget

    Are you sure?

    • dan

      Yes I think it’s more a case of how they are sold. VPT was meant to cost $300 million but once you start saying it was meant to cost $400million its back in budget.

  • Christopher T

    In the interests of accuracy it really should be called a PPSR scheme (privatise the profits, socialise the risk).

  • So it is a good thing according to the NZCID that investors lose their shirts off their backs?! Now the pendulum will swing the other way and private partners will only get involved if the returns are guaranteed. What is the point of their involvement then?

  • “This will require bidders to develop innovative solutions to constructing and maintaining the road…”

    Current tendering processes should already achieve this. This is not unique to PPPs.

  • A $3,000,000,000.00 price tag to build a $900,000,000.00 road that has $300,000,000.00 of benefits being duplicative to an existing road.

    It’s criminally insane and completely indicative of the intellectual and moral bankruptcy of the current government.

    Tell all your friends to change the government come 2014.

  • obi

    How is this different to the government renting office space? The government lets developers and investors construct buildings, rents space in them, and pays for the space with a monthly rental payment over a period of years. The investor who owns the building pays interest on the money they borrowed to construct the building, and also performs all maintenance on the building. The construction risk, any risks involved in maintaining the building, and the risks involved in owning the space when the government no longer needs it are all outsourced to the investor.

    There is some merit to costing a project over its lifetime (or lifetime for a reasonable period in to the future), including interest payments and maintenance costs. Genter has been doing this in parliament recently, including interest charges in her costings for roading projects. I’d be interested to see what this does to non-roading projects… the sticker price for the CBD rail tunnel already includes extra trains and other network improvements, but we’d need to add 30 years worth of maintenance, interest, operating costs for the tunnel and stations, and additional subsidies for rail users. It might well end up being a $20billion tunnel.

    • Most of the road’s maintenance costs would come after the 25 year period when it is older surely, when it’s back on the taxpayers.

      • obi

        There must be some sort of preventative maintenance going on. I once saw some workers injecting some sort of compound in to the minute cracks on the surface of an autobahn. Presumably that stops the cracks turning in to holes. They had a lane closed and the workers were walking along with spray guns stopping every so often to do the injecting. Plus, you need to paint markings, fix damage caused by accidents or weather events, keep foliage under control, etc.

        However… Being paid a fixed price for maintenance over a long period gives you an incentive to build the thing properly in the first place. Build the road (or railway line, or office block, or whatever) cheap and you’ll suffer financially for the next 30 years while you pay for repairs. Build the road to a high standard and you’ll be collecting money for nothing. I think the non-PPP system gives contractors an incentive to bid low and build cheap.

  • SteveC

    things like redoing lane markings come in pretty quickly into the project’s active use

  • Sacha

    “How is this different to the government renting office space?”

    Office space is not monopoly infrastructure. It can be rented to a number of organisations besides public agencies. Who do you imagine the alternative users of a public road might be?

    • obi

      And that makes a difference how, exactly? The government wants something (a road, office space, electricity, computer servers, etc) and buys it off someone (Fletchers, Bob Jones, Meridian, HP, etc). The procurement is competitive. At the end of the day, it is just a service that the government wants.

  • From the perspective of society as a whole, PPPs shift risk from the government to the private sector but the risk still exists, unless the private sector is better at managing risk that the government and total risk reduces as a result (which is arguable).

  • I would like to see a side by side comparision of the total project costs over 30 years: the PPP on one side, including all interest payments; and the standard NZTA procurement model, including capital costs, and ongoing mainteneance costs for that period. Apples with apples.

    • Anna

      Bearing mind there are standards and levels of service, it would be good to have the ability to make this comparison especially if you cost in the opportunity cost of investing in infrastructure or services that are genuinely needed. There is ver little opportunity for innovation in solution it design as these things have already been determined. There is no demand risk . It has been pursued for ideological reasons.

  • Trev

    A better solution seems to be the deal over Auckland’s electric trains where CAF build them and then maintain them for a decade. However, ownership of the trains is always with Auckland Transport and it’s not a PPP in that CAF aren’t paying for the trains up front and then charging the higher interest rate onto Auckland Transport.

    • Greg N

      Trev
      Maybe CAF isn’t being a PPP operator, but the government certainly is as far as the EMUs go – and is doing the middleman act including the higher interest rate thing to boot.

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