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Council to look at using PPPs

Len Brown has announced that the city will be looking at using Public Private Partnerships (PPPs) to help fund building some of Auckland’s infrastructure. Here’s the press release.

Public-private partnerships an option for Auckland

Auckland needs to take a good hard look at public-private partnership models for funding infrastructure says Mayor Len Brown, to relieve the financial burden on ratepayers and taxpayers.

Len Brown today released a position paper on PPPs that may be suitable for civic projects in Auckland.

“As the country’s largest and fastest growing city, we have the need for both major investment in infrastructure and finding new, innovative and fiscally responsible ways for this to be delivered,” says Len Brown.

“Every dollar we invest in capital projects – and there will be many billions – needs to make economic sense and be backed by a robust business case. But the traditional procurement and delivery models cannot deliver the infrastructure Auckland needs, which is why I am not inclined to rule out any options that will help us.”

The Mayor says one of the benefits of the Auckland amalgamation was creating the scale to make PPPs at a civic level possible for the first time, and with the Government pursuing greater private sector involvement in infrastructure and services, the public also have a better understanding of PPPs, and why they are distinct from privatisation.

“We have a large and growing body of international experience to draw from – many successful, some not so successful. While PPPs seek to take advantage of private sector expertise and efficiency, a key difference – and a lesson learned early on in the UK’s experience – is that in most successful PPP models, ownership is retained by the public sector, while the risk falls to the private sector.

“That is important for a city like Auckland, where we are seeking to deliver on social as well as economic aspirations through our infrastructure investments.”

Len Brown says with his position paper he aims to kick-start a process of looking at options that might work for Auckland, that would clearly define PPP models and what they can – and can’t – deliver.

“I wanted a realistic, warts-and-all assessment of PPP models. I wanted to know exactly what value PPPs can deliver – both so that we don’t miss opportunities, but also so we don’t trip up.

“PPPs will seldom if ever deliver lower capital costs. We can borrow money at least as cheaply as the private sector. For a PPP to make sense, the prerequisite equation is the value that it delivers – whether it be through applied expertise, commercial synergy, improved service delivery or risk allocation – is greater than any additional cost of finance.

“If Auckland is to be ambitious and prudent, we need to be smart too. While our balance sheet is strong, it cannot sustain the pressure of the magnitude of investment Auckland needs. And the same is true of the Government.”

The position paper includes international examples of where PPPs have or haven’t worked and why. It also lists dozens of projects in Auckland as large as the City Rail Link and as small as the upgrading Auckland’s parking meters that might benefit from PPPs.

Len Brown will now ask council staff to use the framework presented in his position paper to create a work programme through which the council and wider community can have a good hard look at all the options and apply the ones that will deliver real benefits for Aucklanders.

And the position paper is here.

Now I obviously haven’t had time to go through the entire position paper however here are just some initial thoughts on it and the press release.

1. Work out what we actually need

Yes if Auckland is to grow as expected then it will obviously need to invest in more infrastructure and I don’t think anyone doubts that. This isn’t just from a transport point of view but also covers other infrastructure like water and community facilities. However on the issue of transport I think that before we start rushing ahead and working out how to pay for the massive wish list the council is proposing we first need to actually work out what projects re needed.

The list of projects and in the Auckland Plan and their priorities were largely decided at the political level and the modelling in the ITP showed that despite spending $68 billion that measures like congestion would still get worse. So let’s start by actually working out what projects and priorities will deliver the best outcomes for the city. I’m almost certain that if we did that, there would be some substantial changes to what is current planned and of course this is one of the key ideas behind the Congestion Free Network.

2. Different types of PPP

While we work out what is needed in 1. we can of course have a discussion about funding options and I guess that is where this release from Len Brown comes in. The press release does at least acknowledge a couple of key points in that building with PPPs will almost always be more expensive and risky. The question really becomes if the private operator is able to deliver other benefits that would not normally be available to the council/government.

Further not all PPPs are the same and there are different types and it’s important to marry the right type to the right project. The main types of PPP are shown in the chart below.

PPP Types

I have had a number of people from within different parts of the industry tell me that when it comes to just building infrastructure, that pretty much all of the benefits associated with a PPP from private sector innovation can be obtained through an alliance that sees risks shared. That type of model is already used in New Zealand on a number of projects including the likes of Waterview. An example of the type of innovation often talked about is that with more traditional contracts the client (e.g. council) may award a contract to a company that offers the cheapest price. As the project goes one and cost pressures come in they may substitute some materials for cheaper ones but that have higher maintenance costs. By comparison the alliance model apparently allows the builder and client to work though the longer term implications as issues invariably come up.

In short it’s incredibly important that if we go for a PPP that we get the right model for the right project (or part of the project).There may be opportunities for PPPs in some specific parts of projects but if it is just to build infrastructure then our existing contracting methods can likely do that much better.

As an example with the City Rail Link you might find that the council/government pay for the tunnel portion and the basic station box but do a PPP for actual station construction and operations. That might allow for the private partner to buy surrounding properties and integrate that with the station itself to maximise its use through the likes of providing retail and office space, similar to what is done in places like Hong Kong. If that were an option and the council structures the deal right it could significantly reduce the long term costs of building that part of the CRL.

Of course the council or government could do that itself however over the last few decades we have them shift away from these kinds of activities.

3. Demand Risk

Of course when it comes to transport the biggest issue of all is that of demand risk. In Australia the high profile failure of numerous toll roads due to woefully wrong projections on traffic volumes – especially when a toll is involved – has burnt the PPP sector strongly and now it seems they aren’t prepared to take on the demand risk. As such they have ingeniously worked out that they can push that risk back to the public sector which is why we are now seeing projects like Transmission Gully about to be built using an availability contract. That effectively means the private company builds it and the client (NZTA in this case) pays a fee to use it providing it is up to a certain standard. This kind of project is almost certainly a waste of time and money as it presents virtually no risk to the private sector yet is being paid for by more expensive private sector debt. The table below shows where the risk would site under a PPP with the council

PPP Risk Matrix

It’s also worth considering what the shifting of the demand risk says about various projects. It basically confirms that we are in a period of change and we can no longer just assume traffic growth will always happen. If the private sector isn’t prepared to take on the risk on motorway projects themselves then perhaps it’s a good indication the government shouldn’t be either.

4. Deal Structure 

When a PPP deal is put together the banks financing it will go through each aspect and work out how much risk it creates. Just like insurance the more risky you are to the company, the higher they charge you just in-case something goes wrong.

That means if we put out to tender vague documentation, we could end up paying a lot more over a 30+ year period compared to if we had just used more traditional methods. Any variations to the contract along the way can also lead to much higher costs. It also needs to be noted that the private sector can be incredibly tricky and will do anything to find loop holes to get out of deals. The paper notes the case of the Araat Prison in Australia where there were two building companies who set up a joint venture to build the project. However as the project hit difficulty the joint venture split up leaving little opportunity to tie any recourse back to the two parent companies.

Lastly it will be really important for the council to consider the reputational risks and its citizens expectations. For example if we were to build the CRL as a PPP and that involved the operation of the trains too then if something were to go wrong the trains would likely stop running. That could have serious impacts for the economy until the issue is resolved.

 

I think that in conclusion there might be some specific cases where a PPP might actually work for some projects but we are going to have to be extremely careful about how we do them. I have to imagine the NZCID has been pushing extremely hard for this announcement behind the scenes. Their members list contains most, if not all of the organisations involved in PPP industry in NZ. There is probably a lot more to talk about but I’ll end it with this.

At the end of the day PPPs are just another form of debt which is a way of spreading the costs out over a long period of time. It means those that get benefit in the future also contribute towards the cost. The millennials (1980-2000) like myself are the generation that will still primarily be paying for this infrastructure in 30 years-time. So perhaps we should also be considering a focus on the projects that enable the kind of city this group wants to be living in, not the infrastructure that reinforces the ideals of their parents.

26 comments to Council to look at using PPPs

  • George

    Unless a government has very high levels of debt, it can almost always obtain further debt cheaper than the private sector.

    Auckland is not Greece.

    • TimR

      But the main point of PPPs is that the debt sits off the government balance sheet, regardless of cost of borrowing. Who cares what it costs the next generation as long as we can continue to borrow now?

      • I’ve heard this before, but surely a PPP would have to be stated on a balance sheet as a future debt? It is a contractual obligation that is material to the financial picture of the organisation.

        • I think the point is it shifts from being a debt on the books to being an operational cost so yes it’s a forward commitment but in the same way as maintenance is.

        • GTP

          It’s like the way and Operating Lease on a Car doesn’t show on Balance sheet as a debt, you simply expense the monthly lease cost, whereas a Hire Purchase shows as a debt on the Balance Sheet for the balance outstanding. The leasing company is wearing the risk of the residual value of the asset.

          For a PPP it would come down to the exact nature of the contract and who is bearing the “risk”

  • Chris S

    Love your closing statement:
    “The millennials (1980-2000) like myself are the generation that will still primarily be paying for this infrastructure in 30 years-time. So perhaps we should also be considering a focus on the projects that enable the kind of city this group wants to be living in, not the infrastructure that reinforces the ideals of their parents.”
    Totally agree.

    • Rob Mayo

      I second that emotion.

      • Sacha

        Verily. Let’s make clear the repayment obligations on different cohorts of citizens for each of these projects, so it’s clear where the load sits.

    • Dave B

      And as a “baby boomer” (b 1950’s) I too have been banging my head against a brick wall over this whole issue of car-overdependence since I was 14. What triggered it for me was a combined realisation of the phenomenal wastage of rail assets (in Britain) and of the incredibly polarised attitudes to cars which saw them ‘excused’ from all manner of resultant problems. So not all of us BB’s fell for the prevailing ethos of the time, but back then it sure was a lonely path to tread trying to oppose it.

      • Yes I know not all boomers think the same way, as also evidenced by our very own Patrick. Unfortunately just a large number of them. Equally I know there will be plenty of people in my generation who think we should just build heaps of roads and forget about PT but thankfully that doesn’t seem to be the majority.

  • Christopher T

    The Metronet fiasco in London should be a warning to any governmental organisation wanting to enter into PPPs: risk is socialised; profits privatised. An excellent analysis can be seen at: http://www.parliament.uk/briefing-papers/SN01746.pdf‎. By the by, didn’t the dreadful Vector Arena require a large late injection of ratepayer cash in order for it to be completed?

    • Well, yes. I think the case studies have been sugar-coated a bit.

      You’d think it would be pertinent to mention that the Vector PPP (p. 15 Case Study 3) was a complete failure for Mainzeal, and was a contributing factor leading to their financial collapse.

      And the box in case study 9 about Aussie toll roads is misleading when it claims “risk allocation in these structures held and Government has not had to bear any additional costs resulting from the shortfall in traffic”

      Brisbane Govt had to buy Clem 7 back for $618m, on top of the $700m they contributed.

      Spending over a billion dollars of capital on a project no-one actually wants is a huge misallocation of capital.

  • john smith

    Beware of the risk that PPP’s bias transport planning towards projects that happen to be easier to set up as PPPs (usually, tollroads), at the expense of projects that might be more beneficial in an economic cost-benefit sense (usually, public transport investments).

    Prioritising transport investments should be based first and foremost on rational city-wide transport planning considering real economic costs and benefits – not on which merchant bank happens to take a fancy to which project.

    And let us not fall for silly tabloid journalist lines to the effect that PPP failures are a good deal for taxpayers because the investors take the bath and the government picks up the finished project cheap.

    Building white elephants is an economic cost that is bad for the whole community regardless of where the financial loss falls. The $3 billion cost of Brisbane’s wildly uneconomic Clem 7 tunnel, wherever it came from, is money that could have been spent on worthwhile projects.

  • Jacques

    I think it’s OK as long as both the risks and the rates of return to all partners in the alliance are very visible and kept under control by contract.

  • It is important to be clear that PPPs are not a source of Funding, but a means of Financing. We the people still pay, just how, to whom, how much, and for how long is different.

  • Bryce P

    Tear up the ITP (or whatever it is called now) and start again. The numbers that are being bandied around for transport infrastructure are ridiculous and point to us needing a better plan. AT are on a road building program that Robert Moses would be proud to bear his name. Lincoln Rd, East Coast Rd, Te Atatu Rd, GNR, Mill Rd. The list goes on.

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