EUROROADS 2007 UNDERSTANDING THE NATURE OF PPPS E.R. Yescombe Yescombe Consulting Ltd., London [www.yescombe.com] What are the main PPP models? Let me begin by defining what I mean by a PPP, since “public-private partnership” is one of these expressions which can mean whatever the speaker wants it to mean. In my opinion, a PPP involves: Private-sector investment in public infrastructure; plus: long-term service provision by the private sector; plus: transfer of investment and operating risks from the public sector to the private sector; with ultimate ownership normally retained by the public sector—i.e. this is not privatisation. These arrangements can be called “partnerships”, but this is really only a political slogan: they are not partnerships in the legal senses, but long-term contracts between the public and private sectors. The commonest form of PPP in the road sector is the concession, i.e. construction of a road by private-sector investors, for which users pay tolls. Although, as I will discuss shortly, concessions have become more popular in recent years, the concept is of course an old one. The French would probably claim to be the inventors of concessions, first used to finance the construction of a canal in the 17th century. Closely related to concessions in the road sector, but not actually a PPP as defined above, is the franchise (or affermage). In this case the road has already been built by the public sector, and users are paying tolls; private sector investors then buy the right to operate the road and collect tolls for a period of years. There is an overlap between concessions and franchises, since in the latter case investors may have to inject additional investment to upgrade the road. From a risk point of view the main differences between the two models are that in the case of a franchise there is no initial construction risk, and the traffic flow will already be established. Of course outsourcing of road maintenance contracts is also commonplace—the key difference between this and franchises is that the contractor does not have a significant investment at risk in the contract, a point discussed further below. A far more recent variant of PPPs is what I would call the PFI Model, because its modern development originates from the British PFI—Private Finance Initiative—programme, which began in the early 1990s. (In the PPP road sector, the term DBFO—design-build-finance-operate—is generally used to refer to the PFI Model, but sometimes to Concessions as well.) In the PFI Model payment for use of the road is made by a public-sector authority, not by the actual users. Such payment may be based on: – – – usage by vehicles—i.e. so-called “shadow tolls”; or payment of fixed sums provided pre-agreed maintenance and service standards are maintained; or performance measures such as speed of traffic or, e.g. a combination of the latter two systems. Euroroads 2007 E R Yescombe—PPPs A PFI-Model project may involve the public authority charging tolls to users, and using these to pay the PPP contractor. In some countries state-owned motorways raise private-sector financing for new projects rather than rely on government funding. This would not be a PPP as defined above, but from a financing point of view it may share similar characteristics. -oOoOverview of the worldwide PPP road market It is difficult to produce complete, consistent and coherent statistics for the worldwide PPP market. In 2006 private-sector project-finance debt financing raised for infrastructure projects was probably in the range $65-80 billion.1 Road (and bridge / tunnel) projects made up a significant share of this— perhaps 40-50%. The volume of financing in this sector has increased considerably over recent years. Notable road PPP transactions in 2006 included franchise sales of the Indiana Toll Road (U.S.), and motorway operators in France, large new concessions in Australia and Greece, and significant concession activity in both the well-established Spanish market and the very new Indian market. New markets for PFI-Model projects included Austria and Malaysia, and major projects were also concluded in Canada. From a pure financing point of view (i.e. without new investment) there were also some notable refinancings of existing debt, notably for the U.K.’s only major toll road, the M6, as well as the Hungarian M6. Major transactions in 2006 are set out in the table below:2 PPP ROAD PROJECTS, 2006 Amount Region / Country Europe - Austria Project - Finland - France E18 A19 A41 Autoroutes Paris-Rhin-Rhône [APRR] Eiffarie La Société des Autoroutes du Nord et de l'Est de la France [SANEF] Ionia Odos Thessaloniki Tunnel M6 Motorway Limerick Tunnel Wayerford Bypass Mestre Ring Road Autostrada Wielkopolska SA A1 Gdansk-Torun Azores SCUT Shadow Toll Road Autoviá Santiago-Bríon Autopista de Alicante Autopista de Mediterraneo M-407 - Greece - Hungary - Ireland - Italy - Poland - Portugal - Spain Ostregion 1-Ypsilon –2– Type €800m DBFO (shadow tolls + availability fees) €300m DBFO €618m DBFO €840m Concession $2.2bn Franchise sale $7.0bn Acquisition finance for APRR $4.3bn Franchise sale €1,150m €460m €412m €268m €360m €750m €660m €325m €115m €383m €532m €93m Concession Concession Refinancing Concession Concession DBFO (shadow tolls) Concession Concession Concession DBFO (shadow tolls) Euroroads 2007 Region / Country - U.K. Americas - United States - Canada - Mexico - Dominican Rep. - Peru Asia-Pacific - Australia - India - Malaysia - Philippines E R Yescombe—PPPs Project PPP ROAD PROJECTS, 2006 Amount Type Valladolid-Segovia (2 tranches) Pamplona-Logroño Motorway M6 Toll Road €196m DBFO (shadow tolls) US$410m Refinancing £1.0bn Refinancing Indiana Toll Road Pocahontas Parkway US$4.1bn Franchise sale US$420m Transfer of franchise and upgrading C$365m DBFO C$1.1bn DBFO (with tolls paid by users) US$722m Refinancing US$162m Toll road (with minimum revenue guarantee) US$213m Access Roads Edmonton Golden Ears Bridge Toluca Toll Road Santo Domingo Toll Road Concessionaria IIRSA Norte Brisbane North-South Bypass Tunnel Melbourne EastLink Balaji Tollways Indu Navayuga Infra Projects Jallandhar to Amritsar Toll Road Jas Toll Road Krishnagiri Toll Road L&T Vadodara Bharuch Tollway Kumarapalyam Tollway L&T Western Andhra Tollway Lucknow - Sitapur Expressway Mumbai Nasik Expressway Raipur-Aurang Road Salem Tollway Swarna Tollway Tamil Nadu (DK) Expressways Trichy Thanjavur Expressways Trichy Tollway Western U.P. Tollway Penang Bridge Extension Manila North Tollway A$1.8bn A$2.1bn US$24m US$59m US$36m US$41m US$101m US$268m US$75m US$60m US$47m US$148m US$44m US$54m US$80m US$50m US$57m US$120m US$85m US$96m US$166m Concession Concession Concession Concession Concession Concession Concession Concession Concession Concession Concession Concession Concession Concession Concession Concession Concession -oOoAssessing the advantages and disadvantages of PPPs There has been an enormous expansion in the PPP road sector over the last few years, in line with the expansion in PPPs on other sectors such as social infrastructure (schools, hospitals, social housing, student housing, etc.), rail and other transportation, defence, government accommodation, and so on. What are the reasons for this rapid growth in the use of PPPs? It is clear that one major reason for this growth is that the initial investment in PPP roads falls outside the public-sector budget, and so avoids budgetary constraints (such as those under the Maastricht Treaty) which would otherwise prevent such investment. Some time ago I carried out an evaluation of the European Investment Bank’s lending to the PPP sector,3 and as part of this process I visited a –3– Euroroads 2007 E R Yescombe—PPPs cross-section of projects in various different countries. The first question I always asked the relevant public-sector authority was why they had used a PPP for the project, and the answer was the same in all cases—“We didn’t have a budget, so it was the only way to get it done.” Having said this, there are other potential arguments for using PPPs, albeit secondary to the budgetary motive. The most important general case for procurement through PPPs is that the private sector can provide such facilities more efficiently, and therefore more cost-effectively, and that the rôle of the state should be limited to facilitation and regulation of this provision. The cost (or “value-for-money”) argument in favour of PPPs is, however, difficult to prove, even if it is theoretically reasonable. Opponents of PPPs naturally point to the obvious fact that a public-sector project can be financed more cheaply than a private-sector PPP project. This is of course correct—but it ignores the fact that people lend to the government at a lower rate because they have no risk. Nonetheless, if the government undertakes a project risks such as the project’s costs overrunning, or the project not performing properly, do not disappear but are spread amongst taxpayers generally. The response from PPP proponents is therefore that these risks retained by the public sector have to be valued, and added to the cost of borrowing, to enable a true comparison to be made with a PPP. (This is known as a “public-sector comparator”.) But this theoretical case is difficult to prove in practice. One comment often made is that PPP projects come in on time and on budget, unlike other public-sector procurement. This is generally true, but reason for it is that most public-sector procurement takes place on a “design-bid-build” basis—i.e. the public sector designs the project and then asks for bids to build it based on this design. This process easily results in cost overruns. In PPPs, on the other hand, construction is generally on a “design and build” basis by the PPP contractor (or rather its construction sub-contractor), so such cost overruns should not, and generally do not occur. Moreover transferring risk to the construction sub-contractor has a corresponding cost, as illustrated by an interesting study published by the European Investment Bank.4 The study agrees that the ex-post cost overrun for publicly-procured roads is around 22% on average in Europe. However the study finds that the average ex-ante cost of road PPPs is about 24% greater than that of public procurement and hence the final result is similar whatever method of procurement is used. This is not a surprising result—one would expect the market to price for risk in this way. Therefore arguments about cost-effectiveness do not appear to carry much weight in relation to initial capital costs. There is a much stronger case in relation to transfer of long-term maintenance risks. Both the running maintenance costs for a road and its long-term surface-renewal and similar “lifecycle” costs cannot easily be predicted many years into the future. These costs are therefore a significant risk (albeit one difficult to value), and are initially passed to the private sector under a PPP. But again care needs to be taken in considering this risk transfer: the PPP contractor will not have funding to cover maintenance or lifecycle costs whose outturn is much higher than originally anticipated. If these costs are not fully underwritten by a maintenance sub-contractor (and usually such sub-contractors put caps on this liability), then the lenders to and investors in the PPP contractor should step in to protect their investment—and this “capital at risk” is another argument for brining private finance into long-term projects. (It is also an argument for franchises rather than outsourcing road maintenance.) But there may still come a point where maintenance and lifecycle costs are so much higher than expected that investors walk away (or threaten to) and this risk ends up de facto falling back to the public sector. Another argument in favour of PPPs relating to maintenance / lifecycle costs, is that the public sector has a habit of deferring this expenditure where there are budgetary constraints, which means that they snowball in size, become unaffordable, and so public infrastructure deteriorates. PPPs ensure that maintenance is kept up to date. –4– Euroroads 2007 E R Yescombe—PPPs But even though PPPs do not appear immediately in the public budget, there are long-term effects. Payment of tolls under a concession is just an alternative to raising taxes. And payments from the public budget under the PFI Model are just deferred in time, which can of course create budgetary problems in future (as I understand has been the case in Portugal as a result of its very large-scale shadow-toll road-building programme). PPPs may also distort choice, or other decisions by the public sector—for example “non-compete” provisions in a toll-road concession may limit flexibility to construct other parallel roads to respond to traffic growth; or a road may be built because it is viable as a toll road, not necessarily because it is the road which will bring the best overall economic benefit. Political opposition to PPP roads is commonplace. Often the arguments are misconceived—e.g. the suggestion that private companies are making unfair profits from what should be a public service, whereas of course private companies also make profits from the state constructing roads. However a PPP programme can run into political difficulty, e.g.: – where the procurement process for a PPP is not carefully planned and fully transparent, with a proper competition—as may happen in countries which are not used to this highlysophisticated form of procurement; if “willingness to pay” is not properly taken into account—i.e. users feel that the tolls are too high, however much these may be necessary to make the project financially viable; where private investors appear to be making large “windfall” profits, e.g. from refinancing of debt or sale of their equity investment a few years into the PPP contract. – – There is also an argument—which applies especially to road PPPs—that it is very difficult to get the traffic-risk transfer right between the public and private sector. Either too much risk is transferred and the project gets into trouble, which usually rebounds in one way or another onto the public sector; or too little risk is transferred and windfall revenues are made by private investors from traffic growth which has little to do with the project itself, but is the result of general economic growth. This brief summary does not do justice to the debate for and against PPPs, which is highly complex,5 but perhaps may illustrate that there is no “black and white” answer to the question whether PPPs are a suitable method of procuring public infrastructure. The reality is, however, that governments seem to have little choice, and we can therefore expect a continuing expansion of PPPs in the road sector. Notes 1 2 3 4 5 Based on statistics published by Dealogic Project Finance Review and Project Finance International. Note that these figures relate to debt, not the total project costs, and also do not include loans from multilateral banks such as European Investment Bank.. The table has been compiled from a variety of sources; figures are therefore not consistently based between projects, and are incomplete. Evaluation of PPP projects financed by the EIB (European Investment Bank, Luxemburg, 2005) Frédéric Blanc-Brude, Hugh Goldsmith & Timo Välilä, Ex Ante Construction Costs in The European Road Sector: A Comparison of Public-Private Partnerships and Traditional Public Procurement (Economic and Financial Report 2006/01, European Investment Bank, Luxembourg, 2006) The topics discussed in this paper are covered at greater length in my recent book Public-Private Partnerships: Principles of Policy and Finance (Butterworth-Heinemann, Oxford, 2007). The Bibliography to the book—also available online at www.yescombe.com—includes information on recent academic papers on the arguments for and against PPPs. –5–