Australia: PPPs & The Infrastructure Boom

Public Private Partnerships (PPPs) are an example of how innovative procurement can provide material savings through lower funding costs. They are often lauded as the procurement method that enables the community to receive the benefit of infrastructure delivered sooner and, hopefully, managed better, while governments get the political benefit of new infrastructure, and the private sector gets viable long-term commercial opportunities. As such, PPPs are likely to be a popular way for governments to successfully fund the current infrastructure boom. In this article we outline Queensland's project pipeline (SEQIPP) and some of the emerging variations on the PPP theme.

The Infrastructure Boom

Forecasts suggest that over A$400 billion could be spent on economic and social infrastructure in Australia over the next 10 years to rejuvenate infrastructure.

The same forecasts suggest an increasing number of infrastructure projects will be financed privately due to the magnitude of funding required, the fiscal restraints on Government and an increasing private sector appetite for funding infrastructure projects. The New South Wales Government, for example, expects that 10-15% of its capital expenditure will be procured through private sector infrastructure financing models, such as PPPs. Of course the private sector's ability to deliver the community's expectations (including in relation to PPPs) will be heavily dependent on the outcomes for capital markets and debt funding arising out of the current crisis in the United States and elsewhere in western markets.

An important factor in securing PPPs to service the infrastructure boom lies in Government's ability to assure the construction, facilities maintenance and financing industries that there is a pipeline of future projects to be procured innovatively. The Queensland Government have shown the way forward in how this may be achieved.

Queensland's Visible Project Pipeline

In a move surprisingly rare for any western government, the Queensland Government published the South East Queensland Infrastructure Plan & Program (SEQIPP) in June 2005. It is ambitious for any democratically elected government to commit to a plan of action because it clearly constrains political expediency. But SEQIPP has definitely caught the attention of foreign infrastructure players because it lays out future commercial opportunities for industry in a transparent way. That visibility and the higher margins being earned by Australian commercial infrastructure participants are attractive to European and American investors.

The latest iteration of the plan and program, SEQIPP 2008, constitutes a major review of the first SEQIPP released in 2005. It seeks to achieve a tolerance between delivering infrastructure to support growth and showing fiscal restraint consistent with Government's Charter of Social and Fiscal Responsibility. The Charter mandates that 'borrowings or other financial arrangements be undertaken only for capital investments and only when these can be serviced within the operating surplus, consistent with maintaining a AAA credit rating'.

A visible pipeline of projects is an important part of attracting the necessary resources to deliver those projects. A visible plan is especially desirable in light of the fact global resources are now under stress from the level of high activity in infrastructure delivery around the world.

SEQIPP is summarised in the following table.

Estimated investment identified*

Notes

1. Estimated investment is in 2008 dollars. Cost estimates in the state budget and other public documents may differ, as they may incorporate project costs that reflect anticipated changes in input prices between initial planning and the time of construction. Estimated investment includes funds already spent on projects.
2. Infrastructure projects have been indexed to account for inflation and expected increases in construction costs. Refer to 'Cost estimates used in this infrastructure plan'.
3. Where funding is required from other levels of government, their estimated costs have been included. Where projects are part of (or connect to) the AusLink National Transport Network, these projects and their timing are subject to negotiation with the federal government.

*SOURCE: SEQIPP 2008

Some PPP Basics

PPPs are often used for what are commonly referred to as economic or social infrastructure.

Economic infrastructure assets are the assets that facilitate the day-to-day operation of the economy. The Airport Link in Brisbane, Australia's largest PPP deal to date, is an example of economic infrastructure.

Social infrastructure are assets that support people's standard of living, health or social opportunity. Examples of social infrastructure include the various state school PPPs in place across the country.

Infrastructure projects, economic or social, have two project phases: the risky construction project phase, followed by a comparatively stable (if the bid financial model is sound and based on sound patronage forecasts), re-financable, facilities management or supply of services project phase. This second stage starts after construction and lasts the remainder of the life of the project.

Government can borrow (with taxpayers as guarantors) more cheaply than the private sector. The private sector can most often manage other project risks, particularly operational risks not only more cheaply but often more efficiently.

The challenge for Government in funding the infrastructure boom is to develop and implement innovative procurement, for example, by using variants of the PPP model which play to the respective strengths of both private and public sectors.

Australia is already a breakaway global leader in innovative government debt funded infrastructure project delivery, through the development of commercially rigorous project alliance and early contractor involvement (ECI) procurement models.

Both project alliancing and ECI seek to integrate relationship management into procurement. Project alliancing does this by the parties agreeing to jointly manage all or the majority of project risks. ECI rethinks this shared risk philosophy. Parties negotiate the parameters of their project, including risk and price, in a transparent way before entering into a contract for construction which may be a fixed price contract reflecting the negotiation of risk. ECI is an appropriate procurement model if the initial process of open negotiation can remove uncertainty as to risks and allow the parties to price and accept them.

PPPs And Variations On The Theme

PPP Model

In Australia, PPPs have evolved though 'build own operate' or 'build own operate and transfer models' since the 1990s.

Under the PPP model, which effectively transfers to the private sector the key risks of design, construction and whole of life maintenance:

• There is a concession agreement between Government and a privately owned Special Purpose Vehicle (PPPCo) which has responsibility for construction and management.
• A construction contractor contracts for the design and construction of the project.
• A facilities management contractor contracts with PPPCo for maintenance or other services during the life of the concession.
• A senior debt provider takes a security interest in the project assets and provides finance to the PPPCo to develop and construct the project. The senior debt may amount to 90% to 95% of the total cost depending on the type of project.
• Equity (perhaps 5% to 10%) is provided by the private sector. PPPCo manages the project.
• Service payments by Government to PPPCo pay the services management fee, PPPCo's management costs, taxation costs, debt servicing costs and distributions to shareholders.

The PPP model has been used in many other countries. For example, the UK government has over 510 projects in the stable operational phase with an aggregate capital value of £45.1 billion. The UK Government has released results reporting general satisfaction on these projects. They have measured satisfaction against important criteria of success such as end user expectations, payment and performance mechanisms, public and private sector relations, and flexibility of change for the public sector.

Credit Guarantee Finance Model (CGF)

CGF, the first of the 'underpinned debt' and 'de-risked' funding structures, was developed in the UK to respond to the challenge of combining the benefits of the private sector taking key risks and securing lower funding cost from Government by the use of public finances.

Under CGF, the risk allocation is the same as under the PPP model, except that Government takes the risk on the guarantor's ability to guarantee payment of the senior debt provided by Government.

As with the PPP model:

• The private sector invests equity in PPPCo.
• Government enters into a concession agreement with the PPPCo.
• Government provides senior debt to PPPCo.
• A financial institution provides a financial guarantee to government to guarantee the payment of senior debt.

Supported Debt Model (SDM)

This model is currently being used on the South East Queensland Schools Project where short-listing is underway but has been delayed. Under SDM, Queensland Treasury Corporation (QTC) provides a level of supported debt through a refinancing arrangement with the private sector drawing down QTC funds after the completion of construction.

Upon completion of construction, the project risk exposure reduces significantly and so too does the probability of senior debt being unpaid upon a termination (including a termination for the contractor's default). To safeguard senior debt, Government guarantees minimum termination payments aimed at the whole or a proportion of the underpinned or supported debt. The supported debt is thus notionally risk free and benefits from a risk free borrowing rate, ie Government's cost of funds.

Under SDM, the risk allocation is again similar to that under the PPP model except Government takes the risk that the minimum termination payment may exceed the value of the constructed assets as it might, for example, if the assets were in disrepair or destroyed, 'the most extreme default and disaster scenarios':

• QTC refinances an agreed proportion, 70%, in the case of the South East Queensland Schools Project, of the private sector's total senior debt facility upon completion of the construction phase.
• Equity is provided by the private sector.
• The QTC provided debt is first ranking senior debt for the operations phase.
• Government guarantees a minimum termination payment to PPPCo. The minimum termination payment should cover the QTC supported debt amount outstanding during the remaining concession period apart from the last 12 months of this period.

Conclusion

• Detailed plans such as SEQIPP are one way to meet the infrastructure investment challenges facing government.
• Innovative procurement is another key to success.
• Innovative funding models are an important part of innovative procurement.

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