Thursday, June 20, 2024

Public private partnerships – getting back into gear | Infrastructure and Capital Projects | Deloitte New Zealand

Must read

Public private partnerships (PPP) are poised for a comeback. The coalition Government is actively aiming to revive and promote PPPs as a means of delivering infrastructure projects.

In recent years, PPPs have not been a focus for government-led infrastructure projects.  After over a half decade where no new PPPs have been brought to market, getting the New Zealand PPP market back into gear will represent a considerable challenge for procuring agencies, the government’s central PPP team (which has resided in Te Waihanga), as well as the new National Infrastructure Agency.

This article delves into the challenges and considerations for government as it explores delivering part of its infrastructure programme through PPPs.

Before delving into this, we note that PPPs in New Zealand have a specific definition – they are a long-term contract for the delivery of a service, where provision of the service requires the construction of a new asset, or enhancement of an existing asset, that is financed from external sources on a non-recourse basis. Full legal ownership of the asset is retained by the Crown.

Why PPP?

 

The purpose of the original PPP programme was to enhance value for money in the delivery and operation of public infrastructure, through:

  • Reliable delivery at a reliable price from a financing and payment structure that incentivises on time delivery to the required standard (across both delivery and operational aspects), and
  • Enhanced innovation from a long-term contract structure that focuses on optimising whole of life outcomes.

The original PPP programme also had a supporting objective of attracting international design and construct (D&C) contractors (i.e. builders) into the New Zealand market to build depth and capability. Large international contractors have historically been attracted to PPPs given the size of these deals.

New Zealand’s PPPs are also often misunderstood as trying to achieve ‘off balance sheet’ outcomes, or as offering some form of funding solution. However, all of New Zealand’s PPPs are ‘on balance sheet’ and the government ultimately pays the PPP for the new infrastructure delivered.   

Overall, the government is likely motivated by a desire to see enhanced value for money from public procurement as its key driver in delivering a new PPP programme. The challenge will come in building a market that is willing to enter into PPP contracts, while also ensuring these contracts still represent value for money.

Considerations for getting the next generation of PPPs off the ground

 

We have identified three key considerations for enhancing both value for money and for developing a viable PPP market in New Zealand:

A committed and credible programme of bankable opportunities

PPPs are costly to tender for, and one PPP does not make a market. The PPP pipeline will need to be both credible, and of sufficient scale to convince the market there is a pipeline of relevant opportunities. This challenge is enhanced by our 3-year election cycle, with PPPs representing a politically contested model.

These challenges can be mitigated by developing, and adhering to, a considered pipeline and running robust market sounding processes for candidate PPP projects. Wider changes to the procurement process can also enhance the attractiveness of the PPP pipeline. For example, there may need to be an increased focus on bid compensation to help alleviate costs of bidding (and thereby ensure a competitive tender). This is particularly where the PPPs value is at the lower end of the viability threshold for equity participants (e.g. $200m project value), given that PPP bid costs can be substantial. Another opportunity is to signal changes to the interactive tender process used for PPP procurement. These have been criticised for being overly formal, with bidders expressing a desire for more open discussion (within the bounds of probity).

Resetting PPP risk allocation so its attractive to design and construct contractors while not losing the ‘on time’ and ‘on cost’ discipline of PPP. Domestic design and construct (D&C) contractors (i.e. builders) are generally wary of PPPs as a commercial proposition. Added to this, D&C contractors have been under pressure in recent years, with cost escalations and limited resources impacting major projects. In this context, the hard ‘risk transfer’ in the original PPP model may need to be reconsidered, particularly in the context of horizontal infrastructure projects such as major highways. Ground conditions risk is often cited as a risk that contractors find challenging to accurately price and control. As part of a revised risk allocation framework, there may be opportunity to share this risk. For example, in Victoria, the incentivised target cost model has recently been used to introduce additional risk sharing (borrowing from collaborative procurement models) within the hard incentives of the PPP framework – noting this model is more complex to administer and creates more downside cost risk for the government.

Another risk allocation consideration is D&C contractor insolvency. Regardless of contractor, the underlying supply chain often represents a similar mix of local firms. The government may wish to take a more active interest in having line of sight / recourse over this supply chain in case the D&C contractor becomes insolvent – rather than leaving to this largely to the PPP consortium to manage.

Innovation in PPP financing

A common critique of PPPs is that they attract a higher cost of capital than government borrowing (which is cheaper due to the government’s taxation powers). However, the project cost of capital should reflect the risks inherent with each particular project – whether it is delivered under a PPP or a traditional delivery model. Private finance’s role in the PPP model is to sharpen incentives to ensure value for money, and the PPP procurement process is designed to evidence whether these efficiencies offer value over traditional delivery models.

There may still be opportunities to reduce the cost of finance while still preserving the incentive value of private finance. From the perspective of reducing the cost of finance, one option being discussed is procurement of an initial SPV comprising equity and its delivery subcontractors, and then competitively tender the debt component (which forms circa 90% of a PPP’s capital structure) to ensure debt margins are as sharp as possible. Another solution to reduce the requirement for private financing, which has been used in Australia, is for the government to make upfront capital contributions – this reduces the privately financed component of the project (and associated costs) while also theoretically preserving the incentives that come from private finance (and associated value for money benefits). Capital contributions may also be a mechanism for increased risk sharing between government and private sector – and part of making opportunities more attractive to participants. 

Given the challenges facing the infrastructure sector, there must be an ongoing focus on evolving delivery models and adopting more commercial approaches to infrastructure delivery and management. While there are several challenges to overcome, the reboot of the PPP programme offers a significant opportunity for innovation. 

Latest article