There is a strong movement in support of Public Private Partnerships to offset the cost of transportation funding.  While this does provide an avenue for funding there are some very strong caveats that need to be understood when making decisions about transportation funding.  The Foundation has looked deeper at the different proposed funding schemes in order to present all sides of the issues involved.  The following synopsis was done on Public Private Partnerships and the myths that are perpetrated in order to sell the idea.  The Foundation does not take a stand on the various transportation financing schemes but seeks to find the truth and the liabilities for the drivers.  The Foundation keeps track of and researches the other proposed financial funding sources such as congestion pricing, weight-distance taxes, toll roads, etc.

 

Synopsis of Public Private Partnerships in Australia

 

The use of the term “partnership” is simply for presentation reasons and the public private partnerships generally do not have any of the desirable attributes of partnerships such as:

• Working towards common goals
• Common interests and responsibilities
• Equality between the partners

 

In a report done by Policy Solutions of Australia in June of 2006:

1. Executive Summary:
• Many of the claimed benefits of PPPs have not always been realized and PPPs can result in poor fiscal outcomes for governments and/or infrastructure users.
• PPPs need to be closely scrutinized and there should be no presumption that a PPP is a superior method of infrastructure delivery.
• There are a variety of legitimate criticisms of PPPs, the most important of which is that the financing arrangements may lead to windfall gains to project investors at the expense taxpayers and/or users. 
2. Criticisms of Private Infrastructure financing:
• The key driver for the utilization of PPPs for infrastructure programs is the aversion to undertaking new debt financing.  This allows governments to announce multi-billion dollar projects with little to no impact on net government debt.  There is not credible economic argument that there is insufficient public funding available for large scale increases in debt to finance public infrastructure investment.
• Government can never effectively transfer the risk associated with the delivery of large projects to the private sector.  Regardless of the outcome of contractual negotiations, the public will still (rightly) hold the Government responsible for the delivery of core services.
• If a risk of non-delivery of an essential service eventuates, government may be forced to step in to ensure continuity of service regardless of the terms of any PPP contract.

Example: A.) The NSW Airport Rail Link where the whole ownership and operation of the service had to be transferred to the NSW Government after the private owners became financially unviable. B.) The Victorian Government had to make an emergency cash injection to Melbourne public transport operators who were financially unable to continue.

3.   Higher Borrowing costs & Supernormal Profits
• The higher borrowing costs of the private sector means that taxpayers can rarely, if ever, get value for money from private infrastructure financing.
• Financiers will demand all kind of fees for investing that can add up to supernormal profits at the expense of taxpayers.
4. Higher Transaction Costs:
• PPPs can be some of the most complex commercial and financial arrangements in business and result in high transaction costs for all parties.
• Government will have significant on-going service monitoring and contract management costs.

Example:  The sponsor of the Melbourne City Link project (a $1.8 Billion project) has stated that the winning private consortium spent $28 million tendering for the project prior to financing closure.  Substantial cost was also accrued in determining PPP project feasibility, managing the tendering process and negotiating the legal and financial structures that govern the PPP. 

5. Public Accountability:
• Problem is where the government retains accountability to the electorate but the private sector has taken on responsibility for service delivery.
• These problems have become compounded by the substantially increased complexity of PPP arrangements and “commercial in confidence” obligations being used to obscure public scrutiny of PPP arrangements
6. Anticipating Future Needs:
• There is a lack of flexibility that creating private sector rights might entail.
• Creating private sector owners of infrastructure may lead to unforeseen compensation claims in the future if government needs involve changing infrastructure usage that is contrary to a PPP contract.

Example:  The government of NSW is proposing changes to traffic arrangements arising from the controversy surrounding the new Cross City Tunnel.  There is a very significant potential compensation liability which will accrue to the NSW Government should they adjust the traffic conditions surrounding the tunnel.

Appendix A: Paying for Private Profit (myths)

 

Myth 1:  PPPs free up public funds that could be used in other essential services. 
Truth: Funds saved in this way have mostly been allocated to consolidated revenue to be used to retire debt and not used in the provision of better community services and infrastructure.  The private sector requires a rate on return of around nine per cent as compared to the public sector of around 6 per cent.  That would mean a project costing $4 billion through conventional public sector financing would cost $5.6 billion through a PPP.

 

Myth 2: Private sector investment accelerates the availability of community goods and services.
Truth: Longer term financial liabilities are not recognized.  PPP agreements can produce significant unforeseen outcomes and reduce the capacity of governments to provide adequate services.

Example:  In California the existence of a ‘non-compete clause’ in the state’s franchise agreement with a private toll road operator has forced the Orange County Transportation Authority to buy back the 91 Express Land Toll Road from its private operator. Orange County had made some needed road upgrades in the area surrounding the private toll road.  Non-compete clauses are common in infrastructure PPPs.

 

Myth 3:  The private sector is inherently better at providing services.
Truth:  The private sector is motivated by bottom line profit, and hence it has an incentive to continually reduce costs and to improve delivery mechanisms. Not all services can be provided profitably.
Example:  In the UK a recent report on the private financing of health services concluded these serious problems, all hospitals were short of beds, poor quality of design of buildings and quality of care declines as time spent with each patient was limited. 

 

Myth 4:  Private sector involvement reduces the level of financial risk to government.
Truth:  The use of private funds as against public funds increases the level of contingent liability exposure when service contracts fail.
Example: The Sydney Airport Rail Link contract where the public sector was left to pick up the tab when it failed.  The New Southern Railway linking central Sydney CBD with Kingsford Smith Airport will only break even for the NSW Government after 23 years.   In cases where the private sector loses money and walks away from a contract the public sector must intervene to maintain services.  In 1999 the La Trobe Hospital reported a loss of $6.2 million and handed the hospital back to the Victorian Government.

 

Myth 5:  PPPs reduce taxation.
Truth:  PPPs don’t provide free goods and services.  Taxation has not been reduced but has increased through the application of user charges, such as tolls.

 

Myth 6:  The user pay principle is inherently a fairer way of paying for services.
Truth:  The application of the user pay principles is not equitable as it charges a fixed fee to all users regardless of their ability to pay.  In highways governments have tended to enter exclusive supply agreements with the partnering developers, whereby alternative and pre-existing services are downgraded, and in the case of some infrastructure removed, as a way of reducing competition.
(Making adjacent roads off-limits to truckers, or closing facilities parallel to the interstate would be examples).

 

Myth 7:  The introduction of new players will increase employment and improve conditions.
Truth:  Experience suggests that if the PPP takes over an existing project, the net employment in the post-construction phase will reduce as a means of reducing cost. PPPs rarely allow for an increase in charges to occur, therefore operators have little choice but to reduce outlays if their shareholders’ interests are to be protected. (Good point for the toll roads that talk about controlling the toll cost, this will result in cost cutting other places like maintenance etc).

 

Myth 8:  PPPs improve accountability.
Truth:  Performance indicators often depend on data provided by the service provider and many mechanisms can be used to inflate or deflate statistics. (Enron)  Once a private sector partner has been awarded a contract the government is “locked in” and will seek to renegotiate rather than terminate a contract.  Higher prices to sustain profitability are normally a better option than terminating a private sector partner. (So even if a State has negotiated that prices can only rise by a certain amount, if the private contractor is ready to fold renegotiation is usually followed).

 

Public Private Partnership Projects
Myth Busting
Dr. David Dombkins
National President, Australian Institute of Project Management

 

Public Private Partnership projects are promoted as adding value to society.  Unfortunately, this high idea has been lost to short term profit and political expediency to make budgets look artificially good. 

 

Example:  The Sydney Harbour Tunnel where motorist saw a rapid rise in toll charges to cover commercial miscalculations. 
Example:  The Sydney Airport Rail is another example of the public purse coming to the rescue of a financial miscalculation.
Example:  The Sydney Cross City Tunnel where we see the public purse again used to support yet another commercial miscalculation.

 

There is no giving back to the public when there is a windfall profit by the private partner. In looking at the financial structure of PPP projects there is a capital investment at project initiation and a setting of tolls taking into consideration of the initial capital costs, interest and maintenance costs.  The only cost that should vary over the life of the project is maintenance but this has not been the case. “Tolls have risen and risen with no justification other than to cover financial miscalculations or to artificially increase profits.”

 

Future PPP projects should be stopped until a better approach is used.

 

Abstract of Public-private partnerships in the US and Canada:  “There are no free lunches”
Presents a transaction cost model that suggests that PPPs can often be prone to conflict, high contracting costs, opportunism and failure.  Based on evidence of 6 prisons that were PPPs in the US, these cases confirm that contracting costs reflect the presence of complexity/uncertainty, asset specificity, the potential for ex post bilateral opportunism and a lack of contract management skills by governments. “Given these circumstances, the private sector can behave opportunistically at the expense of the public sector as there has sometimes been a political imperative to prevent projects from terminating”.

 

Australia:  Privatised road tunnel creates havoc in Sydney

By Rick Web October 21, 2005

 

The Cross City Tunnel, running under the center of Sydney, opened under the control of a PPP.  They paid the New South Wales (NSW) government $105 million based on a forecast of 90,000 vehicles would make daily use of the tunnel.  The populace boycotted the tunnel and only 25,000 cars used the tunnel daily. The government then began to shut down and restrict traffic on public roads to force vehicles to use the tunnel.  It was disclosed that under the terms of the deal the government was compelled to take such measures to ensure an adequate traffic flow to the investor.  For weeks the government contended it could not release details of the negotiation because they were “commercial-in-confidence”.  One section of the contract requires the state government to buy out the Cross City Tunnel operators and pay expected profits of up to $100 million a year for the next 30 years if it fails to maintain the specified public road and lane closures.

 

The NSW agreed to pay more than $100 million to the receivers of the private company that formerly operated the Sydney airport rail link. 

 

In spite of these failures the Lane Cove Tunnel will charge motorists tolls; for the privilege of driving through one 210 yard section of the road, $1.20.  There will be road closures and restrictions on public roads to guarantee motorist use the Tunnel.  The road closings and restrictions are euphemistically called “road calming”.

 

Through a highly complex scheme know as the infrastructure offset borrowing tax offset scheme (IBTOS), the federal government effectively underwrites private loans to road infrastructure companies through tax concessions worth billions of dollars. “Toll roads cost a lot to build and generally don’t make a profit for many years.  So to make their stock attractive to investors, toll roads companies borrow against future earnings and pay that yet to be earned money out to shareholders in dividends today, often refinancing and upping the debt again and again.  Of course those debts eventually have to be repaid.  So to keep investors fed with dividends, toll road companies have to buy new assets and start the process all over again”.

 

Summary of: The Fatal Flaw in the Financing of private Road Infrastructure in Australia
John Goldberg
Honorary Associate
School of Architecture, Design Science and Planning
The University of Sydney 2006

 

With respect to traffic engineering, the models in Australia have a common property, namely that the traffic forecasts are correlated more with financial outcome required than with proper regard for traffic engineering practice.  Peak hour congestion is a common property of these forecasts.  If the financial outcome is adverse, a failure to pay the promised equity dividends, then such failure can be wrongly attributed to traffic shortfall. 

 

Dr Goldberg studied the financial models of the Cross City Tunnel, the Lane Cove Tunnel and the M2 Motorway.  The question is can the long term debt of a project be amortized within the concession period?  He found that there was zero chance that the debt can be amortized.  He then calls many of the financial models examined as showing a considerable amount of creative accounting. 

 

Example:  The Cross city Tunnel which paid equity dividends with virtually no cash flow.
Example:  The introduction of large spurious amounts of debt capital of unknown origin to augment cash flow, and the drawing down of fictional amounts of capital from reserves as was done in the Lane Cove Tunnel.
Example:  The use of dual entries to disguise the non-amortization of project debt as in the Motorway project.

 

In 1999 the owners and operators of the M 2  Motorway used a scheme known as “financial engineering” based on a revaluation of the asset, well above its true economic worth, in order to provide security for increased borrowing out of which investor returns were paid.  Another prospective method of paying off debt involves securitization.  In this scheme toll roads are grouped together in pairs so that the cash flow or asset value of one serves as security for the debt of the other and a new financial instrument is created which is sold through capital markets.  Both the use of financial engineering and securitization tend to emphasize the intrinsic non-viability of toll road projects.   Over eight years of operation the average return on investment (POI) for the M2 Motorway was only 3.5% pa, whereas the average cost of capital was 11.8%pa.

 

The one that made money was Macquarie Bank which received performance fees amounting to $91.59 m, based on an increase in market capitalization value of its Macquarie Infrastructure Group of $3355m.  If the government has given a guarantee to the project owners, then the debt becomes a public liability.

 

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