As we move into a period of intense focus on infrastructure as a means of stimulating economic activity post Covid-19, it is timely to consider the Public Private Partnership model (“PPP Model”) and whether it has delivered value to Government and produced a fair economic return for the private sector. The following article focusses on traditional PPPs and not on unsolicited proposals relating to infrastructure or toll road procurement.
The PPP Model
All Australian States and Territories and the Commonwealth have utilised the PPP Model to deliver a variety of social infrastructure and major transport infrastructure. A quick snapshot reveals the following picture in regard to the use of the PPP Model in Australia to date:
- Victoria has most embraced the model and procured a significant number of social and transport infrastructure projects using the PPP Model – including hospitals, schools, a new train station, a new convention centre, bio-sciences precinct, major roads, new metro trains rolling stock, metro tunnels and stations and arterial roads upgrade and maintenance;
- NSW has used the model to deliver schools, hospitals, prisons, a new convention centre, new regional rail fleet, a new light rail system for Sydney and social housing;
- Queensland has used the model to deliver schools, two major transport projects (one road and one rail project) and a new light rail system for the Gold Coast;
- SA has used the model to deliver courts, a major hospital and new schools;
- WA has used the model for courts, a hospital, a car park, a prison, schools and a new sports stadium;
- Tasmania has used the model for student accommodation;
- the Northern Territory has used the model to deliver a convention centre and prison; and
- the ACT has used the model for new courts and a new light rail system.
A variant of the traditional model has also been used in NSW to deliver new social housing under which land is provided as part of the project company’s contribution (and at the project company’s risk) and the State obtains delivery and maintenance of new social housing. Victoria is also currently procuring social housing under a new model.
The Commonwealth has used the PPP Model to deliver a new Defence HQ and defence force housing and is currently using the model to procure a section of the inland freight rail route.
All States and Territories adopted the National PPP guidelines in 2008 – accordingly, Federal, State and Territory Government agencies now apply the National PPP Policy and Guidelines to all public private partnership projects released to the market. However, each State can make State specific variations to those guidelines and several States have done so. These guidelines set out clear rules as to the risk allocation to be adopted in the project deed for a PPP between the State and the private sector provider.
Trouble for the PPP Model?
- Reliance Rail PPP in NSW – the banks providing the initial funding package threatened to withdraw funding post-GFC as a result of concerns over the viability of the project’s monoline insurers. The project company faced financial collapse as a result of a downgrade in its credit rating. The NSW Government had to step in and provide the project company with certain assurances to avoid the project company being placed in administration. Legal issues subsequently arose in connection with a proposed refinancing of the project’s $2 billion debt package which led to further court proceedings concerning the ability to refinance without all lender consent.
- Hopkins Correctional Centre in Victoria – after various construction related issues arose, the builders became insolvent and the banks financing the project appointed receivers and managers to the project company. The project company subsequently went into administration. Two of the three original banks took the project over and arranged for a new builder to complete the project at a substantial additional cost. The project is currently being sold by the bank investors having been completed in 2015.
Other PPPs have also incurred significant cost overruns and in some cases this has led to claims being made against government - the most notable being:
- the Sydney Light Rail PPP - a claim was made by Acciona against the State alleging misleading and deceptive conduct by the Government when providing information on how to handle Ausgrid utilities running underneath the light rail tracks which it was alleged led to cost increases to move the utilities. The $1.1 billion law suit brought by Acciona against the Government was settled in June this year with the State agreeing to pay an extra $576 million to settle the dispute on the basis that financial claims for an additional $1.5 billion were withdrawn by Acciona. The total cost of the project increased from $1.6 billion to $2.77 billion;
- New Royal Adelaide Hospital PPP (NRAH) in South Australia - project cost overruns amounted to some $640 million (as a result of contaminated soil and other claims) and the project suffered significant delays. This ultimately led to negotiations between the State and the project company to resolve the outstanding claims;
- the Melbourne Metro Tunnels and Stations PPP (MMTS) - according to Press reports earlier this year, the cost of the project could blow out by $3 billion and that the Victorian Government was seeking to reach a negotiated solution with Cross Yarra Partnerships. No outcome has been announced as yet; and
- the Cross River Rail PPP in Queensland - again according to Press reports, the Cross River Rail PPP is likely to suffer significant cost overruns (reported to be between $600 - $900 million) as a result of design flaws in one of the stations (leading to a stop work order on that aspect of the project, cost delay compensation claims by the project company and disputes between the CRRDA and the project company in relation to proposed modifications) and platform issues at another station.
Also, in Victoria, the Government paid compensation to the private sector consortium when the East West Link PPP was cancelled after the project deed had been signed. There was concern expressed at the time over increased sovereign risk in Australia when contracting with the Victorian Government, although this has not seemed to impact the willingness of bidders to participate in PPP bid processes.
It is interesting to consider how the market has developed in terms of the participants in PPPs. The main players fall into 4 categories:
- Specialist PPP arrangers/investors (e.g. Plenary Group, Tetris Capital and Capella Capital);
- Bank arrangers/investors (e.g. Macquarie Capital)
- Infrastructure fund investors (e.g. John Laing, Amber, AMP Capital, Brookfield Infrastructure); and
- Construction companies/investors (e.g. CIMIC, Acciona, John Holland, Lend Lease).
Notably absent from the sector to date are the large superannuation fund investors (such as AusSuper, Cbus, Unisuper). The main reason for this appears to be an insufficient level of economic return for the risks which must be accepted by PPP investors. Some infrastructure fund managers have participated in the sector (such as QIC) but this has been quite limited to date – these investors have shown more of an appetite for the privatisation of large-scale infrastructure (such as port, electricity assets and WestConnex).
Feedback from a number of private sector participants (particularly the major construction companies) suggests that, on a number of larger infrastructure projects, the construction companies have incurred significant losses and have been unable to earn a fair return on these projects. These participants are beginning to challenge the traditional ‘closed box’ PPP Model, citing projects such as Sydney Light Rail for why delivery risk should be more evenly shared. Despite this, these companies remain active in the PPP space.
Private Sector PPP Considerations
It is interesting to make some observations about the PPP model as a procurement method from a private sector perspective, having now seen the model used quite widely in Australia.
- Economic considerations: As an over-arching observation, PPPs are long term low economic return transactions with very limited adjustment and compensation mechanics if risks adversely impacting the project arise. Bidders also invest substantial time and incur substantial costs in bidding for these projects. The government requires a value for money outcome but the private sector needs to earn a fair return. If not, the project is likely to face financial hardship or fail, or otherwise not deliver an optimal outcome for private sector stakeholders or government and, ultimately, taxpayers. Accordingly, an appropriate and equitable risk allocation at the outset is critical. Government as the party running a tender process has the advantage of competitive tension and has a responsibility to run a sensible process (and, for example, avoid a situation where the process is truncated for political expediency (such as upcoming elections)) and to adopt a transparent and appropriate risk allocation from the outset. Private sector bidders also need to be robust in terms of not accepting risks that they cannot understand or identify, and manage or mitigate. In this regard, the provision of information on which bidders must rely in both a timely and transparent manner is critical and if information is not available then the process should be delayed or extended.
- Unforeseen risks: Risks which arise in PPPs and which are genuinely unforeseen need to be managed in a better way than has been the case to date. A number of major construction companies have suffered significant losses through their participation in PPPs and this has weakened the financial strength and viability of the construction sector in Australia. A more cooperative approach by government and the private sector to managing an unidentified risk in an open and fair manner needs to be developed. Unforeseen risks and/or incorrectly priced risks on large scale PPPs has proved to be a major issue particularly where a project involves extensive tunnelling. The PPP Model is a “closed box” model so if a risk is discovered later during construction and that risk has not been identified and passed through to Government under the project deed, this can lead to financial stress on both the project company and the builder and ultimately project failure. It can also cause the builder to suffer significant losses and in some cases lead to the financial collapse of the builder. We have seen several recent examples of this where undiscovered soil contamination has led to project delays and disputes over who should bear the costs of removal of such soil. This is one area where a better approach to risk identification, risk sharing, risk management and treatment of additional costs could be adopted by government after workshopping with the private sector.
- Project company management and oversight: Management of the project company and monitoring and oversight of the project during the development/construction phase is critical. The project company must have an experienced project manager and team who can keep on top of cost variation claims from the builder and any other events which entitle the project company to relief under the project deed and ensure they are processed and passed through to the State in a timely manner. This flows on to matters such as early identification of any supply chain issues which can cause project delay, management of insurance claims and management of defect rectification when the project is complete. Most project deeds now contain mechanisms for consultative groups to be established and operate during the life of the project with representation from the Government, project company, builder, maintenance provider and financiers.
- D&C must be robust: Selection of an experienced and financially robust builder/D&C Contractor is critical – the ability of the builder to absorb the financial shock of something going wrong with the project during the construction phase (resulting in its performance bonds being called on) can make the difference between the project failing and reaching completion. Whilst second or third tier builders can offer an attractive D&C price there is a trade off in regard to the ability of such contractors to remain viable if difficulties are encountered during the construction phase. If a builder fails, this will have disastrous consequences for the project company and its financiers as any builder appointed to complete construction will charge a much higher price and equity value will be destroyed.
- Interface risks: Interface risks in very large transport infrastructure projects is another area of difficulty. These risks arise where part of the project is delivered under one procurement method by one contractor and another part is delivered using another contractor and the two parts must connect seamlessly. This can be particularly challenging when the operations (including rolling stock) and maintenance aspects of the system is then procured using a PPP. Contractual regimes cannot always provide a complete answer and arguably a more dynamic approach with Government playing an intermediation role may be more useful.
It is interesting to note that whilst the Victorian Government is delivering major transport projects through the PPP Model (i.e. North East Link and MMTS), the NSW Government has used (and is considering) other models to deliver large scale transport infrastructure projects. For example, the first three stages of WestConnex were procured by the Government (through Sydney Motorway Corporation) using a traditional D&C procurement model. Once construction was underway on the first two stages, the Government then sold a 51% interest in the entire project retaining a 49% interest. This enabled the Government to be confident about the quality of the contractors appointed to deliver construction of the project and their terms of appointment and at the same time establish a structure which realised significant value when the 51% interest was sold (A$9.08 billion) through a public auction process. It is expected that the remaining 49% interest will be sold shortly (Stages 1 and 2 having now opened to traffic).
What next for PPP's?
At a recent IPFA webinar, representatives of the NSW Government indicated that
- the PPP Model was still under consideration by NSW Treasury and would be used where appropriate. Although no announcement has been made as yet, that model may be used to deliver the operations, rolling stock and maintenance aspects of the new Sydney Metro West rail project and
- alternative models are also being considered for the delivery of Western Harbour Tunnel (WHT). The Government has announced that WHT will be procured and delivered through a State led process – however, the Government will be seeking a private sector development partner with whom it will work to deliver the WHT. Who that partner will be, the precise role and terms of appointment of that partner, the structure of the relationship with the partner and entitlements of that partner are not yet clear. This model will allow the NSW Government again to retain an active role in the delivery of a key piece of infrastructure for Sydney but presumably pass some of the risks to the development partner. The focus will be on procurement and delivery and not financing. The NSW Government will be able to monetise the asset by sale at a future time.
In terms of the future:
- The PPP Model seems to retain attractiveness to at least some Governments in Australia – Victoria in particular seems set to continue to use this model not only for social infrastructure but also for large scale infrastructure transport projects. Other States have indicated a continuing interest in using the model where appropriate (e.g. NSW).
- Several States and Territories are using the Augmentation process which has been a more recent feature of project deeds to enable negotiation, financing and delivery of enhancements to/extensions of existing PPP projects. The Augmentation process provides a contractual framework for the delivery of an enhancement or extension of a project by the existing project entity and avoids the need for a complete re-offering of the project to the market. This is being used for the Sydney and South West extension of the Metro rail system in Sydney and for extension of the light rail systems in the Gold Coast and the ACT.
- At least some States are considering alternative models for large scale transport infrastructure projects. In particular, NSW is exploring other delivery models for key infrastructure (such as the WHT) to overcome some of the deficiencies in the PPP Model particularly in relation to close and meaningful government involvement during the construction phase where risks are highest. These models may see the PPP Model in NSW at least being confined in future to more traditional social infrastructure (such as hospitals and schools) and discrete parts only of larger transport projects.
- Some jurisdictions are using a variant of the PPP Model to deliver new social housing. NSW has been at the forefront of these developments using a services delivery approach where “hard” assets (i.e. land) are retained by and remain at the risk of the project company. Victoria is currently testing the market for an appropriate social housing delivery model. The NSW social housing model has been successful in unlocking large land banks (held by churches and other charitable organisations) but has not been successful in attracting private finance to date (due to the challenges of dealing with residual land value risk).
- The appetite for other jurisdictions to use the PPP Model remains unclear with no current announcements in respect of the use of this as a delivery model for projects in NSW, SA, WA, Tasmania or the NT. In Queensland and the ACT, current light rail procurements are being conducted as augmentations of existing PPPs.
Gilbert + Tobin’s Infrastructure and Project Finance team regularly advises on many of Australia’s largest and most complex infrastructure deals. The group’s partners are leaders in their field, consistently ranked by Chambers, IFLR, Legal 500 and Best Lawyers, among others. We work on transactions that define the market, including advising participants in all major roles relating to Public Private Partnerships (PPPs), including financiers, owner/operators and sponsors.