Common Misconceptions about Public Private Partnerships (PPP’s)
Every society needs infrastructure to function and access to good public infrastructure defines the basic quality of life for many people across different segments of the population. The growing trend of urbanization has put into spotlight the need for better public infrastructure like never before. While countries in the developed world like the US are faced with an aging and crumbling infrastructure, in the developing world like India the need is for provisioning new infrastructure to meet the demands and aspirations of a growing urban population. But governments around the world are faced with a deficit of an estimated $800 billion a year for investments in basic infrastructure like transportation, power, water and telecommunication systems. While there is growing demand for better infrastructure, there is also an increasing focus on fiscal discipline in government budgets resulting in infrastructure budget cuts. How do we bridge this ever growing infrastructure investment deficit?
In addition to the need for capital, a combination of factors has brought to limelight Public Private Partnerships (PPP or P3 or Private Finance Initiative (PFI) ) as one possible answer for the public infrastructure investment challenge facing many countries. Some of the key factors include: structural reforms that promote Foreign Direct Investment (FDI) in key infrastructure sectors in emerging economies like India, country specific corporate tax reforms that provide greater incentives for private sector to invest in public infrastructure projects, growing appetite of institutional investors to invest in public infrastructure assets, lack of expertise in the public sector and the ability of private sector to better manage risks and efficiently execute complex infrastructure projects. With any trend that has a lot of buzz surrounding it, there is also lot of misunderstanding that goes along with it. PPP’s are no exception. I’ve delved into a few of the most common misconceptions about PPP’s:
With PPP, private sector provides an alternate source of funding: This is one of the most frequently quoted and misunderstood aspects of PPPs. Private sector does not FUND public infrastructure projects, rather they FINANCE them. It’s important to understand the subtle difference between infrastructure funding and financing. And private financing is just one aspect of a comprehensive PPP arrangement. In many large public infrastructure projects, financing could be from multiple sources and some PPP projects may not involve private financing. PPP arrangements across projects can range from the most simplest of PPP procurement model like Design-Build model to a more comprehensive one like Design-Build-Finance-Operate-Maintain model. For example the Elizabeth River Tunnel (ERT) project in Virginia was executed under a PPP arrangement using the Finance-Build-Operate-Maintain model and funding was from a combination of tolls, private equity, contributions from the Commonwealth of Virginia and a low-interest Federal Highway Administration (FHA) loan. Most recently the Tappan Zee Hudson River Crossing project in New York was executed under a PPP arrangement using the Design-Build procurement model with no private financing. In summary PPP’s are an alternate procurement model, not an alternate funding model.
PPP is a panacea for all public infrastructure challenges: As much excitement as there is about the possibilities for private sector investment to help address the public infrastructure issues facing many countries, there are certain categories of projects that fit better into a PPP model. If private financing in a project will be expected, a key criteria will be to understand the project funding model i.e. how the investment will be repaid to the private investors along with a reasonable Return on Investment (RoI). If the project cannot generate sufficient revenue to meet the payment obligations, the possibility of attracting private investment is next to none. For PPP projects where private financing will not be involved, a clear understanding on the value private sector will bring in terms of innovation, operational efficiency, risk management or other best practices need to be clearly laid out. For example in India, out of the 1575 PPP projects awarded since 2011, a lion’s share of 83% of the total investments were in the transport and energy sector. Among many other factors, these two sectors attracted most of the investments for the simple reason that they had a viable and proven funding model (e.g revenue from road tolls, electricity supply back to the grid etc) to meet repayment obligations.
With PPP taxpayers don’t have to pay for the infrastructure: The impact on taxpayers depends on the funding model for a project. At the end of the day, private sector is driven by profits and will look for an appropriate RoI. It really does not matter if this RoI were to be met by revenues or cost savings from one or more sources like user charges, increase in local sales tax, selling naming rights for an asset, government payments from tax revenue, digital advertising in public right of way, savings from more efficient operations or other appropriate concession models. The LinkNYC project executed under a PPP model by City of New York (NYC) in partnership with CityBridge Consortium, is a great example of delivering a public infrastructure service like high speed Public WiFi with no impact on tax payers. The private consortia is responsible for provisioning and managing the infrastructure including digital kiosks, fiber to the kiosk and services enabled in the kiosks. By using digital advertising in public right of way as a revenue model, this project has the potential to generate incremental non-tax revenue for NYC. This is estimated to be over and above the private consortium recouping their investments and realizing their RoI.
PPP is a path to privatization: By definition PPP’s are contractual agreements between a public agency and a private sector entity to deliver a service or facility for use by the general public. During the contractual term, the private entity gets only leasing rights to manage the asset and/or deliver services according to negotiated Service Level Agreements (SLA’s). The private entity can claim no additional rights on the asset including: selling it, raising additional funds using it or mortgaging it. Beyond the contractual term, complete control of the asset is transferred back to the public agency. For example on behalf of the City of Jaipur in the Indian state of Rajasthan, the Jaipur Municipal Corporation (JMC) entered into a PPP with a consortium led by SMC Infrastructures Private Limited to finance, upgrade, operate, and maintain over 100K public street lights. Among a host of other benefits, this 10-year energy performance contract will benefit over 1.65 million people, save the local government $1 million per year and is expected to reduce Green House Gas Emissions (GHG) by 36,750 metric tons every year. Beyond the 10 year term, the local government will have complete control of the public lighting infrastructure.
With PPP, private sector profits at the expense of taxpayers: Leveraging private sector financing & expertise to build & manage public sector infrastructure is the key mantra behind PPP’s. Unfortunately there are several examples of PPP projects not living up to their promise which has given an opportunity for this negative narrative to spread its wings. At the end of the day, PPP is a business transaction. Private sector will go all out to drive a hard bargain at the negotiating table to ensure profitability and take care of the interests of their shareholders. The onus on ensuring that the taxpayer interests are taken care of, and that the private sector stakeholders are held accountable for the appropriate risks is the responsibility of the negotiators working on behalf of the public sector. Where the public sector lacks the skill set, drawing upon the services of experienced advisors & negotiators can go a long way in ensuring a successful win-win partnership. In June 2006, the Indiana Toll Road Concession Company (ITRCC) was awarded a 75 year lease to operate & maintain a 157 mile highway stretch in Northern Indiana. Eight years into a 75 year lease agreement, the consortium filed for bankruptcy given that the deal was structured on weak economic and financial fundamentals. In spite of the chapter-11 proceedings initiated by the private consortium, the state was allowed to keep the $3.8 billion upfront payment. Since the bankruptcy filing, an alternate private investor has been identified to take over the remainder of the lease. My intent here is to highlight an example of an appropriately structured partnership agreement protecting the interests of taxpayers.
Tax payers expect their government to provide quality infrastructure and services, and to be prudent about spending their tax dollars by executing projects on-budget, and on-time. But public works projects are littered with examples like the Oakland-Bay Bridge project that had a 10+ year schedule over-run and more than $6 billion+ cost over-run. Compare that to the on-budget and ahead-of-schedule completion of the Tappan Zee Bridge in New York executed using the Design-Build procurement model. This is not to say that PPP projects haven’t had their own set of debacles — for example the colossal failure of the London Underground PPP, or the collapse of the $400 million Ararat Prison PPP in Australia to name a few. Unstable political environment, commercially unviable projects, inexperienced negotiators, corruption, inadequate risk analysis, lack of stakeholder engagement, bloated revenue projections, inexperienced partners are some reasons for the failure of some high profile PPP projects.
There is no doubt that private sector is driven by the need for increased profits to deliver on shareholder commitments. But with this motivation comes unflinching focus on innovation, quality, risk management and delivering on the bottom line. The question is can the public sector take advantage of this and put it to good use? With stable statutory environment, right due diligence, extensive stakeholder engagement, transparent procurement process, experienced partners and a well structured deal, PPP’s can be a powerful tool to meet some of the infrastructure needs of many countries. Its not a question of how much profit the private sector will make out of a project, but the most important questions that need to be asked when it comes to PPP projects are: a) if they will deliver value for money to the taxpayers and b) are they taking into account the needs & interests of various segments of the population.