PPP - Paper 4 - avoiding pitfalls and another examples

INTRODUCTION:

In this paper we further address how the pitfalls relating to the Benefit Cards Agency set out in the previous paper might be avoided through reviewing the approach of the Dutch Government.

FORMULATION OF THE SCHEME

The Way Forward

In identifying a project, there are many ways in which it can be taken forward. This is not just a challenge in a country where private sector participation may be unusual. The Dutch Government promoted the high speed rail link referred to in the previous paper. Currently the Dutch Government has undertaken to make a contribution towards the cost of the line from Antwerp in Belgium to the border and will then undertake the construction of the new line from the border. It issued the consultation paper[1] which recognised that there are different ways of achieving the objectives. Whilst this approach clearly relates to a linear transport project nevertheless the concepts being considered are applicable (albeit in some cases indirectly) to other schemes.

The Objectives

Government may have a number of objectives which it wishes to achieve and those identified by the Dutch Government are as comprehensive as any. In the case of Dutch linear transport project such objectives included:

(a) the recognition and support of The Netherlands transport policy and planning goals;

(b) the ensuring of the financial strategic and operational participation of parties other than The Netherlands in one or more aspects of the design, construction, operation and maintenance of the project;

(c) the achieving of a framework for the privatisation of the project which draws heavily on the creativity of the private sector;

(d) the creation of a proper interaction with the "market place" in developing the project framework;

(e) the procurement of optimum service levels and maximum consumer satisfaction while obtaining maximum value for money from privatisation with an appropriate risk transfer in the development and operation of the project;

(f) the completion of the Project as soon as possible, on schedule and within budget;

(g) the balance of commercial risk to both the public and private sectors, and therefore by implication the project would be economically viable;[2]

(h) allowance for the state to have sufficient control over the project, whilst recognising the requirements of the private sector to optimise its own efficiencies and economies;

(i) enable the project to have minimal negative environmental impact and be properly assimilated into the urban and rural landscape;

(j) obtaining all required planning and other consents so as to permit construction to commence as soon as possible;

(k) allowing the private sector to harness a robust and deliverable financing to ensure that the project is built and operated on time and budget and can be integrated with the rest of the relevant network (in this case, the Trans European Transport Network) as soon as possible;

The Approach

A Government can achieve its objectives in a number of ways and the options listed below represent the broad cross section but the actual implementation could be by any variant or combination of those options.

In considering any infrastructure it is also necessary to consider the environment within which that infrastructure is to operate. Many industries have, until relatively recently, been run on a vertically integrated basis. For instance in the electricity sector generation, transmission and distribution were all included within one organisation. Railways have included infrastructure provision, operation, passenger and freight services and the supply of rolling stock again within one organisation. Recent developments, however, have lead to unbundling. In the case of energy, this has led to a segregation between generation, transmission and distribution. A similar approach can be taken to railways including the unbundling of rolling stock from the supply of passenger or freight services. It is not the purpose of this paper to comment upon those different regimes but merely to recognise the impact that those different regimes may have upon the approach which may be made in the procurement of a new project.

Transport Options

On one approach, the Government could incorporate a special purpose company whose shares were initially owned by the public sector. That company would procure the design and construction, completion and operation of the infrastructure. Where plant (including rolling stock if appropriate) was required, that too would be acquired by the special purpose company. Once the special purpose company was shown to be income producing to a satisfactory level then there could be an entire or partial sale by the Government of the shares in the company. The disadvantage of this approach is that whilst the special purpose company is borrowing funds and is owned by the public sector this will normally be treated as a public sector obligation. However, funds can be released for further transactions once there has been a successful share offer and sale.

An alternative approach is that having established a special purpose company, before borrowing to finance the project commences, the public sector could require contractors and suppliers to buy shares in the special purpose vehicle. To the extent that the special purpose company was not considered to be controlled by the public sector, the borrowings of that company ought to be treated as falling outside the public sector borrowing requirement. A further advantage of this technique is that it may well bring in private sector management skills at an earlier stage.

A further variant is that the public sector could design and construct the project and then sell the project assets to the private sector either during or after construction. Whilst this technique has been adopted both in Portugal[3] and Morocco[4] in relation to power stations and in Canada in relation to Highway 407[5], as this was not planned at the time that the schemes were conceived the construction contracts and the like were not easily assignable to the private sector purchaser.

A further scheme is where the civil engineering works are carried out by the public sector and the operational aspects are added to by the private sector. For instance a dam may have a number of turbine halls and the private sector will install turbines as the demand builds up. Alternatively, for a railway the private sector could supply signalling and control systems together with the rolling stock.

Finally, there is the more recognised route which is where the public sector sets out its minimum requirements and invites the private sector to bid to design, construct, finance, operate and maintain the project.

Procurement Strategy

As an overview, the public sector will want to know what it or the users will pay for using the facility, what risks will remain with the public sector and that the users will have a reliable system of transport. Therefore, in developing the procurement strategy there are obvious advantages in involving the private sector. Such involvement will also enable the public sector to understand the needs of the private sector. The private sector wants to know what it is being obliged to do and the circumstances within which it is to carry out its obligations. It is not practicable to ask the private sector to assume all risk because most project companies are financed on a limited recourse finance basis which also means limited resource. It is simply not possible for the private sector to take total risk and there needs to be, therefore, a sharing of risk. In addition, the private sector needs to know that it will get a commercial return. Although not a fundamental reason for the collapse of the Hungarian toll road concessions, nevertheless, the fact that a private motorist was able to make application to the court and the court overturned the toll regime set out in the contract between the concession company and Government does give some indication as to the sort of concerns that the private sector will now have. It will need to know that whoever is granting the concession has clear statutory right to authorise the collection of tolls and that such collection, provided that it is in accordance with the terms agreed, will not be capable of being overturned by the courts.

Issues for the Process

BNRR

The author was instructed in 1991 as part of his firm's team to supply services to the UK Government in relation to a proposed new tolled road known as Birmingham Northern Relief Road (BNRR). The concession contract for BNRR was signed in 1992 but financial close was only achieved in October 2000 and construction started in that month. There are a number of lessons to be learned from such a sequence of events:

Lesson 1 - The private sector shared with the public sector the risk of delay in achieving the necessary land use consents and compulsory purchase orders. Not only did the public inquiry process take longer than envisaged but matters then became complicated as applications were made by objectors to the courts for judicial review of ministerial decisions. Until relevant consents were obtained, no lender would be prepared to advance monies to the project and, therefore, these costs had to be borne by the initial sponsors. There must be a real concern as to whether it is feasible for the private sector to carry these types of costs during a long planning process.

Lesson 2 - Following the disposal of the court proceedings, one of the original sponsors sought permission to withdraw from the project and to put in a substitute. A further feasibility study was carried out by the proposed new investor which revealed a continuing need for the relief road. In that respect, therefore, the scheme remained robust in the context of developments, both at the time that the original contract was signed and prior to achieving financial close. The scheme must be capable of being and remaining robust.

Lesson 3 - The concession contract is for a period in excess of 50 years. Notwithstanding that, there was considerable political pressure to announce a winner without the concession agreement having been drafted, let alone negotiated. As a consequence, the private sector was able to re-negotiate certain terms which were originally incorporated in a brief memorandum of understanding.

Lesson 4 - As indicated in Lesson 2, the transport study carried out in 2000 produced results which echoed the results of studies carried out both prior to the project being changed into a PPP as well as before the signing of the concession agreement. There is substantial concern as to the reliability of feasibility studies and, for instance, on the Hungarian toll roads, the advent of a macro-economic downturn and the resulting reduction in traffic meant that the traffic forecasts were non-sustainable. Accordingly, it is important that the forecast takes into account sensitivities.

Lesson 5 - At the time the Concession Agreement was signed, because there was the possibility (which transpired) of the planning process taking more than five years (which was at that time about the longest period for which commitment to finance could be obtained before the right to draw down funds expired) no financing had been locked in. There is, quite clearly, a risk in doing this insofar as there is no assurance that after a number of years the lending market will take the same view with regard to a certain type of project that it would do at the time that the contract was signed.

Lesson 6 - At the time that the concession agreement for BNRR was signed, there was no integrated transport policy. There was no commitment that goods should be transported by rail or for congestion pricing in order to reduce usage of roads by private vehicles and to move users onto public transport. Notwithstanding the development of a co-ordinated transport policy, the transport feasibility studies still stood up. Nevertheless there is a potential risk that the development of an integrated transport policy could adversely affect a tolled road scheme.

[1] Issued by Dutch Government 5th June 1998 - Consultation Document - HSL - South.

[2] In the opinion of the Economic and Social Committee on the Communication from the Commission to the Council, the European Parliament, the Economic and Social Committee and the Committee of the Regions on the Public - Private Partnerships in Trans European Transport Network Projects (98/C/129/14) - economically viable was construed as being viable in macro-economic terms rather than commercially viable which was construed as being profitable.

[3] Pego Coal Fired Power Station.

[4] Jorfe Lasfar Coal Fired Power Station.

[5] Concession for Highway 407 for Ontario Government realising C.$3.1 billion.