Tag Archives: P3

Pursuit of P3s Can Be Risky

Political risk is a key concern for participants in the public-private partnership (P3) market in the U.S. and Canada. Large infrastructure projects generally, and P3s in particular, can serve as lightning rods in debates surrounding investment decisions using public funds. Due in part to the potentially higher up-front price of delivering an infrastructure asset through a P3 or the perceived loss of public control of an infrastructure asset, P3s can generate significant opposition – ultimately ending with the cancellation of a project for political reasons and no contract to award. Though the risk of project cancellation is considered a business risk and is not insurable, this does not mean it is something risk advisers should ignore.

To help prospective bidders on these projects manage and assess risks, it is important to look at the readiness and friendliness of a company. Readiness is a measure of the legal and regulatory climate of a given state or province as it relates to P3 procurement, while friendliness is a measure of the public sector’s willingness and drive to successfully procure a P3. Within the readiness score are sub-factors, such as whether the state or province has legislation authorizing the use of P3s, whether P3s can be used for both civil and social infrastructure projects and whether the state or province has an office dedicated to assessing and procuring P3 projects. Within the friendliness score are sub-factors such as whether the state or province is in an election year, whether the state or province has experience procuring P3s and whether there is organized opposition to P3s.

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Aon’s latest Public-Private Partnership Pursuit Risk and Opportunity Index (P3-Pro), takes a deeper look at these two scores, and the results provided valuable key learnings. States and provinces that have relatively long track records of successful P3 procurements and institutions established to bring certainty to the procurement process topped the list. In the U.S., the top states for certainty as it relates to successful P3 procurement were Colorado and Virginia. Both these states have experience procuring P3s and each had two major projects successfully reach financial close in 2017. Both of these states also have offices dedicated to the assessment of whether the P3 model is in the public’s best interest. These offices lend a given procurement an increased sense of legitimacy and show that the public sector has thought about the project and is not simply looking at a P3 as a source of free money.

P3 Trends

Overall, last year saw a general decline in certainty across the U.S. Much of this was due to coming gubernatorial elections in 36 states. The potential change in executive can foster uncertainty for a project, particularly if the project becomes a campaign issue, as happened in the British Columbia elections in 2017. Additionally, last year saw the expiration of authorizing legislation in states that have had significant experience with P3s, particularly Texas. Texas has completed multiple highway P3s over the past decade, but due in part to public opposition to continued development of toll highways, the legislature allowed the legislation authorizing Regional Mobility Authorities to pursue P3s to lapse.

When looking at which states currently have large projects in procurement, there are some continuing projects in states that scored in the middle of the pack on the index. For example, Alabama is in the process of procuring the $2 billion I-10 Mobile River Bridge and Bayway project but falls into the “less certain” category, in part due to its inexperience in procuring a P3 project. While Michigan is in the process of procuring the $650 million I-75 Modernization project, the state also falls into the “less certain” category due to its lack of explicit P3 authorizing legislation.

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Canada has historically been less dramatic than the U.S. when it comes to P3s. However, 2017 was a little different. A new government took power in the summer and subsequently canceled the George Massey Tunnel Replacement project. Aside from the turbulence in British Columbia, many provinces in Canada scored fairly high in the index. Ontario, which for the last three years of P3-Pro’s publication secured the top scoring jurisdiction in North America. In terms of certainty of reaching financial close once a project begins procurement, Ontario has been the P3 leader in North America for some time. The province has successfully reached financial close on dozens of projects and has a robust pipeline of more than 20 projects.

The pursuit of a P3 can be a risky decision. Once the pursuit begins, there is no guarantee that the project will actually be awarded. Though there has been some progress in recent years to add certainty to the P3 process, with more states passing enabling legislation and getting experience in this delivery model, political considerations remain a key concern.

infrastructure

New Approach to Risk and Infrastructure?

Globally, the World Economic Forum estimates that the planet is under-investing in infrastructure by as much as $1 trillion a year. Since 1990, for example, the global road network has expanded by 88%, but demand has increased by 218%.

With the global population continuing to grow – and urban populations, in particular – the pressure on existing infrastructure is only set to worsen. And in the developed world, that infrastructure is creaking: In the U.K., 11 coal-fired power stations are nearing 50 years old, the end of their operational lives, and replacements have yet to be built; in the U.S., the average age of the country’s 84,000 dams is 52 years old; in Germany, a third of all rail bridges are more than 100 years old; parts of London’s Underground rail system, still in daily use by hundreds of thousands of commuters, run through tunnels that are more than 150 years old.

According to the Report Card on America’s Infrastructure by the American Society of Civil Engineers (ASCE), the U.S. alone will need $3.6 trillion of infrastructure investment by 2020.  The report assigned near-failing grades to inland waterways and levees, and poor marks for the state of drinking water, dams, schools, road and hazardous waste infrastructure.

Europe’s infrastructure is in worse shape. The Royal Institute of International Affairs has suggested that the continent needs $16 trillion of infrastructure investment by 2030, more than any other region in a world.

Taxing Issues, Tragic Consequences

While taxes once covered the cost of building and maintaining public infrastructure, entitlement programs such as Social Security and healthcare have started to claim a larger share of these funds as a percentage of government tax revenue, particularly as the number of people in retirement has expanded.

In addition, as the cost of social programs grew, governments came under pressure to cut taxes, leaving even less money available to maintain existing infrastructure, let alone invest in the requirements of growing populations. “Too often infrastructure is seen only through the lens of cost, expenditure and not as core to society’s prosperity”, says Geoffrey Heekin, executive vice president and managing director, global construction and infrastructure, Aon Risk Solutions.

“Since the 1950s, investment in infrastructure in developed countries has been declining,” he says. “In the U.S., for example, investment as a percentage of GDP has fallen from around 5% to 6% in the 1950s to around 2% today.”

Tragically, train derailments, road closures, water main breaks and even bridge collapses have become commonplace. “Until situations like the water crisis in Flint or a bridge collapse happens, infrastructure does not hold proper weighting in the psyche of leaders in government,” Heekin says.

This lack of attention to infrastructure is costing developed economies billions of dollars in lost productivity, jobs and competitiveness. Without addressing the infrastructure investment gap, the U.S. economy alone could lose $3.1 trillion in GDP by 2020, according to the ASCE, while one estimate attributes 14,000 U.S. highway deaths a year to poorly maintained road infrastructure.

A Private Sector Solution to Public Sector Under-Investment?

To begin reversing the infrastructure gap, it is likely that governments will need to find ways to encourage private sector investment toward replacing, renewing and upgrading physical infrastructure.

Governments of all political stripes are increasingly supportive of private investment in infrastructure. One model that is now gaining attention is the Public Private Partnership (P3) model.

P3s in one form or another have been used successfully in developed countries for several decades. They are being used to procure everything from public healthcare facilities, schools and courthouses to highways, port facilities and energy infrastructure. While the volume and type of P3 deal can vary widely by country, there continues to be an upward trend for the model’s use by the public sector.

In 2015, for example, Canada procured 36% of its infrastructure with the P3 model. Aon Infrastructure Solutions anticipates that 21 P3 projects will close in Canada in 2016, with a total capital value of US$12.8 billion – the highest value of P3 projects in Canadian history. In the U.S., where adoption of the P3 model is less widespread, 11 projects are expected to close in 2016, with a capital value of US$8.7 billion.

Like traditional design-bid-build procurement, P3 projects involve public authorities’ putting public projects or programs up for competitive tender and selecting a preferred bidder from multiple consortia.

The key difference is that the contractual structure in P3 allows the public authority to transfer a different set of risks to the private party – including (but not always) the financing for the project. The arrangement can allow the private partner that designs, builds and finances construction of the asset to operate and maintain it in return for either a share of the revenue generated by the use of the asset, or a stream of constant payments from the public authority (also called availability payments).

Keeping Focused on the Big Picture

“The public sector benefits from P3 delivery when the model is applied to a project that meets a community need and is procured through a transparent, accountable process,” says Gordon Paul – senior vice president, Aon Risk Solutions and member of Aon Canada’s Construction Services Group executive committee and Aon’s  global PPP Centre of Excellence.

“Public authorities seek ‘value for money’ in a P3 project by looking to the long-term value,” Paul says. This means identifying whether the private sector party is able to design, build, finance, operate and maintain an infrastructure project for a price lower than if the public authority did it on its own over the same period. It’s about the full lifecycle of the project – not just the building costs.

Taking a big picture view is equally important for the private sector party, says Alister Burley, head of construction for Aon Risk Services Australia. He points to the importance of taking a holistic view to P3 projects and investments to enable efficiencies to be built that will carry forward.

If done right, P3 arrangements can be a significant benefit to both the public and private sectors. Public bodies gain a much-needed boost to their infrastructure, often with long-term maintenance included in the deal, reducing the potential negative economic and health consequences of infrastructure failure. And private investors can secure a stable, long-term return through a stake in some of the underlying essentials of our economies.

Whatever route governments take to secure the integrity of our underlying infrastructure, one thing is clear – without a significant increase in infrastructure investment over the coming years, the world’s economy and health could well be put at further risk.