P3 101: A new model for US infrastructure
October 6, 2017
Already a common means of delivering infrastructure in many countries, the public-private partnership is growing in importance in the United States. Generally referred to as a P3 or PPP, this procurement model allows governments to use private-sector expertise and financing to deliver infrastructure ranging from bridges to water systems to public buildings.
Outside of specialist circles, however, most people know little about P3s. This month, Doggerel features a series of conversations with members of our advisory team exploring the basic concepts behind P3s. In this first installment, Arup transaction advice specialists Alfonso Mendez, Roberto Sierra, and Jorge Valenzuela discuss the relationship between P3s and privatization.
Are P3s a form of privatization? How do the two models compare?
Mendez: Even when some of the principles behind privatization and P3s are similar — private-sector involvement in the delivery of public infrastructure — these terms cannot be used interchangeably, since they have substantial differences. The term privatization is most commonly used to refer to any shift of government activities or functions from a public agency to the private sector, and it occurs when the government sells public assets to the private sector, or when it stops providing a service directly and relies on the private sector to deliver it instead. There’s no going back.
Ownership is the key distinction. With privatization, there’s private ownership, versus P3s, where the asset is still publicly owned. This means the P3 contract has a time limit and the public sector has ultimate control of the infrastructure assets. The public owner determines the requirements that the P3 delivery partner has to meet, enforces the achievement of those requirements, and retains the right to terminate the contract.
Also, with privatization, a project’s risk is 100% borne by the private sector. This is different than the responsible risk-sharing structure that characterizes P3s — it’s based on an assessment of which party is best qualified to properly mitigate and manage each one of the risks involved. Typically, P3s involve some combination of sharing risks between the public and private sectors in the tasks of designing, building, financing, operating, and maintaining an asset.
Valenzuela: Most infrastructure assets have a useful life that exceeds the term of a P3 contract. Therefore, the management of the assets will be handed back to the government at zero cost at the end of the P3 agreement. At all times the P3 delivery partner has to maintain the assets, and when they hand them back they have to meet strict maintenance and useful life conditions. The procuring authority can then decide if it wants to operate the asset directly or if it wants to enter into a new P3.
Think about the Goethals Bridge Replacement Project, for example. The new bridge has been designed to last for 100 years, while the private developer will build, maintain, and operate the asset over 40 years.
Some people believe that one of the reasons that P3s are less common in the US than in some other countries is that Americans tend to view them as a private-sector grab of public assets. Can you discuss?
Valenzuela: Here in the US I think the issues related to P3 implementation are largely political. Whereas other countries have a national legal framework for P3s, here every state basically decides whether it wants to use them. There are states like California and Virginia that are open to the idea, but there are many others that wrongly equate P3s with privatization, and therefore don’t like them.
Sierra: In my mind there hasn’t really been an effort to educate people here about the limitations of the current traditional delivery methods and, on the other hand, what an infrastructure PPP entails: essentially, risk transfer to a private entity to build, design, finance, operate, and maintain assets.
Modern P3s were developed in various countries in the last 30 years. In the UK, for example, back in the ’90s the government faced a difficult combination of persistent underinvestment in infrastructure and rising national debt. At the time, this was a smart solution to say, “We don’t need to invest our annual budget in infrastructure. We’re going to have investors. We’re going to have the private sector share that risk.” The P3 framework was a way to deliver more infrastructure and subject it to quality and performance requirements when you had constraints from a public budget standpoint. Other countries such as Australia, Canada, and Chile, for example, don’t have national debt problems but actively use PPPs to deliver larger, more complex infrastructure projects where it makes sense to share risk and get better results in terms of on-time, on-budget construction and higher quality operations and maintenance for many years after construction is completed.
The operation and maintenance [O&M] aspect of P3 delivery is very important. That’s one of the things that US infrastructure has a big problem with: deferred maintenance. I remember reading that the US has something like 60,000 structurally deficient bridges. The American Society of Civil Engineers current report card gives infrastructure a D+ grade. The investment deficit is estimated at over $200 billion annually. This is the unfunded amount needed to simply bring the existing infrastructure up to a state of good repair — i.e., to address deferred maintenance — which doesn’t even account for modernization and expansion!
People should look at P3s as a way to make real progress with these kind of issues, because ideally you engage the private sector to take care of those long-term O&M problems, thinking about the life cycle of assets, thinking about the replacement of specific parts, or of a section of a road or a building. That’s where the P3 method is a pretty good match for the long-term needs of society.
Are some P3s better than others for society at large, though? If a P3 isn’t structured well, could it be a much better deal for the private-sector partner than for the public?
Valenzuela: First of all, it’s important to remember that infrastructure projects exist to solve a need for society, to provide a service to the public. That’s tricky, because we have a lot of needs, and public agencies need to come up with a methodology to give priority to certain projects. The process of planning, formulating, screening, and coming up with a pipeline of projects is key. Then you need to clearly define the objectives for each infrastructure project: what it needs to deliver and at what standard of quality and cost. That absolutely needs to be done by the public sector.
Mendez: But the P3 model itself isn’t the problem. I think we as an industry need to do a better job of educating the general public about how P3s actually work. The public sector is transferring a bunch of risk associated with the construction and operation of the project, as well as the O&M, to the private partner. Because of that, the private partner can make some profit in return. That’s because if something goes wrong, the private partner has to absorb the cost of fixing it. Otherwise the public owner can step in to charge penalties and, if the situation warrants it, terminate the contract. The private partner has to hand the asset back to the public sector at the end of the term of the concession, so it only has certain period of time to recover the initial and ongoing investments it is required to make.
I think if people understood this better there wouldn’t be as much demonization of P3s, or comparing P3s to privatization. The public infrastructure always reverts back to the public-sector owner with certain preestablished physical, functional, and operational conditions. Basically the government is handing the public infrastructure, with the associated service, to a private partner who has agreed to keep it up to the conditions necessary to perform the service. And then the private partner reverts the infrastructure back to the government.
Valenzuela: That’s right. I think when people hear that the private sector is involved in public infrastructure, they often automatically think, “Oh, you’re involving a private party, and therefore they want a big financial return.” They think it would be better to just do 100% public delivery.
But they are forgetting about two things. One is that most public delivery has a history cost overruns, especially for large and complex infrastructure projects. We’ve seen this on our own projects. When we worked on the Presidio Parkway here in San Francisco, the government decided to do the project in two phases. The first phase included a third of the total work, and they decided to do it as a traditional design-bid-build contract. The second phase, which included two-thirds of the work, was done as a PPP. At the end of the project, the construction cost of the two phases was actually similar, even though the second phase included almost twice as much construction work. In addition, the first phase was nearly two years late, while the second phase was delivered essentially on time. So I think that’s one of the best examples of this idea of best value and cost certainty. With PPPs you’re more confident that you’re going to get the project for the investment cost you initially budgeted. There are way fewer surprises, because in general the risks are better managed.
The second big advantage of PPPs is that by bringing in the private sector you have a better chance of getting cost-efficient innovation. What I mean by that is a lot of the time a public agency hires an engineer and the engineer designs a project, and then the agency thinks it’s the only way to build the project, and they stick with it for years. And sometimes a private developer comes in with an idea about how to design and build it that is more efficient and therefore better value. In the right conditions and with the right controls — again, all of which need to be set by the public sector — private-sector companies can create value for society at large, because they have a lot of experience with similar projects.
Questions or comments for Alfonso Mendez, Roberto Sierra, or Jorge Valenzuela? Contact firstname.lastname@example.org, email@example.com, or firstname.lastname@example.org. Want to learn more about Arup’s transaction advice services? Contact email@example.com.
This is post 1 of 2 in the P3 101 series
- P3 101: International mixing / Oct 16, 2017
- P3 101: A new model for US infrastructure / Oct 6, 2017