Private financing of infrastructure assets is a hot topic right now, with political parties of all stripes making transport and infrastructure policy statements ahead of the general election in October.
And the discussion is critical, including looking carefully at the how the current infrastructure public private partnership (PPP) model is working, and how it might work in the future.
When we refer to the current model, we’re talking about the model used for Transmission Gully and the new Pūhoi to Warkworth motorway; that is to say an asset availability-based PPP model incorporating design and construct, and operations and maintenance (25 years) contracts.
Politicians are looking for, and suggesting, alternative ways to fund New Zealand’s considerable infrastructure deficit. As is often the case in an election year, private financing options come into focus as a way of paying for assets on a hire-purchase type basis.
Our two main political parties have either talked about private financing as a key part of the infrastructure solution, or have indicated that all options are on the table. Regardless of political affiliation, private financing is certainly important to consider, as stretched New Zealand taxpayers need to find a way of spreading the cost.
Infrastructure New Zealand, quoting Te Waihanga – the NZ Infrastructure Commission, has said in its policy position statement: “New Zealand has a significant infrastructure deficit. Te Waihanga considers the country would need to spend $31 billion on infrastructure each year for the next 30 years, to build ourselves out of the existing infrastructure challenges New Zealand faces. Underinvestment in our crucial infrastructure is one of New Zealand’s greatest long-term economic challenges.”
While preferred approaches may vary, if we take as fact that private financing is an important piece of the infrastructure funding puzzle, next we need to figure out how to do it well, and in a way that works for Aotearoa.
Unlike in many overseas contexts, we’re a nation of small subcontractors and suppliers which can’t afford to take big risks and associated losses on a single job, offset against gains in others. Nor do many, if any, New Zealanders in the infrastructure sector want to work in a highly litigious and oppositional commercial environment; I would say most just want to do the mahi, and proudly produce good outcomes for their clients and communities.
New Zealand is also trying to drive broader outcomes from its large project procurement, including better inclusivity and diversity in its supplier base, community focus and connectivity, and to make sure our industry is sharing and collaborating for improved outcomes.
It is in this operating environment that we need to find a model for private financing that treats all parties fairly, and that truly drives good outcomes – economically, socially, culturally and environmentally.
The common myths
Let’s begin by addressing some of the more common myths and misconceptions we hear about PPPs:
Myth one: Public infrastructure can be delivered by passing all risk to the private sector for a fixed price.
A basic internet search will reveal that internationally PPPs, like other delivery models, are subject to cost overruns and significant variation claims.
Of New Zealand’s eight PPPs being delivered to date, six are in the education (schools) and corrections (prisons) sectors. Relatively speaking, these PPPs seem to have been successful. The two remaining PPPs – roading projects Transmission Gully and the Pūhoi to Warkworth motorway – are comparatively more risky and complex, largely due to ground and environmental factors, including weather and storm damage.
Neither Transmission Gully nor Pūhoi to Warkworth have been delivered for a fixed price with all risk taken by the private industry. For the capital build, the Transmission Gully contract was signed in July 2014 and was priced at $800 million; it ended up costing $1.25 billion. Meanwhile, the contract for the recently-opened Pūhoi to Warkworth motorway was signed in November 2016 at around $700 million and is likely to have a final price tag of $1.1 billion.
Both Transmission Gully and Pūhoi to Warkworth have experienced successful and significant claims, including for the likes of Covid-19 disruption. Using Covid-19 as an example of challenges with the current model, the ability for PPP consortia to insure against risk is important for the success of the PPP model. Published media on the availability of insurance for losses associated with pandemics produces mixed results, but there does seem to be some alignment in that even if available, premiums would generally be unaffordable.
This presents a tricky situation for a PPP tendering consortia, in deciding what to allow for in a tender price for this type of risk, when procurement processes are heavily weighted towards a low price.
Myth two – PPPs deliver the best outcomes
When it comes to judging success, it’s important to first define what success looks like. There are any number of reports or opinions about the success or failure of Transmission Gully and Pūhoi to Warkworth against stated objectives. Opinions on the success of PPPs generally have a financial focus and are subjective, even on that front.
If you look at the objectives for projects delivered under the more recent New Zealand Upgrade Programme being delivered by Waka Kotahi–NZ Transport Agency, you will see much broader objectives including social procurement and outcomes for communities, for example. The point here is that as society becomes more progressive, so too do the needs for our public infrastructure.
Whether the current PPP model can be adjusted to deliver our current societal needs is questionable.
Aotearoa is a small country of small businesses. The largely international organisations that lead PPPs don’t bring large resource pools to New Zealand to deliver the work; that work is still mostly done by local subcontractors and suppliers. What these organisations do bring with them is access to large commercial and legal teams. Mixing this dynamic with our New Zealand industry is like trying to mix water and oil – our subbies and suppliers don’t have big legal and commercial teams so this creates a commercial imbalance.
This imbalance means subbies and suppliers are faced with having to spend years, and potentially millions of dollars, in escalated dispute processes, just to get reliance on the basic contract rights and risk profile they signed up to. Some don’t have the capacity or inclination to do this and simply suffer the results.
At the very least this is wasteful from a NZ industry productivity perspective. Further, there seems to be a lack of any effective processes to require PPP consortia leads to check on the health of the PPP organisation they are making a healthy return on, including protecting sub-contractors and suppliers from the commercial imbalance.
Governments can borrow at a lower interest rate than private industry can, although there are increasing pressures on balance sheets and appetites to take on more debt. One of the ideologies driving PPPs is that private industry brings superior management and risk management processes that offset this additional cost of borrowing.
Te Waihanga in its standard form PPP Project Agreement (the head agreement between the procuring or delivery agency and the contracting entity or special purpose vehicle (SPV) delivering the PPP) says: “The PPP model seeks to improve outcomes by capturing best practice and innovation.”
To assess how this applies in the New Zealand context however, is a fraught exercise. Given the lack of transparency within PPPs, due to confidentiality requirements and significant liabilities for breach, who really knows what good management processes were brought in and applied?
Looking outside of New Zealand, and as reported in The Post: “Britain’s National Audit Office concluded a few years back that PPPs cost more than standard construction contracts, and there was no evidence they delivered better services.”
Myth three – Transparency and accountability are a top priority for PPPs
New Zealand’s small industry relies on collaboration from a diversity of partners to bring good outcomes for our unique communities and environments. This in turn relies on openness and sharing of ideas and lessons learnt to improve and innovate. PPPs in their current form, regrettably, do not allow this.
Parties within a PPP consortium are bound by confidentiality rules that do not allow them to share freely with industry; they are censured if they do. As an example, technical papers sharing the lessons learnt from two of New Zealand’s largest ever infrastructure projects, Transmission Gully and Pūhoi to Warkworth, are just not available.
Similarly, a scan of finalists and winners over the last few years of Engineering New Zealand’s biennial ENVI Awards, which promote and celebrate “The best and brightest of engineering in Aotearoa”, highlight numerous great project submissions, but none from PPPs. This is not ideal for the industry, given the dominance of the Transmission Gully and Pūhoi to Warkworth projects over that time.
Good outcomes should also allow good public debate on the pros and cons of PPPs. Yet at present public discourse is very one-sided. While funders and financiers, Treasury and politicians have opportunity to speak freely about PPPs, the people and organisations within PPP contract frameworks, including contractors and designers with experience in delivering them, are restricted by confidentiality requirements. So how do we reconfigure the model to be best for New Zealand?
Let’s start by kicking the above misconceptions into touch and by allowing the development of a PPP delivery model that works for the New Zealand operating environment.
What can be done?
Firstly, we need to change the expectation that all risk can be transferred on these hugely risky infrastructure projects – projects which are delivered and operated over extended periods of time for a fixed price. For example, the timeframe in the case of Transmission Gully and Pūhoi to Warkworth is more than 30 years.
Procurement 101 says risk should be owned by the organisations best placed to manage risk. Te Waihanga describes a key policy characteristic of the New Zealand PPP model as including “the efficient allocation of risk to the party best able to manage that risk”.
The Transmission Gully and Pūhoi to Warkworth PPPs have both included a design and construct contracting model for the capital build. Procurement fundamentals would further say that design and construct contract models should only be used for well-defined and less complex projects. And yet we have used them here to deliver some of New Zealand’s most complex and risky public infrastructure projects, in order to provide a fixed price and guaranteed return for the finance companies.
So let’s consider changing the contracting model within the PPP to a better risk sharing and collaborative model such as an ‘alliance’. This also means we have to face placing more risk on the returns for financing organisations and government delivery agencies.
We also need better processes to protect our subbies and suppliers from the commercial imbalance described above. This should include more obligation being placed on PPP consortium-leading organisations to make sure they are checking the health of their PPP consortia.
If we wanted to be really inclusive, we need to look at insurance requirements. Small subcontractors and suppliers are not able to access the insurance policies required by government delivery agencies to take part in these types of projects. If a project insurance policy is not taken out by the consortium or head contractor (noting that project insurance has become increasingly difficult to obtain) then it is a barrier to entry.
This flies directly in the face of the likes of the New Zealand Upgrade Programme, which has looked to bring broader outcomes into its project delivery, including social procurement objectives providing opportunity for local and iwi owned businesses.
Te Waihanga has developed a suite of guidance documents and a standard form PPP Project Agreement. This is a great start, and to address the commercial imbalance described above, a mandatory standard contract suite, like New Engineering Contracts (NEC) for example, is needed that flows down from the head Project Agreement to sub-contracts for subbies and suppliers. This is important to appropriately define rights, obligations and the risk profile, and to efficiently resolve disputes.
Procurement processes need to improve to take the focus off getting the lowest tender box price and/or to provide more transparency on risk pricing so it is easy to understand what has been allowed for. This would allow for “being transparent on the value and allocation of risk” – one of the key principles of the Construction Sector Accord.
Let’s also take a ‘good for industry’ approach where we think wider than the current project being delivered and where we put obligations on PPP consortia to prioritise the protection and enhancement of the health of the construction industry, and to share lessons learnt and innovations, above protecting confidentiality.
In the current environment, with the pressure on the government’s balance sheet, private financing has an important place in addressing New Zealand’s infrastructure deficit. But if it’s to deliver real value, then the delivery model needs to be improved.
Beca is a foundation supporter of Newsroom