Making New Zealand’s Infrastructure PPPs work

Recent, and not so recent, press on the performance of New Zealand’s infrastructure public private partnerships (PPPs), shows a clear need to reconsider delivery models for our country’s future infrastructure needs. 

Here, Quintin Blackburn, Senior Principal – Project Delivery, discusses the background to the current PPP model, its performance, and some of the ways it might be improved.

While my employer Beca does not provide financial advice services for PPPs, we are one of Asia Pacific’s largest independent advisory, design, digital and engineering consultancies and have been involved in the delivery of a number of PPPs. 

Given this we are uniquely placed to provide a view on PPPs in New Zealand, and to provide an alternative perspective to the mostly financially focussed reviews published by economists and financial experts. 

Incumbent of me to note though, that this article is my opinion and is intended as a conversation starter and commentary.

In this piece I will attempt to discuss the current PPP model used for infrastructure delivery in New Zealand, what its limitations are and why it is not sustainable to continue its use, and what we might be able to do to improve it.
 

What the current model is and why it was introduced

When, almost 10 years ago now, the government brought in an economic availability based PPP model option to deliver infrastructure projects in NZ, its test for doing so here was that it “offers value for money over the life of the project, relative to conventional procurement methods”.

The current PPP model (Design, Build, Finance, Maintain and Operate (DBFMO)) being used to deliver Transmission Gully (TG) and the Ara Tūhono – Pūhoi to Warkworth motorway extension comprises a special purpose vehicle (SPV), and lump sum contracts within to deliver the capital infrastructure and maintenance and operations (25-year term) components.

Ostensibly, contract price certainty with the use of lump sum contracts is required to guarantee a long-term return for investors.  In return, the government will pay a fixed price for the delivery, operation and maintenance of the asset paid in instalments over the contract term.  Procurement for both PPPs has been via a competitive tendering process, with the use of an “affordability threshold” price that tenderers must be under and show value within. 
 

Why the current model does not work

Notwithstanding the recent Te Waihanga New Zealand Infrastructure Commission review on the TG, and media articles highlighting its troubles, there are posts such as this one from Infrastructure NZ that validate the TG PPPs’ performance concluding “Transmission Gully successfully passed all the value for money tests”. It’s not in my field of expertise to say otherwise, but I would point out that these “tests”, in the current New Zealand infrastructure delivery environment, could be considered quite narrow.

Since the TG PPP was signed back in 2014, NZ has changed.  A “wellbeing” focussed government was voted in and organisations like the Construction Sector Accord have arrived.  It is now clear that the country’s infrastructure procurement needs to not only satisfy financial objectives, but also broader objectives including wellbeing and sustainability (social, economic, and environmental).  For this reason, surely we can say the current infrastructure PPP model is looking a little dated, and we must look for a model that better fits NZ’s needs.
 

Why private funding is still important

The arguments bookending private versus public funding options can be  summarised as:

• “Why use private funding when the government can borrow at lower rates”, and

• “The PPP model delivers efficiencies (brought by the equity and finance components bringing better risk management and delivery structure) that offset the additional cost of borrowing.”

However, even though the current government’s approach may not favour PPP, in a post-Covid world the government’s balance sheet cannot disregard private funding options altogether.

From an NZ inc. perspective, good long-term investment opportunities, such as PPPs, that grow the nation are hugely important.  Such opportunities, if available to all, also help to decrease our over-reliance on property investment. 
 

What makes a good infrastructure delivery model?

In addition to achieving a procuring authority’s usual time, cost, quality and the now standard “broader outcomes” (aka social procurement), a good infrastructure delivery model could be described as a model that:

1. Promotes innovation and industry productivity gain (value improving practices)

2. Provides assets with good whole-of-life, and sustainable, performance

3. Promotes safety, wellbeing, diversity and a healthy construction industry in New Zealand

4. Places risk where it can be best managed, is proportionate and appropriate

5. Provides for aligned objectives across all parties involved in delivery

6. Provides an affordable funding model for all.

How does the current model perform?

I’d say, awarding partial points across criteria two, four and six - current performance is a two out of six against that list.  Let me explain: 

Shush! Value improving practices and sustainability

The first rule of PPP club is you can’t talk about PPPs.  So while financial experts and economists publish one-sided views from afar, the people involved in delivering PPPs are bound by tight confidentiality clauses over a long time, with significant breach penalties.  So if we can’t talk about it, do PPPs really promote value improving practices? 

Consider this.  In comparison to projects delivered under non-PPP models, how many papers or presentations have you seen communicating lessons learnt on Transmission Gully or Pūhoi to Warkworth?  To outline this challenge, a designer wanting to publish its views in a technical paper on one of the current infrastructure PPPs is required to pass three review and approval gates.  Who’s got the time or energy for that, when the result will likely be approval to publish a version of what you wanted to say, sometime later.

There are also no current infrastructure PPP’s in the pipeline, so there are no immediate future opportunities to roll out any lessons learnt and improve.

Another question you could ask is about innovation and productivity gain.  What have the current infrastructure PPPs brought or enabled that wouldn’t have been brought under other delivery models?

Whole-of-life analyses for assets are usually calculated using a net present value system.  This model is dominated by the discounting rate used and invariably ends up favouring spending less money on capital delivery, and deferment to maintenance activities in the future.  Perhaps this gives the correct result, but the point here is that generally PPP contracts have not brought about any significant changes (e.g. neither Transmission Gully or Pūhoi to Warkworth has been able to justify concrete pavements) in how infrastructure assets are delivered, maintained and operated compared with how they would have been under separate delivery, maintenance and operation models. 

Safety, wellbeing, diversity, a healthy construction industry - and risk

On the topics of safety, wellbeing, diversity, and a healthy industry there are many questions and observations.
Firstly, it’s pertinent to point out what attracts certain organisations to PPPs.  Given their large scale, they offer a unique (and one-sided) risk profile for which there is limited appetite or competition in the market.  This provides good opportunity for a limited few with considerable resources. 

But if there is a competitive tendering process and at least a few players are seriously interested, then why does this matter?  If you believe that in a competitive tendering process, the PPP proponents diligently price risk and transfer it at the tender box then I guess this might be okay. 

The delivery reality, not often talked about (mostly because of the confidentiality situation described above), is that there is a commercial imbalance between the large PPP contractors and their suppliers.  Someone always pays for downside risk.  This commercial imbalance and the PPP model allows PPP contractors to manage risk by pushing it onto suppliers, whether the suppliers signed up for it or not and, who do not have the commercial means or inclination to defend themselves. 

Commercial behaviour is unproductive – it soaks up valuable industry resource which is often diverted from providing real productivity gain elsewhere.  It can also carry high financial penalty which at one end of the scale could just be much better spent on productive activity, and at worst can cause business collapse and/or contribute to negative wellbeing statistics - running serious risk of adding to New Zealand’s mental health woes, and disturbingly high suicide rate in the construction industry.  At a basic level, commercial behaviour is win-lose focused and is not conducive to good wellbeing outcomes.

This situation does not create an environment that promotes safety, wellbeing, diversity, a healthy construction industry or indeed care about people at all.  It has a single, financial, bottom-line focus. 

Furthermore, how this and the risk allocation model within PPP delivery models affect the sustainability of our insurance industry is another consideration. 

Provides for aligned objectives across all parties involved in delivery

Here’s how I think the objectives for the participating organisation look in the current model:

• Government – to procure infrastructure as efficiently as possible, aligned with the principles of the government of the day

• SPV, equity providers, debt funders – given risk profile, to facilitate a return on investment

• Delivery contractors – given considerable risk profile, to deliver scope to the objectives assigned (incl. time, quality and budget) and return a profit.

Putting this more bluntly, the private financing primary objective is about return on investment, rather than the health of the construction industry.

A fundamental component of this is the contract form the PPP model uses to deliver and maintain the asset.  Design & Construct, or hard money, contracts are only suited for delivering work that is well defined (low risk, not complex, fixed scope) but yet they are used within the PPP model to deliver our largest and most complex infrastructure projects.  Under other non-PPP delivery models, Design & Construct contracts would be considered unsuitable for delivery of this work with more collaborative models able to better cater for flexibility and efficiency of delivery where there is less scope and risk certainty.    

Provides an affordable funding model

Closing out with consideration for affordability, PPPs definitely offer the government a good option here – and particularly in times of uncertainty (e.g. Covid). 

To use a simplified example, under the current model of a $1B PPP contract with a five-year capital delivery and 25-year maintain and operate term, the government pays nothing until year five (when the asset is available for use) and $40M per annum for the remaining 25 years.  Under other capital delivery only models (such as Alliance) with the majority of the spend (let’s say 80%) related to capital delivery, $800M of this would be paid by the government across the first five years. 

While this looks like a good deal for government, this “affordability” can be very one-sided, and at the expense of other smaller players in the PPP consortium (refer commentary on Safety, wellbeing…. above.)
 

How can we improve?

So – how can we do this better?  Putting safety, wellbeing, diversity, and a healthy industry, alongside affordability, at the forefront and considering what the Construction Sector Accord is driving for in our construction industry is a good start. 

One thing to consider is “Could collaborative delivery models be successfully incorporated for the capital, and maintenance and operations contracts, within a PPP model?” 

Collaborative models such as Alliance (a relationship-style arrangement, that brings together the client and one or more parties to work together to deliver the project) have a no-blame and no-sue premise encouraging collaborative behaviour and a proportionate share in profit and loss (including government as an Alliance participant). 
 

Hypothetical model analysis – replace D&C with Alliance in the current PPP model

Let’s have a look at what might result from replacing D&C with Alliance in the TG and Pūhoi to Warkworth PPPs, as they are currently.

Given a scan of the news and other publicly available information on the TG PPP contract we know; ‘Transmission Gully opening delayed due to Covid19’ and ‘Transmission Gully to open by September 2021 after lengthy negotiations’.

With an award price of $850M for the capital delivery on TG, and an expected outturn of $1.25B (pre-2021 Covid-19 lockdown), and including variations paid to date, there is a significant shortfall between the estimated outturn and current contract price.  Then add the risk of delay damages associated with late delivery.   

Publicly, the pre-2021 Covid-19 lockdown situation is less clear for Pūhoi to Warkworth other than the award price ($710M for the capital spend) and that significant variations ($168M) and extensions of time (seven-months) have already been awarded.

If you consider the Transmission Gully situation, within a hypothetical scenario of a PPP delivery model that incorporates collaborative contracting models (ultimately rebalancing risk by shifting some to investors), could market returns still be delivered to investors? 

Without getting too deep into financial analysis - using an approximate current model risk split to investors (7%) and considering the current delta discussed above on Transmission Gully as the example, it would seem that the answer is “No”.  But as always, this depends on who is underwriting the risk. 

There are a number of international thought pieces on this, including this one from Infralegal in Australia – ‘The Alliance PPP delivery model’, which provides a great overview of the Australian mega-project context, and a proposed Alliance PPP model in particular.
 

Conclusions

As with any changes in the industry, there needs to be good investigation, analysis and communication about possible options and alternative models for PPPs. 

If the risk model was rebalanced, with the government and New Zealand public (taxpayers, ratepayers, and infrastructure users) taking on more risk – or, perhaps taking on selected low probability but high consequence risks that would otherwise have skewed a PPP contractor’s risk exposure and modelling - then it might work.  But you would then need to ask yourself again “why PPP?” 

The answer to this question lies in the government’s need for private funding and in how you get efficiency gains from the equity and financial components of a PPP consortium.

However, our immediate future in infrastructure delivery in New Zealand looks to be dominated by the challenges presented by a post Covid-19 environment (including international constraints) and a resource constrained market. 

It would be great to see a new, collaborative and more workable - for all parties - PPP model being developed and discussed. 

To start with though, what we need is an open and honest conversation on what’s worked in the past, and what hasn’t, to put lessons learned to effect as we work together to shape the sustainable future of New Zealand’s infrastructure.