Corrs High Vis: Episode 51 – Public Private Partnerships in the Australian construction industry

Brianna Ryan - Hello and welcome to Corrs High Vis. My name is Brianna Ryan and I’m a lawyer in our Brisbane Projects Practice group. Today I’m joined by Trevor Thomas, a partner in our Sydney Projects team.

and we will be discussing a key highlights from our special edition of the Corrs Projects update. In this special edition there is a particular focus on public private partnerships or you may hear us refer to them throughout this podcast as PPPs.

So, Trevor, thanks for joining us today and could you start us off by giving us a little bit of background into the PPP model.

Trevor Thomas – Certainly. PPPs, I think as we all know, are in common use around the globe for major infrastructure projects. Look, it’s been noted that in countries such as Australia and the United Kingdom, PPPs are not new any more and are now considered part of the standard policy toolbox that governments can use if they choose.

The contemporary approach to PPPs began in Australia and the UK in the 1990s. The PFI model was originally set up by a conservative British government in 1992. Its objectives were to bring private sector skills and efficiencies to improve service delivery in the public sector to allow some risk to be transferred to the private sector, and to bring in private capital to the public sector. The PFI model also had the added benefit of keeping government spending off the balance sheet.

From a public policy perspective, the main objective of the PPP is that new infrastructure can be delivered in a manner whereby the public and private sector share the risk, and the cost is deferred and repaid over a long concession period which is typically 20 to 30 years.

PFIs were slow to start in the UK but were increasingly used from 1997 when the Labour party came to government, their popularity peaking in 2006. The UK PDFI model expanded rapidly from there and was adopted around the world, particularly in Australia, Europe and Canada. Indeed, Australia was quick to adopt the PFI during the 1990s and, as such, is widely seen as an international leader in the PPP space.

In 2000, the Victorian government introduced its Partnerships Victoria policy. However, Australia does not have a specific legislative framework for PPPs but rather a national PPP policy and guidelines that set out the processes that authorities should follow in the investment, procurement, development and operational stages of PPPs, along with the standard risk allocations and commercial principles to be adopted. State governments have their own jurisdictional requirements and departures that are read in conjunction with the national guidelines.

In 2008 the global financial crisis hit, and the UK government reduced its use of PFIs understood to be as a result of the increased costs of private finance and due to banks being unwilling or unable to provide such private finance.

In 2012 the British government introduced a new model known as “PF2” to address a number of government concerns with PFI, which included it being too costly, inflexible and opaque. However, the PF2 model did not see widespread adoption with only six PF2 projects reaching financial close.

In January 2018, the British National Audit Office issued a report into PFI and PF2 known as the ’2018 NAO Report’. This report observed that as at 2018, there were over 716 operational PFI and PF2 projects in the UK with a capital value of around £60 billion, and the charges for these projects amounted to £10.3 billion in 2016 and 2017. Even with no new projects, future charges which will continue until the 2040s amount to £199 billion in total.

The British government’s use of the PFI model has slowed significantly, reducing from an average of 55 deals each year in the five years to 2007/08 and to only one in 2016/17. Of the 11 departments recently surveyed by the National Audit Office, seven stated that the main reasons for their reduced use of private finance in recent years were concerns about cost efficiency and value for money.

Following the collapse of Carillion and the 2018 NAO Report, on 29 October 2018 in the annual budget the UK chancellor, Philip Hammond, announced the end of PFI. He stated:

“I remain committed to the use of public private partnership where it delivers value for the taxpayer and genuinely transfers risk to the private sector but there is compelling evidence that the private finance initiative does neither. We will honour existing contracts but the days of the public sector being a pushover must end. I have never signed off a PFI contract as chancellor and I can confirm today that I never will. I can announce that the government will abolish the use of PFI and PF2 for future projects”.

Victoria has very much been a frontrunner in the use of PPPs to deliver major infrastructure. There have been 32 Partnerships Victoria projects contracted worth around $30.1 billion. It’s been observed that in Australia the PPP model is generally used to describe contracts that incorporate two key features – the bundling of design, construction, maintenance and potentially other services into a single contract, and the use of private sector finance.

Whilst PPPs can be categorised in a number of different ways, a common means of distinguishing different models is by the primary source of revenue they generate. Some PPPs derive their revenue by way of charges imposed on users of the infrastructure. These are known as a ’user charge PPP‘. The other primary way revenue is generated is by service payments or an availability payment. These PPPs are known as ’service payment PPPs”. The key difference between the two models is the question of who bears demand risk.

In Australia, most toll road PPPs were delivered under a user charge PPP model such as the original CityLink toll road in Melbourne, however, following a number of high profile toll road failures private sector investors have been unwilling to invest in toll roads unless the demand risk is borne by the government, meaning that the service payment PPP model has become more common for contemporary road PPPs in Australia.

Brianna Ryan – Now that we have a better understanding about the models themselves does the PPP model pose any risks to the construction industry?

Trevor Thomas – Spending on Australian mega infrastructure projects those with a value of over $500 million has soared over the last three decades. In a 2017 report on mega infrastructure projects, it was observed that in 1990 the largest single project tendered in Australia was worth $50 million. By 2000, this had grown to $500 million and in 2015 it was of the order of $8 billion - an increase of 1500%. Since that time, we can add the $16.8 million WestConnex project in Sydney; $12 billion Sydney Metro; the $11 billion Melbourne Metro Tunnel and $9.3 billion in the Land Rail project and a $6.8 billion Westgate Tunnel Project just to name a few. However, this record growth is not of itself demonstrative of a strong and stable construction industry.

At the close of 2020, the University of Melbourne released a survey based research report into the health of the Australian construction industry. This report found that only 34% of respondents believed that the industry was healthy with 55% believing that it was not, and only 50% were optimistic about the future of the industry. The most commonly identified issue confronting the industry in the 2020 report was the approach to risk allocation and a lack of collaboration leading to an adversarial culture.

In relation to risk allocation, governments have tended to prioritise certainty of cost as one of the driving factors for the delivery of mega infrastructure projects. As the 2020 report observes, governments, often driven by Treasury, strive for a ‘not to exceed’ price and this drives an attitude of transferring all the risk. This has led to many mega projects being delivered by either a PPP model or through fixed time, fixed price design and construct contracts. These models which are favoured by government’s legal, commercial and technical advisors tend to shift the maximum risk away from the public sector into the private sector ultimately landing with the D&C and operationally maintain contractors. This approach ignores the oft-cited Abrahamson’s Principle that risk should be allocated to the party best able to manage it, and gives precedence to cost certainty as one of the overriding objectives.

Brianna Ryan – Speaking of sustainability, have there been any observations made about the impact of PPPs on the sustainability of the Australian construction industry?

Trevor Thomas – The 2017 report found that since 2000, on average Australia construction companies working on mega infrastructure projects have posted a loss of 16% for each project. For an average project size of $1.3 billion that represents an average loss of $215 million per project. Cumulatively, that amounts to losses of $6 billion between 2000 and 2015 and the report projected further losses of $11 billion between 2015 and 2020. This amounts to a total projected loss of $17 billion between 2000 and 2020 with an average loss of 28% per project.

Whilst making it difficult to verify actual losses on any particular project, it is clear that an approach to project procurement which results in losses of this magnitude will be unsustainable and may well precipitate the failure of a number of mega infrastructure projects and tier 1 contractors.

Brianna Ryan – Well, given these impacts are there any alternatives to the traditional PPP model which might be useful?

Trevor Thomas – Certainly. We are not suggesting that the PPP model should be discarded in its entirety. On the contrary, there are many instances where the model remains appropriate and is likely to offer best value for money for taxpayers. However, given the current economic climate and the state of the Australian construction industry, it is timely to consider whether there may be opportunities to combine characteristics from various methods to develop a hybrid methodology which provides a more nuanced approach to risk allocation in the context of delivering future mega projects.

There is evidence of such a rethink approach – for example, Transport for NSW is currently delivering the last stage of the $16.8 billion WestConnex project. This is through a hybrid model combining a series of design and construct contracts followed by a user charge style concession period. The NSW government is currently considering whether a similar model should be deployed for other mega infrastructure projects such as the Western Harbour Tunnel project.

Another example is the Victorian North East Link PPP project, where following an unsuccessful tender process the government decided to significantly modify the risk allocation for the project. In November 2020, it retendered the PPP project on the basis of an incentivised target cost approach rather than a traditional fixed price PPP model.

The United Kingdom has adopted a hybrid regulatory asset based approach for the delivery of the £4.2 billion Thames Tidal Tunnel Project which is in construction and scheduled for completion in 2025. The British government is also considering using that model for the $20 billion Sizewell C nuclear power plant in Suffolk. These projects have taken characteristics of PPPs and other procurement methods and blended them to form different hybrid models for the delivery of mega infrastructure projects.

Brianna Ryan – Well, we’ve covered quite a bit of ground today. How would you sum up everything that we’ve discussed?

Trevor Thomas – I think we can reflect that Australia has been an early adopter and is now a world leader in the deployment of public private partnership projects for the construction of mega infrastructure. This approach has led to Australia being in a position to deliver very significant infrastructure projects that are for the benefit of the community. However, the approach through risk allocation which is typically adopted in PPP projects, and is also frequently implemented in fixed time/fixed priced design and construct contracts, has led to a number of commentators questioning whether that approach to risk allocation is both sustainable and offering the best value for money for taxpayers.

Accordingly, it is opportune to consider whether alternative models may be appropriate for the delivery of mega infrastructure projects. Models which take a hybrid approach combining elements of different procurement methods have been flagged by a number of commentators as potentially offering advantages over the traditional PPP approach.

Brianna Ryan – Well Trevor, thank you for your time today and thank you to our listeners for tuning in.

The link to the special edition of the Corrs Projects update that we’ve discussed in this episode can be found on the Corrs website accompanying this podcast. We look forward to you joining us for the next episode of the Corrs High Vis Podcast.

This podcast is for reference purposes only. It does not constitute legal advice and should not be relied upon as such. You should always obtain legal advice about your specific circumstances.