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Public sector entities (federal, provincial, municipal, health, etc.) are increasingly adopting public-private partnerships (P3s) for the replacement, renewal and development of infrastructure. With intense competition for public sector capital funding showing no signs of letting up, a P3 is a proven vehicle for stretching those resources further.
P3s are typically long-term, performance-based contracts involving significant risk transfer to the private sector. Beginning a P3 relationship involves the selection of a single provider (generally a consortium of companies) through a competitive procurement process. The selected provider is responsible for delivering the design, construction and financing elements of a project and may also be required to deliver one or more of the maintenance and operations needs of the project.
P3 projects are highly geared, with debt financing (loans, bonds) amounting to approximately 85% to 90% of the project’s capital needs and equity financing (ordinary equity, subordinated debt) the remaining 10% to 15%. The private sector provides both debt and equity financing, with government financing generally limited to milestone payments when the project reaches substantial completion.
Public concerns are sometimes raised over the higher cost of private financing compared to what governments can achieve—the conclusion being that P3 contracts are more expensive than traditionally procured projects and do not offer the best value for the public purse. But this is simply a common misconception that does not consider the true or total cost of a P3 project, which comprises many elements in addition to financing that in fact reduce the total cost of the project.
Valuable Benefits of a P3
Lower Insurance Costs
To cite one example, an analysis of a P3 project based on financing costs alone ignores the additional fees and taxes that government may have to levy to repay lenders if a project is unsuccessful. A P3 model provides an unstated insurance and therefore lower risk premiums from lenders due to a lower risk of default. Since the risk to the public sector for project investment is the same as that of the private sector, this should be reflected when calculating the project value for money.
Greater Risk Oversight
While private financing has a higher associated cost compared to government financing, it introduces private lenders and equity providers who are in turn motivated by having significant funds at risk and therefore exercise a greater degree of active project oversight. This results in a greater degree of true risk transfer than would otherwise occur in a project that is traditionally procured and managed by the public sector.
Innovative Design Solutions
In addition, the long-term nature of the project (typically 25+ years) and required financing creates an incentive for the asset to be designed in a manner that considers its whole life cost; i.e., the private sector remains accountable for the consequences and costs of a poor design as the financing for the project is typically non-recourse, based instead upon a performance-monitored revenue stream. This approach encourages innovative design solutions and a high standard of ongoing maintenance management and provides reassurance in regards to the completeness and accuracy of project costs. In the event of failures that cause lenders to step in, the public sector will benefit from organizations with the experience and expertise to manage and remedy such circumstances prior to project default.
Accelerated Project Delivery
Finally, when considered across a portfolio of projects, such as multiple offices, schools, courthouses, etc., a P3 offers the benefit of accelerating the delivery of required works, which encourages solutions to consider the long-term well-being of the portfolio as a whole and the efficiencies that can be achieved across that portfolio. This would typically not be the case under a traditionally procured project, which tends to consider a portfolio as 10 individual projects that make up a whole.
As this post has outlined, a decision on whether or not to pursue a P3 project based solely on the higher cost of private financing does not consider the many non-financing-related benefits of the P3 model, all of which have value. A comprehensive and more accurate analysis of the total project cost to the public sector needs to take these benefits into account.
Related Topics:Public Sector
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