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Cost Benefit Analysis Economics Infrastructure

A Damming Idea

Tinaroo Dam Spillway (Source: ABC News)

Constrained water supplies in Far North Queensland are hindering economic development and can threaten water security of a number of towns. Inaction on supply has been driven by feasibility, concerns, funding gaps and worries about environmental sustainability. (1) In addition, politics focussing narrowly on dams as the supply solution runs the risk of missing other smart infrastructure and demand management opportunities to improve supply apart from just bulk storage. (2) Project proponents are also challenged often challenged by a user pay model required by the National Water Initiative. (3)

A strong evidence base of economically viable, financially feasible and prudently sustainable investments is needed to unlock these constraints. The balance between the public purse, private irrigator interests and environmental sustainability needs to be reset.

If considering just dams, what is an appropriate period of cost recovery? If an appraisal period is less than the economic life of the dam, usually an estimate of residual value would be included in the final year of the analysis. For example, a 25-year appraisal period for a 50-year asset, may include an asset value offset of up to 50% in the final appraisal year to ensure cost recovery over the appraisal period approximates around half of the expected use of the asset.

Similarly, where a dam is considered by policy makers to be a catalytic piece of infrastructure that supports and enables economic growth opportunities, an argument that there are economic externalities needs to be established. In effect, this means that not all the economic benefits are being captured by the users – providing a basis for partial public funding alongside expected user revenues. This externality argument is the logical basis for identifying the level of offset to user revenues. It presupposes both other uses for water as well as downstream benefits captured by non-users.

As a starting point, getting the evidence together to make the preliminary case for the residual value argument and a market failure argument around significant externalities is critical.

References:

  1. Parliamentary Library (Australia) Water Management https://www.aph.gov.au/About_Parliament/Parliamentary_Departments/Parliamentary_Library/pubs/BriefingBook45p/WaterManagement
  2. For example, the Sustainable Rural Water Use and Infrastructure Program https://www.agriculture.gov.au/water/mdb/programs/basin-wide/srwuip
  3. National Water Initiative pricing principles (https://www.agriculture.gov.au/water/policy/nwi/pricing-principles)

Categories
Cost Benefit Analysis Economics Infrastructure Transport

A $7 Crossing

Kangaroo Point Pedestrian Bridge artist impression
Kangaroo Point Crossing, Artist Impression
Source: Brisbane City Council

Brisbane City Council has announced a program to construct five ‘green’ bridges across the Brisbane River. [See https://www.brisbane.qld.gov.au/traffic-and-transport/roads-infrastructure-and-bikeways/five-new-green-bridges-across-brisbane] Analysis of the crossing at Kangaroo Point appears most advanced.

There is a handy infographic on Council’s website. Unfortunately, details of how the benefits have been calculated are not publicly available.

What we do know is that Council intends to spend $190 million to build the bridge. Council believes trips per day will rise from 5,300 in 2021 to 6,100 in 2036.

Making a couple of assumptions, we can work out the level of benefit per trip required for this to cover the capital costs. First we assume a 25 year evaluation period (2020-2044) and a 7% real discount rate. We also assume the asset has a 50 year life and include an offset residual value on the capital cost. The capital cost attributable to the evaluation period is a present value of $172.5 million.

Then we extrapolate the average crossings, which rise on an annualised basis from 1.9 million trips in 2021 to 2.4 million trips in 2044. This implies some 54 million trips will take place (2021-2044). However, using trips as a stand in for benefits, a trip today has a stronger present value than a trip tomorrow. The present value of all the trips had they occurred today is 24.5 million.

The capital cost per trip is $3.18 undercounted. In discounted terms, this is $7.03.

Given ratepayers are paying for it, one would hope Council is confident benefits are at least $7.03 per trip in benefits.

Do you think that is the case?

Categories
Cost Benefit Analysis Economics Infrastructure Lytton Advisory

Economics of Infrastructure Podcast

Image result for podcast

Thanks to Gene Tunny, Principal at Adept Economics, for inviting me onto his new podcast series – Economics Explained. We discussed the nature of infrastructure, the services these assets supply and how good economic analysis helps select better infrastructure projects. Gene and I have collaborated on a number of projects over the last two years. He is a leading independent economist who blogs regularly at queenslandeconomywatch.com.

You can listen to the podcast here: https://queenslandeconomywatch.com/2019/09/16/economics-of-infrastructure-interview-with-craig-lawrence-of-lytton-advisory/

Categories
Cost Benefit Analysis Economics Infrastructure Lytton Advisory Policy

6th Anniversary

Economic Effects of Infrastructure Investment and its Financing

Today marks the sixth anniversary of Lytton Advisory as an independent economic consulting practice. Over that time, we have worked on a wide range of economic issues. This has taken us to places as diverse as the Solomon Islands, Papua New Guinea, Kuwait and Saudi Arabia.

We have never lost our enthusiasm for helping clients make smarter capital investment decisions. Neither have we wavered in our passion for proper planning, prioritisation and funding of infrastructure. In more recent years, our work has been around leading project teams of committed, experienced economists and professionals to bring high conviction analyses to our clients. Good cost benefit analysis is at the heart of what we do.

In the first half 2019 founder, Craig Lawrence took, in effect, a sabbatical from the practice to lead the establishment of the Economic and Social Infrastructure Program in PNG. This $130 million 4+4 year Cardno-delivered, Australian Government funded program seeks to improve the quality of planning, prioritisation and funding of infrastructure to achieve economic outcomes and social development goals for Papua New Guineans.

Whether it is: developing an investment manual to incorporate climate change adaptation in infrastructure development decisions in the Solomons; a full cost pricing algorithm for food and drug regulatory services in Saudi Arabia; or generating savings from waste transfer station closures that fund a ten-year capital works program – Lytton Advisory is up for the challenge. At every stage, it is about driving value for the clients and communities affected by infrastructure.

We are excited about the future for infrastructure, its contribution to sustainable economic and social development, and how emerging economic incentives, new social paradigms and innovative technologies are shaking up these services.

Categories
Cost Benefit Analysis Economics Infrastructure

Surfing the Pipe

Building Queensland has released its latest Infrastructure Pipeline Report.  It shows how the Queensland Government is addressing the State Infrastructure Plan, and how this relates to funding by the Commonwealth Government.

Queensland faces big challenges.  Population growth and ageing, ageing infrastructure assets and increased demand for social infrastructure, and constrained funding envelopes.  These challenges require innovative thinking around services, assets, operations, funding and financing.

The Report highlights how a staged business case process can drive value for the State infrastructure spend before final funding decisions are made.  It also makes very transparent which projects the State has to decide to actually fund. The infrastructure pipeline is informing Queensland Government investment decisions with 23 proposals funded since our first report in June 2016

The importance of the Infrastructure Pipeline Report is in the credibility of the project development path for projects.  Since 2016 the Pipeline has informed Queensland Government investment decisions to fund 23 proposals.  This level of transparency attracts a lot of focus, energy and resources from the private sector.  It also enables longer-term planning by businesses to anticipate future project delivery needs.

The credibility of this Pipeline is in stark contrast to the rash of unfunded announcements that were made by governments in the past, leading to ridiculous capital works programs that were never delivered.

Publicly released independent reviews of business cases and, in particular, the mandatory cost-benefit analyses, would strengthen this further.

The 2019 Infrastructure Pipeline Report can be found at:

Click to access Infrastructure-Pipeline-Report-2019.pdf

Categories
Cost Benefit Analysis Infrastructure

More Infrastructure Debt Now? Yes but …

infrastructure

The Economic Society of Australia recently polled a number of senior economists on its National Economic Panel, posing the following question:

“As interest rates are at low levels by historical standards, federal and state governments, despite their public debt levels, should be borrowing more than they currently are to invest in infrastructure”.

Just over 70% of respondents either agree or strongly agree, and on a confidence-weighted basis, 75% agree or strongly agree. This is a rare consensus.

But …

It is worth reading the individual responses. This strong consensus is backed by a requirement for solid cost-benefit analysis, case-by-case consideration of projects and a recognition that any infrastructure spending is not automatically a ‘good thing’.

See: http://www.monash.edu/business/economics-forum/polls/public-borrowing-for-infrastructure-investment

Do you think we should increase public debt now to invest in infrastructure?

Categories
Cost Benefit Analysis Economics Policy Transport

Transport Planning Award

aitpm-2017-winning-presentation

A great collaboration with the Department of Transport and Main Roads and Aurecon.

Lytton Advisory prepared cost benefit analysis modelling of this active transport infrastructure program for TMR, drawing on great research and analysis undertaken by the project team.

Queenslanders will continue to benefit from TMR’s engagement in developing further active transport infrastructure.

Many thanks to all who contributed to this.

Categories
Cost Benefit Analysis Economics Policy Transport

Economic Benefits of Cycling Infrastructure

cycling-brisbane

Very pleased to see that my colleagues at Queensland Department of Transport and Main Roads and Aurecon will be presenting our analysis on the economic benefits of cycling infrastructure at the National Traffic and Transport Conference of AITPM in mid-August.  The abstract is available here:

https://www.aitpm.com.au/economic-benefits-of-cycling-infrastructure/

 

Image: Southbank, Brisbane. Source: Brisbane Tourism.

Categories
Cost Benefit Analysis Transport

Cross River Rail Dice Roll?

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In this note we consider there is a 25% possibility that Cross River Rail may fail to achieve a positive economic net present value and explain how we arrive at that opinion.

Building Queensland reported in its cost benefit analysis summary that Cross River Rail produces a Net Present Value (NPV) of $966 million with a Benefit Cost Ratio (BCR) of 1.21. However, its summary did not publish the actual present value totals of the benefits or costs from the study. The full report is not available for public scrutiny.  Also, the government’s website for Cross River Rail has still not published the business case.

The BCR was expressed in terms of P50, which implies there is a 50% probability that it could be lower than 1.21. Similarly, if the NPV was expressed as P50 that implies a 50% probability the NPV could be less than $966 million. Interestingly, no formal sensitivity analysis was presented in the summary.

Is it possible to assess the probability that the net present value of the project could be less than zero or the benefit cost ratio less than one?

Using the NPV and BCR information from the summary we calculate the implied present value of benefits (B) and the present value of costs (C). Since NPV = B – C = $966 million, and BCR = B / C = 1.21, we can solve for C. This gives us a present value figure for C of $4,742 million. Therefore, the present value for B is $5,738 million.

Since we do not know the risk profile of these values, let’s assume variability in the estimates are normally distributed around the benefit and cost values implied by the NPV and BCR figures. This is a generous interpretation of the variability of the actual result compared to the estimate because we know that costs are typically skewed towards overruns and realized benefits fall short of estimates more often than exceed them.

We assume a standard deviation that is approximately 20% for each cost and benefit estimate. We assume in the absence of any guidance that the estimate is the mean for the purpose of this analysis. This applies both to costs and benefits. Under a standard normal distribution the estimate statistic is also a P50 estimate.

Benefits and costs in the tails of each distribution are likely to be extreme values. We assume that values in the 5% tails either side of the mean are not sampled. That is, values are drawn from a normal distribution that represents 90% of possible values for benefits and costs.

One final consideration – no correlation is assumed between benefits and costs. What it costs to build and operate Cross River Rail has no influence on the level of demand achieved. The same project is delivered irrespective of cost.

Running @Risk probability software over this, we find that running the NPV calculation through 1,000 iterations there is a 25% chance that the project will generate a negative NPV. No formal consideration is given to optimism bias, which would tend to increase this value.

Is this a risk worth taking? Hard to say because some of the fundamental information is still not in the public domain. Also, components of both benefit and cost may be well identified and estimated. As a consequence, their probability profiles might be within a much smaller range.

Within the project, further work would be required to minimise and mitigate risks that could affect benefit realisation or lead to increased costs. Release of further detail about the project would enable the public to assess this.

Image: Brisbane Times.

Categories
Cost Benefit Analysis Economics Lytton Advisory

Make the Casino Work for You

rouletteNothing is more hair raising than exposure to risk without a sense of the level of that exposure.  This is especially true in capital investment decisions.

Monte Carlo simulations perform risk analysis by building models of possible results by substituting a range of values—a probability distribution—for any factor that has inherent uncertainty and significant impact on the final result.

By using probability distributions, variables can have different probabilities of different outcomes occurring.  Probability distributions are a much more realistic way of describing uncertainty in variables of a risk analysis and improve the quality of sensitivity analysis.

During a Monte Carlo simulation, values are sampled at random from input probability distributions.  This is done hundreds or thousands of times, and results in a probability distribution of possible outcomes.  It provides a much more comprehensive view of what may happen.

Advantages over deterministic, or “single-point estimate” analysis include:

  • Probabilistic Results. Showing how likely each outcome is.
  • Clearer Graphical Results. Visual presentation of probabilities.
  • Improved Sensitivity Analysis. Sharper sensitivity analysis to show what counts.
  • Scenario Analysis: Model repeated variations in combinations of factors to show which scenarios need further investigation.
  • Correlation of Inputs. Represent how, in reality, when some factors goes up, others go up or down accordingly.

Done poorly or with low quality input data, the results can be potentially misleading – producing a level of certainty on the basis of some very uncertain assumptions.

Lytton Advisory holds an @Risk software licence which enable us to provide this type of probabilistic analysis to clients, helping them make better informed decisions. Examples of how we have applied this for clients include:

  • Estimating financial costs of schedule delay on a major metropolitan public transport project.
  • Assessing probability of breaching a cost contingency levels on a +$500 million infrastructure program.
  • Building probabilistic NPV profiles in cost benefit analyses given uncertainty about key economic inputs.

Contact us today to find out how we might be able to help you.