Category Archives: Infrastructure

Q&A With David Baxter, PPP Navigator and Infrastructure Specialist

ppp-infrastructureI chatted recently with David Baxter, an infrastructure specialist with significant experience in public-private partnerships. He shared some of his insights with me.

He gave me some meaningful comments regarding challenges facing governments in providing public infrastructure and how commercial interest can be created, risks shared and benefits for communities achieved.

So how would you characterise recent PPP activity in the Pacific?

Much of the activity seems to be focused on small island nations or be tied into China’s Belt and Road Initiative. Although there is great merit in building up these island nation trade capabilities through the improvement of port and airport facilities, the following questions need to be asked:

  • Are these facilities being constructed in the interest of the host nations or are they being built for geopolitical leverage?
  • Can these small island nations and even bigger nations afford these projects?
  • Are adequate feasibility studies being done on the financial and commercial viability of the projects?
  • Are full and competitive procurements being pursued?
  • Is the long-term sustainability and resilience of PPP projects being considered?

Many countries have PPP policies in place and a PPP unit located in their Treasury or Finance departments. What are some of the biggest mistakes you have seen in implementing PPP policy?

The following are the most common that I see:

  • In many instances, the PPP Units are the initiators of PPP projects when they are imposed upon unwilling line ministries which have not always been consulted on the viability or desirability of projects.
  • Often the laws and best practices that are introduced, get ahead of institutional ability to implement the laws accordingly and so delays occur as everyone tries to meet requirements imposed by regulators.
  • In some instances, the PPP Units try to be autonomous of the Treasury or the Finance Ministry (for political reasons) and this then leads to conflict between the institutions that is not healthy in the long run.
  • Often the PPP Units do not have well define mandates and this leads to confusion on whether they should provide technical support to government institutions or whether they should be the initiator of PPPs. It is important that they realize that their activates should subject to national procurement laws and they are not a law unto themselves.

What characteristics do you think differentiate infrastructure PPPs from other types of PPPs?

Primarily the greater level of due diligence that needs to be completed on private sector partners due to the long-term commitments that are required and their ability to manage risk for 30 + years. Most typical contracts rely on the design-build element. PPPs require financing and O&M on top of this which requires that the public sector must monitor the performance of its long-term partner and the performance-based parameters.

What are the most significant conditions necessary to ensure an infrastructure PPPs is successful?

Appropriate allocation of risk during the feasibility, procurement, and contract award stages and monitoring and immediate mitigation of risk when it occurs.

PPPs are often seen as a panacea for difficult national budget circumstances. What are the risks around developing PPPs with this as the prime consideration?

In many instances, PPPs should not be implemented because they do not pass the litmus tests required such as Value for Money, commercial and financial feasibility, etc. They cannot be seen as an automatic panacea, it needs to be proven that proposed projects are viable and feasible as well as sustainable to be a panacea.

What governance arrangements are more effective for infrastructure PPPs?

Governments need to be fully engaged in the management of PPP contracts. They cannot step away and only engage the private sector partner when the close-out phase is reached. Many government employees do not understand the level of commitment required from their side and the need to have a technical understanding of PPPs to ensure that they are implemented correctly.

Is a rigorous public sector comparator really that important for an infrastructure PPP?

Most certainly in countries that are still developing or which are launching their first PPP projects. As PPP national markets mature, the private sector can become a more competent partner and this leads to a more trusting and professional collaboration.

PPPs often address a particular infrastructure service or need. How effective are they in addressing asset maintenance and preservation of benefit streams from existing infrastructure?

Brownfield PPP projects can be a minefield due to many unknowns. However, experience gleaned from existing projects and infrastructure can be beneficial – so it depends. However, I believe that every PPP project is unique and thus a certain amount of innovation is necessary to improve asset preservation and to do it better than it was done in the past. The goal should always be simple – do it better each time.

PPPs are inherently commercial in nature, as risk along with return is transferred to the private sector. How can social benefits and returns be properly incorporated in the development of PPPs?

I believe that this has to do with a mature and well-defined understanding of Value for Money: adherence to people first PPPs is an option as well as incorporating the SDGs into project goals and objectives. This can help project proponents determine the non-commercial elements of risk transfer in socially beneficial projects and the possible subsidies that might need to be introduced to offset non-commercial vitality pertaining to certain risks.

If every PPP had to contain one mandated element, what would that be?

By answering the following questions –

  • Why are we doing this as a PPPs?
  • Are we confident that this should be a PPP?

Good answers require completion of due diligence, gaining political support, full stakeholder engagement and full disclosure of all information to all private sector parties equally, so that they all understand the merits of the project.

If these answers cannot be motivated and supported fully – do not do it as a PPP.

David, thanks so much for making the time available to talk with us and share these insights.

 

Payment Terms Improvement

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BHP has announced it will be reducing the amount of time it takes to pay its suppliers to thirty (30) days:

https://www.linkedin.com/pulse/resource-industry-network-welcomes-bhp-announcement-30-day-network/

This has a number of significant, positive impacts on its supply chain in the Mackay region.  The effects will be felt across hundreds of firms in the region.

Earlier this year Lytton Advisory did analysis on the impacts of extended payment terms for the Resource Industry Network, which included some modelling of different effects.  Details of the report are publicly available:

http://www.resourceindustrynetwork.org.au/announcements/report-shows-big-opportunity-being-missed-in-regional-economy-when-adopting-extended-payment-terms

 

More Infrastructure Spending Required in PNG

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Last month I introduced day two of the 2018 PNG Investment Conference in Brisbane.  This included an overview of some key PNG infrastructure sectors and an observation that the country needed to increase its infrastructure spending.

https://www.businessadvantagepng.com/six-per-cent-of-gdp-required-to-maintain-papua-new-guineas-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?

Success Diagnosed

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Very pleased to see PNG and Australia have signed an Agency Support Arrangement for the PNG Department of Transport this month.  I led an earlier Agency Capacity Diagnostic of the Department for the PNG Transport Sector Support Program.

“These diagnostics are undertaken by independent consultants and provide the agency management with objective assessments of capacity, including through the identification of existing strengths and skills gaps. The diagnostics also provide recommendations for addressing agency needs.  TSSP then works closely with the Australian High Commission and agency heads to develop programs of structured capacity support to improve performance and address identified priority capacity gaps.  This is formalised through  Agency Support Arrangements (ASAs) which detail the multi-year frameworks for funded activities to bridge some of the gaps highlighted by the diagnostics.” (Source: TSSP website)

A great outcome which also included a lot of hard work from senior officers in the Department, the Transport Sector Support Program and at the Australian High Commission.

[Link to article]

 

Significance of O&M in Infrastructure

maintenance

Installation of new infrastructure assets creates streams of services and improvements to existing services for users. Benefits accrue to these uses as well as a wider set of stakeholders. Maintaining the service potential is a critical element in ensuring that value for money is achieved from the initial capital investment.

However, many governments and asset managers are under significant pressure to trim maintenance budgets and scrimp on operating costs. In some contexts, this emerges as an extreme build-neglect-build scenario. Many Pacific Island nations experience this, as do a number of smaller Australian local government authorities. The full lifecycle cost of infrastructure assets is not factored into the budget planning processes of these organisations. Similarly, many private sector operators of infrastructure have commercial and financial incentives to focus on next quarter financial performance rather than long-term service provision from these assets.

The back end of infrastructure is seen as much less interesting, but it is where all the benefits are generated. So approaches to operating and maintaining these infrastructure assets is as equally critical as the planning and investment decisions to deliver them.

Two broad maintenance strategies are predictive maintenance and condition based maintenance. Predictive maintenance is like regular scheduled servicing based on the design performance of an infrastructure asset. It is less costly to implement but also less likely to match the actual performance of the asset. Condition based maintenance requires the collection of data and information about the actual performance of the asset and provision of a tailored asset maintenance response.

The approaches set up an economic challenge. Should an infrastructure manager simply maintain its assets according to schedule and only collect data and information on condition at the times of regularly scheduled servicing? Or should some initial data costs be incurred to change and adapt design-based, predictive maintenance? Decisions to underfund reasonable maintenance activities need to be made with good information and in an appropriate strategic context.

So it depends. In one sector, for example, the response is clear but not clear-cut. Analysis of wind turbine maintenance to address gearbox, generator and blade failure scenarios shows that for small wind turbines, predictive maintenance is more cost effective than condition based maintenance. Condition based strategies were based on an array of sensor data (optical, oil, vibration and temperature). However, for larger turbines, condition based maintenance where there is a high expected gearbox failure rate is a much better approach. In that instance, the cost of collecting additional data and information enables timelier and more appropriate servicing of the turbines.

For these reasons, infrastructure owners and managers need to ensure there are effective asset management and maintenance policies included in their strategic asset management frameworks. It is not enough to supply the assets, as only the services from them will be able to generate the full suite of expected benefits. This can only be achieved when the design potential of these assets is realised over time.

Infrastructure Asset Transactions

moneyshield

Economic infrastructure provides fundamental services to economies. Typically, this type of infrastructure provides electricity, water and gas to industry, businesses and large institutions, community organisations and households. It also assists in providing transport, freight and logistics services.  In the information age, access to low-cost, high-speed broadband facilitates a range of e-services.

The quality, cost, and access to these services affect the productivity of an economy, the efficiency with which goods and services are both produced and consumed, and the equity between different sections of society.

The physical aspects that underpin these services have a range of characteristics that separate these services from everyday goods and services delivered through competitive markets. Service provision can be characterized by a large, up-front capital investment. Installation of an asset can create a local demand response and establish a natural monopoly. Economic arguments for duplication of the asset to stimulate competition are usually weak.

Also, there is usually a long-term stream of benefits that are generally small relative to the capital investment. In some cases, user benefits alone are insufficient to justify the construction and operation of economic infrastructure. Wider benefits can accrue to society, and some societal costs can be avoided.

These assets contain a high level of optionality. Unlike purchasing a retail good, it is possible to develop the asset in phases or stages, with options to scale up or down or abandon operations. In other cases, once the decision to build has been made and construction started, it is tough to change the project scale or scope.

These factors contribute to determining how these assets can be funded as well as who should potentially own and control them.

The classic argument for government provision of infrastructure assets, and consequently related services, concerns market failure. That is, the operation of the private market leads to under or over provision of services from these assets. As a result, mismatch of supply and demand reduces economic value in the economy. In the case of under provision, supply is constrained and the level of inputs is less than required to meet the demand. As infrastructure services are critical inputs into other sectors of the economy, economic efficiency is impeded. The productive potential of the economy is not fully realized and potential economic growth is stymied.

Where there are significant externalities, these are not captured in the price mechanism, where price signals between buyers and sellers determine the optimal level of production and consumption.

This affects the funding and revenue models for infrastructure assets. Consequently, asset transactions can become very complicated.

Where benefits largely accrue to users, and use of infrastructure services can be individually identified, it is possible to develop cost reflective charging regimes. The funding model, without recourse to other sources than user charges, is only limited by extant economic regulation where this is imposed on assets with strong monopolistic characteristics. This river of user revenue forms the basis of the transaction value, and also the initial assessment of feasibility.

It is not without significant risk because of the long period evaluation, accompanied by the risk around maintaining fixed parameter assumptions over that timeframe. Construction cost blow outs, poor demand forecasts, changes in consumer preferences, shifts in relative related prices for products and services that are substitutes or complements can all combine to turn a positive investment into a financial fiasco.

This is before considering the situations where direct asset-related revenue streams cannot support the creation and operation of economic infrastructure.

An infrastructure asset that cannot be funded from its future stream of user revenues requires additional funding contributions. The private sector will not fund infrastructure without a financial return. It is important to distinguish from an economic return.

Economic infrastructure may produce a return to an economy but will not be provided by the private sector if the private sector cannot get a return on its investment. In other words, the return to the economy is contrasted with the return to the balance sheet of a private investor.

Given the extraordinary imbalance in costs and benefits in any particular period over the life of an infrastructure asset, some form of financial intermediation is necessary. It is important to see this as a financial service rather than a private sector investment. This ensures that the cash flows needed to build, operate and maintain the economic infrastructure asset are provided as and when they are required.

Similarly, change of economic control of an infrastructure asset occurs at a specific point in time – a transaction date. The control is exchanged for a specific valuation of the asset.

As an example, early stage infrastructure development is heavily exposed to construction risk and unproven demand. In contrasts, mid-life infrastructure assets have mature demand profiles and risks associated with construction are better known. Late life assets face potential increases in maintenance and rehabilitation costs, as well as changes in user demand and the impact of technology.

Having a very clear perspective on the inherent economic and financial values of an economic infrastructure asset is very important. These valuations are combinations of knowledge at a point in time. It is where a very strong risk assessment is needed as well as an understanding of the relevance of that point in time.