Economic analysis starts from an assumption that people act in a rational way. Over the past few years economists have been exploring why people seemingly break this assumption on a regular basis. Understanding how people react to information, incentives and the way in which choices are presented is becoming increasingly key to developing effective approaches to designing and delivering public policy. It was one of the reasons I recently completed a short course on behavioural economics.
The coronavirus pandemic will have significant impacts on how we design, develop, fund and operate infrastructure. As the pandemic evolves, the nature of these impacts will emerge, creating increasing risks. There is a stark difference between the impact of the Global Financial Crisis (GFC) and this pandemic. The former was initially a financial liquidity impact that affected cash flows around infrastructure investment and operation.
The pandemic’s first impacts are likely to be around the loss of human capacity in the systems that support this complex sector. The near term impacts are likely to be more associated with loss of certainty, affecting planning, operation and funding of infrastructure.
There is a range of considerations; which will have varying degrees of impact on governments, communities, organisations and people.
i) Demand-based assets are vulnerable because of the drop in use as with the coronavirus takes away discretionary spending. This particularly so for transport infrastructure, which directly engages with end consumers. Supply chains for these assets will be affected.
ii) Contracted assets have some increasing counterparty risk. Energy assets, for example, depend on the continuing creditworthiness of their counterparties. Many utility services may be called on by state actors to contribute to the overall effort to address the economic impacts of coronavirus.
iii) Merchant infrastructure potentially faces higher volatility in commodity prices and heightened uncertainty of demand. This kind of infrastructure operates at the margin of markets, rather than profiting from significant baseload provision at low, guaranteed margins. It will vary across markets for infrastructure services.
iv) Some specialised infrastructure has exposure to sports. This group of assets has both contracted and demand-based revenues. In Australia, we see the challenges facing our principal football codes with the loss of stadium revenues. It has exposed football codes that have not been developing multi-year contracts for stadiums and areas, and cannot defer refunds and provide credits for future ticket purchases. Some infrastructure owners have not undertaken sufficient risk analysis to determine the financial reserves for significant events.
v) Expect construction delays and cost increases as labour and material shortages occur, as well as the introduction of appropriate occupational health and safety processes are developed to address coronavirus.
vi) Expect the possibility of some operating underperformance of infrastructure assets associated with possible labour and material shortages. As operating environments are adjusted, with some delays in scheduled maintenance, this should only be a short-term impact. Retaining the capacity to do critical maintenance is essential.
vii) Contractual triggering of force majeure declarations may become more likely. The effectiveness of these declarations will depend on the specific wording in each contract, which may create many disputes around non-performance.
viii) Policy exclusions in business interruption insurance may affect the ability of infrastructure asset owners and operators to respond. Management teams are going to have to think more about internal liquidity policies and how to structure their cash flows in both infrastructure transactions and operations.
ix) The debt position infrastructure owners and operators will be compounded by refinancing challenges. More volatile credit markets mean more considerable uncertainty about the costs of refinancing when it is needed. Understanding debt maturation profiles and alternatives will be essential. Assets with long concession periods or very long useful lives possibly have a better ability to manage their short term debt profiles.
Some of these risks might be mitigated in part by the following:
i) Government intervention is more likely to occur. While some government actions might have adverse impacts. Across a range of infrastructure classes, governments might take interaction to support the overall performance of the economy.
ii) Infrastructure businesses are more protected at the enterprise level. Many firms operate in multiple markets and hold multiple sets of infrastructure assets. Also, many infrastructure businesses operate long-live assets with capex plans that can be modified and significant management discretion on operational tempo and allocation of surpluses.
iii) Infrastructure projects typically have strong capital structures. How cash flows are applied is tied to contractual requirements and ensuring funds flow to relevant parties. This is the core of traditional project financing. Infrastructure projects without recourse to full cash-funded debt reserves are exposed to prolonged delays and a slow economic recovery.
Our response to coronavirus is only limited by our understanding of it and our ability to imagine and execute solutions.
Municipal waste-to-energy (WTE) systems incorporate significant uncertainty and risk. However, they provide ways to achieve significant environmental and economic sustainability for communities. With growing uncertainty, there are significant challenges around when and how to exercise flexibility.
Flexibility is important because as a mechanism it helps ensure better sustainability for WTE systems with long-term lifecycles. Flexibility of capacity expansion, in particular, is an important consideration given the expenditures that are typically required. Multi-stage stochastic modelling can help develop an optimal decision rule to guide decision making on capacity expansion using a real options approach.
Research on the expected net present value (ENPV) arising from flexible design suggests significant improvements are possible over the fixed rigid design in terms of economic lifecycle performance. The ability to make multi-stage decisions in any time period based on available information as uncertainties are resolved is an advantage over lifetime capital investment decisions that are typically set in the first year of WTE projects.
Through work with UTL Utilities, we bring strong cost benefit analysis and real asset option approaches to this kind of infrastructure investment.
Linear economic systems are inherently unsustainable, creating intergenerational equity where markets for this are not readily available. Understanding waste management approaches and the role of critical raw materials is key to developing effective approaches that move us towards the circular economy. It was one of the reasons I recently completed a short course in these issues.
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/
State Infrastructure Plan plays to division between SEQ and Regional Queensland.
The recently released State Infrastructure Plan (SIP) provides a much needed framework for the planning and prioritising of infrastructure delivery in Queensland and should be widely supported.
However, it also reinforces subconsciously the division that exists between SEQ and Regional Queensland when it comes to limited infrastructure dollars being spread across a large and high needs state.
The SIP outlines a $49.5 billion infrastructure program over the next four years from the Queensland Government ($12.9 billion in 2019-20) that claims to be supporting an estimated 40,500 jobs. Based on these metrics alone it is delivering economic development at a time when overall economic growth in Queensland is below trend.
Since the original SIP was released in 2016, Queensland has experienced significant changes including our population growing to more than five million, changing regional economies, and advanced technologies altering both infrastructure and service delivery.
As a result the 2019 SIP details the infrastructure investment strategy and delivery program for the next four years, in order to provide the private sector and other levels of government with clear direction of what is in the pipeline.
The Queensland Government’s SIP mantra is ensuring the right infrastructure is delivered in the right place and at the right time to meet the demands of a growing state. This is a commendable goal of any government and one that directly aligns with community and industry expectation.
If the document has one regrettable feature it is the cementing of an ‘us’ and ‘them’ attitude when it comes to infrastructure rollout across Queensland. For example the SIP reads “Importantly, about 60 per cent of the capital program and 25,500 of the jobs supported are outside the Greater Brisbane area.”
Much of the narrative of a fair split between the two parts of the State is about a political necessity following the Federal Election result whereby Queensland Labor were wiped out north and west of Brisbane.
As an illustration of this point, the 2019 SIP is 207 pages long verses 159 pages back in 2018 and these extra 48 pages are directly up front and relate purposefully to what the Queensland Government is doing in infrastructure delivery in regional Queensland.
It is not wrong to support regional Queensland but constructing a zoning of spend is counter to the commendable objectives of SIP in supporting economic development, increased productivity and the creation of communities in which people want to live across all of Queensland.
The reality is, what benefits SEQ undoubtedly benefits Regional Queensland and vice-versa when it comes to infrastructure.
Glowing examples of this point are the Gateway North Upgrade and Toowoomba Second Range Crossing whereby freight is passaged through these assets that benefits Regional Queensland. On the other side of the coin is investment in rail and ports in regional Queensland is enabling royalties for frontline service delivery in SEQ. The right narrative is a symbiotic relationship between the South East Corner and all of Regional Queensland.
Putting aside the politics, what the SIP really does is highlight how incredibly difficult infrastructure delivery and prioritisation is in Queensland. Our State has the unfaltering complexity of higher economic and population growth in SEQ meaning we are continually behind the infrastructure roll out curve and yet we have the geographical size, decentralised population and low population densities of regional Queensland.
All of which mean the road, rail, electricity transmission and electricity distribution kilometres are higher than other states and we require more airports and seaports. Quite simply infrastructure delivery in Queensland is complex and difficult – with differing priorities benefiting differing areas at differing times.
In summary, the SIP represents a very good iteration or constant continuing roll out of enabling projects for Queensland. Looking past the politics of its presentation it is investing in critical infrastructure and is in fact investing in a positive future for the Sunshine State.
The schools and TAFE are delivering the skills our economy requires. The bridges, roads, ports and rail are enabling our exports to get to market and commerce to flow. The electricity and water assets are providing the vital inputs for our economy.
The overall spend as impressive as it sounds is still low by historical percentage of GSP standards but the SIP has been well received from many communities and industry sectors and rightly so.
The plan can be found here:
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.
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:
I 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.