Given the COVID-19 pandemic and current economic recession, it’s no surprise that public agencies throughout the United States are cash-strapped and stymied. At the same time, American infrastructure is in vital need of repair and reinvestment. Amid the upheaval, the US has an opportunity to help alleviate both our economic and infrastructure challenges at once — through public-private partnership (P3) project procurement.
Underutilized in the US, well-executed P3 procurement delivers lasting infrastructure for better taxpayer value. Authorized in 38 states, P3s can provide the de-risked, long-term certainty that our country is craving, and the delayed payment structure offers leeway for the sorely needed but currently untenable financial investment.
With the pandemic acting as a trigger, we have a new opportunity to build confidence in properly executed P3 procurement methodologies and lead crucial behavior change in how we structure and deliver our infrastructure investments.
Breaking down project procurement models
In the United States, design-bid-build and similar models have been the traditional procurement methods for decades, but these models leave significant levels of risk with the public authority. In this model, design and construction elements are tendered separately, which means that the public authority is exposed to the associated interface risks between those elements, leading to claims for more time and money. In design-build, the next step on the procurement spectrum, one private entity takes on the risk of those two elements and the interface between them, thereby protecting the public authority.
The P3 procurement methodology goes one stage further and brings together design and construction with maintenance and, where appropriate, operations elements into one holistic package. P3 procurement adds in finance, allowing for payment over a much longer period of time as well as a mechanism for penalizing poor performance. Through the contractual structure put in place, the single project delivery partner is incentivized not only to deliver assets on a timely basis but also to maintain them over an extended period at a predetermined price. This means that the private partner will consider the optimal cost of construction and maintenance when developing the design.
Putting P3s in context
Outside of the United States, P3s have been leveraged extensively in Australia, Canada, and Europe, among other markets. The United Kingdom has seen more than 700 projects delivered successfully through P3 procurement, which has significantly transformed their public services, from hospitals, primary healthcare facilities, schools, and universities to highways, rail, and government buildings.
Within the United States, the Port of Miami Tunnel, the Long Beach Civic Center, and numerous transportation projects in Texas, Virginia, and elsewhere have proven this type of procurement can provide good value for US taxpayers. There are also several federal programs that can enhance these projects, particularly in the transportation and environmental sectors.
Throughout my career in project finance, I have worked on successful P3 procurements in the US, UK, Latin America, and many countries in Europe, including flagship projects like the Rion–Antirion Bridge in Greece, the vast majority of which have come in on time and on budget. With the right programs in place, these projects have successfully leveraged public resources to ensure more projects are undertaken (and therefore more jobs created) than would otherwise be the case.
Despite these successes, the use of P3 projects has been relatively slow in the US. Traditional methods combined with municipal finance, the primary public financing mechanism in the US, are perceived as cheaper (which they are at the outset for public authorities and therefore used extensively). However, little consideration is given to the additional cost of the risks retained by the public authority, including cost and time overruns, which often more than outweigh the difference in financing cost.
When and why it can go awry
The vast majority of P3 projects have been successful, but when P3 procurement does fall off course, it’s often the direct result of overzealous risk transfer or the acceptance of abnormally low bids. The founding premise of P3s is to allocate risks to the parties best able to manage them. That doesn’t mean maximum risk transfer — it means sensible, analytical risk transfer. The procurement process and strategy for the project must be based on achieving best value for money. This is done through a thorough consideration of the risks and where it is best to allocate them.
The 2002 London Underground P3 refurbishment project is one example. Unlike earlier successful P3 projects for the London Underground, a decision was made for the refurbishment project to transfer a significantly greater level of risk compared with other P3s.
P3 projects are financed with non-recourse debt and equity and are typically highly leveraged in order to achieve the best price. The new risk approach led to a cascade of events that eventually meant that, on the one hand, risk was transferred that couldn't be managed and, on the other hand, debt guarantees were provided that resulted in one of the counterparties securitizing the guarantee and making a windfall profit.
How to ensure success
The key to success in these projects is to ensure the thorough consideration of what would be a sensible balance of risk and use a structure that allows all parties to manage those risks effectively, deliver projects on time and on budget, and provide necessary public services for the communities they serve. This preparation also de-risks the project as more becomes known prior to start of construction.
A good example is the Port of Miami Tunnel, which had some risks around the uncertainty of ground conditions. While the public authority could have argued to move all that risk to the private side, they instead distinguished a separate pool of funds to address any unforeseen ground condition issues. This alleviated the risk for the contractor, who was then able to offer a better price for the construction contract.
Part of P3 procurement success is also in ensuring the private side can communicate effectively with the many third parties involved in the procurement phase. The public authority should consider interfacing with third parties on behalf of all the respondents to guarantee effective communication in analyzing those risks. It's also important to have the right people in the room, including senior leadership, when conducting one-on-one meetings with respondents.
The final piece of the puzzle is to legislate out the ability to simply pick the lowest cost proposal if the proposal comes in significantly below the others. As public authorities develop their strategies around this type of procurement, they need to ensure that the proposal with the best value over time is chosen, not just the bid with the lowest upfront cost — especially as the latter is often more expensive in the long run.
The blue-sky potential of further P3 procurement
The key benefits of this procurement model include on-time and on-budget delivery, as well as a consistent maintenance schedule. Through traditional procurement methods, projects are built without any guarantee of future maintenance, which is also often the first thing cut as public authorities experience budget constraints. Continued maintenance offers substantial savings for the public authority in the long term, as a well-maintained asset won’t need to be replaced before its original design life.
Additionally, the public authority often doesn’t have to pay for these projects until construction is complete. At the moment, public budgets are very tight. This procurement mechanism would allow necessary projects to begin construction while giving the public authority a buffer of several years before requiring payments. The payments themselves are spread out over a significant contract period, allowing for additional breathing room.
Unlocking the benefits through necessary behavior changes
In the United States, I hope to see a broader change in approach in terms of which public sector entities consider P3 a routine option, perhaps justifying why they aren’t using a P3 model for any major capital expenditure, as opposed to why they are. This isn’t to say that P3 is always the most applicable approach for every project, and they do require certain skills and resources to manage on an ongoing basis, but such a policy might force people to think more rigorously and realistically about the longer-term value of different procurement models and, in particular, the cost of risks they are retaining.
Fortunately, there is now a significant market of P3 developers ready and able to respond to P3 procurements and who have raised significant sums of capital to do so. P3 developers, particularly those with a long-term approach to investment, can be first-class partners to public authorities in developing and managing public facilities over the long term.
When structured correctly, P3 procurement offers the opportunity to significantly improve a broad range of sectors in the United States, from health and education to transportation and water. With the right policies in place, and the right advisors to inform behaviors around those policies, we can save the taxpayer money on hugely beneficial infrastructure investments at a time when both are desperately needed.