Infrastructure Investment

01 Sep 2010

Is There a Change in the Wind?

The National led government has put infrastructure at the top of its economic agenda. Of the six policy drivers forming the core of its economic programme, "investing in productive infrastructure" is one.

No question here that the focus is on investment, not merely expenditure. This means infrastructure that will produce a positive economic return in terms of increases in productivity for every dollar spent.

But how is this investment going to be delivered?

The traditional model favoured by the previous Labour led Government was based on utilising public sector finance, with separate contracts with private sector contractors for the design, construction and maintenance. Under this model the operation may be contracted out (eg roads, wastewater treatment plants) or be kept in the public sector (eg prisons, hospitals, schools).

The more recently evolved "Public Private Partnership" or "PPP" model involves private sector finance, often incorporated into a single agreement between the public and private sector covering not only the provision of finance but also the design, construction, maintenance and operation.

This PPP model was squarely out of favour with the previous Government, which introduced legislation to tightly control, or even prohibit, PPPs. Good examples are in the areas of water and wastewater, roads, and prisons.

The Local Government Act 2002 included restrictions on contracts for the operation of water and wastewater infrastructure including limitations on the duration of contracts for such operations to an uneconomic (in PPP terms) 15 years. These provisions were stated at the time they were introduced to be intended to reduce the scope for private sector involvement in the operation of water or wastewater infrastructure.

The Land Transport Management Act 2003 introduced a means of obtaining authority to toll roads, but also introduced a complex and ultimately discretionary process requiring ministerial approval for PPP agreements. Prior to the LTMA 2003 no such restrictions on contracts between the public and private sector had existed. Only public toll roads have been built since the LTMA 2003 was introduced.

The Corrections Act 2005 expressly precluded contracts for the management of prisons by any persons other than the Crown, which were expressly allowed under the previous legislation.

The National led Government, with infrastructure now at the top of the agenda, seems to have a more open mind.

The Minister of Infrastructure, Bill English stated at that the New Zealand Council of Infrastructure Development Conference last year that:

"The Government will enter into PPPs only if they work and deliver value for tax payers. Our interest is increasing the performance of public assets across the board... but let me clear – this is not about ideology: Private Sector involvement will happen where it makes sense."

So, some qualified support, but behind the scenes a lot of work is being done to open the way for PPPs.

The legislative road blocks above are being removed. The Corrections Act has now been amended to expressly allow contracts with the private sector for management of prisons. Under the current Local Government Act Amendment Bill before Parliament, the 15 year period for contracts with the private sector relating to the provision of water and wastewater services has been extended to 35 years. This is a much more realistic period to allow a private sector operator to generate an economic return on a PPP project. The LTMA has yet to be amended to provide for a more certain process for the delivery of PPP roads, but there has been a lot of talk around identifying suitable candidates from the list of major roading projects in the Government's infrastructure plan.

The newly established National Infrastructure Unit formed within Treasury has also produced model guidelines and standard form documentation for PPP projects, which will be able to be used by all Government departments, and local government, wishing to consider the PPP model for infrastructure delivery.

PPP projects are actually happening too. The operation of Mt Eden Prison is to be contracted out to the private sector, and the next major prison on the Government's agenda, Wiri Prison in South Auckland, is going to be delivered under a PPP model based on the new guidelines and documentation produced by the National Infrastructure Unit.

Many of the detractors of the PPP model question whether this model can truly deliver greater value. Many simply cannot get past the difference in cost of debt to the public sector compared to the private sector (which has only increased in recent years). These detractors find it difficult to accept that this increase in the cost of funding can be offset by other efficiencies and value drivers inherent in the PPP model.

However, there are many pieces to the value jigsaw when it comes to infrastructure delivery. Risk and time are two big pieces. The bundling together of all of the obligations from finance and design through to construction and operation under the PPP model allows the maximum allocation of risk to the private sector as well. Utilising the PPP model will also allow many projects to be brought forward and delivered sooner. Remember the Government is talking about investment in productive infrastructure. That of course means infrastructure that will deliver an economic return by boosting productivity. The benefit of bringing forward these productivity increases needs to be factored into the value equation.

Also, in the future the higher cost of finance to the private sector may not continue to be the given that it has been to date. A case on point is the recent interest shown by China Road and Bridge Corporation to be involved in consortia with New Zealand contractors to deliver some of the Government's largest road infrastructure projects. That organisation may be able to obtain funds at a cost comparable to or even lower than the cost of public sector finance in New Zealand.

The Government's cautious approach to PPPs, providing support, qualified by the requirement that PPPs "deliver value" seems to be the right approach. But will PPPs prevail in this environment? The old adage that the "proof of the pudding is in the eating" comes to mind. The Government is providing qualified support, and has removed many of the legislative blockages. If the PPP model does not prove it can deliver value, the traditional models for infrastructure investment will remain at the fore. If it does, the PPP model will survive and probably prosper and will supplant the traditional model in some areas.

This article was first published in the New Zealand Herald's Infrastructure Report August 11 2010.

Author

Michael Weatherall

Partner - Property & Infrastructure

DDI: +64 9 977 5097

Mobile: +64 29 977 5097

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