Stephen King: PPPs need better ways to handle risk

5:30 AM Tuesday Feb 26, 2013

Is there a future for privately funded toll roads? BrisConnections has been placed into administration only seven months after opening the Brisbane Airport Link toll road/tunnel. It has not had sufficient users to make the project viable. So what does this mean for future public-private partnerships (PPPs)?

In the short term, it will mean very little. The citizens of Brisbane have a great tunnel that (from my experience) cuts significant time off a trip to the airport. The investors have done their dough. And there may be various lawsuits about who misled whom.

However, this is the fourth in a series of PPP toll road failures, including Sydney's Lane Cove and Cross City tunnels, and Brisbane's Clem7. If PPPs are to have a future, we need better ways to handle the project risk.

The risk associated with large infrastructure projects can be significant. For toll roads, the viability of a project depends on projections of future traffic flows. But these flows may be highly variable, depending on a range of choices by the government and car users.

Under a traditional PPP contract, much of this risk is directly borne by the private investors. However, this risk will be reflected in the contract that underpins the PPP. So the risk will be indirectly borne by car users and taxpayers.

Most obviously, the greater the risk, the higher the tolls that will be demanded by the private participants in the PPP. So car users bear the risk of the project through high toll charges. This can undermine the social benefits of the toll road. Instead of taking traffic off congested suburban roads, high tolls may mean too few cars use the toll road.

More subtly, car users may bear the risk through limits placed on the government. The PPP contract may restrict future government transport policies that would alter traffic flows - even if these policies were in the public's best interest. If the government wants to implement these policies in the future then it will need to renegotiate the PPP contract. This can be a messy and costly process, meaning that desirable transport policies are left in the "too hard" basket.

Taxpayers may also bear the risk of a PPP through guarantees on revenue or via "take or pay" contracts that guarantee a flow of government funds.

In the extreme, taxpayers bear the risk through the potential for a government bailout. If the government decides that a PPP can't be allowed to fail for political reasons, taxpayer funds may be used to protect private investors.

If car users and taxpayers are going to bear the risk of a PPP toll road, what is the point of using private funding? The government can fund a PPP and directly bear the project risk, even if it is built and operated by the private sector. And government funding is significantly cheaper than private funding. Indeed, as Michael Pascoe notes in Melbourne newspaper the Age:

"Australian governments can borrow more cheaply than the private sector to invest in infrastructure. The federal government, in particular, can borrow extremely cheaply on very long terms."

Unfortunately, this option for improving the nation's infrastructure appears to be off the agenda. The current "budget surplus" fetish means that long-term government borrowing and investment in public projects is ruled out on the grounds of short-term political pragmatism.

So, if we want on-going investment in public infrastructure, we need better PPPs that handle the risk in clever ways. One alternative, being investigated by Melbourne University's Centre for Market Design, is to provide the private investors with a fixed return in current dollar terms.

Rather than specifying a length of time for the toll operator to charge road users, this approach allows the private operator to charge tolls until it receives a certain amount of money. This shares the risk between the private operator and the car users. If traffic volumes are high, the private operator will get their return quickly and the road will move back into government hands sooner than expected. If traffic volumes are low, the private operator will have a longer time to get a return.

Such an approach to a PPP will not save private investors when traffic flows are so poorly predicted that they can never get their money back. But it does protect them from short-term fluctuations.

The approach also improves flexibility over future government policies. To the degree that government policies change traffic flows, the private operator is protected. Changed traffic flows automatically change the length of time for the payback to the private investors. The PPP contract will only be renegotiated if the changes in traffic flows are so significant the private operator cannot receive the full return on their investment.

The failure of BrisConnections does not spell the end of PPPs. If we want infrastructure investment and government budget surpluses, then PPPs are a must. But it does spell the end of naive PPPs and it signals the need for research in order to design better PPPs. That is, unless we can find some more private sector bunnies who are happy to lose their money building roads for the rest of us.

Stephen King is professor in the Department of Economics at Monash University, Melbourne.