The pros and cons of public-private partnerships
A lagoon near the Regina wastewater treatment plant is seen in this file photo.
Published Monday, September 23, 2013 7:17PM CST
To P3 or not to P3?
That is the question Regina residents will consider in this week’s referendum, the city’s first in more than 20 years, on the funding model for a new wastewater treatment plant.
City council has already made up its mind on the issue. In February, it unanimously approved a public-private partnership (P3) funding model for the $224.3 million project.
That prompted Regina Water Watch to launch a petition, which ultimately led to the upcoming referendum. The local group is hoping residents will vote “yes” on Wednesday to a traditional, fully public funding model.
What is a P3?
PPP Canada, the Crown corporation tasked with screening requests for grants through the Conservative government’s Building Canada Fund, defines P3s as “a long-term performance-based approach to procuring public infrastructure, where the private sector assumes a major share of the risks in terms of financing and construction.”
John McBride, the chief executive of PPP Canada, says cost-benefit analysis has shown the P3 approach typically creates five to 15 per cent value for money.
One of the reasons for that, he says, is that the private firm is contractually obligated to deliver the project on time and on budget.
“Under a P3, if they don’t deliver on time, they don’t get paid,” McBride said.
“Under the traditional project, people get paid along the way. In fact, they’ve got an incentive for it to go longer and slower because they get paid by the amount of money that they put in…But when you’re not getting paid, you have an incentive to deliver it on time.”
Moreover, he says, P3s account for the entire life cycle of the project, unlike the traditional model. In the case of Regina’s wastewater treatment plant, the agreement between the city and the private sector firm would span 30 years.
Under that approach, the company that wins the contract would design, build, finance, operate and maintain the plant. The city has stressed that it would still retain ownership and control of the facility, however.
“In a traditional-type project, somebody will put a project out to design and then you’ll get a design back and you put it out to build and somebody will build it. Then, a third person will operate it,” McBride said.
“Quite often when you have problems with cost overruns, the builder says there’s a problem with the design and the finger gets pointed at the designer. Or the operator will say it wasn’t built properly.
“But when you have one person who’s responsible for delivering that under one price, it forces them to think of all of those kinds of things.”
Criticisms of the P3 approach
As Regina residents are well aware, not everyone is convinced that the P3 approach is the way to go. Critics argue it costs more compared to a conventional procurement model. How much more is anyone’s guess, though.
A recent University of Toronto study of 28 P3 projects in Ontario suggests private-public partnerships cost, on average, 16 per cent more than a traditional contract.
“There’s really only one reason why you would use (a P3),” said Simon Enoch, the director of the Canadian Centre for Policy Alternatives’ Saskatchewan office.
“I think it’s advantageous from a politician’s perspective because that debt is usually either off the books or it’s sort of kicked down the road by 30 years.
“So, from a politician’s perspective, it’s advantageous. But from a taxpayer’s perspective, you will end up paying more for a P3 than you would through traditional public procurement.”
Enoch says transparency and accountability is also a concern with P3 agreements because the contracts often contain proprietary information that can’t be released to the public.
University of Montreal professor Pierre Hamel notes many Canadian cities that entered into P3 agreements to deliver various services have since done an about-face, and they’re saving money as a result.
“Cities were going more and more toward private contracts during the ‘90s,” said Hamel. “But since 2000, cities are going back to in-house more and more. So there must be something they understood – they acted based on their experience.”
The City of Hamilton’s experience with public-private partnerships is one that “any anti-P3er would dream of,” says Hamel.
In 1994, the city awarded an untendered contract for its water and sewage treatment plants to Philips Utilities Management Corporation. In turn, the company promised economic prosperity, new jobs and cost savings.
However, within 18 months of the deal being signed, the workforce at the plant was cut in half, and some 180 million litres of raw sewage had spilled into the city’s harbour.
In the decade that followed, the contract changed hands four times. Two of the contractors are now bankrupt, and it was eventually revealed that one of them was a subsidiary of the scandal-plagued Enron Corporation.
When the contract came up for renewal in 2004, municipal politicians voted to put water and sewage treatment back in the hands of the public sector. The move reportedly saved the city $1.2 million in the first year alone.
Proponents of the P3 approach point out that a major advantage of such agreements is that they transfer risk from taxpayers to the private sector.
Mark Romoff, CEO of the Canadian Council for Public-Private Partnerships, says the advantage of P3s is they are a fixed-price contract, in which the private partner is responsible for incurring any cost overruns.
“When you cost out a project done in the traditional way, normally no one attaches any cost to the risk incurred by taxpayers for projects that aren’t delivered on time or on budget,” Romoff said.
“There is a risk there because if that cost therefore goes up, in the end, it’s taxpayers who end up paying for that.”
McBride says the fact that the private partner has to put hundreds of millions of dollars on the line is a strong incentive for the firm to deliver a project that is both innovative and cost-effective.
“Nothing beats having (private) money at risk to deliver the very best results,” McBride said. “I always say I’d much rather have their money at risk than the taxpayers’ money.”
Still, critics say the problem with transferring risk is that governments have no standard measure for monetizing risk. As a result, the risk valuations in P3 agreements are often wildly inflated, says Enoch.
“Everyone’s just sort of making this up as they go along,” he said. “This so-called risk transfer is being used as a way to make the P3 option look more cost effective than it actually is.”
With risk comes potential reward
It stands to reason that a private firm wouldn’t take on the enormous risk involved in a P3 project if it had nothing to gain from the deal. After all, the private sector is in the business of making money.
But how does a company turn a profit under a P3 agreement?
The short answer, according to the president of the Saskatchewan Construction Association, is by being innovative and cost-effective.
“If they can do it under cost, then whatever money is left over is their profit,” said Mark Cooper.
“But the reality of these projects and where the risk comes in is that those profits aren’t guaranteed. If the contract is negotiated effectively and the private sector isn’t able to do things cheaper, they still have to do them, and they may have to operate for periods of time at a loss. That’s the risk that comes inherent in the project.”
Naysayers of the P3 approach say that because the private partner is motivated by money, it will cut corners in the design, construction, operation and maintenance of the facility to ensure it’s making a profit.
“If you want to end up with the lowest price, you must cut the workforce, you must be cutting corners,” said Hamel. “It might go well, cutting corners, having less people. But it might go worse.”
McBride rejects that argument, however, saying most P3 contracts include specific performance standards that must be met over the duration of the agreement.
“People say ‘they’re driven by the profit motive and they’ll deliver a substandard project.’ Well, they can’t deliver a substandard project because they’re accountable for running the project for (30) years,” McBride said.
“So, if they build something that is going to break in five years, who has to fix it? They do. What happens if they don’t fix it? They don’t get paid.”
McBride also notes that the collective bargaining agreement of city workers at the plant would be respected under a P3 contract, and there would be no layoffs, should residents vote in favour of that funding model.
The cost of borrowing money
There’s little debate that governments can borrow money at a lower interest rate than a private sector firm.
As Ben Dachis of the C.D. Howe Institute puts it, if a government funds a project entirely with public money and it goes over budget, it can rely on taxpayers to cover the bill. However, if a private company can’t pay its debts under a P3 contract, it goes bankrupt.
In short, he says, there’s less risk involved in borrowing money to governments and, as such, they enjoy a lower interest rate than the private sector.
However, a recent study by the institute found that while the public funding approach appears risk-free to lenders, it isn’t risk-free for taxpayers.
“The cost of capital question, whether it’s cheaper for government to borrow or not, really hinges on taxpayers being unwitting and, in many cases, unwilling insurers for cost overruns,” said Dachis.
“You hear over and over and over that it’s cheaper for the government to borrow. But that’s not true when you think that it’s not necessarily cheaper for the government to borrow, it’s just easier for them to go after taxpayer dollars.”
Romoff says if you consider the cost of a project over the long-term, and not just the initial cost of borrowing, it’s apparent that a P3 agreement is a better deal.
“When you look at infrastructure projects, you have to look at the full life cycle of the project to really get a fair understanding of what the costs are,” said Romoff.
“When you look at the true cost of the infrastructure build and its long-term use, the reality is that in present-value terms, (P3s are) a significant saving relative to traditional procurement.”
The $58 million carrot
One of the City of Regina’s main arguments in support of the P3 approach is that the wastewater treatment plant project won’t get federal money unless it is funded through a public-private partnership. The suggestion is that to forego millions of dollars in funding would be costly to taxpayers, not to mention foolish.
But several of the experts CTV News spoke with insisted that, even without the $58 million in federal funding, the traditional procurement model would still be cheaper.
“It’s hard to ignore $58 million, and I’m not suggesting that they do that entirely,” said Cooper.
“But I also think that it would be wrong for the city to only do a P3 project because of federal dollars. I think there’s a lot of other good reasons why they should do it, and I think they think so too. But maybe they’re focused a little too much on that $58 million.”
Some question whether the federal government should be getting involved in funding infrastructure projects in the first place.
“There’s no fundamental reason for the federal government to play infrastructure tooth fairy to the lower-level governments,” said Dachis.
“Sewage is a classic example, water, electricity – all of these sorts of things are things that users can pay for through their water rates, through sewage rates, through user fees. This is a tried-and-true practice.”
The devil is in the details
If the debate over the funding model for the project seems murky, it would appear that both the city and Regina Water Watch share responsibility for muddying the waters.
The city says the traditional model would be an estimated $79.6 million more expensive, and that residents would end up paying an additional $276 for utilities annually.
However, the Deloitte report on its website provides only a cursory overview of how the consulting firm reached those conclusions. In addition, parts of the report have been redacted to comply with information and privacy legislation.
On the other hand, Regina Water Watch points to a report it commissioned by economist Hugh Mackenzie, which concludes that, even with $58 million in federal funding, the P3 approach would cost $77.2 million more.
But those numbers are based on assumptions from PPP Canada, and Mackenzie’s own calculations on the “possible” cost of private borrowing.
However, experts say that, as with any agreement, public or private, the devil is in the details. Citizens have been given the power to choose a funding model in the upcoming referendum, but city administrators will be responsible for negotiating the terms of the contract.
“The negotiation of the contract is really central to the whole thing,” said Cooper. “If the contract isn’t negotiated effectively, then the P3 will not work out well.”
Regardless of the outcome of the referendum, those who pushed to put the vote in the public’s hands will have to trust their elected representatives to get it right when it comes time to negotiate a contract.