Lessons learned from the first Wave of P3 projects

The first wave of P3s in Canada reached financial close between the early 1990s and 2004, as indicated in Exhibit 1. These projects have already been reviewed by several authors,1 based on information that was publicly available at the time. These case study reviews produced several findings:

First, the off-balance-sheet treatment of public sector liabilities was a widespread practice in the first-wave P3 projects. The Confederation Bridge and Highway 104 projects are two prominent examples of such public sector accounting treatment. However, this practice reduces the transparency of public sector accounts and provides no economic value. Further, the extra effort required to structure an off-balance-sheet transaction arguably leads to higher transaction costs and thereby destroys value. Fortunately, this accounting practice has been abandoned in the second wave of P3 transactions.

Second, many first-wave P3 transactions were also characterized by an attempt to transfer all the revenue risk inherent in a project (also known as "demand risk" or "use risk") to the private consortia. Typically, this would mean that a private sector consortium was responsible for all the risk associated with any variation in revenues arising from the use of the facility, as was the case for toll revenues in the Confederation Bridge and Highway 104 projects. Vining and Boardman have argued that these attempts to transfer revenue risk were largely unsuccessful, because private sector consortia usually have only limited influence over traffic levels or infrastructure use levels.2 As a result, the effective transfer of revenue risk was seldom achieved in the first-wave P3 transactions, because other features of these transactions were usually adjusted to lower the likelihood of reductions in traffic levels or to mitigate the commercial consequences thereof. For example, in the Highway 104 project, the Nova Scotia Auditor General noted that "the final agreement required the Province to compel large trucks to use the road [and] to maintain a 30 km per hour speed differential between the old and new road."3

The difficulty of transferring revenue risk arises in situations where the key variables determining traffic or demand levels remain largely under public sector influence, such as the management of network-wide traffic levels and economic activity levels in the regions surrounding the tolled facility. Since risks are managed most cost-effectively when they are allocated to the party best able to manage them, revenue risks in these situations are best allocated to the public sector, as has generally been done in second-wave P3 projects.4 The latter have been characterized by availability-based performance payments.

A third finding worth noting is that some first-wave P3 deals did not succeed in fully transferring financing risk to the private consortium, although the projects in question relied on private financing (e.g., Confederation Bridge). In such cases, the public sector owners incurred the higher costs of private financing (relative to public sector debt financing) without arguably enjoying its full benefits, because the financing was not at risk for the consortium.

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1  See Allan, Public-Private Partnerships; Vining and Boardman, "Public-Private Partnerships"; Auditor General of Ontario "Brampton Civic Hospital"; Murphy, "The Case for Public-Private Partnerships"; Vining et al., "Public-Private Partnerships in the US and Canada"; Iacobacci, Steering a Tricky Course.

2  Vining and Boardman, "Public-Private Partnerships."

3  Auditor General of Nova Scotia, "Highway 104 Western Alignment Project," p. 127, cited in Vining and Boardman, "Public-Private Partnerships," p. 27. Non-compete clauses are also common risk-mitigating features in projects that attempt to transfer revenue risk (e.g., limitations on expanding the capacity of adjacent roadways, as in the case of State Route 91 in California). The limited success in transferring financing risk to the private consortium is another feature of P3 deals with substantial revenue risk, as was the case in the Confederation Bridge project and the construction of Highway 407 ETR.

4  Some second-wave P3s did transfer revenue risk to the private consortium; however, these projects involved either a limited transfer of revenue risk (e.g., sharing of toll revenues in the A25 and A30 highway projects) designed to provide the consortium with incentives to keep the facility open for service, or transferred revenue risks that tended to lie largely within the control of the consortium (e.g., the Sierra Yoyo Desan Resource Road).

Sources: Vining and Boardman, "Public-Private Partnerships"; Iacobacci, Steering a Tricky Course.