There may also be additional costs associated with P3 projects that occur after project close because of unanticipated changes in public policy or public aspirations, as reflected in the electoral cycle, and that result in major changes to the requirements stipulated in the P3 agreements. These costs, which tend to arise in long-term P3 contracts rather than in the build-finance projects, can lead to contract renegotiations or even contract terminations.39 The key point is that accommodating such major changes in long-term contracts can be more costly than doing so in a succession of shorter-term contracts.40
Modest changes in contractual requirements can usually be accommodated in both conventional and P3 contract settings in ways that maintain the cost discipline found in a competitive bidding process. For example, conventional contracts allow for change orders based on pre-set unit prices already incorporated in the contract. And in the P3 context, the facilities management components of the contract usually allow for market testing against prevailing rates for the same services, with the P3 partner taking the risk (or benefit) of any adjustment. P3 contracts also allow for any modifications to the facility under contract to be undertaken by third-party contractors (i.e., not by the P3 consortium).
Major changes in requirements, such as those arising from changes in the political cycle, are much more difficult to accommodate at a low cost in long-term P3 contracts. This is particularly the case in projects that exhibit a high degree of asset specificity, complexity, or uncertainty about the requirements. Vining and Boardman explain these costs as a form of unanticipated transaction costs:
Transaction cost theory suggests that contracting costs are likely to be raised when projects exhibit high asset specificity, high complexity/ uncertainty and low competitiveness. Public-sector infrastructure-such as roads, hospitals and schools-usually involves considerable asset specificity. Most design work for a particular project is not usable for any other project and is, therefore, sunk (although knowledge and expertise that can be used elsewhere is not sunk). The value of infrastructure in other uses is very low and often negative.41
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Major changes in requirements are much more difficult to accommodate at a low cost in long term P3 contracts. |
These unanticipated transaction costs can be contained through contractual provisions that allow for voluntary termination, which are standard in P3 agreements. They can also be contained by designing P3 transactions in such a way as to exclude any part of the asset that is subject to relatively high uncertainty regarding future requirements.42 Nevertheless, these unanticipated transaction costs can be significant relative to those in conventional contract settings. The second wave of Canadian P3s has not yet experienced any major changes in requirements leading to renegotiations or terminations. However, it is still early to judge how the second wave of Canadian P3s is likely to handle major unforeseen changes in requirements.
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39 For example, if a newly elected government decides to eliminate tolls on a new P3 highway where the P3 partner collects and shares in the toll revenues, this would require renegotiating or even terminating the P3 agreement.
40 As one example of the costs resulting from unforeseen policy changes, or the loss of policy flexibility, Murphy ("The Case for Public-Private Partnerships," pp. 112-14) recounts the story of the P3 to build and operate terminals 1 and 2 of Lester B. Pearson International Airport between the T1T2 Limited Partnership and the federal government in the early 1990s. A newly elected government cancelled the contract and eventually settled on a payment of $60 million to the consortium in 1997. This first-wave P3, a design-build-finance-operate-maintain project, was cancelled despite the lack of a voluntary termination clause. Second-wave P3s usually do include such clauses and are almost certainly in a better position to contain the costs of major unforeseen policy changes.
41 Vining and Boardman, "Public-Private Partnerships," pp. 18-19.
42 For example, road tolls are usually subject to more uncertainty regarding future requirements, including political and technological requirements, than the road or bridge structure itself.