Most of the efficiency gains in a P3 procurement rest on a successful and cost-effective allocation of risks between the public and private partners. These gains (or benefits) arise from transferring selected project risks to the private partner, provided that the risks in question can be managed at a lower cost by the private partner, and part of this cost saving is transferred to the public sector owner in a competitive bid environment. Risks that may be worth transferring are those where the private partner has some control over how to achieve the desired outcomes, which puts it in a better position to manage the outcomes than the public sector partner. However, not all risks are worth transferring. For example, the risk of soil contamination that is undocumented and unknown prior to the start of the P3 project is sometimes retained by the public sector, because the private partner has no control over the outcome. Given that the private partner's discount rate is typically higher than that of the public sector, the cost to the private partner of dealing with such uncertain outcomes is higher than for the public sector partner and this would be reflected in the price of the bid.
The risks where value can be gained from transferring them to a private partner (in a competitive bidding process) include:
◆ financing risks;
◆ construction cost escalation risks;
◆ scheduling risks (e.g., delays);
◆ design coordination risks (i.e., the facility is not built according to the design-a risk that usually rests with the public sector in conventional procurements where the design is procured separately);
◆ commissioning and facility readiness risks; and
◆ operation, maintenance, and selected geotechnical and environmental risks.
A third category of risks consists of those that are best shared between the two parties to the extent that they both have significant influence over the outcomes. One such example is traffic risk. If a project includes a bridge or a roadway segment that is part of a larger network (as in the Autoroute 25 or Autoroute 30 projects), a private operator will certainly have some influence over traffic levels within a certain range, by virtue of the quality of maintenance work and lane availability. But traffic on the facility is also driven by the management of the overall road network and by economic activity levels in the region, both of which are outside the control of the private operator. This is the basis for sharing such traffic risk, but it can be a difficult balance to strike: The private operator needs to have the right operation and maintenance incentives without the public sector giving away too much of the benefit from higher traffic levels that would have occurred regardless of the private operator's behaviour.
In practice, there tend to be subjective elements in assessing the value of risks. However, several Canadian P3 procurement agencies have developed formal, quantitative risk assessment processes, which draw on past infrastructure procurement experience and on commercial cost evaluators to prepare risk templates for assessing which risks to transfer to the private partner. The very presence of a rigorous risk assessment process can also help both the public and private partners avoid certain risks altogether.
Private contractors always evaluate the relevant commercial, technical, and even political risks when bidding on a project, regardless of whether the project is a conventional one or a P3. What is unique to a P3 procurement process is the effort that the public sector owner (or procurement authority) devotes to identifying the wide range of possible risks and to assessing the value of such risks retained by the public sector under a conventional contract and under one or more potential P3-type contracts-such as a build-finance (BF) or a DBFM arrangement.1
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Private contractors always evaluate the relevant commercial, technical, and even political risks when bidding on a project, regardless of the procurement type. |
Infrastructure Ontario has had construction cost valuation experts develop a detailed set of risk templates identifying up to 80 categories of material risks for large infrastructure projects. These templates have been developed for different stages of the project life cycle, from the policy and planning stage through to design, procurement, construction, operation, and maintenance.2 The risk templates include an assessment of the value of each of the specific risks retained by the public sector under a conventional contract and under a BF (or DBFM) approach.3 For example, the cost consultant estimated that, in an average infrastructure project, the value of the risk exposure retained by the public sector under a Canadian Construction Documents Committee (CCDC) 2 construction contract amounts to 43.6 per cent of the base construction costs. The consultant further estimated that the value of these risks is reduced to 16.7 per cent on average under a BF contract. When the scope of the project includes the design, build, and maintenance work, 76.5 per cent of the construction cost base is retained as risk by the public sector in a conventional approach, as opposed to 16.2 per cent of the construction cost base in a DBFM project.
The full case for efficiency gains from transferring (or sharing) a risk is made only after factoring in the costs of transferring the risks (i.e., the risk premium) and any other associated costs, such as the incremental costs of private financing. However, the risk templates above provide a good starting point for determining which risks should be transferred to the private partner in each project. The P3 agencies or public sector procurement authorities also meet with each of the short-listed (or pre-qualified) bidders for a project to discuss what changes, if any, should be made to the draft project agreement between the public sector owner and the eventual P3 partner. The draft agreement is finalized by the procurement authority in advance of the final bids, based on the comments received from the short-listed bidders, and these bidders then submit their proposals based on the draft project agreement. This approach ensures that the project agreement is not subject to any negotiations between the procurement authority and the winning bidder, thereby minimizing a potentially important source of transaction costs.
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1 The value of a specific risk can be expressed as the relevant cost base (e.g., a $100-million construction capital cost at time of planning) multiplied by the probability that the particular risk in question will occur (e.g., 10-per-cent probability of a cost escalation event), multiplied in turn by the impact of that event (e.g., a 20-per-cent cost increase), which in this case would value the risk at $2 million or 2 per cent of the cost base.
2 For example, see Altus Helyar Cost Consulting, "Infrastructure Ontario Build Risk Finance Risk Analysis and Risk Matrix."
3 Infrastructure Ontario has also developed risk templates for specific sectors, such as transportation.