1 Infrastructure is one of Australia's largest asset classes and plays an important role in the economy's productive capacity, output and microeconomic performance. Governments at all levels provide around 70% of economic and 64% of social infrastructure.
2 Infrastructure is especially important to the Queensland regional economy and for many years, state investment was a demand-response approach to high levels of population growth, particularly in urban areas, and strong regional economic growth.
3 Public investment in infrastructure has declined as a share of gross domestic product (GDP) from around 6% in the 1960s to 3.8% in 2007. The average age of infrastructure is increasing and in 2007, 54% of all new investment was accounted for by depreciation and capital retirements. In Queensland, real infrastructure investment between 1996 and 2004 fell in both per capita and gross state product (GSP) terms.
4 The South East Queensland Infrastructure Plan and Program 2008-2026 (SEQIPP) is a supply-led approach to infrastructure provision and contemplates significant private investment in the next 18 years. The private sector is increasing its share of infrastructure investment and management mainly through outsourcing and public private partnerships which currently account for up to 10% of state capital spending on infrastructure.
5. Internationally, PPPs are being used across a wide variety of economic and social infrastructure projects in more than 85 countries. PPPs are a procurement methodology that brings a rigorous risk-weighted approach to major projects using a competitive bid process and private sector expertise and innovation. PPPs are achieving a number of significant improvements in major project procurement and improved public service delivery. A wide body of evidence supports the following findings:
● PPPs are bringing forward the delivery of major projects
● The model is achieving value for money, reducing procurement costs and delivering more projects on time and within budget than traditional methods
● PPPs are improving the science of state procurement and have led to wider application of Gateway Review and alliance contracting methods with significant benefits for state procurement outcomes
● Certainty with lifecycle costing
● High levels of construction and design innovation and new technologies.
6. PPPs are highly leveraged and a number of major assets are either listed on the Australian Stock Exchange (ASX) or controlled by listed portfolio investment funds. PPPs are highly dependant on capital markets for many services including:
● Raising equity capital through initial public offerings
● Debt finance
● Financial risk management
● Intermediation, credit insurance and related services
● Innovation from financier-led competitive bids.
7. Conditions in international and domestic capital markets are unstable and volatile. Present conditions exhibit the following characteristics:
● A 50% fall in stock prices since the market peak in 2007 and stock price volatility
● Limited opportunity for on-market equity raisings
● Increased difficulty raising debt and higher debt financing costs
● Limited supply and repricing of credit insurance
● Uncertainty and lack of confidence.
A consequence of these market conditions is limited availability of equity and debt capital and a higher cost of capital. This condition is exacerbated in Australia where projects listed on the ASX make greater use of medium-term corporate debt and periodic refinancing than other countries. Revaluation and refinancing, once revenue maturity is achieved, are key elements of investment economics through increased leverage, a return to equity and a reduction in the cost of debt. Present market conditions would indicate that these opportunities will be considerably reduced over the medium term.
8. Present market conditions imply that future PPPs will be subject to new disciplines - lower leverage, higher reserves, stronger underlying credit credentials, higher debt service coverage criteria and higher cost debt. This will affect both bid depth and state risk allocation with lenders expected to take a tougher approach to the support of delivery and operational risks. This suggests some impact on the value for money outcomes for the PPP model in the short-term.
9. PPPs with positive credit characteristics will fare much better regardless of size. These characteristics include:
● More conservative leverage than has been common in recent years
● Availability based payment regimes and benign regulatory frameworks
● Strong reserves and debt servicing capability
● No exposure to patronage risk for debt service coverage
● Availability of appropriate credit insurance
● Capabilities, financial strength and track record of consortium members
● Limited or shared lifecycle servicing obligations.
10. To maintain a PPP bid market and to maintain a flow of PPP transactions in present market conditions, government has several policy options including the issue of state bonds, the credit guarantee finance model, the supported debt model and direct guarantees. Bonds remain a state option at any time although they are treated as state debt for Loan Council purposes and carry both deadweight and, to the extent that they offer tax deductibility of bondholder interest receipts, revenue costs. Direct guarantees are a contingent liability for the state and offer a relatively low-cost support mechanism for PPP projects. The credit guarantee and supported debt models may lower cost of capital but also increase transaction and agency costs. The options for government are examined in further detail in this report.
11. PPPs deliver procurement benefits and are improving the science of state procurement. Present market conditions do not close the door on PPPs but do provide an opportunity for both government and industry to develop a more refined model that is more appropriate for the new environment. This may require a more scientific costed approach to risk allocation, state guarantee support, improved underlying credit credentials and a rethinking of patronage risk. It is a shared responsibility. It may also be a further step in the continuing evolution of alternate major project procurement mechanisms.