Risk transfer is illusory
Critics of PPPs say the risk transfer is illusory.
It is true there have been some Australian PPPs where the government has felt the need to:
• take control of a project; or
• provide additional financial support to a project,
because risks had occurred that the private sector had accepted but ultimately not been able to manage.
For example, in October 2000, the Victorian Government took control of the Metropolitan Women's Correctional Centre to overcome a failure by the private sector to provide adequate service levels. In the same month, it also bought back the Latrobe Public Hospital project for similar reasons. And in 2006, the NSW Government announced it would buy back the contract for the provision of health services at the Port Macquarie Base Hospital to address poor service levels. In each case, the private sector had underestimated the cost of meeting its service obligations and, in the case of the hospitals, had underestimated demand risk.
More recently, in 2012, the NSW Government agreed to provide conditional deferred equity of $175 million to the Waratah train PPP project, to overcome concerns regarding the SPV's ability to refinance its debt in 2018.
So, there have been occasions where government has ended up sharing some of the risk that it thought it had transferred to the private sector under a PPP contract.
That said, there are many more PPPs where the private sector has paid dearly for miscalculating or mispricing the risks involved. In recent times, it has either been the design and construction costs, or the operating revenues that have been miscalculated. Examples include:
D&C costs
| • Southern Cross Railway Station: Leighton Holdings announced forecast losses of $122.6 million as a result of cost overruns under the D&C contract; • Waratah Train: Downer EDI announced losses totalling $440 million on the D&C contract; • the Victorian Desalination Plant: in March 2012, Leighton Holdings announced that it expected to make a loss of $602 million on the D&C contract, after originally forecasting a profit of almost $300 million; • Brisbane Airport Link: at the same time, Leighton Holdings announced that it expected to make a loss of $668 million on the D&C contract, after originally expecting to make a profit of $407 million; |
Operating revenues
| • Toll road projects where traffic has been overestimated: those holding equity in the Cross City Tunnel project were expected to lose between 80 and 90 cents for every dollar they invested, when the project was sold by the receiver in June 2007. But they fared better than those who held equity in the Lane Cove Tunnel, who lost all of their equity when that project was sold by the receiver. Indeed, the lenders also took a haircut on that project, as the sale proceeds were insufficient to fully repay the debt. Those who bought ConnectEast shares for $1 in 2004 received just 55 cents for their securities when the road was sold in September 2011. On CLEM7, RiverCity Motorway did not collect enough tolls to pay the interest on its debt and went into receivership rendering the shares worthless. Similarly, investors in BrisConnections which undertook the Brisbane Airport Link project lost their equity; • Brisbane Airtrain: initial predictions of passenger numbers went unrealised, resulting in a financial restructure which saw debt swapped into equity, and the interests of existing equity investors reduced by about half; • AustralAsia (Adelaide-Darwin) Railway: demand for rail freight services was over-estimated resulting in the SPV becoming insolvent, and the project being sold by the receivers for an amount less than the senior debt. |
Clearly, risk transfer was not illusory on these PPPs.
Perhaps, with the recent shift to more 'full service' hospital and prison PPPs with significant operating and maintenance costs, we may see more instances of the O&M contractor seeking to cut corners on service levels as a result of seriously underestimating the these costs? This could lead to more instances where government determines that the only way it can deliver the services levels the community expects is by taking control of the project or providing additional money to the O&M contractor.