Economic Risks

P3 supporters share the assumption that the party best equipped to cope with a given risk should bear that risk. In an ideal P3, since the government pays a fixed amount, it is the private partner that bears the risk of cost overruns, delays or labour shortages. The private partner should possess superior management and technical expertise, and should thus be better equipped than the government to address this risk.

In fact, governments face significant risks. When a company secures private financing, a government is protected from risk only to the extent that the private partner is able to absorb potential financial difficulties. If the private partner defaults or fails, or is unable to meet the cost of continuing with a necessary project, the public has no choice but to provide a bail-out or to take over the project., often at a cost of millions.

The City of Cranbrook, BC used a P3 to construct a new 4250-seat arena. The private partner had difficulty securing financing and meeting construction deadlines, and suffered cost overruns. Ownership changed hands several times, and fees increased from what was charged at city-owned rinks. In March 2007, the City signed a termination agreement and brought the arena under City control.

In 1998, Guelph signed a DBFO deal with Nustadia Developments to provide  a $21 million arena facility. The City paid half of the initial construction cost, and Nustadia was responsible for the rest of the financing. In 2001, Nustadia was unable to make its payments, and the City was forced to take over its loan and capital tax payments at a cost of almost $4 million over four years. In 2005, Nustadia walked away from the deal  completely, leaving Guelph with $9 million in unanticipated debt. In addition, in order to build the arena, the City had to buy the adjacent mall, which cost $1.7 million plus $500,000 to 600,000 in annual operating losses.

In California, one highway P3 deal was extended from 35 to 45 years after cost increases meant that the private partner was no longer earning its expected 18.5% rate of return.

Governments can consider the size, equity and cash flow of bidders and subsidiaries in awarding P3 contracts, but it is impossible to prevent a corporation from gaining or losing assets, selling or losing equity, or re-organizing such that the P3 contract is transferred to a subsidiary. Ownership of Hamilton-Wentworth's 10-year water services P3 contract changed hands several times before the agreement was finally severed in 2004.

The Negotiating Advantage of the Private Sector

The Complexity of P3 Contracts

P3 contracts are extremely complex, and a P3's effectiveness in sharing risk fairly depends greatly upon the specific structure of the agreement. For example, if a project is perceived to be high risk, the private partner may insist on a higher rate of return or a certain guaranteed profit, which would transfer some of the risk back onto the public partner.

The private sector has a considerable advantage in experience and expertise in structuring P3 deals. For example, one of the bidders in Edmonton's Southwest Recreation Complex project is a group headed by Forum Leasehold Partners Inc., a nationwide company with numerous P3 holdings, including a $225 million project in Ottawa, while this would be the City's first attempt to structure a P3 deal of this sort.

Given the complexity of P3 deals, a relative lack of experience and expertise puts the public sector at a major disadvantage. In Nova Scotia, a highly complex school construction P3 deal went to arbitration several times, and as a result schools lost the right to cafeteria and vending machine profits, and saw the hourly rate for the rental of school sports facilities rise from $7 to $57.

Nova Scotia had no idea it was conceding these terms when it negotiated the contract.

Even in the UK, where PFIs make up 15% of all infrastructure spending and public sector expertise is concentrated in a government corporation, a recent House of Commons report indicated that the private sector possesses a major negotiating advantage, and that this has resulted in delays in the tendering process, added costs to the public, and inaccurate cost and revenue projections.

On a related note, the Federation of Canadian Municipalities emphasizes that one of the key factors in apportioning risk between public and private partners is the capitalization rate granted to the private partner, i.e. the percentage of the total capital cost that the government pays each year. A higher capitalization rate means that the private partner receives a greater guaranteed return in the project’s early stages.  When the company's capital investment is repaid faster, it is protected from radical fluctuations in costs or revenues.  The public and private partners have opposing interests in determining the capitalization rate, and the accuracy of cost and revenue projections is crucial. Once again, the private sector has a resource and negotiating advantage, as is demonstrated by the number of P3s that have proven unfavorable to the public sector.

The Cost of Developing Proposals and Contracts

It is enormously expensive to evaluate and develop P3 deals, in terms of both real costs and delays. In developing Abbotsford's 35-year hospital P3 contract, lawyers and consultants were paid $24 million before the contract was even signed.

In Calgary, in the time between the announcement that the new South Health Campus hospital would be considered as a P3 and when the P3 option was ruled out, project costs had soared from approximately $500 million to over $1 billion. In Edmonton, the City spent $1 million and took close to a year to evaluate P3 options for the construction and operation of a badly needed new transit garage. In that time the estimated cost of the project has gone from just over $50 million to well over $90 million.

Calgary opened the $5.8 million Radisson Park School this year, announcing it as a success. Contract negotiations on that project took two years.

Britain's House of Commons Committee of Public Accounts released a report this October indicating that the cost of the tendering process has reduced the level of competition for P3 contracts, and that the average tendering time for projects from 2004 to 2006 was three years.

Some provinces have taken steps to concentrate and centralize public expertise in evaluating and structuring P3 proposals. The BC government has established Partnerships BC, a government-owned corporation dedicated to facilitating and developing P3s. Ontario Infrastructure is a similar arm's-length Crown Corporation. In Alberta, the Capital Planning Initiative (CPI) provides support to Alberta Infrastructure, but does not provide any support to municipalities. The British House of Commons report indicates that this sort of centralization of expertise does not mitigate against the private sector's advantage.


More:

Cost and Quality: P3s Lead to Higher Costs and Lower Quality Than Public Service

How P3s Erode Transparency and Accountability

Loss of Flexibility: P3s Reduce Public Control Over Services and Planning


Get Informed and Take Action

Current P3 Projects in Alberta: More Expensive, Less Effective