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P3 Toolkit

Analytical Tools

P3-VALUE Analytical Tools

December 2012

 

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Chapter 2 - Overview of P3s

Types of P3s

P3s for transportation projects have drawn much interest in the United States for their ability to address traditional financing constraints and to transfer certain project risks from the public sector to the private sector. P3s are contractual agreements between a public agency and a private entity that allow for greater private sector participation in the delivery and financing of transportation projects than with traditional approaches. With P3s, private firms take on the risks of some or all of the financing, designing, constructing, operating and/or maintaining a transportation facility in exchange for future revenues. The distinguishing characteristic between different forms of P3s is the degree of responsibility and risk that is transferred to the private sector (see Table 2-1 for typical risk transferals).

Table 2-1. Typical Risk Transferal to Private Partner by P3 Procurement Type
P3 Procurement Type Design Risk Construction Risk Financial Risk O&M Risk Traffic & Revenue Risk
Design-Bid-Build (DBB)   Partly      
Design-Build * *      
Design-Build-Finance (DBF) * * *    
DBFOM w/Availability Payment * * * *  
DBFOM w/Toll Concession * * * * *

P3s differ from traditional publicly financed, design-bid-build (DBB) procurements of transportation projects where the different project delivery phases (design, construction, operation and maintenance) are each conducted by different public or private entities. 'Public-private partnership' describes a project for which a private entity (which may be a consortium of several private companies) assumes responsibility for more than one project delivery phase.

Design-Build (DB): The simplest form of P3 is design-build procurement. In this procurement model, a single private contractor is responsible for designing and building a project. The design-builder assumes responsibility for the majority of the design work and all construction activities, together with the risks associated with providing these services, for a fixed fee. When using DB delivery, public sector project sponsors usually retain responsibility for financing, operating and maintaining the project. While DB procurement has been more prevalent in private sector work, it is also gaining acceptance among many public sector transportation infrastructure owners.

Design-Build-Finance (DBF): In a design-build-finance structure, the design-builder takes on the additional responsibility of financing the project. The design-builder arranges financing for the project and is repaid over an agreed upon period, often upon completion of the project. The public sponsor transfers financing risks to the private sector partner, thereby increasing the incentive for the partner to deliver the project in a timely and cost-effective manner.

Design-Build-Finance-Operate-Maintain (DBFOM): In this procurement structure, a private entity (usually a consortium of companies) assumes responsibility for designing, building, financing, operating and maintaining a project for an agreed upon period. While the public agency retains ownership of the project and must manage the project, the private partner assumes the long-term operations and maintenance risks of the project. The operations and maintenance period of the contract effectively acts as a warranty, enhancing the private partner's incentives to design and construct a quality facility that can be managed efficiently over a long period.

There are currently over 20 active DBFOM P3s in the United States. The majority of these projects are in Virginia, Texas, Florida and California. Generally, the projects range from a few hundred million dollars to several billion dollars. Many of them involve toll facilities, in which case the private partner receives compensation either directly from toll payments or from the public agency making regular "availability payments" based on project milestones or performance standards.

P3-VALUE Capabilities and Limitations: Procurement Structures

This Guide focuses on three P3 structures popular in the United States and modeled in P3-VALUE: Design-Build (DB), Design-Build-Finance (DBF) and Design-Build-Finance-Operate-Maintain (DBFOM). The analytical tools allow the user to assess the costs of delivering the project as a DBB, DB or DBF (using the PSC tool) and compare those to the costs of delivering a project as a DBF or DBFOM (using the Shadow Bid tool) as they would in a VfM analysis. P3-VALUE does not assess the benefits and costs of long-term leases of existing revenue generating facilities, a form of P3 otherwise known as a "brownfield" or "asset monetization." Specifically, the P3-VALUE Shadow Bid model does not calculate the payments that a private partner would make to the government entity in a brownfield scenario.

Potential Benefits of P3s

P3s allow public agencies to access private equity capital to finance projects. This can help public agencies achieve their goals in a number of ways: expanding the capacity of states to finance infrastructure projects; reducing delivery times and project costs; transferring project risks; and improving the cost-effectiveness of long-term maintenance (see Table 2-2). Public agencies often use P3s to accelerate project delivery by leveraging future revenue streams to bring in upfront private capital for project delivery without assuming additional financial risk. Additionally, by bundling project delivery phases, P3s can result in more cost-efficient project delivery and can create incentives to better manage the project's life cycle costs. P3s can also reduce the risk to the public sector that a project may experience cost overruns, schedule delays or lower-than-expected traffic demand and revenue. An optimum transfer of risks to the private sector is a primary driver of P3 benefits. The public sector pays a premium to the private sector to manage those risks, but under an optimal risk transfer, this premium is less than the cost to the public sector of retaining those risks.

Table 2-2. Primary Public Benefits of P3s
Benefit Description
Increased capacity to finance projects Using private equity and debt to help finance a project lessens the amount of public funds required in the short-term to support a project. In addition, the private partners may be less risk-adverse than the public sector allowing them to leverage greater up front capital from anticipated project revenue than the public sector can. By accessing private financial resources, P3s can free up public funds to be used on other worthwhile transportation projects that may not be suitable for P3 delivery.
Accelerated infrastructure provision P3s may provide public agencies access to upfront capital needed to complete major projects that is not subject to annual budget constraints or public debt caps.
Improved reliability of project delivery Many P3s create incentives for the private sector to design and construct a project more efficiently. Several studies have found that P3 projects are more likely to be completed on time and on budget than projects using traditional procurement methods.
Improved allocation of resources over the project life cycle In P3s where the private sector is responsible for operating and maintaining the asset, the private sector has a strong incentive to minimize operations and maintenance costs over the life of the project by improving quality of initial construction.
Transfer of selected risks to the private sector Public sponsors can transfer risks, such as construction and financial risks, to the private sector.
P3-VALUE Capabilities and Limitations: Project Delivery Schedule

As in a VfM analysis, P3-VALUE allows users to quantitatively assess the benefits derived from more efficient project delivery and from improved risk management that P3 procurement options may offer. P3-VALUE does not quantitatively assess the non-financial benefits from accelerated infrastructure provision as this is beyond the scope of traditional VfM analysis.

Limitations of P3s

P3s do not allow public agencies to transfer all project risks to the private sector.

While a P3 can enhance a public agency's financial capacity, a P3 is not a source of funding and does not provide new revenue for a project. A P3 can accelerate project delivery, by providing upfront capital, and potentially reduce the overall life-cycle costs of a project, but that upfront capital is not a substitute for revenue and must be paid for over time with future revenue. P3 agreements often involve the commitment of a long-term revenue stream to pay back lenders and private investors. Private lenders and investors typically demand a higher rate of return than investors in tax-exempt municipal bonds; so, the cost of private financing is generally greater than that of public financing. Public agencies must carefully analyze these and other tradeoffs when deciding whether to pursue private financing of transportation projects. Furthermore, P3s are not appropriate for all transportation projects. FHWA is developing a screening tool to assist in assessing the appropriateness of a major project (costing $100 million or more) for P3 procurement.

Some aspects of P3s cost more than traditional project delivery. The additional costs of P3s include higher transaction and financing costs and the payment of premiums to transfer risks to the private sector. To be worthwhile to the public agency, the anticipated benefits of delivering a project via a P3 must outweigh these higher costs.

Due to the size and complexity of P3 agreements, greater time and expertise is necessary to develop P3 procurements, thereby raising transaction costs. Higher transaction costs of P3s mean that the use of P3s is generally limited to large and complex projects.

Financing costs are typically higher because, unlike the municipal bonds typically used by public agencies to finance transportation projects, private finance is not tax-exempt and is not backed by the "full faith and credit" of the state agency. Furthermore, private equity investors demand a competitive return on their investment. Higher financing costs may more accurately represent the true costs of the risks associated with a project that are otherwise borne by the public; nonetheless, they represent higher actual costs to the procuring agency.

P3-VALUE Capabilities and Limitations: Financial Costs

P3-VALUE allows users to assess differences in transaction and financing costs between different procurement options as well as savings generated by more efficient risk management. The tools can only give a rudimentary measure of potential differences in financing costs, however, as they use a simple form of modeling financial cash flows that cannot accurately represent the complex structure of most P3 financial plans, which are highly leveraged and which utilize multiple sources of financing.

The benefits of risk transfer can be undermined, however, if the public agency fails to adequately enforce the contract or seeks to renegotiate the contract when risk events occur. Once partners agree to a contract and a project is underway, the public agency responsible for managing the contract must be careful not to take back risks unintentionally by:

  • Requesting scope or design changes;
  • Modifying performance specifications; or
  • Not following the performance management provisions.

Finally, by entering into long-term contracts for providing operations and maintenance of a facility, public agencies can secure specified levels of service, but they may lose flexibility to respond to changing policy goals or technologies, as agencies must negotiate changes to levels of service with the private partner.

 

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