What Is the P3 Model? Can It Save Infrastructure?
Todd Danielson, the editorial director of Informed Infrastructure, spoke with several private-sector infrastructure executives to learn more about the public-private partnership (P3/PPP) model, how it works and if it can be part of the solution to the massive infrastructure problem in the United States and beyond.
Danielson: What’s the status of infrastructure in the United States?
Hopping: I think most of us agree, even Congress agrees across the aisle, that our infrastructure is really in trouble. I think officially we got a score of D+ during this past year from ASCE. There seems to be some momentum across the aisle, both from republicans and democrats, to do something about infrastructure.
People also talk a lot about roads and bridges when it comes to infrastructure, but there’s a lot more to our infrastructure needs in the U.S., across ports, airports, buildings, smart grid, etc. It’s a chance to expand the conversation beyond roads and bridges.
Eriksson: The state of U.S. infrastructure is, unfortunately in many areas, pretty poor. It’s falling behind on a number of fronts, and there is a massive need for investment in the infrastructure space. I think when the need is estimated, there is talk about trillions of dollars in backlog. When you drive on roads or when you go through airports, you can understand what they’re talking about.
Danielson: How does the P3/PPP infrastructure model work?
Casciano: Public private partnerships (P3s) mean different things to different people. At its core, it’s a partnership where you bring expertise and capital from the private side. We fund them typically through equity or a balance sheet with debt. On the other side, there’s protection that the government—whether federal, state, city or municipal—has support to make payments over a long period of time: often 25, 30 years, but sometimes shorter.
There’s comfort that if a project is made available—if it’s a road, if it’s a bridge, if it’s up and operational—that the municipality or the government will support it through a payment stream. That’s called “availability based.”
There are other projects that can be “demand based.” If it’s roads, it can be based on traffic patterns. They deviate depending on the market and the way they’re structured. There’s been some demand-based projects that we’ve done internationally where we were comfortable taking the risk. For instance, on a train line that the traffic would be enough to support or underpin the risk, or protect us from the risk, and need availability-based protections.
You have financial investors in equity and debt, capital markets, and then you would have the state participate through creating that revenue stream, which is the ability to pay back the debt or obligation.
Hopping: Public private partnerships are bringing private money into the initial investment of getting something accomplished in the public arena. On our side of the business, we also would use the phrase “pay per usage.” You see this a lot in central plants, for example, where private money will come in and actually build the central plant for a campus or facility. The government would not have to put any money upfront, and then they would pay for that over time based on how they used the assets.
I also think performance contracting is a way of doing public-private partnerships, because they’re using private money to finance deferred maintenance while installing infrastructure upgrades. These projects are typically backed up by operation or energy savings, and then supported by some type of performance guarantee on the back end.
We see a lot of performance contracting, and we see more coming to “pay per usage.” Even something in security systems and buildings we’re starting to see “video as a service,” or “card access as a service,” or there’s no upfront investment, and they’re paying based on the use of the technology or the use of the infrastructure or use of the equipment. It all starts with the private sector funding a lot of these projects vs. the taxpayers.
Eriksson: People equate P3 with funding, but that’s only one component of the procurement model. P3s work really well for complex projects where the client wants to achieve risk transfer and when you are looking for innovation and best practices in the design, construction and operations. When we do a P3 project, we bring the contractor, the designer, the architect and the people that are actually going to operate the facility into the same room. When we all work together holistically, that’s when we can materialize the key benefits of P3s—you take out a lot of inefficiencies, bring in a lot of innovation and make sure that the facility can be constructed on time with the intended performance output.
The key benefit of a P3 is the risk transfer from the public to the private sector. We take responsibility for project completion and on-time delivery. If we don’t deliver on time, that’s on us. If it’s insufficient quality, or if the facility doesn’t work or if it doesn’t hold up for the designated period, that’s also on us, we need to fix the problem without charge to the client. The government sets the standard, and then we have a contractual responsibility to deliver and operate the facility to that standard.
What often happens with public infrastructure in the United States is that public entities will move forward and build the infrastructure, while much less attention is paid to its upkeep. When there is a need for maintenance, that maintenance is often postponed by the public sector year after year due to lack of funding or other competing priorities. On the private side we can’t do that, because in a P3 we’re liable to meet a minimum contractual standard, and, furthermore, it makes good sense from an investment point of view to make sure that your asset is working properly and that people using the facility are happy with it. At the end of a concession period, a well-performing asset is handed back to the public sector at a pre-agreed standard for the public sector to operate for many years to come—that’s another key benefit of P3 projects.
Danielson: Can the P3 model be effective in transforming our infrastructure?
Casciano: The availability of capital to fund these types of projects is greater today than it has been in many, many years. The demand side appears to be there. The capital side appears to be there. So then it becomes about how to execute.
It’s not just roads. It’s not just bridges. It’s all elements of infrastructure. Siemens has experience, whether it’s grids, airports, bridges, etc. Wherever that infrastructure need is, we can travel with it, and I think bringing awareness is critical. I think timing becomes critical, too, because as we know from a financial market perspective, it opens and closes, and it is open now. I think we just need to find the right projects to focus on and bring to market.
Hopping: One thing I learned in a lot of my discussions with senators is they seem to be open to this public-private partnership opportunity to fund these projects, but they don’t know how it works and how it can work. What they’re mostly familiar with is toll road systems, where a private entity will come in and buy a toll road and do all the repairs on the road, but then earn their money back from the tolls. It goes a lot more beyond that.
Danielson: What are some of the difficulties of the P3 model?
Eriksson: P3s in general are very political, and they suffer from being difficult to explain in a short and simple way. To explain the benefits to somebody, you need to go into a detailed discussion about risk transfer for the design and construction, financing, operations and maintenance. Also, when we give a fixed price for a P3 project, what you see is the true cost of not only construction but also of operation and maintenance. When a government agency assesses the cost of a project, they rarely account for operation and maintenance, and even if they do, they are not really accountable for maintaining the asset at a certain minimum standard. Think about a government building; when built, it’s nice, new and functional, but, over time, maintenance is compromised. Thirty years later, there is no other alternative than to tear it down and start all over again, The same is happening to many other infrastructure assets like roads, bridges, tunnels and even hospitals.
With a P3, we are responsible to keep the asset in excellent condition throughout the life of the concession, whether it is a building, road, bridge, tunnel or whatever the asset happens to be. Sometimes our P3 projects seem costly, but what you see is the actual full cost for the construction, financing operations and maintenance. The public sector doesn’t normally account for the full cost the same way. Hence there is no good and simple public-sector comparator to show the amount of savings that can be achieved by a P3.
Hopping: As far as headwinds, I would say complexity and then the notion of, “OK, we’re just going to borrow money, but it’ll be from the private sector, and there’s still this debt out there.” There seemed to be some concerns over that, but also interest in learning more if they could get past the complexity issue.
Casciano: When we looked at an aquifer project, for example, we had to look at things such as environmental risks. We had to look at its smaller scope. Can the project be built on time and on budget? Who are the partners? Who has the expertise to construct or develop the project?
Then, when it’s constructed, where’s my path to repayment? In the aquifer project, it’s a shorter term, which means that at some point when the project is completed, there needs to be another round of financing, because the P3 runs much longer. The debt won’t be repaid in that seven-year term, so there must be that availability of capital that will allow it to amortize itself.
There you have refinance risk. In some of these larger projects, where you can proceed with financing 20-plus years, you take refinancing risk off the table early. In some of these smaller or more complex projects or local projects, there are more questions that need to be answered, and more volatility in the risk. You start to lose pools or pockets of capital that would support it.
Danielson: Can you describe some examples of effective P3s?
Hopping: In the federal sector, we’ve secured projects for the federal government at no cost to the taxpayer that have generated close to $300 million of savings for the federal government just on the projects we secured in 2016. A lot of these projects were basically upgrading infrastructure in a number of federal facilities and bases, putting new technology in, and driving energy and operational costs down. We’ve also done projects similar to this on the healthcare stage and the city/municipal front. We have a very successful project at the Louisiana Superdome, where we were able to bring private financing from private dollars into the project, and were able to upgrade the technology in the facility to achieve energy savings.
This performance contracting model not only plays in the federal government, but cities, states and even a little bit into the private sector.
Casciano: Having the expertise to finance those projects that Dave mentions becomes really important, because they include complex risks that typically traditional lenders either don’t have the patience or background to fully understand. For example, Siemens Financial Services provided the Louisiana Superdome with a $7 million municipal lease to finance improvements under the performance contracting agreement.
Eriksson: I think a really good P3 example is the project that Skanska currently is delivering at LaGuardia Airport. We are responsible for design, construction, financing, operations and maintenance of the new Terminal B to replace the outdated Central Terminal Building. While construction is ongoing, we are operating the old terminal.
When we were pursuing the project, the Port Authority of New York and New Jersey had worked on a design for the new terminal for a number of years; it was actually 10-12 years in the making. We realized the design was not as efficient as it could be and wouldn’t work as well as they desired. We brought together the designers, architects, contractors and terminal operators, and we came up with a completely different solution that increases the overall efficiency of the terminal to the benefits of the traveling public and the airlines as well as other stakeholders. Our design reduced the number of phases of construction, which meant a much faster and smoother implementation, shortened walking distance and easier wayfinding for passengers, improved aircraft circulation helping the airlines to save time and fuel with less waiting time for an open gate at the same time saving the environment.
Working in a live environment like an airport is challenging, with a lot of interfaces—you can’t impact the airlines and their operations, and passengers should at most be minimally affected by the $4 billion construction project that’s going on outside the terminal. With those complex interfaces, if you have 10-20 different contractors each responsible for implementing a piece of the project, you are bound to run into difficulties. It’s much easier when the client only has one point of contact, one single entity that is responsible for the entire project, managing the risk of on-time and on-budget delivery. With the innovation and risk transfer achieved in the LaGuardia project, it stands out as a very good example where the P3 method works really well.
Danielson: What are some recurring components of successful P3 projects?
Casciano: I think knowing who your partners are. Who is the developer? Who is going to anchor the project and build or construct it? How is it structured? How is it capitalized between debt and equity? How much capital is at risk at the bottom? What is the risk of loss? Who are the anchor investors? Can you raise the long-term debt to support the cash flows of the project? Can you build a project on time and on budget? Is it capitalized appropriately?
Then, if it’s built as expected, what is the feasibility of the project? Will the demand come? You don’t want a “field of dreams.” You want to have a good sense that the underlying fundamentals of demand are there and will support the ability to pay back the investment. Whether the risk transfers to government through availability or whether it transfers to just pure commercial risk through demand base, the fundamentals need to be there.
The governments need to know that if it’s a road and there are tolls, the tolls are at a level where they don’t have to continue to increase them to make payments. If it’s demand based, then you need to understand traffic risk. The lenders need to understand the traffic risks to make sure they don’t end up with an empty road. We’ve seen that in certain markets where the larger roads were built, but people stayed on the local roads because they couldn’t afford the tolls. That’s a bad fundamental. That’s just bad underwriting.
Hopping: A lot of times everybody focuses on the upfront costs of rebuilding the infrastructure, but there’s another angle: the lifecycle costs associated with operating the infrastructure. One of the key areas that we’re trying to get across is utilizing smart technology to make that happen. How can you build infrastructure that takes either first costs out of building or operating costs out of long term?
If you can build infrastructure upfront and use integrated technology to save upfront costs, you basically take costs out of rebuilding. For example, you don’t have to duplicate pipe and wire and control panels and computers in a building. You’re able to install and build much more effectively. The big one is utilizing visualization and analytics to reduce long-term operating costs which you can take out of servicing the building and equipment, or you’re using analytics to only service the equipment when it’s absolutely necessary and not based on some schedule or routine. Nine times out of 10, this is less costly.
You could also squeeze more energy out of the building by leveraging new technologies, whether it’s analytics or decentralized energy applications where you’re building buildings, connecting it to onsite power generation upfront. You can also take out people running buildings, which is more of the operation capacities.
We’re trying to drive more to an autonomous building approach, where you don’t have to have as many people in buildings running and operating them. There are ways to build the infrastructure to make it less costly upfront, and to reduce operation costs, service costs, and energy use from in facilities by utilizing visualization and smart technologies. This is something that we’d like to make sure the federal government and anyone who is rebuilding infrastructure takes into account, so we’re not looking at first costs only, but you’re also looking at lifecycle costs of running infrastructure.
Danielson: What are the main benefits of P3s from the side of the private investors?
Eriksson: We’re capturing more of the value chain. Normally, you only work as a contractor, but here you can also work as an investor in the project. A lot of the risks in P3 projects relate to the construction period, so from an investment point of view, we’re very comfortable with our own capabilities. Do your analysis right and invest your money, and you can get it back with a return when you sell the asset maybe 10 years later.
There is certainly risk in these projects. You’ll see a number of P3 projects where the investors have suffered, where they’ve been too optimistic or things have happened that hurt the return of the project.
You have to know what you’re doing. If you don’t understand the risks or don’t get the risks right, you can end up taking a hit as an investor. We’ve done around 30 P3s around the world now, and, so far, our business has done very well on these projects.
Casciano: The market will always speak. The banks will decide whether a deal is done or not because they’ll determine whether it’s bankable. If it’s bankable, there’s typically the liquidity there to support it.