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The Rise of P3 Hybrid Infrastructure Deals

The Rise of P3 Hybrid Infrastructure Deals

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The stereotypical private public partnership (P3) project is a toll road where a government agency negotiates a contract with a private sector partner which designs, delivers, and manages the road and then collects toll revenues. In a perfect world, these revenues would cover expenses and generate a return for the private sector partner.
Some P3s toll roads, however, have run into financial difficulty, including bankruptcies, when overly optimistic traffic and revenue projections did not materialize. Most of the roads which have encountered such difficulties have continued to operate while control was transferred to the government agency or creditors or sold at a discount to new investors. Having the private partner bear all the demand risk makes a P3 similar to full private ownership but it can also make P3s more prone to failure and very costly. If a project is a financial failure, politicians may risk negative headlines, even if such a financial failure does not negatively impact service to customers. Moreover, imposing tolls or other user fees where they have not previously applied may be politically difficult. Alternatively, if demand is higher than expected and the project is very financially successful for the investors, politicians risk criticism for having given too lucrative a deal to private investors at the expense of taxpayers.
Infrastructure investments are no exception to the rule that investors demand higher returns for taking greater risk. Higher financing costs relative to municipal bond financing can make undertaking a P3 project more politically and economically difficult. P3 project costs should be compared with conventional procurement financed with debt. The comparison should be based not only on design and construction costs, but also on the costs over the asset’s lifecycle. Such issues have led to the development of hybrid P3 arrangements that can address a more equitable sharing of risks and responsibilities between the public and private sector partners.
For example, P3s projects need not include user fees. Instead, they can be funded with government revenue, just like a conventionally procured, municipal bond financed project. Under an availability payment arrangement, the government agency compensates the private sector partner with a pre-negotiated stream of payments which is paid with tax revenue in exchange for the private partner continuing to meet certain standards. For example, the $350 million Kansas City streetcar extension project will receive support from special tax assessments on commercial and residential property and parking lots in the surrounding Transportation Development District. Examples of other P3s projects which rely on availability payments   include the Denver FasTracks Eagle light rail project, the Goethals Bridge between New York and New Jersey, the Kentucky Wired broadband project and the Long Beach Courthouse. Social infrastructure projects typically rely on availability payments because of limited commercial revenue potential.
Availability payment concessions have become more popular with state governments because revenue forecasting is becoming more difficult given unexpected economic downturns. For example, the Great Recession contributed to three bankruptcy filings for projects with overly optimistic traffic projections such as the South Bay Expressway in San Diego and the Indiana Toll Road. These failures highlighted the risk to private sector investors of conventional P3 projects.
The objective of hybrid P3s is to find new ways of reducing risk to both the private and public sector partners. In addition to availability payments, risk can be reduced by closer collaboration between public and private partners, greater focus on cost reductions during the construction phase, the installation of low-cost energy sources and improved inventory management.
All these approaches to reducing risk and costs were used when the City and Port of Long Beach embarked in 2016 on the largest municipal public-private partnership in the U.S. to date. The P3 team completed a $520 million civic center development in 2019 that included a new city hall, the Billie Jean King Main Library, the Port of Long Beach headquarters as well as the rejuvenation of Lincoln Park. Plenary Edgemoor Civic Partners agreed to design, build, finance, operate and maintain the new civic center for 40 years.
The project team took a collaborative approach and continually explored cost-effective solutions for this complex project. Each month, collective problem-solving and cost-reduction sessions were held to eliminate potential problem issues before they affected the project schedule and expenditures. Completed units were stockpiled in a nearby warehouse, allowing for just-in-time delivery. To reduce operational costs over time, the team added solar energy panels. The solar strategy, combined with an efficient centralized utility plant design, are expected to substantially reduce annual energy costs.  For these reasons, the Long Beach project was referenced several times as a model for future hybrid P3 projects by Shelly Doran, Senior Vice President of California-based Webcor Builders, during her presentation at the Canadian Council for Public-Private Partnerships Annual Conference in Toronto in November. Shelley and the other panel members had a number of recommendations for P3 hybrid projects including:

  • a more long-term view of the project in question should be taken by the government agency rather than trying to merely resolve its financial issues;
  • the private sector partner should be involved at the very beginning of the planning of the project;
  • the government agency should assume some of the initial costs as this will give the private sector partners confidence that the project will move forward;
  • the government agency should consider absorbing the cost of construction labour wage escalation;
  • the private sector partners should try to ensure that there is a government sector “project champion”; and
  • all partners should conduct rigorous due diligence.

Hybrid P3 projects have evolved as a way to reduce and control infrastructure costs in an environment where the types and severity of risk continue to rise. These modifications and the resulting success of many hybrid P3 projects illustrate that the P3 model can accommodate changing parameters in a world where unpredictability is the only constant variable.

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