Treasury Department Weighs in on Ideal Conditions for a P3
by Andrew Ausel | June 8, 2016
In case you missed it, at the end of last month, the U.S. Department of the Treasury published an Economic Framework for Comparing Public-Private Partnerships and Conventional Procurement. Within the publication, the Treasury concluded that there is no single factor that definitively informs whether a P3 is likely to yield a stronger benefit than if the project were delivered through conventional means. However, they did find some key considerations that will help to guide public owners in the decision to initiate a P3 versus a more traditional method. The paper also outlines important steps for a government to take prior to procuring a P3 project in order to maximize the benefit to the taxpayer, and determine if a P3 is the correct course of action.
The report was explicitly written for, “those in state and local government who may be interested in [P3]procurement but who are less familiar with this form of procurement of public infrastructure.” However, the findings may also be of interest to more experienced owners who are in need of a refresher or a supplement to their understanding of P3s. The report finds that “In short, a balance of elements – the project characteristics, the economic environment in which the project is being developed, and the ability of the project sponsor to take certain actions [emphasis added],” determine the success in a joint fashion.
Project Characteristics:
Several project characteristics were identified as crucial to a successful P3. The first and arguably most important was the capacity of a project to bundle several projects into one large contract. The chief mechanism for a P3 to bring cost savings, bundling transfers multiple projects and their risk to a single entity. The report concluded that the capacity to bundle is by far the most important factor in a P3 creating cost savings.
But bundling is not the only factor. The report found the following project characteristics to serve as key indicators of eventual project success:
- Private-sector expertise: For a complex project delivery, a strong indicator of whether the project will provide a net-benefit over the full life cycle of a P3 is how much technical expertise is out there.
- Clearly defined terms that are quantifiable: How precisely can the contract lay out the service level required? How the terms can be spelled out is undoubtedly a necessary component for a viable P3.
- High capital costs and long lived assets: The high transaction costs affiliated with P3s and the greater tax burden on private debt puts P3s at a disadvantage when compared to tax-free publicly funded projects. It is therefore essential that assets procured using a P3 need to be sufficiently large to generate cost savings to offset the transaction costs.
Economic Environment:
Internal project conditions are not the only factor at play in deciding whether to undertake a P3. The Treasury’s report also outlines several key economic conditions that owners should take into account when charting a project delivery course. Among those noted in the report are:
- Accurate forecasts of operation and management (O&M) costs: This may sound more like a project component than an economic consideration, but when labor costs, technological developments and user demand for a facility are relatively unpredictable, a P3 can be a risky sell to private developers.
- Potential private partners’ willingness to assume a limited demand risk for projects using user fees as a funding source: What happens when drivers choose to navigate around the toll road to save a penny? Identifying the viability of a toll road, and gauging private interest in sharing demand risks can play a big part in determining whether a P3 is appropriate.
The Ability of the Project Sponsor to Take Certain Actions:
The third emphasis area noted in the Treasury report was on contractual considerations of how much the private party can innovate. Project considerations in this field included:
- How much to protect the ability to cut costs vs. quality maintenance: There is only so much that a contract can write into terms, but the more clearly an owner can anticipate how the private party will respond to cost cutting opportunities, the better. The report notes that, “The best procurement choice will depend, in part, on whether the non-contractible investment opportunities that can be expected to arise during the contract term will have a larger effect on quality or costs.” In other words, try and figure out how to prevent loss of quality over the life cycle of a project while maintaining a developer’s ability to innovate and cut costs over the same term.
- Identify the scope and incentive of private sector innovation not present with conventional procurement: This is going to largely be dependent on the extent to which performance-based contracts are used and exactly how comfortable the owner is to innovation over the life-cycle. If output and quality are not contractible, the report notes that a conventional delivery may be preferable. However, owners do not want to become too prescriptive, stifling private sector innovation and undercutting a reason for procuring a P3 in the first place. In other words, prescriptive requirements are not great for innovation, but not all projects work well without prescriptive requirements.
The report goes on to outline best practices for P3 implementation and conducts a more full discussion on P3s than what is outlined in this piece. To access the full report, please click here.
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