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The Progressive Economics Forum

What’s the real risk and cost for Regina’s wastewater P3?

The City of Regina is engaged in a controversial debate about a proposed public private partnership (P3) for the city’s wastewater plant.

Residents formed a Regina Water Watch group to keep the facility public.  They collected enough names to take the issue to a municipal referendum on September 25th, despite attempts by the city to disallow signatures on spurious grounds.   Regina mayor Michael Fougere launched an aggressive advertising campaign in support of the P3, spending over $300,000 in advertising and robocalls.  (For its part he Regina Water Watch group has produced an excellent video, starring Eric Peterson).

Three issues haven’t received much attention in the public debate over Regina’s controversial wastewater P3 project, but they should give residents there and elsewhere cause for concern (although others have raised some of them elsewhere).

First is the issue of risk transfer.  The higher costs and profits associated with public private partnerships (P3s) in Canada are now all justified because they’re supposed to transfer large amounts of risk to the private sector.

The proposed wastewater P3 plant in Regina is no exception.   According to the Deloitte report assessing the options, a P3 would supposedly involve transferring more than $40 million of “risk” to the private sector.

But how do they calculate the value of this risk?   They don’t say: it’s a closely guarded secret.   While this information is absolutely central to claims that P3s provide value for money, P3 agencies and governments in Canada refuse to make it public.

So, are we just supposed to trust them?   The recent financial crisis should have taught us to be more skeptical of the creative financing accounting that often hides behind these claims.  And whenever auditors have conducted full reviews of P3s, they’ve invariably found they cost more than the public alternative.

Increased transparency is central to accountable democracy.  It’s disturbing government representatives want to push through a controversial major infrastructure project without revealing these details to the public who will ultimately pay for it.   But even if they continue to hide this information, there’s a simple calculation that can demonstrate if these claims of risk transfer are excessive.

The only real risk private operators assume in a P3 is limited by the net amount of unsecured money or equity they have in the project: usually no more than 10-15% of their total capital, as I pointed out in a previous post.   Since P3s are set up as “special purpose vehicles”, the big companies behind them can simply walk away if they aren’t making enough profit or if problems develop, or use the threat of doing so to get more money out of the government.   The maximum they lose is their unsecured equity and cash.  And a number of P3 companies have abandoned their projects—from small P3 arenas in Ottawa to the multi-billion dollar Metronet failure in London—leaving government with the responsibility for delivering the service and paying off the creditors.

Any calculations of risk transfer exceeding the private equity in a project should have no credibility.   The amount of private equity involved in the Regina wastewater plant has not been revealed, but with total private financing at just over $118 million, it is highly unlikely the private equity share (usually a maximum of 15%, so $18 million) exceeds the estimated value of risk they claim will be transferred, which amounts to $40 million according to some of their calculations.

So even if the city administration continues to hide the financial details, it appears these claims of risk transfer are simply not credible.

A second issue of concern is the total liability a P3 would impose on Regina taxpayers and residents for decades. P3s seem attractive to politicians of all stripes because they appear “innovative”; because they can relinquish responsibility and blame others if something goes wrong; and also because they can get a shiny new facility for little money up front during their term in office, and foist the real cost onto residents over future years.

This P3 wouldn’t just commit Regina to $224 million for the capital costs, but also to $760 million in operations, maintenance and debt servicing costs over thirty years, as the Regina city council report of February 2013 shows.   Instead of being a project with a price tag of about $240 million; it’s really a project with a cost approaching a billion dollars, or close to $10,000 for every household in Regina.

While it’s understandable that politicians are attracted to P3s, the residents of Regina—who will be liable for the full cost of the P3—should be much more concerned.

The fate of the UK’s Private Finance Initiative (PFI) program, on which Canada’s P3 program was based, should be a warning.  After numerous P3 failures and scandals, the UK’s PFI program imploded.  The excessive cost of servicing PFI liabilities ate into funding for basic public services and put over 60 hospitals into financial difficulty.  The Conservative government significantly reformed and scaled back their PFI program, renaming it PF2, but not before revealing it had built up £300 billion in liabilities, equivalent to C$490 billion or more than C$20,000 per UK household.   This is a massive liability—equal to 80% of the Canadian federal government’s total debt—that was largely hidden off-book through P3 accounting.

Canada is following closely behind in building up our very own P3 debt bomb.  Canada’s market for P3s is now considerably larger than the UK, but our governments are keeping the true extent of these liabilities a secret.

The third issue of concern is why the city doesn’t apply for other federal and provincial sources of funding.   When Regina’s wastewater project was initiated, there was no money left in the Building Canada Fund because the federal government had fast-tracked spending of it through the stimulus program.   The only federal funding available at that time was the P3 Fund.  But that changed with the March 2013 Federal Budget commitment of funding for a new Building Canada Fund. There will be plenty of funds available in this when the wastewater plant construction is expected to be completed and bills will be paid in 2016/17.

Expansion and upgrading of the Regina wastewater plant is a prime candidate for funding through this program because it’s required as a result of new federal and provincial wastewater regulations.   Municipalities across Canada expressed strong concern to the federal government about the estimated $20 billion cost to meet these new wastewater standards and they were a major factor behind the new federal infrastructure funding.

The Building Canada Fund provides up to one third of funding for projects, cost matched by provincial and municipal governments.   This means Regina could potentially receive two thirds of the $224 million capital cost, or $149 million, from federal and provincial governments for the wastewater plant.   That’s a lot more than $58 million funding through P3 Canada.  This would mean a cost of only $75 million to Regina for this project—far less than the total liability a P3 would impose.

It’s true the federal government requires larger projects to undergo a “P3 screen”—that’s already been done and they found a non-P3 option would cost less, even after inflated calculations of “risk transfer” for the P3.  In addition, the Deloitte report acknowledged non-P3 options could proceed faster.

City councillors and officials may be excused for not understanding the creative accounting that goes into the value for money assessments used to justify P3s, but they shouldn’t be excused for refusing to release this information to members of the public who can make sense of it.

It’s understandable that politicians find P3s attractive by foisting debt onto future taxpayers, but the residents who will ultimately pay the real cost for these bills should be a lot more skeptical.

What’s harder to understand is why city councillors don’t take advantage of new federal funding programs that could provide far more funding for the wastewater plant at a much lower cost to Regina residents, without embarking on a controversial and costly P3.

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Comments

Comment from Jack Boan
Time: September 19, 2013, 11:50 pm

Assuming that the para. beginning with the words “The City of Regina is….” is number one; you lost me in para. 10. where you put a dollar figure on possible risk that the p3 partner faces. I just didn’t follow your math. Could you elaborate a bit?

What comes before that para., and what comes after it, I followed easily. BTW: I agree that Risk is the key element in comparing the two competing systems on offer: I just didn’t follow your argument in that paragraph.

Comment from Gary Carlson
Time: September 20, 2013, 12:16 am

Great analysis and well written. Thanks.

Comment from Toby Sanger
Time: September 20, 2013, 9:48 am

Dear Mr Boan:

Thanks for your comments and for the chance to elaborate further on this. The fundamental argument I’m making here is that if the amount of private equity (or more properly unsecured capital) in a P3 project is less than the risk assumed transfered to the private sector, then those calculations of risk transfer should be questioned. They can always walk away or threaten to do so, with just their unsecured capital at risk thanks to limited liability laws.

The actual amount of private capital at risk at any one time will vary of course and so should calculations of risk retained or transfered. But the private capital that is actually at risk should be considered an upper limit to the calculations of risk actually bourne or shifted to the private sector.

Limited liability legislation for the private sector and the public sector’s implicit obligation to provide these services create an asymmetry in exposure to risk that does not appear to be addressed in these risk assessments. I haven’t seen it mentioned in P3 risk assessments, nor in the literature, even though there have been a number of significant failures of P3s.

In terms of the specific numbers with regard to the Regina WWTP, there isn’t a lot of information to go on, but table 9 on page 20 of the Deloitte Delivery Model Assessment report claims the DBB has retained risk and a risk premium of approximately $61.7 million while the retained risk and risk premium of the DBFOM adds up to about $21.1 million. This implies $40 million of risk is transferred to the private sector. These are of course their NPV calculations over the life of the project. Table 11 has their calculations of construction cost related risk and there the difference (e.g., risk transferred) between DBB and DBFOM is approximately $24 million. While they don’t reveal how much private equity will be at stake, it is usually no more than 15% in these deals and so in both instances, at that amount it would be less than these calculations of risk transferred.

Looking again at Table 11, we can see that the CMAR-DB (Construction Manager at Risk through DB) option is far preferable to the DBFOM if the PPP Canada grant is taken out of the equation. Even with their calculations of risk transfer, without the PPP Canada grant, these calculations show a total debt and financing liability under the DBFOM option at $218.4 million ($167.2 plus $51.2) while the total debt and financing libaility under the CMAR-DB option is $200.5 million — or $18 million (and 8%) less than the DBFOM.

This underlines the third point I make, that it would be far better for the City of Regina to apply through the Building Canada Fund: they could receive significantly more federal and provincial funding (up to $75 million from each of the federal and provincial levels of government) and also be able to carry out this project in the most cost-effective way. And even this Deloitte report shows that non-DBFOM provide greater value for money than the DBFOM (even if we take their risk and other calculations at face value).

I would appreciate any further comments you have, either in terms of the Regina WWTP or this argument with respect to risk. These calculations and comparisons of risk should be conducted for specific points in time, but that isn’t possible as they make very little of this information public. In fact I’m not convinced the risk assessments that have been done for P3s even bother to estimate the specific risk that applies at different points in time. My sense is that it’s pretty crude creative accounting conducted largely to justify P3s — and that’s what they’re covering up by keeping them secret.

Comment from Toby Sanger
Time: September 20, 2013, 10:53 am

It’s also important to note that most of the real risk at stake for the public sector in an infrastructure project is at the construction stage.

This can be reduced and managed through other methods of contracting, incuding DB and CMAR or other arrangements with fixed prices and penalties, without having to resort to expensive P3 financing.

With the Harper federal government now apparently pushing for maximum degrees of private involvement throughout the spectrum of P3s, this means accounting companies such as Deloitte (or others that do these risk assessments) are presumably becoming ever more inventive in their calculations of risk during the operations and maintenance (O&M) stage in order to justify DBFOM P3s.

Now some levels of risk exist during the O&M stage of course, but 30 year P3 contracts reduce the flexibility to deal with changing circumstances (including the “unknown unknowns” to quote Donald Rumsfeld and the unknown knowns) and so increase risks rather than reducing them.

This is why P3 proponents apparently charge a 50% premium for operating and maintenance costs into the future: they have little idea what these costs will be decades down the road and so charge a large premium. This also may be why the Conservative government in the UK moved to restrict O&M in their P3 contracts going forward through their PF2 program.

Known risks that exist during the O&M phase can be much less expensively managed through other means without resorting to much more expensive P3s.

Comment from West58
Time: September 21, 2013, 10:31 am

Fiacco raised our sewer and water rates almost 9 years ago. In each of those years we are paying 9%. That money was to pay for that future wastewater treatment plant, so where is all that money?

That 9% will never go away … so you will continue to pay more. The 276.00 is just there to side track all.

So John Hopkins of that union called the Regina Chamber of Commerce figures that a P3 is the best way to go … the fact is that a P3 project will ensure that Regina taxpayers hard earned dollar$ will leave the city for parts unknown for the next 30 years.

How can this be a benefit to the Regina taxpayer and business? How much money will the foreign P3 company put back into Regina?

Answer … none, why would they?

Voting YES will keep that money in our community called Regina.

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