Private sector roles

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Private sector roles
OzProspect Windows on Economics 2005

• David Greig

150 330pm, 9 February 2005
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Session content

• A brief history
• Private sector roles
• Case 1 Citylink
• Case 2 Electricity
• Case 3 Public rail transport
• Public private partnerships

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Some potted history

• Early in Australias history, private provision
  of infrastructure was common
• In the late 19th - early 20th centuries,
  governments took over for financial or political
  reasons
• The private sector role has now increased
• At first it was largely construction, with
  in-house government provision phasing out

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Some potted history (contd)

• Then outsourcing (of cleaning, maintenance and
  later IT, HR and some management functions)
  became common
• From the 1980s privatisation, concessions
• In the last few years, through Public Private
  Partnerships

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Types of private sector investment

• Privatisation
• Private Sector Infrastructure development
• Build-Own-Operate (BOO)
• Build-Own-Operate-Transfer (BOOT)/Concession
• Design-Build-Fund-Operate (DBFO)
• Build-Own-Lease-Back (BOLB)
• Public Private Partnerships (PPP)

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Reasons for private sector involvement

• Public sector difficulties with construction cost
  overruns, operating inefficiency and lack of
  innovation
• due to poor incentives faced by public servants,
  conflicting objectives and political interference
• Experience with private provision, starting
  originally with the French water concessions,
  indicated scope for efficiency and innovation

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Reasons for private sector involvement (contd)

• Financial markets have become more flexible
• Private sector is often better at managing risk

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(No Transcript)
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Claimed Pros and Cons of Private Sector
Investment

• Pros
• Innovation, efficiency
• Transfer of risk
• Private sector capital available
• Reduced public spending/borrowing

• Cons
• Government can borrow more cheaply
• Residual taxpayer risk
• Need (sometimes) for regulatory intervention

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The myth of cheaper government borrowing..

• It's a myth that governments have access to
  'cheaper' finance to undertake projects a
  government's ability to borrow more cheaply is
  purely a function of its capacity to levy taxes
  to repay borrowings (Secretary, Victorian
  Department of Treasury and Finance)

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The myth of cheaper government borrowing
(contd)

• Private investment requires assessment and
  carrying of risk
• Public investment risk shed onto taxpayers.
  Example Concorde

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Some problems..
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Private sector investment will continue

• Expanding role and understanding of private
  sector investments
• The private sector is improving its expertise
  with public projects
• Financial markets are improving their ability to
  service such investments
• Scope for increased use of PPP, especially in
  social infrastructure

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Opportunities Australia

• National
• Transport (AusLink)
• Electricity interconnectors
• Gas pipelines
• Water and wastewater
• Environment/renewables

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Opportunities Victoria

• Infrastructure Planning Council cited needs in
• Water (eg Melbourne -Geelong link, irrigation
  infrastructure, water sewage treatment)
• Energy (eg extension of gas reticulation)
• Transport (eg rail and road bottlenecks)
• Communications (eg broadband)

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Opportunities Other States

• NSW flagged 5bn in next 5 years esp schools,
  major roads (eg Orbital), prison, courthouses,
  water sewerage)
• Qld water resource development (eg Burnett),
  energy, transport
• WA water, electricity plant, transmission, gas

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Case 1 Citylink

• A BOOT concession
• Private sector built, owns, operates - and will
  later transfer to the government
• The government negotiated the framework/rules
  (including pricing), and facilitated land
  acquisition, local connections etc

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Citylink... continued
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Case 2 Electricity Reform in Victoria

• Poor investment record
• Low operating efficiency
• Low power station availability
• Little customer focus
• Performance deteriorating
• SECV had great political power
• State finances in crisis through late 1980s

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Electricity Reform Objectives

• Improve operating efficiency
• Better investment practices
• Empower and benefit customers
• Reduce State debt, improve States budget
  position
• Transfer risk away from taxpayers
• Enhance electricity sector contribution to the
  State economy

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Structural Framework

• Generation, Fuel Supply and Retailing
• Competition through competitive spot market (for
  dispatch), hedge contracts
• Competitive retail market, competitive
  electricity sourcing
• Distribution and Transmission (wires)
• Monopolies regulated by Victorian ESC and the
  ACCC (Wholesale)

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Roles

• Government Role
• Planning
• Regulation (monopoly functions, safety etc)
• Creating open access where possible
• Private Sector
• Operations
• Investment
• Risk management

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Roles (contd)

• Financing
• Long term private equity and debt
• Risk Allocation
• Assign risks to parties best able to manage
• Commercial risks assigned to private sector
• Sovereign risk to government
• Minimal residual exposure to government (but now
  debated)

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Reform Agenda Main Features

• Disaggregation to ensure adequate competition in
  competitive segments (generation, retail), with
  cross ownership rules
• Capital markets were sufficiently mature to
  evaluate the businesses and provide financing
• Cross subsidies (eg to rural distribution)

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Reform Agenda Main Features (contd)

• An independent regulator was established aim
  for tariffs to balance consumer and investment
  objectives (ongoing debate about this)
• Political intervention in investment and
  operations to be avoided.

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(No Transcript)
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Second Stage of Reform (1994) - Corporatisation
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(No Transcript)
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Labour Force Reductions

• The SECV became highly overmanned by the mid
  1980s
• Labour force reductions started from the late
  1980s in response to financial pressures
• Industry staff numbers
• 1988 25,000
• 1995 9,000
• 1999 7,000

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Labour Force (contd)

• Labour productivity in generators rose sharply.
  GWh/employee
• 1994/95 12.8
• 1997/98 - 19
• Voluntary departure packages there were no
  compulsory departures
• Protection of entitlements (super etc)
• However there was a large regional impact

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Reform Outcomes

• Reduction in State debt and risks
• Lower average prices
• Better service
• Greater efficiency
• New investment

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Outcomes Debt reduction

• Energy privatisation (1995 1999) proceeds A28
  billion
• Net interest savings A1200 million per annum
• State net debt
• 1992 - A32 billion
• 1999 - A5 billion

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Outcomes Lower Prices

• Households
• Average electricity charge fell by 20 in real
  terms from 1989-1999
• Savings for most business customers
• Debate about electricity prices versus asset sale
  prices

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Outcomes Efficiency Investment Gains

• Over A 1 billion in new Victorian investment
  planned as new capacity required in response to
  forward pricing signals
• Gas Turbine (Peaking), Combined Cycle Gas
  Turbine, Wind
• Research continuing to improve competitiveness of
  coal

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Outcomes Efficiency Investment Gains (contd)

• Brown coal power station availability
• Up from 70 to 95
• Better industrial relations
• Upgrade of inter-state interconnections

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Substantial risk transfer from taxpayers

• Interest risk on State debt reduced
• Taxpayer ownership risk removed (cf. NSW which
  remains in government ownership - has experienced
  losses)
• Taxpayers freed from future investment risk and
  trading risk
• Environmental risk (Kyoto etc) substantially
  transferred

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Substantial risk transfer from taxpayers (contd)

• Ministers political exposure significantly
  reduced
• Investment decisions
• Operational performance
• Labour relations issues
• Supply continuity issues
• Acknowledgment most slides in this section are
  modified excerpts from a presentation by Farrier
  Swier Consulting

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Case 3 Trains Trams Private Franchising

• Performance of PTC, although improved in 1990s,
  was well short of best practice
• Hard to achieve more under the cumbersome PTC
  structure
• Policy to introduce private sector disciplines
  and innovation
• Tram strikes around 1990 and 1997 Grand Prix

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Objectives of transport reform

• Progressive improvement in quality of service
• Substantially increased patronage
• Minimisation of long term taxpayer costs ie
  reduce but not eliminate losses
• Transfer of risk to private sector
• High safety standards

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Features of Victorian Passenger Rail Privatisation

• Competition for passenger markets, rather than
  competition within
• Horizontal separation and vertical integration
• 12-15 year franchise length allows for trade-off
  between competition and investment
• Operators own rolling stock and lease
  infrastructure

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Franchise Agreements

• Specify what operators must do in exchange for
  subsidies
• Tension between prescription and encouraging
  innovation
• Maximum fares and minimum levels of service
• Incentives for punctuality and reliability

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Gains from privatisation

• Subsidy reductions based on improved efficiency
  and increased patronage
• Bids showed subsidy reduction of 1.8b NPV but
  much lower in practice
• Government shed most of the operating cost and
  investment risk
• Improved services refurbished and new rolling
  stock, increased reliability and frequency, some
  facility upgrades

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Difficulties encountered

• Poor franchisee financial performance patronage
  increases well below forecasts
• Only partly shed revenue risk
• Disputes over revenue allocation
• Continuing fare evasion
• Little incentive to improve service mix or
  infrastructure

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Difficulties encountered (contd)

• National Express pulled out
• Refranchising Connex and Yarra
• Net benefit to Victoria remains substantial
  despite bailout costs (and NX took a large
  write-off)

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Some lessons and questions

• Private franchising can save subsidies, finance
  new equipment, and improve services
• The government is involved as subsidiser and
  regulator so has borne some of the winners
  curse
• But the expected financial gains have been
  reduced. Franchisees offered subsidy cuts they
  couldnt sustain

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Lessons and questions (contd)

• Some risks have moved back to the government
• How to maintain competitive bidding yet reduce
  overbidding?
• Wrong to conclude that networks should not have
  been divided in two. If they hadnt been, NX
  would have won the lot, and present difficulties
  would have been worse

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Public private partnerships

• PPP Private sector planning, financing,
  construction and operation of a facility
  providing public services
• Central component risk sharing
• Example courthouse (private operator provides
  accommodation services to Justice Department
  Department provides justice services to the
  people)

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What is a PPP (contd)

• Used for providing public infrastructure and
  related services
• Economic infrastructure (eg roads, water)
• Social infrastructure (eg schools, hospitals)
• Private sector provides capital assets
• And bears associated risks
• Government procures services, not infrastructure

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Rationale for PPPs

• Value for money in delivery of public
  infrastructure services
• Partnerships Victoria identifies key drivers
• Risk transfer
• Whole-of-life-costing
• Innovation
• Asset utilisation

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Overview of Vic PPP Policy

• Value for money as prime objective
• Value risk management, innovation and efficiency
• Applies to public infrastructure projects gt10m
• Specific principles processes
• Neutral accounting

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Overview of Vic PPP Policy (contd)

• Detailed guidance on identifying and allocating
  risk
• Model documents
• Approval processes
• In some cases (eg where cannot specify outputs,
  or likely to require frequent changes) PPP
  inappropriate

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Public Sector Comparator (PSC)

• Mechanism for assessing value for money
• Hypothetical risk-adjusted cost if project
  financed, owned and implemented by government
• Based on a best public procurement option to meet
  specifications
• Competitive neutrality

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Economic theories underlying PPPs

• Market failure
• Rationale for govt involvement - but not
  necessarily direct provision
• Private sector incentives
• Strong commercial incentives for efficiency
• Public sector incentives less clear-cut
• Competition and contestability
• Harnessing competition for the market to
  encourage efficiency

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Economic theories underlying PPPs (contd)

• Contract theory
• Optimal allocation of risk
• Principal-agent problem and need to align
  incentives in contract
• Ways to address incomplete contracts
  (relational contracting)
• Minimisation of transaction costs

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Value for money?

• Typical estimates of 15 to 20 per cent cost
  savings
• Transaction costs reduce but do not negate
  savings
• Improved project delivery times
• But mainly ex-ante estimates largely based on
  value of transferred risk

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Value for money (contd)

• Overall costs reduced if risks allocated
  optimally
• Eg Citylink Burnley Tunnel
• Facilitation of greater third-party utilisation
  of assets
• However some failures
• Private sector failure to perform
• Public officials may lack contract negotiation
  skills

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Competing views on PPP

• Enabling better infrastructure services versus
  privatisation by stealth
• Benefits
• Risk-sharing
• Opportunities for revenue generation from third
  party asset utilisation
• Improved project delivery times, efficiency, costs

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Competing views (ctd)

• Costs
• Reduced budget flexibility constraints on
  Government from long-term contracts