Th e Nature and Role of Public Private Partnerships

The American Society of Civil Engineers has estimated that the United States needs to spend hundreds of billions of dollars to repair, replace or expand our infrastructure. Government spending, however, cannot provide all the necessary funding that is needed. Public Private Partnerships (PPPs) are emerging as an alternative source of infrastructure funding.

The National Council for Public Private Partnerships defines PPP as “a contractual agreement between a public agency (federal, state or local) and a private sector entity. Through this agreement, the skills and assets of each sector (public and private) are shared in delivering a service or facility for the use of the general public. In addition to the sharing of resources, each party shares in the risks and rewards potential in the delivery of the service and/or the facility.” Although they may take many forms, fundamentally, in a PPP private capital is used to construct and operate facilities that would normally be built and operated by the government entirely. PPPs can be used in many ways to suit many needs. These projects include toll roads, bridges and tunnels, power projects, water and sewage treatment projects, and schools.

PPPs have been used successfully in Europe and Asia to provide needed infrastructure project when government funding was not available. PPPs should be a valuable supplement to government infrastructure spending in the United States to meet this country’s substantial infrastructure needs. The Administration’s stimulus plan would not likely displace the role that PPPs can play in rebuilding our infrastructure. U S infrastructure needs are greater than the public funding for infrastructure that could be included in any such plan. Consequently, the availability of financing for private investors in this economy presents the greatest challenge to the viability of PPPs in the short term.

PPPs allow governments to build projects for which funding might not otherwise be available, and they allow private investors to tap potentially lucrative sources of revenue while meeting a public need. Those private investors frequently form a separate corporate entity or LLC to contract with the public agency for the right to build and operate the completed project. That long term right to operate and obtain the revenue from the project is usually referred to as a concession, and the private entity is the concessionaire. While these projects present some unique challenges, they also present opportunities for significant rewards.

Risks and Rewards

PPPs have their share of risks for all participants. Investors must identify a project and submit a proposal to an interested public agency, which must convince the agency of the value and the viability of such a project.

A PPP project can require a substantial investment to prepare and submit a proposal to a public agency. The concessionaire would typically identify a location, develop a preliminary design, forecast use and revenue, and make the preliminary arrangements for financing to determine whether the project would provide a profitable return before any proposal would be presented to a public agency. The concessionaire must project revenue over a long period, 20-40 years, and it must factor in the operating and maintenance costs into such projections. For example, predicting changes in traffic patterns and use of the project presents a significant challenge.

Once a project is identified, the viability of PPPs may be affected by political considerations and public opinion. Public opinion may impact the award of the project, and public scrutiny will certainly temper the public agency’s negotiating position. The agency must deal with the possibility that the project will not be popular, or that the terms it gave the concessionaire are perceived to be too generous.

Public agencies need to know what they want, and define their needs clearly. They must also be prepared to commit appropriate resources, particularly senior personnel, to complete their responsibilities with regard to the project. Further, public agencies must take the long-term view and recognize that each concession agreement and PPP project will set a precedent for future projects.

Although a PPP may proceed from proposal to completed project faster than a government project, from the concessionaire’s perspective the time and money the concessionaire spends from the presentation of a proposal to the negotiation and award of the concession contract will frequently be greater than a bidder would spend on conventional government project. There is always the risk that others will offer competing proposals. Investors must be prepared to be patient with the process.

The concessionaire takes the risk that it can build and operate the project within its cost forecast so that it will make a profit. On some projects the public agency must pay the concessionaire if the project does not generate the revenue that was expected. For example, if there is a shortfall in toll revenue because other public roads projects diverted traffic away from the PPP, the agency may be required to make up a portion of the shortfall with payments to the concessionaire. The parties to the concession agreement should strive to provide a project that is needed and that provides a reasonable return on investment for the concessionaire. The parties must avoid terms that will result in a windfall for the concessionaire because of the significant political consequences that could result. The parties must also avoid a revenue sharing arrangement between the concessionaire and the public agency that eliminates a reasonable return, or worse a financial failure for the concessionaire.

The global economic crisis has added additional pressure on state and local governments with regard to PPPs. Government agencies are beginning to push back on PPP investors in an effort to get terms more favorable to the government than previously, in part to satisfy taxpayers and in part to obtain more revenue at the beginning of the project. The economic crisis has also limited the availability of traditional lending for PPP participants. Of course, private equity firms may form funds to invest in infrastructure projects. As interest in commercial REITs has waned, these infrastructure funds appear to be gaining favor with investors.

Contractor Opportunities

Contractors have several opportunities to participate in PPPs. First, they can play the traditional role of the constructor of the project. Usually, PPPs use designbuild or turnkey contracts in an effort to place the entire design, construction, and performance responsibility in the contractor’s hands. Second, the contractor may have the opportunity to participate as an investor or shareholder in the concessionaire, thus providing the contractor with the opportunity to earn a profit on the construction contract and to earn a long-term return on its investment in the concession company.