Babies and bath water

As it strives to achieve value for money, the UK government should avoid alienating the private sector partners it needs more than ever, writes Andy Thomson.

The axing of a large portion of the previous administration’s £55 billion (€66 billion; $83 billion) Building Schools for the Future (BSF) programme did not exactly put the new UK coalition government’s relationship with the private infrastructure developers, investors and advisers on a firm footing. For many of these groups, BSF was a vital source of deal flow or revenue.      

With the results of the UK’s Comprehensive Spending Review to be announced next week, there is a chance that the relationship could be further strained. After all, the government’s determination to reduce the public deficit leads many infrastructure professionals to fear that it may seek to alter the terms of existing private finance initiative (PFI) contracts. (PFI is the UK’s standard procurement process for public-private partnerships). 

Andy Thomson

The first sign that the government might place existing contracts under the microscope came in May when it was announced that the National Audit Office (NAO) was analysing whether procuring agency the Highways Authority had “selected a cost-effective option to deliver its objectives and value for money” when handing developers Balfour Beatty and Skanska a £6.25 billion contract to widen the M25 motorway in June 2009.

The deal’s defenders said the significance of the M25 deal was not that it necessarily delivered value for money relative to whatever relevant cost efficiency metrics might be applied; instead, it delivered needed infrastructure at a time when obtaining finance for such large-scale projects was deemed all but impossible. 

The NAO ultimately delivered a nuanced verdict: namely, that 2009-vintage PFI deals such as the M25 had delivered a welcome stimulus to the economy even though they had been costly to the public sector and involved less risk transfer to the banks. While adding that such deals would not necessarily represent value for money had they been procured in 2010, the NAO also inferred that value for money was not the only relevant factor in judging the merits of the procurement.

The private sector will be hoping that the government also appreciates the context within which other PFI contracts were drawn up rather than seeking to renege on their key terms. Such contractual revision has already been threatened in Spain, where retroactive changes to renewable energy feed-in-tariff mechanisms were mooted. Suffice to say, such knee-jerk responses to fiscal pressures do not tend to go down well with investors – and legal challenges may follow (in which case, what of those cost savings?).      

Besides, the UK government should keep in mind that the need for the public sector to tighten the purse strings means it will surely have a stronger reliance on private sector capital for infrastructure delivery going forward than ever before.

For instance, as the plug was pulled on BSF, participants in that sector quickly went about switching resources to areas such as waste and renewables – knowing that the government is committed to delivering on its green agenda. And the transition to a low carbon economy simply can’t be done without the private sector playing a prominent role.

Here’s another thought. The infrastructure projects of the future will be delivered against a regulatory background that will almost certainly make it more difficult for banks to commit long-term capital (consider Basel III). Does the government really wish to add political risk to this financing/regulatory risk? After all, UK PFI is a market that has always attracted international as well as domestic finance precisely because of its perceived stability and predictability.

Riffling through existing PFI contracts in an attempt to identify potential savings may be attractive to the government in the current environment. But it should tread carefully. The hope – and probably the best bet – is that savings will be sought around the margins rather than by attempting to change contractual fundamentals. All those with an interest in past, current and future PFI market will be watching very closely.    

In upcoming issues of Infrastructure Investor, our editorial team will be asking whether the established PPP model still works – and taking a look at alternative models.