Competition and bad risk allocation threaten to implode PPPs

SNC-Lavalin and Skanska have decided to stop bidding for such projects. If other developers follow their example, the entire procurement model might be at risk.

In a stark video message, Ian Edwards, SNC-Lavalin’s interim president and chief executive, said it would “stop all lump-sum turnkey contracting”. The Canadian firm has blamed the contracts for cost overruns on large infrastructure projects that resulted in C$367.6 million ($276.3 million; €249.2 million) of negative cashflows during the second quarter of this year.

SNC-Lavalin’s decision comes less than a year since another major construction company, Sweden’s Skanska Group, said it would stop bidding for mega public-private partnership projects in the US, after it wrote down SEK 900 million ($92.9 million; €83.8 million) related to the construction phase of two such schemes.

Although one may view these developments as isolated moves, we wouldn’t be so quick to shrug them off. As Nicholas Varone, director of the US corporate finance group at Fitch Ratings, told us: “In the US, there have been snippets of commentary in companies’ earnings reports and earnings calls indicating undertones of frustration in that market. But it hasn’t been as explicit as Skanska or SNC-Lavalin”.

What’s more, the situation is not limited to North America. Earlier this month, the Financial Times reported that mega-projects in Australia – including PPPs – had a history of losing money, with contractors writing off A$6 billion ($4.0 billion; €3.7 billion) on projects completed between 2000 and 2005.

So why is this happening now? Half of the answer lies in increased competition; the other half concerns questionable risk allocation.

“We believe the pendulum has now swung too far out to the public sector side and so, the public sector has put more risks on to the private sector simply because they could,” said Michael Barz, special counsel at Duane Morris, in reference to the US PPP market. “What happened was a result of incredibly intense competition.”

Equity sponsors pushing off risks to contractors has also exacerbated the problem, argued Richard Dyer, a partner at Duane Morris whose practice focuses on construction law: “Far too often, the sponsor negotiates with the government entity and [although] they negotiate hard, they may not when it comes to construction issues. The sponsor then pushes the risk down to the contractor, who did not have a seat at the negotiating table. That results in more risk being passed down to the contractor.”

The consequences of inappropriate risk allocation only seem to have affected contractors so far. However, they could have broader implications for infrastructure investors, the public sector and PPPs in general if contractors no longer have an incentive to participate in these projects.

“Improper risk allocation is an issue,” acknowledged Scott Zuchorski, senior director, global infrastructure group and head of North American transportation and P3s at Fitch Ratings. “In a January report, we noted that where too much risk is pushed on to the private sector that perhaps would have been better off retained by the public sector, it resulted in delays, disputes and other problems.”

One example of the type of risk that may be more appropriate for the public sector to take on is that of third-party approvals. Government is usually better placed to secure such approvals, as it has more leverage over and greater long-standing relationships with the public agencies responsible for granting them.

That is just one adjustment that could keep the PPP model alive – an objective we believe is in the best interests of both the private and public sectors: the former because its appetite for PPPs is evidenced in the intense competition in the market; the latter because it needs the capital, knowledge and experience of the private sector to upgrade or modernise its infrastructure.

If the public sector could afford to do it on its own, it would have done so already.

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