Competition for fixed-price public-private partnerships is proving to be too risky for their worth for some construction contractors, according to a report by Fitch Ratings.
Unexpected costs and delays in developing fixed-price PPPs has led to a number of project defaults and two of the industry’s largest construction companies to turn away from the financing structure completely. According to Fitch, the construction phase of fixed-price PPPs “remains one of the most important risks posed to a project”.
Unlike availability-based PPPs, which typically allow developers to collect revenues from the projects they build, fixed price or lump-sum projects pay a single payment. It’s up to the developing consortium to make its investment profitable.
According to Mario Angastiniotis, who co-authored the Fitch report and is director of infrastructure and project finance in Canada at the ratings agency, competition for contracts in mature PPP markets like Canada is leading developers to “underestimate the risk of construction”.
“As people get more comfortable with the PPP structure, they also start to get comfortable with the risks they’re bidding on,” Angastiniotis told Infrastructure Investor. “The issue is that when problems crop up unexpectedly, and you haven’t priced that risk in, that leads to potential loss of profit.”
In July, Montreal-based SNC-Lavalin cited fixed-price PPPs as the “root cause” of the company’s low second-quarter earnings. As a result, SNC-Lavalin said it was withdrawing from ongoing bid processes, including for the C$1.4 billion ($1.05 billion; €940 million) Patullo Bridge PPP, the C$2.8 billion Millennium Line Broadway Extension and the C$2.6 billion Edmonton Valley Line West LRT.
“We are pulling out of the projects where we’ve been shortlisted but are working closely with clients to either bid if the contracting model changes to one with a better risk profile than [fixed-price] or being a subcontractor with limited risks to those leading the bid,” a spokesman for SNC-Lavalin said.
SNC-Lavalin also announced it would reorganise the company into two businesses, separating its “high-performing” engineering, nuclear and infrastructure services groups from its PPP development arm. “This will form the focus of the future of our company,” Ian Edwards, the company’s interim president, said.
According to Angastiniotis, construction contractors have been the party taking the heat with fixed-price PPPs as governments shift risks to the private sector, and equity sponsors in turn put that weight on developers.
“Risks tend to be passed down the line,” he said. “The contractor agrees with the equity sponsor that they’re going to build something for a certain price. Then, the contractor signs a bunch of agreements with subcontractors for them to build something at a fixed cost.”
Swedish construction firm Skanska announced a similar move last October in which it would pull out of the US PPP market after taking a $100 million write-down from two high-value projects.
Skanska did not disclose which two projects caused the loss but said in an earnings statement that it was caused by “additional cost overruns due to low production rates and delays”. At the time, Skanska was involved with the $4 billion LaGuardia Central Terminal B project and the $2 billion Interstate 4 expansion in Orlando, Florida.
While Angastiniotis said he views contractors shying away from fixed-price PPPs a “necessary readjustment of the process”, he added that it could take a toll on the industry long-term.
“A healthy PPP market needs a healthy construction sector,” he said. “Contractors may be willing to lose money on one or two deals to keep the pipeline going, but if you’re constantly losing money, then you have to ask yourself why you’re in it.”