What Drives Public-Private Partnerships and the Risks to Be Aware of

As the nation struggles to repair, maintain, and expand its infrastructure, public-private partnerships are gaining traction as a strategy for delivering traditionally “public” services. Public-private partnerships (or P3s) are touted on the idea that public projects can benefit from the private sector’s increased competition, more accurate pricing, expanded financing options, and more flexible personnel and procurement processes. In return, the private sector is given the opportunity to access a market otherwise served by the public. It can be a mutually beneficial relationship.

There are a number of stages of infrastructure development and operations in which the private sector can and has engaged. The most common stages are in designing, building, financing, operating, and maintaining a project. A partnership is formed when a public entity engages a private partner to comprehensively provide two or more of these stages and take a vested interest in their performance. The most basic (and common) public-private partnership engages a private entity to both design and build a project that might otherwise be bid separately. One of the benefits associated with public-private partnerships come from a private entity being able to comprehensively bid and address multiple steps of the public service provision. In other words, in this most basic case, the private entity doesn’t have to build someone else’s design.

The financing stage is an interesting one to consider what could be gained from private involvement. In general, due to the tax-exempt nature of their debt and the relative stability of their revenue stream, governments can borrow money at lower rates than the private sector. However, the federal government has a number of financial mechanisms that are available (or in consideration of being available) to decrease the cost of capital to private entities for the purposes of financing public infrastructure. The hope of the federal government in creating these mechanisms is to increase the amount of private capital used to finance public projects. In the water sector, these strategies include the, relatively recently passed, Water Infrastructure Finance and Innovation Act, Private Activity Bonds, Qualified Public Infrastructure Bonds, Move America Bonds, and America Fast Forward Bonds. (I’m just waiting for the Apple Pie Bond from the sound of some of these financial mechanisms.)

And while, these mechanisms seek to level the financial playing field so that private dollars and some public dollars with limited to no tax liability (e.g. pension funds) can be used to increase investment in our public infrastructure, it’s not likely going to be cheaper than a good ole general obligation bond issued by a highly-rated public entity.

So why would a local government with a decent credit rating want to pursue a public-private partnership, particularly in financing the infrastructure? And why is the federal government so interested in helping them do this? The following factors have been motivating ones for engaging the private sector in public services, particularly financing.

• For starters, the local government may have bad credit or low-to-no debt capacity. In these cases, private financing may be the only funding option.
• The local government wants to transfer the risks of constructing, financing, and/or operating a development to the private sector and only pay when the service is delivered (using availability payments). P3s can protect the public entity against changes in the economy and politics and provide budget certainty for the duration of the contract. These types of deals can work if the service can be measured.
• There can be cost-savings in private provision that come from the scale of a private entities operations; the alignment of concurrently designing, building, financing, operating, and/or maintaining a facility; and the personnel flexibility of private enterprise.
• The local government may need cash to dedicate to another debt of project. This is not always the pretty side of public-private partnerships, but some P3 concession arrangements grant the public entity cash on the front-end in exchange for access to that market (i.e. water rate payers or toll road drivers).
• By changing the payment schedule and asset accounting, P3s have been used to overcome a public’s lack of willingness to pay for a project. This is another not-so-pretty reason for them.
• Public-private partnerships can be quicker to mobilize, as they can sometimes alleviate procurement hurdles.

And, of course, there are risks to public-private partnerships that should also be recognized and planned for. Some of these include:

• The requirement for good contracts. Poorly drafted agreements can be costly and difficult to correct. Considerations must be made for the possibility that the private partner goes bankrupt, designs require costly changes, or there is a dramatic decline in the number of users. Furthermore, if a contract needs to be renegotiated, it is most likely taking place in the absence of competition, so if it’s not anticipated on the front-end, the ultimate result can be costly.
• Public-private partnerships can lack the transparency expected of purely public projects, transparency expected and required to protect public interest and public dollars.
• Because of their complexity, the costs of developing and bidding the Request for Proposals for public-private partnerships are higher.
• If the revenue streams associated with the project are not clearly identifiable, private financing may not be available.
• Long-term agreements can be a gamble. Predicting the next 20 – 30 years in a contract will always be difficult.

The EFC, in partnership with the EPA’s Water Infrastructure and Resiliency Finance Center and the West Coast Infrastructure Exchange, will be spending the next nine months taking an objective, balanced look at the potential quantitative and qualitative benefits of alternative water service delivery partnerships and mechanisms. Profiles of these partnerships will be highlighted in this blog in the coming year.

Read more:

Norma Houston’s Coates’ Canons blog post “New Construction Delivery Methods – Public-Private Partnerships”

State of New York Comptroller’s report on “Private Financing of Public Infrastructure: Risks and Options for New York State”

Jeff Hughes’ Environmental Finance blog post “Breaking News: MS4 uses P3 for TMDL!”