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Municipal P3s: Considerations From Ontario's Market

Municipalities are facing unprecedented fiscal challenges. Increasing populations and costs coupled with dwindling tax bases, budgets, and funding sources are compelling them to explore new options to revive and build new infrastructure. Public-private partnerships (P3s) have been gaining attention for their ability to leverage capital markets without incurring public debt. While a worthwhile goal, municipalities should assure themselves that the decision to pursue P3s is made in consideration of broader business practices. This article explores some of the key lessons learned in the Ontario P3 marketplace including: understanding the motivations for P3 delivery, ensuring the appropriate scale of project for a P3, developing a business case, focusing on lowest lifecycle costs, budgeting realities, the need for strong unbiased P3 advisors, appropriate governance structure, tendering using output specifications, and the minimal ability to modify project scope after commercial and financial close. 

Ontario’s P3 Market

Ontario is a global leader in P3s. With one of the most mature P3 markets, this Canadian province has continued to bring new P3 projects to the market at a steady pace and continues to have a robust pipeline of projects well into the future. Much of the success of P3s in Ontario is due to the provincial government’s investment in a dedicated P3 agency (Infrastructure Ontario) that provides a standardized procurement process recognized by the private sector.

Infrastructure Ontario

Infrastructure Ontario is an independent agency owned by the government of Ontario. It was created to address the challenges of on-time, on-budget delivery of mega infrastructure projects in the province. Since 2006, Infrastructure Ontario has brought 50 P3 projects to market, worth in total over CAD 26 billion, on time and on budget. To date, the majority of projects completed in Ontario have focused on the social accommodations sector (Box 1) with transportation projects rapidly gaining momentum (Box 2).

Alternative Financing and Procurement (AFP) is the government of Ontario’s brand name for P3s. The AFP model is predicated on the basis that risks should be managed by the party best able to handle them. All AFP delivery models contain some degree of private financing: Build-Finance (BF), Build-Finance-Maintain (BFM), Design-Build-Finance (DBF), Design-Build-Finance-Maintain (DBFM), and Design-Build-Finance-Operate-Maintain (DBFOM). By having a dedicated procurement agent such as Infrastructure Ontario, the marketplace is reassured by the consistency of procurement methodology and documents being used.

Municipal P3 Considerations from Ontario

Having worked with municipalities to structure P3 projects, reoccurring concerns are evident. Considerations are organized by project lifecycle phases (pre-transaction, transaction, and delivery) and presented throughout the remainder of this article. 

Pre-Transaction Phase Considerations

Understand motivations for P3 delivery. The existence of funding programs that support P3 delivery models has intrigued some municipalities in Canada to explore previously unconsidered alternate delivery models. While initially tempting to pursue a higher-tier government funding source that would otherwise be unavailable, it is more important to answer the question of where the additional funding will come from first and not vice versa. The decision to pursue a P3 model should be based on a municipality’s interest in pursuing ancillary benefits beyond securing a funding source or access to capital markets, such as project acceleration, risk transfer, cost savings, and the ability to achieve synergies through the integration of discrete project components including design, build, finance, operations, and maintenance.

Determine scale of project. Due to the increased complexity and the significant upfront due diligence that is undertaken for P3 deals, projects in Canada typically have a minimum capital value of CAD 20 million and at least a similar value in operations, maintenance, and lifecycle replacement (state of good repair) to be evaluated for P3. This is because, generally, the larger and more complex a project is, the greater the potential for risk transfer to offset increased private borrowing and ancillary costs. To achieve the threshold, similar projects or projects requiring similar skill sets can be bundled and tendered to market as one integrated package. Infrastructure Ontario has had multiple success stories tendering bundled projects, including a project for 18 Ontario Provincial Police detachments, regional headquarters, and forensic identification services in 16 communities across the province, valued at CAD 298 million.

 

 

Develop a business case for the project regardless of the delivery model. Working with strong unbiased advisors, municipalities should develop a business case that explores the qualitative and quantitative attributes of a project prior to choosing a delivery model. Once a project sponsor is satisfied of the merits for the project to proceed, the municipality should conduct a P3 assessment as part of the business case to determine the optimum delivery model. Value for money (VFM) becomes one of many relevant metrics for deciding the optimal delivery model of a project. Municipalities are cautioned not to misinterpret the output of a VFM assessment as a go/no-go metric for the project to proceed. Similarly, a larger VFM figure does not suggest that one project is better than another because it has a higher value. Simply, VFM measures the difference between the public sector comparator and the adjusted shadow bid. If VFM is positive, subject to sensitivity testing and assuming qualitative measures align, P3 delivery should be recommended.

Focus on lowest lifecycle cost. P3 delivery often becomes a lightning rod for exposing the true cost of a project over a long-term horizon. Municipal councils, often driven by accountability to its citizens, tend to hold a hard-line on the capital budgets established for new construction not considering the long-term costs of operations, maintenance, and lifecycle replacement. In these instances, P3s are unlikely to become a reality as they will be deemed “too expensive” from the onset for having determined a sober cost over the established concession period. Instead, this reality check should be seen as a positive—P3s force the discussion of how much a project will truly cost during its lifespan. Municipal councils should switch their mindset from lowest cost construction to lowest lifecycle cost. The synergies created through P3 delivery can save upwards of 30 percent in overall project lifecycle costs (Box 3).

Deferring maintenance is not a budgeting option. In order to maximize risk transfer and coincide with amortization periods of financing solutions (bank financing, private placement deals, and bond financing), P3 concession terms for DBFM/DBFOM projects in Ontario are generally 30 years. Longer-term concessions may pose challenges for municipalities that like having the option to defer non-critical maintenance and lifecycle replacement. In the case of a P3 project, the municipality is contractually obligated to make periodic capital repayments, as well as operational and sculpted maintenance and lifecycle payments over the agreed-upon concession term; otherwise, they will be in default.

Having strong unbiased advisors that understand P3s is vital. P3 projects are highly sophisticated transactions. They need to be staffed with individuals who understand the process and have demonstrated expertise to guide the municipality.

Typically, technical, financial, legal, fairness, and procurement advisors are needed and can account for five to 10 percent of the projected capital costs. Each advisor plays a vital role in the overall success of the project and their significance must not be downplayed. Advisors must be unbiased and must look for the best solution, not create the best P3 project. A municipality that takes on the task of P3 procurement without prior expertise may find itself unable to reach commercial and financial close because their procurement has not been optimally structured; this is usually due to unrealistic expectations of risk transfer to the private partner.

An example of a municipality in Ontario that has found value in retaining seasoned P3 advisors is the Regional Municipality of Waterloo. Parsons Brinckerhoff, in collaboration with Infrastructure Ontario, is working to bring Waterloo’s rapid transit project to market in the near future. As general engineering consultant, Parsons Brinckerhoff is assisting the municipal government and Infrastructure Ontario to prepare design criteria and performance requirements for a DBFOM concession. Parsons Brinckerhoff is also assisting with design, utility relocation, and construction management, and will help to implement a public participation program.

Transaction Phase Considerations

P3s require strong leadership. Consortiums will look for delineation and dedicated point-people assigned to the project; this is especially true of the Project Manager’s day-to-day role. Weak governance structures may not give adequate confidence in the municipality’s seriousness in using a P3 delivery model, resulting in a less competitive procurement process. In addition, consortiums will find reassurance where a municipality has partnered with an experienced procurement advisor. In Ontario for example, consortiums advise that when a municipality partners with Infrastructure Ontario, they have greater confidence that the project will proceed and have bankable commercial terms they are familiar with.

Comfort tendering projects using output specifications. Municipalities are often accustomed to tendering projects with prescriptive input requirements to achieve a desired end product (Design-Bid-Build). P3 project delivery requires an overhaul in mindset. P3 projects are tendered using output specifications (also known as performance specifications) in order to drive innovation. Project consortiums are contractually obligated to deliver to a predetermined level of service, and accordingly, need to be given the flexibility to choose the components they feel will best satisfy those requirements. For example, in the case of a light rail transit project, a municipality will identify the expected service level (e.g., train headways of “X” minutes) and the private sector partner would design and build a system in order to achieve those contracted specifications. Municipalities must realize that they will be defining the output desired from the onset and will have minimal input into the “nuts and bolts” of what goes into the project during construction.

Delivery Phase Consideration

Minimize opportunity to modify project scope after commercial and financial close. On-time, on-budget project delivery is achieved when change orders are minimized during construction; this is true of any project delivery model. P3 projects are particularly sensitive to change orders during construction because of the degree of due diligence that is necessary upfront on the part of a consortium bidding for the project. Generally, once a budget, scope, and schedule are committed to under a P3 model with a preferred bidder, little to no opportunity exists to alter scope without material cost and/or schedule impacts. It is the job of the procurement advisor to scrutinize discretionary change orders, and when the decision is made to proceed, identify the impact to budget and schedule and secure project sponsor sign-off. For this reason, municipal councillors and staff need to be aware that once selection of a preferred bidder is made under a P3 delivery model, changes to the scope, budget, or scheduled are highly discouraged because they are costly.

Conclusion

P3s should not be seen as a panacea for municipalities with fiscal challenges. While initially intriguing for their ability to leverage capital markets without incurring public debt, municipalities need to look beyond this feature to realize other ancillary benefits that P3s offer. This article has touched on some of the key factors municipalities should consider prior to pursuing a P3 according to the phases of a project’s lifecycle. In Ontario, municipalities have realized the need to alter their business practices across all phases of a project (pre-transaction, transaction, and delivery) if they wish to pursue a P3. Ultimately, municipal council and staff need to educate themselves on the mechanics of the P3 model and appreciate that the sophistication of the transaction will necessitate competent and experienced P3 advisors to guide their projects to ultimate success.

 

Notes:

  1.  Savings are not cumulative

 

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