John, thanks again for your comments and I read Ian's submission with great interest. Ian's most compelling point seems to be that, with an Emissions Trading Scheme, WCC's actions to reduce its emissions through this project will likely not reduce NZ's emissions and therefore the project is not only pointless in that sense but extraordinarily expensive relative to the current carbon price. We see these kinds of alleged emissions reduction projects in numerous other places within the NZ public sector. It is tempting to attribute them to ignorance amongst their proponents about how the Emissions Trading Scheme works. Perhaps the proponents of these schemes do understand how the Emissions Trading Scheme works but extract utility from being seen to be saving the planet by people who themselves do not understand how the Scheme works? Cycle ways seem to be the classic example.
Re: "Well-written and well-enforced PPP contracts can transfer blowout risk from the public to the private sector". Have we had well-written and well-enforced PPP contracts to date? Is it not the case that the public sector had to pick up a big chunk of the cost overruns for Transmission Gully and the Puhoi-Warkworth extension? And don't private sector companies have incentives to submit unrealistically low bids to secure public sector contracts and then bully the public sector once the point of no return is reached to secure additional financial concessions from the government? And does government have the staff expertise to negotiate and manage PPP contracts adequately?
All fair questions, for which I have no definite view on. However, I think I can more confidently state that the Guidelines significantly bias the decision in favour of PPPs. Having critiqued them in that way, it seemed important to acknowledge that there might be advantages and identified some possibilities.
‘Risk transference’ can be somewhat illusionary because:
(a) its project specific and rolling out ‘boiler plate’ PPP deals (along with the SVPs) is a recipe for future problems, and
(b) when it comes to the financial structuring and legal wrapping in such deals then governments (councils) invariable are at a disadvantage as they don’t have the resources compared to the private sector -look no further than the UK or the US for examples where authorities have gotten themselves caught out and paying exorbitant amounts of money for the provision(maintenance) of services.
It seems to be a common assumption in NZ that that the worst of this has been avoided, but this requires more upfront public scrutiny of such deals, which requires better transparency.
For example – looking at the Wellington’s Moa Point Sludge facility (not quite a PPP but uses a SPV) which is a facility that needs to be built, and is currently estimated to cost Wellington City rate payers $400mio (from, as I’m told, an initial NZ$70mio costing). The Government, (through Crown Infrastructure partners) is the equity (first loss) component in the deal (approx. NZ$8mio) in other words if the construction costs more than NZ$400mio, Central Government absorbs the ‘cost’ up to NZ$408mio – above that it falls back to the rate payers – who wants a half-built sludge facility?
The cash flows (over the 30-year financing period) which are raised through a levy on rate payers and distributed to debt and equity holders of the SPV are listed here:
Assuming that all those projected cash flows are made – then using interpolated government bond rates from the end of May 2024 the discounted cash flows* on this transaction gives an equivalent yield of about 9.1%, which compares with a 30-year government borrowing rate at the time of 4.94%..that seems quite high.
In theory, as the levy is a direct lien on the rate payers it potentially renders the SPV as having credit equivalence (if not slightly better – but I haven’t looked at the legals or structure of its other debt) with the Councils’ current rating (AA+/A-1+ @ S&P)
All up, thank you for posting I really enjoyed reading it.
Regards
John
*It’s very back of the envelope, but there isn’t more detail to go on
John, thanks for your weblink to that document. The yield differential you determine is huge but there would be opex to deduct from the levies before running the Internal Rate of Return, and that would lower it. I agree with you that these deals warrant more public scrutiny, and therefore more transparency is needed, but some people don't want the sunlight in. The webpage you cite notes that such debt won't sit on the WCC's balance sheet and then claims that "This allows the Council to retain debt headroom for other projects without the need to increase rates and/or reduce capex." This is tooth fairy stuff. The levies on ratepayers to fund this project are rates in all but name.
Hello Martin, I was looking at Ian Harrison's TailRisk Economics for something else and came across this submission he made back in 2022 - interesting that from when he made his submission 2 years ago the cost of the Moa point facility has doubled.
Ian's comments about lack of information and tight time frames again highlights the issue on transparency and sunlight on these sort of deals
Thanks for those insights Martin. A little outside my realm of expertise, so I confess I found myself somewhat in the weeds initially, but it's intuitive that government borrowing costs are almost always lower, and so it's clear these guidelines are forcing the Ministry to measure private financing to an entirely different standard from that of public financing... It may have been intentional, but I also couldn't help noticing that you made no mention of 'profit'. All construction/operating costs being equal - which you seem to assume - surely the PPP model has to build in some shareholder profit as well, which the traditional model has no need for, making the gap between what is actually delivered for each dollar even wider?
Hi Tim, profit is the return on equity capital, and there is none in this simple example, hence no profit. In the SSRN paper for which a link is given, a more realistic example is presented, with equity capital and hence profit. The inclusion of equity capital accentuates the problem here because the allowance for profit that is usually provided adds even more to he financing cost disadvantage of private sector provision.
John, thanks again for your comments and I read Ian's submission with great interest. Ian's most compelling point seems to be that, with an Emissions Trading Scheme, WCC's actions to reduce its emissions through this project will likely not reduce NZ's emissions and therefore the project is not only pointless in that sense but extraordinarily expensive relative to the current carbon price. We see these kinds of alleged emissions reduction projects in numerous other places within the NZ public sector. It is tempting to attribute them to ignorance amongst their proponents about how the Emissions Trading Scheme works. Perhaps the proponents of these schemes do understand how the Emissions Trading Scheme works but extract utility from being seen to be saving the planet by people who themselves do not understand how the Scheme works? Cycle ways seem to be the classic example.
Re: "Well-written and well-enforced PPP contracts can transfer blowout risk from the public to the private sector". Have we had well-written and well-enforced PPP contracts to date? Is it not the case that the public sector had to pick up a big chunk of the cost overruns for Transmission Gully and the Puhoi-Warkworth extension? And don't private sector companies have incentives to submit unrealistically low bids to secure public sector contracts and then bully the public sector once the point of no return is reached to secure additional financial concessions from the government? And does government have the staff expertise to negotiate and manage PPP contracts adequately?
All fair questions, for which I have no definite view on. However, I think I can more confidently state that the Guidelines significantly bias the decision in favour of PPPs. Having critiqued them in that way, it seemed important to acknowledge that there might be advantages and identified some possibilities.
Thank you for helping me understand (at least some of) the obfuscation around large infrastructure projects.
We really need to find a way for voters to consider the potential consequences of PPPs!
Really Good note.
‘Risk transference’ can be somewhat illusionary because:
(a) its project specific and rolling out ‘boiler plate’ PPP deals (along with the SVPs) is a recipe for future problems, and
(b) when it comes to the financial structuring and legal wrapping in such deals then governments (councils) invariable are at a disadvantage as they don’t have the resources compared to the private sector -look no further than the UK or the US for examples where authorities have gotten themselves caught out and paying exorbitant amounts of money for the provision(maintenance) of services.
It seems to be a common assumption in NZ that that the worst of this has been avoided, but this requires more upfront public scrutiny of such deals, which requires better transparency.
For example – looking at the Wellington’s Moa Point Sludge facility (not quite a PPP but uses a SPV) which is a facility that needs to be built, and is currently estimated to cost Wellington City rate payers $400mio (from, as I’m told, an initial NZ$70mio costing). The Government, (through Crown Infrastructure partners) is the equity (first loss) component in the deal (approx. NZ$8mio) in other words if the construction costs more than NZ$400mio, Central Government absorbs the ‘cost’ up to NZ$408mio – above that it falls back to the rate payers – who wants a half-built sludge facility?
The cash flows (over the 30-year financing period) which are raised through a levy on rate payers and distributed to debt and equity holders of the SPV are listed here:
https://www.hud.govt.nz/our-work/infrastructure-funding-and-financing-wellington-sludge-minimisation-facility-levy-order-2023 (it took me a while to find this, just to reinforce the point about transparency, but also are HUD the best government entity to 'monitor' this, should it not sit with Treasury?)
Assuming that all those projected cash flows are made – then using interpolated government bond rates from the end of May 2024 the discounted cash flows* on this transaction gives an equivalent yield of about 9.1%, which compares with a 30-year government borrowing rate at the time of 4.94%..that seems quite high.
In theory, as the levy is a direct lien on the rate payers it potentially renders the SPV as having credit equivalence (if not slightly better – but I haven’t looked at the legals or structure of its other debt) with the Councils’ current rating (AA+/A-1+ @ S&P)
All up, thank you for posting I really enjoyed reading it.
Regards
John
*It’s very back of the envelope, but there isn’t more detail to go on
John, thanks for your weblink to that document. The yield differential you determine is huge but there would be opex to deduct from the levies before running the Internal Rate of Return, and that would lower it. I agree with you that these deals warrant more public scrutiny, and therefore more transparency is needed, but some people don't want the sunlight in. The webpage you cite notes that such debt won't sit on the WCC's balance sheet and then claims that "This allows the Council to retain debt headroom for other projects without the need to increase rates and/or reduce capex." This is tooth fairy stuff. The levies on ratepayers to fund this project are rates in all but name.
Hello Martin, I was looking at Ian Harrison's TailRisk Economics for something else and came across this submission he made back in 2022 - interesting that from when he made his submission 2 years ago the cost of the Moa point facility has doubled.
Ian's comments about lack of information and tight time frames again highlights the issue on transparency and sunlight on these sort of deals
https://tailrisk.co.nz/documents/sludgeminimisation.pdf
Thanks for those insights Martin. A little outside my realm of expertise, so I confess I found myself somewhat in the weeds initially, but it's intuitive that government borrowing costs are almost always lower, and so it's clear these guidelines are forcing the Ministry to measure private financing to an entirely different standard from that of public financing... It may have been intentional, but I also couldn't help noticing that you made no mention of 'profit'. All construction/operating costs being equal - which you seem to assume - surely the PPP model has to build in some shareholder profit as well, which the traditional model has no need for, making the gap between what is actually delivered for each dollar even wider?
Hi Tim, profit is the return on equity capital, and there is none in this simple example, hence no profit. In the SSRN paper for which a link is given, a more realistic example is presented, with equity capital and hence profit. The inclusion of equity capital accentuates the problem here because the allowance for profit that is usually provided adds even more to he financing cost disadvantage of private sector provision.