Commentary: Risk Vs. Rewards in P3s for Design-Build Contractors
Public-private partnerships (P3s) have burst onto the scene in the U.S. as a solution to help meet the overwhelming need for public infrastructure and the underwhelming public resources to pay for it.
P3s, of course, are hardly new. Private funding sources have been used for decades to develop major infrastructure and social assets in Europe, Asia and Latin America. In the last decade, P3s have become common in Canada, and they were utilized in the U.S. in the 1970s to develop post offices. In many cases, these privately financed assets are well timed, developed and operated.
They can also provide a good opportunity for contractors who have the financial wherewithal to take on large design-build contracts and for specialty firms that perform as subcontractors. While P3s present opportunities, they also create risks in financing large-scale projects.
The entrepreneurial drive inherent in P3s is created by private-sector demands for a timely financial return on investments. Risk is priced and apportioned by those parties in the P3 structure best able to understand and mitigate it. However, all parties involved in a P3 project have a common goal: to build an infrastructure asset and have it begin to generate revenue as quickly and efficiently as possible.
Efficiency is the key. Given the long-term operate-and-maintain component typically included in P3s, everyone involved in project development must focus on its full life cycle. The asset must be buildable but also productive and cost efficient to operate and maintain.
Financing must also be efficient. Some financing sources are prepared to take on greater risk in exchange for the higher returns associated with the design-construct phase. Other financing sources prefer the stability of low risk and lower but generally more predictable returns during the operations and maintenance phase.
For a select group of contractors, P3s may also create sound investment opportunities. It’s not uncommon for the design-builder to invest in the project’s equity. But this investment may not be suitable for all contractors because:
• The investments are not very liquid and require the backing of a large balance sheet.
• Even contractors with the financial resources should limit their investments so that the adverse impact of one job does not damage their entire enterprise.
• The aggregate money invested in the non-liquid assets of a P3 has to remain small compared to the balance sheet and full scope of the contractor’s operations.
But there’s no free lunch. P3s also create risk. Financial risk exists for the design-builder if the project is not completed on schedule. Because the project is design-build, the financiers are counting on it to come on line as scheduled to service the debt.
Therefore, P3s typically do not allow contractor extensions due to bad weather, changed conditions and scope or other obstacles.
The relationships and contracts among the parties involved in a P3 can be complex. With each party trying to obtain the most favorable conditions, risks may be passed downstream to the contractor—where they do not belong. For instance, in a P3 the concessionaire typically manages the financing, but it may try to get the contractor to take on this risk.
The role of the design-builder also affects risk. For example, the responsibility to operate or maintain the asset requires different skills that may not be aligned with the contractor’s experience. It also increases the contractor’s duration at the site and may have cash-flow implications. A design-builder’s P3 capital investment is likely to be non-liquid for many years.
Opportunity is the catalyst of free enterprise. Risk creates the chance to make a profit. Both exist within the developing P3 market, and both require careful exploration.
Rick Ciullo is chief operating officer for Chubb Surety and can be reached at RCiullo@chubb.com.