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Public-Private Partnerships Potential for Arizona-Mexico Border Infrastructure Projects

Final Report

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Chapter 7 - Public-Private Partnerships Background

Public-private partnerships are contractual agreements formed between a public agency (federal, state, or local) and a private sector entity that allows for greater private sector participation in the delivery, operation, and financing of infrastructure projects. Public-private partnerships can include projects where significant design, construction, financial, and operational risk is transferred from the public sector to the private sector. Through these types of arrangements, inherent project risks are borne by that party best suited to control and manage those risks. A public sponsor's responsibility during a public-private partnership project includes:

  • Conducting upfront due diligence on potential projects
  • Defining public objectives
  • Selecting the appropriate public-private partnership model
  • Conducting a fair procurement process
  • Negotiating a well structured public-private partnership agreement
  • Ensuring compliance with the public-private partnership agreement over its term

Some of the benefits of public-private partnerships for state and local governments include:

  • Public-private partnerships are an effective way of financing, managing and operating roads and other infrastructure facilities while minimizing taxpayer costs and risks.
  • Governments across the country and around the world are seeking ways to finance needed infrastructure projects and trying to deliver better services to taxpayers.
  • Public-private partnerships maximize the strengths of both the public and private sectors, offering taxpayers more efficiency, accountability, and cost and time-savings.
  • Public-private partnerships can be used to build roads and other infrastructure projects that may have been delayed or shelved altogether due to fiscal constraints.
  • Public-private partnerships are very flexible delivery systems that can be structured to meet the objectives of the sponsoring public agency. Public-private partnership structures can cover an entire spectrum of risk transfer. On one end of the spectrum is a fully self-funding concession agreement where the private sector takes all development, design, construction, revenue, finance, and operations risk. The other end of the spectrum is a design-build contract where the public sector retains all project risks and simply transfers design and construction risk.

    In evaluating the appropriateness of a specific public-private partnership structure for a given project, the public agency's goals and objectives must be clearly defined. These goals and objectives may differ from project to project. Examples of potential objectives that a public sector sponsor may have for a project include:

    • Provide unfunded infrastructure
    • Leverage scarce resources
    • Minimize an agency's investment
    • Expedite project delivery
    • Provide for long term operation and maintenance
    • Generate revenue to fund other needs
    • Foster economic development

    The objectives that a private entity has in entering into a public-private partnership arrangement are based on the viewpoint that public-private partnerships are essentially business ventures. Ventures where, within the context of the public-private partnership agreement, the private entity is attempting to maximize a return on investment, while minimizing and/or managing its risks. The view of risks, and required returns for those risks, vary significantly among private parties and across projects. As a result, specific public-private partnership projects must compete with other investment opportunities available to a private party, and with other public-private partnership projects offering differing perceived risk and return formulas. The perception of these factors vary substantially among private entities participating in the public-private partnership markets and are often significantly influenced by business objectives and strategies that are only tangentially related to a specific project.

    While the various elements of a specific public-private partnership project may vary from project to project, there is considerable evidence that the following seven factors are critical to a successful public-private partnership undertaking:

    1. Legal Framework: The legal framework establishes the basic structure under which a public sponsor can undertake a public-private partnership project. This framework needs to establish procurement authority and contractual guidelines that provides guidance to both public sponsors and private participants. In addition, a clear legal framework will help engender a transparent process that is critical to achieving stakeholder and public acceptance.
    2. Public Sponsor: A public agency planning to undertake a public-private partnership project needs to be able to commit the resources necessary to manage the public-private partnership process. Whether these resources are internal or external, successful public-private partnership projects requires a team of experienced people who develop a clear understanding of a public sponsor's objectives, structure a procurement to achieve those objectives, and then subsequently negotiate an agreement that clearly sets forth the business deal. The public sponsor also needs to be able to provide ongoing monitoring and oversight of the private partner's performance to ensure compliance with the terms of the agreement.
    3. Agreement: Ultimately, public-private partnership projects are a business arrangement between a public sponsor and a private entity. Public-private partnership projects can cover a span of time stretching out over as much as 99 years. It is very important to have an agreement that is both comprehensive enough to reflect the nature of the business arrangement upon which the project was awarded, yet remain flexible enough to address changing situations over the term of the agreement.
    4. Reliable Revenue Stream: The private partner has to have the ability to reasonably rely upon the revenue stream used to support the project. Whether this revenue stream is from tolls or from other sources, the risk of those revenues will be reflected in how the private sector prices a project. The greater the perceived risk of the reliability of the revenue stream, the greater the risk premium that will be needed by the private sector to invest in and undertake the project.
    5. Stakeholder Support: For a public-private partnership project to be successful, it needs to have the acceptance of major stakeholders. These stakeholders include elected officials, public agency decision makers, major users of the facility, and other affected and interested parties. Given the emerging nature and complexity of public-private partnerships, this often requires an educational outreach effort to explain the pros and cons of public-private partnerships, explain the public sponsor's reasons for undertaking a public-private partnership project, and to explain the anticipated public-private partnership structure.
    6. Private Sector Partner: Public-private partnerships create long term business relationships. Consequently, the "lowest bid" is not always the best choice for selecting a public-private partnership partner. The "best value" in a partner is critical in a long-term relationship that is central to a successful partnership. A candidate.s experience in the specific area of partnerships being considered is an important factor in identifying the right partner. It must be a real partnership, with shared burdens and shared rewards, for both the public and private participants.
    7. Consultant Team: Public-private partnerships are extremely complex transactions that involve technical, financial and legal expertise. Few public agencies have this expertise in house. Public sponsors who have successfully delivered public-private partnership projects have usually relied on qualified firms specializing in these areas of public-private partnerships for advice and counsel.

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    7.1 Types of Public-Private Partnerships

    Public-private partnerships can be structured to deliver a wide range of infrastructure projects. Properly designed public-private partnerships are a means to efficiently allocate risks and returns between the public sector and the private sector. Some of the typical types of infrastructure projects include the following:

    • Roadways, Bridges and Tunnels
    • Water/Wastewater Facilities
    • Buildings
      • Correctional Facilities
      • Schools
      • Courthouses
      • Office Buildings
      • Maintenance Facilities
    • Ports of Entry
    • Airports
    • Intelligent Transportation Systems (ITS)
    • Parking Facilities
    • Railroad Lines

    Though specific objectives vary significantly by project, there are generally four basic objectives for a public agency to enter into a public-private partnership:

    • Maximize the ability of public sponsors to leverage existing federal and/or state revenue sources
    • More effectively use existing public funds
    • Move projects into construction more quickly than under traditional financing mechanisms
    • Make possible major infrastructure investments that might not otherwise receive financing

    In the US there are four basic public.private partnership models which have been utilized: design/build/finance, design/build/operate/maintain, design/build/finance/operate/maintain, and a concession. Each of these models is discussed below.

    Design/Build/Finance

    DBF public-private partnerships allow the public sponsor to pay for infrastructure over a term which extends beyond the facilities construction period. Under this model the private partner finances the construction based on a promise by the public sponsor to make a series of payments. DBF projects are often utilized for governmental buildings, where the financing is secured by a lease or rent payment.

    DBFs allow public infrastructure projects to be expedited and not wait for all of the funds to be accumulated. Public agencies traditionally utilize bond offering to accomplish the same objective. However, payments pledged under a DBF are typically subject to prior appropriations and do not have the same financial reporting implications as a bond offering.

    Design/Build/Operate/Maintain

    Typically these are D/B contracts here the D/B contractor retain the responsibility to operate and maintain the facility. The public sponsor retains all revenue and financing risks. DBOMs typically are used in two scenarios: when the specific infrastructure requirement is specialized and requires operational and or maintenance expertise which is not otherwise available to the public sponsor; or where it is felt that outsourcing the operations and maintenance will result in a better facility by incorporating life cycle costs in the design of the facility.

    Design/Build/Finance/Operate/Maintain

    DBFOMs are also referred to as availability payments. DBFOMs are similar to DBOMs except that the private partner is responsible for financing a stream of revenue pledged by the public partner. Under an availability payment structure, the private partners compensation is based on the performance, or availability, of the facility. Under this structure the public partner retains control of the revenue stream.

    DBFOM projects are gaining increasing popularity for new toll projects which have significant startup risks and require public sector support or guarantees in order to make them commercially viable. Under this model the public partner retains revenue risk, but also receives the benefit of increases in future revenue streams. Like DBOMs, DBFOMs incorporate life cycle costs into the design of project by linking compensation to performance or availability.

    Concession

    Pure concessions transfer all design, construction, financing, and operational risks from the public sponsor to the private partner. The fees that constitute the revenue source are set by contract. Increases or decreases in these revenues impact the private partner's compensation.

    Concessions can be used for any revenue producing facility such as toll roads or parking facilities. Pure concessions usually work best for established facilities with predictable revenue streams. Such facilities often result in significant upfront payments for the right to the concession, though more recent concessions incorporate some form of revenue sharing. For new facilities, the revenue stream is less predictable and therefore is viewed as more risky. In order to make such projects commercially viable, some form of support or enhancement is required of the public partner. Depending upon the level of public support a DBFOM may be a preferred alternative.

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