6 december 2002

Tony Williams

Building Value Ltd

the independent strategic advisor to the building materials, construction

& support services sectors

6 December 2002

Infrastructure improvement in Europe:

private and/or public?

Private Finance Initiative in UK

“another fine mess you got me into”but

“the report of my death was an exaggeration”

PFI

Established in 1992 (by a Conservative government)

Alternative method of procuring services for the public sector

‘Build now, pay later’; just like hire purchase and government eventually owns the asset

Revenue not capital spend; ex-PSBR

Public Private Partnerships (PPP) employ joint capital; ownership does not revert to government

Another fine mess….

Current ‘witch hunt’ on PFI

Blanket media criticism

Focus on project delays; costs; value; ideology

Accounting practices have been questioned

Controversial proposed PPP of London’s Underground Railway

Report of death is an exaggeration

£100 billion worth of schemes

- £22 billion completed

- £14 million where formal contracts signed

- £64 billion of schemes in the pipeline

This compares to annual UK construction output worth circa £80 billion

Eurotunnel share price

British Energy Share Price

What are the main issues?

Timing and cost

Government is cheapest borrower

Value for money; transfer of risk – for Government

Off balance sheet funding

Re-financing and ‘windfall’ profits

‘Build now pay MORE later’

Amey share price

Pressure on public funding

-4 -3 -2 -1 0 1 2 3 4

Austria

Denmark

France

Greece

Italy

Netherlands

Spain

UK

Government net debt as % of GDP

Series2

Series1

Positives

Need - £100 billion worth of schemes to date

National & regional government support

Abundance of capital

Returns are attractive

Participants see higher quality earnings

Negatives

Protracted development and project delays

Costs and value for money / windfall profits

Bureaucracy / ideology / negative surveys

Poor privatisation record

The contractor

Accounting

Solutions 1

Positives exceed negative ‘WACC’ by 22%

Half the negatives are logistical: timing; bureaucracy; accounting; negative surveys

Re-definition needed plus education, training and establishment of a new PFI executive

The accounting issues are on the mend….

----and why not blow PFI’s trumpet?

Solutions 2

New practices, accounting standards & forecasting

Industry rationalisation will help

Standard contracts to streamline procurement

Commoditisation and bundling

Finance raised in form & price that reflects risk

Solutions 3

Role and responsibility of government needs to be agreed

A strong owner in place from the outset

Replace contractor as front man

A full empirical audit of PFI

Value for money test is flawed

Is private provision of services better than public?

Build cost of asset is the yard stick; it is called the Public Sector Comparator (PCS)

Alternative is to ‘rent’ asset over 25, 30 or 40 years

This is the basis of comparison

Government asks which is cheaper: buying an asset or buying a service?

‘Apples with Oranges’

Cannot compare build cost with rent of same asset over number of years is wrong

Net Present Value (NPV) of rents is massively risky

Rents need large discount due to scale of uncertainty

If not, then NPV of rents is grossly over-estimated...

…and building the asset will look more attractive

Discounting ‘rent’ vs capital cost

Government traditionally uses 6% discount rate (and Treasury proposes change to 3.5%)

PFI projects are long lived

Consequences of small differences are huge

If PFI discount rate is wrong by 1%...

…then cost of private provision maybe overestimated by 14% of a 40 year project

Value for money (VTM) test fails

Contrary to popular conception, VTM universally underestimates private sector provision:

- failure risk: user pays only on receipt of service

- inherent risk of service: the asset may not be busy

- quality of private service is not recognised

- potential for productivity is ignored (as focus for government is reduced cost)

What needs to change?

Different discount rates for PFI projects and PSC

Study sensitivity of existing projects…

…and look at those which failed

Reassessment of the reassessment procedures

Need a clear idea of PFI’s financial benefits

PFI conclusions

A debate that can be won

Vital for infrastructure provision & public services

Vital for economic growth

Vital for sound public finances

It is competitive and….

….there is a wall of money for PFI to scale

“…I am not going to go to parents and children and patients…and say I’m sorry because there’s an argument about PFI

we’re going to put these projects on hold. They don’t care who builds them. So long

as they’re built. I don’t care who builds them…”

Tony Blair, British PM, Sept 2002