Transmission Gully costs misunderstood

Media Statement
1 March 2013

"Recent reports that $60 million might be spent on Wellington's Transmission Gully project before construction begins and that it will cost three times more as a PPP are misleading. But they do point to a much larger issue in the delivery of major infrastructure in New Zealand - an inadequate understanding of how projects are built and paid for," says Stephen Selwood CEO of the NZ Council for Infrastructure Development.

"Sixty million dollars is a lot of money, but it is 2 per cent of total project value when finance costs, risk, and on-going operations and maintenance are taken into account. The upfront expenses include everything from environmental and community impact assessments to financial and legal advice and, critically, an on-going business case evaluation which must at all times demonstrate better value for money for the public.

"Billion dollar projects are complex. Mistakes are expensive. To avoid this cost, dozens of contractor, subcontractor, financial, architectural, engineering, planning, consenting and political entities contribute to deliver a single, effective connection on time and on budget.

"All of these parties will be continually assessing and managing risk - the risk of construction in steep earthquake prone terrain; the risk of poor design; safety; environmental effects; and on-going whole of life operations and maintenance costs, for example. Understanding who carries what risk and how best that risk should be shared is a time consuming, detailed process and must be completed before projects are contracted.

"The benefit under a PPP contract is that, in so far as possible, risk is assessed up front and allocated to the party that is in the best position to manage the risk. When risk is not assessed correctly the party making a mistake is the party that pays for it.

"This is exactly what we have seen in Australia, where several PPPs have underestimated the risk that traffic demand will not be as good as expected. A common misconception is that these PPPs have failed. In fact the opposite is true. In passing demand risk onto private parties, the government, and the tax payer, have not had to carry this cost. It has almost fully fallen on the investors and the financiers who have put their money at risk. Under conventional procurement, we often don’t see these sorts of failures accounted for because the tax payer’s deep pockets keep poorly designed projects afloat and hide the real costs to taxpayers.

"Limited Knowledge also plagues understanding about the total costs of PPPs. In the case of Transmission Gully, it is easy to make headlines by saying the total cost of the project will be three times its $1billion construction cost.

"Again, what is poorly understood is what that $3 billion represents. It includes the cost of construction plus the operation and maintenance of the motorway over 30 years plus repayment of debt plus interest and transfer of construction and operating risk to the private sector. Cost blow-outs or failures do not sit with tax payers and if the road is not open and to standard every day for 30 years, the public withholds payments. The PPP will only proceed if a successful private sector bid to design, build, finance, maintain and operate the new road provides a better overall outcome than more traditional procurement methods.

"This will require bidders to develop innovative solutions to constructing and maintaining the road for the duration of the 30 year concession period, and beyond, maximising the value for every dollar spent.

"Although debt funding will incur capital and interest repayments into the future, the benefit is that people using the corridor in the future will also contribute to its cost.

"The purchase of a home provides a helpful analogy to understanding the structure of a PPP. Before you even bid at an auction or build a home, you may well spend several thousand dollars on lawyers, builders reports, designers, bank loan applications and engineers. These are comparable to the $60 million on Transmission Gully, with the notable exception that the upfront costs for Transmission Gully include sophisticated analyses which must always show that the public is getting best value for money, or the project does not proceed as a PPP.

"After you’ve bought your house, as any homeowner knows, the spending doesn't stop. Sometimes you find there’s something wrong that needs fixing. That risk sits with you, which is why smart buyers pay for builders and inspections before they buy. Then there are the lawns that need mowing, the drains that need clearing, the repaint, the new roof, a replacement hot water cylinder and all that sort of thing.

"Once you collate all these expenses and add them to the debt repayment over 30 years, whatever you have in total paid for your house looks nothing like the figure you paid for the home. This is the equivalent of the $3 billion figure associated with the Transmission Gully project.

"It is much more difficult to understand the costs of PPPs than it is to highlight headline figures, but there are good reasons PPPs are used all over the world: they are widely viewed not as perfect in themselves, but better than the alternatives.

"A Transmission Gully PPP, if successful, will pass risk away from the public, incentivise innovation in construction and operation, improve accountability of performance among those responsible for building and financing and, by utilising debt, allow, not prevent, projects like Auckland’s Central Rail Link or others to proceed in the near term," Selwood says.

ENDS

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