Road Network Infrastructure: Public Private Partnership

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Topic: Politics & Government
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Introduction

Government constructions and renovations of infrastructure by the contractual agreements with Public-Private Partnerships (PPP) have become the most adopted processes in developed and developing countries (Abdullah et al. 2014). Infrastructure refers to the fundamental organization of the physical structures and facilities that are needed by the public.

Project background

This paper looks at PPPs in the context of a road construction and renovation project in Indonesia, which is meant to improve the transport infrastructure in the country. The renovations and the construction activities are estimated to take approximately two and a half years (Meng & Harshaw 2013). The Indonesian government will fund more than two-thirds of the construction and the renovation projects. The company working under PPP approach will grant fifteen years of concession period of ten years.

What is PPP?

Public-Private Partnership (PPP) is an agreement based on the contract between a private sector and a public agency (Amponsah 2011). The agreement results in the greater participation of the private sector in the construction and improvement of national infrastructure. The structure and operations of PPPs vary significantly among countries and projects due to different legislative structures and frameworks. In PPPs, private sectors are contracted to supply assets and services of infrastructure usually provided by the government (Bala and Dahiru 2013). These services include the construction, management and renovation of the infrastructure to improve the economic condition of the country (Burnett 2012). PPPs are formed to utilize the expertise and resources of the private sector by the government.

The concepts of PPP merits and demerits in the context of the proposed project

Concepts of PPPs

PPP is one of the options that the government uses in the procurement of infrastructural materials. PPP does not imply that the government and the private sector are in a joint venture, but rather the partnerships that governments form with the private sector investors to provide or contribute towards public services, which is different from government interventions in supporting the general developments of the private sector. Through the partnership with the government, the private investor can be awarded the revenue stream by the government through the budgetary allocations that consider the quality of the constructed project. Therefore, through the agreement, risks such as demand service threats and service availability are transferred from the public to the PPPs that have been contracted (Meng & Harshaw 2013).

Through the PPPs, the private investor invests in the venture to avail the services and products according to the terms of the contract. Apart from budgetary allocations by the government, private sectors can benefit from contributions in the form of land, provision of funds to cover expenditures in capital and assets contributions. The investors can also benefit from the guarantees provided by the governments, which provide the opportunity of hiring risks and uncertainties of the projects (Ganah & John 2013).

Merits of PPP

Public sector

The most important benefit of PPPs is that they deliver suitable services and assets at much lower costs. Therefore, they provide governments with an affordable avenue to execute their projects. Under the PPP, the private investors fund the infrastructural construction and are refunded by governments through service fees and other fees charged from the projects (De Marco, Autunno & Chinyio 2013).

Through the usage of PPP, the private sector owns up the risks associated with costs. The objectives of the private sector are to design and implement projects while considering their long-term costs rather than the upfront capital expenditure. Operations of PPP are designed and priced to avoid the life cycle risk. Thus, the first pricing processes appear costly when compared to traditional procurement (Ganah & John 2013).

Private sector

The use of PPP maximizes the usage of the private sector skills and expertise. The private sector often works on a tight schedule and time; therefore, the requirements for construction projects are delivered within the stipulated time and budgetary allocations. Also, they ensure that the resources delivered to meet the expectations the public sector. PPP ensures that there is coordination among all procured assets hence leading to the successful delivery of services (Eadie, Millar, & Grant 2013).

According to Hare (2013), PPPs are designed in a manner that risks are considered and allocated to individuals who have expertise in mitigating them. Therefore, the risks associated with the projects should be referred to the private sectors. This way, the risks are absorbed by experts in the private sector, and their pricing is done appropriately thereby reducing the associated costs.

PPPs are known to deliver certainty in budgetary allocations. For example, during the close of a contract, possible future costs can be projected accurately and thus, the public sector can receive the exact valuation of the known outputs. In contrast to the public sector, there is uncertainty in costs incurred in the project after completion and future maintenance cannot be accurately determined. Henjewele, Sun and Fewings (2014) argue that the evaluation of previous PPP projects provides a more accurate value of the money spent on construction projects. Below is a summary of other advantages of PPPs.

  1. There is an observed swiftness in procurement processes.
  2. The use of PPP promotes innovation.
  3. There is access to expertise that is not otherwise available in the public sector.
  4. There are minimal developments and probabilities of risks.
  5. The private sector complies better to the regulations that are aimed at environmental conservation.
  6. There is improved cost effectiveness.
  7. Use of PPP experiences fewer interferences from the politics of the country.

Disadvantages of PPP

Public sector

Using PPP is also associated with certain shortcomings. These challenges include the difficulties that are associated with cost. Costs of the projects are always overlooked due to the perceived benefits of PPPs (Lam & Javed 2013).

Also, considerations should be made regarding the expertise of the private sector team regarding the project to be undertaken. Some private sectors do not have enough experience to warrant the use of PPP. Therefore, the private sectors must be able to provide effective and satisfactory services because private pricing and cost valuations of the project require experts (Meng & Harshaw 2013). The availability of expertise enable the specialists to predict risks and prepare mechanisms to mitigate the risks.

Private sector

  1. The private sector lacks attractiveness due to its high costs of transactions.
  2. There are high costs of bidding.
  3. There are penalties when the projects are underperformed and fail to meet the government expectations. Penalties are also levied on delayed completion of the projects.
  4. There are high costs to be met by every transaction process like paying for lawyers and financial advisors.
  5. The financial risks are high.

The formats of PPP

There are various PPP modalities that are used in the development of the infrastructural projects. A PPP transactional approach can be a hybrid of several transactional approaches (Ross & Yan 2015). The major modalities used in the transactions are outlined and explained below.

Build-and-Transfer (BT)

This is a contractual agreement that is undertaken by the private investor in funding and constructing a project and handing it to the public agency on completion (Meng & Harshaw 2013). Thereafter, the private sector is reimbursed the total value of the project. This approach is applicable in the development and construction of any infrastructural structures. It can be used in the construction of facilities whose operations are handled directly by the concerned government agency.

Build-Lease-and-Transfer (BLT)

It is a contractual arrangement that involves the private investor funding and financing the development of a project and upon its completion handing it over to the public agency through a lease agreement (Meng & Harshaw 2013). The duration of the lease is agreed on the completion of the project. The government agency becomes the automatic owner of the project after the lease expires.

Build-Operate-and-Transfer (BOT)

It is a contractual arrangement where the private sector funds and finances the construction of the project as well as the maintenance operations associated with the project. The private investor is expected to use the property for an agreed period during which the investor can collect taxes and revenues, tolls, tariffs, fees, and rent. The charges levied on the property users should not exceed those documented in the PPP agreement (Oyedele 2012). This arrangement allows the private investor to recover all expenses. The entire project including its operations is transferred to the government after the expiry of the agreed time. Therefore, selected government personnel should be trained to facilitate a smooth transition after the transfer.

Build-Transfer-and-Operate (BTO)

It is a contractual arrangement that involves the government agency contracting the private investor to execute a project under turn-key approach (Oyedele 2012). This agreement gives the private investor the mandate to levy charges on the project or facility users once the project construction has been commissioned.

Design-Build-Finance-Operate (DBFO)

DBFO is a contractual arrangement that authorizes the private investor to facilitate the financing, construction, owning, operating and maintaining an infrastructural project. The arrangement accords the investor an opportunity to recover the investment capital by imposing and collection levies from the project users. The private investor owns the project but may decide to appoint and assign a project operator to manage and oversee maintenance (Ross & Yan 2015). The project transfer to the government is not included in the contractual arrangement, but the private ownership may be terminated after a specified time.

Build-Own-Operate-Transfer (BOOT)

It is a contractual arrangement whose terms and conditions are similar to those of the BOT agreement. However, the private investor is allowed to own the property for a fixed period before its transfer to the government agency.

Build-Own-Operate (BOO)

The development, operation and maintenance of a new project is contracted to the private investor. The contractual agreement imposes no time limitation on the ownership of the project and the infrastructure (Oyedele 2012). The private investor can impose and collect levies on the project user to recover the invested capital.

The most apposite PPP format must consider the intent of the project and the partners’ attributes. Therefore, no sole PPP archetype can meet all conditions regarding a project’s locality as well as its technical and fiscal characteristics. Buertey and Asare (2014) recommend that since private sectors aim at expanding profits, PPP involvement should only be restricted to the building of highways and trunk roads where road levy points can be positioned to act as cost recovery systems. Therefore, the Build-Operate-and-Transfer format is the most appropriate PPP format for Indonesia.

New PPP approach/format towards maintenance of existing roads renovation project

Format for a new project

Just like any other project approach, PPP projects are carried out in phases (Oyedele 2012). Though the phases vary from project to project, the implementation has the same approach. The summary below describes the procurement process that will be used in the construction of infrastructure in Indonesia.

Phase I

This phase involves assessing the condition of infrastructure to identify specific needs. Sometimes the government presents these needs but in most cases, the private company that is contracted to construct the infrastructure performs this step (Ross & Yan 2015). This phase is followed by the needs appraisal, which is done to help with the valuation and cost analysis of the project. These processes help the private sector to consider how it will finance the construction of the project and determine the affordability of the project.

Phase one also considers and identifies the procurement procedures that will be used for the specific project by taking the preliminary approach through a qualitative PPP test. It gauges the possibility of carrying out the project as a PPP by evaluating the influencing factors such as technical abilities, organizational nature of the company and political and legal procedures necessary before the commencement of the project (Shrestha & Martek 2015).

Phase II

This stage involves developing PPP options that are detailed and comparable to the traditional approaches (Zhou & Smith 2013). The government also begins to develop a time plan and schedule for the completion of the project basing their decisions on the traditional public procurement.

Phase III

In this phase, the tendering processes of the contract begin while considering the applicable laws (Abdullah et al. 2014). Usually, the government uses competitive tendering where bidders need to provide explicit details regarding the specifications of the infrastructural project outputs, the anticipated duration of the project. Consequently, prospective interested private companies referred as the consortia will begin to execute their feasibility studies in readiness for the submission of their bids (Meng & Harshaw 2013). Relevant government bodies will evaluate the presented bids and only select a few preferred bidders to negotiate the tabled costs and the project length. These negotiations provide an opportunity to redraw the terms and conditions of the project (Lam & Javed 2013).

Phase IV

This phase involves the execution of the project (Ross & Yan 2015). Before the actual project starts, the winning bidder and government come to an agreement regarding the costs and duration of the project. A contract is drawn after which the actual construction begins.

Phase V

The fifth phase of PPP involves the termination of the contract. Upon the successful completion of the construction project, the functional models under PPP are then transferred to the government as described by Abdullah et al. (2014).

Comparing the PPP format for a new project and a maintenance project

PPP projects for renovations and new projects differ in their operations in some approaches:

  • For the cases of a new project under PPP, all the phases of the contracts are awarded to a private company. In contrast, the initial contractor completes some phases of the contract in renovation projects.
  • The costs of both PPPs vary a lot in many aspects. The costs of new PPP projects are often associated with large figures compared to the costs of maintenance projects.
  • The processes involved in procuring a new PPP project takes a longer time compared to the time taken to procure PPP projects for renovations.

Evaluating the viability of the Private Finance Initiative (PFI) for new and maintenance projects

The notion of value for money (VFM) is the main reasons PFI projects are appealing in many countries (Takim et al. 2009). The execution of new and maintenance projects should aim at obtaining the optimal value for the money spent, which can be achieved through carrying out a VFM assessment before deciding to go the PFI route. The VFM evaluation needs to look into the four stages of project life cycle namely program, project, procurement, and project construction stages. The application of VFM in all these phases is vital to realize project effectiveness in the form of optimum risk distribution, time and cost effectiveness, quality improvement, customer gratification, and public benefit.

The Indonesian government has the advantages of borrowing funds at lower interest rates than the private sectors. Therefore, the increased interest rates paid by private sectors are factored into the costs of project construction by the PFI (Amponsah 2011). There is a belief that the private sectors compensate and meet the high cost of projects by their characteristic innovative team members. The members show their ground-breaking skills in developing novel projects designs, maintaining and running cost-effective operations that are efficient in quality and only require a little or minimal maintenance (Ross & Yan 2015). These features reduce the cost of operations incurred by the Indonesian government and public sectors.

From the time a PFI contract expires, the public bodies and governments are committed to large revenues payments (Oyedele 2012). The accrued effects of the PFI projects means future public institutions will have to meet the costs. Therefore, they will be forced to raise the rates of revenues and the taxes. The total cost due to the PFI projects can only be approximated accurately, but the long-term costs cannot be fully ascertained. The use of PFI is a temporary fix to the problems in the construction sector.

Due to the future increased rates of revenues and taxes, the Indonesian governments will have to cut down the costs associated with the provision of other services to the public.

The success of PFI projects has a positive correlation with the transparency and accountability of the entire project, which is directly linked to financial reporting. Accountability in terms of government expenditure on important public services implies that citizenries or their civil delegates and the media can visualize the expenditure of public resources. Furthermore, there should be fairness in the entire procedure without providing an unfair advantage to certain parties (Edwards et al. 2004). In Indonesia, measures have been placed to ensure transparency and financial stability of PFI projects (Oxford Business Group 2014). Therefore, PFI is a feasible option in the construction of the country’s new and existing transport infrastructure.

Viability of alternative basic procurement routes/types for the new and maintenance projects

Traditional procurements

The two main hallmarks of traditional procurement are: the design procedure is independent of the construction process and that complete documentation including plans, work programs and bills must be provided by the customer prior to inviting tenders from contractors. The selection of the contractor occurs through a spirited tendering process, and a qualified consultant is assigned to act as an autonomous contract overseer. The client bears the sole responsibility of the design. Some of the benefits of traditional procurement include reasonable assurance on the project cost since the contract figure is established beforehand. Tentative risks are well-adjusted between the parties. A lump sum contract gives preferentiality to the client compared to a measurement contract. A conventional lump sum methodology regarding design, quality and cost has relatively low risks. Nonetheless, more time is needed to execute the project.

The Indonesian government can adopt the traditional procurement approach because it has few shortcomings. Under the traditional approach, contractual agreements can be based on balanced risk partnerships. Here, the government retains the greater potentials of risks as opposed to the conventional approach of transferring the risks to the private sector. Reducing risks transfer means there is an associated reduction in cost. However, the transfer of risk eventually ends up with the client (Meng & Harshaw 2013).

Another suitable approach under the traditional contracts is the measured contracts where the contract total for measurement contracts is only finalized at the end of the project. The sum is evaluated based on a previous agreement. Such a contract is suitable in instances where the contractor’s workload cannot be estimated accurately ahead of the tender. Usually, the tenderer has a complete design and a precise suggestion of quality. This type of contract poses the least risk to the client.

Traditional procurement should be used when there is adequate time to execute the project, and when the quality of the ultimate product and price certitude are required before the project commences (Davis, Love & Baccarini 2008). The construction of road infrastructure is a long-term project that is required to serve for many years thereafter. Therefore, a government should be able to spend enough time and resources to ensure quality outcomes, which is possible through traditional procurement.

Design & Build (D & B) procurements

In this approach, the main contractor is contracted to develop a design and execute the actual construction. Private investors can apply to oversee the development of major roads in the country. The government selects the investor based on the amount of fee, overheads, preliminaries and profits they present for the construction of the roads.

The contractor takes accountability for the entire design or part of it, which is indicated explicitly in the contract. The taking of liability needs to be supported by adequate indemnity, and should be verified prior to appointing a contractor. In cases where a contractor lacks internal designers and decides to use outside experts, their identity should be ascertained before a tender is acknowledged. The client’s requirements might be stated simply or in details. The client can also provide the contractor with a scheme design with which to develop details. D & B provides assurance on the contract amount hence brings cost benefits. The amalgamation of design and construction techniques in addition to the virtual liberty of the contractor to employ their procuring influence and market know-how effectually can give the client an economical price (Davis, Love & Baccarini 2008).

Examples of success and failure

Indonesia has recorded immense success in improving its infrastructure through PPP, which is attributed to the establishment of the Indonesia Infrastructure Financing Facility (Oxford Business Group 2014). This body acts as a non-banking fiscal arbitrator to marshal funds for PPP projects. An investment guarantee fund has also been established to improve the creditworthiness of PPP projects by providing investors with financial guarantees.

There are cases of PPP project failures in some countries. For example, in Slovakia, the D1 motorway project under phase one failed due to malpractices. Financial analysts reported overpricing (D1 motorway, Phase 1, Slovakia 2010). Additionally, the project overseer ignored the recommendations proposed by Environmental Impact Assessment, which had a negative impact on the environment.

In London, the underground project under PPP has received criticism due to its high cost and outrageous profits reaped by investors (Bankwatch 2015). These happenings led to the termination of the PPP project.

Conclusions

PPPs offer governments an opportunity to improve their infrastructure by taking advantage of the expertise and resources available in the private sector. However, the success of any PPP format depends on the careful evaluation of the benefits and shortcomings of the arrangement.

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