Government Operations Committee on Oct. 25th, 2012

[The Chair, NDP, Pat Martin]

Good morning, ladies and gentlemen.

We'll call to order the 59th meeting of the Standing Committee on Government Operations and Estimates. We will continue today with our study of public-private partnerships.

We're very pleased today to welcome, by video conference, two witnesses.

First of all, from the University of Manitoba, we have Professor John Loxley.

Welcome, John. Can you hear us clearly?

[Dr. John Loxley, Professor, Department of Economics, University of Manitoba]

Yes, I can. Thank you.

[The Chair, NDP, Pat Martin]

Very good. Thank you, John.

From Markham, Ontario, we have Mr. Damian Joy, the president and chief executive officer for North America of Bilfinger Berger Project Investments.

Welcome, Mr. Joy. Can you hear us well?

[Damian Joy, President and Chief Executive Officer for North America, Bilfinger Berger Project Investments Inc.]

I can hear you very well. Good morning.

[The Chair, NDP, Pat Martin]

Very good. Thank you.

First we'll invite both of you to give brief opening statements of five to ten minutes. I would ask you, please, to moderate your rate of speech somewhat, so that the people from translation services can follow you. Then we'll invite our committee members to ask questions.

Following the order on our agenda, I'll ask Dr. Loxley to go first.

John, the floor is yours for five to ten minutes.

[Dr. John Loxley]

Thank you.

The P3 module has been under-researched in Canada, and the large profits that are being made on them by large construction companies, finance houses, and consultants and the ideological commitment to P3s by various levels of government mean that the Canadian public finds it difficult to have an objective view of them.

On the basis of more than 15 years of research published in a number of places, including a book I wrote with my son, called Public Service, Private Profits, and more recently a guide called “Asking the Right Questions: A Guide for Municipalities Considering P3s”, my conclusion is that the model has many crucial flaws, that future generations of Canadians will be paying heavily for them, and that we should not be tying infrastructure finances to P3s, but rather exploring alternative models.

There are two major claims made for PPPs. The first one is that they make more dollars available for infrastructure. It's kind of a macro argument. The second one is that they provide microeconomic benefits—cheaper, greater efficiency, more value for money.

Earlier in the week you heard from our mayor, Mayor Katz, who argued both of these. Both of these arguments are highly questionable, if not incorrect. I was pleased to see that the committee asked the mayor to verify these, as we have been unable to do so in Winnipeg.

I think it's important to note that the private sector always builds projects, not the public sector. In a PPP what we do is we add private financing, private operations, private maintenance, a degree of private equity, and occasionally private ownership of the facility. Debt servicing and operation expenses are replaced by public sector lease payments to the private sector.

Leases, as we all know if we lease cars, are a form of debt regardless of how the PPP is entered in the public sector accounts, and private borrowing is almost always higher than public borrowing. Therefore, I would argue that in the long term the micro argument of greater resources for infrastructure investment is invalid.

What about the micro argument? The issue is what makes the value for money of P3s better than that of the public sector comparator. In fact it is an entire sparer of risk. If you look at the websites of Infrastructure Ontario and Partnerships BC and the individual projects on the websites in places like Winnipeg, you will see this is clearly the case.

The so-called savings that Mayor Katz mentioned, for instance, on the Chief Peguis Trail of $31 million were arrived at by a risk transfer said to be $51 million. Were it not for the risk transfer, the public sector comparator would have been superior. If you examine the individual projects on the websites of Infrastructure Ontario, you will find that this is the case for every single project.

I'll pick a few examples. The Durham Region Courthouse has a value for money of $49 million and a risk transfer of $132 million, if one can believe that for a courthouse. The Kelowna and Vernon hospitals had a value for money said to be $25 million, and the risk transfer was $32 million. These figures for risk transfer are not substantiated and are quite often just unbelievable. Risk transfer is the key, and it's not substantiated.

I attempted to find the calculations behind the risk transfer in Winnipeg. I was unable to obtain them through freedom of information. I was not given access. I then appealed to the company that had conducted them, the consulting firm, and it also denied me access on the grounds of commercial confidentiality. Such risk analysis has to be based on reality and public projects, and yet we're denied access to these.

Other problems with P3s, I would argue, are very high transactions costs. The legal cost, the organizational cost, the massive amount of documentation involved add up to quite significant costs. Frequently there's a lack of competitive bidding because of the size of these things. Value for money is sometimes missing, and is often flawed. Occasionally we find quite bogus arguments about there being no debt in P3s, as, for instance, with the Moncton water treatment plant, but there it is built in to the water charge. There's a capital charge that every person drinking that very fine water in Moncton now pays. The cost of that debt implied in the project is 10%. P3s introduce long-term inflexibility and rigidity. These projects last for a very long time. They often damage local small scale construction capacity, and small scale contractors are often very vocal against them. There's a long-term problem of monitoring P3s given the long life of these projects, and the relatively short institutional memory of politicians and civil servants. We're finding that with the school system in Nova Scotia, where auditors are being quite critical of our ability to monitor commitments under P3 arrangements.

Once the construction phase is finished and that period of high risk has ended, the ownership of these P3s is often flipped. As we know from various cases in B.C., that ownership may end up overseas, so original calculations about tax revenues have to be looked at very carefully.

It's a very short presentation and I elaborate on these issues in my publications.

I would argue that we should take a very cautious second look at P3s. I don't believe that they are in any way suitable for first nations, and I would say for the vast majority of municipalities, which simply don't have the capacity to handle them. I would argue that we should be exploring alternative models, and strengthening the ability of the public sector to handle investment projects more efficiently.

[The Chair, NDP, Pat Martin]

Thank you very much, Dr. Loxley.

Next, for five to ten minutes we have Mr. Damian Joy.

Go ahead, sir.

[Damian Joy]

Good morning, everyone. I have to say I have a contrasting opinion on many of the things that John talked about. One that I completely agree with, however, is the understanding of risk. That is central to any discussion about public-private partnerships.

By way of introduction, my name is Damian Joy. I'm the president of Bilfinger Berger Project Investments Inc. We are a developer, investor, and manager of infrastructure P3s here in Canada and in North America.

I first worked in the Canadian PPP markets about 10 years ago. I've been based in Toronto for the last six and a half years, which is where our regional headquarters is.

We've had a long experience working with provincial PPP authorities and in a couple of instances, for example, the Trans-Canada Highway, where we're responsible for the Kicking Horse Pass, we have had projects that use federal funding.

I think we are talking about the fundamentals of PPPs, so I'd like to give you a definition that I've taken from Gordon Brown, the former British prime minister and chancellor of the exchequer. In 2005, talking about the U.K. version of P3s, the private finance initiative, he gave a definition that sums up some of the key points about the roles of the public and private sectors. Ill give you his definition:

Under the Private Finance Initiative (PFI) the public sector contracts to purchase services on a long-term basis so as to take advantage of private sector management skills incentivised by having private finance at risk. The private sector has always been involved in the building and maintenance of public infrastructure, but PFI ensures that contractors are bound into long-term maintenance contracts and shoulder responsibility for the quality of the work they do. With PFI, the public sector defines what is required to meet public needs and ensures delivery of the outputs through the contract. Consequently, the private sector can be harnessed to deliver investment in better quality public services whilst frontline services are retained within the public sector.

I think it's the roles of the public and private sectors that are important here.

The public sector is defining what is required to meet public needs. It's refining front line services, and it's contracting to purchase services on a long-term basis and ensuring the delivery of those outputs through the contract.

The private sector is, as always, involved in building and maintaining public infrastructure, but it's bound into long-term maintenance contracts. It shoulders responsibility for the quality of its work. It's incentivised by having private finance at risk.

In other words, government becomes a specifier and a procurer of infrastructure, rather than a direct provider. In my opinion, hospitals, roads, military bases, are not core functions of government. The core functions of government are health care, transportation, and national defence. I think when you look at what government is here to do, infrastructure is not a core service per se.

If infrastructure is just a means to deliver that public service, there's no erosion of the role of government in delivering the public service. There is support from the private sector to use its capabilities and capacities to deliver and maintain it as it has always done.

Traditional public sector procurement of infrastructure has many examples of projects that have had problems. I'm sure there are too many to count and they're well documented.

Typically, a project can overrun its schedule and budget, and builders can walk away, leaving the government to pick up the cost of fixing defects. There have been many instances where maintenance costs far exceed the government's expectations and where assets require major renovation prematurely early in their life.

These are the big risks with infrastructure procurement that PPP is intended to address. PPPs work because the private sector does not get paid until the project is completely built and is in public service. We receive no money for delivering four hospital buildings in Kelowna and Vernon until they are satisfactorily commissioned and in public service.

There are also long-term obligations to maintain those facilities to specified standards so the private sector cannot walk away, leaving defects for the government to pay for. If the private sector is on the hook for the maintenance costs, then they make sure it's designed and constructed for economical performance over its whole life. When maintenance and renewals are needed, they have to be paid for by the private sector partner, and that's us.

This all works because the private sector is incentivized by having a large amount of its own money on the table to guarantee that performance. This shows that any debate about the advantages and disadvantages of PPPs centres around the issues of how risk is understood, how it's evaluated, and how it's managed. In that respect, I agree with John's comments very clearly.

The best way I could demonstrate the risk transfer is with a quick example, a project that involved our own company in the state of Victoria in Australia for a medium-size remand prison. In that case, one of the construction companies in our consortium went bankrupt. The project got into serious delays. Despite immense efforts by the rest of the consortium over the period of a year or 18 months, the project could not be recovered within the contractual timelines, and the equity and debt investors in the project company suffered very significant financial losses, to the tune of well over $100 million.

However, the state will get the completed project at about the original price it had anticipated because it had transferred the risk to the private sector. Had it been a traditional procurement, the state would have overpaid for a half-finished prison and it would have had no means of completing construction. As it is, the state has not paid anything, and it will not pay anything until that prison is complete and the additional burden of the delayed construction and the bankrupt contractor is picked up by the consortium.

I don't enjoy telling this story because it was a painful loss for us, but it is important to recognize that these are real risks that are being transferred. They're being taken away from government by the private sector, and in a situation like this where risk materializes, the apparent difficulty to evaluate risk becomes very tangible in dollars.

I'll conclude my remarks there. Perhaps the further debate needs to be not just the face of whether public borrowing is cheaper than private borrowing, but how we evaluate the risk that associates with the financial commitment government is making.

[The Chair, NDP, Pat Martin]

Thank you very much, Mr. Joy.

Thank you to both of you for good, well-argued points.

We're going to go to rounds of questioning now, and we'll start with the NDP, the official opposition, Mr. Denis Blanchette.

[Denis Blanchette, NDP, Louis-Hébert, QC]

Good morning gentlemen. Thank you for being here, even though it's a little early in the morning in some parts of Canada.

I listened to you attentively. You aren't the first witnesses to appear before our committee of course, and we are always pleasantly surprised by our witnesses' expertise. Thank you for that.

I see a common thread in all of this. We talk a lot about risk transfer, borrowing power and the interest rate. However, whether it's a PPP or not, the private sector always builds the infrastructure or provides the service. In other words, whether we opt for the traditional model or a PPP, the contract is signed with a private company. Therefore, should we not be focusing more on contract evaluation?

Perhaps it's not necessary to enter into PPP contracts, although I am open to the idea. Furthermore, maybe we should look at the way in which these contracts are managed. That might be the key to optimizing public investment in these projects.

[Damian Joy]

Shall I take that first, John? Are you okay with that?

[Dr. John Loxley]

Go ahead.

[Damian Joy]

Thank you very much for your question, Monsieur Blanchette.

My comment on that is, to some extent I do agree with you. If the public sector was an expert procurer and it did have the depth of skills to manage complex infrastructure procurement, it probably could do so without a P3 model, but I think P3 is just one of several mechanisms that can be used to ensure the enforceability of the objectives that government puts into its contracts.

I'm obviously an advocate of P3s, but they are not the only solution, and in many cases they are not the right solution. I think in certain instances where projects are large and complex and particularly where the infrastructure itself is not something in which the government's authority is expert, then it's a means by which the objectives can be enforced very clearly by contractual means.

I'm agreeing with your point. Yes, in certain cases where the expertise exists, P3 is just one option, and not necessarily the best.

[Denis Blanchette, NDP, Louis-Hébert, QC]

Thank you very much.

[The Chair, NDP, Pat Martin]

Go ahead, John.

[Dr. John Loxley]

Yes, we are in a sense talking very directly about contract evaluations.

I think the key is to ask a number of questions. One, is risk actually being transferred? There's a lot of skepticism about that in the literature. Two, at what cost is this risk being transferred? Three, could this risk transfer be achieved in other ways? For instance, could we not have a design-build system that would satisfy most of Mr. Joy's criteria without having to handle the operations, financing, and in some cases, ownership of infrastructure?

If we are going to evaluate contracts efficiently, we need to know how these risk numbers were arrived at. I think the private sector has an obligation, together with the governments that are proposing P3s, to show the public where these numbers came from and how they were calculated.

Finally, we have to understand that if we are cutting back the public sector systematically, as we have done for a number of years, this will affect the public sector's capacity to handle infrastructure, which I personally believe to be a front line service. We do have to look at the implications of what we're doing when it comes to the capacity of the public sector.

[The Chair, NDP, Pat Martin]

That is it for time, I'm afraid, Mr. Blanchette.

Next, for the Conservatives, we have Mr. Jacques Gourde. Five minutes, please, Jacques.

[Jacques Gourde, Conservative, Lotbinière—Chutes-de-la-Chaudière, QC]

Thank you, Mr. Chair.

I would like to thank the two witnesses for being here this morning. This is very fascinating. We are discussing the PPP model from an objective standpoint.

My question is for both witnesses.

We touched on a concept that I find very interesting. We spoke about the transfer or sharing risks, or the transfer or sharing of responsibilities. When it comes to laying out the terms of the contract, I think a distinction needs to be made.

If both parties understand that the risk is to be transferred from the public sector to the private sector, it might be more difficult to establish the terms of the contract. If they are in favour of sharing risks, they might be able to reach a consensus. However, there is still a transfer of risk when contracts are drawn up. It's as though one party shirks certain responsibilities over the long run.

How should the different parties approach the drafting of long-term contracts?

Mr. Loxley, what do you think?

[Dr. John Loxley]

The writing of contracts is quite difficult. Obviously we've gained a lot of experience over the last 15 years in the writing of P3 contracts. We still, I believe, make some huge mistakes, and we have done so recently in Canada on P3 contracts. The question is whether you can ever design contracts that are foolproof. I think it's probably quite difficult.

If you have a 35-year contract or a 40-year contract and things go wrong in the middle of the contract—and they do go wrong, even for P3s. They overspend. They come in over budget. Sometimes the contractors walk away. All of this has happened, especially in the U.K. That was the model, and now they're moving away from that. When things go wrong in the middle of a contract, the bargaining power of the public sector is minimal, because you have a single company handling the infrastructure.

I would agree with your basic point that if you are sharing risk, it's probably easier to arrive at a contract than it is if you are trying to transfer all the risk.

The proof has to be in the practical details. We have to evaluate each contract, and do it contract by contract. Of course, these contracts are not accessible to the public. All we get on the websites are very short summaries. In order to do a proper job of evaluating contracts, there has to be a whole different approach to freedom of information and accessibility. Much of what the private sector would say is market confidentiality should in fact be in the public realm.

[Damian Joy]

I'll add my comments, Monsieur Gourde. Thank you for the question.

I agree there is a lot of experience in writing contracts to share and transfer risks. I think Canada has benefited from some of the early mistakes that were made in other markets, notably Australia and the U.K.

Going back to a point that John made earlier regarding what is a front line service, one of the areas that has been contentious in the U.K. market is the inclusion of soft services in social infrastructure PPPs. I'm talking here about, within hospitals, say, catering and housekeeping services.

In Canada I think we've learned that message. I don't know of any projects since the very early ones in 2003, in Ontario and Alberta, where there has been any transfer of soft services. The model has developed in such a way that government recognizes what is a good risk to transfer, what is a good responsibility to transfer, to the private sector so that it retains front line services.

I think the model across Canada generally has adopted a prudent and socially acceptable level of risk transfer that is widely accepted. It's avoiding some of those mistakes that were made in the U.K. and that have attracted criticism.

On the question about sharing risk as opposed to transferring risk, I think we're getting down into the detail as to what risk it is. There are many risks within contracts that are shared, so potentially there is a range of exposure that the private sector takes and a range that the public sector takes. There are other risks where it's absolutely proper to fully transfer.

I think the detail of the model allows for both sharing and transfer, depending on what that specific risk might be.

[Jacques Gourde, Conservative, Lotbinière—Chutes-de-la-Chaudière, QC]

Thank you.

[The Chair, NDP, Pat Martin]

That concludes your time, Jacques. Thank you.

Next, for the NDP, we have Jean-François Larose.

Five minutes, please, Jean-François.

[Jean-François Larose, NDP, Repentigny, QC]

Thank you, Mr. Chair.

I am going to cite a specific case in Quebec, that of the bridge on Highway 25. This bridge had been needed for some time. It was an immense project and the risks were high. Decision-makers opted for a PPP. It was one of the first in Quebec.

Many promises were made. We were promised a user fee of $2.40. There was an overrun of $226 million over the promised cost. Initially, in the PPP agreement, the cost estimate was $204 million. Four years later, in 2011, right after the bridge was completed, the bill was $500 million. What a great buy! Not only that, the current toll of $2.40 could go up to $7.40, because the agreement with the company responsible for maintenance and pricing indicates that as the number of vehicles using the bridge increases, so does the price. One could almost say that this is a hidden tax.

I have used the bridge many times, and I have noted infrastructure problems. Engineering did not take certain elements into account. For example, the exit was badly thought out; it is a nightmare. People are outraged.

There is no more talk of concluding more PPPs. However the Eastern train line project is almost done. The cost of the project was estimated to be $500 million, but the final bill is $800 million, and there is still no PPP in place.

Let's come back to the bridge project. The final cost is 245% of the estimated cost. A class action lawsuit has been launched to challenge the hidden car fees, the higher than expected tolls, and the loss of control by the public sector for 30 years.

Risk-sharing has been discussed, but the same problem keeps cropping up: when it comes to acquiring the bridge, there is no guarantee that a beam will not fall off. Furthermore, there is no control whatsoever.

My question is for both of you. Is the public sector really coming out ahead when it comes to costs?

[The Chair, NDP, Pat Martin]

Who would like to begin?

[Damian Joy]

I'm happy to respond, if that's okay.

Mr. Larose, thank you very much for your question. I'll do my best to answer it, but I do not have specific knowledge of the A-25 project in Quebec, so I can't speak to the details of that.

In the case of many of these projects, quoting individual numbers is inevitably misleading and I can't respond to any of the numbers that you mentioned. Comparisons are sometimes made between construction costs, including risks. Sometimes there are inclusions of long-term maintenance costs, whether the costs are provided in current-day dollars or whether they are provided on a real basis. There are numerous ways in which the numbers can be used to mislead, so I wouldn't attempt to justify whether your assertion is correct or not. However, I would comment on one point, which is that there is no guarantee that nothing will fall apart on the bridge.

However, there is a guarantee that the private sector partner has put a substantial amount of money into the project, which is guaranteeing his obligations to maintain it in a specified condition for a specified period of time and to ensure that, when it is transferred back to the management of the public, at that time it will be in a specified condition. The private sector has that obligation. It cannot walk away. If this were a traditional contract or a design-build contract, the private sector partner could walk away. Very often private sector companies go bankrupt and they disappear. Then you have no long-term hold on the performance of that asset.

In the case of a P3, you do have that money--