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Sunday, 17 February 2019

2014 – A new infra federalism

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During its early months the new Commonwealth Government has demonstrated a willingness to take a very active role in encouraging the rapid progress of major state infrastructure projects. The new Prime Minister, Tony Abbott, has declared a number of times that he wishes to be known as the “Infrastructure Prime Minister”. By David Larocca, partner and Oceania leader, infrastructure advisory, Ernst & Young.

To see the full digital edition of the PFI Asia Best Practice Report 2014, please click here.

To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com

The Commonwealth Government is building on the institutional skills built up in Infrastructure Australia and the Department of Infrastructure to shape a more interventional role, potentially recutting the balance of Commonwealth and State responsibilities, and moving the Commonwealth Government out of its traditional grant-based funding roles into a more active partner role with state governments.

One can see the clear economic drivers for accelerating infrastructure development: Slowing Australian growth in the aftermath of the resources boom, and growing government fiscal pressures that limit the capacity for stimulatory initiatives. The productivity benefits of targeted infrastructure spending are well demonstrated, so the use of limited budgetary capacity to support infrastructure projects can represent a “win-win” opportunity. The key question then is: Will the initiatives announced by the Commonwealth Government enable the rapid progression of the right projects and thus maximise the economic impact of each scarce dollar spent?

Key drivers for Commonwealth Government action

* The need – Globally, an estimated US$40trn–$50trn of spending will be required by 2030 to meet existing infrastructure deficiencies1. As the diagrams below indicate, water, telecoms and road infrastructure will consume the majority of the infrastructure spending, accounting for more than 80% (US$30trn–$40trn) of total spending over the next two decades2.

Charts

Across the Asia-Pacific region as a whole, analysts calculate that around US$8trn will be committed to infrastructure projects over the period3. As for Australia, Infrastructure Partnerships Australia estimates Australia’s infrastructure backlog to be approximately A$800bn.

* State government fiscal limitations – The tiered nature of the Australian government structures places the primary funding responsibility for most public infrastructure on the state governments. The global economic slowdown has had a material impact on the fiscal performance of all states, with WA and Queensland most affected as both these states relied on the continuation of the resources boom to sustain their budgetary positions.

SA, WA and Queensland lost their AAA credit ratings in the aftermath of the global financial crisis and have been pursuing austerity measures to regain these ratings. Both Victoria’s and NSW’s AAA ratings are under pressure and the respective state governments have made retaining these ratings a financial priority, similarly looking to control expenditure, improve revenue and return to sustainable budget surpluses. This strategy naturally makes the states less likely to initiate large-scale infrastructure programmes without substantial funding support.

* Transaction process inefficiencies – A continuing issue for the private sector is the perceived cost and time inefficiencies in the “end to end process” for infrastructure projects to be developed and delivered. Private sector criticisms are in respect of government tender and evaluation processes, and environmental and other approval steps for both public and private infrastructure projects.

A recent confidential briefing on a large resource logistics project noted that 51 separate approvals at state, commonwealth and local levels were required before any construction work could commence. This duplication of process is expensive, time-consuming and involves substantial risks to project sponsors. There are a number of examples where past commonwealth governments have intervened in environmental approval processes and halted projects, undercutting the substantial work done by consortia in developing responses to concurrent state processes.

Our recent review of barriers to further institutional investor participation4 found that a significant proportion of superannuation funds still regarded state procurement processes for new infrastructure were inefficient, expensive and time-consuming, and were still a significant issue.

* The Productivity Commission Report –The Commonwealth Government’s concern over the pace of infrastructure development and the need to identify long-term solutions led it to request the Productivity Commission to perform a detailed view of the opportunities to accelerate the development process by tapping additional private-sector funding and financing. Some of the draft report’s key findings were:

There is no evidence of a shortage of private capital willing to invest in infrastructure, the limiting factor is the number of projects with an appropriate risk/return profile; too little infrastructure is funded by user charges, particularly transport infrastructure, and this limits the pace of development to the financial capacity of governments to commit funding to projects; overall governance and control of the development and delivery of infrastructure is deficient and a significant barrier to more rapid investment in infrastructure; and improving the planning and delivery process requires a consistent and integrated process adopted by all tiers of government – refocusing on selecting the right projects is a key element of this process

In its detailed recommendations the PC effectively challenged the state and Commonwealth Governments to commit to far-reaching reform all aspects of planning, delivery and funding, including:

De-politicisation of the project selection process by agreeing on consistent cost/benefit evaluation approaches for all governments; access to Commonwealth Government funding/financing support to be contingent on projects meeting agreed evaluation protocols and benefit levels; sale of the state owned electricity generation, network and retail business and major ports; streamlining the project tendering processes by greater focus on early design work; and active consideration of Australia-wide road network pricing.

The government responses

* Commonwealth Government – The main thrust of the Productivity Commission report supported the Abbott government view that fundamental change was needed if substantial improvement was to be made in the pace and efficiency of the delivery of needed public infrastructure.

The recent initiatives announced by the Commonwealth Government have demonstrated that it has an appreciation that an effective response requires the government to make use of all the policy levers it has access to, and to do so in an integrated fashion. The most significant elements of this infrastructure policy restructure can be summarised as follows.

Strengthening the role of Infrastructure Australia – A core element of the commonwealth approach is to improve the performance of the states in bringing the right projects to market in a co-ordinated fashion. Infrastructure Australia’s structure and role is being expanded to give it the power and resources to become the Commonwealth Government’s “enforcer”. The restructuring means that Infrastructure Australia is an independent corporate entity. The key elements of the changes to Infrastructure Australia’s activities include:

a – Production of an audit of the state of Australia’s infrastructure every five years, highlighting where the most significant deficits are;

b – Development of a 15-year infrastructure plan, revised every five years, that specifies national and state priorities based on rigorous and transparent assessment. The plan will define the require service standards for projects, set out the expected productivity benefits and identify any project dependencies that will impact on the emergence of the benefits. The plan will include a delivery timetable, based around the benefit profile of individual projects;

c – Review all Commonwealth funded projects with a capital cost over A$100m for cost-effectiveness and financial viability; this review will focus on the documentation and analysis provided by the sponsor agency supporting the project; and

d – Publishing all assessments, including the cost/benefit analysis, used to justify project priorities and investments.

Incentivising the states to recycle capital – State access to funding is a critical limitation on acceleration of the infrastructure development process. The Productivity Commission report and recent NSW port sales highlight the opportunity for states to generate significant additional funding through asset sale initiatives.

One element that has acted as a barrier to further sale processes is the fiscal inequality when a profitable business is transferred to the private sector. Under state ownership, an operating business will pay a notional taxation element to the state – once transferred to the private sector the actual taxation liability will be paid to the Commonwealth Government. A sale process therefore represents a direct transfer of state revenue to the commonwealth sphere.

The Commonwealth Treasurer, Joe Hockey, recently announced an agreement with the states to provide an additional subsidy, (15% of the assessed business value) where the proceeds of an asset sale are marked for re-investment in infrastructure. This initiative encourages asset sale processes and the direction of the proceeds into needed infrastructure development.

Developing a wider set of funding support tools – The traditional funding mechanism used by the Commonwealth Government to support state projects has been a cash grant. The Commonwealth Government does not have sufficient budgetary capacity to support all the priority state projects through upfront grants, so the new government has been continuing the earlier analysis on the development of support mechanism that make more effective use of the limited budgetary capacity. The 2013 National Infrastructure Plan (NIP) produced by Infrastructure Australia mentioned the following additional funding mechanisms as potential structures that would improve the balance sheet efficiency of the Commonwealth’s funding allocations:

a – Seed equity investment; this option is for where there are early period risks or costs that prevent efficient private investment. The investment would bridge these gaps, allowing rapid project progression and further private investment:

b – Guarantee facilities; similar to the UK Treasury initiative, the NIP envisages the Commonwealth offering guarantee facilities or insurance products, potentially covering patronage risks for transport projects and long-term private sector debt;

c – Subordinated debt facilities; the NIP recognises that there will be long-term project risk profiles that will be difficult for lenders to effectively price and the plan highlights the opportunity for the Commonwealth to co-lend on a subordinated basis to act as risk buffers and lower the overall cost of capital for large projects; 

d – An enhanced project broker role; the financial strength of the Commonwealth enables it to play a larger role in bringing together public and private sector entities to structure efficient financing and funding mixes. This is the role the Commonwealth has played in the Moorebank Intermodal Terminal; and

e – Infrastructure taxation incentives; inefficient elements of the taxation system can act as significant barriers to private-sector investment. The Commonwealth Government recently implemented a change to the taxation provisions that removed an unintended limit on the transfer of taxation losses in infrastructure sales processes.

Streamlining the approval process – The three-tiered structure of government in Australia has led to the development of three overlapping project approval processes. The Commonwealth Government recently announced changes to its environmental approval legislation, allowing state agencies to be accredited under the Commonwealth process. This will remove an expensive process by allowing states to provide project environmental approvals covering both state and Commonwealth legislation and remove the risk of the Commonwealth Government intervening in the project development process on environmental grounds.

New funding commitments – The Commonwealth Government has already demonstrated that it is prepared to move rapidly to support projects that it believes are a national priority. The following funding commitments have been announced recently, with negotiations over the funding form currently under way: NSW WestConnex road network, A$1.5bn; Queensland Toowoomba second range crossing, A$1.3bn; Victoria East-West Link Stage 1, A$1.5bn; Victoria East-West Link Stage 2, A$1.5bn; and Queensland Gateway upgrade north, A$718m.

In summary, the Commonwealth initiatives represent a balance of additional financial support with further pressure on the states to ensure that they do the required analysis to demonstrate that they are selecting the best projects to secure Australia’s economic future. Success will rely on all parties agreeing to follow the more open and rigorous processes outlined in seeking Commonwealth support.

* State governments – The key ongoing battle for the states is to secure additional funding for infrastructure backlog without producing further deterioration in the fiscal balances. This effectively means either increasing the revenue potential of each project or materially reducing the spending profile. Three areas are currently the focus of most state governments.

Asset sales – The term “capital recycling” is now being used by most government treasurers as an accepted method to realise value from existing assets to fund new infrastructure. Recent sale processes run by NSW and Queensland have highlighted the potential additional funding that can be generated in a competitive process – A$5.07bn from Port Botany/Port Kembla and A$1.5bn from Port of Newcastle, and A$7bn from the Queensland Investment Corporation sale of the Brisbane toll road network. The Commonwealth subsidy makes this process even more attractive and we are aware of major asset sale processes under way in WA and further sales envisaged in Queensland seeking to replicate NSW successes.

The rigour and efficiencies that private ownership brings to economic infrastructure was highlighted in the sale in early 2014 of a minority stake in the Port of Brisbane: the original 99-year lease of the Port was purchased less than three years ago for A$2.1bn, while the minority sale valued the Port at around A$6.2bn.

A key barrier is public acceptance of the privatisation process. Past attempts at selling large state assets have floundered where public opinion has not been effectively managed during the process. The NSW approach whereby the sale proceeds are placed into a separate fund, Restart NSW, and earmarked for investment in new infrastructure seems to have been an effective mechanism to neutralise public concerns.

Value capture mechanisms – These are approaches that seek to derive additional funding from a wider pool of infrastructure facility beneficiaries than the immediate users. Key mechanisms that are under study currently include:

a – Development contributions and other development rights that can be exercised on property developers where there is a demonstrable uplift in values brought about by the infrastructure, eg, a new train station or rail line will improve accessibility and increase land values for residential developments in the vicinity of the new infrastructure;

b – Levies and taxes that align with the incremental benefits delivered from the infrastructure to property owners, eg, Tax Incremental Finance – as used in the US the UK; and

c – User charges such as tolling and micro tolling that apply directly to users.

Value capture is in the early stages of development in Australia and has some way to go until it becomes adopted. Importantly, some of the mechanisms currently being considered may require changes to legislation to enable governments to collect the revenues. While value capture can be applied to any type of infrastructure and procurement model, it seems likely that it will feature in future infrastructure procurement in Australia.

Commissioning and contestability – Faced with continuing pressure on their budgetary positions, Australian governments are closely reviewing the full range of services that they provide to assess whether they are efficiently delivering meeting the specific needs of the population with reference to their geographical and demographical characteristics and then rigorously analysing who is best placed to deliver these services.  

This is an increasing focus as it strikes at the heart of key inefficiencies in government costs by asking the fundamental question, are the services we are delivering actually meeting consumer needs? This is a fundamental change since earlier drives to “outsource” government functions usually assumed that not providing a particular service was never an option.

Integral to the process of formulating such an approach is a robust assessment of the opportunities that may be driven through collaboration with the private sector. These opportunities include the reduction in recurrent expenditure, redistribution of operating risks, liberating capital and human resources, stimulating the private sector and expanding the revenue base, and improving productivity and service outcomes.

Moving forward, we will continue to see state governments, possibly also incentivised by the Commonwealth Government, including more “core services” such as the operation of a hospital, prison or public transport service, into PPPs. We will also see these types of services contracted out on existing, brownfield, assets across Australia.

Closing remarks

The stated aims of the Abbott Government to re-invigorate government infrastructure procurement and delivery are a laudable policy position. The initiatives it has chosen to implement this policy position set an ambitious framework around state/Commonwealth relationships and a very active role for the Commonwealth Government. The next 18 months will be a baptism of fire for this approach and we look to the outcome of current funding negotiations over the NSW WestConnex and Victorian East-West Link projects as early indications of how effective the new processes will be in changing government planning processes and encouraging private sector investment.

Footnotes

1 - EY, Extra Credit Infrastructure, 2013

2 - EY, Superannuation investment in infrastructure: Steps to further efficiency, 2014

3 - EY, Extra Credit Infrastructure, 2013

4 - EY, Extra Credit Infrastructure, 2013

 

 

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