Owen Hayford from our Construction and Major Projects group looks at the current funding models for toll roads - is the traditional toll road PPP model broken? Or is it just in need of some tailoring?
Where to now for toll road PPPs?
Owen Hayford, Partner, Construction & Major Projects
Some say that a number of toll road projects, such as the Cross City and Lane Cove Tunnel projects in Sydney, and the CLEM7 in Brisbane, have failed, and so we need a new model for future toll road projects. Is the traditional toll road PPP model broken?
It's not correct to say that these projects have been 'failures'. It is certainly true that each of these projects failed to generate the traffic and toll revenue which the private sector investors forecast, and that this has resulted in significant losses for those investors and, in some cases, for the project lenders as well.
However, in each case:
- the infrastructure was delivered on time or ahead of schedule; and
- the road has remained available for use by motorists at all times since opening for tolls which are:
- at or below the maximum tolls permitted under the contracts,
- and certainly below the toll levels which would have been required to enable full recovery of the capital cost of the asset.
In addition, the tax payers have been protected from the losses suffered by the investors on these projects. Government has not had to tip additional taxpayer funds into the projects to cover these losses. The losses have been borne by the investors who took on the traffic risk.
Finally, in each case the PPP model enabled the infrastructure to be delivered much earlier than would have been the case had the project needed to wait in line for government funding to be made available. This has meant that the economic and social benefits which these pieces of infrastructure have delivered - such as travel time savings, reduced congestion and lower vehicle operating costs - have been delivered earlier than would have otherwise been the case.
Accordingly, from the perspective of motorists and taxpayers, the PPP model used on these projects has in fact been very successful.
You've mentioned that it has been the private sector investors and banks that have been burned by these projects. Does that mean that they will no longer invest in toll road projects unless the model changes?
This is a good question, and it is true that many people have suggested that the model is broken and that the allocation of patronage or demand risk needs to change if future toll roads are to be developed as PPPs. It is certainly true that we can expect equity investors and bankers :
- to take a much more careful look at their traffic projections for future toll road projects,
- and to be far less willing to invest or lend money based on heroic traffic projections like those which were made by the private sector on the Cross City Tunnel, Lane Cove Tunnel, CLEM7 and Airport Link projects.
However, this does not mean that equity investors will never again accept full traffic risk on a toll road project. Clearly, if an opportunity exists to make money by investing in a toll road project on the basis of sensible, robust traffic projections, then there will always be investors willing to invest in that opportunity. The risk-reward equation just needs to make sense.
Looking forward, what changes to the PPP model for toll roads may be required?
As I've said, I don't agree with the view that the allocation of demand risk needs to change in order to attract private sector investment to toll roads.
That said, it is always necessary to tailor the model to each specific project. For example, the capital cost of all of the toll road projects presently under consideration is so great that they will never be capable of being funded solely on the basis of future toll revenues alone. The days of the self funding toll road PPP are over.
This means that government will need to provide a financial contribution to bridge the gap between:
- the cost of the project on the one hand,
- and the amount of private sector funding that can be raised based on projected toll revenues, on the other hand.
This government financial contribution can take many forms.
For example, it might take the form of an availability payment, such as that used on the Penlink project in Victoria. Accordingly, you might have a toll road PPP project where the revenue comes from two sources - tolls paid by motorists and an availability payment paid by government.
Alternatively, you might link the payment from government to things other than availability. For example, toll road deals have long been financed overseas on the basis of shadow tolls, where the toll to use the road is paid by the government, rather than motorists.
Government payments could also be tied to the achievement of other outcomes such as:
- route performance - reflecting the reliability of journey times and the effects of incidents; or
- the condition or safety performance of the road;
Another method by which Government might bridge the funding gap is by actually paying for some of the works as they are built, thereby reducing the scope and cost of the remaining works which the private sector need to finance.
For a project such as the duplication of the M5 East tunnel, the government could help bridge the funding gap by giving the developer of the new tunnel the right to toll not only the new tunnel, but also the rest of the existing untolled link between the M5 and the Eastern Distributor.
Indeed, the proposed duplication of the M5 East provides an opportunity to revisit the existing concession arrangements for all of the toll roads which form part of the Sydney Orbital Network with a view to moving towards a more consistent and equitable tolling regime across the entire Orbital Network.
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