UK: PPP Briefing: Current Developments in the United Kingdom - September 2010

Last Updated: 21 September 2010
Article by Nick Maltby

We have a new government, whose overriding priority is deficit reduction. Over the Spring and Summer there has been a stream of announcements on PPP with some projects being approved, others cancelled and many made subject to a review, which will only be completed in the Autumn. Of the announcements so far the one that stands out is the cancellation of the Building Schools for the Future programme on 5 July. Ministers have blown both hot and cold on PPP as they get to grips with the work of Government. However, any understanding of how severe the cuts will be and what this means for the UK infrastructure industry in terms of pipeline and cancellations will have to await the publication of the Comprehensive Spending Review on 20 October 2010.

At the time of writing it remains difficult to discern any overarching policy thread that unites the new government's approach to PPP. George Osborne, the Chancellor, specifically mentioned the need to continue with investment in infrastructure in his emergency budget statement on 22 June and has repeated this theme subsequently. However, what the industry needs is certainty and the current hiatus does not help.

In the period 7 May to August 2010, 12 PPP projects reached financial close with an approximate value of £725m. This compares with 11 projects with a value of £1.5bn closing in the period from 1 January to the General Election on 6 May but less than the number of deals closed over the same period of 2009. The closed projects comprise three BSF projects (Cambridgeshire. Lewisham Phase 3, Southwark Phase 2), one schools project (Moray), two energy projects (Glenkerie and Ferndale/Castle Pill), two health projects (Tayside and Liverpool LIFT), two street lighting projects (Nottingham and Coventry), a library (Liverpool), a prison (Belmarsh) and a waste project (Staffordshire)1.

Policy

As ever with a new Government, while there is a lot of activity, it is difficult to discern at this juncture which policy strands will survive and which will not be pursued.

Accounting Treatment

Perhaps the most significant announcement of the new government is that the UK's PFI deals will now be accounted for on the Government's balance sheet. The new Office of Budget Responsibility is considering how this might be achieved. While Government has repeatedly stated that value for money remains the key driver for whether PFI is chosen, in practice the likely accounting treatment of PFI projects has been an important factor since the advent of PFI.

Green Investment Bank

At the end of June, a group of leading bankers, led by Bob Wigley. issued a report, urging the new Government to fast track the development of the planned GIB with a view to having the institution open for business in six months. The report also considers how the GIB should be structured and funded and outlines the proposed mandate for the GIB. The report considers that investment in low carbon infrastructure over the next decade will total more than £550bn. It is expected, should the Government proceed with the report's recommendations that a bill will be presented to Parliament.

National Audit Office Reports

The NAO has published a number of reports on PPP. In June, it published four reports, 'Increasing passenger rail capacity', 'The performance and management of hospital PFI Contracts', 'Managing complex capital investment programmes utilising private finance' and 'PFI in Housing'. These were followed in July by 'Financing PFI projects in the credit crisis and the Treasury's response'. While the healthcare, housing and transport reports are reviewed under the relevant heading below, the general reports deserve further comment. 'Managing Complex Contracts...' sets out a model to provide guidance to Departments on HMT's and NAO's expectations of how they should manage their programmes involving PPP and PFI projects. The model describes how departments should undertake six key functions (implementing PPP policy, managing PPP projects, controlling quality, supporting operational projects, managing the market and deliver continuous improvement) and the tasks associated with each, what good looks like and sets out case studies of how Departments are currently implementing them

'Financing PFI Projects...' found that during the credit crisis the cost of finance increased by one-fifth to one-third. This increased the cost of a typical project by 6 to 7%, costing between £500m and £1bn and eroding value for money. Although steps were taken to assess the impact of these changes on value for money, there were limitations in the assessments. The NAO identifies the challenges going forward as including identifying the best funding models, which may not be PFI funding options (the report highlights the French approach where the government guarantees 80% of the debt and the flexibility of the EIB to lend). While the report accepts that the extra finance costs in 2009 were justified, it states that, on projects yet to be developed, there should be no presumption that the use of private finance at current rates will be value for money. The report recommends, inter alia, that there should be mandatory reevaluation of projects where there are material changes and regard should be had to how infrastructure might be funded from a wider variety of sources.

OFT Stock-Take of Ownership and Control Across Economic Infrastructure in the UK

On 14 May, the OFT announced a stock-take of ownership and control across economic infrastructure in the UK. The key aims of the work are to map ownership and control across the economic infrastructure sectors (ports, airports, energy and water networks, and car parks) and assess how ownership of infrastructure affects outcomes for consumers in these markets. Alongside this the OFT will be looking at who controls which assets. The stock-take is intended to improve public understanding of competition issues in UK infrastructure markets and is expected to be completed in Autumn 2010.

IUK Investigates Cost of Infrastructure Projects

At the end of June, Infrastructure UK announced it will investigate how to reduce the cost of delivery of civil engineering works for major infrastructure projects in the transport, energy, utility and waste sectors and will report its initial findings in the Autumn. The investigation will examine why output costs are higher in the UK than elsewhere in the European Union and non-EU countries. Terry Hill, chairman of Arup, will chair a steering group overseeing the investigation. IUK aims to publish a final report and recommendations by the end of the year.

Infrastructure Planning Commission to Go

The government plans to introduce legislation this year to replace the IPC with a new structure that puts planning for projects of national importance back into the hands of the relevant government departments. The change could become law in 2011. The new plan would create a Major Infrastructure Unit within DCLG. Recommendations on significant national infrastructure projects would go the relevant minster for a decision. Given some of the planning problems, which are afflicting the waste PPP sector (below), a further period of uncertainty seems regrettable. Not surprisingly, this announcement has not received universal acclaim.

Defence

No defence projects closed. The defence budget is seen as being particularly vulnerable to cuts. In June, the Treasury confirmed that the £6bn Search and Rescue helicopter PFI project was to be suspended, pending a review. The recently closed £13bn Future Strategic Tanker Aircraft project is also thought to be vulnerable.

Education

The big news in the education PPP sector is that the Building Schools for the Future programme has been cancelled. On 5 July Education Secretary, Michael Gove, set out a complete overhaul of capital investment in England's schools. The key elements of his announcement were that 706 schools would be opened but 715 schools would no longer be rebuilt or refurbished through BSF. Gove's announcement launched a controversy, which is yet to die away not least about the specific schools concerned. Several iterations of the list later, it appears that 735 school and academy projects have been stopped altogether, either because they have not reached financial close, or because they have no funding agreement in place.

In the context of academies, the Academies Act 2010, which speeds up the process for maintained schools to become academies, received royal assent on 3 August, after a passage through Parliament of less than two weeks. Only a handful of schools have availed themselves of this new legislation in time for the new academic year.

At the same time as Gove's July announcement, the Government launched a comprehensive review of all capital investment in schools, early years, colleges and sixth forms led by Sebastian James of DSG international plc. The review will guide future spending decisions over the next Spending Review period (2011-12 to 2014-15).

As noted in previous issues, BSF was the flagship PPP programme in terms of progress and closes and its cancellation is a major blow to the UK PPP industry. However, notwithstanding the announcement, schemes continue to close. Financial close was reached by a consortium of Kier and Equitix on the Cambridgeshire BSF project on May 20. Second phase BSF schemes at Lewisham and Suffolk were closed in August. Other schemes such as Hertfordshire appointed a preferred bidders and closes are expected in the Autumn on Ealing, Halton, Oldham and Somerset. In Scotland, the £45m Moray Schools PPP reached financial close in late June with International Public Partnerships (INPP). Senior debt of £40m has been arranged by Aviva.

Energy

While from a policy perspective, the prospective Green Investment Bank is the key iniative, a number of projects closed or reached preferred bidder. In June, DONG Energy secured a £250m loan from the EIB as part of the financing for the London Array offshore windfarm. In July, Infiris reached financial close on its £40m 22MW Glenkerie Wind Farm project. Senior debt is being provided by Lloyds and BNP. Also in July, Infinergy closed its £18m Ferndale and Castle Pill Wind Farm projects with debt provided by NIBC. In early August, preferred bidders were announced for the £700m Offshore Transmission Links project to establish transmission links to seven offshore windfarms off the coast of Britain.

Healthcare

As noted above, the NAO published its report, 'The performance and management of hospital PFI contracts' in June. The report found that most contracts are performing satisfactorily or better and meeting the expectations of Trusts. The level of penalties applied for poor performance is low with 53% of Trusts charging no deductions in 2008-09. However, there is scope for improvement as no Trust rated all services as excellent.

On the issue of management, the NAO commented that most Trusts needed help with more complex issues and that some Trusts are not devoting enough resources to management. While Trusts are expected to make efficiency savings the scope to do so is limited, as the contract price is fixed and there is little evidence of partnership working to drive costs down. The NAO warned about undertaking scope reduction exercises without support. As far as the Health Department was concerned, the NAO noted the expertise of the PFU but found that the PFU's ability to support Trusts was limited by a lack of performance and cost data.

The report recommended that Trusts should provide sufficient resources to manage their contracts and engage with the available support from the Department and that the Department should target those contracts that need its support the most. There were various ways Trusts could work with their PFI contractor better to drive efficiency savings.

In England, the £450m Royal Liverpool PPP project, which advertised in April, was confirmed as continuing. The £150m Papworth hospital project, which has been at the conception stage for almost 15 years, was also advertised in August. How these schemes sit in the light of the Health Secretary's criticisms of PFI in August is unclear.

In Scotland, a consortium of Robertson Capital Projects and Morgan Sindall Investments reached financial close on the £120m Tayside Mental Health PFI. The project will be structured as a non-profit distributing model. The £9m Liverpool & Sefton LIFT Tranche IV project also closed. A new panel comprising 6 companies was established for ProCure21, the Department of Health's capital scheme.

Other Accommodation

In early July, Serco reached financial close on a £140m contract to provide and operate a new prison at Belmarsh West, London. The project is being funded by Bank of Ireland, Barclays, Helaba and the Royal Bank of Scotland, while Barclays Infrastructure Funds will provid the equity. Serco intends to sign the Maghull prison contract later this year. The prison will be built by Skanska.

Also in July, the £50m Liverpool Library PFI renovation reached financial close with £45m financing for the deal being divided between Nationwide and Helaba. Inspire Partnerships, which consists of Amber Infrastructure and Shepherd Construction, will design, build, finance and operate the refurbished facilities.

Social Housing

No new scheme reached financial close (with only the second phase of Brent social housing closing). Many of the reasons for this lack of progress are evident from the NAO's report, 'PFI in Social Housing', which was published on 25 June 2010. The report noted that while the use of PFI by local authorities to improve housing, usually in areas with a high need for housing and where stock condition is particularly poor, has had a measure of success, risks to value for money of the programme have not been managed.

In the context of this programme, PFI has been a flexible and useful funding route for local authorities to improve existing housing and build new stock. However, the majority of projects required significant increases in central funding prior to contract signature and all have suffered delays. Twenty one of the 25 projects which have been signed to date have experienced cost increases above estimates in the business case, 12 of which were over 100 per cent. The limited evidence available allowing the NAO to compare PFI to alternative forms of procurement meant the Government could not demonstrate the programme had achieved value for money.

The NAO also reported that early programme management was weak although improvements are now in place. On value for money, the NAO concluded that the Department had not managed the risks effectively in terms of delivery to time and budget, evaluation of whether PFI was the best option and putting in place adequate programme management arrangements. It was too early to tell whether the improvements would make much difference.

Street Lighting and Highways Maintenance

Two deals closed. In late May, Nottingham City Council and Tay Valley Lighting, a wholly-owned subsidiary of Scottish and Southern Energy, reached financial close on the £50m project to replace 29,000 street lights in Nottingham. Senior debt is being provided by Lloyds Bank and Nationwide. In early August, financial close was reached on the £230m Coventry Street Lighting PFI scheme between Balfour Beatty subsidiary, Connect Roads and Coventry City Council. The project involves the replacement of 28,000 street lights, 4,200 lit traffic signs and 1,500 illuminated bollards. Senior debt is being provided by Barclays Corporate and Norddeutsche Landesbank. North Lanarkshire appointed Amey as preferred bidder on its highway maintenance project.

Transport

Transport for London (TfL) finally brought to an end the London Underground PPP on 7 May by buying the Amey and Bechtel interests in the Tube Lines PPP contract for £310m. The deal also brings to an end the rancorous relationship between the two Tube Lines owners on one side and TfL and London Mayor Boris Johnson on the other. Amey had been responsible for maintenance and Bechtel for capital improvements. Amey said it would continue to manage and maintain services for the next 7.5 years under the existing contract. Bechtel will continue to work with London Underground for an interim period to ensure a smooth transition of the capital improvements programme into TfL.

On 4 June, the NAO published in report, 'Increasing passenger rail capacity'. The NAO commented that the Department for Transport's latest plans for increasing rail capacity would not deliver as much extra capacity as originally specified, although the taxpayer would have provided nearly as much financial support (£1.2 billion over the period 2009-14) to train companies as originally envisaged. The report also points out that value for money is at risk because costs, particularly of rail carriages, have risen at the same time as the recession has reduced the Department's projections of demand. Against this background, the Department has reviewed each individual scheme before entering into contract to ensure that it still offers value for money.

In July, the DfT published its report, 'Reforming Rail Franchising'. The report canvasses longer franchises among other things but it is hard to see how even a 15 year franchise will do much to encourage investment given the mismatch between asset life and the length of franchise. There is considerable scepticism within the industry about the merits of yet another franchising model.

In the aviation sector, at the end of June, Vancouver Airport Services agreed to acquire 65% of Peel Airports Limited, including Liverpool John Lennon Airport, Robin Hood Airport Doncaster Sheffield and Durham Tees Valley Airport, from the Peel Group. Peel retains a 35% stake in PAL and a presence on the board.

Waste

The Government announced a long overdue review of waste policy on 16 June. The review will include the effect of waste policies on local communities and individual households, and how local authorities can best work with people to make the best decisions; how to maximise the contribution of the waste and recycling industries to the UK economically and environmentally; how we work towards the 'zero waste economy', and drastically reduce the amount of waste created and valuable resources sent to landfill, looking at the entire process from source to end of life; and new approaches to dealing with commercial waste and promoting 'responsibility deals', reducing the amount of waste generated by production and retail.

On 1 August, after more than a year, a waste project reached financial close. This was the £122m2 Staffordshire Waste PFI between Staffordshire County Council and Veolia. The scheme is based on an Energy Recovery Facility, which will handle residual waste from Staffordshire as well as assist Sandwell, Walsall and Warwickshire. Interestingly, the scheme will be financed off Veolia's balance sheet rather than through third party private financing. Amey Cespa reached preferred bidder status on North Yorkshire waste, eighteen months later than originally planned.

Planning remains the key issue for the waste sector. On the Cheshire Waste PFI project planning applications were rejected from both bidders in June (this follows a similar rejection at Derbyshire in January). Both bidders are considering appealing. Covanta's EfW plan will now be examined by the Infrastructure Planning Commission.

Water

On 26 August, Caroline Spelman, the Environment Secretary announced that OFWAT, the industry regulator for the water industry, will be reviewed. The process will examine how the industry regulator works, whether it offers good value for money and if it is delivering what the Government and customers expect. The process is due to be completed early next year. Defra is also due to publish a Water White Paper early next summer which will set out policies for the future of water management.

Footnotes

1. Values are based on the value of equity + debt rather than the value of payments over the life of the project or the capital value of a project or the amount of PFI credits, if relevant.

2. This is the value of PFI credits.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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