Tony Williams Building Value Ltd the independent strategic advisor to the building materials, construction & support services sectors 6 December 2002

Infrastructure improvement in Europe: private and/or public? Private Finance Initiative in UK “another fine mess you got me into” but “the report of my death was an exaggeration”

PFI  Established in 1992 (by a Conservative government)  Alternative method of procuring services for the public sector  ‘Build now, pay later’; just like hire purchase and government eventually owns the asset  Revenue not capital spend; ex-PSBR  Public Private Partnerships (PPP) employ joint capital; ownership does not revert to government

Another fine mess….  Current ‘witch hunt’ on PFI  Blanket media criticism  Focus on project delays; costs; value; ideology  Accounting practices have been questioned  Controversial proposed PPP of London’s Underground Railway

Report of death is an exaggeration  £100 billion worth of schemes - £22 billion completed - £14 million where formal contracts signed - £64 billion of schemes in the pipeline  This compares to annual UK construction output worth circa £80 billion

Eurotunnel share price

British Energy Share Price

What are the main issues?  Timing and cost  Government is cheapest borrower  Value for money; transfer of risk – for Government  Off balance sheet funding  Re-financing and ‘windfall’ profits  ‘Build now pay MORE later’

Amey share price

Pressure on public funding

Positives  Need - £100 billion worth of schemes to date  National & regional government support  Abundance of capital  Returns are attractive  Participants see higher quality earnings

Negatives  Protracted development and project delays  Costs and value for money / windfall profits  Bureaucracy / ideology / negative surveys  Poor privatisation record  The contractor  Accounting

Solutions 1  Positives exceed negative ‘WACC’ by 22%  Half the negatives are logistical: timing; bureaucracy; accounting; negative surveys  Re-definition needed plus education, training and establishment of a new PFI executive  The accounting issues are on the mend….  ----and why not blow PFI’s trumpet?

Solutions 2  New practices, accounting standards & forecasting  Industry rationalisation will help  Standard contracts to streamline procurement  Commoditisation and bundling  Finance raised in form & price that reflects risk

Solutions 3  Role and responsibility of government needs to be agreed  A strong owner in place from the outset  Replace contractor as front man  A full empirical audit of PFI

Value for money test is flawed  Is private provision of services better than public?  Build cost of asset is the yard stick; it is called the Public Sector Comparator (PCS)  Alternative is to ‘rent’ asset over 25, 30 or 40 years  This is the basis of comparison  Government asks which is cheaper: buying an asset or buying a service?

‘Apples with Oranges’  Cannot compare build cost with rent of same asset over number of years is wrong  Net Present Value (NPV) of rents is massively risky  Rents need large discount due to scale of uncertainty  If not, then NPV of rents is grossly over-estimated...  …and building the asset will look more attractive

Discounting ‘rent’ vs capital cost  Government traditionally uses 6% discount rate (and Treasury proposes change to 3.5%)  PFI projects are long lived  Consequences of small differences are huge  If PFI discount rate is wrong by 1%...  …then cost of private provision maybe overestimated by 14% of a 40 year project

Value for money (VTM) test fails  Contrary to popular conception, VTM universally underestimates private sector provision: - failure risk: user pays only on receipt of service - inherent risk of service: the asset may not be busy - quality of private service is not recognised - potential for productivity is ignored (as focus for government is reduced cost)

What needs to change?  Different discount rates for PFI projects and PSC  Study sensitivity of existing projects…  …and look at those which failed  Reassessment of the reassessment procedures  Need a clear idea of PFI’s financial benefits

PFI conclusions  A debate that can be won  Vital for infrastructure provision & public services  Vital for economic growth  Vital for sound public finances  It is competitive and….  ….there is a wall of money for PFI to scale

“…I am not going to go to parents and children and patients…and say I’m sorry because there’s an argument about PFI we’re going to put these projects on hold. They don’t care who builds them. So long as they’re built. I don’t care who builds them…” Tony Blair, British PM, Sept 2002