Australia infrastructure changes may reduce role of PPP as inflation payers

Private sector consortia bidding for infrastructure projects in Australia are increasingly asking state governments inviting public-private participation (PPP) to underwrite payments over the life of the concession, as their appetite for demand-risk under the traditional user-pay principle has fallen significantly. At the same time, state governments are also showing a preference towards paying the concessionaire fixed financing structure, instead of linking their payment to the consumer price index.

This trend during the past 18 months means the winning private groups responsible for building and operating the projects, such as hospitals, schools and prisons, will now tend to receive a flat monthly or quarterly payment stream over the life of the concession, usually up to 25 years in Australia. This is instead of a floating stream of payment indexed to the consumer price index (CPI) that mirrors the country's inflation trend.

Changes in the financing structure of the Australian PPP market come at a time when project bonds, the likes of the A$300 million ($280 million) of 3.12% inflation-linked bonds due in 2030 issued by Sydney Airport Corp in 2006, which was credit wrapped by monoline insurers such as Ambac Assurance Corporation (Ambac) to achieve AAA ratings, have ground to zero since the demise of the monoline insurers. Such credit-wrapped project bonds had held up the Australia inflation market during the credit rally of 2006 and 2007, when a number of PPP consortia issued credit-wrapped inflation linked bonds. This filled an important role in the inflation market following the decision by the Commonwealth Government to stop issuing linkers in 2003, although Australia resumed issuance last year.

Banks are playing an increasingly bigger role in funding PPP projects in Australia after bond investors shunned long-term infrastructure bonds in the wake of the financial crisis. A source close to New South Wales Treasury, who asked for anonymity, says as a result, state governments in Australia are getting demands from private consortia to underwrite revenues, even for economic infrastructure, such as bridges, toll roads, airports and power utilities, which had traditionally followed a user-pay principle in the past.

"The private sector in the past used to take full risks about the traffic that would turn up on the toll road and pay the toll," the source said. "But due to the financial crisis the private sector is more reticent to take traffic risks... thus some PPP done on toll roads are being done on the social infrastructure category where fixed payment is paid."

Such fixed payment is called an availability payment model, where regular payments are made by the public sector to the concessionaire (private sector) contingent on specific contracted services being available. These payments would risk being abated by the state governments if there is quality or availability failure.

The availability payment model is a feature of social infrastructure, such as education, healthcare, public transport, housing and/or civil facilities, which provide social services to the community and are often developed under the stewardship of the government, market participants said.

This contrasts with economic infrastructure, such as bridges, toll roads, tunnels, airports, gas power and water utilities that generally support economic activity and often follow a user-pays principle, demand-based revenue model - essentially inviting the private sector to take on the patronage risks.

Sources say the shift to the availability payment model for building economic infrastructure is seen more often in the State of Victoria. The Victorian Department of Treasury and Finance in Melbourne was not available for comment.

Meanwhile, another source at a PPP developer based in Sydney says state governments during the past 12-18 months are also opting to pay the concessionaire fixed revenue payment, instead of CPI-indexed streams. When the private sector makes a bid for an infrastructure project it will offer the government a choice of either CPI-indexed or fixed payment. It is usually the government's choice to decide whether they want those payment streams fixed or indexed.

Government sources say the decision process is driven by whether the government considers it best value for money and its attitude towards risks in general. "From the government's view, while the taxation revenue is correlated with CPI, the question is between the treasury of the state governments and other government departments, ‘do they want the complication of CPI - linked budget allocation at that department level?'" the source says.

While it is difficult to gauge the extent to which state governments and private consortia have agreed to a shift in PPP financing structure, the move towards the fixed payment, or availability payment model, would mean these infrastructure consortia might not have as strong a demand as they did before in hedging their inflation-linked revenue streams through issuing linkers or using inflation swaps that could mimic the same inflation-linked liability profile of a linker.

In 2006 and 2007, a total of A$1.52 billion and A$1.09 billion inflation linkers respectively were issued by corporate and infrastructure; that had dropped to A$344 million in 2008, and zero in 2009, according to data from RBS. However, market participants said demand for patronage risks from the private sector is often cyclical and the current diminished appetite might return as the capital markets digest all the bad sentiment related to the global financial crisis.