With more and more procuring authorities talking about ‘buying themselves out of hugely inefficient and costly PFI contracts”, PFI has once again hit the headlines for the wrong reasons.
A greater level of transparency and efficiency for future projects is needed, but I am increasingly frustrated by the negativity and often misrepresentation of the industry and found myself revisiting an article that I co-wrote for Partnership Bulletins in 2011, examining the role of life cycle management in PFI.
With the chancellor’s iron grip on public finances and unclear stance on PFI/PPP, the article seems more relevant today than ever before …..
The honeymoon period is over
The honeymoon period for PFI and PPP deals is most definitely over. But like any successful marriage, PFI contracts are a long-term relationship with highs and lows which need lifecycle management.
The first wave of PFI/PPP projects arenow entering a mature phase of operations and expenditure, with some projects nearing the mid-point of 25-30 year concessions. For example, major hospital projects are now spending in excess of £1m per annum funding lifecycle works. Within each project or facility there are thousands of individual assets (from boilers to door handles) and most have escaped what lifecycle managers call the “burnin” phase where they fail due to design or installation defects. They are now well into the “useful life” phase with a low constant failure rate. As assets reach the end of their life, they incur an increasing failure rate to the point where they require replacement.
Lifecycle Funds in Place
Fortunately, lifecycle funds or major maintenance reserves have been set up to fund such replacements. These are prefunded by a slice of the authority’s unitary payment (usually paid well before any private profits are released). In addition, authorities have the payment mechanism to make sure that assets are well maintained and will meet their anticipated design life.
This explains why aging assets run the risk of failing early. More thorough examination of recent PFI/PPP project failures and difficulties seen on operational projects will show that lifecycle is far from being an exact science. Processes are yet to be fully developed to manage lifecycle risks within the confines of a financial model.
Inaccurate Forecasts and Budget Planning
It is not uncommon for unplanned expenditure to occur, causing returns and cover ratios to be heavily reduced; often the unpublicised but key driver behind project collapse or subcontractor failure.
Once a project is up and running into the steady state operational period, lifecycle risk is now accepted as the most significant risk faced by operators and investors alike. Considering that lifecycle budgets are often based on forecasts and estimates made pre-financial close – as much as 10 years earlier –the chance of getting it wrong is significant.
So what does this mean for PFI/PPP?
First, lifecycle cash flow movement or overspend is the biggest risk to investors’, funders’ and infrastructure portfolio holders’security once projects are operational. The risk is not achieving predicted levels of equity returns and, in extreme cases, leading to credit default.
Without robust lifecycle planning the risk of running out of cash against short term fixed annual budgets is ever-increasing as well as placing building occupiers’ health and safety at risk if essential works are not undertaken. Operators, with better lifecycle planning, can determine where underspend is occurring and target areas of overspend or choose to make improvements and enhance asset condition to the customers’ benefit.
Lifecycle funds containing “enhancement” or overprovision can provide equity shareholders with additional flexibility. But only if senior lenders and their advisors can be technically and robustly persuaded that any unspent funds are not needed at a later date and are genuine unspent funds that can be returned as an additional source of revenue.
Surely the time has now come for an alternative way of thinking for delivering lifecycle asset management through the use of real time ‘one stop approach’. The ability in real time to analyse historic or forward lifecycle expenditure over any time period is now required. This information has to live in an asset database delivering visibility of key asset data at portfolio, project or asset levels.
Utilising this alternative approach the benefits could be:
• Proactively manage and estimate handback liability;
• Understand lifecycle fund performance in real time across project and portfolios;
• Benchmark cost and asset performancein terms of asset reliability, durabilityand cost;
• Abandon resource intensive, error-strewn spreadsheets that struggle with portfolio assets;
• Maintain a secure audit trail of changes over time; a complete asset investment history “cradle to grave”;
• Fully understand the condition of assets, the risk to loss of availability of assets and risks to the health and safety of assets’ users or operators.
• Streamline shareholder and client approvals;
• Reduce costs associated with client and lender operational reviews by providing secure and controlled direct access to headline cost performance data;
• Provides the framework to cost effectively procure and contract lifecycle works;
• Reduce overheads employed to manage lifecycle functions across all areas of the project/portfolio.
• All round visibility of lifecycle reserve performance;
• Auditable trail to release unspent lifecycle funds as ability prove funds are genuinely not needed in future spend cycles.
Given the public’s outspoken opposition to PFI and the Treasury’s current determination to squeeze as much value for money out of operational projects, perhaps now is the time to consider an alternative lifecycle asset management approach for PFI/PPP projects?