Productivity Commission Inquiry into the provision of Public Infrastructure

To view the PDF response to the Productivity Commission Inquiry from IVMA (John Bushell) click here.

Below is a brief summary of key points by John Bushell, FIVMA, Accredited VMS Facilitator

This dry-sounding subject has important ramifications for Australia, not just for infrastructure, but for relate initiatives such as management systems and strategic planning. For this reason on 3 April 2014 the IVMA made a submission to the Commission’s Interim Report – one of a total of 214 submissions.


Background

In November 2013 the Federal Treasurer requested the Productivity Commission (PC) to “undertake an inquiry into ways to encourage private financing and funding for major infrastructure projects, including issues related to the high cost and long lead times associated with these projects”.

The Commission released its Interim report in March 2014 and issued its Final report to government on 27 May and to the public on 14 July 2014.

For the purpose of this inquiry the PC clarifies the distinction between ‘funding’ and ‘financing’. Funding refers to revenue raising sources and streams to pay for the costs of infrastructure over its life (such as user charges). Financing refers to the supply of capital (private or public) used to pay for the upfront investment costs of an infrastructure project.


Key Findings

One of the headings in the PC’s Final report is “There is scope to do much better”! Whilst this my not be too much of a surprise to most Australians the Commission makes the following findings:

“Institutional and governance arrangements for the provision of much of Australia’s public infrastructure are deficient and are a major contributor to unsatisfactory outcomes.

“Where project selection decisions are made in accordance with the framework recommended in this report, there is additional capacity for the Australian and State and Territory Governments to finance public infrastructure through borrowing.”


Key Recommendations

The Report makes a total of 30 Recommendations but it makes very clear that the following Recommendation (number 7.1 in the Report) is critical and should be put in place and used by all levels of government as a matter of urgency.

“All governments should put in place best practice institutional and governance arrangements for the provision of public infrastructure. This includes: 

  • clearly defining the principal objective of ensuring that decisions are undertaken in the public interest, taken to be the wellbeing of the community as a whole
  • setting clear and transparent public infrastructure service standards
  • instituting effective processes, procedures and policy guidelines for planning and selecting public infrastructure projects, including rigorous and transparent use of cost–benefit analysis and evaluations, public consultation, and public reporting of the decision
  • use of transparent, innovative, and competitive processes for the selection of private sector partners for the design, financing, construction, maintenance and/or operation of public infrastructure
  • ensuring efficient allocation and subsequent monitoring of project risks between government and the private sector
  • regularly reviewing funding and financing policies, including application of transparent user-charging mechanisms as the default setting where this is efficient
  • monitoring of project performance and ex-post independent evaluation and publication of project outcomes (including periodic reporting of benchmark costs by Infrastructure Australia)
  • retaining sufficiently skilled public sector employees to be responsible and accountable for performing these functions
  • establishing mechanisms for transparent review or audit of the decision making process by an independent body, for example, an Auditor General or Infrastructure Australia.”

 

Two further recommendations are also considered fundamental to achieving the necessary significant improvements to public infrastructure investment,
“All governments should commit to subjecting all public infrastructure investment proposals above $50 million to rigorous cost–benefit analyses that are publicly released and made available for due diligence by bidders. In general, analyses should be done prior to projects being announced. If a project is announced before analysis is done, for example, in the lead up to an election, this should be conditional on the findings of a subsequent analysis.” (Recommendation 2.3)
“Australian Government funding or other forms of financial assistance (including incentive payments under Commonwealth–State agreements) for public infrastructure that is provided to State and Territory and Local Governments should be conditional on the adoption of the governance arrangements outlined in recommendation 7.1.
“This assistance should only be provided where there is evidence of a demonstrable net public benefit from the project that would otherwise not be obtainable without Australian Government support.
“The Australian Government should support the incorporation of the framework in recommendation 7.1 for project assessment in the energy network investment framework.
“Consultation on the criteria to be applied and any potential implementation issues associated with such an approach should be undertaken with the State and Territory and Local Governments.” (Recommendation 7.3)


General Comments by the PC

The PC makes it clear that the federal government’s proposed “asset recycling” should be the subject of its proposed “cost-benefit analysis” – separately in respect of the sale of the asset (or assets) proposed to be disposed of and the asset(s) to be acquired. The “recycling” should only proceed if both analyses are positive.

However the Report makes the point that governments’ can fund projects through taxation or borrowing – the difference being the way intergenerational equity is treated. The PC remark: “The key point is that there is no apparent constraint on Australian Government borrowing, if the proceeds are used in a way that would deliver a demonstrable net public benefit.”

The PC finds that private sector involvement in infrastructure projects is not necessarily a “magic pudding” because “the replacement of public finance with private finance does not create a new source of funds or value.”

In the case of public / private partnerships (PPPs) the PC makes what could be a very beneficial proposal for a trial. It proposes that tendering of the infrastructure provision and operation should be unbundled from tendering for the financing of the project. After the preferred design / construction / operation option has been selected then the financing of that option can be tendered. This could potentially save on tendering costs and permit the best functional solution and best financing package to be selected.


Comments in relation to Value Management

There however are a few points that could have benefitted from greater attention in the PC’s report.

The Report is strongly focused on project selection but the project definition phase is not mentioned. Conspicuous by their absence is no mention of the importance of the fit of infrastructure initiatives, which by their very nature have very long-term implications, into a long-term strategic plan.

Similarly, the importance of system and network implications of infrastructure initiatives are not mentioned although almost all such initiatives will have impacts on other parts of any system (eg: road, rail, healthcare infrastructure, etc.)

It is at this critical project definition stage of the project that functional effectiveness (as opposed to cost-effectiveness) is maximised by thorough application of value management.

Control of risks and their allocation of risk to the organisation best able to manage it, (particularly in respect of any risk premium that may be imposed in project financing), is recognised as important factor. However as value management facilitators know, the optimum time to identify risk and initiate its removal, reduction and management is in the formative stage of projects and programs.

The project definition phase is also the time to address two key issues with the contribution of a multi-disciplinary group of stakeholders:

• What would happen if the proposed project does not proceed, the “base case”? I.e. what is the “business as usual option”. Also, is there a non-infrastructure, operational or technological option to improve operation of the existing infrastructure?
• What alternative, competing, options are available as possible alternatives to the proposed project? How might this project impact on them? How might the alternative options impact on the proposed project? For example the high-speed rail line between St. Pancras and the Channel Tunnel (Line HS1) did not take account of low-cost airfares and the project (and the Channel Tunnel itself) is unlikely to ever meet its anticipated return on investment. [V2 p656] It appears that the Darwin to Alice Springs railway project did not take into account the cost of the competing transport option or the urgency of moving the freight. Whilst current freight rates on the railway are not available publicly, a 2005 study found that costs to move a single container from Darwin to Adelaide varied from $2,100 to $2,500 whilst the cost of shipping the same container from Shanghai to Adelaide was $750. [V2 p663]


Best Value for Money

“Best value for money” is mentioned a number of times in the Report but always in the context of the tendering process for the project. Recognition that best value for money is almost always generated during the Project Definition phase is not recognised. Adoption of the Commission’s Recommendation 7.1 if it fully incorporates the structured value management process could potentially maximise value for money on all projects on which it is applied.


Cost-benefit Analysis

The PC recommends that projects should be preferred on the basis maximising ‘net benefits’, net present value (NPV). However if a number of projects are to be compared it is useful to have other measures available including net present value per dollar invested (NPVI), internal rate of return (IRR) and benefit /cost ratio (BCR).

The IVMA recommended the use of the NSW Total Asset Management methodology which incorporates Value Management (VM), Risk Management (RM) and Economic and Financial Evaluation (E&FE) as there is over 20 years experience in using the techniques and delivering value for money.

The PC recommended applying cost-benefit analysis to projects with a capital cost exceeding $50 million. Our Submission recommended applying the NSW Total Asset Management methodology to all projects and programs exceeding $10 million in capital cost. We also recommended the methodology be applied to projects below $10 million estimated capital cost where new technology is involved, on information technology projects and projects where there is a degree of uncertainty as to the required outcomes or where scope and procurement risk is perceived to be high.

Ongoing Actions

On 5 September 2014 Jamie Briggs, Federal Minister for Infrastructure and Regional Development, released the “Overview of project appraisal” by the Department of Infrastructure and Regional Development (DIRD) in consultation with state and territory governments, outlining a new framework for the appraisal of transport infrastructure projects.

The DIRD “Overview” is available here:

http://www.bitre.gov.au/publications/2014/files/overview-project-appraisal.pdf

The “Appraisal methodology flow chart” on page 3 of the “Overview” commences with the following processes that will be familiar to Value Management Study practitioners,

flowchart-jb-gov-IVMA

Of course, full adoption of the Value Management Study process as laid out in AS 4183:2007 and further explained in the NSW Total Asset Management Manual, provides the whole process for the transparent methodology for achieving better value for money at project inception.

The Value Management section of the NSW Total Asset Management Manual, is available at: http://www.treasury.nsw.gov.au/__data/assets/pdf_file/0009/5112/value_management.pdf


This DIRD “Overview” invited comments by 3 October 2003. The IVMA will be making a comment generally along the lines that there already exist tried and tested project optimisation and evaluation processes and the first step is to ensure their use and transparent availability of results on all projects and programs to which they apply.