Public-Private Partnerships and the Allocation of Risk


by James A. Bacon

It’s easy to whack Virginia’s public-private partnership law for failing to meet expectations for transparency and public involvement. (I have done so repeatedly.) There are important issues that the legislature needs to deal with, as the controversy over the U.S. 460 Connector has made abundantly clear. But there are virtues to public-private partnerships that have gone unsung. Perhaps the most important of these is the identification and mitigation of project risks.

Virginia’s transportation public-private partnerships (P3s) have an elaborate process for identifying risks, tracking them and allocating them between the public and private partners, according to the “Special Review: US 460 Corridor Improvements Project” ordered by Transportation Secretary Aubrey Layne. The review was tasked to dig into how the state could have paid US Mobility Partners nearly $300 million under terms of the U.S. 460 partnership deal even though U.S. Army Corps of Engineers (USACE) permits had yet to be issued and construction had yet to begin.

As the Special Review explains, there are a wide variety of risks in a transportation mega-project:

  • Development risks: design conflicts, environmental permits, changes in regulation, lack of financing, right-of-way acquisition, politics.
  • Construction risks: cost overruns, design defects, unknown utilities, acts of god.
  • Operation & Maintenance risks: shortfalls in traffic demand, construction of competing facilities, design defects, political and regulatory changes.

“Under traditional public procurement of highway projects, the public agency retains most of the risks, yet these risks are not usually quantified, nor are their costs always included in the project cost estimates,” states the review. “A key component of P3 procurement involves the transfer of certain risks from the public agency procuring the project to the private sector partner. The concept of ‘transferring risks’ requires that the private partner will be responsibile for cost overruns or expenses associated with the occurrence of that risk.”

An example of a risk that might be transferred to the private sector is construction risk — the risk the the project may not be completed on budget or on time. Another is transportation demand risk — the risk that traffic and toll revenues may not materialize as forecast.

In embarking upon a P3 project, Virginia’s Office of Transportation Public Private Partnerships (OTP3) compiles a “risk register,” which systematically identifies all major risks and decides whether the state should retain the risks, mitigate them, insure against them or transfer them to the private sector partner. Risk registers are updated as new risks are spotted and old ones closed out.

In the case of the 460 project, OTP3 maintained a risk register over five years, from 2008 until 2012. The office held four risk workshops in which the project team included OTP3 and VDOT representatives, consultants and key stakeholders. The group discussed different risk items, the probability of occurrence, cost and schedule impacts and appropriate actions to manage each item.

An independent audit found that VDOT had accounted for and/or mitigated the major project risks. The audit team estimated that the present value cost of these risks ranged from $177 million to $295 million (depending upon the methodology used) above the official $1.4 billion project cost.

In the case of environmental approvals, VDOT purchased wetlands credits in the summer of 2012 in anticipation of wetland mitigation discussions with the Corps of Engineers and conducted a study to collect additional data to facilitate those discussions. Based on correspondence with the Corps, the independent auditors concluded that the risk profile for the permitting element of the project had been reduced substantially.

While all material risks were adequately identified, concluded the report to Layne, the authors concluded, “We do not believe key stakeholders, including the public, were aware of the nature and extent of risks associated with the 460 project.” The problem was not the identification of risks but the failure to share that information with the Commonwealth Transportation Board.

Bacon’s bottom line: It’s good to know that the people negotiating P3s understand risk, which is more than we can say about politicians flogging forward traditional VDOT projects. But what does all this have to do with the U.S. 460 fiasco? It narrows the scope of the problem. Whatever went wrong, it wasn’t a failure of the OTP3 office to identify the wetlands risk. I’m still not clear, however, where the project ran off the rails — how the state managed to shell out $300 million before the wetlands issue was resolved. Hopefully, I’ll get more answers as I continue wading through the report.

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11 responses to “Public-Private Partnerships and the Allocation of Risk”

  1. larryg Avatar

    Here’s my take. All P3 agreements should be developed and executed via a separate fiscal agency who has no interest in the specific project – only that the financial part of it be done according to accepted industry practices.

    And – the process does not progress until permits are in hand.

    I never thought that VDOT should be involved in these kinds of non-transportation issues – to start with – and became convinced of it with the Pocahontas Parkway and Dulles Toll Road.

    this aspect is about finance – not roads and VDOT has abundantly demonstrated that their lust for new roads exceeds their due diligence duties.

    yes.. this is one more layer… but this is what you end up with because fundamentally VDOT has a conflict of interest in their mission to build roads – to get through the wickets to build roads – but a lack of expertise (or the will) to be competent and/or independent enough (of the road building part of VDOT) when assessing risk.

    I see this a little like I see the requirement to get independent bids on big projects. As soon as you hear the words “sole source” warning signs should be going up. The finance part of a PPTA should not go through VDOT but through an independent PPTA state level authority.

    in my opinionated view…

  2. Well the P3 is not confined to roads etc. Universities across the country are using P3s to build hundreds of billions in non-academic facilities. All off the books or so they say. They lease land to a company which gets an economic development loan through the city or county and builds a dorm/expensive housing and then leases it back to the university. (Of course they have this lease up front.) Some colleges/universities have seen their enrollments lag expectations but they have to fill the P3 lease first and one college I know has an 8 story dorm fully paid for sitting empty because they have to fill the P3 housing first according to the lease. And lots of athletic facilities are built this way. When you hear a university say that no state funds are involved in building a say $50 million basketball practice facility most people assume that they are getting donations but in most cases it is a P3 deal.
    Lots of institutions have more than a billion in this type of debt that Moody’s would never approve. So hard times may be coming soon….

    1. larryg Avatar

      not understanding why the University could not get the same low loan rates with a RFP – design-build.

      We’re seeing some things like this – down our way for things like a YMCA right next to a new school – and an agreement for the school to use the YMCA as a gym while the YMCA is free to also sell memberships for off-hours non-school use.

      are the colleges uses the P3 to avoid having to get a loan and instead signing a lease that holds them liable for the total amount?

      If that is what is going on – then my concerns are even more heightened that P3 needs to be vetted by an independent authority because obviously the college is counting on the state bailing them out if they mess up.

      this is bad…

    2. Wade, has anyone conducted a thorough examination of Virginia university balance sheets — including the kind of off-balance sheet financing that you describe — to see how indebted the institutions are?

      1. larryg Avatar

        does anyone think that dorms sitting empty are not paid for by others paying for dorms?

        I’m not sure how this kind of thing – benefits the University – it seems to encumber them.. at best. What’s the upside to the academic institution?

        1. Tysons Engineer Avatar
          Tysons Engineer

          University admins have friends in the construction industry, this is a good way of lining their pockets while also creating a nice ribbon cutting ceremony for photos.

          Oh you meant for the university itself? Nothing.

          1. larryg Avatar

            well then, I’m actually more outraged that Va agencies and institutions beyond VDOT are engaging in this subterfuge…

            and I’m disappointed in JLARC and the Virginia Auditor for next exposing it.

  3. For the past year and half or more Moody’s has issued warnings of all kinds regarding college debt. And I am not sure how or why but many colleges and universities have been able to build extraordinary non academic facilities using these off the books approach. Easy credit schemes of the 1990s and 2000s was not limited to homes and credit cards. Many government or quasi government organizations have been able to accelerate sppending and the chickens may be coming home to roost…as we used to say in SWVA!

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  5. Walter White Avatar
    Walter White

    Pursuant to the theme a couple of days ago of “transparency”, another $350,000,000 VDOT contract that should be looked into is that with SERCO for taking over the five Regional Transportation Operations Centers and their Safety Service Patrols (SSP), or motorist assistance. SERCO was to purchase dozens of the pickups and vehicles used by the SSP, paying VDOT “Bluebook value”. They assumed responsibility during October – November 2013 and received transfer of title and ownership of the vehicles, but I understand VDOT has yet to receive a $.01 for the vehicles, now eight or nine months later. The COV is also furnishing facilities and communications networks at no cost to SERCO.

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