KPMG Global Infrastructure’s Bastien Simeon offers an excellent overview of the evolving water privatization market in an August 2008 report entitled, “Delivering water infrastructure using private finance.” The paper examines the risks and rewards of using private finance to fund water infrastructure, including how local governments and investors can benefit. Topics covered include regional trends, traditional vs privately financed procurement, opportunities, risk allocation and extracting value. Here’s an excerpt on what I’ve found to be a woefully underappreciated issue in infrastructure–the chronic neglect of infrastructure maintenance seen under traditional U.S. project delivery approaches, and the opportunities PPPs offer in locking in future asset maintenance costs and shifting to life-cycle approaches to ensure asset quality and durability:
The traditional infrastructure procurement method used to budget construction, enhancement, maintenance, and/or operation of water facilities may result in suboptimal outcomes. That’s because most government budgets are based on a one or two year budget cycle for operating costs, with capital projects subject to a five-year work plan. Often, governments may find themselves pressured to balance the budget by incrementally deferring maintenance or deferring capital projectsÃ¢â?¬â??a process that may appear innocent on a project-by-project basis. But the exponential nature of deferring maintenance or capital projects over time can result in breakdowns in infrastructure or capacity shortages that compromise public needs. Once a government gets behind in maintenance, it becomes very difficult to recover. The government is then put into a position of choosing between maintaining or rehabilitating existing infrastructure or building capacity necessary to fuel the growth in its economy. This dilemma can lead to unintended maintenance backlogs, substandard service quality, and life-cycle costs that are considerably higher than would have been achievable with optimal maintenance. [. . .] The long-term nature of concession and PPP contracts allows governments to build maintenance costs into the net present value of the monetization and assign responsibility for maintenance to the private sector. The private sector can plan and implement accordingly, since it focuses on the long-term internal rate of return, not the current-year budget cycle that can compromise service quality. This long-term approach, often referred to as life cycle asset management, can be reflected in the innovative design and construction solutions for privately funded water facilities, such as using more expensive construction materials that may increase the investment cost but decrease the longer-term maintenance costs, thereby decreasing the total net present value of the project. Governments also have the ability to impose strict operations and maintenance requirements in concession agreements and lock in future maintenance costs. While this approach may decrease upfront payments from private concessionaires, governments can effectively remove the responsibility for maintenance from their budgets and thus not make those costs subject to year-to-year budget pressures.