When President Donald Trump announced his campaign pledge to upgrade the country’s infrastructure, he endorsed public-private partnerships (P3s) as a way to help finance and build the $1 trillion worth of projects subject to his proposal.
He said he would leverage the power of P3s to turn $200 billion of public dollars into $1 trillion of investment, refurbishing crumbling infrastructure without emptying public coffers.
But just a year later, he had soured on the idea, telling a group of legislators in 2017 that private financing of public infrastructure isn't likely to work and that P3s are "more trouble than they're worth."
Whether P3s will be a critical part of an eventual national infrastructure program of that scale remains to be seen, but in recent months, several large construction firms have, like the president, moved away from this type of contract agreement. This summer, Granite Construction called out P3 arrangements for having detrimental effects on business and last fall, Skanska announced that it would no longer pursue major design-build transportation public-private partnerships in which it held an equity stake.
P3 arrangements pair public entities with private investors to create projects that range from toll roads and highways to airports, government buildings, schools and universities. They are seen as an innovative way for municipalities to get much-needed infrastructure upgrades without cutting corners or breaking public taxpayer-funded budgets. Most P3 contracts are for design-build, fixed budgets and fixed schedule work, according to a recent position paper from the Design-Build Institute of America.
Profit or pain: the pros and cons of P3s
In recent years, P3s have been used to take on projects like the $2.3 billion I-4 Ultimate highway project in Florida and a $2.8 billion U.S. Army Corps of Engineers' flood risk management job in Minnesota. Because most P3 jobs are large in size and long in duration, they are valuable for firms that want to secure business growth for several consecutive years, said Ben Vaught, CEO of online procurement marketplace DemandStar.
Nevertheless, the contractors that are moving away from this type of public/private collaboration say that the benefits of P3s are outweighed by problems.
Granite CEO James Roberts told investors in August that the P3 process is no longer viable for his company, and that the firm’s heavy civil division will no longer pursue megaprojects, though it had prior to that been active in transportation and infrastructure work ranging from aviation and roads to rail and mass transit.
One of the biggest issues with these arrangements, he said, is that they involve fixed-price agreements that lock contractors into a set fee and timetable. As things change on these jobs, additional costs are often incurred, leading to disputes between owner and contractor about who will pay for them.
“In these situations, the owner assumes that the contractor had those issues in their bid and the contractor didn’t assume that and so it ends up in dispute,” he said. “That is the bottom line and that has to change in this industry.”
This summer, four disputed projects led Granite to declare a net loss of $97.8 million for the second quarter of 2019. Even so, it must continue on with the work and deal with litigation or mediation later, Roberts said.
“We are contractually obligated to continue work on these jobs and to recognize the associated costs regardless of whether we agree that the work we have been directed to perform is within the scope of our contracts,” he said.
Fluor CEO and director Carlos Hernandez has echoed Roberts' sentiments, saying that the risk that contractors assume with these types of projects has caused the industry to “suffer severely” over the last few years.
Going forward, Fluor will only perform fixed-price work on a selective basis in which there is a limited bid slate and an identifiable, quantifiable advantage over other bidders, or work that carries with it a sole-source, negotiated lump-sum agreement. It will also only select projects on which Fluor executes the FEED (front-end engineering and design) package or is allowed to perform sufficient due diligence.
In all cases, risk projects will be subject to an initial bid/no-bid approval followed by final approval by the Fluor executive team, Hernandez said during a recent investor call. This increased focus on selectivity is already changing the company's prospect pipeline.
“If it means we’ll get less work but consistently profitable work we’re OK with that," Hernandez said.
Skanska also has said it will limit the type of P3s it takes on. Last fall, after taking a $100 million write-down on its P3 business, the company announced that it would no longer pursue major design-build transportation public-private partnerships in which it held an equity stake.
Do P3s face too much volatility to be viable?
The issues associated with a P3 contract stem from the fact that there are many moving parts and parties, budgets, outside entities and deadlines, Vaught told Construction Dive. What’s more, risks facing large public projects have increased in recent years, according to Nicole Gelinas, a senior fellow at the Manhattan Institute, a New York City-based urban policy think tank. The long-term nature of large projects has made them more volatile in recent years due to growing uncertainty over labor and materials prices, she said.
For instance, a project like the $7.9 billion overhaul of LaGuardia Airport begun in 2016 by Skanska, HOK and others is predicted to take 10 years. A lot can happen to prices, inflation, interest rates and the overall U.S. economy before a project of that size and scope is complete, Gelinas said.
“The stress on major global contractors to make a profit on these projects is part of the reason for the pullback we’re seeing on them,” she said.
Rising costs and delays recently sent the Denver International Airport P3 project into a tailspin. Officials terminated the airport's $1.8 billion public-private partnership (P3) contract with Great Hall Partners, the consortium performing a renovation of the facility's Jeppesen Terminal.
Great Hall representatives said they were "disappointed" that they could not reach a resolution with airport officials to the "serious issues" presented by weak concrete and "more than 20 large-in-scale, badly timed and unnecessary change directives" issued by the airport.
Kim Day, CEO at Denver International Airport, said that although this particular P3 did not work out, she is still a fan of the delivery method. In retrospect, she said, the airport did two things well in setting up the contract with Great Hall — writing in a termination clause and an audit clause, which gave the airport the right to look at GHP's books. If she had it to do over, Day said she would also make sure the contract had penalties and bonuses attached to project milestones, which would have given the airport more control.
In addition, not all state and local agencies have the legal authority to enter into a P3, as seen in the map below.
Capitalizing on change through collaboration
While several of the country’s largest contractors are moving away from public private partnership projects, others see them as a worthwhile solution to financing, designing and building large-scale government projects.
For instance, Clark Construction Group’s Edgemoor division is working on the $1.5 billion Kansas City Airport project under a develop/design build/finance P3 agreement. The 39-gate terminal and parking garage broke ground in March and will be complete in 2023.
Geoff Stricker, senior managing director of Edgemoor, said that P3s are a “great arrow in the quiver” for public sector projects but they are not an “end-all,-be-all panacea." They are most appropriate for large, complex projects the require a lot of project management.
Attorney Yukiko Kojima, a partner with Nossaman’s Infrastructure Group, said the smoothest P3s are the ones with collaboration between all stakeholders and where risks are allocated efficiently before work begins.
“They create an opportunity for contractors and subs to get involved in very large, complex projects with corresponding risks and returns,” said Kojima, a DBIA national board member and chair of the association's P3 committee. “It’s certainly not for every contractor — as a lead contractor, you need to be at a certain size before it starts to make sense.”
Mitigating risk to realize the rewards
The first step to ensuring a favorable P3 is to identify and mitigate risk, Stricker said. This includes doing as much upfront work as possible when selecting and pricing subcontractors. It's crucial to be "smart and strategic in the selection of partners," he said.
In a fixed-price agreement, contractors must keep in mind that any cost overruns will come out of profits. “If we say building this will cost a dollar, then our risk is to make sure we deliver the building for a dollar,” he said. “If it’s $1.10, that’s our risk for the extra 10 cents.”
Stricker, who has worked on P3s for nearly 20 years, said it’s up to all parties to do their due diligence before entering into one.
“There’s obviously a lot of risk in any project in construction and one of the things with them is that it’s important to identify all the risks that you can think of and allocate those risks to the party that’s best able to price and manage them,” he said.
The DBIA position paper notes that the key to a successful P3 is collaboration between parties in all phases of project delivery, including procurement, contracting and project implementation. "This successful collaboration results in increased efficiency and innovation and contributes to the likelihood that a project will be successful," it reads.
Effective collaboration is critical for every P3 project, Kojima added, pointing to two successful P3s underway at the Los Angeles International Airport: a $4.9 billion automated people mover system, a design-build joint venture led by Fluor, and a $2 billion consolidated car rental facility, a design-build venture led by PCL. The $1.3 billion UC Merced 2020 project from design/builder Webcor, which is due to be completed next year, is also on time and on budget, she said.
Other ways to assemble a successful P3 project team were covered in a recent report from FMI Corp., which said that contractors should also build relationships with public officials and finance representatives and plan for project complexities.
The bottom line, said DemandStar’s Vaught, is that contractors considering a P3 arrangement fully understand every aspect of the job or scope of services they are bidding on.
“There are a lot of complexities involved in using P3’s, therefore there are a lot of risks that come with delivering on these types of projects,” he said. “We suggest making sure each company does their own due diligence on risk vs. reward on the size, length and complexity of each of these projects.
A never-ending highway of P3s in the pipeline
No matter the contract type, large government-backed projects are not going away anytime soon and in fact there could be more of them in the works next year if the highway reauthorization bill, America’s Transportation Infrastructure Act of 2019, becomes law.
The $287 billion bill, which would fund the repair and maintenance of roads and bridges over five years, would increase spending by 27% over the current authorization and could become law by early next year, according to Jimmy Christianson, vice president of government relations at Associated General Contractors of America.
“The demand for infrastructure doesn’t go away with the ebbs and flows of the economy,” Stricker pointed out. “In fact, in recessionary periods where budgets might be tighter, coming up with creative ways to continue to deliver assets — like a P3 — is appealing.”
As demand grows and the number of experienced contractors to work on these types of projects dwindles, the question is how all the work will get done, Gelinas said.
“A lot of state and city governments are depending on these large companies to bid on their projects, but they are kind of pulling back,” she said. “The bidding pool looks very shallow now.”