A positive outlook: Why Australian infrastructure expenditure and PPP outlook are on upward trajectories

Problems in the market and uncertainty from some in government are being mitigated by innovative approaches from a variety of partners

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According to Infrastructure Partnerships Australia, funds allocated to infrastructure projects across the nation are on the up. In its November Infrastructure Budget Monitor, which measures infrastructure funding commitments by jurisdictions for the current Budget year and forward estimates (up to 2025-26), the independent body noted: “The Budgets delivered by Australia’s federal, state and territory governments increase infrastructure expenditure once again.”

It continued: “By allocating AU$254.8bn of general government expenditure over the four years to FY2025-26, this year’s Budgets have eclipsed last year’s infrastructure spend of AU$248bn - by 2.7%.”

That figure masks the huge uptick in political focus on the sector, with federal government allocations increasing by 91% since the 2019/20 Budget. State leaders have followed suit, with Victoria earmarking almost a quarter of its total general government four-year expenditure (AU$85.3bn) for infrastructure, New South Wales (NSW) setting aside AU$88.4bn (17.9%) and Queensland increasing its infrastructure spending by 19% (AU$5.8bn). Even Western Australia, the traditional holder of the wooden spoon in the state rankings, has designated one tenth of its budget for infrastructure projects.

Andy Haining, managing director of John Laing, recognises the importance of the state-level programmes responsible for most of the country’s infrastructure delivery and is confident about the current outlook for the leading states. “Victoria has been the state government that has consistently utilised the PPP model across social and transport infrastructure projects, and we see this continuing, particularly in the health sector where there are a number of potential PPPs in the pipeline,” he says. “In addition, NSW has also looked for opportunities to leverage private sector capability in transport, particularly rail, using a variety of partnership models between the public and private sectors.”

That positivity is echoed by Plenary Group, whose chief investment officer Paul Crowe credits these two jurisdictions with providing the “consistent pipeline” that “has ensured that there is a competitive market pursuing the opportunities, providing strong competition benefits.”

He continues: “Across other states, decisions around the use of private capital in public infrastructure tend to be made on a project-by-project basis.” Victoria, in particular, he explains “has consistently procured around 10-15% of its total infrastructure on PPP or PPP-like projects”. That suggests a PPP pipeline of AU$8.5-13bn in this state alone.

What’s more, the new Labor federal government, elected in May 2022 and ousting the incumbent Liberal/National Coalition, continues to provide funding to the states for critical infrastructure, which will help ensure that the pipeline of new projects, including PPPs, continues. As Owen Hayford, principal of Infralegal, specialist infrastructure law firm, points out: “The PPP model has bipartisan support at all levels of government, so changes of government have not resulted in significant changes to the deployment of the PPP model.”

In fact, Hayford sees the low number of 2022 deals and activity as indicators of a disappointing year for Australian PPP: just two PPP deals achieved financial close in 2022 – both in Victoria. A sole preferred bidder for the Inland Rail PPP was announced in March, but this deal is yet to achieve financial close, and is currently being reviewed by the new federal government. Meanwhile, the last PPP closed in NSW was the regional Rail Fleet PPP in early 2019. Hayford singles out the Sydney Metro Western Sydney Airport as the only real potential PPP transaction that the NSW government has announced since 2019.

According to Crowe, much of the reduced activity can be attributed to “the severe supply chain uncertainty that Australia has faced over the past two years, which impacted the contracting market’s ability to provide fixed design & construction prices to underpin PPPs”.

Haining adds: “As with many countries across the globe, resource constraints and cost inflation pressures are key considerations in the Australian infrastructure market, including for PPPs.” His view is that “these constraints are causing some clients to consider their infrastructure priorities, which may see the procurement of certain large-scale infrastructure projects deferred”.

For Hayford, the low level of PPP activity seen recently in NSW and Queensland shows the model is generally falling out of favour with senior bureaucrats responsible for delivery model decisions. “They are increasingly sceptical about the value for money proposition associated with the use of private finance. They see the SPV transferring virtually all risks and responsibilities to its design & construction and operation & maintenance contractors respectively, and so query the value (risk management) that the SPV is providing in return for the cost of its finance.”

While the level of risk transfer that Australian governments have historically achieved on PPP deals has generally been greater than that achieved in the UK or US, Hayford’s prescription for reinvigorating the Australian PPP market is for equity investors in PPPs to offer ‘active equity’ that involves “a more active role in managing the interfaces between key construction participants, and between D&C and O&M”, including “a slice of the painshare if the actual D&C costs exceed the target cost”.

For some, this is a challenging message, especially as global economic headwinds and general increases in risk-free rates across the globe have translated into an increase in debt funding costs. Haining describes cost escalation as “a key consideration across the infrastructure sector, including for PPPs”.

Alex Guy, partner at law firm Ashurst, sees it like this: “Infrastructure investors look for projects with long-term, steady, sustainable revenues covering the initial capital expenditure incurred in delivering or upgrading infrastructure assets, ongoing operating and maintenance costs and a reasonable return. Set that desire for long-term stability against the fact that we're going through a period of extreme uncertainty from climate change, extreme weather events, supply chain issues, sanctions, domestic political risk, hyperinflation, and more and it makes for a difficult environment.”

The good news, though, is that this year the Australian PPP model has shown an ability to innovate and cater to this issue with the inclusion of price adjustment mechanisms, such as the Incentivised Target Cost mechanism adopted on Victoria’s AU$11.1bn North East Link PPP. This is part of what Guy describes as “industry stakeholders across the board working hard to develop flexible contractual mechanisms to make projects more resilient”.

He goes on: “We’re seeing the PPP model evolve into more flexible and collaborative approaches that recognise the market uncertainties that exist at present and seek to develop solutions to address the problems that have arisen in 'traditional' PPPs in recent years.”

There is also plenty of private finance looking for the right deals, with the Global Infrastructure Investor Association counting 30 private investor members in the region, with a combined AU$121bn worth of assets under management. Then there are the swelling coffers of the Australian superannuation industry, which is providing deep pools of funds that are chasing suitable investments - including infrastructure. Accordingly, there is significant competition for equity and debt stakes, resulting in keenly priced finance.

On the supply side, the costs of Covid support and economic stimulus measures, as well as the current inflationary environment, have created increased deficits at state, territory and federal levels, pushing public authorities to look at the role of private finance as a way of accelerating the delivery of infrastructure.

What’s more, the scale of investment needed to deliver the infrastructure required to transition to Net Zero across Australia “remains significant and the resources required to deliver this pipeline remains a key issue across the industry”, says Haining. “We have seen governments starting to look to the PPP procurement model to help deliver critical new power transmission infrastructure which will help to achieve these outcomes.”

Despite being behind the UK and parts of Europe in displaying a larger focus on using private capital in energy transition projects at present, Guy says Ashurst is “seeing a huge increase in market players’ focus on resilience, decarbonisation and sustainability in project development, procurement and delivery”, with “a lot of capital out there at the moment, looking for opportunities that fit within investors’ ESG goals. Projects under development and competing for that capital need to focus on resilience, decarbonisation and sustainability in order to be attractive.”

In fact, Plenary has just submitted its first bid for a large scale energy transmission PPP project in NSW, reflecting what Crowe calls “a burgeoning interest in this space”. He sees many more reasons for an optimistic outlook, with the federal and state governments “increasingly looking to attract private capital to public infrastructure and, for greenfield infrastructure in particular, the certainty of long-term outcomes that PPPs and PPP-like procurement delivers is attractive”.

John Laing is similarly positive, also noting the ongoing emergence of greenfield projects being brought to the Australian PPP market across a range of sectors. Haining says: “Both the Victorian and New South Wales state governments as well as the Australian federal government are currently our most active clients using the PPP procurement model, with current or confirmed projects across the rail, power transmission, health, housing, civic infrastructure and defence accommodation sectors.”

The pipeline in Australia is certainly encouraging, sitting at a projected five-year forward programme of around 70 infrastructure projects worth some AU$83bn - many of which are strong candidates for the use of private capital.

To drive that activity, Infrastructure Partnerships Australia’s September 2022 Australian Infra Investment Report calls for Australia to “ensure the policy and regulatory settings encourage private finance in the sector. Governments need to seize the opportunities that private capital provides - particularly in green assets, which can contribute to achieving decarbonisation goals.

“Strong policy leadership boosting Australia’s environmental and social credentials, a recommitment to key market principles of competition and limited intervention, and utilising private capital to unlock funding will secure Australia’s place as an attractive destination for infrastructure investment.”