The proposed East West Link road project in Melbourne, Victoria, shows the pendulum swinging back towards public financing in the Australian toll road sector following the mistakes made by private finance in the last few years.

The East West Link was the key infrastructure announcement of Victoria’s state budget this week, which received a warm welcome from industry. Infrastructure Australia, for example, gave the budget “full marks”, adding “Everyone agrees that the East West Link is the most important investment for Victoria, so it is particularly pleasing to see a firm delivery timetable announced.” John Field, a partner from Ashurst, said “potential users of the road and the infrastructure industry have been championing its cause for years, so it’s a very welcome development.” 

Victoria’s treasurer Michael O’Brien went as far as to say "From the market soundings we've already taken, we expect to get knocked over in the rush."

How far the pendulum swings is not yet clear, as the eventual payment mechanism for the project is yet to be determined. The only figure that is close to fixed for the moment is the A$1.5 billion (US$1.52bn) pledged by the Liberal opposition, which is expected to be in power after federal elections later this year. Victoria’s state government, also led by the Liberal Party, will allocate an unspecified amount, so how much private financing will be required out of a total of A$6-8 billion in expenditure is not yet known.

It’s fair to say that the private sector competing on which could offer the biggest grant to the government for the privilege of sponsoring a toll-road project are gone, and that investors’ gambling on traffic forecasts is likely at an end. These debacles, in which traffic risk was borne by the sponsors, show why:

Another place to look for information is the new PPP policy produced by Partnerships Victoria earlier in the month.

For example, to encourage bids, the government is planning to trial the partial reimbursement of losing bidders. Amounts will be determined on an ad hoc basis. John Field, a partner at Ashurst, suggests that firms have been limiting the number of projects they bid for to lower their costs, and “it’s good that the government has finally recognised this”. Whether the lower bids resulting from more competition will be able to offset the higher cost of the procurement process is presumably unknowable.

The key point in the new policy, however, is “use of modified financial structures”. This provides the policy background for the statement that the state government will make a capital contribution to East West Link. It does not detail percentages or caps, but explains: “An alternative to full private finance is part public finance either during construction or by substantial repayments at or soon after construction completion. Procuring Agencies should consider government capital contributions where there are liquidity constraints or where there are opportunities to reduce project costs by reducing the level of private capital at risk during the operations period.”

Although there is a caveat that sufficient private capital should be present to incentivise the sponsor, it seems clear enough that the policy has traffic risk in mind here.

It goes on to state that a contribution can be made either as milestone payments during construction, or as a lump sum payment at the end of the construction period.

But this still leaves the interplay between East West Link’s toll revenues and payments to the sponsor to the imagination.

“The government has announced that the corridor will be tolled, and I imagine it will be procured as a PPP, so how those two are put together will be the path-finding aspect of the project,” says Brendan Lyon, chief executive officer of Infrastructure Partnerships Australia.

“My gut feeling is that the road will be put to market as an availability PPP, and that tolling rights will be sold separately once the road is up and running,” Lyon states. The assumption must be that there would be less scope for the government to offload traffic risk if the tolling revenue is privatized separately, or at least that this is no longer a reason for potential sponsors and financiers to be discouraged from involvement.

Alternatively, the government could simply collect the toll revenues which could then disappear into treasury funds. 

Field agrees with Lyon on the larger point, however: “Post the global financial crisis, and with the difficulties of raising bank debt, the availability model is the one that has seen the most success in securing private funding. My guess is that we will see it again here.”

So it seems that the ability of Australia to procure roads on the cheap is at an end, and that it will no longer be private finance left carrying the can. It’s simple enough to deduce that the reason Australian industry is welcoming the Victoria budget is that it is putting more money on the table, whether via bid reimbursements or by capital contributions, and taking traffic risk off the table.

What the government appears to have learnt is that, if it wants to procure roads, it needs to put up enough money. This may sound obvious, but a few years ago it wasn’t actually true.