Select Committee on Agriculture Sixth Report

Annex

PFI & Flood Defence Projects

A paper prepared by Lindsay Allen for The Chartered Institution of Water and Environmental Management Meeting 30 January 1998

INTRODUCTION AND BACKGROUND

  Within England and Wales the Environment Agency (EA) has a permissive responsibility for the provision of flood defences. Although the EA has this responsibility the funding for such projects is provided jointly by the Ministry of Agriculture, Fisheries and Food (MAFF) and by a precept on the county rate. Consequently, all flood defence projects proposed by the EA have to be approved by MAFF and a project evaluation methodology has been developed for application in respect of such projects. The principal driver in this project evaluation methodology is the economic value of the loss avoided by providing the project works.

  Apart from the rather obvious aspect of none of us wishing to be subjected to the financial loss and emotional disturbance of flooding, flood defence policy and flood defence projects are currently and critically important aspects for many other reasons. First, the provision of flood defences offers a major market opportunity for the construction and engineering consultancy business sectors as it is currently estimated that investment in flood defence projects over the next 10 years will cost in the region of £1.3 billion. This expenditure is necessary not only to replace many existing life expired defence works but also to address the anticipated consequences of the rise in the level of the sea. Of course, the growing competition for land in parts of England will also provide additional incentive to protect areas which at one time might have been regarded as of marginal value.

  As a relatively new organisation the EA was naturally anxious to ensure that its budgetary expenditure was achieving best value for money. Accordingly, the EA commissioned an independent study to assess this aspect of its activities and at broadly the same time the previous Government mandated that all capital procurement projects would have to be tested for provision under the Private Finance Initiative (PFI). With this latter need in mind the EA and MAFF commissioned Brown & Root and Ernst & Young in late 1996 to consider the applicability of PFI for flood defence projects. This paper summarises the analyses, findings and interim conclusions of that study. The principal sections included in this paper are:

—  overview of PFI;

—  a brief description of pertinent characteristics of flood defence projects from a business perspective;

—  the approach adopted by EA and MAFF to market testing;

—  a summary of the market response to that testing;

—  a commentary on the principal issues which have been identified as a result of the work by the EA, MAFF, Brown & Root and Ernst & Young;

—  the intended next steps;

—  the identification of a number of longer term relevant issues.

OVERVIEW OF THE PRIVATE FINANCE INITIATIVE

  The Private Finance Initiative was announced originally by Mr Lamont when he was Chancellor. The prime objective of PFI was and remains the obtaining of better value for money in carrying out major procurement.

  In summary, PFI is focused on inviting bidders to provide offers to deliver service(s) over an extended number of years (perhaps 20 years or more). The provision of such service(s) typically encompasses the construction or making available of an asset together with the maintenance of that asset for the contract period and the provision of other services in order to sustain the availability of that asset. For example, under the DBFO road schemes the contractor has an obligation to construct a new or widened road, ensure that it is appropriately serviced and maintained and provide other services such as cleaning, gritting and snow clearance. In return the contractor is paid an agreed periodic contract amount which is dependent on the level of service delivered. From the contractors point of view the contracted cash flows offer a valuable security which can be used to raise finance to fund the project.

  Under PFI as the funding is to a private sector organisation the cost of funds is greater than if the public sector were to raise an equivalent amount of money. This additional cost together with the profit margin that the contractor expects to make over the contract life cycle are expected to be offset by the successful bidder introducing innovation into the design of the assets provided and more efficient delivery of the services encompassed within the contract. Further, PFI envisages that those risks which can be more cheaply borne by the private sector should be. The previous Government was a consistent advocate of PFI and apparently was reluctant to recognise the circumstances in which the concept did not have commercial applicability. To some extent, this has led to the concept being brought into disrepute particularly as many projects have remained in a state of advanced negotiation for periods in excess of years rather than months.

  The present Government appears to have a realistic commitment to PFI in that it is anxious to see it applied where it is appropriate and for inappropriate proposals to be excluded at the earliest opportunity. Further, the concept of partnership between the private and public sectors as promoted by the present Government offers opportunities for variance around the PFI concept. As in other forms of procurement the ultimate test must remain which option offers the best value for money.

FLOOD DEFENCE PROJECT CHARACTERISTICS

  In the view of the author of this paper, flood defence projects have a number of unusual characteristics which need to be recognised in considering their appropriateness for procurement under PFI. I hope that the learned audience will forgive the fact that these characteristics are now set out when, no doubt, they are blindingly obvious to everyone else.

  Certainly, all flood defence projects do have one element in common and that is the need to provide a mechanism or mechanisms in order to ensure that land and water remain segregated at a predetermined point and within certain parameters of weather conditions. However, the nature and ferocity of the forces which the defences may have to withstand vary substantially according to the location on the coast and whether the principal threat arises from the sea, an inland water system or some combination of the two. Further, this diversity of threats is made more complex by the fact that the behaviour of wind and water at surface and sub-surface levels results in the conditions to be addressed at any one site not being replicated by the conditions at any other site. Of course, industry and professional engineering experts recognise these issues but it does result in substantial research and testing work having to be undertaken to support the design work for the more substantial flood defence projects. Further, the options of using hard and/or soft defence measures mean that even a carefully analysed need can be addressed with a range of alternative solutions.

  At the first glance, it might appear that these issues would tend to dilute the applicability of procurement under PFI or a similar procurement relationship. However, looked at in a different way it could be said that these issues present the opportunity to:

—  stimulate design innovation;

—  vary the mix between hard and soft defences giving the opportunity to create service streams;

—  create new income in certain circumstances by incorporating flood defence schemes into other commercial enterprises such as housing development and the construction of boating and other leisure facilities.

APPROACH TO MARKET TESTING

  The Brown & Root and Ernst & Young study commissioned by the EA and MAFF initially focused on:

—  understanding the issues raised by procuring defences under PFI;

—  assessing the merits of PFI procurement for each of three proposed flood defence projects selected by the EA and MAFF.

  It quickly became apparent that one of the selected pilot projects would not be appropriate for procurement under PFI as it primarily consisted of the provision of a large fixed structure with a minimal level of on-going maintenance service. The two remaining projects were:

—  flood defences at Pevensey Bay which is situated between Eastbourne and Hastings;

—  a flood alleviation scheme for Broadland in Norfolk and Suffolk.

  For the purposes of this paper it is not considered important to describe these two projects in any detail. However, as illustrations or some of the points made earlier it is pertinent to point out that:

—  the two projects are of a fundamentally different nature in that the project at Pevensey is focused on avoiding flooding of a developed area by the sea breaching or overtopping the existing defences whereas that at Broadland addresses the strengthening of some 240 km of banks in an area which has a designation equivalent to that of a National Park;

—  the existing defences at Pevensey comprise a shingle bank which requires periodic recharging and timber groynes. Engineering consultants have identified a range of possible solutions with substantially different ratios of hard and soft defences;

—  a critical issue in respect of Broadland is that the strengthening work is likely to take in excess of 10 years and it will be important to ensure that the strengthening of the defences at any one point in the system does not result in creating new critical points of weakness elsewhere in the system.

  The EA and MAFF agreed to launch a programme of interactive market testing to ascertain the willingness of the commercial market to compete to provide flood defence solutions at the identified pilot sites. In doing so, the EA and MAFF have been consistently conscious of the need to avoid prospective bidders wasting time and cost on approaches that would be unlikely to be successful. Accordingly, a commitment was given to the market and is being adhered to that should it become apparent that either of the pilot projects is deemed not to be suitable for some new form of procurement the private sector will be informed and discussions terminated. This approach is being adopted as the EA and MAFF wish to retain and harness the goodwill of the private sector for the longer term so that the best value for money can be obtained from the estimated £1.3 billion spend projected for flood defences over the next 10 years.

  After preliminary discussions had been completed with the private sector the EA issued an OJEC notice in order to elicit expressions of interest for the works at each of the pilot sites. A good response was received and an initial list of prospective bidders was drawn up for each pilot project.

  Subsequently, a site visit was arranged for the prospective bidders and background briefing was also provided in respect of the proposed project and the on-going tendering process. After the site visits each of the prospective bidders submitted an outline proposal identifying relevant and commercial issues.

  Subsequently, each of the prospective bidders had an opportunity to make a presentation to the EA and MAFF and to discuss their particular concerns. Following the completion of the presentations the EA and MAFF with advice from Brown & Root and Ernst & Young evaluated against predetermined evaluation criteria each of the initial prospective bidders. The evaluation process resulted in the agreement of a shortlist of three bidders for each of the pilot schemes.

  The various concerns and issues raised by the prospective bidders were broadly similar and consistent with those which had already been identified as a result of the informed discussions with the private sector and from previous experience with other PFI projects. The key issues are summarised in the next section.

KEY ISSUES

  Broadly speaking the key issues which were raised as a result of the interactive discussions and preliminary bidding processes can be grouped under the following headings:

—  legal;

—  planning and consultation;

—  service definition, performance monitoring and payment structure;

—  risk transfer;

—  funding.

Legal Aspects

  Clarification was sought in respect of two particular legal aspects of the private sector providing a term of flood defence service. These were:

—  Did the EA have the statutory authority to contract with the private sector to provide a term flood defence service?

—  What would be the legal responsibility of a private sector contractor in the event that defences provided failed resulting in damaged property and/or loss of life?

  In respect of the first issue expert legal opinion has indicated that the provision of flood defences under PFI or a similar procurement mechanism would be achieved by the EA, in effect, appointing an agent to carry out its responsibilities and that the responsibilities of the EA to the community in general would be unchanged.

  In the case of the second issue the relationship between the EA and the private sector contractor would be described by the contractor undertaking to provide defence within a defined service level. The responsibility for the design and performance of the project works within the agreed level of service would be that of the contractor. Consequently should a failure occur at a lower level than that specified, the contractor would be responsible through the EA for consequential loss. A failure of the works as a result of an event outside the contracted level of service would not involve the contractor in any liability.

PLANNING AND CONSULTATION

  The provision of flood defence works may be subject to obtaining planning consent. In addition, the Environment Act identifies a number of statutory consultees who must be addressed in the development of any proposed works. The prospective bidders expressed concern that these processes could be disruptive to the orderly initiation and execution of the contracted works.

  In this regard, a number of issues are pertinent:

—  the EA and MAFF are conscious of this concern and are already undertaking vigorous action to address it. It should not be overlooked that flood defence projects would not normally be proposed unless a threat existed and, therefore, the statutory consultees and the planning authorities have a shared interest in ensuring an expeditious process;

—  the EA powers to provide flood defences are permissive, there is not an absolute obligation for such defences to be provided.

Service Definition, Performance Monitoring and Payment Structure

  Clearly for a term contract for the provision of flood defences to be capable of operation in practical terms it must address:

—  the nature and extent of the deliverable which the contractor is obligated to provide. The most likely approach which will be adopted for further market testing purposes is that the EA and MAFF will specify a bench mark level of service in terms of the protection to be provided, compliance with statutory processes and adherence to environmental guidelines and perhaps on other matters such as emergency response times;

—  the definition of the nature and extent of the contract deliverable must recognise the ability for the contracting parties to determine with a reasonable degree of assurance whether any failure of the works occurred inside or outside the boundaries of the contract deliverable. Therefore, the definition of the contract deliverable will need to recognise the approaches and techniques available to monitoring service and storm events on an on-going basis;

—  typically under a PFI and other similar contracts any shortfall in the level of service provided results in a reduction in the periodic contract payment. The level of the reduction of the payment is normally at a greater level that the level of the service shortfall so as to provide an incentive to the contractor to deliver the full contract obligations. A similar structure is envisaged in respect of the flood defence projects.

Risk Transfer

  A key aspect of PFI and similar contracts is that the contract risks are carried by the party most able to carry them. In other PFI contracts this area has been a source of considerable discussion and some ground rules and recognised methods of risk evaluation are now emerging.

  The principal issue as far as the prospect of bidders were concerned was that, at this stage, no precedents currently exist. However, some ground rules have been established and discussed with contractors and the issue is not seen as being a deal breaking matter.

Funding

  In addition to this paper brief reference was made to the joint MAFF/county precept funding for flood defence projects. The fundamentally different nature of a PFI or similar contract would mean that an obligation would be incurred to pay the contract sum in each year of the contract duration. Some prospective bidders required clarification as to whether such a commitment could be made given that the element of county precept funding.

  This particular issue has already arisen in the context of PFI schemes not connected with flood defences. The present Government has recognised the issue and has stated that it will be an impediment to the completion of appropriate good value for money projects.

  In the case of some non-flood defence projects negotiations have eventually failed as public sector approval for them has not been forthcoming due to funding difficulties. The EA and MAFF understand this point and are taking measures to ensuring that such a difficulty will not impact the pilot projects providing suitable value for money proposals are achieved.

THE MARKET RESPONSE

  The intitial proposals received from the prospective bidders and the subsequent presentations and discussions were characterised by a very high level of enthusiasm for the concept of developing new methods for procuring flood defence projects. The key issues raised above, although important, were essentially founded on a wish to receive clarification rather than to identify reasons not to proceed. There also appeared to be a sense of appreciation that the EA and MAFF undertook that prospective bidders would be kept fully informed of progress and would not be invited to participate in a process if the public sector side did not believe that there was a real chance of success.

  It was also extremely encouraging that the various prospective bidders had identified a range of different approaches to meeting the project objectives. These different approaches not only encompassed varying mixes of hard and soft defences but also suggested the use of alternative materials and different methods of working. Further, the prospect of bidders expressed a willingness to accept a benchmark level of service for contract purposes whilst pointing out that appropriate transitional arrangements would have to be made if the existing service level is less than that to be contracted.

  Many suggestions were made as to how design innovation could be exploited and knowledge developed in an iterative manner whilst recognising the need to meet the contract service obligation. This offers a real opportunity to develop knowledge concerning the most appropriate form of flood defence project design in terms of efficiency and achieving value for money.

  The concept of developing working partnerships comprising the EA, the planning authorities, consultees and the contractor was put forward as a responsible method of protecting the interests of the various parties. The commitment to this principle was demonstrated by an acceptance of becoming involved in a bidding process which would involve substantial expenditure by both the bidders and the EA.

  In summary, the response from the market far exceeded what would normally be expected in terms of "chasing" new business. The quality of the response was, no doubt, influenced by the openness of the EA and MAFF and their commitment to discontinue the initiative should it prove inappropriate.

NEXT STEPS

  In keeping with the commitment of the EA and MAFF to the prospective bidders the period since the completion of the presentations has been used to:

—  obtain the approval of the EA Board to the pilot projects being taken forward to the next stage of procurement;

—  briefing a representatives of HM Treasury and the Treasury Taskforce on the progress made to date and the future plans in respect of further market testing;

—  clarifying the issues in respect of the county precept and the funding of long term contracts;

—  obtaining legal advice concerning the most appropriate and lowest cost method of developing contract terms;

—  ensuring that an appropriate structure and resourcing are available within the EA to carry the projects forward.

  As soon as the EA and MAFF are confident of being able to honour their commitments to the market the shortlisted bidders for each of the projects will be announced. The next step will then be to move towards the development of an Invitation To Negotiate (ITN) document.

  The ITN will be developed on an iterative basis by having extensive consultations with the shortlisted bidders on all the key issues. The intention is that as many issues as possible should be confronted prior to the issue of the ITN so as to optimise the quality of the responses from the bidders.

  Clearly, preparing for an responding to the ITN will involve the bidders in significant cost. Therefore, the ITN will not be issued unless at that time (probably in or around April 1998) the EA and MAFF remain confident that the project remain viable commercial opportunities for the bidders.

  Assuming that the ITN is issued, bidders will be given an appropriate period in which to develop responses. The responses will then be evaluated and a period of negotiation undertaken prior to selecting a preferred bidder.

LOOKING FURTHER AHEAD

  The initial indications concerning the willingness of the private sector to develop innovative design solutions may well of itself offer further commercial opportunities. Providing value for money can be demonstrated there is no reason why further projects should not be procured using imaginative commercial terms. This possibility, coupled with the likely future spending on flood defence projects means that there could be opportunities for projects to become larger and more complex.

  Historically, the method of funding of flood defence projects has meant that they are constrained both on a geographical basis (county precepts) and an annual basis (cash accounting). A willingness of Government to address these constraints would reinforce the opportunities mentioned above in terms of larger projects.

CONCLUSION

  The initial reactions to the market of participating in flood defence projects on new commercial terms has been extremely encouraging. This encouragement has been complemented by the high level of commitment by individuals within the EA and MAFF to developing better ways of achieving value for money. These "soft feel good" factors combined with a real need to address the issues of sea level rise and replacing older flood defences offer an enormous opportunity for the private sector to develop a large and exciting market.

---

---

Prepared 5 August 1998