Written evidence submitted by North Yorkshire
Waste Action Group
EXECUTIVE SUMMARY
1. NYWAG believe PFI is inflexible, expensive
and inherently wasteful of public resources. In waste management,
it tends to lead to large capital-intensive projects that lock
Local Authorities (LAs) into long-term (~25 year) inflexible contracts.
This locks out technical developments, discourages greener options
and freezes out cheaper solutions such as providing services through
a multiplicity of local providers who would create many more jobs.
2. In PFI there is a conflict of interest between
the desire to make the best use of the skills and knowledge of
the private sector, the inevitable self-interest of firms motivated
by profit and the democratic wishes of local communities. Separation
of responsibilities between waste management consultants and the
eventual contractor could help address this issue. This is especially
important where the public sector lacks sufficient experience
to act as an informed customer.
3. PFI projects are generally more costly; private
debt always costs more than public debt and PFI incurs additional
transaction and financing costs. In long PFI contracts managing
the quality of service is difficult.
4. The psychological impact from greater transparency
and visibility of debt would have reduced the use of PFI. Problems
with lack of transparency render bringing PFI debt on to the balance
sheet imperative.
5. Under PFI, public bodies are expected to develop
interdependent relationships with suppliers that allow risk to
be transferred. This often leads to asymmetrical relationships
where the private body holds much of the power so risk isn't transferred.
Moreover, risk is often factored into the original cost so facilities
cost markedly more than if funded directly. As the public sector
wants the project to do the intended job, if the contractor faces
real difficulties in meeting the PFI terms then the state is likely
to bail them out. This implicit guarantee renders risk transfer
to the private sector somewhat illusory
6. Observing the decision-making process locally
makes us doubt whether PFI is a suitable vehicle for LAs, particularly
for large projects where the LA has little or no experience (eg
MSW incineration). There are also dangers in many LAs taking similar
decisions at about the same time (a classical "bubble"
situation). An immediate decision to remove PFI support for incineration
projects would reduce this risk and save the taxpayer £billions.
Introduction
1. NYWAG believe PFI is inflexible, expensive
and wasteful of public resources. In municipal solid waste (MSW)
management, it tends to lead to large capital-intensive projects
that lock Local Authorities (LAs) into inflexible long-term contracts
which lock out technical developments and discourage greener options
This is particularly unfortunate as rapid technical progress is
being made in MSW management in several competing technologies.
This is contrary to the current opportunity to create an environmentally
sound strategy for MSW management. This would reduce the amount
of waste produced, maximize re-use and recycling and avoid incineration
with its inflexibility, high capital costs and financial, environmental
and health risks.
2. Our evidence derives largely from the perspective
of MSW management following the Landfill Directive. While PFI
may impact differently in other areas, some of the factors concerned
are common.
Strengths and weaknesses of public procurement
methods
3. We cannot review all methods of public procurement.
Instead we examine some of the tensions involved in using PFI:
(a) There is a conflict of interest between the
desire to make the best use of the skills and knowledge of the
private sector, the inevitable self-interest of firms motivated
by profit and the democratic wishes of local communities.
Moving towards a "zero waste" economy requires public
acceptance, making it crucial that LAs use waste management consultants
guided by strong "green" central government policies
to derive their waste strategies. Only after doing this with full
public consultation should waste management firms be brought in.
Separation of responsibility between those who design the strategy
and those who implement it is essential. PFI doesn't provide this
safeguard.
(b) In MSW management, some LAs have insufficient
knowledge to design a viable, cost-effective strategy that meets
local needs. When moving away from a landfill-based strategy,
this makes them over-reliant on private sector advice but without
the experience to act effectively as informed customers. Reliance
on their PFI partner during public consultation risks a "sham"
consultation with commercial interests playing too strong a role.
(c) There is a democratic deficit. Small local
(eg parish) councils can object strongly to major developments
in their area but have no effective say in whether they go ahead.
They (and local people) should be given a much stronger say.
4. PFI projects cost more than direct-funded
ones due to financing costs which a public sector alternative
would not incur; Pollock et al (BMJ, 342: 1205-209, 2002)
found that on average financing costs for NHS PFI schemes in three
areas added 39% to total capital costs. More generally:
(a) Private debt always costs more than public
debt. Even before the credit crunch, private finance interest
rates were 2.5%-4% above public borrowing rates (Audit Scotland,
2002: 58, Pollock and Price, BMJ, 341:7175, 2010).
The PAC's 2010 report on financing PFI projects found PFI has
become less affordable following the credit crunch; banks lending
to PFI projects have increased their interest rates by 20-30%
since the financial crisis. This means higher annual repayments;
the PAC (op cit) said increased bank charges "added £1
billion to the contract price, payable over 30 years, for the
35 projects financed in 2009."
(b) The amount of capital raised under PFI is
inflated by financing charges such as professional fees and the
"rolled-up interest" due during the construction period
when the PFI consortium is not yet receiving any payments. Additionally,
there are fees for preparing the PFI bid and contract negotiations
(not always identified in advance).
(c) PFIs/PPPs suffer from increased transaction
costs arising from the complexity and long duration of the relations
between the diverse actors. This may be exacerbated by culture
gaps between the two sectors.
5. When LAs use PFI, central government gives
them PFI "credits" to meet the capital element of funding
(with which LAs pay the private sector). The LA selects a private
company and transfers detailed control of the project, and in
theory the risk, to them. This can mean both the taxpayer and
council taxpayer unwittingly accepting financial risks:
(a) Some LAs lack the experience to carry out
proper sensitivity analysis and risk assessment and do not carry
out a proper discounted cash flow analysis. Instead, they use
a very limited range of assumptions, some of which are implausible
(eg landfill tax will rise in real terms every year in perpetuity;
waste quantities will increase despite national trends to the
contrary) to make a case for their "preferred" (PFI)
solution. The latter can be selected at a very early stage and
the financial implications of newer competing technologies and
greater waste reduction, reuse and recycling is never taken into
account.
(b) PFI typically involves large contracts. In
MSW management, this means a preference for expensive technologies
like incineration. Cheaper options through variety of smaller,
local providers are not considered because they don't fit well
with the PFI model as a multiplicity of smaller contracts (often
using a range of different technologies) would be involved. This
adds unnecessarily to costs. The table compares North Yorkshire's
preferred PFI option at Allerton Park (featuring a large incinerator)
with alternative independently costed options (others exist, also
without incineration).
| Option
| Cost | Saving vs option
|
| | |
| 1 | 2 |
| 1 | Continue to landfill |
£1.8bn | | |
| 2 | Proposed Allerton Park facility.
| | £320m |
|
| 3 | Use small to medium local companies with their own facilities and using their own capital to build new plant as required, capable of digesting and mechanically sorting black bag waste. Meets permitted levels of landfill, involves no risk for taxpayers and offers potential for future developments and local jobs.
| | £958m | £638m
|
| 4 | Working towards "zero waste", implementing a waste hierarchy relying on Reduce, Re-use and Recycle. Realistically achievable in 5-10 years; many regions and cities across the world have exceeded the 60% recycled rate envisaged here.
| | £1.2bn | £880m
|
| 5 | Bio-drying (variant of Mechanical Biological Treatment), which has low capital costs and is technically simple. First step: dry and clean black bag waste, reducing weight by 30-40% (hence reducing landfill by ~40%) and making it easy and safe to sort. Next, sort and bale materials such as plastics, metals and other recyclables leaving a residue that can be sold as RDF or put into landfill.
| | £545m | £225m
|
Why has this substantial saving been ignored?
(c) The planning process and selection of preferred bidder
take a long time. In a fast-moving field, the chosen technical
approach can be out-dated even before final approval. Yet no-one
reviews the decisions made to check they remain appropriate and
no subsequent risk assessment is made. Thus an inappropriate choice
becomes probable.
6. PFI is inflexible as contracts are typically 20-25 years.
This "locks-in" any erroneous choice and places reliance
on obsolescent technology for some, or all, of the contract. Government
should advise LAs to include break clauses in long-term contracts
(eg every five years) so they periodically have the opportunity
to get out of commitments they no longer see as sensible
7. PFI leads to excessively high capital costs and unnecessarily
high interest rates that place an undue burden on the taxpayer.
It can distort the market, eg by preference for large-scale facilities
at the expense of a multiplicity of smaller, local facilities
at lesser cost. PFI contracts frequently create fewer jobs than
the local alternative. In MSW management, PFI tends to favour
multi-national giants and incineration (which is inflexible, capital-intensive
and creates relatively few jobs) and runs counter to smaller local
providers (who offer flexibility and would employ many more people).
Should PFI debt be on-balance sheet?
8. Financial problems can arise from lack of transparency
(c.f. the banking crisis). Currently, the public sector can "hide"
debt by taking it off-balance through PFI making it appear less
"real"; this risks spending decisions being taken too
lightly. This debt can be ignored when considering further PFI
deals so the portfolio of hidden debt builds up without anyone
noticing. Keeping it on-balance would increase awareness of the
debts and perhaps influence decision makers.
9. Failure to realise there is a price to be paid for any
transfer of risk to the private sector reinforces the effects
of the lack of transparency arising from PFI debt being off-balance.
For LAs, this may be further exacerbated through the PFI "credit"
which may "hide" the PFI debt, further reducing transparency.
10. The increased awareness from greater transparency and
visibility of debt would probably have reduced the use of PFI.
Problems with lack of transparency make bringing PFI debt on to
the balance sheet imperative. It would alert Government and LAs
to the true extent of their debt.
Risk transfer to the private sector?
11. PFI should transfer risk to the private sector. Under
PFI, public bodies are expected to develop interdependent relationships
with suppliers that allow risk to be transferred. However, engineering
such relationships isn't always possible and public bodies will
often find themselves asymmetrically locked-in to their supplier.
This leads to private sector suppliers becoming dominant in those
relationships, allowing them to pass back risk and obtain greater
returns. Whether risk can be transferred under PFI comes down
to timing and the nature of the relationships involved.
12. An example of this type of skewed relationship is the
imposition on LAs to supply and pay for a certain amount of MSW
in Energy from Waste (EfW) incineration plant and to pay for it
even if they don't supply it; a form of "take or pay"
contract that places most of the risk on the LA. LAs should avoid
such clauses which place them in a weak position; the incinerator
operator can effectively force changes to planning consent and
the types of waste treated in ways that may be contrary to the
original tender documents.
13. Under PFI, transfer of risk to the private sector can
be illusory in that the public sector pays an inflated price.
Pollock et al (op cit) found that before
risk was costed, the hospital schemes they studied would have
been built much more cheaply with public funds, even with a high
discount rate (which favours PFI). Thus risk transfer was critical
to proving the vfm case. While they found considerable variation
between schemes in the absolute and relative value of risk transferred,
in all cases risk transfer almost equalled the amount required
to bridge the gap between the public sector comparator and the
PFI. (Even after this manipulation, the difference was marginal
often under 0.1%). They concluded that the function of risk transfer
is to disguise the true costs of PFI and to close the difference
between private finance and the much lower costs of conventional
public procurement. They felt this both raises questions about
the reliability and validity of the methods used and about why
the government is using an unevaluated method of procuring critically
important services.
14. Risk can be a matter of differing perceptions and this
can lead to wrong technology choices. Councils seeking a long-term
alternative to landfill were attracted by PFI to secure private
funding. However, the Sunday Times has reported that bankers
were only prepared to lend the large amounts of money involved
in return for a very low risk. They believe only incinerators
offered such low risks so the choice of PFI skews the LA's technology
choice.
15. PFI can introduce additional risks:
(a) Poor service is hard to manage when locked into a 25 year
contract, eg facilities management in a lease-back building may
be the responsibility of the property company. Poor service would
be hard to manage because there is little real incentive to improve
it.
(b) Private sector organisations respond to commercial pressures
which may exacerbate environmental and/or health risks. For waste
incineration, there is a need for strong independent monitoring
to counteract commercial pressures.
Risks and projects suited to PFI?
16. It is perhaps easier to say what should not be dealt with
under PFI. Observing the local decision-making process makes us
doubt whether PFI is a suitable vehicle for LAs, especially for
large projects where the LA has little or no experience (eg incineration).
17. Many LAs may take similar decisions at about the same
time without giving consideration to national or international
factors; eg the Landfill Directive has led to a large number of
MSW incineration projects at various stages of development. This
could mean overcapacity, something already seen in some European
countries. A past president of the Chartered Institution of Waste
Management thinks the UK has benefited from not currently having
too many EfW plants in operation, saying. "It has been useful
in having Kyoto targets and also funding mechanisms for projects.
But, in some ways we have avoided the problems that the Germans
and Dutch are facing, ie over-capacity as far as their EfW facilities
are concerned. In the UK we have the possibility of other options
in developing other sustainable sources of energy as well, such
as biofuels rather than just incineration".
18. Perhaps this view is over-optimistic—there is a
risk that PFI could kill other options. An immediate decision
to remove PFI support for incineration would reduce this risk
and save the taxpayer £billions.
Implicit and explicit state guarantees
19. Ultimately the public sector wants the project to do the
job intended. Hence, if the contractor faces real difficulties
in meeting the PFI terms the state may bail them out in some way.
Hampshire overestimated waste volumes, resulting in the construction
of three large incinerators. The original planning consents allowed
only waste from within Hampshire to be burnt. However, the high
capital cost means incinerators need a high load factor and hence
an adequate and regular supply of waste. By April 2006 Hampshire's
incinerators were being topped up with residual waste material
from household waste recycling centres. By October 2009 BBC Radio
Solent reported that Veolia (who run Hampshire's incinerators)
was asking Hampshire to allow importing waste from surrounding
counties. Today, despite local opposition, it is obliged to import
waste from outside Hampshire to remain fully operational. There
is now a risk that the Hampshire Council Taxpayers could be penalised
due to the inaccuracy of the original project figures.
20. Transfer of risk is considerably less than it might appear.
Also, if the project is too big or too important to be allowed
to fail, there may be an implied guarantee of the project, or
even the PFI partner.
When are PFI deals suitable?
21. PFI typically leads to long-term contracts which offer
benefits to the private sector supplier(s) but lock the public
sector into facilities and services that may become obsolete or
uncompetitive during their lifetime. This is especially true in
fast-developing fields where there are a number of competing choices,
rendering PFI unsuitable in such fields. PFI shouldn't be allowed
to stifle the possibility of innovation and development and the
concomitant benefits.
22. PFI is suitable only for long-term capital projects (eg
offices) where innovation appears slow and for any development
which can be properly future-proofed. For the latter, risk must
genuinely lie with the private sector.
CONCLUSIONS
23. PFI typically leads to long-term contracts which offer
benefits to the private sector supplier(s) but lock the public
sector into facilities and services that may become obsolete or
uncompetitive during the lifetime of the contract. PFI is costly,
leaves too much risk with the public sector, makes management
of the quality of service delivery unnecessarily difficult and
stifles technical innovation. The practice of PFI debt being off-balance
sheet leads to lack of transparency about the scale of debt and
may have led to unsuitable projects proceeding. PFI is unsuitable
for many large projects by LAs. Government should take a decision
that waste incineration will no longer be supported by PFI. This
includes any projects for which approval has been given but construction
work has not yet started.
April 2011
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