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8 July 2014
In May, when the Office of Fair Trading (OFT) report entitled 'More competition, less waste' landed on the desks of senior civil servants at Department for Environment, Food and Rural Affairs (Defra) and the Treasury, drawing on the research of the second Kelly market report into waste management projects, the prognosis for the municipal waste management sector, and in particular the role of the PFI, was far from good.
With only 12 out of a total of 800 PFI deals across all sectors signed in relation to waste, and with no projects having reached financial closure since May 2003, many in industry, the finance sector and advisers asked the question of whether PFI was the right solution to deal with the nation's ability to meet the significant potential fines that will be imposed if the UK fails to meet the EU Landfill Directive targets.
Moving forwardHistorically, the UK has relied on landfill for waste disposal. However, the directive, together with the targets imposed on local authorities under the Waste and Emissions Trading Act 2003, requires significant reductions in the amount of biodegradable municipal waste being sent to landfill. Indeed, as outlined in the OFT report, Defra has identified that around 2,300 new waste-treatment facilities will be required by the year 2020.
The past few months have, however, seen the bottleneck on waste projects funded under PFI starting to clear, with three significant projects reaching financial close after being in procurement, on average, for a period of four years. These projects include the £1.2bn Nottinghamshire Waste PFI Project won by Veolia Environmental Services, the Cornwall Integrated Waste PFI Project won by SITA Suez and funded by the Royal Bank of Scotland and the European Investment Bank, and finally the £600m Central Berkshire PFI Project signed between Reading Borough Council, Bracknell Forest Borough Council, Wokingham District Council and Waste Recycling Group with funding provided by NIBC Bank.
With a further £4bn worth of waste deals due to close in the new few months, including the largest project in Europe - the £1.5m tonne Greater Manchester PFI project, things are starting to move in this troubled sector.
The impact of DefraSo why has the market started to move? And who are the drivers? Well, much of the credit must go to Defra and Partnerships UK, which have sought, through active participation in both the Nottinghamshire and Cornwall projects, to engage with contractors and their financiers to understand the key risk issues and where waste PFI projects differ from other sectors. This process has resulted in new guidance for PFI waste contracts, together with a revised set of criteria, which local authorities must meet in order to qualify for receiving PFI credits.
To explore the drivers, and get to the bottom of whether PFI is the right solution for waste, it is necessary to re-examine what makes a PFI, and how waste projects fit this definition.
In its most basic form, a PFI project is a long-term service contract between the private sector and a public body for the provision of a service for an annual price that is generally fixed subject to inflation. The contract will typically involve the construction of a capital asset, together with the ongoing maintenance of that asset, and usually some services relating to its operation as a public facility (cleaning, catering, etc). Normally, the construction costs of the asset are financed using project finance provided on a non-recourse basis to a special purpose company established specifically for the project. Typically, payments are not made until the asset has been constructed and handed over for use by the public sector. The private sector will receive payments over the life of the contract (typically 25 to 30 years) to cover the initial cost of construction, together with the ongoing costs of maintenance and the provision of services. These services will be subject to certain standards, and financial deductions will be imposed to the payment stream if the private sector fails to meet them.
Risks involvedIt is not difficult to see that, compared with other sectors, such as schools and hospitals, where there is a fixed asset that requires services, waste projects have a somewhat different risk profile. The risks of the project are increased due to the complexities of the technology and the difficulties of achieving planning permission for new waste facilities, as well as the fact that if it all goes wrong, it may not be possible to find an alternative contractor to take over. In waste projects, these risks have often been compounded by a desire for the public sector to look towards the PFI contractor to provide a cradle-to-grave waste solution, mixing the operationally intensive but relatively low capital costs of collecting and recycling waste together with the management and operation of civic amenity sites and the more capital intensive treatment facilities, including energy from waste plants. This leads to conflict between the interests of the financiers and the other contract services.
The answers that have been imbedded within the new Defra criteria are that PFI is only part of the solution, and projects should:#focus on the delivery of capital-intensive treatment assets where finance is required upfront;#look at regional solutions where economies of scale will lead to lower costs;#take steps to manage planning risks by clearly identifying sites within an approved waste development framework and take steps to secure interests in those sites; and#clearly identifying the risks for the project and which party is best placed to manage them.
If all of the above criteria are fulfilled then PFI may well be the best solution. If not, authorities should probably think again before deciding to go down the PFI route, and look to other service delivery models to encourage a mixed economy of projects of different technical complexities.
With the rapid rise up the political agenda of environmental issues, there is no doubt that the waste sector offers significant opportunities for commercial investment to move the UK a few steps nearer to some of our European neighbours in finding alternatives to dumping our waste in the ground. nJames Snape is a partner at Nabarro Nathanson