The Age: Sovereign risk does not apply to Victoria’s desalination plan. April 25, 2014. Kenneth Davidson, Senior columnist at The Age
At last the charade is over. Anybody can break a contract. This includes governments. Sovereign risk does not apply where governments choose to break a contract and remain subject to the legal remedy in the form of compensatory damages, according to a paper presented to a recent legal forum in Melbourne by Dr Nick Seddon, adjunct professor at ANU College of Law and the author of a standard text on government contracts.
The issue was spelt out against the background of the unity ticket between the Coalition government and the Labor opposition who argue that PPP contracts involving the desalination plant with AquaSure and the intended contract for the East-West Link cannot be broken, once signed, due to sovereign risk.
Both positions were exposed by Seddon, at the April 16 forum, as politically expedient, especially as the government has promised the project’s unsuccessful bidders would be paid up to $12 million for the cost of tendering a bid.
Seddon said: ”Sovereign risk is more of a political perception. The legal issue is straightforward, they can do it … there is going to be a certain amount of flak, but that flak can be fended off.”
In response, the shadow treasurer, Tim Pallas, backed down from the Opposition’s previous position that it involved sovereign risk. He said: ”while tearing up the contract would break no law, it would risk damaging Victoria’s strong credit rating and add to the cost of borrowing.”
Rubbish! If the East-West Link goes ahead as a public private partnership, the effective cost of capital tied up in the $6-12 billion project will be in the vicinity of 10-12 per cent. The immediate question is: if the project is worth doing then why doesn’t the government borrow the money itself, exploiting its triple-A status and paying 4 per cent on the borrowings, which would be half to two-thirds the PPP rate. The government is just as capable of buying the design and construction capability as the financiers who specialise in putting PPP packages together. Putting the project out to competitive tender is still the tried and true method of getting genuine value for money for infrastructure projects at minimum risk.
Countries such as Greece and Spain, whose credit ratings are B and BBB respectively, according to ratings agency Standard and Poor’s, have had a good response to recent long-term bond issues. The interest rates on these borrowings are about half the rate on a typical Victorian PPP.
Worse, the Coalition government refused to renegotiate the AquaSure desalination contract in order to take advantage of the easy availability of finance and low interest rates since the contract was initially signed in 2009. It said it couldn’t be done due to ”sovereign risk”.
The argument was completely bogus. For Victoria to refinance the loan at a rate less than 4 per cent – compared to 11.5 per cent payable over 28 years – is no different in principle than a mortgagor taking advantage of lower interest rates to renegotiate the loan, with a rival bank if necessary.
But last July AquaSure announced it was refinancing its debt. In September, Bloomberg New York reported that ”AquaSure is poised to more than halve its borrowing costs”. If the government had refinanced the contract, raising $6.5 billion to pay out the contract (which the Auditor-General said was the present value of the 28-year PPP), the Victorian government would have saved about $270 million a year.
By allowing AquaSure to refinance the debt and not fully passing through the savings to Melbourne Water users, the net saving to Victoria is only about $43 million a year, according to the government.
The refinancing has allowed AquaSure to both increase its surplus and use $1.05 billion of its refinanced borrowings to finance the losses due to flooding and industrial disputes. The company had announced its intention to sue the government over the losses, but Water Minister, Peter Walsh, dismissed the claims as without substance.
AquaSure was fully financed by bank debt. It has a plant that will not be switched on to produce water. The Coalition has set up a special unit in the Department of Sustainability and Environment to ensure that any potential future water shortage is met from recycling and conservation, not the desalination plant.
So how has AquaSure been able to borrow at the risk-free rate only available to governments with a triple-A credit rating?
Both the government and the opposition have denied AquaSure has been provided with a government guarantee for debt raised by AquaSure. This suggests AquaSure has been given a guarantee that the lease payments, totalling $28.3 billion over the 27 years remaining of the PPP contract, would have to be paid up front.
Breaking a lease agreement is less straightforward than refinancing a debt. It is likely to be more messy in that it would raise issues that would invite questions – who has really benefited from these contracts and whether any trailing commissions exist. Such questions may lead to a serious examination of the efficacy of all PPPs in Victoria.
Kenneth Davidson is a senior columnist for The Age. firstname.lastname@example.org