Morina Rennie is a professor of accounting in the University of Regina’s Faculty of Business Administration. She researches public sector accounting, risk management, and private company auditing.

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Regina Water War - Referendum 2013There has been a lot of posturing on both sides of the Waste Water Treatment Plant (WWTP) upgrade issue with much contradictory information being bandied about. People I have talked to are having trouble knowing what and who to believe. I have been studying the publicly available information on this issue (from an accounting prof’s perspective) and I’m hoping I might be able to say a few helpful things in relatively plain language in this commentary.

The City relies primarily on a consultant’s report prepared by Deloitte LLP which carried out a Value for Money analysis on various approaches to upgrading the WWTP. The three finalists were the traditional public sector procurement model (Design-Bid-Build or DBB); the P3 model (Design-Build-Finance-Operate-Maintain or DBFOM); and a third hybrid option that is not on the referendum ballet. On the other side, Water Watch is relying on another consulting report, written by economist Hugh Mackenzie.

It seems that there are two main issues that have caused confusion:

Financing costs
Water Watch says that the P3 will be more costly than the traditional public sector option (even with the federal government grant) primarily because the borrowing (i.e., financing) costs will be higher under the P3 option. Under the P3 arrangement, the private partner must initially pay for a portion of the WWTP construction costs. The City must then pay the private partner back over a 30 year period at a higher interest rate than it would have to pay if it were borrowing the money from its usual lenders. The City acknowledges the greater financing costs in its website Q & A on P3s: “Financing costs will be higher with a P3 because the City will pay a premium for the financing costs and the risk assumed by the contractor.”

It appears that the Deloitte Report has not incorporated the financing cost differential into its analysis. The Mackenzie report includes an estimation of the extra financing costs for the P3 option and the figures that Water Watch is publicizing are based on Mackenzie’s calculations. While I believe the Water Watch estimate of the extra financing cost may be on the high side, the extra financing cost is a substantial real cost that will be paid by taxpayers over the next 30 years.

The $79.6 million cost saving
The City uses a figure of $79.6M as our savings under the P3 approach (and the City’s $276 annual taxpayer saving is computed as each household’s share of this $79.6M, divided over the next 4 years). The City presents the $79.6M to the public as if it were a hard and fast number. But it is actually a very soft number.

The $79.6 comes from Deloitte’s Value for Money (VFM) estimates. It is the difference between Deloitte’s cost estimates for the traditional public sector (DBB) approach and the P3 approach. The P3’s estimated cost in this calculation has been adjusted downward for the federal grant money, but does not incorporate the net present value of the extra financing costs mentioned above. Also the $79.6M is significantly influenced by what is referred to as “retained risk” estimates that ultimately swing the VFM in favour of the P3 option. The Deloitte calculations include $60.9M of retained risk in the estimated cost of the traditional (DBB) public sector approach and include just $12.7M of retained risk in the P3 estimated cost. Retained risk assessments are not without controversy. Concerns have been expressed that the risk amounts assigned to the traditional public sector option may be too large in many VFM calculations and it is not uncommon to find this issue raised in academic research articles on the VFM methodology. The retained risk issue has also been addressed by Ontario’s Auditor General in an audit the Brampton Civic Hospital P3 project. The AG was concerned that the risk amount in the VFM calculation was inflated for the public sector option (as were other cost estimates for this option). The Auditor General concludes, “the all-in cost could well have been lower had the hospital and the related non-clinical services been procured under the traditional approach, rather than the P3 approach implemented in this case” (2008 Annual Report of the Office of the Auditor General of Ontario, p. 104).

If one thing is certain, it is that the various estimated costs that we are presented with are, on the whole, very uncertain. Perhaps it would be useful to keep in mind recommendation #2 from the Deloitte Report which points out that this issue is not just about the money: “The City should determine whether transfer of operating responsibility to a contractor under a DBFOM contract [the P3 option] is acceptable as this is a key determinant in the final selection of delivery model.” It seems to me that a democratic process such as a referendum is exactly the means by which such a key determination should be made.

Please contact me at morina.rennie{at}uregina{at}ca if you would like information on assumptions or calculations underlying my comments.

Morina Rennie, PhD, FCA, FCMA
Faculty of Business Administration
University of Regina