The Funding Strategy of the Cross City Tunnel Project - Case Study Example

Case Study: Cross Tunnel Sponsors of the cross tunnel project a) During project initiation: A private concessionaire (CCM), Baulderstone, Bilfinger, CKI City Tunnel Investment, GmbH, SAS Trustee Corporation, PSS Board, JP Morgan Nominees Ltd, CSS Board (UCL, n.d.). b) At financial close: Baulderstone, Bilfinger, Deutsche Ban Aktiengesellschaft c) After opening of the tunnel: Leighton Contractors/ABN Amro. 2. Funding a) The funding strategy that has been implemented is highly effective and efficient. While the project was being planned, public funding was ruled out. The underlying reason behind ruling out public funding may be the following: Public funding proposals can be very time consuming and often difficult to write. Government authorities and other agencies have their own sets of rule and regulations which may be difficult to understand and may be less convenient compared to other funding agencies. The conditions associated with public funding may be numerous and rigid. For example, reporting requirements, conditions associated with ways of administering programs and operating, arrangements for prescribed management of money may often heighten the difficulty for the agency responsible for conducting the project. Strict audit and accounting mechanism are required in case a project is publicly funded. The money that is in the grant has to be e-tracked accurately and the agency might need to return the money back to the financer in case it is not spent according to the condition that was agreed upon. This might prove to be a barrier at a later stage when the agency responsible for conducting the cross city tunnel project may need to spend the money elsewhere instead of spending it in the area that has been agreed upon in the conditions (Community Tool Box, 2013). The agency opted for a bidding process in order to seek for the contractor with the lowest bid who could be assigned with the project. The project was then funded by a combination of debt and equity. This is a highly effective strategy that is adopted in majority of situations where large amount of funds are required. The project needs to be funded by a combination of debt and equity and in order to ensure that operations are smooth throughout. In addition, amalgamation of debt and equity enables the agency to shield the project from risk exposures to any particular form of capital. Given the fact that equity capital is expensive to obtain, companies opt for debt financing to maintain the cost of capital at an average level. On the other hand raising funds through equity capital enables the agency to shield the project from interest rate risk (Thacker, 2014). The project was financed by AUD 0.58bn debt and AUD 0.1bn equity which makes the debt to equity ratio 5.8. This suggests that the proportion of debt is sufficiently high. This is not a good proposition as it makes the whole project vulnerable to interest rate risk in case the interest rate rises. However, financing the project with a greater proportion of debt might reduce the overall cost of capital needed for the project. On the other hand the agency could have maintained close to even proportions of both forms of finance. b) Demand risk is referred to as the risk that arises if the demand forecast does not meet the demand of the consumer. An in-depth study of the case reveals that demand risk is being taken by the entities that have funded the project. These are Baulderstone, Bilfinger, CKI City Tunnel Investment, GmbH, SAS Trustee Corporation, PSS Board, JP Morgan Nominees Ltd, and CSS Board. c) The traffic forecast that was done for cross city tunnel was apparently optimistic. It was reported that at full toll level of $3.56, the traffic that used the tunnel did not even reach 50% of the traffic forecast that was made. It is understandable that forecasting traffic is not an easy task and is susceptible to error. Flyvbjerg, Holm and Buhl (2006) conducted a study on traffic forecasting in infrastructure projects related to transportation. According to the report for 50% of road infrastructure projects the difference between forecasted and actual traffic is more than ±20%. The difference is greater than ±40% for 25% of the projects. Due to extreme inaccuracy in traffic forecasts along with higher standard deviations, a project gets exposed to large economic and financial risks. As far as the case of cross city tunnel is concerned a certain level of optimism bias was associated with the traffic forecast of toll roads. Empirical evidences have indicated that toll road forecasts on an average have been overestimated by 20%-30% (Phibbs, 2007). The conclusions which were drawn from the empirical evidence suggested optimism bias and errors after a year of operation was completed. The cross city tunnel traffic forecast was hugely inflated over the actual traffic that used the tunnel. This led to a considerable financial loss for CrossCity Motorways Pty Ltd, the initial owner of the tunnel. 3. Front end loading a) The procurement method adopted by the promoters in order to construct the cross city tunnel was highly effective. This can be evidenced by the fact that the tunnel was successfully built despite many barriers that the project faced in between. The cross city tunnel project basically involved procurement of two toll road tunnels that run 2.1 kilometres east-west underneath the central business district located in Sydney. The front end loading of the project was done quite mindfully. The project catered to address several issues such as reducing travel time, minimizing vehicle count on city streets, enhance the dependability of bus services, improved access for pedestrians as well as cyclists and enhanced aesthetic and safety features. The procurement strategy involved the usage of a Build Own Operate Transfer (BOOT) model by the public private partnership. Within the model, components required for the project were owned, operated and thereafter maintained by the private sector entities associated with the project. The cross city tunnel was designed, financed, constructed owned, operated and maintained by CrossCity Motorway Consortium. The construction cost was revealed to be $680 million which was majorly funded by private consortium and the expenses were reimbursed by toll tax receipts. The total cost incurred by CrossCity Motorway Consortium to complete the cross city tunnel project was reported to be approximately $1 billion which included the financing costs as well. This is the segment where the planning was a bit out of place. According to the forecast done by analysts of the authorities involved in the project, the whole project was expected to cost somewhere close to $800 million but the end result was not similar. The inception and planning of the cross city tunnel was highly effective and efficient. The planning phase of the tunnel was extensive. This was very obvious as the tunnel was going to address some of the major traffic related issues in a highly busy city such as Sydney. The idea was to construct a tunnel that would run 2.1 kilometres east west underneath the central business district situated in Sydney. At that particular time, a thorough economic evaluation gave estimation that a positive cost benefit could only be obtained when extra benefits accrued from operating a large underground car park with certain associated retail was incorporated with the mega project. Without the incorporation of extra benefits, when the benefits realized by the road user that included savings in travel time and many other factors were evaluated against the cost of construction, the benefit cost ratio was reported to be 0.88. This ratio is slightly lower than what is anticipated of the project. However a certain degree of optimism bias led to the approval of the project (PWC, 2008). The fundamental concepts lying behind the construction of cross city tunnel were mainly created by the road traffic authority ad were subsequently released to the public. The concept of the tunnel was quite similar to the previously designed long running streets. Following the consultation and feedbacks obtained from stakeholder and community further refinements were made in the design. An environmental impact assessment report was prepared and thereafter bids were called for from contractors. The plan of funding the project using a combination of debt and equity was a highly effective one as it shielded the project from being exposed to interest rate risk as a result of accruing significant debt. However, the significantly high debt to equity ratio suggested that the project was funded through a major proportion of debt which in reality exposes the project to market wide risk. b) Stakeholders of the project Client: Roads &traffic authority concessionaire Previous owner: CrossCity Motorway Consortium Contractor: Baulderstone, Bilfinger, Deutsche Ban Aktiengesellschaft New owner: Leighton/ABN Amro 4. The key risk exposures First of all, it has to be said that among all the public private partnership projects that took place in the country, the cross city tunnel project is very different because in this case the private partners were exposed to majority of the project related risks. The actions that have been taken by the government while breaking the terms of the contract will make the private partners are susceptible to higher financing costs and risks in the future. First of all at the onset of the tunnel project there was a great misjudgement while forecasting the rate of traffic that will avail the tunnel every day. The authorities responsible for making the tunnel forecasted that close to 90,000 vehicles will avail the tunnel which will require them to pay toll tax. The toll tax booths have been placed appropriately and in a way that the tax would enable the authorities to pay the interest of the debt accrued in order to complete the project. It was found that the forecast of traffic for the cross city tunnel was hugely inflated to the actual rate of traffic availing the tunnel. Thus as a result of extremely erroneous traffic forecast amalgamated with huge standard deviations led to economic and financial losses borne by the authorities associated with the project. The auditor-general heavily criticized the state road agency (RTA) for not being prudent about the traffic forecasts made by CCM. Although CCM was majorly responsible for forecasting the rate of traffic that would be availing the tunnel they clearly were exposed to a significant level of revenue risk. The misjudgements that were made by CCM while forecasting the traffic exposed the country’s government to a greater degree of political risk. This eventually forced CCM into receivership. The considerably lower level of traffic that availed the tunnel meant that the traffic changes above ground which was designed according to significantly lower level of traffic above ground was not able to cope up with the actual traffic using the tunnel. This led to huge public criticism against the tunnel project. As a result less and less people were availing the tunnel which in turn decreased the revenue that was generated by the authority leading to failure of the overall project. The bitterness of the public regarding the road changes must have contributed significantly to the lower levels of patronage in the tunnel. The instable government characterized by a changing Minister for Main Roads did not help the cause. This proved to be a huge barrier in the overall process of communication where the government was majorly responsible for conveying the road changes to the public. Thus a weak communication channel put the governments, other associated authorities as well as the owner of the tunnel into great deal of risk. In the event of growing unpopularity of the changes that were brought about in the road network and an upcoming state election, the state government was compelled to reverse the number of road changes. This involved closure of 13 roads in the year 2006. This attempt was made in order to shield the project from any political influences. Despite that the government was exposed to damage claims made by CCM. This destroyed any pre-formed notion about a public private partnership in the project. As a consequence the cost of undertaking any further public private partnership increased hugely for New South Wales State Government as private sector partners would most likely price higher for their partnership as a result of increased political or regulatory risk associated with the project (Phibbs, 2007). In order to mitigate the financial risks associated with the project the project was funded with an appropriate combination of debt and equity and toll levels have been set up in such a way that will enable the owner to pay off the interest for the debts that were accrued in order fulfil the project. Reference List Community Tool Box, 2013. Section 15: Acquiring Public Funding. [online] Available at: [Accessed 23 April 2014]. Flyvbjerg, B., Holm, M. S. and Buhl, S. L., 2006. Inaccuracy in Traffic Forecasts. Transport Reviews, 26(1), pp. 1-24. Phibbs, P., 2007. Driving alone-Sydney’s cross city tunnel. [pdf] University of Western Sydney Available at: [Accessed 23 April 2014]. PWC, 2008. Review of Major Infrastructure Delivery. [pdf] PWC Available at: [Accessed 23 April 2014]. Thacker, L., 2014. How equity and debt work together in your company. [online] Available at: [Accessed 23 April 2014]. UCL, no date. Sydney Cross-City Tunnel. [pdf] UCL Available at: [Accessed 23 April 2014]. Read More