CBI calls for more waste services outsourcing

The CBI has published a report on open access to public services, which has been produced by Oxford Economics. This includes estimates of the potential savings which the public sector could make from outsourcing those services which are currently conducted in-house by the public sector.

The report highlights the fact that just over half of waste (collection) services remain in-house. It then estimates that there is a minimum of £192 million savings which the public sector could make from a fully open waste services market.

This estimate is based on assumed producitivity improvements of 15% which are then applied to all authorities which currently retain their services in-house. That 15% figure seems to come from primary research with private sector providers.

As one might expect, I am a big fan of outsourcing waste services to the private sector but these suggested savings seem high to me. I feel that a lot of the efficiencies in the waste services market have already been driven through. Margins on waste collections are very tight and further improvements may be more difficult to achieve. I also don't believe that such large savings would be realisable without half of authorities spotting them. It just doesn't seem credible, although I could of course be wrong.

Some local authorities are also apparently in the naughty habit of calling their services to tender before withdrawing once they have received private sector bids. This allows them to pinch private sector method statements and apply them to in-house services, thereby undermining some of the practical case for large savings' estimates.

I also note that the case study cited in the report is from poor old May Gurney who have run into some recent difficulties on their recycling contracts. They appear to have been quite aggressive in their revenue assumptions from recyclate sales. Now that commodity prices are falling their contracts are running into difficulty. Recyclate prices follow those of primary commodities but tend to be even more volatile on a proportionate basis and this is now hurting the industry.

Contrary to the CBI/Oxford Economics proposals, there has been an increasing recent trend for local authorities to bring waste services back in-house. This has been driven by high recyclate revenues on the back of the recent biggest boom in commodities' history. Authorities have seen these high revenues as a potential cash cow in straightened times.

Falling prices mean that this model may be undermined going forward and more authorities will realise that competition between private sector providers does deliver decent potential savings to public sector budgets. But I suspect not as high as 15% for waste services.

Risk transfer - who benefits the most?

I was at the RWM exhibition last week, which apparently again attracted record visitor numbers. These large-scale events give the opportunity to hear some leading industry figures give their views on the big issues of the day, and while these are often banal you can find the occasional nugget of interesting information.

Wednesday's panel debate in the leaders' theatre was a case in point. Much of the discussion centred on concerns about access to finance coupled with falling material prices, both topics which I have covered before. What was interesting for me though was the disagreement between the participants regarding the exact nature of the risk transfer between the public and private sectors. Generally the operators/contractors felt (unsurprisingly) that the private sector had taken on too much risk in their municipal contracts, while an advisor was of the opposite view and suggested that local authorities had retained too much risk.

So, who is right?

In an ideal world different risks would be appropriately shared according to the principle of which party is better able to manage that risk. When discussing residual waste projects we might group the risks into: inputs; process; and outputs.

When it comes to input (feedstock/volume) risk we might think that authorities would be able to better manage that as they are the ones directing householders through collections. But contractors tend to take a view which they build into their assumptions. They then rely on being able to substitute commercial waste for municipal waste to be able to make up for any shortfall. (It is of course a shortfall we want as this would indicate that residual municipal waste has been minimised and is below expectations.)

Where there may be a potential antagonism is where authorities demand (rightly) priority access to a facility when volumes are high but do not give the contractor the freedom (perhaps through non-compete clauses for commercial waste) to be able to make up for a shortfall when volumes are low. In this way we may find that the contractor ends up being unable to manage their exposure to volume risk appropriately.

When it comes to process/technology risk, this is undoubtedly something which it seems to me should rest with the contractor. Some disagreement may however arise concerning the differing risk profiles of the construction and operational phases of a facility. The construction (and commissioning) phase is high risk and fraught with potential technical problems. The operational phase however tends to be relatively straightforward and lower risk.

Early PFI contracts saw some big gains to contractors who were able to refinance on favourable terms and make relatively large returns once projects were into the operational phase. This was seen by the public sector as unfair profiting at their expense. The contractors would probably argue that the rewards they gained were commensurate with the risks they took, but this is certainly a controversial area. It is also an area where the rules on refinancing were subsequently tightened so that any potential upside to the private sector is now effectively capped.

This has therefore now become another area where contractors feel that they are exposed to large potential downside losses while their upside is capped, i.e. the risk transfer has now swung in favour of the public sector.

The other area of risk is on outputs/offtake. This is again an area where the contractor is going to have to take a view and hope that they are able to manage resulting price volatility over the life of the contract. We may find increasingly that some contractors (perhaps more applicable for recycling contracts) have overestimated potential offtake revenues and run into trouble.

From the above, I find it difficult to conclude that local authorities are retaining too much risk and instead would agree with contractors who suggest that they offer good value for money to their local authority customers. This may not always have been the case and those who managed to secure favourable terms in the early days of PPP/PFI agreements may have done well out of them. But right now being a waste management contractor is a difficult place to be with both volumes and prices falling. These are conditions which could place severe pressure on some industry participants.