New Paradigm Equals New Opportunities
The global environment for transportation financing is entering a new paradigm. Like many states, Pennsylvania finds itself at the convergence of two intersecting trends that demand fiscal attention: First, growing transportation needs are outstripping available capacity, and second, the need for maintenance and renovation of existing systems is eating up available resources. A failure to address these twin challenges will lead to even greater congestion in various forms and lowered relative reliability of service in the future. By any measure, these realities impact Pennsylvania’s economic competitiveness and its citizens’ quality of life.
While the vast majority of transportation projects around the country continue to be funded from traditional sources—gas and vehicle taxes—a new funding paradigm is rapidly emerging. State and local transportation agencies are increasingly looking to supplement these sources with private investment. While public-private partnerships (P3s) are just one “tool in the tool box,” they remain a promising and valuable tool available to policymakers that has been relatively untapped in Pennsylvania. P3s come in many forms; including the building of new infrastructure and assets and perhaps most promising, lease-concessions for existing toll roads.
We’re hear essentially because in the last two years have seen a major increase in interest, on the part of investors and toll road companies, in the U.S. highway market. The underlying reason for this interest is the large and growing funding shortfall in the highway sector. The most recent Conditions and Performance Report from the Federal Highway Administration estimated annual capital investment in our highways at $68 billion—yet simply to properly maintain the condition of our highways and bridges, we should be spending $6 billion more every year. And to improve the system, to cope with increases in auto and truck travel, we should be spending $51 billion more every year.
The newest trend is the rediscovery of the long-term concession model of public-private partnership. Under this model, in exchange for a long-term license to operate a toll road, an investor-owned company will finance, design, build, operate, modernize, and maintain a highway project, financing its expenditures from the toll revenues it is allowed to charge. This is a modernized version of the toll road charters issued by governments in the U.K. and states in the USA in the 18th and 19th centuries for the original turnpikes in both countries. It was revived in the 1990s with the Dulles Greenway in Virginia and the 91 Express Lanes and SR 125 toll projects in California.
This model is what built most of the postwar toll motorway systems in France, Italy, Portugal, and Spain. That’s why investor-owned companies from those countries are among the world leaders in the toll road business. Australia discovered this model in the 1980s, and today both Melbourne and Sydney are well-served by modern urban toll roads—and two Australian companies have become investors in the U.S. toll road market. The model was adopted in Latin America in the 1990s, especially in Argentina, Chile, and Brazil.
Essentially what this model is all about is extending the investor-owned utility concept from network industries like electricity and telecommunications to the network industry of limited-access highways. Just as those vital industries are affected with the public interest, so too is the highway industry. And just as the public sector has a role to play in protecting the public interest in those network industries, so it has a comparable role to play in the highway industry.
The model that has worked best around the world is to use the long-term concession agreement as the basis for protecting the interests of both parties in the long-term relationship. And the issues that need to be addressed in the concession agreement are pretty much the same, whether the agreement concerns the leasing of an existing toll road or the development of a new one. Over the span of 50 or 75 years, major construction or reconstruction will be required in any case, so all such concession agreements must address the same set of issues. The only major differences between agreements for existing toll roads and those for new ones is that the former involve large new revenues for the states, while the latter involve much higher levels of initial risk for the private partner.
Advantages of PPPs
Leasing parts or the whole Pennsylvania Turnpike has many benefits for taxpayers and commuters.
1. Access to large new sources of capital.
Theconcession model is attractive to many different types of investors, including equity investors and lenders. More important, it opens the door to institutional investors such as pension funds. Infrastructure has become a fashionable asset class for a host of investors that don’t invest in toll-agency bonds. Billions of dollars of private investment is available, as we’ve seen recently with the concession agreements for the Chicago Skyway and Indiana Toll Road.
2. Shifting risk from taxpayers to investors.
Public-private partnerships involve parceling out duties and risks to the party best able to handle them. For example, the state is the party best able to handle right-of-way acquisition and environmental permitting, so those tasks and risks are assigned to the state. The private sector in these deals nearly always takes the risks of construction cost overruns and possible traffic and revenue shortfalls. Given the poor track record of the public sector in transportation mega-projects, being able to shift construction and traffic/revenue risk to investors is a major advantage.
3. Multi-state potential.
One of the most important needs for investment is to cope with the growth in truck traffic. Much long-haul truck traffic involves several states, connecting a port or other origin to a major destination (such as a logistics hub). State toll agencies are, by definition, limited to doing projects within their own state. Long-term concessions are a good vehicle for organizing multi-state projects such as truck-only toll lanes to serve major shipping routes. These projects need to be developed in a unified manner, offering seamless service from origin to destination. The federal government can continue to play a vital role in standardization, but individual states or their toll agencies are not well-positioned to develop such unified projects; concession companies are.
4. More businesslike approach.
The typical U.S. toll agency and the typical European or Australian toll road company are miles apart in their approach to everyday business. Private toll road companies are less constrained by political pressure and are more customer service oriented. They are quick to adopt cost-saving and customer-friendly technology and specialized products and services to meet customer needs.
PPP Guidelines & Answers to Objections
Like anything else, P3s can be done well or poorly. This is true of each type of P3 from simple operational contracts to concession agreements for new and existing. Fortunately, while these arrangements may be new to Pennsylvania, they are not new to the rest of the world. A long history has established best practices and guidelines to ensure that quality is delivered and that taxpayers are protected.
The public sectors key role is setting the agenda—outlining expectations, goals, and desired outcomes. They set the standards and performance requirements. Once a private partner has been selected and a contract is signed, the role of the public sector shifts to that of oversight and evaluation. The government should never sign a contract and walk away. Rather, strong reporting, evaluation, and auditing components should be in place.
Given the focus and importance on a potential lease on any of Pennsylvania’s toll roads careful examination is warranted. While there are general guidelines as to how these deals are completed, it’s important to note that each is unique in its own way. Indeed, one of the undervalued benefits of P3s and concession arrangements is that they are customizable to fit the needs, goals, and desired outcomes of a community. In addition, the concession should be structured to mitigate any concerns and that adequate protections for the public interest can be included in the terms of the concession agreement.
There are many components of a concession agreement—length of concession, toll schedule, and performance level to name a few. One way to think of this is that each component is like a dial that can be adjusted up or down depending on the goals or needs of the governing body. Of course, each adjustment to the dial will have an impact on the on the concession price the private sector would offer. For example, “dialing down” the length of the concession term will lower the concession price while “dialing up” the ability of the concessionaire to raise tolls will increase the price. The governing body will have to balance their need for raising revenue with the needs of users and taxpayers. They’ll ultimately have to find the best mix of outcomes to satisfy their needs and appropriate protections for users and taxpayers. With that said the governing body has tremendous control and power to set the terms of the agreement.
It’s also worth noting at this time that these arrangements involve only a long-term lease, not a sale. The government remains the owner at all times, with the private sector partner carrying out only the tasks spelled out forit in the concession agreement.
Some key dials to consider:
There are concerns that PPP deals will lead to sky-high toll rates in future years, leaving the impression that tolls are uncontrolled. That is not the case in any actual or proposed PPP toll road that I’m aware of. Most concession agreements, to date, have incorporated annual caps on the extent that toll rates can be increased, using various inflation indices. It is important to note that those caps are ceilings; the actual rates a company will charge will depend on market conditions. Before entering into any toll road project, a company (or a toll agency) does detailed and costly traffic and revenue studies. A major goal of such studies is to determine how many vehicles would use the toll road at what price; too high a toll rate means fewer choose to use the toll road, which generally means lower total revenue. So the toll road must select the rate that maximizes total revenue. That rate may well be lower than the caps provided in the concession agreement, especially in recession years.
Here again, the notion of a dial illustrates the trade-offs that must be considered and the power the government has. While there is nothing that says a concession agreement needs to control toll rates, politically speaking it is a necessary component. The greater the flexibility and/or ability for the concessionaire to set toll rates, and increase them over time, the greater the initial pay out will be. “Dialing back” or limiting the ability of concessionaires to raise tolls will likely result in smaller bid prices. The goals and needs of the state will have to be weighed in this context.
2. Non-compete clauses
Clauses designed to protect toll road operators from the construction of new, parallel “free” roads have evolved over the years. The approach has changed from an outright ban on competing facilities to a wider definition of what the state may build—generally, everything in its current long-range transportation plan—without compensating the toll road developer/operator. And for new roadways the state builds that are not in its existing plan and which do fall within a narrowly-defined competition zone, the current approach is to spell out a compensation formula. The idea is to achieve a balance between, on one hand, limiting the risk to toll road finance providers (of potentially unlimited competition from taxpayer-provided “free” roads) and, on the other hand, the public interest.
Two recent long-term lease transactions provide a useful illustration. For the Chicago Skyway, there were no protections for the private-sector lessee. For the Indiana Toll Road, the agreement set up a narrow competition zone alongside the toll road. The state may add short, limited-access parallel roads (e.g., local freeways), but if it builds a long-distance road within the competition zone, there’s a formula for compensating the private sector for lost toll revenue.
3. Existing employees
The bulk of state jobs at jeopardy—manual toll collectors—is a dying occupation in the world. They’re quickly being replaced with electronic toll collection machines. With that said, concessionaires, like any business, would likely want to the freedom and flexibility to hire their own workers. Still if the state wanted to protect toll collectors jobs they could make this a condition of the concession—or at least make available positions to qualified candidates.
Even though existing employees would have an advantage in getting hired, because of their experience, this onerous condition will likely reduce the value from investors.
Another option is available. The state could take some of the proceeds from the concession to help displaced workers find new employment.
4. Maintenance and Performance Requirements
The widely expressed fear that states will lose control of vital highways reflects a misunderstanding of a concession agreement. These documents typically run to several hundred pages, and may incorporate other documents (e.g., detailed performance standards) by reference. These agreements establish guidelines for who pays for future expansions and rebuildings, how decisions on the scope and timing of those projects will be reached, what performance will be required of the toll road, how to deal with failures to comply with the agreement, provisions for early termination of the agreement, what protections (if any) will be provided to the company from state-funded competing routes, what limits on toll rates or rate of return will be, etc.
This isn’t a “dial” in as much a critical piece of the concession agreement. It goes without saying that a minimum the agreement should require the facility to be kept in good and safe physical condition throughout the term of the concession. However, the concession agreement presents an opportunity to establish standards and performance requirements.
Indiana’s lease is guided by a detailed 263-page concession agreement protects the public’s interests. Indeed, it has spelled out all kinds of “what-ifs” and established well-defined performance levels that the contractor is legally required to meet or face penalty. Dead animals, for example, need to be cleared off the road within eight hours and potholes need to be filled within 24 hours. These standards often go beyond traditional Indiana Department of Transportation requirements, something that could not have been done except through a private-lease agreement.
Most important of all, the state of Indiana can revoke the contract at any time. The concession agreement and lease sets the conditions for the state to cancel the contract and resume operations of the road should the contractor fail to perform. In any event, the state keeps the $3.85 billion payment. All risk is assigned to the contractor.
At a minimum the concessionaire should guarantee safety and provide for acceptable traffic flows.
There is great debate about the appropriate uses of proceeds from lease concessions or P3s. Some considerations:
First, any debt on existing assets should be paid off first—which in the long run, will create a stream of future benefits because of a smaller debt service. Doing so can avoid having the project characterized by negative metaphors like “selling off the family silver.”
In addition, proceeds should primarily be directed toward one-time capital expenses such as transportation infrastructure upgrades and improvements. Many of the state’s bridges are in need of significant repair; a prime example of where and how the proceeds should be spent.
Another widely accepted use of the proceeds is the establishment of a transportation trust fund to fund continued maintenance and operations. Generally speaking this would represent a much smaller piece of the proceeds. However, it is important to dedicate these resources, new infrastructure will need maintenance over time—it’s far wiser to dedicate and protect those funds today than years from now. Again, the bridge example highlights this need.
6. Foreign Ownership
In the early years of U.S. adaptation of the concession model, states want to deal with firms that have extensive experience as toll road providers. The simple fact is that the United States has no such industry, as yet, because we have used only public-sector agencies to build and operate toll roads. Thus, a responsible state government, wanting to ensure that the toll road is in experienced, professional hands, will weight prior experience very heavily in its selection criteria. As the U.S. market matures, we will see the emergence of a U.S. industry. Already, joint ventures between U.S. and global companies are bidding on such projects—Fluor/Transurban, Zachry/Cintra, Kiewit/Macquarie, to name several recent examples. In fact, in a recent P3 proposal in Colorado several of the bids were from domestic firms. In addition, US union pensions are attracted to investing in infrastructure because those investments create jobs for union members. Unions have already contributed to investment funds like the Australia-based Macquarie, blurring the line between foreign and domestic interests.
With that said, it would be unwise to ignore foreign operators, and their experience and expertise, simply because they are foreign. It’s important to remember that even deals that involve 100 percent non-U.S. companies are very good for the U.S. economy. Attracting billions of dollars in global capital (and expertise) to modernize America’s vital highway infrastructure is a large net gain for this country—rather than investment and jobs going overseas; foreign entities are willing to invest their money domestically, creating jobs here in the US. The further build-out and investment in our transportation infrastructure only makes the US more competitive in the global marketplace as well. In effect, foreign investment in our nations’ infrastructure represents the “in-sourcing of America!”
We might keep in mind that 150 years ago, European capital played a major role in creating America’s railroad network.
As we move into the 21st century it is clear that we’ve entered a new paradigm in transportation funding and operations. The success of existing private sector participation in transportation services highlights the potential benefits for the vast majority of transportation projects needed in Pennsylvania. Public-private partnerships offer some major advantages, none more important than relieving congestion and improving mobility.
Business as usual won’t work any longer. Pennsylvania’s policy makers need to embrace a new paradigm for highway funding and operation. Doing so will better position the state for future economic development and growth.
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Geoffrey F. Segal is director of government reform at the Reason Foundation (www.Reason.org), and an adjunct scholar at the Commonwealth Foundation (www.CommonwealthFoundation.org), an independent, non-profit public policy research and educational institute located in Harrisburg, PA.