Privatizing Transportation Systems

1. Privatizing Transportation Systems Highways, Buses, Rail, water and airports: Literature Review

2. The Problem with Highway funding • Congestions cost America $168 billion a year. If not resolved then cities will die as centers of economic productivity, as centers of culture, and a pleasant place to live. Over half of interstate are congested and one fourth of bridges are rated deficient. • The annual investment needed to maintain the current level of pavement condition using public funding is 8.3% short. • In order to just keep pace with the growth in driving and truck usage should be higher by 74% than current capital spending of $68.1 billion.

3. Advantages of P3 in Transport PPPs have been widely recognized over the last several years as an innovative approach to transportation funding and procurement that can reduce project costs, accelerate project delivery, transfer project risks to the private sector, and provide valuable, high-quality projects; but these benefits alone do not explain the growing number of PPPs that are being procured in the United States.

4. Reasons for P3 in transport PPPs are being utilized at a record pace because: • PPPs respond to congestion and system unreliability by providing high-quality, well managed projects and better performance; • PPPs address the demand for transportation investment by providing access to a vast amount of private capital available for investment in transportation; • PPPs reduce the wasteful effects of political and special purpose spending by incorporating financial accountability for investment decisions into the transportation funding process;

5. Reasons for P3 (continued) • PPPs help align the Nation’s transportation funding policy with critical energy and environmental policies by substituting private capital for fuel tax revenue; and  • PPPs can significantly accelerate project delivery by providing upfront private capital for a project’s full cost.

6. History of P3 Hwys in US • Prior to 2005 P3 were from DB to DFBOM. • Since 2005, long term concession-based P3. private sector assumes significant financial risk related to operation & maintenance, and for new projects risks related to design and construction. The private partner assumes greater financial risk. For existing hwys in operation & maintenance. For new projects: the design, and construction.

7. Benefits of P3 • P3 save 6-40% in construction cost, and limit potential overruns through fixed–price contracts. Private capital ease public debt. A good example is the Miami Port Tunnel project. The planners calculated $68M a year payments by FLDOT for design, construction, operation, and maintenance. The bidder selected required annual payment of just $33M. • P3 are no riskier than procurement approaches. P3 can reduce public sector exposure by well structured concession agreements. Financial incentives to concessioners can assure high operation and maintenance standards. Proper allocation of risk between the two sectors can reduce overall risk, accelerate project delivery and reduce cost. A good example is P3 of VIDOT for I-95/Capitol beltway corridor where the concessionaire assumed the financial, technological and operational risks of implementing a variable toll rate based on congested (peak time) system. It assumed the risk for the expected return if the project is successful.

8. Benefits of P3 • P3 encourage innovations and greater introduction of IT at the construction stage to achieve lower DPV for the project. Life time savings in operation and maintenance costs. • P3 shortens project completion significantly. Immediate availability of private capital accelerates the project that otherwise will be delayed until public resources become available. The concession for improving 800 bridges in Missouri was assigned to one private partner per bridge. It will take 5 years instead of 20 years to the public sector.

9. Long term (LT)Concessions of Existing HWYS • Chicago Skyway P3 Description: 1st LT concession of existing toll road in US. 7.8 miles. Connecting the Dan Ryan EXPWY in south Chicago with the Indiana toll road. Private consortium includes Spanish Cintra and the Australian Macquarie. Both toll roads developers. Terms: The Concessionaire paid upfront the City of Chicago $1.8B and will operate and maintain the toll road for 99 years, collect all revenues for the 99 years. Revenues will be used for operations, and maintenance, repay debt, and contribution to equity. Annual toll prices were preset through 2017, and capped thereafter at the greater of 2%, CPI, or Per Capita GDP. Chicago used the proceeds to fund several programs. • Indiana Toll Road (ITR) Description: Competitive bidding to operate and maintain the east-west 157 miles road connecting the Chicago Skyway and the Ohio Turnpike. Again, Cintra and Macquarie won the contract.

10. LT Concessions of Existing Hwys ITR (cont. ) The concessionaire paid upfront $3.8 B. Again, BOT for 75 years. Unlike Chicago, Indiana invests all in the 10 years road improvement projects, and transportation projects for the IN counties. • Evaluation: Both significant upfront private capital. Long term concession. Mature with existing customers. Pocahontas Pkwy No proven customer base for a large upfront pay by concessioner. 9 miles bypass, southeast of Richmond VI connecting I-95 with I-295. State funded through a non-for-profit entity that issues construction bonds. When opened no sufficient toll revenues to pay the debt. Vi decided to convert from non-profit to LT concession type P3. Terms: 99 years concession with an Australian toll road operator. Price Included debt, maintenance and repairs by VDOT and the transaction costs. Prices capped to provide necessary returns. If excess revenues result then shared with VDOT.

11. LT Concessions for New Hwys Texas, Virginia and Florida lead in P3 for new and capital improvements. TXDOT initiated the innovative Trans-Texas Corridor (TTC) projects. TTC is a proposed network of super-highway corridors that could include separate lanes for passenger vehicles, and large trucks, freight and high speed commuter railways, water lines, oil and gas pipelines, electricity and communication services. TTC must be built with P3. Principles of TxDOT: • It will oversee planning, construction, maintenance. • 2. Government needs innovations of private sector. • 3. TTC is a LT, concession based P3 which includes private sector’s share in design, construction, financing, operation and maintenance(1). For each segment: 1. A competitive bidding. 2. The consortium provides a master development and financial plans. 3. Development of 1st facilityunder a separate facility agreement.

12. Hi Occupancy Toll Lanes (HOT) • VIDOT and a private consortium agreement for a concession to design, build, operate and maintain 2 HOT lanes on 14 miles portion of the Capital Beltway. Concessionaire will construct 2 general purpose lanes and convert the two innermost to HOT. Toll revenues will finance $1.4B of the $1.8B expected cost. $588M loan from USDOT, $589M private bonds, and $350M consortium equity, and $409M of state sources. • PPP is possible for projects that generate negative profits; bidding on minimum subsidy. Used for low traffic bridges in Missouri, and BART’s Oakland Airport connection.

13. Federal Programs encouraging P3 • Private Activity Bonds. IRS allowed issuance of public issuer of private Tax exempt bonds (PABs) to finance privately developed and operated hwys and freight transfer facilities. The private developer is deemed the borrower and is responsible for the repayment. The total Federal PABs is limited to $15B and allocated by the Secretary of USDOT. • TIFIA. The Transportation Infrastructure Finance and Innovation Act, 1998. federal direct loan, loan guarantee or a line of credit. For direct loans, payments start up to 5 years and final maturity 35 years after project completion. USDOT may allow payment deferrals. Private sector is allowed to combine TIFIA with PABs for P3 transactions.

14. Managing Risks in P3 LT Toll concession (or lease, franchise) agreements where private consortium design, finances, builds, and maintains a toll project for 35-99 years in exchange for toll collection. Advantages: pool risks and deploy expertise across multiple countries. Innovations in toll collection eliminate any congestions at the booths.

15. Managing Risks in P3 • New innovative approach to transportation funding. Risks exist to the public sector, however, they are manageable and can be mitigated. Create well balanced P3, perform due diligence before committing to project, and negotiate well structured concession agreements. • Agreements should specify performance standards for facility conditions, safety measures, levels of service, and maintenance obligations. Failure to obey may revert right to collect tolls. Also, existence of public alternative will reduce use of the poorly maintained P3 facility. • Private operator’s accountability to public authority and to the users which are the source of revenues assures high standards. In Indiana’s Toll Road Concession, standards were higher than when the State operated it. No formal standards for public operation.

16. Managing Risks in P3 • Public-Public Partnerships are not a good substitute for P3: • Public entity does not enjoy unlimited authority to issue debt, and public funds are limited. Thus, PPP’s equity contribution that yields higher return than debt should not be avoided. • Private equity is another source of investment proceeds that is less confined than debt. • Equity risk is borne by the private rather than the public sector. • Much of the success of P3 is attributed to the innovative and superior service, and accountability for its customers. Protection of equity investment in a competitive environment lead to innovations. Private bidders for P3 must incorporate cost and service innovations in their proposals. Congress’s PAB program that allows tax-exempt bonds enables private entities be at leveled field with public sector.

17. Managing Risks in P3 • Private investors will be interested in just profitable routes 1. Investment of private capital frees public sources of revenues and debt to other transportation projects. 2. Possible packaging in P3 procurements various return and risk projects. Used in Mexico for toll roads and bridges. 3. Bidding on the lowest subsidy for non-profitable projects. Example, the Port of Miami Tunnel or the Oakland Airport Connector for design, construct and operate.

18. Managing Risks in P3 • Price regulation when Private toll operators enjoy monopolistic power 1. Concession agreements for toll facilities often set ceiling limits. Hikes are allowed for inflation, changes in GDP per capita, a fix percentage etc. In case of congestion pricing, allow operator to vary tolls based on demand price elasticity. 2. Failure to comply lead to shift control to the public authority. 3. Setting toll rates is important in a constrained or monopolistic market. Prices should not exceed marginal social cost. In a constraint market with monopolistic power, shadow tolls can be established and the revenues are paid by the public authority. Thus, the concessionaire efficient performance is reflected in the amount of traffic generated while shadow tolls are paid by the public authority. 4. Another option is a regulator that approves private charged rates. For Dullas Airport the regulator is allowed by State law to approve the higher price of the three for the period 2013 through 2020: 1. The increase of CPI plus 1%. 2. The increase of GDP. 3. 2.8%.

19. Managing Risks in P3 • Price regulation when private operator enjoys monopolistic power: 5. Revenue sharing to regulate the private partner’s return on investment. Limits private partner’s incentives to develop innovations since the public partner can reap extra profits. Can encourage the private partner to “overcapitalize” the project in order to increase revenues without reaching the maximum rate of return. Best is to protect consumers by regulating prices without hurting incentives to innovate. Price regulation rather than regulation of rate of return.

20. Managing Risks in P3 • Congestion pricing appears to improve traffic flow and social benefits on all routes: 1. On such toll roads, traffic is diverted from peak to off-peak times and NOT to other roads. 2. Diverts traffic from other roads to toll roads because of time saving and certainty. 3. Managing demand on freeways by congestion pricing during peak time improves traffic flow. 4. Congestion pricing can divert traffic to transit, which leads to increase net benefits.

21. Advantages of Tolling • A safe and predictable source to serve the debt, maintain the road in good condition. • Creates a direct voluntary (market) link between the provider and the consumer assuring high performance by both the producer and employees to satisfy customers. Customers pay for service they receive every time they enter the road and will enter only if the benefits exceed the toll price. • Under tax-and-grant system, the public sector produces a “wish list” of transport projects. Assuming no net social external benefits, private investments in roads justifies economic viable projects. R. 91 in CA is an example of combined private sector’s initiatives and tolling. • Variable tolls best to manage traffic flow. Stop-and-go traffic reduces capacity of vehicles per lane from 2,000 per hour to 1,200. Traffic engineers can calculate pricing to maintain 1,700-2,000 veh/hour/lane.

22. Advantages of Tolling (cont.) Price adjustment raises the efficient use of lanes. Example, tolled R. 91 is 1/3 of the entire lanes but carries ½ of rush hour total traffic because of its free flow flexible pricing (1).

23. Reasons for Customers Use of Toll Roads Research in Ontario, Canada related to the 407 Express Toll Route revealed 3 reasons: • Time saving • Reliability and convenience of the trip • Safety of the hwy.

24. Traffic & Revenue Model • Projections of population and land use in corridor • Estimate Trip Generation • Traffic Assignment to different roads based on origins & Destination & the time on each route • Time saved ($ per hour) and likely toll rates • Forecast volumes willing to pay the toll and divert to the new road • Annual revenues calculated • Annual operating costs • From 6 & 7 annual revenues

25. Costs Estimates • Capital costs estimated include design, permitting, land, construction, legal and financing fees plus reserve fund for uncertainty and bond insurance against default (to raise the debt rating an lower the interest rate). • Landers want cushion termed “coverage ratio” between net revenue and debt services obligations at 1.3 ratio. • 25-30 years bonds with fixed interest rate. Toll rates are set based on constant debt service requirements through the life of the loan. Holds if revenue forecasts are conservative and no inflation.

26. Problems with Traditional Model • Traffic forecasts were on the high side. Population growth or real estate development in corridor did not materialize. • This uncertainty creates pressure for larger reserve funds, reduces credit rating, need to raise faced interest, call for shared tax money and elimination of some road projects. • The old model of paying off the bonds and removing the tolls are removed is impossible. Also, roads need complete rebuild every 30-50 years (1).

27. Innovative Financial Alternatives • GARVEE bonds: State DOTs borrow by pledging a portion of their future federal highway grant receipts to service the debt. A method of financing projects but does not to the amount available for investment. • Shadow tolls: A way to enlist the private sector in financing, building, and operating existing road. Government commits a consortium over the life time of agreement, pre-defined per vehicle driven or per vehicle/mile of traffic. Saves tolls collection costs. Limitation: No new revenues are generated. Portugal, Spain, Finland, Britain. Politically popular to current officials while letting future government pay the cost. New European version is Availability Concession where long term rental payments are made. Like of prisons cells schools. • Non-Profit Corporations: allowed to issue tax-exempt toll revenue bonds. Termed also 63-20 corps, after the numbering by IRS. Non-profit corp. had to be an arm length from both state DOT and for profit construction corp.

28. Innovative Financial Alternatives • Non-Profit (Conti.) • Initiated by engineering and construction firms interested in design and construction projects. The State is the other interested party in getting a road it may not otherwise get. • The firms lose interest once the project is built and their fees are paid. The non-profit has no equity and no shareholders with vested interest. Its directors are chosen after the road is complete and thus unaccountable for failure. Indeed all failed.

29. Long Term Toll Concession: Advantages • Greater access to capital. Traditional bond investors in toll roads get no upside advantage because they do not share profits and are only concern with downside risks. Debt coverage ratio=annual revenues/annual debt services= 1.25 to 2.00. This reduces the amount of capital that can be raised for construction in tax-exempt markets. Private concessionaires can fill in the gap with equity money. In Australia large IPOs of stocks. Concession Cos. Are flexible in the ratio of debt/equity. Bond financing recovers capital entirely in 25, 30 or at most 40 years. Concessions can be structured for 75+ years. • Financing based on bond markets requires large amount to

30. Long Term Toll Concession: Advantages reserve funds since all the capital is under debt that must be met. Provider of equity can deny dividends when revenues are tight for years. Thus, concession toll road funded by a mix of equity and debt can better survive during years of low revenues. • New financial instruments: Goldman Sachs and a British report estimate $250B available for toll roads. In the 1st half of 2006, $100B was globally raised for infrastructures mostly in the US. Pension funds are interested because of long term prospects. The problem is lack of investment opprtunities not in available capital.

31. Long Term Toll Concession: Advantages • Toll rate flexibility: Set at market value and raised by the concession limits. Tolls of public roads are not raised as long as debt service is paid, and do not reflect rising opportunity cost of time saved or increase of the time saved. Tolls seldom reflect the effects of inflation. The Indiana Toll Road kept prices constant over 20 years regardless of increase in traffic flow, causing congestion. Often when a road needs significant improvements, tolls are raised by 1/3 causing a decline in usage which could have been avoided if LT inflation would have been used. • Private vs. public operator can upgrade electronic systems while public agencies face difficulties in raising the capital

32. Long Term Toll Concession: Advantages Occurs approx. every 7 years). • Private operator can easier adjust staffing and training. • Public operators defer maintenance when necessary while private operator must comply by contract or to maintain customers. • Private operator has easier time implementing congestion tolling; responding to changing demand level and price elastic ties. • Labor cost of toll collectors in the public sector is double of the private sector’s. Also, raises in the public sector’s wages are input or seniority based rather than by productivity. • When toll roads are operated by cities then maintenance is conducted by the relevant city department and is queued there with all other jobs uncontrollable by the road management. • Private toll road operators can combine toll collection across state lines.

33. Long Term Toll Concession: Advantages • Expertise gained of major projects can be globally transferred by private operators from one place to other. State Turnpike experience is lost if no more major projects are internally initiated.

34. Funding of Roads • US: toll revenues enable tax exempt bonds and hwy trust funds supported by dedicated motor fuel tax. • Europe: No hwy trust fund nor tax exempt bonds. Toll funded long term concessions: 1st France then Italy, Spain and Portugal. The toll roads companies started out as state owned and controlled while since the mid 90’s were sold. These companies invest in Latin America, Eastern Europe and the UK. • Australia: Toll road companies operate under LT concession agreements operate all urban expressways in Melbourne and Sidney since 1990. Now these companies went global and developed road mutual funds for LT investors.

35. LT Concession Models Works well for large scale hwy, bridge and tunnel projects. Reasons: • Private equity can be raised if excess demand and willingness to pay exist for LT right to toll. Patient capital is less vulnerable to default in the early years of new toll roads. • The private sector absorbs the risks of cost overruns, unmet construction schedules, traffic shortfall. Accountability. • Concessioner that operates and maintains the road has no incentive to “cut corners” in the construction phase. • Innovations by private sector: e-collected tolls, demand sensitive pricing by time of day and the day of the week (R. 91). Same in Paris, the mother co. of R. 91 where a tunnel was built under Versailles to complete a ring road (A86). • In Melbourne, a private toll co. linked 3 existing roads in densed urban areas by tunnels and elevated roads.

36. References • Samuel, Peter, 2007. The Role of Tolls in Financing 21st Century Highways, the Reason Foundation, Policy Study 359, Los Angeles. • US DOT, 2008. Innovation Wave: An Update on the Burgeoning Private Sector Role in U.S. Highway and Transit Infrastructure, July 18. • US GAO, 2008. Highway Public-Private Partnerships: More Rigorous Up-Front Analysis Could Better Secure potential benefits and Protect the Public Interest. GAO-08-44. • Poole, Robert, and Samuel, Peter, 2006. The Return of Private Toll Roads”, Public Roads, Vol. 69 (5): March/April.