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FOREIGN EXPERIENCE WITH SHADOW TOLLING
Eight shadow toll contracts have been signed with private consortia in the United Kingdom, and one in Finland, though thus far no projects with shadow tolls have actually begun operation. However, these contracts, which will result in operating highway projects shortly, demonstrate how the private sector in these countries has reacted to these innovations and what terms it has found acceptable.
Shadow Tolls in the United Kingdom
The use of shadow tolls in Great Britain has been part of a larger program developing public/private partnerships — the "Private Finance Initiative" — which has extended across many departments of the Government. In the case of transportation, the PFI has taken the form of "DBFO" concessions whereby a single private consortium develops, builds, finances and operates the road for a set number of years. DBFO-type concessions have long been used to develop projects in various parts of the world, but in all cases thus far the concessionaires' revenues have been earned through real, user-paid tolls. Even in the U.K., the Queen Elizabeth II Bridge across the Thames and a second crossing of the River Severn have been developed as DBFOs with user- paid tolls. But because real tolls continue to face strong political resistance in the U.K. (except on the occasional bridge or tunnel), the Government views shadow toll schemes as the next-best alternative. The U.K. Government had two major objectives in using shadow tolls: (1) to obtain better value for money by incentivizing the DBFO company to consider life-cycle costs, and (2) to cultivate a private sector highway operating industry that will be prepared for real tolls when (and if) they are implemented.
It is widely held that use of the private sector can lead to innovations in construction and financing that would create savings, mainly through speeding up the construction schedule and allowing for earlier openings. The Government has also been eager to use the DBFO program to shift economic risks to the private sector. And in fact, the U.K. Highways Agency claims that the contracts signed thus far will shave an average of 15 percent off of total costs compared to what the public sector would have paid under traditional arrangements. The Agency also claims to be very satisfied with the final arrangements to transfer risk — in particular the risk of delays from protests and the risk of latent defects — to the DBFO companies. However, at this early stage any quantification of savings is necessarily arbitrary as it involves attaching net present monetary values to unknown risks. These savings have also since been questioned by the U.K. National Audit Office because they are very sensitive to changes in the discount rate used.
For future projects, the Conservative Government was aiming to involve the private sector in earlier stages of project development. It also planned to move away from pure shadow toll schemes and adopt a greater variety of incentives to factor in other objectives such as safety and environmental quality. However, the new Labor Government is currently reviewing the entire DBFO program, though the first eight projects will be unaffected.
Projects in Development
The DBFO program was launched in August 1994. As of March 1997, two groups of four concessions each had been awarded for eight separate DBFO projects totaling £567 million ($947 million), and a third group of seven others was under development. In selecting the first eight, the Government included a variety of projects in order to identify those types for which shadow toll schemes would be most beneficial. Among the projects are brand new roads, upgrades of existing roads to "motorway" standards, and the maintenance of existing roads with only minor improvements. The estimated capital value of these projects ranged from £9.4 to £214 million ($15.8 to $360 million).
Due to their varying nature and location, each of the eight DBFO contracts has unique features. Nevertheless certain terms and structures have been consistent throughout the entire program, and a clearer picture of what burdens the private sector is generally willing to bear has emerged from discussions and negotiations with bidders.
Payment Mechanisms/Incentives
Payments by the Government to the operator will be based primarily on actual traffic levels, as measured in vehicle-kilometers. However, it was up to the bidding consortia to propose a precise formula for determining the payments. Since payments do not begin until traffic begins, there is a powerful incentive for the DBFO company to open the road as quickly as possible. But, since payments are pegged to traffic for the duration of the concession, the company also has reason to ensure that the road will need a minimum of disruptive repairs during that time.
Banding
Payments are not based simply on the product of traffic volumes and a single shadow toll. Instead traffic is divided into two to four "bands" representing different levels of annual traffic volumes with different per-vehicle payments attached to each. The lower bands have higher per- vehicle payments, while higher bands have lower per-vehicle payments. In all cases, the top band must be zero so that the government's liability is capped in the event of higher-than-expected traffic. This also addresses concerns that a shadow toll scheme would create incentives for the DBFO to vastly increase travel demand. The bands themselves may be increased over time to match anticipated growth in traffic. Separate bands are constructed for two vehicle classes — vehicles less than 5.2 meters in length, and vehicles greater than 5.2 meters. The DBFO performs continuous traffic counts to calculate annual vehicle-miles, which are verified by the Government every 90 days. Payments are indexed to inflation. An abstracted banding scheme is illustrated on the next page. Note that the increasing slope over time does not represent inflation but the change in bands to match traffic growth.
This banding structure determines the final cost to the Government, and as such con stitutes the heart of the DBFO proposals. Most bidders have chosen to split traffic into four bands. The lowest band has typically represented a conservative forecast, with shadow tolls sufficient to cover debt service but with no return on equity. Obviously traffic forecasts are the major input to developing any banding scheme as there is no assurance that even the lowest band of traffic volumes will be achieved. Interestingly, while the Government maintains its own in- house traffic forecasts for each project, it has chosen not to disclose them to bidders. According to official documents, this was to foster a private domestic forecasting industry.
Other Incentives for Performance
For the current round of projects, there are a few additional financial incentives for performance: bonuses for reduced accidents and deductions for lane closures. The DBFO may propose measures to increase safety. If the Highways Agency approves, then the DBFO builds and pays for the safety-related improvements. The DBFO will earn back this investment by additions to total annual payments of 25 percent of the economic cost of each personal injury avoided. Accidents avoided will be calculated by comparing accidents in the three years prior to implementation of the safety scheme (U.K. Highways Agency 1997).
Similarly, deductions from total payments will be made for lane closures (not including those required by the police or utilities). The deduction will vary depending on the number of lane-miles closed, the length of time, and the amount of expected traffic inconvenienced.
Allocation of Risks
One of the major justifications for the British PFI program as a whole has been to transfer risk to the private sector and thus control costs. The DBFO contracts place all risks related to delivery of the road on the consortium, unless explicitly assumed by the Government in the contract. Thus, any unforeseen risks will be the responsibility of the private sector.
Risks typical of any private sector development (such as in real estate) apply to the DBFO company. These include higher than expected construction and operating costs, delays in completion, extra costs incurred due to inadequate design, and changes in law (except for those which specifically address PFI companies).
Risks which are specific to transportation projects include the risk of lower-than-expected traffic levels, protestor actions, and latent defects in existing roads. The risk of low traffic is assumed by the DBFO through the shadow toll mechanism.
For protestor actions, the Highways Agency asked bidders to compose three separate bids (i.e., three proposed per-vehicle shadow toll schedules) for three different risk-sharing scenarios: one where the DBFO assumes all costs associated with delays from protest, one where the costs are shared, and one where the government covers all extra costs. For most of the eight conces sions, a risk-sharing arrangement was negotiated.
Bidders were responsible for inspecting the condition of existing roads for structural problems. But, in some cases, certain problems may not be detectable. The Government again asked the bidders to develop separate bids for three risk-sharing scenarios. It turned out that the private sector was generally willing to assume all of the risks of latent defects (U.K. Highways Agency 1997).
Criteria for Selection of Bidders
An average of eight consortia expressed interest in the projects put out to bid thus far. To control costs, the Government limited the competition to four bidders. Using its own traffic forecasts, the Government determined which bid provided the best "value for money," as measured in net present value.
In order to measure the savings generated by the DBFO bids, the Agency developed "public sector comparators" — estimates of what the state would pay to build the same project and operate it for 30 years using traditional contracting methods. These costs were expressed as a net present value using an 8 percent discount rate. The comparator includes a value to represent the various risks noted above. The Government project team and a team of risk consultants independently estimated these risks based on historic cost overruns in traditionally procured projects. The two teams came up with similar results.
It was by using such comparators that the Agency derived its average estimate of 15 percent savings for the eight projects. However, no documents are available to ascertain how risks are converted into monetary terms, or what proportion of the total value is made up of these risks (U.K. Highways Agency 1997). Moreover, the U.K. National Audit Office has questioned the precision of these estimates because they are very sensitive to the discount rate used to convert future payments into net present value. The Agency used a rate of 8 percent, but the U.K. Treasury recommends using a lower rate of 6 percent which is closer to the Government's actual cost of borrowing. If the lower rate had been used, one of the first four projects could then have been developed for a less costly amount by the Government, and the savings on the other three would have been significantly less than initially estimated.
Equity Relationships/Financial Performance
All equity has come from project sponsors — there has been none from third parties, perhaps due to restrictions on the transfer of equity. Thus far, debt has been raised through commercial banks, funding from the European Investment Bank, or bond issues. The bank loans were for terms of 15 to 20 years and a margin of 120 to 140 basis points over the comparable term U.K. Treasury "gilt." A single £165 million bond was issued for two projects awarded to two subsidiaries of the same company. Because the bond was guaranteed by the AMBAC Indemnity Corporation, it received an AAA rating. The coupon was 9.18 percent. The Govern ment requires that the consortia guarantee their performance by obtaining a bank guarantee for an amount commensurate with project construction costs (U.K. Highways Agency 1997).
Third Round of DBFOs
Before the 1997 elections the Conservative Government announced a third group of seven road projects to be included in the DBFO program, some of which had already been put out to bid. However, the new Labor administration has launched a review of the DBFO program, killing two of the new projects, delaying three and allowing two to proceed. The original eight projects have been basically unaffected by the change in administrations ( Public Works Financing September 1997).
The previous administration had wanted to make some modifications to the DBFO program, most notably to incorporate additional incentives other than shadow tolls — deductions for lane closures, payments based on "reliability" of travel time, accidents as measured against national trends, and the proportion of high-capacity transport to low capacity transport. Other criteria may include the quality of information and signing, the condition of driver facilities and noise and air pollution.
Shadow Tolls in Other Countries
Other European countries have long used private concessions to develop roads, but none with shadow tolls. However, Finland has recently followed in Britain's footsteps and recently closed financing on a project that includes shadow tolls — adding a second lane to a 70 km. section of the road linking Helsinki with Lahti. If the state's traffic forecasts hold true, it will pay 1.2 billion Finnish Marks over the 15-year concession period (or about 200 million US dollars). The Finnish government estimates that this represents a ten percent savings over traditional construction methods.
Terms of the concession are very similar to those in Britain. But, unlike the British concessions, the Finnish concession will last only 15 years (though bids for longer concessions were considered). The sharing of risks is also structured similarly to the British projects, although the Finnish government will assume all risks derived from protestor actions (Raitanen 1997). The bidding process also differed slightly in that government traffic forecasts were made known to the bidding consortia.
This project was financed locally, but it is likely that future projects in Finland will require the involvement of international finance due to the modest size of the Finnish banking community ( Privatisation International 1997).
Elsewhere, a major privatization initiative was recently launched in Germany. Thirty transportation projects have been earmarked for DBFO development, 14 of which are under active discussion, but only one of which has been financially closed. While plans are to use explicit tolls on these roads, pressures to keep tolls at "socially acceptable" levels may result in the use of shadow toll mechanisms (Bonar 1997). The German Government has shelved any further DBFO schemes. In France, Spain and Italy, plans to introduce public/private partnerships have been based on a more traditional concession model, with fees paid by users. Thus there are no plans to introduce shadow tolls in these countries.
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