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Challenges and Opportunities Series: Public Private Partnerships in Transportation Delivery

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Introduction

Introduction

State and local governments provide more than two thirds of U.S. highway funding and are responsible for developing and delivering most of our transportation infrastructure. But many of these agencies do not have enough funds to maintain the existing transportation system, let alone expand it. In response, many agencies are looking to public private partnerships (P3s) to allow them to get more done with less. FHWA prepared this series of papers to enable transportation agencies to make informed decisions with respect to P3s by exploring the myths and realities of this complex - but often effective - project finance and delivery approach.

P3s are contractual agreements between a public agency and a private entity that allow for greater private sector participation in the delivery and financing of transportation projects than with traditional approaches. With P3s, private firms take on the risks of some or all of the financing, constructing, operating, and/or maintaining a transportation facility in exchange for a future revenue stream. This is a departure from the traditional model where private contractors construct projects based on a public design using public funding, after which public agencies take responsibility for long-term operations, maintenance, and rehabilitation. While the term public private partnerships be applied to a range of contract types, from design-build contracts to the lease of existing assets, these issue papers focus on P3s that involve private partners financing, constructing and long-term (10+ years) operation and maintenance of new highway capacity.

When all goes well, the agency gets a transportation asset built and taken care of for decades for a guaranteed price and the private firm has a chance to make money. However, P3s are complicated transactions. Successful P3s take special expertise, a stable political environment, and diligence.

This series of issue papers explores five key issues involved with taking a potential P3 from conception to long term oversight:

  • Legal and Statutory Issues;
  • Decisionmaking Processes and Tools;
  • Financial Considerations;
  • Performance Management; and
  • Organizational Capacity.

The papers describe the policies, processes, and decisions required to evaluate, implement, and manage P3s in the United States in a way that serves the public interest. The intended audience is transportation agency staff with responsibility for carrying out P3 project development, as well as legislative staff and policy makers tasked with creating the policy environment conducive to successful P3s.

Use of P3s in the United States to Date

P3s are used extensively around the world to encourage private investment in public infrastructure, limit public debt, and deliver infrastructure more efficiently. In the United States, P3s, as defined in this paper, are relatively rare with only a dozen transactions completed and four projects open to traffic (Table 1) over the last 20 years.1 Projects range in size from $126 million for the SR 91 project in California to $2.6 billion for the I-635 managed lanes project in Texas. Some use tolling as a revenue source, while others do not. Sometimes the private partner takes on the risk of project revenues achieving expectations by accepting compensation based on tolls charged to users of the facility. Other times the public agency retains this risk by compensating the private partner through annual "availability payments" that are based on keeping the facility "available" at agreed-upon service levels rather than toll revenues or traffic levels.

P3 projects have been less prevalent in the United States than in many other countries in part due to historic public policies that have led to large Federal investments in highways and have discouraged the construction of toll roads. Policies in many States have also limited the ability of public agencies to apply tolls to roads or utilize private capital to finance public infrastructure. The lack of a legal framework to utilize tolls or private capital combined with the establishment of a large network of non-tolled public roads whose construction has been largely federally funded, has limited opportunities for private investment in transportation infrastructure. In addition, federal tax policy that allows for tax-exempt municipal bonds has tended to make private financing of public infrastructure less attractive than in countries without such policies. Since the 1980s, however, traditional sources of public funding for transportation infrastructure construction have not grown in proportion to inflation in highway maintenance and construction costs. This has put pressure on State and local governments to look for new sources of revenue and investment and more efficient ways to deliver infrastructure. In the late 1980's both Virginia and California passed legislation enabling private investment in and operation and maintenance of publicly owned roads. Since that time, some 30 States and Puerto Rico have passed various forms of P3 enabling legislation.

A recent report by the Congressional Budget Office, "Using Public Private Partnerships to Carry Out Highway Projects," estimates that less than one half of one percent of investment in transportation infrastructure was delivered through P3s over the past twenty years. However, P3s are becoming an increasingly common way of delivering new capacity, and many States are giving them serious consideration. Major projects are underway in Florida, Virginia, and Texas, totaling nearly $10 billion and many other States are passing P3 enabling legislation, establishing P3 offices or agencies, and exploring P3 options. As more public agencies consider P3s, so does the demand for clear and objective information on the opportunities and challenges that P3s present.

Table 1. P3 Projects* in the United States
Facility Lease Term (years) Total Cost ($ millions) Public Investment Grant/TIFIA Private Investment Equity/Debt Year of Financial Close** Compensation Model Project
Website
Notes
Presidio Parkway (CA) 33.5 $368 $0/$152 $46/$170 N/A Availability Payment presidio
parkway.org
Pending final approval
IH 635 Managed Lanes (TX) 52 $2,615 $490/$850 $672/$606 2010 Toll revenue newlbj.com Under construction
Port of Miami Tunnel (FL) 35 $1,073 $100/$341 $80/$342 2009 Availability Payment portofmiami
tunnel.com
Under construction
I-595 Managed Lanes (FL) 35 $1,834 $686/$603 $208/$781 2009 Availability Payment i-595.com Under construction
North Tarrant Express (TX) 52 $2,047 $573/$650 $426/$398 2009 Toll revenue northtarrant
express.com
Under construction
SH 130 (Segments 5-6) (TX) 53 $1,328 $0/$430 $210/$686 2008 Toll revenue mysh130.com Under construction
Capital Beltway (I-495 HOT Lanes) (VA) 80 $2,006 $409/$589 $350/$589 2007 Toll revenue virginia
hotlanes.com
Under construction
South Bay Expressway (CA) 35 $774 $0/$165 $209/$400 2003 Toll revenue southbay
expressway.com
Open. Concessionaire defaulted in 2011. The concession was acquired by San Diego Association of Governments for $341.5M.
Pocahontas Parkway (VA) 99 $655 $0 $0/655$ 1997 Toll revenue pocahontas
895.com
Open. Sold for ~$552M in 2006. Lease term extended to 99 years.
State Route 91 (CA) 35 $184 $0 $31/$153 1993 Toll revenue dot.ca.gov/hq/
paffairs/about/
toll/rt91.htm
Open. Acquired by Orange County Transportation Authority in 2003 for $207.5M.
Dulles Greenway (VA) 63 $495 $0 $56/$439 1993 Toll revenue dulles
greenway.com
Open. Concession extended 20 years in 2001. Original concessionaire defaulted Concession sold for $615.5M in 2005.

* P3s are defined as those projects that involve a private partner financing, constructing operating and maintaining new highway capacity.

** "Financial close" means the signing of financial commitments by lenders, project sponsors, and project funders to assemble the funds needed to construct the project.

†Tentative pending financial close. Includes only initial construction costs.

Sources: CBO, Public Works Financing, AASHTO Center for Excellence in Project Finance

Why Do P3s?

P3s can be controversial. They are complicated, and they shake up the status quo. There are misconceptions about how they work and who benefits. P3 critics question whether promised benefits will be realized. P3 advocates are not always eager to discuss the potential pitfalls of P3s. Each P3 is different and presents unique challenges and opportunities. This paper series attempts to shed light on both the potential benefits and pitfalls of P3s -- dispelling some of the myths and identifying important practical issues for policymakers to think about when considering P3s.

Whatever you believe, P3s are not a panacea to the transportation funding shortage. P3s are not a source of free money. The private partner gets involved because they want to make a profit. If they contribute money to help get a project funded, they do so with the expectation of being repaid – with a healthy, market-appropriate profit. If that were not the case, they would invest their money elsewhere. When P3s are successful, the private sector is able to make a profit while creating benefits that the public sector could not otherwise have achieved. Ultimately, however, just like with publicly financed projects, the revenue to pay for the project will come from the public's pocket - via tolls, taxes, or other fees.

P3s are not "privatization." While the private sector plays a larger role in delivering P3s, the public sector retains ownership and directs what the private partner can and cannot do through statute and contract. P3s do not sell public assets to corporations, domestic or foreign. The reason P3s have drawn the interest of policy makers is that they offer an opportunity for cash-strapped public agencies to accelerate the delivery of much needed projects and to do so more efficiently. Done right, P3s can harness the desire of private firms to make money to create a valuable long-lived asset that will be maintained in good repair for decades.

How can profit-seeking private firms save the government money and deliver projects they may not be able to afford? By aligning incentives and accessing financial resources in ways that government just cannot do. P3s can create public benefits through more optimal allocation of risks, responsibilities and incentives between the public and the private sector and integrating design, construction, operations and maintenance phases of a project. Fixed price contracts to design, build, operate, and maintain an asset over a long period of time incentivize private partner to innovate, cut costs and deliver projects on-time to increase their profit margin. The private partner takes on the risk that long-term project costs may be greater than expected or that there will be unanticipated delays, but when those risks are well- managed, they are in a position to turn those risks into opportunities.

P3s can also help public agencies access financial resources that allow them to accelerate project delivery. P3s allow public agencies to leverage future revenue streams for up-front capital in the form of private investment. These arrangements do not eliminate the need for additional revenue. But they do overcome a significant barrier to project delivery: the lack of a financial strategy that can take advantage of future streams of revenue without requiring governments to take on additional financial risk.

Table 2 provides a brief overview of the potential benefits for a public agency in undertaking a P3.

Table 2: Primary Public Benefits of P3s
Benefit Description
Projects open to traffic sooner May provide public agencies with access to up-front capital needed to complete major projects that is not subject to annual budget constraints or public debt caps.
More reliable project delivery Many P3s create incentives for the private sector to design and construct a project more efficiently. Several studies have found that P3 projects are more likely to be completed on-time and on-budget than projects using traditional procurement methods. P3s also provide greater cost certainty for public agencies.
Contractually-obligated life-cycle project delivery reduces costs In P3s where the private sector is responsible for operating and maintaining the asset, the private sector has a strong incentive to minimize life cycle costs which often means building to higher standard initially and timely maintenance through the life of a project. Public agencies may be unable to do this simply because of fiscal challenges.
Transfer some risks to private partner Risks such as construction and financial risks can be fully or partially transferred to the private sector in a cost effective way.

Challenges

There are also pitfalls to P3s. P3 projects are a potentially effective way to transfer long-term project risks to the private sector, but they are not guaranteed to succeed. P3s do not eliminate the risks that come with financing, constructing and operating large infrastructure. There is always the potential that the public sector will still experience losses, financial and otherwise.

Furthermore, although construction and long term preservation can cost less, the transaction costs are usually much higher due to legal fees, financing costs, and procurement expenses. Finally,, an important element of P3s is the transfer of risk to the private partner, which the private partner builds into their price. As a result, the higher transaction costs of P3s mean that the use of P3s is generally limited to large and complex projects.

P3s are limited in that they are only appropriate for a small segment of potential transportation projects - typically large, complex projects with stable revenue streams. Only large and complex projects make the substantial transaction cost of a P3 worthwhile, so it is unlikely that P3s will have such broad application that they can solve the transportation funding gap that many States and local governments currently face.

Table 3 summarizes some of the challenges of P3s for transportation agencies.

Table 3: Primary Challenges of P3s
Challenge Description
Higher transaction costs Delivering a P3 project involves the development and procurement of complex long-term contracts which takes special technical expertise and extensive due diligence to get right.
Higher finance costs Because the costs of financing a P3 are typically greater than comparable projects financed with debt issued by public agencies, the private sector requires a competitive rate of return on capital investments that factors in the cost of risk, while public agencies can often issue tax-free bonds. But, it can be difficult to make a comparison because the public agency may be unwilling or unable to borrow for a project.
Difficulty estimating long-term value of transferred costs and risks Given the complexity and uncertainty involved in the design, construction, financing, and long-term operations and maintenance of major transportation facilities, it can be difficult for the parties involved to estimate the appropriate value of an agreement.

Allocating Risks

Risks associated with P3s include construction, geotechnical, financial, demand/revenue, political, operations and maintenance cost, and liability. Most of these risks are inherent in traditionally procured projects as well; a P3 arrangement, however allows the public sector to transfer some of these risks to the private sector.

With a P3, a public agency can transfer, allocate or retain specific risk depending on how well it believes it can manage the risk weighed against the expected cost of the risk transfer. When an agency transfers all or part of a risk to the private partner, the private partner has to conduct the due-diligence necessary to price and mitigate them. Many uncertainties associated with a project have a potential upside, or reward, as well (see Table 4.) When transferring certain risks , the public agency may forgo certain rewards if revenues are greater than expected or costs are lower than expected. Oftentimes, a P3 contract will stipulate that excess revenue be shared between the public and private partner; but this is factored into the private partner's risk and reward calculation as well.

Table 4. Typical Risks and Rewards of P3s
Risk Type Downside/Potential Costs Upside/Potential Reward
Financial Higher financing costs Lower financing costs
Design Design-related cost increases Cost-saving design innovations
Construction Construction costs overruns Construction cost savings
O&M O&M cost increases O&M cost efficiencies
Revenue Revenue shortfalls Higher revenues
Environmental Unanticipated environmental costs or delays None
Force Majeure Catastrophic failure None
Performance Performance lapses (Fines) None

The Life Cycle of a P3

This paper addresses P3 development issues from enabling legislation through identification, evaluation, negotiation, and management of P3 agreements. The aim is to help public agencies anticipate the challenges and develop the needed capabilities to be successful. While some of these capabilities can be acquired through contracts with private advisors, many will need to be developed in house. Agencies will need:

  • A legal framework to enter into and enforce long term P3 agreements;
  • Policies, processes, and tools to guide policy decisions;
  • Technical skills to develop, evaluate, and negotiate agreements; and
  • Skilled staff to manage and oversee projects over the long-term.

Developing projects as P3s will require organizational and cultural change. The public sector will need to gain a better understanding of private sector interests and perspectives and become comfortable transferring a greater degree of responsibility to the private sector - a cultural shift. Managing the organizational changes needed to develop an effective P3 program will take committed leadership at multiple levels that can champion P3 policies and projects.

Public and private sector organizations have different interests, values, cultures, competencies and processes. In effective P3 arrangements, these differences are leveraged to create value for both parties. However, these differences can also be barriers to negotiating agreements that create value. Differences between the two parties can create distrust that can undermine perceptions of value and raise perceptions of risk. Surmounting these differences and implementing an effective P3 program requires leadership commitment to developing new processes and capabilities on the part of public agencies.

Just as the public sector wants a private partner that can meet its commitments and create public value, the private sector wants a public sector client it can trust to see a deal through. Public agencies will need sufficient commercial knowledge and experience to understand the perspectives of the private sector, develop attractive P3s, and select and manage qualified advisors and concessionaires. Significant differences in the way the public and the private sector perceive project development are summarized in Table 5.

Table 5. Public and Private Sector Cultural Perspectives
Public Sector Private Sector
Projects - Seeks to address transportation needs by developing "projects" to improve the infrastructure network. Deals - Sees the process in terms of negotiated transactions.
Stakeholders – Seeks to address the concerns of various parties, including local residents, facility users, and political representatives. Stockholders – Seeks to generate dividends for its stakeholders.
Process – Applies and complies with prescriptive, standard operating procedures designed to provide uniformity, minimize risk and build consensus among stakeholders. Outcome – Demands greater flexibility and expediency to arrive at final objective.
Policy Goals – Develops projects to achieve policy goals such as improvements to mobility and safety. Profits – Interested in a competitive return on investment
Transparency – Seeks to share information with the public to ensure public participation and accountability. Confidentiality – Protects intellectual property and the competitive advantages derived from innovations.

Overview of the Chapters

Together, these chapters address policymaker concerns and identify research questions that can support public decisionmaking:

  1. Legal and Statutory Issues describes how State legislation can be structured to provide public agencies with the legal authority to reach P3 agreements while ensuring that there are safeguards in place to protect the public.
  2. Decisionmaking Processes and Tools discusses the ways in which public agencies structure decisionmaking processes to effectively evaluate and negotiate P3 agreements.
  3. Financial Considerations explains how P3s can be financially structured to leverage the interests and capabilities of private financial investors.
  4. Performance Management describes how public agencies can design and manage contracts that enable them to ensure private partners meet their obligations and P3 projects help achieve public goals.
  5. Organizational Capacity discusses how public agencies can develop the capabilities needed to evaluate, negotiate and implement P3s in the ways discussed in the previous papers.

1 Notably absent from this list are the Indiana Toll Road, Chicago Skyway, Northwest Parkway in Colorado, and PR-22 and PR-5 in Puerto Rico asset leases - P3s that netted hundreds of millions of dollars for their project sponsors. These projects do not meet the criteria for inclusion in this series of papers - in that they were "brownfield" transactions where public agencies monetized the value of an existing asset, but no new highway capacity was built.

 

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