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Challenges and Opportunities Series: Public Private Partnerships in Transportation Delivery

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2. Decisionmaking Processes and Tools

KEY FINDINGS

  • States vary in their approach to identifying and evaluating potential P3 projects. Some States use a programmatic approach, where an agency screens a set of projects for feasibility as a P3. Other States evaluate P3s on a project by project basis.
  • State use different tools to evaluate potential P3 projects, such as Value for Money analysis, which allows public agencies to compare the risk adjusted net present value of different procurement options.
  • One of the primary ways P3s generate value is by optimally allocating risks through, but project risks are not always well understood and this can hamper risk allocation decisions.
  • P3 agreements can vary significantly from project to project depending on the goals of the project sponsor, the nature of the facility, the legal and political environment, and the capabilities and interests of potential private partners. Significant differences can include the type of compensation model used, the length of the agreement, and the allocation of specific risks and responsibilities.
  • Because of the size, complexity, and length of term of P3 agreements, special procurement processes are needed to ensure there is sufficient and qualified competition.

Introduction

Public agencies have to make important and complicated decisions to develop effective P3 programs and projects—often under intense public scrutiny. P3s tend to be large and complex projects that present unique challenges to decisionmakers. As a result, policymakers must make difficult decisions with limited information and few points of reference.

Once a public sector agency has decided to enter into a P3 program or project, as enabled by State legislation, policymakers must consider:

  1. Whether to set up a P3 program or develop P3 projects on a project-by-project basis;
  2. Establish a criteria and process for the selection of projects for evaluation as a potential P3;
  3. How to structure a commercially valuable P3 agreement that achieves policy goals, optimally allocates project risks, and brings value to the investment;
  4. How to conduct a fair and competitive procurement to select the best partner and negotiate a final agreement that is transparent and protects the public interest while addressing the private partner's concerns.

While the types of decisions and the tools and processes used to make these decisions are similar for all States, approaches to P3s and types of projects vary significantly by State. Many States evaluate P3s on a project-by-project basis. These States sometimes rely on the private sector to help identify opportunities to develop projects as P3s or developing a project as a P3 once other approaches to financing and delivering a project prove insufficient. However, some States are now starting to apply a more programmatic approach that identifies P3 opportunities early in the planning process. States have used different methods to evaluate the value of the P3 approach. Some States have allowed public toll authorities to compete with private bidders. Other States have developed value for money analyses that use financial models and risk assessments to compare different models of project delivery.

While the structures of individual P3 agreements have evolved as the P3 market has developed over the past 25 years, they vary greatly depending on State's internal financial and legal structure, appetite for risk, market conditions, and other factors States have employed different lengths of term, methods of compensation, risk allocation, and performance management processes in P3 agreements to create public value and incentivize performance. There are also variations in how States have procured P3 projects to select the best partner and negotiate the best final agreement. These differences provide a rich pool of experience and lessons learned on which policymakers can draw when considering future P3 projects.

The first section of this chapter discusses decisions associated with initiating a P3 project or program. The second section discusses methods public agencies can use to identify potential P3 projects. The final two sections discuss the issues that policymakers face in developing P3 project agreements and selecting an appropriate private partner.

Authorizing Legislation: The Framework

States generally require enabling legislation to begin using a P3 procurement model. P3 authorizing legislation sets out the legislative mandate and legal framework for P3s (see Chapter 1). The P3 legal framework may preclude or constrain potential agency decisions regarding P3s, although executive agencies may benefit by coordinating with the legislature on the initial legal framework to allow flexibility in the procurement model due to the unique nature of the proposed projects. Decisions that are typically addressed in the legal framework include:

  • The agencies that have the authority to enter into P3s;
  • The types of eligible projects; and
  • The types of agreements that are allowed.

Decisions regarding the identification, development, and implementation of specific P3 projects are often left to the implementing agencies.

Table 2-1 describes how three States have set different parameters on public agency's authority to enter into P3s through legislation.

Table 2-1. Statutory Decisionmaking Frameworks
  Virginia Texas Florida
Entities with authority to enter into P3s Commonwealth of Virginia, local governments, and specified transportation agencies and authorities. Texas DOT, the Texas Turnpike Authority, Regional Mobility Authorities, and Regional Tollway Authorities. Any expressway authority, transportation authority, bridge authority, or toll authority.
Eligible P3 projects Any road, bridge, tunnel, overpass, ferry, airport, mass transit facility, vehicle parking facility, port facility, or similar commercial facility used for the transportation of persons or goods. Twelve highway projects specifically named in legislation. Projects programmed in the DOT's adopted 5-year work program or projects in the 10-year Strategic Intermodal Plan that increase transportation capacity and are greater than $500 million.
Allowable Agreements Any lease, license, franchise, easement, or other binding agreement transferring rights for the use or control of a transportation facility by a responsible public entity to a private entity for a definite term during which the private entity will manage the facility in return for the right to receive all or a portion of the revenues of the facility. Agreements that provide for the financing, design, acquisition, construction, maintenance, or operation of a designated transportation facility. Agreements that allow the lease of existing facilities as well as financing, design, construction, operation, and maintenance of new or expanded tolled facilities using either annual availability payments or toll-based payments.

Establishing a P3 Program

Once P3 authorizing legislation is in place, public agencies can take different approaches to identifying and evaluating potential P3 projects, conducting procurements, and managing contracts. A public agency's approach to P3s may depend on the enabling legislation in the State, an agency's commitment to and expectations for P3 projects, and an agency's existing traditional processes for developing and delivering projects, the use of internal and external resources, among other things. An important initial decision is whether to pursue P3 opportunities on a project-by-project basis or to establish a P3 program.

Some public agencies have pursued P3 projects on a project-by-project basis as opportunities arise. For example, Florida and Texas have each been very active in using P3 procurements but do not have established centralized P3 programs. Project champions in Division Offices (Florida) or regional mobility authorities (Texas) initiate P3 projects in these States, with some oversight and technical support from the State DOT. A project-by-project approach to P3s can allow a public agency to be responsive to local demands and to allocate resources as needed to support project opportunities as they arise. In some cases, the approach to P3s may evolve. Virginia DOT (VDOT), for example, started developing P3 projects on a case-by-case basis. In 2010, Virginia's governor created the Office of Transportation Public-Private Partnerships, which is now responsible for developing and implementing a multi-modal statewide program for P3 project delivery.

If a steady stream of projects is expected, a permanent P3 program can improve identification of P3 opportunities, reduce transaction costs, and educate stakeholders. An established P3 program could potentially instill private sector confidence. If the private sector sees public agencies investing in a P3 program, then potential bidders may have added confidence that the agency is serious about carrying P3s from inception to deal-close and beyond. This can improve the number, quality and competitiveness of interested bidders on a proposed project. In addition, a permanent P3 program or agency may allow staff to accumulate institutional knowledge and to proactively identify future opportunities where P3s may be beneficial. However, setting up a program office in an existing or new agency is a significant undertaking that may not be worthwhile unless there is an expectation of a significant pipeline of P3 deals to evaluate and manage.

States may establish P3 programs within an existing public agency, such as a DOT, or, through legislation, in a new independent agency or authority. Institutionalized P3 programs establish policies and processes for identifying, analyzing, and implementing projects and dedicate resources and staff to carry out those processes. States and territories with institutionalized P3 programs include Virginia, Georgia, Arizona, and Puerto Rico.

In some countries with well-established P3 programs, such as Canada, Australia, and the United Kingdom (UK), specialized P3 agencies have broad authority over a wide range of social infrastructure including highways, schools, water and sewage treatment facilities, and energy plants. Having broad authority to implement P3s across an array of social infrastructure expands the set of potential P3 projects and may lead to lower transaction costs and faster procurement processes. P3 programs in these countries are often located within a treasury agency or within an agency exclusively dedicated to the evaluation and implementation of P3 projects. In Canada and the UK, some P3 agencies are set up as P3s themselves and work on a fee-for-service model, with implementing agencies paying for the P3 expertise of the centralized P3 agency. Such a centralized program might limit the ability to respond to regional or local issues, and be more difficult to implement in countries such as the U.S., which has a long tradition of State and local governments retaining broad authority over project implementation.

Program Goals and Structure

States with ongoing P3 programs typically establish goals, policies, and standard processes that guide and facilitate the development and implementation of P3 projects.

Georgia P3 Program Goal Statement

"The goal of the P3 program is to create a fair, transparent and reliable process to support a climate for private sector innovation and investment in a manner that provides value and benefit to the State's transportation system."

Clear program goals can guide agencies in establishing policies and making decisions related to identifying projects, structuring agreements, and selecting partners. In general, public sector agencies enter into P3 arrangements when they believe there can be added value for the public sector as compared to more traditional development options. Specific program goals may include:

  • Encourage competition and innovation;
  • Realize long-term cost savings;
  • Transfer cost and schedule risks;
  • Accelerate major projects;
  • Communicate the benefits and risks of P3s to stakeholders;
  • Coordinate agency processes and build public capacity to undertake P3s; and
  • Promote economic growth.

Decisions regarding the specific mechanisms to achieve the goals of a program are made at the implementation level. P3 programs need sufficient human resources to identify and develop projects and monitor contract performance. P3 programs often draw from political, technical, financial, legal, and managerial skills from throughout a transportation agency and sometimes within other public agencies. P3 programs sometimes establish working committees and steering committees to assist in the identification of P3 opportunities and to coordinate the resources necessary to develop P3 projects. In addition, P3 programs typically engage private advisors as needed to provide specialized technical, financial, and legal skills. Figure 2-1 shows how Virginia's Office of Transportation Public-Private Partnerships is structured to use cross-agency committees and private advisors.

Figure 2-1. Virginia's P3 Program Structure

Figure 1. Virginia's P3 Program Structure

Project Identification and Screening

Not all projects are suited to P3 project delivery, so agencies need a way to identify which projects have the best potential to succeed as P3s. Agencies may identify projects with the help of the private sector through unsolicited proposals or a call for nominations, or projects may be selected through programmatic project screening. In some States, such as Texas, potential P3 projects are limited to those that are specifically identified in State enabling legislation. In States where public agencies have broader authority to enter into P3 agreements, public agencies may choose to identify and solicit projects themselves or they can permit the private sector to submit unsolicited proposals. Several States, including Virginia and Florida, consider both solicited and unsolicited proposals. Public agencies can also issue a call for proposals that meet specific criteria (e.g., toll projects or projects that increase capacity) or that meet specific policy goals or needs as identified in transportation plans. Other public agencies have defined project screening processes that lead to the development and solicitation of specific P3 projects. The process for screening projects is discussed further below.

Unsolicited Proposals

Unsolicited Proposals: Georgia DOT

Georgia DOT initially accepted unsolicited proposals. Several unsolicited proposals were submitted but only one project was advanced to project development. Ultimately, that project was terminated due to public opposition. In 2009, the State passed new legislation that established a framework for Georgia DOT to identify projects and solicit proposals through a P3 program. The program has subsequently identified a network of interconnected managed lanes around the Atlanta metropolitan area that the Georgia DOT may develop as P3s, some of which the State is pursuing.

The typical unsolicited proposal process allows a private party to submit a conceptual proposal. The public agency evaluates the proposal as to whether it is legally permissible, technically feasible, and, most importantly, meets the agency's policy goals. If the public agency decides to go forward with the unsolicited proposal, it typically publishes the conceptual outlines of the proposal and provides a time period for other private parties to submit competing proposals. This time period varies by State but may range from 60 to 135 days. Public agencies typically charge a fee for reviewing an initial unsolicited proposal ranging from $10,000 to $50,000.

Table 2-2 provides State examples of requirements for accepting unsolicited proposals for P3s.

Table 2-2. State Examples of Requirements for Unsolicited Proposals
  Virginia Texas Florida Puerto Rico
Review Fee $50,000 ($10,000 for concept; $40,000 for detail) $25,000 ($5,000 for concept; $20,000 for detail) $50,000 $50,000
Period to submit competing proposals 120 days 90 days 120 days 90 days

Agencies may allow unsolicited proposals to inject private sector innovation into project selection and implementation. For example, in 2003, VDOT received an unsolicited proposal for the design of the I-495 Capital Beltway HOT lanes in Virginia that reduced right-of-way takings from several hundred homes to less than ten. The redesign was estimated to reduce the project cost from $3.2 billion to $846 million, in part by reducing the number of breakdown lanes from eight to four and deferring improvements to several interchanges. The design innovations in the unsolicited proposal made the project financially and politically feasible. However, by the time the project was under construction, the estimated cost had risen to about $2 billion, as a result of inflation and design enhancements, and the concessionaire needed about $400 million in State grants to make the financial plan work.

Unsolicited proposals can be problematic in several ways. They can be perceived as uncompetitive and non-transparent, although most public agencies that accept unsolicited proposals require a period of competition to allow competitors to offer alternative bids. Unsolicited proposals often derive from planned projects that for whatever reason the public sector has not seen through to implementation. Some observers have questioned whether projects that do not fit into existing public agency transportation plans or priorities should be pursued as P3s, even if it can be demonstrated that those projects are commercially viable and create benefits for the public. Others have expressed concerns that unsolicited proposals allow concessionaires to "cherry-pick" profitable projects that might otherwise generate revenue for a public agency. In addition, unsolicited proposals may face significant delays and scope changes in the environmental review and preliminary design process. These delays and scope changes may make a project less commercially attractive and suitable as a P3. Finally, unsolicited proposals commit the public agency to staff resources to review the proposals, and depending on the result of that review, to conduct a competition with competing proposals. The resources needed to respond to unsolicited proposals can be substantial. For example, between 1995 and 2011, VDOT received more than 50 project proposals but is only moving forward with a small portion of them. As a result, VDOT charges a $50,000 fee to review a proposal—intending that only the most serious of concessionaires will propose.

Calls for Nominations

A call for nominations is a more controlled form of getting creative proposals from potential concessionaires. In a call for nominations, a public agency requests proposals from the private sector for a specified number or set of projects. For example, in 1989, California passed AB 680, which allowed up to four private concessions in the State. The first P3 projects in California - 91 Express (Orange County) and South Bay Expressway (San Diego) - were two of the four projects identified through that process. The other two nominated projects did not proceed to implementation.

Programmatic Project Screening

Public agencies can manage the flow of P3 proposals if they take a programmatic approach to identifying potential P3 opportunities. A programmatic approach may allow policymakers and agency staff to coordinate and streamline decisionmaking processes across the agency. Several State DOTs now conduct programmatic project screenings to identify potential P3 projects, including Georgia and Virginia.

When planners can identify projects with P3 potential during the development of long range planning documents such as the Statewide Transportation Improvement Program (STIP) and Transportation Improvement Programs (TIPs), it puts transportation agencies in a better position to facilitate project development and consider the financial implications of using a P3 approach. To identify potential P3 projects, transportation projects in the STIP or TIP can be evaluated across established criteria to determine the feasibility of advancing a project as a P3. This process can be repeated on a regular basis as projects enter the planning process and can also be used to prioritize and schedule potential P3 procurements. Project screening criteria may include:

  • Size and cost (often over $250 million);
  • Revenue potential;
  • Transferrable risks that may be better managed by the private sector;
  • Completed or near-complete environmental studies (NEPA); and
  • Political support and consistency with existing transportation plans.

Virginia uses a process to identify potential P3s through the normal project development pipeline or through unsolicited proposals (see Figure 2-2). To identify planned projects that may be appropriate to deliver as a P3, Virginia has established a Public-Private Transportation Act (PPTA) Program Steering Committee that includes representatives from each transportation agency and is chaired by the VDOT Commissioner. The Committee works with the P3 Office to apply established evaluation criteria to systematically screen and prioritize potential projects. Once the Committee has prioritized a project, the P3 Office coordinates project development activities, develops the scope and design concept, prepares cost, traffic, and revenue estimates, and conducts an initial value for money analysis. If, after further project development and evaluation, the project is still judged to be appropriate as a P3, the P3 Office begins a procurement process through which a proposal is ultimately selected and a final contract negotiated.

When an unsolicited proposal is received, the P3 Office reviews the proposal to ensure that it satisfies a public need, is identified in a current transportation plan, and is consistent with Commonwealth transportation goals. The Committee ultimately makes a determination whether to advance the project to detailed screening. The proposal is then considered for prioritization, development, and procurement alongside planned projects.

Figure 2-2. Virginia's Process to Identify and Evaluate Potential P3s

Figure 2. Virginia's Process to Identify and Evaluate Potential P3s

Source: Virginia's PPTA Implementation Manual and Guidelines

Using P3 Evaluation Tools

Once public agencies have identified a project as having the potential to be a P3, they typically conduct a series of progressively more rigorous evaluations to determine the best approach to delivering the project. These evaluations help decisionmakers choose how best to structure and procure a potential P3 project. There are several analytical studies and tools used by public agencies to conduct these evaluations:

  • Traffic and revenue (T&R) studies;
  • Preliminary design and cost estimates;
  • Risk matrices /registers;
  • Financial cash flow and valuation models; and
  • Public Sector Comparators (PSC) /Value for Money Analyses (VfM).

These tools are often used in combination to assess potential procurement approaches, agreement structures, and private sector bids. T&R studies and cost estimates serve as inputs to a financial model. Risks identified in a risk matrix inform any sensitivity analysis conducted with the financial model as well as with the VfM analysis. A thorough VfM typically incorporates material from a financial model as well as a risk matrix. Figure 2-3 shows how these tools interrelate. The following sections provide additional details on each of these tools.

Figure 2-3. P3 Evaluation Tools

Figure 3. P3 Evaluation Tools

Traffic and Revenue (T&R) Studies

T&R studies are used to forecast traffic on toll roads under various toll rate structures and macroeconomic scenarios. Agencies typically hire consultants to prepare T&R studies, which are important in determining how to structure toll rates, deciding whether to transfer, retain, or share revenue risk, and understanding what to expect from private sector bids. T&R studies are critical inputs into financial models, but their limitations need to be clearly understood. T&R forecasting involves subjective estimates of the future behavior of millions of people with respect to housing and business location decisions and choices of transportation. There is tremendous uncertainty associated with these forecasts, and a good study will be transparent about pointing out the uncertainties.

Preliminary Design and Cost Estimates

Agencies need to have a reasonable understanding of the costs to design, build, operate, and maintain a facility in order to make a meaningful comparison of anticipated revenues and costs. Preliminary designs will also identify the risk factors in a project (e.g., geotechnical, right-of-way acquisition, hazardous materials).

Risk Matrices

Agencies use risk matrices in evaluating a P3 to identify project risks, risk mitigation strategies, and the appropriate allocation of risk. The risk matrix provides a format for capturing information on risks, the probability of risks occurring, the consequences if an event accounted for in the risk matrix does occur, and strategies to reduce the probability of negative events occurring or to mitigate the consequences if a negative event were to occur. For example on the Downtown/Midtown/Martin Luther King project VDOT conducted several pre-procurement risk assessments and then conducted a risk assessment with the private sector partners so it could identify and mitigate identified risks. While many risk matrices include only qualitative information, agencies can take the risk matrix a step further by quantifying the probability of risks and assessing the potential consequences in monetary terms. Agencies can then use the risk matrix to perform a sensitivity analysis on the project's financial model to assign an equivalent monetary value to each risk. A risk matrix can help a public agency decide which risks to transfer to the private sector, which to retain, and which to share. Figure 2-4 is an example of a simple risk matrix used for the Florida I-595 Express Lanes project that does not try to quantify the risks.

Figure 2-4. Florida I-595 Express Lanes Risk Allocation
Risk Category FDOT Risk
Allocation
Concessionaire
Shared
Political X    
Financial   X  
Traffic & Revenue X    
Right-of-Way X    
Permits/Government Approvals     X
Utilities     X
Procurement X    
Construction   X  
Operations & Maintenance   X  
Hand-Back   X  
Force Majeure     X
Change in Law X    
Contamination     X
Geotechnical   X  

Source: Florida Department of Transportation

Financial Models/Cash Flow Analysis

Agencies use financial models to understand potential project value and cash flow requirements under different agreement structures and macroeconomic scenarios. Financial models include assumptions about revenue, project costs, financing costs, tax and inflation rates, and discount rates to estimate potential concession fees and/or project subsidies and estimate appropriate toll rates, if the facility is tolled. Public agencies use financial models primarily to gain a better understanding of cash flow requirements, but they can also use these models to better understand private sector's perspectives and incentives. The private sector is primarily concerned with net revenues and the internal rate of return on invested capital (for more detail, see Chapter X: Finance).

A financial model will typically rely on these factors:

  • Estimated design and construction costs;
  • Estimated annual operations and maintenance costs;
  • Estimated long term repair and rehabilitation costs;
  • Estimated long-term stream of revenue;
  • Forecast future inflation and interest rates; and
  • Assumed discount rates for future cash flows.

These factors will usually have a range, and the financial model will allow the agency to conduct a sensitivity analysis based on uncertainties regarding critical inputs. Establishing accurate levels for these inputs can be extremely difficult. The discount rate for future cash flows, for example, can have a major effect on the net present value of the project. Unfortunately, there is no industry consensus as to the appropriate discount rate for infrastructure projects. It can also be difficult for public agencies to estimate long term project costs because public agencies often lack historical data or benchmarks. Finally, it is difficult to estimate the probabilities of uncertain events or risks that may affect revenues and costs.

Public Sector Comparator/Value for Money (VfM) Analysis

A VfM analysis compares the projected risk-adjusted life cycle costs of a project delivered through a P3 to a public sector comparator (PSC). A PSC is an independent, objective assessment of project costs if delivered solely by the public sector, against which potential and actual private sector contract bids and evaluations may be judged. It is important to recognize that there are inherent limitations with developing a PSC, including the difficulties of evaluating taxable vs. generally cheaper (but potentially unavailable) tax-exempt financing and the lack of reliable information about private sector efficiencies.

VfM analysis generally follows these basic steps:

  1. Develop a PSC. Using a financial model, estimate the base costs of the project under consideration if it were to be delivered using the project delivery alternative (typically Design-Bid-Build or Design-Build) that might otherwise be used.
  2. Adjust for competitive advantages and disadvantages. Adjust the base costs to account for the inherent advantages and disadvantages of the project delivery alternative, such as relevant tax exemptions.
  3. Identify, assess, and allocate risks. Identify and determine the value of project risks by estimating the probability that each risk will occur and the consequences if it does.
  4. Assess the value of the risks transferred to the private sector through P3 procurement model(s) and develop a risk-adjusted PSC.
  5. Compare the risk-adjusted net present value cost of the PSC to the net present value of the P3 procurement model(s).

VfM is used to guide decisions regarding potential P3 projects, including which procurement approach to take, which risks to allocate to the private sector, and which private sector bid to accept. Agencies employ VfM to compare the costs of different project delivery options by assessing the value of transferring risks to the private sector, as well as the value of any efficiency gains that may be obtained through P3s. Agencies can also use VfM to evaluate the extent to which higher financial costs and risk premiums associated with P3 delivery are offset by efficiency gains from the transfer of project risks and costs to the private sector. When comparing procurement options, the procurement approach which has the lowest cost - after lifecycle cost, risks, competitive neutrality, and other items are considered - would have the best "value for money."

While VfM analysis seeks to quantify the value of risk transfer and any efficiency gains under different procurement methods, a comprehensive VfM also considers factors that can influence procurement decisions but may be difficult or impossible to quantify. Such factors may include:

  • Speed of delivery;
  • Quality of facility and service;
  • Differences in scope;
  • Ability of public sector to enforce performance standards;
  • Value to the public sector of cost and schedule certainty;
  • Effects on public sector debt capacity and cash flow; and
  • Degree of market interest.

Alternative methods for valuation exist, including comparative market analysis, discounted cash flow analysis, shadow bidding, and auction. Texas, for example, has used shadow bidding, whereby public agency engineers and consultants make detailed estimates of long term projects and those estimates are compared to private sector proposals. However, in countries with well-established P3 programs, including the UK, Canada and Australia, VfM is considered a best practice and in some cases, legally required. In the United States, Virginia DOT (VDOT) and Florida DOT (FDOT) regularly conduct VfM analyses of potential P3 projects.

Structuring P3 Project Agreements

Once policymakers have identified a project as having the potential to be delivered as a P3, they can prepare a project for procurement, which typically involves scoping and designing the project and specifying elements of the agreement.

Project Scoping and Design

As with any transportation project, scoping and design considerations will involve evaluating:

  • Estimated long-term costs of design, construction, operations, maintenance, repair, and rehabilitation;
  • Forecasted facility use;
  • Risks and potential risk mitigation strategies;
  • Potential funding, revenue sources, and/or toll rate structures; and
  • Expected impact on network performance, environment, and local populations.

With a P3 project, agencies will have additional factors to consider such as the timing of facility expansion, setting toll rates (if applicable), and identifying other non-toll revenue opportunities such as air rights or rest stops. With these special considerations in mind, a public agency may wish to structure agreements to retain flexibility in the definition of key project characteristics to allow for private sector innovation.

Agreement Definition

Agencies typically develop the conceptual structure of an agreement before procurement. The optimal structure of an agreement depends on the characteristics of a project, the goals and capabilities of the public agency, and the incentives and capabilities of potential private partners. Key elements include:

  • Allocation of responsibilities and risks;
  • Compensation mechanisms;
  • Concession term; and
  • Performance standards and performance management processes.

Building, operating, and maintaining a major transportation project involves risk. P3s derive much of their value by structuring contract agreements that transfer many of the long-term risks that are traditionally retained by the public sector to the private sector. To ensure the best value for the public, the procuring agency needs to perform a thorough risk analysis to determine which risks it should manage internally and which the private sector should handle.

Table 2-3 describes typical risks associated with P3 transportation projects. Risks tend to be highest at the beginning of a project, at the time of major investments, since there is greater uncertainty about long-term costs and revenues. Once construction is completed, risks tend to ebb, and, after an initial ramp up period, costs and revenues tend to stabilize. The change in risk over time has important implications for how agencies value P3 projects and structure and manage their contracts.

Table 2-3. Common P3 Project Risks
Project Phase Risk Type Description
Project Development and Construction Site Risk Acquiring land required for infrastructure development can result in delays or cost overruns; geological, hydrological, environmental or archaeological, cultural resource discoveries can cause delays.
Design Risk The design can have flaws that are not identified or realized until after construction gets underway.
Construction Risk Unanticipated construction delays or obstacles can add time and cost.
Financial/Economic Risk Cost inflation and/or interest rates can be greater than anticipated.
Operations and Maintenance Revenue Risk Revenues can be less than expected.
Performance Risk Operations and maintenance costs can be greater than anticipated.
Appropriations Risk Expected funds may not be appropriated.
Regulatory Risk Regulations can be changed in a way that affects project costs or revenues.
Contract Risk Contract can be interpreted differently than expected by either party.
All Phases Force Majeure XA catastrophic event such as a natural disaster or terrorist attack can occur.

The goal of a P3 is not to transfer all project risks—rather, it is to transfer the risks that the private sector can manage most efficiently. The private sector does not take on risk unless it expects to benefit. For each risk transferred, there is a cost that the project owner must pay. Higher perceived risks for a project will result in higher costs being attributed to those risks—called risk premiums. A risk may be priced differently by the public and the private sector, depending on their capabilities. It may be financially inefficient to transfer risks that are difficult to assess or that the private sector will have a difficult time managing.

The Port of Miami Tunnel and Access Improvement Project is a $900 million P3 project that will connect the Port of Miami with I-395 via a tunnel. Building the tunnel involves significant geotechnical risks. Unforeseen ground conditions could cause significant delays and increased costs. To manage this risk in a way that preserved performance incentives without scaring off investors, FDOT negotiated the following risk sharing provisions:

  • The first $10 million in additional costs due to geological conditions are borne by the concessionaire.
  • The next $150 million is borne by FDOT;
  • The next $20 million is the concessionaire's responsibility
  • If additional costs are over $180 million, either party may choose to terminate the agreement.

FDOT also agreed to extend construction deadlines in case the boring equipment required to dig the tunnel was damaged in transit.

To determine the optimal allocation of risk, an agency should compare the public sector's ability to manage each risk to the ability of a potential private partner to do the same. Risks that the private sector is more capable of managing should be transferred; risks that the public agency is more capable of managing should be retained. Where possible, the party with responsibility for managing the risk will seek to mitigate or avoid that risk. If a risk is difficult to assess or manage, it may be appropriate that it should be shared between the public and private sectors. An effective risk allocation should create incentives for the private sector to supply quality and cost-effective services.

While the concept behind optimal risk allocation is clear, the practice of how agencies allocate risks is more of an art than a science. There are methods for assessing the probabilities and costs of risks as well as various rules of thumb that may be applied. Typically, the public sector will be expected to take on site risks and regulatory risks. The private sector will be expected to take on risks arising from the building, operation, finance, and management of the project. The concessionaire may choose to further delegate risks to other private parties by selling equity stakes, holding subcontractors responsible for performance, and/or insuring against certain risks.

Compensation Mechanisms

Different compensation mechanisms put different risks on the government and private partners, with significant implications for the cost and structure of a P3 deal. P3 compensation mechanisms include:

  • Tolls. A P3 may be structured so that the concessionaire keeps the toll revenue it collects. The toll rate structure and future toll rate increases are typically set in the concession agreement to provide greater predictability to the concessionaire and assurance to the public that the concessionaire will not charge excessive tolls. If facility demand is less than expected, the private concessionaire may face losses, while it could reap windfall profits if demand is higher than expected. Most recent P3s that involve the private sector taking on toll revenue risk have revenue sharing provisions that mitigate the risks and share the rewards. Toll revenue risk is typically greater in a project where there is no history of traffic on which to base an estimate of demand.
  • Shadow tolling. With shadow tolling, a public agency compensates the concessionaire based on the amount of traffic using the facility, but the drivers do not pay the tolls themselves. This allows the agency to mitigate the technical risks associated with a tolled road while transferring most or all of the traffic risk to the concessionaire. This method of compensation has been used in P3s in the UK and Spain, but it has not been applied to P3s in the United States. Internationally, there is a trend away from shadow tolling because it may not effectively align private sector incentives with the public sector goal of managing mobility across the transportation network. For example, if a concessionaire's compensation is purely based on the amount of traffic, the concessionaire has less incentive to reduce congestion. Also, the public sector ends up paying a premium for the concessionaire to take on traffic risk, but the concessionaire may have little ability to influence the amount of traffic that is drawn to the facility. Instead, traffic levels are more likely to be affected by external, macroeconomic factors, such as job and housing trends and resulting regional traffic flows.
  • Availability payments. With availability payments, the agency retains traffic risk. The concessionaire is compensated based on its ability to operate and maintain the road to standards specified in the contract. This allows the agency to choose whether or not to use tolls to finance the project and to keep more control over toll setting if it does use tolls. It also avoids the perception that the concessionaire is setting excessive tolls. Availability payments are described in greater detail in Chapter X (Finance),
  • Flexible-term concession. A flexible-term concession is a form of revenue guarantee whereby once specified gross revenue has been reached (in present value terms), the contract is terminated. Firms can bid the level of present value of project revenues at which the contract would terminate. This arrangement limits downside revenue risks to the concessionaire while continuing to provide strong performance incentives. This model has not been used in the United States, but it has been used in Portugal, the UK, and Chile.
Figure 2-4. Revenue Sharing Provisions
P3 Agreement Revenue Sharing Agreement
I-495 Capital Beltway HOT Lanes Gross revenue sharing of 5 to 30 percent if traffic and revenue exceeds projections and when project is refinanced.
LBJ I-635 Gross revenue sharing of up to 75 percent of revenue exceeding projections and when project is refinanced.
North Tarrant Expressway Gross revenue sharing of up to 75 percent of revenue exceeding projections and when project is refinanced.
State Highway 130 Gross revenue sharing of up to 50 percent of revenue exceeding projections and when project is refinanced.
Midtown Downtown MLK Tunnel Gross revenue sharing of up to 60 percent of revenue exceeding projections and when project is refinanced.

Determining which compensation model to use depends on the agency's goals for the project, the capacity of the project to generate revenues, the financial structure within the State, and the willingness of the private sector to take on revenue risk. In deciding which model to use, a public agency should determine:

  • Is tolling the facility technically and legally feasible?
  • Is there political support for tolling?
  • How certain is the demand/revenue estimate?
  • Are facility revenues sufficient to support design, construction, finance, operations, and maintenance of the facility?
  • How efficiently can the agency monitor facility performance?

In P3 models that involve the concessionaire taking revenue risk, the government may choose to ease that risk by including revenue sharing provisions and/or revenue guarantees. These are described in greater detail in Chapter X (Finance).

Concession Term

Concession terms (i.e. period of performance) vary widely depending on the economics of the project and requirements of the contract. A typical length for a P3 contract is 35 to 40 years, but some contracts have terms of as long as 99 years. In the United States, private firms tend to prefer terms of 50 years or more because they can then capture the potential tax benefits as the asset depreciates. If the concession term is equal to or exceeds the facility's remaining design life, then the concessionaire can be treated as the facility owner for tax purposes and can write off the annual depreciation. Longer concessions can provide the public sector greater certainty regarding asset life-cycle costs and standards of service but can also reduce the public sector's flexibility to allocate resources to other projects, adjust performance standards, or change the delivery model. Concessions of less than 50 years are more likely to correspond to the design-life of a transportation facility, the term of financial instruments, and the time over which an agency can reasonably assess risk. No matter how long concession contracts are, however, there are always provisions to modify the contract over time as needs change, but these modifications may come at a cost.

There are ways of incentivizing concession lengths that better align with public sector policy goals. Where a shorter concession length is preferable, procurements can be structured so that shorter concession length is one of the proposal factors. The length of a concession can be used as a way to manage revenue risks as well. Agencies can use flexible-term contracts to manage revenue risks while maintaining incentives to manage long-term costs.

Some factors that should be considered in setting concession length include:

  • What is the design-life of the facility, and when will major asset upgrades or repairs be needed during the term of the contract?
  • Can revenues or costs be accurately forecasted over the term of the contract?
  • How will the contract manage potential technological advances affecting the facility over the contract life?
  • How will the agency manage resources dedicated to the project over time? What is the value to the public agency to have flexibility in allocating those resources?

Performance Standards and Performance Management Processes

In setting performance standards for a P3, agencies need to consider:

  • The types of performance standards that should be used. Are these standards critical to the performance of the project? Does the agency have the staff and resources to monitor the performance?
  • The level at which the performance standards should be set. High standards are desirable, but standards that are set too high will raise the cost of a project and will result in a project that is at a higher standard than others in the State, or possibly a project with higher standards than are needed for user benefit. For example, requiring that roads be litter-free may lead to a better driving experience for road users: but requiring that litter be removed hourly may not produce enough benefit to offset the additional cost.

Details relating to performance standards are covered in Chapter X (Performance Management).

Conducting Procurements

Given the risks and complexity involved in using non-traditional methods of transportation project delivery, choosing the best partner(s) requires due diligence on the part of the public sector. Because of the size, complexity, and length of term of P3 agreements, special procurement processes are needed to ensure there is sufficient and qualified competition. Some of the methods used to identify, qualify, and attract private partners are discussed below.

Bid Stipends

A well-structured procurement should generate competition and allow the public agency to select the partner that will best help the agency meet the project goals. Bidding firms may spend more than 1 percent of the bid value to develop bids. They are more likely to place a bid if they have confidence that the procurement process will be fair, competitive and that it will be seen through to completion. In addition, most bidding processes are structured so that the public agency can use ideas contained in one proposal while selecting a different bidder. To encourage competition, defray bidding costs, and compensate proposers for the value of ideas that might be used, some public agencies offer stipends to pre-qualified bidders. Bid stipends rarely, if ever, cover the entire cost of a proposal, and the value of an idea that is used in another proposal may be well in excess of the stipend amount.

Unsolicited Proposals

As described above, public agencies may use unsolicited proposals as a way of accessing private sector ideas about potential projects that could be commercially viable. Agencies that allow unsolicited proposals have developed various processes to introduce competitiveness and transparency into the procurement process.

Industry Outreach

A public agency may conduct industry outreach to gain a better understanding of private sector capabilities and interests with regards to a particular project. This process may occur prior to the procurement process or once an agency has selected a short list of qualified bidders. This can help an agency understand how to structure a commercially viable project that will generate competitive bids. Agencies may hold information-sharing meetings or workshops with industry representatives in order to describe the basic attributes of the project and potential agreement and asks for participant feedback. Agencies may also issue a formal "Request for Information" as a precursor to procurement.

Multi-Phase Procurement Process

To create a competitive and fair procurement environment, agencies often use a multi-stage, "best value" procurement process that includes a request for qualifications (RFQ), followed by a request for proposals (RFP), followed by negotiations with the preferred bidder. Figure 2-5 illustrates how this process could occur.

Figure 2-5. Example of a Multi-Phase Procurement Process

Figure 6. Example of a Multi-Phase Procurement Process

Request for Qualifications (RFQ)

The agency can use an initial procurement period to prequalify bidders by issuing a request for a letter of interest or a request for qualification from prospective bidders. The RFQ typically asks prospective bidders to provide information demonstrating:

  • Technical capacity to meet project performance specifications;
  • Past performance on similar projects; and
  • Financial capacity to complete the project.

In addition, the RFQ may ask for a conceptual project development plan and/or a conceptual project financial plan.

Request for Proposals (RFP)

After selecting a response from qualified bidders through the RFQ process, the agency then invites those short-listed qualified bidders to submit a second binding bid through a request for proposal. Bidders are typically required to submit a proposal that includes both technical plans for how the project will meet the design, construction, maintenance, and operational requirements as well as a financial plan demonstrating the financial feasibility of the proposal.

Public agencies can structure bidding so that bidders bid on different aspects of the project. Bidding can be based on different criteria, such as: the dollar value of the offer, the lowest subsidy or availability payment required, the lowest length of the concession term, or the lowest net present value of gross revenues required. The decision to select an appropriate partner often comes down to whether to choose the qualified bidder with the lowest dollar value ("low bid"), or whether to consider bid price in conjunction with other factors ("best value"). To determine the best value bid, the public agency may conduct a VfM analysis. Sometimes, the decision to choose the lowest bid or the best value bid is mandated by State or local law.

Negotiation with the Preferred Bidder

In the U.S., the negotiation stage generally does not include negotiations on key commercial issues or scope, which should be identified during the bidding process, so that all bidders have the opportunity to provide a bid on similar terms. Yet negotiations with the preferred bidder can allow both parties to establish a mutually-agreeable, project-specific solution to issues identified after the procurement process. This requires skilled legal counsel, ideally with expertise in developing long-term, enforceable agreements between the public and private sectors.

For example, the public and private sector may negotiate methods for verifying gross revenues as part of ensuring that the public sector receives appropriate toll revenue shares. The negotiation process can help to ensure mutual understanding on the part of both parties regarding the details of an agreement and the smooth implementation and oversight of a project. However, there are potential disadvantages to addressing items in negotiations with the preferred bidder. For one, the bargaining position of the public sector may be diminished at this point in the process (after substantial sunk costs in procurement). Secondly, there may be a perception of unfairness if the items negotiated are basic elements of the concession that could have changed the outcome of the selection process. For example, if provisions regarding revenue share or concession length are left to negotiation after selection of a successful bidder, other bidders who might have been willing to offer higher levels of revenue sharing or shorter concession terms than the preferred bidder offered might feel that they were unable to offer their best value in the competition. Thus, the basic elements of the concession are usually either established earlier in the procurement process, and are the same for all bidders, or bidders are allowed to use them to differentiate themselves in the bidding process. Provisions that may be left to negotiation generally relate to the implementation, oversight, and monitoring details of the concession – for example, the payout schedule for a revenue share, or how the revenue share will be calculated.

While the basic elements of an agreement are typically established early in the procurement process and, for reasons of fairness, bidders will expect provisions related to the core value of the agreement to remain unchanged, many of the details of agreement provisions may be subject to negotiation with the preferred bidder. Negotiating issues may include:

  1. Compensation structure (payout schedule, revenue sharing provisions, and subsidies). Issues that may be negotiated regarding the compensation structure include: when, how, and under what circumstances the concessionaire will receive payments; what portion of revenues will be shared at what revenue levels; and the degree to which the public sector will contribute to the project with grants, in-kind donations, tax breaks, or public financing.
  2. Risk sharing and mitigation measures. While the risk allocation is generally specified by the public agency in the procurement process, the precise performance measures and mitigation processes for specific risks may be subject to negotiation.
  3. Toll rate setting mechanism. Toll rate setting mechanisms may include defined toll rate schedules, maximum annual percentage increases (often tied to inflation or GDP increases), or regulatory review and approval of proposed rate increases.
  4. Performance standards and measures. P3 agreements typically set output- and outcome-based performance standards and management regimes for enforcing standards (See Chapter X). These standards may be subject to negotiation.
  5. Termination/buyback provisions. The rights to terminate the contract and the conditions under which those rights may be invoked (for example, if the private party defaults), are typically negotiated in the final contract. In the event of early termination, mechanisms are usually described in the contract to ensure that the harmed party is compensated for any losses or for the residual value of the asset.
  6. Refinancing provisions. The concessionaires of a P3 may refinance a project once the project is well established and uncertainty diminishes or operational efficiencies are established. Changing macroeconomic conditions such as declining interest rates can make refinancing attractive as well. Refinancing can result in greater returns to equity from interest rate reductions, extensions of debt maturity, and increases in the amount of debt. Contract provisions related to refinancing may include a negotiated share between the public and private partner in the gains made from refinancing.
  7. Non-compete provisions. The private sector may request some protection against the public sector's ability to reduce facility demand by building or improving competing parallel facilities in the vicinity of the project. Strict non-compete provisions barring the public sector from improving competing facilities are rare and are often forbidden in legislation. More commonly found are non-compete provisions that allow the concessionaire to be compensated if they can prove a net harm to project revenues from public agency activities.

Research Needs

To date, there have been few long-term P3s procured in the United States, so policymakers have few examples from which to draw. As more P3 agreements are made, researchers will have an opportunity to observe short- and long-term performance of the project with respect to the public and private sector's goals.

The following is a list of research questions to be answered:

  • How do compensation structures perform over the long term? Do they provide adequate incentive for the private sector while protecting the interests of the public sector?
  • What items tend to be negotiated in P3 agreements? How well is the public sector prepared to negotiate? Given the available information at the time of making the agreement, would public agencies make different choices, in hindsight, with regards to risk transfer? What issues were not anticipated at the time of making initial P3 agreements that turned out to be important? What issues were of great concern and turned out not to be as problematic as anticipated?
  • How accurately do evaluation tools such as T&R studies, valuation models, and VfM analyses predict eventual project outcomes? Are there ways to improve the evaluation tools?
  • What characteristics of P3 projects and programs lead to greater chance for "success" as defined by the public agency? How should public agencies define success with respect to P3s?

 

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