Selected SLC Research
Presentation | December 13, 2007
Public Private Partnerships (P3s) in Transportation: Trends from the States (presentation)
Before the Idaho Senate Task Force on Treasure Valley Transportation Issues Nampa, Idaho
It is a great honor to be here this morning and I thank Senator McGee for extending this invitation to me and to The Council of State Governments. Established in 1933, The Council works primarily with state legislatures in tracking trends, carrying out research and analysis and promoting state interests. While I work for The Council's Southern Office, the Southern Legislative Conference (SLC) in Atlanta, The Council is headquartered in Lexington, Kentucky and also has regional offices in New York, California, Illinois and Washington, DC.
My presentation this morning covers an important trend surfacing in almost every state in the country: transportation-driven public private partnerships or P3s. Broadly, my presentation comprises four parts. Part 1, after a quick overview of national and state finances, details the impetus for this growing trend while Part 2 describes its pros and cons. Part 3 illustrates several best practices recommended by states and finally, Part 4, explores some specific P3 strategies either currently in place or being explored.
Although the idea of a transportation-related public private partnership is not new, what is different now is that states are increasingly creating legislation that allow for these partnerships to gel. Specifically, P3s refer to contractual agreements formed between a public agency and a private sector entity allowing for greater private sector participation in the delivery of transportation projects. Given that the option of raising taxes to fund an increasing number of transportation projects remains politically radioactive, policymakers continue to pursue a range of alternate funding mechanisms and P3s are a critical trend here.
According to the Federal Highway Administration, 22 states have now passed legislation permitting deals between public entities and private enterprise to finance transportation projects. The federal government, under the leadership of U.S. Transportation Secretary Mary Peters, is actively encouraging states to incorporate P3s into their future transportation calculations.
Even though toll roads are a dominant component of transportation-related public private partnerships they are by no means the only dimension. Selling or leasing state assets by entering into public private partnerships has emerged as a politically feasible option for many policymakers and this includes highways; lotteries; student loan portfolios; parking meters; state-run liquor stores; naming rights for transit stations and sports stadiums; commuter railroads; airports; bridges; and, advertising space on bus shelters, newsstands and garbage cans.
Prior to delving into the P3 debate, it is important to note overall trends with regard to state finances. While state finances have recovered from the depths to which they were plunged in the early years of this decade, there are certain ominous signs looming on the horizon related to both the national and state economies. Despite the improved revenue picture in the last two to three years, state revenue growth lags behind long-term historical levels. Alarmingly, a number of states (including Florida, California, Maryland, Missouri, Virginia, Illinois, Arizona, New Jersey, New York and Nevada) have already signaled that they expect to grapple with sizable budget shortfalls in the coming year. Moreover, a number of states are reporting declining sales tax inflows, a clear sign that the economy is contracting. Given the ongoing blows dealt to the national economy by the shrinking housing and construction sectors, the exploding energy market, and the tightening credit market, the national and state financial outlook appears cloudy.
Against this backdrop, public private partnerships have gathered a great deal of momentum and they have either been adopted, or are being actively discussed, in state houses across the country for the following reasons: One, the federal Highway Trust Fund – the Fund supported by a federal tax on gasoline that serves as the major source of funding for a plethora of state highway and transportation projects – is projected by the Congressional Budget Office to run dry in 2009. Two, the U.S. transportation network – with its multiplicity of highways and bridges – is in dire need of a major, and distressingly expensive, overhaul. Three, an increasing number of states slashed transportation funding and postponed routine maintenance and repair work during the last fiscal downturn, a development that places additional pressure on an already crumbling and aging transportation infrastructure. (For instance, the tragic I-35W bridge collapse in Minnesota and the massive steam pipe explosion in New York City, both this past summer are the result of postponing routine inspections, repairs and maintenance.) Four, the skyrocketing federal deficit and the increasing number of other federal priorities makes it highly unlikely that the federal government will be in a position to fund significant transportation projects. Five, similarly, states face a series of complex challenges with substantial fiscal costs ranging from sizable healthcare, pensions, prisons, education and emergency management expenditures, a development that will prevent them from allocating additional resources to bolster transportation and infrastructure spending. Six, traffic congestion levels have risen to unprecedented heights in many locations across the country – a trend that has enormous economic costs – and the public is demanding improvements in this area. Seven, a mounting number of private (mostly foreign) equity entities with excess capital are actively looking to invest in the U.S. economy and are driving these recent P3s. Finally, as noted earlier, generating funds via higher taxes – either at the federal or state levels – remains politically radioactive and policymakers are eager to explore alternate mechanisms to fund transportation solutions.
After analyzing public private partnerships in a number of settings, experts are able to identify both advantages and disadvantages associated with this escalating trend. On the pro side, the ability to leverage private equity to implement vital transportation projects without having to either raise taxes or take on more public debt is considered a major benefit. Another benefit cited by advocates is the infusion of a substantial amount of cash from the private entity to the state as a result of a P3 agreement that, in turn, could be allocated towards other essential expenditure categories; the $3.9 billion Indiana secured from Cintras/Macquarie is an example here. Yet, another advantage forwarded is the fact that the state can raise revenue by charging tolls based on usage as opposed to levying taxes, a move considered more politically palatable. Experts also cite the expedited completion times for these P3 projects – compared to conventional project delivery methods – and the enhanced quality and system performance once the project is fully in place. The fact that the state now has access to new sources of private capital and does not have to bear the financial risk associated with a major transportation project is cited as yet another advantage. Furthermore, the ability to have a fixed price contract over a number of years into the future is considered another positive feature since constantly increasing transportation costs are a common feature of publicly-financed transportation projects. Finally, the fact that P3 projects permit states to substitute private resources and personnel for scarce and diminishing public resources is cited as a significant advantage.
Notwithstanding these positives, experts also caution policymakers entering into these public private partnerships about the following. One, the possibility that states might be constrained by a non-compete clause, where even the construction of a highway in the vicinity of the P3 project would hamper state transportation projects and also require the state to pay the private company for the potential loss of revenue. Two, the length of the contract's terms, particularly if they extended decades (sometime as long as 99 years) into the future would only serve to bind future legislators and citizens to possibly onerous terms. Three, experts note that the state potentially loses control and access to essential elements of its public infrastructure network after the completion of a P3. Four, experts also stress that that the P3 toll facilities might be insufficiently regulated resulting in the public having to face unreasonably high toll rates or excessive profit margins by the private entity. Another disadvantage is that states run the risk of relinquishing the up-side of increased toll revenues once they enter into a long-term contract under a P3. Finally, specialists tracking this trend in states indicate that P3 projects have the potential to fall outside the realm of the state's transportation overall plan, a development that could result in adverse financial outcomes for the state.
A number of states have years of experience with P3s and focusing on what they consider best practices holds important lessons for states contemplating a P3. Virginia is one such state and maintains that the following features remain central elements in an effective P3 strategy:
• Transparency: It is critical for the entire process to be completely transparent. In Virginia, P3 legislation requires an extremely high threshold of scrutiny at many different levels. Involving the local governments and residents were also listed as important requirements.
• Business Considerations: The entire cost-benefit analysis for implementing a P3 project has to be driven by business considerations with the requisite level of financial discipline. The level of risk that is to be shared by the private and public sectors has to be clearly identified.
• Staffing: Securing competent and highly skilled public sector staff in all the related disciplines (financial, engineering, traffic patterns) remains of the highest importance. Negotiating with large multinational corporations with sophisticated capabilities requires an equal or even greater level of competence on the public sector side. In Virginia, it took several years to build up such a team.
• Customers: Respect for the customer/consumer of these projects, i.e., the individual that will be paying the toll, is very important. In this regard, states should not divert revenue secured from a toll project to another transportation project in the state if this causes a worsening in the level of service provided to the consumer at the original project.
In addition, states may also learn from the Texas experience and the interplay between the governor and the Legislature during the 2007 legislative session. In 2003, Texas enacted legislation that authorized a role for private equity (including toll roads) in building the Trans-Texas Corridor, a massive, a 650-mile corridor stretching from south Texas to northeast Texas. During the 2005 session (the Legislature meets every other year in Texas) further additions were made to the original legislation. However, by the 2007 session, there were 70 bills filed that sought to "either stop, drastically change or alter" the provisions contained in the original 2003 legislation. This was because the Texas Legislature maintained that the Texas Department of Transportation (TxDOT) had not been transparent in its negotiations regarding the role of private equity in the agreements being pursued and that "neither the Legislature nor the public had any idea regarding what was contained in the agreements." Furthermore, even though the Texas attorney general had ruled that these discussions and agreements had to be open, TxDOT opted to maintain a level of secrecy that led to a huge public outcry. The swirling controversy over the plan resulted in legislation in 2007 that placed a temporary moratorium on involving private equity in the building of toll roads in Texas. Consequently, in Texas, which has both a Republican governor and a Republican Legislature, there is a temporary moratorium in place because "Texas went from 0 to 100 m.p.h. in one second" on the private equity toll road issue.
A Texas legislator with a great deal of experience on the proposed P3 in her state has highlighted the following elements "troublesome:"
• Non-compete Clause: While the Texas agreement did not prohibit the construction of a highway in the vicinity of the P3 project, it did require the state to pay the private company for the potential loss of revenue. The Dallas/Fort Worth and Houston areas, which already have their own toll authorities, would be in a bind here. In addition, no new highways could be built within a radius of 200 miles of the toll road constructed by the P3 project.
• Buyout Clause: In the event that the state wished to buy out the private company, the state would be responsible for reimbursing expenses incurred by the private company and all future revenue.
• Contract Length: While the contract term (50 years) was less than the Chicago Skyway project (99 years), "it was still a long time." The question posed was whether legislators in 2007 would have liked to have been constrained by contracts entered into by their predecessors in 1957.
• Profits: "Where would the profits flowing from the toll project be invested? In Spain, Australia or Wall Street?" The point was that there was no assurance that the profits would be invested in Texas so that the state could benefit from these investments.
• Number of Proposals: The original 2003 legislation operated on the premise that Texas would entertain between one and four P3 projects related to the Trans-Texas Corridor; however, this number ballooned to as many as 24 private equity highways. Some of these proposals were adjacent to one of the most successful toll authorities in Texas, in Harris County (Houston).
Finally, New Jersey Governor Jon Corzine lists the core principles of asset monetization – the process by which a state converts its assets into cash – and how these core principles will guide how much new toll revenue might be squeezed from his state's three highways with P3s. Governor Corzine also wants to create a new public agency under the P3 format that would use higher tolls and other revenue sources to pay down about $32 billion in state debt while also financing a new wave of public works projects.
According to the Federal Highway Administration, public private partnerships take many forms, including Design-Bid-Build; Private Contract Fee Services; Design Build; Build-Operate-Transfer (BOT); Long Term Lease Agreements; Design-Build-Finance-Operate (DBFO); and, Build-Own-Operate (BOO). One such approach that has received a great deal of recent attention involves three long-term lease agreements: the 99-year lease of the 7.8 mile Chicago Skyway for a fee of $1.8 billion in January 2005; the 99-year lease of the 8.8 mile Pocahontas Parkway in Richmond, Virginia for $611 million, also in 2005; and the 75-year lease of the 167 mile Indiana Toll Road for a fee of $3.9 billion in July 2006. This particular brand of P3 involves the long term lease of existing, publicly-financed toll facilities to a private sector entity (Macquarie/Cintras in Chicago and Indiana and Transurban in Virginia) for a prescribed period during which they have the right to collect tolls on the facility. In exchange, the private partner operates and maintains the facility, makes necessary improvements and pays an upfront concession fee to the state.
There are several other aspects to the P3 trend that deserve mention. Road pricing is another phrase that is frequently in use now and it refers to the panoply of charges levied on motorists for the use of roads. For instance, road pricing extends to such levies as fuel taxes, license fees, tolls, and congestion pricing charges with the latter varying by the time of day or specific road or vehicle type. Road pricing fees are driven by two main goals: generating revenue and controlling congestion. While assessing fuel taxes, tolls and license fees fall under the revenue generation category levying charges for using high-occupancy toll (HOT) lanes or for entering a restricted area of a city at a certain time fall under the congestion control category.
Congestion pricing, a topic advanced by Dr. William Vickery in 1963 and who many years later won a Nobel Prize in Economics, was first introduced in Singapore in 1975 and is currently operational in select cities in Norway, Sweeden, Malta and in the cities of London and Rome. Mayor Bloomberg in New York City has also proposed introducing it in his city. Germany and Austria also currently have a system in place to charge trucks a per kilometer fee based on their emission levels and number of axles.
In conclusion, the role of public private partnerships in the transportation sphere will only continue to become more dominant as states explore generating alternate funding sources to meet their surging transportation and infrastructure expenditures. In a political environment where raising taxes is toxic and a fiscal environment where reliance on the Highway Trust Fund is tenuous, P3s will most certainly loom large in state transportation plans. As expected, there are pros and cons associated with the growing reliance on these public private partnerships and it is imperative that policymakers heed the advice of states with considerable experience when entering into a public private partnership. In this connection, emphasis on transparency, business considerations, staffing and customer satisfaction will mitigate the potential adverse effects of P3s. Thank you for your attention.