An Attractive Alternative

Nees, a vice president and program manager with Fort Worth-based Carter & Burgess, leads strategic toll-road initiatives nationwide.

By Katie Nees

The author discusses the growing interest in public-private partnerships in highway projects and looks at the pros and cons .

In recent decades, the population of Texas has grown twice as fast as the population of the United States. This rapid growth reflects the Lone Star State’s economic vitality and popularity as a place to live. One downside to this growth, however, is heavy traffic congestion in urban areas.

The state faces a double threat of increased gridlock and gasoline tax revenues falling far short of funding needed for new highway projects. The state finds itself unable to keep up with the funding requirements needed just to maintain what it has today.

A growing interest While still rare in the United States, privately funded and managed highways are common in several European countries, Australia and Chile. By and large, most of these projects are success stories, providing much needed private capital to fund public infrastructure.

Some projects are already under way in the United States. Officials in Indiana leased the Indiana Toll Road in 2006, raising $3.85 billion. In Illinois in 2005, the Chicago Skyway was leased to a private firm for 99 years for $1.83 billion. Leasing public infrastructure to private firms offers many benefits, but remains a controversial concept in the United States. Some politicians and citizens are concerned about turning over control of a public asset to a private firm, even for a limited time period. These arrangements, however, can be structured to minimize risk for the public entity, and to ensure the private sector company or group operates the asset in the public’s best interest.

How public–private infrastructure partnerships work There are many variations of public-private partnerships that can be used for project delivery, and each delivery method has its advantages and risks. The goal of each method is to provide appropriate risk sharing between the public and private sector partners. Public private partnerships range from design-build to concession delivery methods.

A simple design-build approach creates a single point of responsibility for design and construction, and can speed project completion by overlapping design and construction phases. This system is often cited as offering improved coordination and communication among designers and contractors. In the design build approach, the owner is responsible for all financing, operations and maintenance.

The concession model shifts finance, design, construction, operations and maintenance risks to the private sector. It provides continuity of private sector involvement and private sector financing of public projects supported by user fees (tolls, in the case of roads). The concession model provides several advantages to governments: reduces public spending, permits allocation of public funds for other priorities, expedites mobilization of financial resources, expedites construction and shifts risks to the private entity. The toll equity-based concession delivery model draws on competition among private sector bidders to minimize the public funding requirement and ensure the developers take appropriate construction and revenue risks.

When more private funding goes into a road project, more of the public funds previously allocated for road construction are available for other projects. Private developers also tend to have easier access to capital than the public sector, which means more projects get done more quickly. In addition, private sector entities assume more risk than occurs with the traditional design/bid/build method. The developer is bound by performance contracts and assumes financial risk - if the return on investment by toll collecting doesn’t match projections, for instance, the developer is still responsible for the debt service. Also, any construction cost overruns are borne by the developer.

The concession model has some perceived risks such as revenue impacting facilities, buy back provisions and the potential for poor operational performance. These risks are typically mitigated in the contract and are monitored by the owner and an independent, third-party engineer.

Under the concession model, toll revenues must be sufficient for the private sector entity to pay for the cost of up-front borrowing expenses. Toll rates on a typical toll road may be set and capped so all proposers are bidding on a level playing field. Toll rates on Managed Lanes differ in that they may be congestion priced and vary with demand.

In a concession, where the developer will commonly operate the facility for 30 to 50 years or more, the issue of competition from other nearby roads can be thorny. Lawsuits arose. The lesson is that, particularly over several decades, traffic levels and patterns can change. Unplanned, revenue impacting facilities or roadway expansion may be necessary to improve safety. Clauses that prevent roadway expansion or the construction of unplanned facilities should be carefully crafted or avoided.

Safeguarding the public Concession contracts must be written with safeguards to ensure the developer operates a toll road within the public interest. These contracts should include specifications to ensure the road is maintained properly, toll rates are governed, and that traffic flow in a managed lanes system is maintained at a certain average speed or volume, among other provisions.

Ultimately, the owner could take over the asset for lack of performance. Another possible contractual safeguard in a concession contract is to employ a revenue sharing mechanism with the developer so the public entity benefits when toll revenues exceed the base case rate of return on investment for a developer.

Evaluating pros and cons Building a road on a concession model changes the dynamics of management on a public infrastructure project. The big picture differences compared to the traditional government-funded model involve control, cost and risk.

While a concession arrangement can generate financing quickly to allow accelerated infrastructure implementation, there may be a financial disadvantage. If a public agency built and operated the road on its own, it could possibly make more money on tolls over decades than it would gain in private investment in a concession deal. But when there isn’t enough money to go around, it’s a tradeoff worth considering.

The biggest advantage for the states is in the area of risk transfer. Private companies have more flexibility in raising money in financial markets, and are able to take bigger risks than public agencies. This type of arrangement transfers risk to the party best able to manage the risk.

Given all the factors, when faced with gridlock and not enough money to build an adequate amount of roadway to relieve it, more government officials are likely to conclude that the benefits of the concession model outweigh its drawbacks.