Public-private partnerships: What’s old is new again

February 2008 » Feature Articles
An aging U.S. transportation infrastructure can once again benefit from private-sector investment.
Philip Armstrong, P.E., and Mel Placilla, P.E.

An aging U.S. transportation infrastructure can once again benefit from private-sector investment.

State and federal funds available for transportation infrastructure cannot keep up with the demand for improvements. And while some localities have been effective in raising funds for transportation infrastructure, this has not been the case universally. Furthermore, in most instances, the funds are directed at specific projects that appeal to voters. The lack of public funds available to remedy the country’s increasing roadway congestion and deteriorated infrastructure has created a great deal of interest in public-private partnerships (P3) as a new way of doing business. But are P3s really something new?

Colonial legislatures granted toll road franchises, public land grants and direct grants fueled railroad development, and part of New York City’s transit system and the Brooklyn Bridge were developed and operated by private parties. Even the nation’s first president, George Washington, participated in a P3. After his service in the Revolutionary War and before becoming president, Washington was president of the Potomac Canal Company, a partnership with the state of Virginia to develop a canal along the Potomac.

Facing a funding crisis to maintain and expand our aging transportation infrastructure, the United States could once again benefit from the involvement of private industry to improve mobility.

SAFETEA-LU changes
When Congress passed the Safe, Accountable, Flexible, Efficient Transportation Equity Act: A Legacy for Users (SAFETEA-LU), it also established the National Surface Transportation Infrastructure Financing Commission, which is charged with analyzing future highway and transit needs, evaluating the economic outlook of the Highway Trust Fund, and recommending alternative approaches to financing transportation.

The situation is clear: Government and public subsidies alone cannot solve all the country’s transportation problems. Americans need to start thinking of transportation as a utility. Who pays infrastructure costs for water, electrical, and other utilities? Users pay according to their level of use.

P3s can help apply this model as part of the solution to the nation’s transportation infrastructure needs. The U.S. Department of Transportation (U.S. DOT) has been actively promoting P3s through both the Federal Transit Administration (FTA) and Federal Highway Administration (FHWA). Changes in SAFETEA-LU and U.S. DOT procedures enhanced the attractiveness of P3s by establishing private activity bonds. These tax-exempt debt forms, coupled with Transportation Infrastructure Finance and Innovation Act (TIFIA) loans, can be used to supplement normal project finance. Accelerated depreciation schedules for investment in transportation infrastructure also became available. In addition, SAFETEA-LU allows FHWA to develop flexible project implementation procedures that allow project development to occur in parallel with National Environmental Policy Act processes.

What is a P3?
FHWA defines the P3 concept as "a contractual agreement formed between public and private sector partners, which allows more private sector participation than is traditional. The agreements usually involve a government agency contracting with a private company to renovate, construct, operate, maintain, and/or manage a facility or system. While the public sector usually retains ownership in the facility or system, the private party will be given additional decision rights in determining how the project or task will be completed."

Europe, Australia, and South America have used P3s for years, with their projects fueled by banks and domestic or foreign developer/constructor consortiums. U.S. banks, developer/constructors, and investment funds have been slower to enter the P3 market, but this is changing. Developer entities are now more commonly being formed with American participants. However, foreign interest remains a major factor in this market. The United States is considered an attractive, emerging market to foreign investors of P3s by providing a safe haven for their investments.

Significant capital has been identified with interest in infrastructure funds in the United States. The New Jersey Asset Evaluation Program projected in November 2006 that "up to $40 billion in surface transportation concession projects could be awarded in the U.S. during the next few years."

State agencies are experimenting with different P3 approaches. Indiana obtained $3.8 billion in funding in 2006 through the 99-year lease of the Indiana Toll Road—the equivalent of almost 10 years of the state’s transportation improvement program. Chicago leased its Skyway for 75 years for $1.8 billion. Texas, Florida, Virginia, and Oregon, among other states, have been active in the P3 market. Some states are looking at P3 projects involving toll agencies to leverage existing assets, such as the Pennsylvania Turnpike, SH 121 in Texas, and the New Jersey Turnpike, for additional transportation funding. FTA encourages transit agencies to use availability charges and transit-oriented development to leverage partnerships with private development.

States and agencies also have experimented with solicited and unsolicited proposals, the difference being whether the agency solicits proposals for a prospective P3 project, or a development/investment entity submits a proposal without prior solicitation from the agency.

Virginia, for example, has a process in place for accepting unsolicited P3 proposals. If the agency chooses to proceed, competing proposals are solicited within a specified timeframe, usually 90 to 120 days.

Types of financing tools
P3s can use several financing tools to create funds for project development.

The concession agreement establishes a fixed-term contract in which the private partner is responsible for aspects that normally would fall on a public agency, such as project design, construction, finance, operation, maintenance, and revenue collection (see Figure 1). The public partner typically sets performance criteria and might assist in project funding, assumes specific project risks, and shares in revenue above prescribed criteria. In some cases, the private partner has paid an up-front fee for the concession and may offer ongoing revenue sharing. Typically, rate-setting methodology for the project is specified in the agreement. Concession agreements have been used for new (greenfield) projects as well as modifications to existing (brownfield) facilities through addition of high-occupancy or managed toll lanes.

 

Figure 1: Example organizational chart in a public-private partnership.

Project leases are long-term contracts for existing facilities, typically running in excess of the asset’s useful economic life. Normally, in exchange for a sizable up-front payment, the private partner operates, maintains, and collects toll revenues from the operations. The lease may specify certain improvements to be made or set thresholds at which the improvements must be made. Toll rate increases are normally limited to certain economic measures, such as the consumer price index.

Availability payments is a type of P3 in which a private entity designs, builds, finances, and usually maintains and operates a facility. The public entity agrees to make regular payments to the private party based on the facility’s availability and level of service achieved for operations and maintenance. In this case, the public entity normally accepts the revenue risk and may provide some level of initial funding to offset capital requirements. The private entity takes the risk of project delivery, maintenance, and operations. This method is currently more prevalent with transit work. Transit agencies are experimenting with adding incentive payments based on increased ridership or service.

Shadow tolling is similar to availability payments in that a private party agrees to design, construct, finance, operate, and maintain a facility. However, instead of compensating the private entity through availability payments, the public entity pays a toll based on how much traffic actually uses the facility. The private sector takes the risk of traffic revenue, project delivery, maintenance, and operations. The public sector may assist in initial funding of the project or ongoing supplements.

Design-build-finance is a vehicle that allows an agency to advance project completion earlier in its fiscal program than planned. Procurement follows normal agency procedures for design-build procurements. The agency specifies a maximum time for completion of the project and a payment schedule that exceeds the prescribed time, thus requiring short-term financing by the private entity.

A 63-20 vehicle is a nonprofit public benefit corporation established to develop a specific project or set of projects. The term 63-20 refers to the Internal Revenue Service code for this type of entity. Using a 63-20 allows a private project sponsor to advance a project as long as it engages in activities that are public in nature. It must not be organized for profit and the corporate income must not inure to any private person. A state or political subdivision must have a beneficial interest in the corporation while the indebtedness remains outstanding and must approve the corporation. The state or political subdivision must also approve the specific obligations issued by the corporation. Ultimately, unencumbered legal title in the financed facilities must vest to the public agency after the bonds are paid.

Meeting both parties’ goals
The interests of the partners in a P3 are distinctly different. The public agency’s primary concern is providing efficient and economical transportation services. It has a responsibility to provide stewardship of public resources and develop projects that meet expected levels of service. Integral to this responsibility is to ensure satisfaction of environmental requirements and political stakeholders.

The private sector partner’s focus is return on investment. It is responsible for cash flow, ramp-up of facility use, rate setting, and managing risks associated with project delivery, operations, and maintenance. In addition, the private sector partner must assess political risks and the potential for litigation.

Though their motivations and concerns are different, it is important that each partner understand the other. Despite pursuing the project for different reasons, ultimately, their paths to success will converge with the development of a well-planned facility.

Philip Armstrong, P.E., is HDR’s national director of public/private ventures, based in Dallas. He can be reached at philip.armstrong@hdrinc.com. Mel Placilla, P.E., is HDR’s national director for alternative delivery, based in Irvine, Calif. He can be reached at mel.placilla@hdrinc.com.


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