Click for next page ( 28


The National Academies | 500 Fifth St. N.W. | Washington, D.C. 20001
Copyright © National Academy of Sciences. All rights reserved.
Terms of Use and Privacy Statement



Below are the first 10 and last 10 pages of uncorrected machine-read text (when available) of this chapter, followed by the top 30 algorithmically extracted key phrases from the chapter as a whole.
Intended to provide our own search engines and external engines with highly rich, chapter-representative searchable text on the opening pages of each chapter. Because it is UNCORRECTED material, please consider the following text as a useful but insufficient proxy for the authoritative book pages.

Do not use for reproduction, copying, pasting, or reading; exclusively for search engines.

OCR for page 27
28 was not important. Of all the concerns evaluated in the sur- Agreements: Guidance for Municipalities" in 2003 to pro- vey, this is one of few that received the highest response of vide general guidance and information on the subject. It "not important." should be noted that there may be trade principles and treaties that bar discrimination against foreign investors, and such On the other hand, the opportunity for local contractors discrimination could be quite disruptive to many sectors of and consultants to participate in PPPs was considered an the economy. important concern by most states, with only two negative responses. The latter came from states that are not consid- An example of the potential conflict of trade agreements ering PPPs. related to highway PPPs comes from the Highway 407 ETR in Toronto, Canada. As part of the political campaign in 2003, the liberal party promised to reduce tolls on this pri- National Security Concerns vately operated facility. The government brought the case to court and arbitration several times, but the court always After the events of September 11, 2001, the concern about ruled in favor of the concessionaire, who had contractual national security and the call for protecting this country rights to set and increase toll rates. In addition, the dispute has become one of the top priorities of the government. between the government and the concessionaire for 407 ETR Some critics of PPPs have raised concerns about the for- escalated over time with several other issues, and included eign origin of concessionaires and the possibility that this an attempt by the concessionaire to compel the Registrar of may be a threat to national security. During the Indiana Motor Vehicles to deny vehicle plates and permits to drivers Toll Road deal, opposition to the lease was fueled after with outstanding toll payments. Both parties reached a set- public disclosure that the U.S. ports were operated by a tlement on all their issues in spring 2006. However, during company owned by the government of Dubai (Buxbaum the dispute period, the government of Spain threatened to and Ortiz 2007). Although there was no direct relation veto a trade agreement if the government of Ontario contin- between these two deals, the latter served to strengthen and ued interfering with the 407 ETR concessionaire's right to raise additional concerns about leasing the toll road to for- control tolls (Redlin 2004; TollRoadNews, various articles). eign investors. It should be noted that foreign investments in highways that could affect national security are subject Of all our state DOT survey respondents (including U.S. to review by the Committee on Foreign Investment in the DOTs and their Canadian counterparts), about 29% consid- U.S., under the Foreign Investment and National Security ered trade agreement implications to be "not important," all of Act of 2007. which came from U.S. respondents. Over half of the respon- dents considered this concern to be "somewhat important," The "non-DOT" survey brought up the national security including all five Canadian agencies. concern as well by one respondent, specifically in defining what entity will have final oversight and decision making on PPPs, whether it is the public sector or the private concessionaire. The TERMS OF PUBLICPRIVATE GAO (2000b) found that the federal government's involvement PARTNERSHIP AGREEMENTS with PPPs has been limited to projects that have used or will use federal funding; however, some of these deals may have impli- Many of the public concerns related to PPPs are mainly cations of national interest, such as interstate commerce or related to the loss of public control over the facility, and national security. The GAO recommended a reexamination whether the contract clauses adequately protect the public of federal programs that will include a definition of national interest. PPP agreements include hundreds of pages of con- interests on PPP and how these interests can be protected. tract terms and standards that should be met by the conces- sionaire, and are developed to best address risk and the interests of both parties entering into the agreement. And, International Trade Agreement Concerns as the public sector builds experience in PPPs, many of the issues experienced in early PPP agreements become "legacies PPPs can raise international free trade issues. According to a of the past" (Buxbaum and Ortiz 2007), which are reflected in website maintained by Cornell University (http://government. the use of more "limited-compete" instead of "non-compete" cce.cornell.edu/doc/reports/freetrade), state and local gov- clauses (see the section on Non-Compete and Other Unantic- ernments are concerned about losing some of their authority ipated Event Provisions later in this chapter), or revenue shar- because federal law preempts state and local law where there ing as opposed to a one-time up-front payment. Furthermore, is a conflict. Furthermore, under free trade agreement regula- PPP agreements include performance requirements and/or tions, foreign investors "have a right to bring nations into specifications that must be met by the concessionaire. international arbitration to defend government measures that affect their investments (property) negatively" (Gerbasi and Warner, n.d.). Literature addressing this concern in particu- Asset Control and Ownership lar was found from the Canadian Council for Public-Private Partnerships. The Council, an organization that supports In a PPP, the facility remains under ownership of the public PPPs, published the "Public-Private Partnerships and Trade sector; however, certain responsibilities are transferred to the

OCR for page 27
29 private partner, as specified by contract (Samuel 2005); these be a "very important" concern; however, a significant share responsibilities revert back to the public sector once the con- of the respondents (18%; i.e., six states and three Canadian tract expires. Regardless of this, however, there is a tendency provinces) still indicated that it is "not important." to equate a PPP with complete "privatization" (Samuel 2005; Baxandall 2007), especially on very long-term deals. There The PPP debate, specifically related to long-term conces- was a consensus among the states surveyed that asset control sions paid through tolls, is caught in the middle of a debate is an important issue, with more than two-thirds of the states about tolling policy. In the past, most toll authorities acted on surveyed rating it as "very important." a toll policy (not necessarily explicit) of keeping tolls as low as possible to meet debt obligations on a toll facility or sys- The GAO and U.S. Public Interest Research Group reports tem of facilities. Toll increases were typically done as a last on PPPs, and responses from our interested parties' survey resort, and only after much agonizing public debate--similar identified the concerns on asset control and ownership: to debates on transit rate increases. Unlocking the value of a transportation asset actually means allowing toll rates to be Toll rate setting, where toll rate changes do not require set at market levels and/or permitting them to increase in public sector approval. This includes annual increases accordance with inflation, and leveraging that future revenue and maximum rates allowed by contract, and public stream into up-front cash. When tolling as a revenue source sector inability to modify toll rates for transportation and PPPs as a project delivery mechanism are pursued at network management. the same time, toll rate setting control appears to move from Non-compete clauses (such as those included in the the public sector, where elected officials are accountable, to SR-91 in California concession agreement) that pre- private companies that are motivated by rates of return. Both vented modifications to the leased asset or to competing the Chicago Skyway and Indiana Toll Road long-term con- facilities, or limited-compete clauses that allow mod- cessions were done with the explicit purpose of increasing ification and/or construction of competing facilities, the asset value of the project through taking rate setting con- albeit at a cost. This could include implementation of trol away from politically motivated officials. The contract regional or state transportation plans to accommodate terms for both of these agreements allows for toll increases changes over time. well above increases that have generally been seen in the Some PPP agreements may create a "tax" on normal United States, and elected officials no longer have the ability policy making, by including compensation clauses that to intervene in toll increases that are within the caps specified require the public sector to pay the private partner for any in the contracts. revenue losses as a result of transportation improvements sponsored by the public sector. Safety and maintenance standards. Inability to guaran- Opinion/Comment from "Other Individuals/Interest tee state-of-the-art safety and maintenance standards on Groups" Survey: the leased facility. These can always be included in a In light of the fact that we can't just raise tolls, the P3 is the contract, but represent an additional cost that will affect next best answer. the cost or valuation of the facility. Project oversight. Reduced ability to control various aspects of transportation asset management, from con- struction to maintenance and operations. Indeed, the concept of "unlocking the trapped asset value" of transportation assets has been used as a key argument in These asset control and ownership issues are major elements favor of PPPs (Gribbin 2006; Replogle and Funderburg in the formulation of PPP contract terms and are discussed in 2006). By moving to PPPs, elected officials are removed more detail in the subsequent sections. from the mix on individual toll rate setting decisions in legally binding contracts (although they do approve the over- Tolling Policy all structure allowing for future increases). This added value can then be used for a variety of public projects, in addition Highway PPPs are paid for either with direct user fees (such to providing a profit for the private concessionaire. as tolls), government payments (generally from taxes or other general revenues), or both. Most government entities in Allowing toll rates to escalate does increase the value of the United States are struggling with the ability to keep the the transportation asset, but this is a public policy decision cost of developing, operating, and maintaining highway that arguably should be separate from the decision to pursue infrastructure under control, and also find it difficult to raise PPPs (Buxbaum and Ortiz 2007). However, this is not clear either general purpose taxes or motor fuel taxes. Recent sur- because the public sector has historically been unwilling or veys have found that there is higher support for the "user unable to raise tolls, derailed by political debate or popular pays" concept of tolling than for taxes (Zmud and Arce 2008). disquiet (European Commission 2003; Gilroy 2007). The Overall, more than two-thirds of our DOT survey respon- Florida Legislature has attempted to reverse this trend by dents considered the toll setting policies related to PPPs to passing a provision that requires annual toll rate indexing by

OCR for page 27
30 Consumer Price Index (CPI) no less than once every five reality, toll rate increases in the 407 ETR have exceeded the years (Buxbaum and Ortiz 2007). growth rates established by contract. For instance, in 2008, the rate for off-peak travel went from 16.8 cents/kilometer Responsibility for setting tolls depends on the nature of to 18 cents/kilometer, a 7.1% increase. By December 2007, the partnership. Long-term lease agreements, otherwise the rate of inflation in Canada, according to statistics from the known as concession agreements, have received a great deal government of Canada was 2.4%. Therefore, the actual growth of attention because they allow the concessionaire to set the rate over the last year was significantly higher than the growth tolls. Public control of toll setting policies is established rate allowed by contract (e.g., 2.4% inflation + 2% = 4.4%), within the contract and typically includes toll growth caps following a trend of excessive increases (compared with con- that cannot be exceeded by the private concessionaire. PPP- tract specifications) for several years. enabling legislation could include toll setting policy that has been agreed on by decision makers, and with public input Toll Setting Is Not Always About Profit (Buxbaum and Ortiz 2007). User tolls are said to lessen social inequities related to who Some suggest that the private sector cannot be trusted to pays and who benefits by charging drivers for the actual use raise tolls because it will do so inordinately to maximize of highways, tunnels, or bridges. User charges normally profits. The private sector will set tolls based on market are set to recover the cost of the road project and maintain the factors, which will be highly correlated to the level of com- predetermined operating condition of that road and are high petition from alternative facilities or modes (GAO 2000b); enough to allow for the private partner's return on investment therefore, if competition is limited, the private sector may set (Jeffers et al. 2006). Although user fees and congestion pric- toll rates within the allowable maximum rates by contract, ing schemes are often favored by economists as a way to and yet realize revenues that exceed the cost of the road and manage demand, Congressmen Oberstar and DeFazio (2007) a reasonable rate of return. The concern is that besides goug- asserted that tolls are regressive because they charge drivers ing users, the private sector may be taking money that could of all income levels the same amount and suggest that elec- be going to the public agency. Some suggest that it is not tronic toll collection technology can reduce or eliminate tolls always in the best interests of private partners to raise tolls by paid by low income drivers. The RPA (2007) suggests con- the maximum allowable amount if it drives some users to sidering the effect to middle- and low-income groups when alternative routes, thus eroding profits (Samuel 2007). developing the toll-increase schedules, such that these groups are not disproportionately affected. Careful contract negotiations can constrain maximum toll increases. The recent National Surface Transportation Policy PPP legislation and/or concession agreements may in- and Revenue Commission report recommended capping toll clude provisions setting toll rates lower than required to rate increases at the level of the CPI, adjusted by produc- support financing; however, in exchange, the public sector tivity. Tolls on the Indiana Toll Road are scheduled by the would provide funding or subsidies to attract private sector Indiana legislature through June 2010. Thereafter, maximum participation. In Chile, the public sector establishes the annual increases for all vehicles are capped at the greater maximum toll rate, and the evaluation of PPP proposals of 2%, CPI, or per capita nominal growth in gross domestic takes into account the proposed toll rates, among other fac- product (GDP). Tolls on the Chicago Skyway are scheduled tors (Izquierdo and Vasallo 2004). Similarly, some PPPs in in the lease agreement until 2017, with maximum annual Australia have been awarded to bidders that propose oper- increases capped at the greater of 2%, CPI, or per capita ating the facilities with the lowest toll (GAO 2000b). Six- nominal GDP growth beyond 2017. Tolls on the Pocahon- teen of the states with PPP-enabling legislation already tas Parkway in Richmond, Virginia, are specified until 2016, allow the combination of public sector funding with private and annual increases are capped at the greater of 2.8%, CPI, funding on a PPP project (FHWA PPP enabling legislation or per capita real GDP growth thereafter (Subcommittee on survey 2007). Highways and Transit 2007a). Real GDP growth over the last 10 years has ranged between 0.8% and 4.5%, whereas CPI Shadow Tolls and Availability Payments has fluctuated between 1.5% and 3.4%. The recent economic forecast from the Congressional Budget Office (2008) esti- Direct user fees are not the only way that private concession- mated long-term CPI growth at 2.2% and real GDP growth at aires can be compensated. With shadow tolls the govern- 2.3%. However, Replogle (2007) cautioned Congress against ment pays the private partner to operate and maintain the road setting toll rate caps that may limit or impede the application based on throughput of vehicles on the highway, which means of value pricing to maintain free flow operations, which is in that the private partner shares in the risk of how many people line with environmental objectives. actually use the highway. In the case of availability pay- ments, payments made to the private partner are directly In the case of the 407 ETR in Ontario, Canada, the long- related to performance standards stated in the contract, and term concession agreement specifies toll rate increasing at all demand risk is allocated to the government. Both options inflation plus 2% over the first 15 years of the concession, provide incentives for the private operator to maintain the and then increasing at the rate of inflation only thereafter. In facility to high standards. In the case of the shadow tolls, if

OCR for page 27
31 maintenance standards decline, fewer cars will use the road Private Sector Toll Setting and Diversion Impacts and government payments will decline. However, with this model, the private partner also assumes financial risks caused A private firm operating a single highway may not consider by other declines in demand. the network effects of its road pricing. Its toll schedule may be set up to maximize profits, but this can move traffic to Both methods drive innovation and competitive costs other roads, costing municipal and state governments more because they allow the private partner flexibility in design and in the long run as a result of increased local congestion and approach. Instead of having to comply with materials stan- damage done by trucks to local roads (Regional Plan Associ- dards used by the agency, performance-based specifications ation 2007). Also, given that the toll setting rights are trans- focus on the outcome of the end product. Performance speci- ferred to the private sector, the public sector is restricted from fications are established for each element of the asset and then controlling the effect of traffic diversions into public roads, clearly defined as to the minimum acceptable performance and would not have the power to reduce tolls to restore "nor- level and response time to fix deficiencies (Abdel-Aziz 2007). malcy" in other parts of the highway network. Past experi- Availability payments/shadow toll agreements can also be ence shows that significant toll increases will divert traffic, as designed to meet environmental objectives, by rewarding was the case in New Jersey and Ohio, where toll increases greater mobility and reduced congestion, which minimize were eased because of significant truck traffic diversions into emissions and fuel consumption (Replogle 2007). local routes. Shadow tolls are widely used in Europe; however, there Several attempts have been made to quantitatively study are indications of a move to more transparent methods of the relationships between toll increases and traffic diversion direct user charges there. Private financing of roads and that might come about from PPP projects. Belzer and Swan bridges paid with shadow tolls or availability payments does (2008) construct a regression model to demonstrate the diver- not provide new revenue and does not create a relationship sion effects of private companies setting tolls based on profit between who pays for the improvement and who gets the maximization policies. Using historic data along the Ohio benefit (Jeffers et al. 2006). Shadow toll payments in Europe Turnpike, the research suggests the existence of toll rates typically come from general funds. that would simultaneously maximize private profit and shift a significant number of cars and trucks to alternate compet- In British Columbia, Canada, the Golden Ears Bridge ing routes. Diversion to these competing routes, many of will combine real tolls with availability payments. TransLink which are non-limited-access, could pose significant safety (public partner) will collect toll revenues that will be used hazards and maintenance costs to the road system overall. to compensate the DBFO concessionaire through avail- Although not necessarily questioning the wisdom of pricing, ability payments that have been established by contract. the authors suggest allowing private operators to control The Port of Miami Tunnel, a 35-year PPP agreement, will individual roads will erode system performance overall, be financed through annual availability payments that will create economic inefficiencies (deadweight), and curtail inter- be indexed annually for inflation. The availability payment state commerce. will be reduced if the tunnel is not open to traffic or other major performance measures are not met by the private oper- In Oklahoma, opposition to a toll bridge PPP led residents ator. Although still in the negotiation process, the concession near the proposed location for the bridge to take the case to was awarded to the private investors who offered the lowest court on the grounds that the public did not vote on the pro- availability payment of $33 million (in 2007 dollars), com- posal and there were no open bids. One of the main concerns pared with the public estimate of $55 million. of this group was that the surrounding infrastructure could not handle potential traffic growth. The court struck down As PPPs continue to evolve in the United States, availabil- the project, although not for these reasons, but because the ity payments may become more common, as suggested by alignment for one of the bridge approaches fell outside the toll more recent deals. The public sector retains the demand risk, authority jurisdiction ("Municipal Toll Roads Become Likely and it requires additional performance monitoring that should Path" 2008). be accounted for as an additional cost to the public sector. States are aware and recognize the importance of this concern, as expressed through the state DOT survey. All Opinion/Comment from "Other Individuals/Interest respondents indicated that the impact of PPPs on the overall Groups" Survey: transportation networks was important. Our experience with availability payments has been extremely positive . . . Emphasis could be given to institu- Non-Compete and Other Unanticipated tionalizing the P3 process and providing the necessary Event Provisions training to make P3 part of the everyday toolkit for project implementation. PPP contracts typically provide protections of the future revenue stream when tolls are the finance mechanism. In

OCR for page 27
32 addition, addressing other unanticipated events is also a competition zone, may be compensated for using a formula for key element of any contract, including a PPP. any damage done to toll revenues. Recent deals have included such limited-compete clauses. Non-Compete Clauses For example: Non-compete clauses limit improvements the public part- The Pocahontas Parkway includes a 6 mile non-compete ner can make to nearby facilities so that demand for the PPP zone, whereas the Indiana Toll Road agreement defines facility is not eroded. A more appropriate name for such a 10 mile competition zone in which the state could pro- clauses may often be "limited compete" if they do not ban vide compensation for projected loss revenues from improvements outright, but contain negotiated provisions building a new four-lane limited access highway, but for remedies. By limiting competition, the up-front value of can build anything else along the corridor (Buxbaum and a concession would increase; therefore, this becomes a Ortiz 2007; Samuel 2007). trade-off consideration for decision makers. Denver's Northwest Parkway concession agreement requires the public authority to compensate the conces- Non-compete clauses are often cited by PPP critics, who sionaire if road or transit projects not already planned object to tying the hands of government to deliver needed are built in the corridor and cause a loss in revenue. If transportation improvements, and most states in our state the authority cannot pay, the concessionaire may keep DOT survey agreed that this is an important concern. The revenue sharing money, increase tolls beyond set limits, most-cited example of the dangers of non-compete clauses in or extend the lease ("Northwest Parkway Set to Close in the United States is California's SR-91. In the non-compete October" 2007). clause, the California DOT agreed not to make improve- The concession agreement for the CityLink in Mel- ments within one-and-a-half miles of the HOT lanes on bourne, Australia, allows for compensation if a new SR-91 without consulting the private operator, California project takes away traffic from the facility, either Private Transportation Company (CPTC). In 1999, when the through cash or contract extension. Transurban has California DOT sought to add merging lanes to the existing filed a $36 million claim for the construction of the free lanes for safety reasons, the CPTC objected. This objec- Wurundjeri Way, and is contemplating filing another tion raised public opposition and ultimately led to a lawsuit claim if the government proceeds to build a new east seeking nullification of the non-compete clause. In 2003, the west toll tunnel (Millar 2007). Orange County Transportation Authority purchased the toll lanes from CPTC for $207.5 million and the non-compete The Chicago Skyway agreement is the exception in which clause was eliminated (U.S.DOT 2004; Subcommittee on no "non-compete" clauses were included in the lease agree- Highways and Transit, House Transportation and Infra- ment. However, the urban nature of the corridor makes it very structure Committee 2007a). difficult and costly for the public sector to make capacity improvements on parallel, competing facilities (Samuel 2005). Other instances have been cited in Australia where the public sector has been unable to improve toll-free routes Contract terms also regulate the roles of the public and pri- owing to similar agreements. In 2006, one concessionaire vate sectors as a result of unanticipated events. For exam- convinced the local government to close several competing ple, in Portugal, concessionaires are compensated for revenue local roads to through traffic to force drivers to use the tolled losses owing to "force majeure" (Izquierdo and Vassallo 2004). facilities, which were lagging traffic and revenue expecta- tions (AECOM 2007a). Use of Proceeds and Revenue Sharing As a direct result of such cases, Congressmen Oberstar and DeFazio (2007) suggested avoiding non-compete clauses alto- Several projects, including the Indiana Toll Road and the gether. The 2005 federal SAFETEA-LU transportation law Chicago Skyway, yielded large up-front payments to govern- Section 1604(c) bars states from including such non-compete ments by concessionaires in exchange for the right to operate agreements for the Interstate System Construction Toll Pilot transportation facilities. Proceeds from the Chicago Skyway Program (Regional Plan Association 2007). Samuel (2007) concession were largely spent on repaying debt, creating a agrees that earlier approaches such as SR-91 were flawed, but trust fund, and funding public social initiatives. Proceeds asserts that non-compete agreements are necessary in some sit- from the Indiana Toll Road were used to repay debt and fund uations to protect private partners from unfair competition aris- the state's ten year transportation plan (Subcommittee on ing from government subsidies. Most recent agreements Highways and Transit, House Transportation and Infrastruc- include "limited-compete" clauses, generally allowing public ture Committee 2007a). However, both deals have raised con- partners to build everything in its current long-range trans- cerns regarding proper valuation of concession deals, the portation plan. Future roadways a state might build that are not trade-offs between up-front and long-term payments, and in its existing plan and that do fall within a narrowly defined who benefits and who pays (Baxandall 2007; Enright 2007).

OCR for page 27
33 The aforementioned concession deals transferred toll col- mechanisms to ensure that projects can be funded over the lection and road operations for 75 to 99 years to the private life of the lease. By investing up-front or recurring revenues sector. Although the money has been used to meet immedi- in capital projects, particularly from brownfield concessions, ate financial needs, and the repayment of debt benefits the the public receives the benefit from other system improve- government in the long term, the reality is that future gener- ments by monetizing the future revenue streams of an exist- ations might be paying for benefits that were substantially ing facility. Replogle (2007) recommended that surplus realized in the early years of the concession. On the other revenues (specifically in toll-managed lanes) be used for hand, up-front payments could also be invested in capital transit and impact mitigation. projects that may have a useful life beyond the term of the deals and generate public benefits over the long term. PPP-enabling legislation in 12 states prohibits revenues from being diverted to the state's general fund or for unrelated uses. According to our state DOT survey, most states (exclud- Use of Proceeds ing five respondents) consider the use of up-front proceeds to be an important concern. The Pennsylvania Turnpike valua- Large up-front concession fees, typical of brownfield conces- tion analysis by Foote et al. (2008) raised the concern that sions, are popular with politicians managing governments in under a PPP agreement, up-front revenues from leasing the financial difficulties (Thornton 2007). They provide a bud- Turnpike might be redirected for non-transportation uses getary windfall that can be spent flexibly on any public pur- (such as budget relief), because there are no constitutional or pose, transportation or otherwise (Brown 2007). Besides statutory protections that could prevent such action, although paying down debts and funding social programs, $500 mil- the reason for considering a long-term lease of this facility is lion from the Chicago Skyway deal placed in a "rainy day" to provide much needed transportation funding. In Virginia, fund is earning $25 million annually, as much as the city used any up-front payments are to be used in the project corridor. to earn from operating the Skyway itself (Thornton 2007). Applying proceeds in such ways can be seen as fiscally respon- The appropriate amount that up-front payments should be sible ways of improving a city's credit rating and risk assess- is also difficult to calculate. Assumptions regarding discount ment. It is also possible to have the proceeds come as an rates, travel demand, or maintenance schedules may have a annual rather than up-front payment. Although this appears profound impact on the value of the project. The value of the to be an option, no specific examples were found through the facility is also driven by the length of concession, toll rates literature review of PPP deals where the public sector is col- and toll increase assumptions, private equity, and risk. Some lecting annual payments from a concessionaire. A policy brief commentators are concerned that the public sector may be on greenfield PPPs from the Reason Foundation (Gilroy et al. achieving less value than it should for its capital infrastruc- 2007) indicated that this type of concession arrangement has ture (Baxandall 2007; Enright 2007). been used in Europe. For example, there are several instances in Europe of Fitch Ratings, however, noted the need to match invest- private partners earning so-called "super profits"--profits ment decisions made today with long-term sustainability of that grossly exceed the expected profits projected in the orig- transportation. Fitch considers the choice of high up-front inal contract (Jeffers et al. 2006). Such profits can result from payments a risk to the government's fiscal position, as it unanticipated demand and windfalls from refinancing debt. may limit its flexibility to meet future transportation needs. To remedy this, European countries and some Australian states However, Fitch positively assesses deals that generate large generally include a clause in PPP contracts that requires shar- up-front payments "if proceeds are invested in comparable ing of any refinancing profits that may otherwise provide long-term assets that provide lasting economic benefits." windfall profits for private partners. In the case of TIFIA Conversely, it will view negatively "the use of proceeds for loans (a type of federal government subsidized loan), profits short-term operating needs of the government" (Fitch Ratings from refinancing could be used to expand or complete the 2006; Checherita and Gifford 2008). project for which the loan was issued (Hedlund 2007). However, revenue sharing related to refinancing may not be The use of the proceeds is an important consideration, and appropriate in some contracts, because the value of the most observers agree that it could be used for transportation; refinancing may have been included in the initial valuation otherwise, government would be taxing future infrastructure analysis (GAO 2000b). In the case of the Chicago Skyway, for general needs today. Buxbaum and Ortiz (2007) recom- equity was reduced after refinancing, but, according to an mended that decision makers consider debt service, trans- investment banker involved in the deal, no refinancing gains portation programs, and reserve funds as potential uses for were realized, because this had been assumed in the financial concession proceeds, and that if revenues are used for non- offer to the city (GAO 2000b). transportation uses, decision makers should make a case for the relationship between the source and the uses of funds. In Profit can be difficult to measure, because this involves addition, the study suggests that funding could be allocated delving into the detailed accounting practices of companies to projects that benefit the users of the lease facility and find that may have many lines of business and/or a portfolio of toll

OCR for page 27
34 projects that they spread management expenses among. In paying customers, where tolls are involved. However, the response, European PPP sponsors suggest structuring profit- public sector needs to be vigilant that the standards are being sharing models based on revenue rather than profits because adhered to (Buxbaum and Ortiz 2007). revenue is easier to monitor. They also suggest incorporating contract clauses that allow for the review of the concession contract clause every 7.5 years (Jeffers et al. 2006). Rebal- Hand-Back Provisions ancing provisions, which bring the contract terms back into the financial balance achieved in the original negotiation, are At the end of the concession, the O&M of the facility, along currently used in Spain and Portugal (Izquierdo and Vasallo with the right to collect tolls (if any), reverts back to the 2004; Mayer 2007; GAO 2000b). public sector. It is in the public interest that the facility is returned in good condition, preferably requiring none to minimal public investment. The PPP contract terms could Revenue Sharing specify the condition at which the facility must be returned to the public, and may include penalties to the private sector Revenue sharing usually comes at the cost of a lower up-front for not meeting these requirements. payment. But, the public sector does benefit from future profit- sharing revenue, which can offset the reduction in up-front payment. A respondent in our interested parties' survey rec- Opinion/Comment from "Other Individuals/Interest ommended the provision of policy that allows for sharing of Groups" Survey: upside revenue on toll lease (particularly for "brownfield"), and that such policy should be flexible enough that it can be Not clear whether the private lessor will exercise good tailored for each individual project. Texas's State Highway stewardship for the facility. When the lease is up, in what condition will the facility be returned to the public? 130 and Virginia's Pocahontas Parkway PPPs provide exam- ples of revenue-sharing agreements. Both include tiered rev- enue sharing that depend on the equity return and internal rate of return of each of the projects, respectively (AECOM For example, hand-back requirements in the Port of Miami 2007b). However, given the high return thresholds, it is agreement include a hand-back reserve, which is built annually unlikely the public partners will share significant revenues in the later years of the concession term. The hand-back reserve under these agreements (Page 2008). is used to ensure that the facility is turned over to the Florida DOT in top condition. Failure by the concessionaire to provide annual deposits to the hand-back reserve will result in deduc- tions to the annual availability payments (Clary 2008). Opinion/Comment from "Other Individuals/Interest Groups" Survey: The PPP agreement for the I-495 HOT lanes in Virginia There should be strong consideration for policy provisions requires the concessionaire to provide a letter of credit or per- that require the governmental entity to share in the upside formance bond that can be used by the Virginia DOT if the revenue on the lease of toll roads. This should not be overly hand-back requirements are not met. A PPP contract with prescriptive, but give the flexibility needed for each state to work within an overall policy and then apply this based on heavy emphasis on performance standards for compensation the specific situation. could also protect the public interest by ensuring that a specific condition is maintained on the facility throughout the full con- cession term. In the United Kingdom, the Highway Agency retains 40% of the payments during the last five years of Maintenance Standards and the concession, and disburses the payment to the concession- Hand-Back Provisions aire once it determines that the facility has been returned to the government in good condition (Izquierdo and Vassallo 2004). Maintenance Standards PPP contracts, especially those that transfer O&M for a Environmental Safeguards period of time to the private sector, will have extensive terms related to maintenance standards. The goal of the public sec- A PPP can potentially raise, but must not be permitted to tor could be to ensure that the leased facility meets or exceeds lower, environmental standards for highway operation. In late these standards, and that these standards are in line with the December 2006, the Sierra Club and other groups spoke out public interest. In addition to these legally binding obliga- against a potential PPP in New Jersey because environmental tions, the private partner will have other interests in keep- standards might not have been sufficiently met by the private ing up with maintenance needs, because these provide the best sector. In that case the organization was concerned that the long-term return on their investment--small maintenance operator would choose to use less expensive de-icing prod- costs now can avoid larger repair bills later. Also, extreme ucts that damage the environment (Regional Plan Association neglect will lead to the facility being less attractive to toll 2007). Other environmental considerations included the effect

OCR for page 27
35 of congestion and emissions on the environment. In his testi- final design nor construction can be initiated before the NEPA mony to Congress in May 2007, Replogle, representing the process is complete. The rule also requires that the design- Environmental Defense Fund, expressed support to PPPs and build contract should include provisions ensuring that all envi- tolls, as long as these are used to better manage demand and ronmental and mitigation measures identified through the promote alternative transportation modes and environmentally NEPA process will be implemented, and precludes the design- sound behavior. Performance-based contracts that compensate builder from having any decision-making responsibilities in the concessionaire for providing free-flow service and meet- the NEPA process and from preparing the document. The pro- ing environmental goals, variable toll rates for traffic manage- visions in the final rule appear to address the aforementioned ment, and the use of revenues to support public transportation concerns related to PPPs and the NEPA process. are some of the strategies presented in his testimony. Environmental risk is typically better managed by the pub- PPP contracts can make environmental performance stan- lic sector (GAO 2000b), and as such the public sector typically dards enforceable as part of the environmental approvals retains this risk in a PPP. In Texas, for example, concession- process, as well as through incentive-based methods such aires are not involved in the environmental assessment process, as performance bonds, funding set-asides, and enforceable which remain under the responsibility of the Texas DOT; contingency measures (Regional Plan Association 2007). however, this is not always the case. The original investors Other strategies used to address environmental issues in for the South Bay Expressway (SR-125) in the San Diego area PPPs include: took on environmental risk and had to deal with an environ- mental planning process that took many more years and Holding regular meetings with local community groups dollars than what the investors had anticipated, as discussed during both construction and implementation phases to in the section on Roles of Public and private Sectors, Risk identify and mitigate construction-related impacts and Allocation, and Rates of Return. operational impacts once opened; Negotiating agreements with major opposition groups Labor Relation Issues and including environmental mitigation conditions in the concession agreement, such as the use of noise- Labor relation issues are varied among PPP types. In a brown- reducing asphalt; field concession, labor issues are related to displacement of Conducting comprehensive environmental studies before existing employees, ranging from engineers to administra- plan development including extensive public outreach tive staff to road maintenance workers and others, including and stakeholder communications; and toll operators. Displaced (or potentially displaced) workers Integrating environmental mitigation and improvement will have broad employment concerns including the contin- mechanisms early in the preliminary design process uation of employment, wages, health insurance, pensions and (AECOM 2007a). other benefits, working conditions, and, where applicable, union representation. In a greenfield project these issues are Oberstar and DeFazio (2007) warned that states should not related more to the private sector meeting prevailing wage turn to privately financed projects to avoid meeting environ- requirements. PPPs have created significant labor issues in mental requirements that come with federal funding. Most Canada, the United Kingdom, and other European countries, states in our survey (98%) indicated that environmental safe- even though it could be argued that the PPP enabled more proj- guards are very important in PPP contracting. Among other ects to be built, thereby increasing employment, especially in requirements, federal funding forces states to comply with the construction industry. In the United States, construction the National Environmental Policy Act (NEPA). In addition unions in Indiana demanded that the Indiana Toll Road's to federal requirements, many states have their own environ- new operator, ITR Concession Company (ITRCC), provide mental laws and requirements that should be met for any proj- them 95% of the construction work on the facility. However, ect. A respondent of the interested parties' survey suggested ITRCC's concession agreement does not require it to follow that PPP agreements should not be approved until after the public notification and bidding rules. completion of the NEPA process to ensure: On the other hand, the concession agreement for the A full, fair, and open planning process for transportation Chicago Skyway, also owned by Cintra and Macquarie projects; (owners of ITRCC), requires all contracts to contain prevail- Adequate consideration of all transportation alterna- ing wage language. All contractors are required to submit tives; and certified pay vouchers corresponding to a particular job. Thus, Unbiased analysis of viable project alternatives and envi- the concessionaire can ensure its contractors are following ronmental impacts. predetermined wages as set by the Illinois Department of Labor ("Unions Want Indiana Toll Road Jobs" 2007). Nonetheless, FHWA's Design-Build rule was amended in 2007, allowing even with these protections, local and smaller engineering states to release requests for proposals and award design- and design firms may be excluded from benefiting from build contracts before the completion of NEPA, but neither the work generated by a large PPP project, because large

OCR for page 27
36 engineering firms can have the design work done in other Samuel (2007) suggests that workers who are paid reason- offices throughout the country, without tapping local resources able labor-market wages and benefits are likely to be offered (KCI Technologies 2005). work by a private toll company because they have valuable skills and local knowledge. He also noted that government Also at issue are the potential for less favorable terms of toll authorities are cutting back on staff themselves as elec- employment in the private sector and the immediate reduction tronic toll collection reduces or eliminates toll booths. Private in headcount for those employees who operate the facilities. sector groups agree that using local firms saves money and To resolve these issues, labor protections have been incor- has the added benefit of existing relationships with the public porated into some PPP agreements. Several countries have sector (KCI Technologies 2005). legislation that specifically addresses the transfer of public sector workers to the private sector with some or all of their Another labor issue relates to the increase in contracting benefits (Subcommittee on Highways and Transit, House out of services that have been conducted in-house in the past, Transportation and Infrastructure Committee 2007b). such as design and oversight of public works. The GAO (2008a) found that the most important factor in a state DOT's On greenfield projects with federal funding, federal labor decision to contract out some of these services "is the need to and contracting requirements (DavisBacon act) can address access the manpower and expertise to ensure the timely deliv- this concern; many states also have "little DavisBacon" ery of their highway program"; cost savings is a secondary laws that ensure the prevailing wage for projects. The New consideration. It reported that states protect the public interest Jersey privatization legislation provides compensation for through prequalification of contractors and consultants, regu- toll road workers (Samuel 2007), guaranteeing employment lar monitoring procedures, assessment of work performed, to union employees for up to six years. However, omitting and standards and requirements for certain types of work. such specifications from the PPP contract can permit private Nevertheless, it appears that state DOTs are still facing some contractors to reduce staff levels or hire non-union employ- challenges in providing oversight, as they struggle to maintain ees, reducing costs, increasing private profits, and increasing the required in-house expertise to address demand. This the value of the project for the public sector. These benefits, concern was also mentioned in our interested parties' survey, however, may conflict with state labor policies, lead to public indicating that as more projects are contracted out, it becomes disapproval, and could result in potential litigation (Regional more difficult for state DOTs to attract and retain talent. Plan Association 2007). In testimony to Congress in April 2007, the Professional In the United States, recent PPP agreements have included Engineers in California Government (PECG), which represents contract provisions that address some of the concerns related public employees, presented its position on PPPs. The PECG to workforce protection in both long-term leases of new or recommends that all construction inspection be conducted by existing toll roads. In the Chicago Skyway, the contract public employees, and that if the public agency is liable for a required the concessionaire to employ all unionized employ- facility, then the public sector could design, construct, and ees, and employees were given the option to move onto other inspect the facility. Furthermore, PECG indicated in the inter- city jobs. Most of the employees (100 of 105) took other city ested parties' survey that PPPs should require public oversight, jobs, whereas the reminder chose to keep their jobs with the design, and inspection to ensure public safety and cost control. Skyway (GAO 2000b). The legislation that will allow the The group claims that design-build has been unsuccessful in lease of the Midway Airport in Chicago has a range of labor California, resulting in higher project costs. Other respondents provisions that include requiring the concessionaire to pay in the interested parties' survey brought similar concerns, employees in line with the city of Chicago wages and bene- drawing specifically from the "Big Dig" experience in Boston. fits (Illinois Public Act 094-0750). In Indiana, employees The Big Dig had cost overruns, delays, and several issues, were guaranteed that pay and benefits would not be reduced including a fatal accident, owing to flawed construction. if they took a job with the concessionaire. About 85% of the According to a labor union representative, oversight and employees took jobs with private operator at the same or enforcement for this project was not properly conducted and higher pay, whereas others stayed with the state (GAO 2000b). there was no demarcation between the public and private sec- A newspaper report from November 2007 indicates, however, tor responsibilities, given that the relationship between both that promised salary increases have not materialized for parties was "too cozy." From the state DOT perspective, most toll road collectors, prompting workers to become unionized states reported that labor relations are a "somewhat important" (Potter 2007). The Texas' SH-130 lease agreement requires concern; six states considered this a "not important" concern. payment of prevailing wages to construction workers in accor- dance with governing law and the concessionaire should meet Length of Agreement goals for hiring minorities, women, and disadvantaged business groups. The United Kingdom ensures workforce protection by Long agreement terms, such as the 99 years for the Chicago requiring that new and transferred employees of concession- Skyway, 85 years for the Capital Beltway HOT Lanes, and aires are offered "fair and reasonable" employment conditions 75 years for the Indiana Toll Road are a frequent criticism of (GAO 2000b). PPPs, in particular for DBFO or long-term concessions. Our

OCR for page 27
37 state DOT survey confirms the importance of this concern. instead of the entire term of the lease (Subcommittee on Some respondents of the interested parties' survey suggested Highways and Transit, House Transportation and Infra- concession terms of no longer than 30 to 35 years. A study structure Committee 2007a). This amounts to a government by Virtuosity Consulting for the OECD and the European subsidy to the concessionaire that may significantly reduce Commission of Ministries of Transport on successful exam- corporate taxes if the project proves profitable. Longer- ples of PPPs concluded that the optimal concession length is term agreements thus allow the private partner to depreci- between 30 and 35 years; a concession may be sub-optimal ate the asset in the most attractive manner possible and will for taxpayers beyond that range (Stambrock 2005). be reflected in the amount the private partner is willing to pay for the concession (Giglio 1997; Brown 2007). The Chicago Skyway and Indiana leases specified long terms to encourage larger up-front fees. While private opera- Termination and Buyouts tors aim to maximize the length of concessions to safeguard future cash flows, the European Commission (2003) aims to All PPP contracts could incorporate clear terms addressing promote open competition and fair market access, reduce the termination, buyouts, and hand-back provisions, and define possibility of monopolies, and ensure the public benefit. These the roles and responsibilities of both public and private part- objectives would suggest shorter concession agreements. ners if such circumstances arise during the concession period. It is up to the state and its legal advisors to include provisions As the experience level has risen, European Union countries that protect the public interest. have restricted the length of PPP contracts to 21 to 35 years. (Jeffers et al. 2006). The shorter concession terms correspond The termination clause of a contract specifies how the PPP with the accepted lengths of government bonds, commercial contractor will be compensated for work completed if the mortgages, and reasonable risk assessments. In addition, sev- project or the contract agreement is terminated, depending on eral countries include review and renegotiation of payments the reasons for termination, and any penalty clauses for early every 7.5 years to prevent private partners from earning more termination by the sponsoring agency (AECOM 2007b). The than could be earned through other investments given the same majority of the states responding to the survey agreed that risk environment, so-called windfall profits. Some innova- these are "very important" concerns. Performance contracts tive procurement methods propose short concession terms that commit the private partner to specific results are held to (1015 years), after which the state pays a residual value to be the key to successful risk allocation, and contractual per- the concessionaire, recouping this payment through another formance guarantees and termination provisions are safe- concession (Izquierdo and Vassallo 2004). guards that minimize the risk to the public of long-term contracts (Bloomfield 2006). Abdel-Aziz (2007) advises against legislating maximum lengths of concession agreements, maintaining project time- In the case of bankruptcy, the public sector may step in and lines could be decided on a project-by-project basis consid- take over operations of the facility, or contract with another ering unique conditions, whole life-cycle cost, likely term of private entity (Hedlund 2007). It also could allow the conces- senior debt, and financial structure. Public and private part- sionaire to increase tolls or provide funding to avoid default ners, for example, may decide to end the concession once the (Stambrook 2005). In the case of the Indiana and Chicago private debt is retired. A limit on the length of concessions; long-term lease deals, the lenders have the opportunity to for example, the 35 years in California's AB 680 or the 50 years "cure the default," and they could take over the operation of in Texas HB 2702, unless established for specific reasons, the facility or assign a "successor," before the state could might unnecessarily affect achieving the best value for money. step in and regain control of the roadway (Foote et al. 2008). The experience in Mexico shows how very short concession Ultimately, whether a facility immediately reverts back to the terms (maximum of 12 years, and in some cases 5 years) public sector as a result of bankruptcy will depend on the resulted in high toll rates and uncertainty in traffic demand, contract provisions that address this situation. which led to the failed concessions in the 1990s (Izquierdo and Vassallo 2004). Buyback provisions specify the terms and compensation to the private sector of purchasing the rights to operate the facil- The length of concession agreements will affect the abil- ity before the end of the concession term. Typically, the state ity of the concessionaire to realize tax benefits from depreci- would pay "fair value" to the private operator in a buyback ation. Although lessees (concessionaires) of toll roads are not situation (Hedlund 2007). The "fair value" is estimated by cal- owners, if the term of the lease exceeds the remaining design culating the net present value of net revenues over the remain- life of an asset at the time of the transaction, the Internal ing contract term (Poole 2007). This was the method used to Revenue Service treats the lessee as the owner for tax pur- estimate the buyback price for the SR-91 Express Lanes in poses (Subcommittee on Energy, Natural Resources, and California. Legislation in Texas (approved in 2007) allows the Infrastructure 2008). Thus, the lessee may depreciate the por- state to buy back profitable toll roads from private operators, tion of its up-front payment allocated to tangible physical with the buy-back amount based on the original estimates of assets in an accelerated manner over a period of 15 years toll revenues for the life of the project. According to Fitch

OCR for page 27
38 Ratings (2006), a buy-back at fair value may lead to higher The Massachusetts Route 3 North Project was a Design- taxes or high toll rates to support a termination payment, Build-Operate-Maintain project, financed through debt issued especially if valuations are much higher in the future. by a 63-20 corporation. Debt service and O&M costs are paid by MassHighway through annual appropriations. The PPP agreement allows the developer to generate non-project Safety and Enforcement Issues revenues through ancillary development in the corridor. The developer receives 40% of the revenue generated through In a PPP, the private sector is expected to maintain safe oper- development in the corridor (FHWA PPP website; AASHTO ations of the facility, as regulated by the contract terms. Again, Innovative Finance.org). the public is concerned that the private sector will not provide proper maintenance to increase profit, leading to unsafe condi- tions. This argument is countered by the notion that private Data Privacy and Ownership investors are encouraged to provide safe conditions to attract users (Buxbaum and Ortiz 2007) and to avoid liability. Data privacy and ownership is a concern raised for toll roads, for both privately and publicly operated, especially with the Law enforcement services on highways are typically introduction of electronic toll collection, and as such, the con- provided by police and paid by the state DOT or public toll cern was not further investigated for this synthesis. Toll road authority. In a PPP these services can still be provided by the users are particularly concerned of the potential for tracking state, but paid by the private concessionaire, as was stipulated and being able to pinpoint their trips through the facility, as in the Texas SH-130 contract. in some cases these data have been released, for instance, as evidence for criminal and civil cases. Safety concerns also relate to design standards that pro- vide safe operation on these facilities and whether these are enforced and met in a PPP project. The 407 ETR in Toronto Liability, Indemnification, and Insurance has been criticized for adhering to only minimum highway As any agreement between two parties, PPP contracts will safety standards, not only after it opened to traffic in 1997, include clauses that define liability, indemnification obliga- but also after it was leased to private investors (Mylvaganam tions, and insurance requirements for both the public and and Borins 2005; Wikipedia 2008). According to the Ministry private sectors. It is expected that these clauses are crafted of Transportation, compared with the 407 ETR, publicly such that the interests of each party entering the agreement owned facilities typically exceed highway safety standards. are protected. Commercial Development Rights The FHWA PPP website describes some of the provisions that limit liability and the indemnity obligations of each party The literature review found few references to this topic. In the for some PPP projects, including the Chicago Skyway, the case of Denver's Northwest Parkway, Portuguese conces- Pocahontas Parkway, and Texas SH-130, and the PPP legis- sionaire Brisa may undertake activities such as commercial lation survey describes how these are addressed by state. development. Rental revenues for two cell phone towers is split with the public parkway authority ("Northwest Parkway Private investors are concerned about tort liability, because Set to Close in October" 2007). the private sector is not protected by sovereign immunity as is the public sector. The risk of tort liability can be mitigated The TTC 35 High Priority Trans-Texas Corridor Master by using state maintenance and police service, public spon- Development Plan has provisions for several innovative sorship, and insurance. The latter however can add a sig- financing arrangements that involve commercial development nificant cost to the project, affecting its financial feasibility rights. These include having the option to lease a parcel or (U.S.DOT 2004). From the public sector perspective, govern- property from an owner to keep the land vacant before actual mental liability may not be fully transferable in a PPP, and acquisition, purchase, and lease-back arrangements; license the public sector may still be subject to lawsuits if deteriorat- for exclusive or non-exclusive use of a facility; and facility ing conditions of the roadway cause any harm to individuals franchises (such as gas stations and convenience stores). (Fitch Ratings 2006).