Public-Sector Decision Making for Public-Private Partnerships (2009)

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39 As governments struggle with the growing costs to develop, construct, maintain, and operate transportation infrastructure in the face of flat or declining revenues, public–private part- nerships (PPPs) are likely to be looked on as a potential way of reducing costs and bringing in new financial resources. This NCHRP synthesis identified a wide variety of concerns about how decision makers can protect the public interest. In sum- mary, there are three major themes drawn from this synthesis: • How might government decide whether or not to pursue a PPP? • How could the public interest be protected? • Misperceptions about PPPs can be a distraction from the real issues. Each of these themes is discussed here, along with sugges- tions for further research. • How might government decide whether or not to pursue a PPP? PPPs encompass a variety of project delivery options, with varying levels of private sector participation, based on risk transferred. A PPP is not a one-size-fits-all solution, and the decision to use one of the many PPP types or traditional approaches could consider and incorporate: • Valuation of alternative approaches, • Appropriate risk transfer, • Transparency and public participation, and • Unavoidable complexity of the transactions. Although some states use some kind of valuation process, there is a need for a framework or process to carry out this analysis that is well understood by decision makers and define appropriate assumptions that characterize the differences between public versus private delivery. The value for money (VfM) is one of the most well-known techniques to evaluate PPP projects, and has been widely used internationally; three states in the United States (Florida, Oregon, and Virginia) have reported using it. Other states have applied alternative tools, other than VfM, to evaluate PPP projects. Local con- ditions and project characteristics will be the final determi- nant of the assumptions used in the valuation process, but it is essential that there be a clear understanding of those, and they could be subject to a sensitivity analysis. After the Chicago Skyway and Indiana Toll Road deals and attempts by observers to estimate the value of these and other toll facilities proposed for PPPs (e.g., SH-121 in Texas and the Pennsylvania Turn- pike), it has become clear that the value of the facility depends on the assumptions used in the valuation process. To accomplish valuation, there is a need for personnel with skills including value engineering, business modeling, capital budgeting, traditional financial problem-solving methodol- ogy, and performance auditing. Furthermore, different valua- tion techniques have their merits and limitations, and the deci- sion makers might be informed of these. A sensitivity analysis could help to put in perspective some of the potential pitfalls and could assist the public sector to determine whether the disadvantages of pursuing PPPs are minor when compared with the public benefits of implementing the project. The transfer and sharing of project risks is considered by many as one of the main benefits of a PPP. In a well-designed PPP, risk may be allocated to the party that can best manage such risk, and in some instances, there are risks to be shared by both partners. For example, construction risk is typically trans- ferred to the private sector in any PPP that involves design- build, whereas the public sector is considered better able to manage environmental risks and right-of-way acquisition. The type of PPP to be pursued also dictates what risks are trans- ferred and/or shared with the private sector. PPP agreements are complicated, and there have been crit- icisms over deals being rushed through without the public or their elected officials understanding the implications. The lack of transparency in the PPP process has been voiced as one of the main concerns and it is mentioned as an important issue by both supporters and opponents of PPPs. The interna- tional experience provides lessons on how to incorporate the public interest into the PPP valuation, and a major element of this is community consultation and involvement through the PPP valuation and decision-making process. The Virginia PPP process provides a good example of how to ensure transparency and public participation during the review of PPP proposals. Transparency is not limited to the procurement process, and public access to financial statements and performance over the project lifetime has been included as part of PPP contracts. States are motivated to find creative solutions, and they are interested in quick results. However, the PPP process is CHAPTER FOUR CONCLUSIONS

complex, from the valuation and procurement process through the duration of the partnership. There is no uniform set of rules or standards to follow for all projects; therefore, there is a high level of expertise required when pursuing a PPP. Enabling legislation might provide an attractive environ- ment for the private sector to invest, whereas the public sector is able to protect the public interest. Also, after the project is successfully procured and implemented, it is important that the public sector can monitor performance and ensure that the terms of the agreement are met if the PPP includes a long-term concession to operate and/or maintain the facility. • How could the public interest be protected? Transportation infrastructure, specifically highways, has been the responsibility of the public sector for many years. The tra- ditional procurement for highways has been design-bid-build. The public sector develops designs, often with consultant support. The design is then let to the lowest bidder who then delivers the highway under government oversight. Long-term maintenance and operation of the highway is in public hands. A PPP allows a much larger role for the private sector, from bundling design and construction in one contract (design- build) to long-term operations and maintenance of existing or new facilities (concessions). Some PPPs include equity contri- butions from the private partner, and may also transfer toll col- lection and rate setting responsibilities to the private sector. When transferring these responsibilities, it is important to ensure that the private sector has the proper motivations to pro- tect the public interest, while allowing investors to meet a return on the investment that is in line with the risk they take. Most of the concerns about PPPs can be managed through contract terms. Although recent contracts have addressed many of the issues that have caused concerns in the past, unforeseen situations may arise. That is when the strength and flexibility of the contract is tested, and clauses that allow for contract ter- mination or buyout are important. A PPP may be monitored over its sometimes long lifetime to ensure that the private sector meets safety, maintenance, and other standards specified by contract. When valuing the deci- sion to pursue a PPP to protect the public interest it is essential that the public sector account for the additional cost of per- formance monitoring by qualified, independent, public sector/ department of transportation staff. Long-term asset leases of brownfield toll roads have arguably caused the most concern because a few transactions have resulted in large up-front payments to government. This revenue may be used for an appropriate public purpose con- sistent with public policy objectives. PPP-enabling legisla- tion in some states prohibits revenues from being diverted to the states’ general fund or for non-transportation uses. Some other uses of up-front proceeds include paying off debt and 40 transportation investments that will bring long-term benefits to the public. A PPP can potentially raise environmental standards for highway operation. Furthermore, PPP contracts can be designed to encourage environmentally sound behavior; for example, through incentives that encourage the conces- sionaire to provide free-flow service. As for environmental impacts, any PPP that will receive federal money is required to comply with the National Environmental Policy Act; and most states have environmental laws and requirements that need to be met for any major infrastructure project. The public interest is also protected by addressing potential labor issues arising from a PPP. In a brownfield concession, labor issues are related to displacement of existing employees at the toll facility and the loss of pension plans; whereas in greenfield projects these issues are related more to the private sector meeting prevailing wage requirements. Past brown- field concessions have dealt with labor issues by providing opportunities to maintain jobs with the public sector (e.g., the Chicago Skyway) or by including contract terms that guar- antee the pay and benefits for employees that remained work- ing for the concessionaire. For greenfield projects using fed- eral funding, it is necessary that the requirements of the Davis–Bacon Act relating to prevailing wages be met. In other cases, the contract may include terms to address labor issues and concerns. • Misperceptions about PPPs can be a distraction from the real issues Many public concerns are rooted in concerns raised over past transactions, even though more recent approaches have learned from the past and resolved the issues in contracts. Some negative perceptions about PPPs have remained over time. Also, a lack of public information and openness in the process (coupled with sensational press coverage and the political grandstanding that can arise) may lead to mistrust. Project sponsors might communicate with citizens and deci- sion makers in an effort to build trust and to educate the pub- lic about some of the misperceptions related to PPPs, such as: Misperception #1: Non-compete clauses are always part of a PPP with a long-term lease component. Actually, after the experience with strict non-compete clauses in the 91 Express Lanes PPP in California, most PPP deals have included “limited-compete” clauses, requiring the public part- ner to provide compensation for projected loss revenues result- ing for certain types of improvements, although these have not been eliminated altogether (e.g., Denver’s Northwest Park- way lease). The public sector can make the decision whether to include “non-compete” or “limited compete” provisions in a PPP, and explain why such provisions have been included in the contract. The exclusion of such provisions would lower the value of the contract, but will give the public sector more flexibility.

41 Misperception #2: A PPP is a synonym for tolls, and with that, sky-high toll increases are inevitable, resulting in windfall profits. The PPP debate, specifically related to long- term concessions paid through tolls, is caught in the middle of a debate about tolling policy. The recent long-term concession deals (again, one of the several PPP types) have transferred toll responsibility to the private concessionaire. However, the pub- lic sector still controls the toll setting policies by including toll growth caps in the agreement, even when the toll setting and collection responsibilities are transferred to the private sector. In an attempt to distance toll setting policy from PPPs, Florida adopted periodic increases for its public-sector toll roads. However, the public worries about super profits from increas- ing tolls, even within set growth caps. To counter this, some of the international experience, and other more recent PPP deals have included revenue sharing that ensure the public sector benefits of additional profits after the concessionaire reaches a certain return on investment. There are several types of PPPs that do not require the implementation of tolls (e.g., design-build, maintenance con- tracts, agreements with availability payments/shadow tolls). Furthermore, direct user fees (i.e., tolls) are not the only way that the private sector can be compensated. The United King- dom has used shadow tolls extensively to support its Private Finance Initiative, and availability payments are another alter- native to compensate the concessionaire based on facility per- formance measures. The latter could be combined with tolls that are retained by the public sector, thereby providing the needed revenue stream, but insulating the project from con- cerns about the private partner getting rich at the expense of toll payers. Misperception #3: The public sector loses total control of the facility. Under a PPP agreement, the public sector never loses ownership of the facility; however, some responsibilities are transferred to the private sector. The extent to which these responsibilities are transferred is defined by the contract. Well- crafted agreements may ensure that the public interests are protected. An open process helps build trust and support, as long as project sponsors can demonstrate that decisions are being made with the public interest in mind. • Future Research Needs The most pressing research need surrounding PPPs is related to PPP valuation tools. There is very little public understand- ing about how PPP deals are evaluated. In 2008, Morallos and Amekudzi and the U.S. Government Accountability Office (GAO) documented some of the valuation tools (including VfW), citing some of the benefits and limitations of these methodologies. The GAO report found that there has not been a consistent application of methodologies, and other literature shows how the valuation of a PPP is highly dependent on the selection of certain value drivers (e.g., length of agreement, toll policy, and discount rates). The industry would benefit from a compilation of existing valuation methodologies, a description of the advantages and disadvantages of each of these tools, sample applications, and the development of a framework that would help project sponsors to evaluate poten- tial PPP deals objectively. This framework could include rec- ommended value drivers and require a sensitivity analysis to help drive decisions. In the area of tolling policy, additional research is needed on appropriate escalation factors for toll rate caps. The litera- ture review shows that recent PPP deals that transfer toll col- lection to the private sector has included Consumer Price Index and gross domestic product to determine the maximum annual toll rate increase, but little is known about what are the appropriate economic indicators that could be used. There is also a continuing need for professional practitio- ners, elected officials, and their staff to stay abreast of devel- opments in PPPs and, in particular, efforts to separate fact from fiction. Digestible, easy-to-understand primers on PPPs high- lighting the key issues raised in this synthesis could go a long way toward encouraging states to use PPPs in appropriate ways that advance the public interest.