Alternative Funding and Financing Mechanisms for Passenger and Freight Rail Projects (2015)

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93 This chapter provides a discussion of opportunities and potential strategies—beyond mecha- nisms for funding and financing rail projects and services—to realize rail projects and services. The options discussed in this chapter are provided for consideration and debate and should not be construed as recommendations. 8.1 Measuring Public Benefits, Policy, and Funding for Rail Projects 8.1.1 Context This research project focused on alternative funding and financing mechanisms that can be used to eliminate the funding gap on rail projects and services. In other words, it addresses the question—how to fund and finance rail projects? The key question is—why should the public sector fund rail projects that have a funding gap? This is the same question that must be addressed when providing public funding to any infrastructure project or service, including, for example, highways or transit systems. This is largely a policy question and is outside the scope of the present research project. It is nevertheless appropriate to consider this question as it relates to the identification and use of public funding mechanisms and resources to real- ize rail projects that would not otherwise be realized without public funding support, in one form or another. Fundamentally, there are two related considerations: • First, when are benefits sufficient to justify the use of public funding for rail projects? • Second, what kind of policies can help promote the full benefits (or reduction of external costs) and financial feasibility of rail projects? The first consideration is largely an economic one, necessitating a benefit-cost analysis. The second consideration is about broader transport policy. 8.1.2 Challenge In the current U.S. context, both considerations above could be better and more systemati- cally addressed. There is a need to more fully evaluate (1) the range of benefits and costs of rail projects and service to support public funding decisions and (2) policies to support and guide public funding for rail projects and services. C H A P T E R 8 Beyond Revenue and Financing Mechanisms: Opportunities and Potential Strategies to Realize Rail Projects with a Funding Gap

94 Alternative Funding and Financing Mechanisms for Passenger and Freight Rail Projects Need for a Better, More Systematic Basis for Assessing Rail Project Benefits Benefit-cost analysis (BCA)—comparing a project’s total benefits to society to the total cost of the project—is a standard approach for assessing the public merits of a project. Generally, if the project has a benefit-cost ratio of greater than one, this is one indication of a public-sector rationale for providing funding support for the project. Financial Analysis vs. Benefit-Cost Analysis Most private-sector investors assess investments on the basis of a financial analy- sis rather than a benefit-cost analysis. A financial analysis takes into account only the costs and revenues of a project accruing to its proponent (also called “internal” costs and benefits, because they are internal to the project). Although a financial analysis is essential to establish the commercial viability of a project, it does not take into account the non-market (also called “external”) benefits of the project (e.g., reduction in pollution and accidents) that accrue to society. Although some benefits may not be quantifiable, they can be considered in the context of benefit-cost analysis. No Standard Approach to Evaluating Benefits in the United States In the United States, different agencies and jurisdictions use different approaches and definitions in their assessments of a project’s benefits. This complicates the process of benefit-cost analysis when more than one agency, jurisdiction, or funder is involved, which is common for rail projects. In the United Kingdom, in contrast, there is a widely accepted approach to evaluating rail project benefits. In a financial analysis, a project’s revenues and costs can be quantified relatively easily, given a set of assumptions, probabilities, and related scenarios, because both revenues and costs are inherently quantitative and comparable values. In a BCA, it can be much more challenging to quantify a project’s benefits and compare these to the project’s costs because these benefits are often not defined in terms of dollar value. Benefits relating to reduced emissions, improved productivity, and reduced vehicle accidents, for example, require a set of assumptions to convert what are qualitative or otherwise not dollar-value benefits, to a monetary value. This can be sub- jective. It is also challenging to effectively capture the full range of a project’s benefits, because many may be knock-on or longer term benefits. In the U.S. context, rail project benefits are sometimes calculated on a benefit-per-rider basis, whereby a project’s total benefits become a function of the total expected ridership. This likely oversimplifies the benefits used in a rail project’s BCA. Also, that ridership forecasts are

Beyond Revenue and Financing Mechanisms: Opportunities and Potential Strategies to Realize Rail Projects with a Funding Gap 95 typically highly speculative can devalue the significance of the project’s calculated potential benefits. A more robust, consistent, and systematic framework is needed for assessing the full potential benefits of rail projects. This could help bolster the public funding justification for rail projects, where the project public benefits are demonstrably significant in relation to the project’s costs. In the United Kingdom, for example, where rail’s main role is to provide passenger ser- vices, which are partly specified and usually funded by the public sector, rail projects must be assessed using a very detailed set of recommendations for the values passengers attach to dif- ferent improvements. These are published by the Association of (Passenger) Train Operating Companies (ATOC) with access available on payment of subscription. The UK government also publishes detailed guidance on appraisal for all transport investment projects that aim to ensure that projects for all modes are assessed on the same basis; this is broadly followed by devolved bodies (ranging from nations such as Scotland to local government bodies) and gives clarity to those seeking funding. Both these sets of guidance are based on extensive research that is under permanent review. The current discussions about High Speed 2, a proposed $80 billion project between London and the north of England, have led to extensive debate about this guidance. Need to Anchor Public Funding for Rail Projects to Public Policy Objectives A positive BCA is not, on its own, sufficient to justify public funding for a rail project. Other material considerations include availability of funding and competing funding prio rities (which likely include other opportunities to invest in projects that will generate a positive benefit-cost ratio). How to best allocate scarce public funding should be guided by public policy and policy objec- tives. Public funding decisions for rail projects should similarly be supported by a clear policy rationale—i.e., what is to be achieved from providing public support for a rail project, and how does this advance government policy? Unfortunately, public funding considerations for rail projects are sometimes assessed in the absence of supporting policies, or assessed within a rail funding silo, independent of broader overarching transport policies and public policy goals. If there is no explicit and agreed policy rationale that answers “why fund rail projects,” then it is more difficult to justify public funding. It also makes the process of allocating funding to rail projects vs. other, non-rail-related funding needs (e.g., highways) more difficult (and politicized). A clear policy could help justify the use of specific revenue-generating mechanisms that have the dual effect of causing changes in behavior that support specific policy outcomes (e.g., modal shift from road to rail to reduce road congestion and wear and tear on roads), while raising revenue that can be used to fund the rail project. Such revenue mechanisms could also be used to internalize the cost of externalities generated from non-rail modes of transport. 8.1.3 Potential Solutions A more robust and standardized framework, method, and set of indicators for capturing and quantifying the full range of rail project benefits could improve future assessments of overall benefit-cost of rail projects. Such a framework and related resources should be supported by credible, evidence-based research of the actual long-term benefits of rail projects (too often a project’s benefits are assessed only before a project—it would be relevant to assess actual benefits ex-post to inform future BCA).

96 Alternative Funding and Financing Mechanisms for Passenger and Freight Rail Projects 8.2 Establishing a Stable, Predictable Funding Source for Passenger Rail 8.2.1 Context Railroads require long-term infrastructure assets, which in turn require long-term funding and financing solutions to ensure sustainability. Major investments are typically required during planning and construction, followed by lumpy investments throughout the life of the railroad to ensure service levels and safety are maintained (e.g., track upgrading, rolling stock upgrades, and technology improvements). Freight rail financing in the United States typically works well on a market (commercial) basis and does not require public funding support with the exception of some joint projects (e.g., CREATE, Alameda, NORG) and some regional short lines. However, the challenge is that, with few exceptions, new and expanded passenger rail services cannot be financed entirely through market-based approaches. Most passenger railroads cannot cover their capital and operating costs from internally generated revenues, and public funding support (based on net public benefits) is required. Nevertheless, given the long-term nature of rail infrastructure investment and ongoing operations, access to long-term funding sources is critical for efficient planning and programming. 8.2.2 Challenge Notwithstanding many existing federal and state capital grant programs in the United States, public funding for passenger rail operations is generally appropriated annually. No dedicated, long-term, nationwide funding program exists for passenger rail operations and longer term capital projects in the United States, which makes planning and programming challenging for rail owners and operators. For example, Amtrak has traditionally been able to secure just enough funding from public sources to cover its operating losses and capital expenditures, but such funding is only appropriated annually, with no explicit guarantee of funding on a yearly basis. Similarly, occasional one-off rail funding programs (e.g., U.S. HSRIP) are short-lived, leading to a lack of security in obtaining funding for the long term. The temporary, annual nature of passenger rail funding makes it nearly impossible to attract private long-term capital to these projects—someone has to guarantee the funding before pri- vate investors can be attracted. This lack of long-term security in funding makes passenger rail opportunities less attractive generally to potential private-sector partners, because it increases the risks that the public partner could default on their obligations. It is unlikely that a private investor would be willing to sign on to a long-term PPP to provide rail service without a long-term and guaranteed funding commitment from the government partner. For example, HSR projects can require 10 years or more to develop (let alone to begin construction), and engaging private partners in such projects in the face of changing political priorities (and associated funding whims) is difficult without a dedicated funding source. Pri- vate investors would much prefer to see some kind of stable funding allocated to passenger rail projects in the long term (subject to certain performance requirements, of course). 8.2.3 Potential Solutions Long-term funding could be addressed by establishing a dedicated transportation trust fund, similar in structure to the HTF (which receives most of its revenues from a portion of gas tax revenues), but multi-modal in nature. This could provide funds to passenger rail projects and services that exhibit strong public benefits, with funding guaranteed year-over-year over the life of the asset, subject to meeting certain requirements and performance obligations.

Beyond Revenue and Financing Mechanisms: Opportunities and Potential Strategies to Realize Rail Projects with a Funding Gap 97 One way to increase private-sector investment into rail passenger markets could be to struc- ture the public services as contract services with contract terms related to the term of the invest- ment risk (i.e., a private investor would not invest in equipment with a life of 50 years to service a 2-year operating contract unless there was a viable market for the equipment after the term of the operating contract). So a private investor consortium might bid to build, operate, and main- tain railway infrastructure under a 30-year contract (with performance metrics); another private investor consortium might invest in railway rolling stock (especially if it could be standardized to be serviceable across many different operations) with a contract to provide equipment and main- tenance services for, say, 15 years. Another private investor might want to operate the services in a shorter term contract—7 to 10 years. In these cases, the contracting party would provide a fund- ing mechanism through a contract payment stream. Using this structure, the private investors could find private finance for their investments. In many places, this type of private/private operation is called a concession—each private investor group bids for the right to provide the services over the term of the contract. Bids would generally be negative bids (i.e., how much the public entity would have to pay over the term of the contract). Contract rights for land development, parking, and fare structures would all go into the determination of the invest- ment group bid. Concessions are discussed more fully in Section 8.7. The fundamental feature that would enable concessioning is a stable funding source for the contracting entity; without a funding source, private investment will not be attracted to rail projects. Funding Source Options Fundamentally, if one cannot raise money on commercial terms from the market (a strong signal that a program would need to be justified on public benefits rather than private benefits), then one either has to increase the size or scope of an existing public program or get a new public program. Two potential options are discussed below. Increase the Size/Scope of Highway Trust Fund. One option could be to increase the scope of the HTF to add intercity (including high-speed) passenger rail (in addition to commuter and transit rail projects already included within the Mass Transit Account component of the HTF). This option is challenging for several reasons. First, there are no surplus HTF funds available. The HTF (which generates about 90% of its revenues from gas tax) has faced a shortfall in its funding needs since 2008, with the shortfall met through general fund transfers. Second, using HTF funds for passenger rail would lead to significant opposition from citizens and industry stakeholders who use the highway system extensively. Many would view an increase in funding from gas taxes for passenger rail as a cross-subsidization that does not benefit them directly (e.g., people living in rural areas who are not likely to ever be served by a passenger rail service). The allocation of some funds from the HTF to commuter and mass transit starting in 1982 was largely a result of local interests (representatives from large urban centers) who were able to organize in Congress to create an agency (UMTA, now FTA) to bring a series of local needs into a single national focus, generating President Obama recently announced the signing of an executive order creating the Build America Investment Initiative, which, among other things, is intended to modernize national public infrastructure by complementing government funding with private capital, including in the form of PPPs. Long-term stable government funding will be necessary if PPPs are to be viable for passenger rail projects.

98 Alternative Funding and Financing Mechanisms for Passenger and Freight Rail Projects some federal assistance. However, this allocation of funding from the HTF to commuter and mass transit was, and still is, a point of concern across many sectors of industry. It would be possible to give states more flexibility in spending highway (HTF) funding to include passenger rail projects or joint freight/passenger projects such as CREATE and Alameda. As noted above, some passenger rail (commuter and transit) projects can access HTF funding through the Mass Transit Account of the HTF (for capital, not maintenance or operations). It might be useful to expand the flexibility that states have to allocate their highway funds to cover more mass transit and extend to passenger rail services. This will not help unless the basic fund- ing from the HTF is stabilized and increased. Establish a New Multi-Modal Transportation Trust Fund for Infrastructure and Services. A second option would be to establish a new dedicated fund for transportation infrastructure and services, including (but not limited to) passenger rail. A multi-modal transportation fund works best if revenues to the fund are generated, at least in part, by stakeholders who will stand to benefit from the infrastructure and services in question. When users pay directly for the infrastructure they use, they receive more timely and accurate signals about the range of costs the infrastructure imposes on the system. By and large, rail passenger transport is valued because it can reduce highway congestion, provide a transport alternative, and/or reduce emissions of pollutants and CO2. To some extent, safety is also improved with corresponding benefits for lower healthcare costs. Overall, devel- opment of a passenger rail system that prices the social, economic, and environmental ben- efits of passenger rail would contribute to more sustainable development patterns of public infrastructure. Potential sources of revenues for a dedicated transportation fund might include • Road tolling/congestion charging: Highway tolling or congestion charging in urban areas with some of the proceeds going to finance the local share of the rail passenger alternative. The logic behind focusing on urban areas is that these areas stand to benefit most from most forms of passenger rail (e.g., commuter rail and HSR/intercity rail which only stops in major cities). • Distance-based road travel charges: This approach charges drivers based on vehicle miles trav- eled (VMT) and potentially on factors such as time of day, type of road, vehicle weight, and fuel economy rather than indirectly on fuel consumed. One advantage of a VMT approach is that it can be adjusted to reflect the full cost of a particular section of infrastructure—e.g., it can be higher on a busier urban highway, where a passenger rail service could provide an alternative. However, cost and administrative requirements are associated with implementing this (already proven) technology. There are also some concerns around privacy of a GPS-based system where vehicle movements are constantly being tracked. The VMT option has long been debated as a potential alternative to replace gas taxes in order to replenish the HTF. • Carbon tax or cap-and-trade programs: Transportation users could be charged for their car- bon emissions, with revenues dedicated to support transportation infrastructure investments and operational reforms that produce carbon reduction benefits (including passenger rail).71 If it can be argued successfully that rail passenger service reduces highway maintenance by get- ting cars (and trucks) off the road, then some portion of a carbon tax (which could replace fuel taxes) could be allocated to rail passenger (and maybe freight) funding, in this case operating costs as well as capital. However, using all carbon tax receipts for passenger rail funding would likely be unfeasible for the same equity consideration noted above—that some taxpayers would never use these passenger rail projects. 71 To some extent, fuel taxes are already a good surrogate for carbon emissions.

Beyond Revenue and Financing Mechanisms: Opportunities and Potential Strategies to Realize Rail Projects with a Funding Gap 99 Some of the options above involve applying a fee to road-based users that would then be partially used toward passenger transportation. Using this type of approach coupling road user charges with passenger rail service is likely to present legal issues, because the service provid- ers (e.g., state highway and municipal government) are almost always different agencies with different jurisdictions and institutional enabling legislations. The same is true for the gas tax. Although the logic of shared revenues is viable in theory, implementation is challenging in the current legal and institutional environment. The Grow America Act would invest $19 billion over 4 years to, among other things, establish the Current Passenger Rail Service grant program to provide ongoing funding certainty to ensure that existing passenger rail projects and services are maintained in good, working condition. These grants would be oriented around Amtrak’s main business lines. 8.3 Multi-Modal Project Grant Funding: TIGER 8.3.1 Context The era of the massive, single-focus, wholly publicly funded transport megaprojects, such as the Interstate Highway Program, may be over. Instead, for much of the nation’s future trans- portation infrastructure, the emerging model appears to be complexity, with projects touching several modes, involving government at local, state and federal levels, and pursuing benefits (and incurring costs) not solely of transportation efficiency, but also reduced environmental impacts, improved safety, and enhanced urban function, among many others. 8.3.2 Challenge These new multi-modal projects do not fit well with the prevailing modal funding and orga- nization prevalent within the DOT (e.g., commuter and transit under FTA, intercity passenger rail under FRA, and highways under FHWA). A better way is needed to assemble the various interested parties, provide an umbrella organization under which they can identify a project that serves many objectives, assemble the skills needed to deal with all aspects of the potential project, and crystallize the commitments and investments from all parties involved. The early experiences of the Alameda Project and CREATE emphasize this point. In both cases, the approach was initially ad hoc, with no background policy or funding to assist. The parties had to develop solutions and search for financing. In the Alameda case, solutions were eventually found. In CREATE, coordination issues have been difficult, and generation and bal- ancing of funding from all parties has taken years and is still not complete. In response to the economic recovery challenge from the global financial crisis of 2008, the Obama Administration created a transportation funding program that has addressed some of the challenges above head-on: the TIGER discretionary grants program.72,73 In contrast to other 72 See http://www.dot.gov/tiger for a description of the TIGER program, the award criteria, and a history of grant projects in prior years. 73 At the same time, the American Recovery and Reinvestment Act of 2009 (ARRA) was also created. The $750 billion ARRA program covered all areas of the U.S. economy and was aimed at rapidly generating employment. The ARRA program was the source of $8 billion investment in HSR projects, including $3 billion in the California HSR project.

100 Alternative Funding and Financing Mechanisms for Passenger and Freight Rail Projects transport funding programs, the TIGER program provides a good model for a multi-modal coordination and funding. TIGER is a discretionary grant program, although it does have an explicit objective to generate an equitable distribution of money over geographical areas and modes. In each year, the Department of Transportation invites competing proposals for TIGER discretionary grants. The award criteria focus on multi-modal projects that are multi- jurisdictional and otherwise challenging. In other words, TIGER aims to promote projects that do not fit well into the traditional DOT stovepipes but may fit the profile of transportation projects of the future. Since 2009, the TIGER program has provided $3.5 billion to 270 projects.74 The program has settled into an average annual funding level of around $500 million to $600 million. Requests have far exceeded the available funds, which may have contributed to a tendency toward smaller projects; the average size of a grant has decreased from $29 million in 2009 to $9 million in 2013. Every state has received at least one TIGER grant and 10 states have received one or more grants in every year. TIGER grants have spanned every mode—from bicycles to HSR and from trucking to barges and rail. Despite the goal of tackling multi-jurisdictional issues, the explicitly multi-state projects have declined over the life of the program. The proposed Grow America Act authorizes $5 billion over 4 years for additional TIGER funding. 8.3.3 Potential Solution TIGER grants are meeting a previously unmet need and addressing a gap in federal funding programs, although the TIGER program has not been without controversy. The decision to use a small, central staff that also has access to the vast range of expertise in the modal administrations has produced a flexible and cost-effective approach. The TIGER evaluation process has encour- aged applicants to think across modal and administrative lines in identifying problems, and the central staff/modal expertise approach has permitted the U.S. DOT to respond in kind. Equally important, the discretionary element of TIGER has permitted the Secretary and the Depart- ment to use an unusual degree of creativity in project formulation. Because of these attributes, the TIGER program has become an invaluable “bottom-up” source of information about real transportation needs. The TIGER program is an approach to deal with complex transportation issues (and associ- ated funding requirements). The basic strengths of the program—discretionary allocation; multi- modal focus; multi-jurisdictional coverage; access to technical, institutional, and jurisdictional expertise; and reliance on a wide ranging group of applicants—lead to better and more relevant transportation projects and can foster much-improved feedback among DOT and its clients (and the Congress) as to the types of projects that states and communities really need. In addition to existing programs that focus on well-understood modal needs, TIGER adds a multi-modal vision. If the TIGER program continues, it could benefit from a stable funding base and be enhanced with added access to some forms of lending authority, or guaranteed lending authority, that already exist within the modes. This could include access by the private sector as well as state and local governments in order to expand the participation of private-sector investors and operators in the TIGER projects. An “Infrastructure Bank” with lending authority alone will not suffice, but, if this can be matched by grants to cover project formulation and to pay for the public ben- efits realized by projects, PPP will be encouraged. Indeed, TIGER programs could explicitly have the authority to participate in PPP projects ranging from toll-road type projects to concessioning of HSR systems. 74 See http://www.dot.gov/briefing-room/strong-demand-tiger-grants-highlights-continued-need-transportation-investment

Beyond Revenue and Financing Mechanisms: Opportunities and Potential Strategies to Realize Rail Projects with a Funding Gap 101 8.4 Establish Model Institutional and Commercial Frameworks for Complex, Multi-Party Corridor Improvement Projects 8.4.1 Context One of the most difficult obstacles to financing investments for private freight railroads that have significant public benefits is the coordination of various interested parties and the trading off of private ownership rights for potential greater benefits from a joint investment in improved infrastructure. The NORG project is an example of this difficulty. First, all parties agreed that the existing infrastructure was insufficient for projected future traffic and both public and private parties could benefit from improvements designed to provide both public and private benefits. The first problem is to appraise existing costs and dis-benefits (both public and private) and design solutions that can minimize costs and provide sufficient benefits to all parties so as to make a public-private solution worthwhile. Once a politically and economically feasible project (or set of projects) has been selected, a new set of mechanisms may be needed for implementation. This may include federal and state grant programs along with private investments by the railroads with the overall improvement project slated to be completed in smaller steps over time. A comprehensive and wider ranging set of investments may benefit from the formation of an authority, as in the Alameda Corridor proj- ect, to coordinate and finance all the improvements most effectively. This type of solution usually requires coordination of both public and private parties and often requires private companies to contribute assets and ownership rights to a new jointly managed company. The relative values of such contributions need to be reflected in the ownership structure and ultimate cost of the projects. A mechanism to easily coordinate these vital trade-offs is often very difficult to set up. 8.4.2 Challenge The institutional and commercial frameworks for railway development are unusually complex in the United States75 and are often major barriers to obtaining funding. There are significant difficulties with the different levels of government and the large number of public bodies that need to be involved—processes need to ensure coordination and leadership on project develop- ment, funding, and financing and provide technical guidance on project appraisal. The early experiences of the Alameda Project and CREATE indicate that the modal organiza- tion prevalent within the U.S. DOT makes it difficult to assemble the various interested parties and provide an umbrella organization that can take a project from conception to operation. One of the most difficult obstacles to financing investments involving private freight railroads that have significant public benefits (e.g., NORG) is the coordination of various interested par- ties and the trading-off of private ownership rights for potential greater benefits from a joint investment in improved infrastructure. Also freight projects may involve several freight com- panies and/or terminal operators which, if they all contributed, they might be able to fund the project. However, anti-trust laws often prevent them from communicating with each other directly. A joint enterprise or government authority could act as an intermediary negotiating with each company. Legal changes may be required to make this easier. The government authority could provide seed money if necessary. Several major rail improvement projects (e.g., Alameda Corridor, CREATE, and NORG) have encompassed large and complicated transactions involving many different parties. The necessity 75 For example, Germany also has a federal system of government but it has a single national rail infrastructure company. Germany also has hundreds of small, private rail companies, mostly passenger services, but otherwise similar to the US short lines.

102 Alternative Funding and Financing Mechanisms for Passenger and Freight Rail Projects for this has been driven by the complexity of the rail environment in the United States (multiple private railways control most of the existing rail infrastructure except in the largest urban areas where some public rail infrastructure exists) and the similar complexity of the public environ- ment (with cities, counties, suburban cities, public authorities, states, and state authorities). Different approaches have been used to address this complexity. So far, each approach has been unique. 8.4.3 Potential Solution It could be worthwhile to develop a set of standard practices, based on the examples above, for dealing with the complex U.S. environment. For example, the following could be developed: • A set of standard or model agreements between railways and various authorities, between railways and other railways, and between local municipal agencies • Model structures for a project-specific public authority and a joint private enterprise • A set of common approaches to solving complex rail and freight traffic interactions, including models, survey approaches, and data sources • A set of common approaches to determining public benefits. These models could be managed by a multi-disciplinary team from a central resource. The team could include legal support, rail operations and transportation engineering skills, environmental specialists, communications and program development skills, and organi- zation and management specialists. This team could develop the model agreements struc- tures, expand on the CREATE-SPEED approach to environmental approvals, and work as a resource with government and rail companies to help complex rail/road improvement proj- ects progress. 8.5 Create PPP Expertise and Resources Available at the National Level 8.5.1 Context PPPs are often misconstrued as a way to fund infrastructure projects, including rail projects. PPPs are not a funding mechanism. A PPP can have financing features, but it is more than a financing mechanism—it is a project and service delivery mechanism. Key success factors for PPPs include clear objectives and aligned incentives between the parties; access to skills within public agencies to structure, understand, and negotiate PPP contracts that reflect a realistic and optimum risk allocation between the public and private sector; the interest and financial ability among investors to enter into PPP contracts; the political will to implement a PPP program; and a legal and regulatory regime that supports PPPs (including powers laid down by statute or a legal act to enable a government entity to enter into a PPP agreement with a private party). PPP projects for major transportation projects tend to be infrequent (e.g., most cities build a greenfield light rail system at most once in a generation). They are also highly complex to structure and procure, requiring specific expertise not widely available across all levels of gov- ernment. These skills include project finance, financial modeling and engineering, risk man- agement, negotiating with private companies, management and monitoring of long-term contractual arrangements, and assessing value for money using whole-life costing tools (the systematic consideration of all relevant costs and revenues associated with the acquisition and ownership of an asset). PPPs in rail are particularly difficult because the projects are not usu- ally separate from existing railroads and so it is difficult to ring-fence the incremental revenue from the project.

Beyond Revenue and Financing Mechanisms: Opportunities and Potential Strategies to Realize Rail Projects with a Funding Gap 103 8.5.2 Challenge Many government agencies have limited knowledge about PPPs and related expertise and resources. PPPs often immediately become adversarial relationships because government pro- curement is not set up for long-term partnerships in which not all problems can be defined in a contract at the outset and reasonable solutions have to be negotiated along the way. Another challenge to improving the use of PPPs relates to low levels of communication across jurisdictions from which to build institutional knowledge on experience and lessons to date. Although some rail transport PPPs have taken place in the United States, many have faced chal- lenges in implementation. In an optimal context, the lessons from these challenges would be documented and considered in the planning and implementation of subsequent projects. This is a challenge in the United States, in part due to the sheer size of the country, but also because of the jurisdictional barriers that can inhibit communication across cities, states, and national gov- ernment project sponsors. What tends to happen is that states and locals involved in PPPs do not share experiences and then they reinvent the wheel each time, with repetitive and costly mistakes. It is very costly (and often unnecessary) to build long-term skills to structure and procure PPPs across all staff in every government department. Most staff do not need the specific skills and PPP projects in transportation tend to be infrequent, making a major training program redundant quickly (once a project is in place). The exception may be where states anticipate imple- menting a large PPP program and deem it worthwhile to establish dedicated units at the state level to implement the program. For example, Virginia’s Office of Transportation Public-Private Partnerships (OTP3) is responsible for developing and implementing a statewide program for transportation PPP project delivery via the Public-Private Transportation Act (PPTA) of 1995.76 8.5.3 Potential Solutions The United States may benefit from establishing some unit of expertise at the national level and a supporting repository of PPP resources and best practices on the design, procurement, implementation, and management of PPP projects, generally, and rail projects specifically. This would be particularly useful for cities and states in the early stages of considering PPP options for rail projects and/or states and cities that anticipate having relatively few such projects. Over the past decade alone, more than 25 states and national governments worldwide have established PPP units of some sort.77 Such units provide a wide range of different types of support services, from advising on PPP policy development to contract monitoring support. The rationale for establishing such PPP units has varied, but the three most common arguments supporting for- mal establishment of PPP units (rather than ad hoc, uncoordinated support initiatives) include78 • Having a one-stop center of expertise, where standardized documents can be prepared and disseminated (e.g., RFP, contract templates, and Value for Money assessment tools), which provides guidance to all public agencies and also provides confidence to private-sector parties seeking information and some certainty regarding the approach to implementing and financ- ing PPPs in the country. • Development of an institutional memory and ability to capture best practice and lessons learned from PPP transactions, which can then improve project preparation and delivery over time. 76 www.vappta.org 77 For example in the United Kingdom, a unit within the Treasury works on the UK’s long-term infrastructure priorities and secures private-sector investment, mainly through PPPs. It is responsible for coordinating and simplifying the planning and prioritization of investment in UK infrastructure and improving UK infrastructure by achieving greater value for money on infrastructure projects and transitions. 78 See also: Christine Farrugia, Tim Reynolds, and Ryan J. Orr. “Public-Private Partnership Agencies: A Global Perspective.” CRGP Working Paper #0039, August 2008.

104 Alternative Funding and Financing Mechanisms for Passenger and Freight Rail Projects • Benefits of centralizing technical expertise in one unit, staffed with experienced professionals (e.g., financiers, lawyers, and economists) who are well placed to negotiate with, and under- stand the needs of, the private sector; often establishing an independent unit (arms-length from government) is necessary in order to attract and remunerate these experts above a typical public-sector pay scale. Build America Transportation Center: Recent Development in Line with Such a Solution President Obama recently announced the signing of an executive order creating the Build America Investment Initiative. Among other things, this initiative includes the establishment of a Build America Transportation Center, under the oversight of the U.S. DOT. This center will seek to provide information and tech- nical assistance about innovative financing strategies, including PPPs, to state and local governments, among others. Technical assistance to be provided by this center will include information on best practices from states and communities that already have established successful PPPs as well as analytical toolkits. 8.6 Improve Insurance Market for Shared Corridors 8.6.1 Context All types of railroads need insurance to cover the costs of unforeseen events (e.g., derailments, level-crossing accidents, collisions, and loss of life). Most rail freight companies are self-insuring up to a loss limit; over those limits, insurance covers at least part of any losses and liabilities associated with the unforeseen event. Rail passenger and freight services exhibit three challenges for insurance markets: losses can be very large, the specific cause of the liability can be hard to establish, and the probability of any event occurring is hard to calculate. When freight and passenger operations are fully separated, the insurance market for liability coverage is somewhat more conventional because both liability and exposure are more readily calculable. However, when one type of service (usually passenger) operates as a tenant on the tracks of the other (i.e., a shared corridor), the situation is more complex, particularly with respect to identifying who should take liability for the cause of the accident. The liability associated with passenger services is generally considered to be much higher than for freight services because of the potential for loss of life and personal injury—the United States has a very unpredictable and expensive system for determining these liabilities. Until 1997, Amtrak and non-Amtrak (commuter) rail operators using freight rail networks were effectively required to indemnify the freight owner against all liabilities, even those caused by errors on the part of the freight owner. In part to address this unbalanced approach, the Amtrak Reform and Accountability Act of 1997 (ARAA) included a provision intended to define and limit the maximum liability of passenger carriers (Amtrak and non-Amtrak) to a total of $200 million per incident or accident. It also included a provision explicitly intended to enable agreements between a carrier and an owner as to allocation of liability.79 The liability provisions of ARAA have not been fully successful for several reasons. First, the $200 million limitation for a single accident or incident does not include third-party liability. As a result, even with the $200 million limitation, total liability is still not fully calculable and 79 Codified as 49 U.S.C. § 28103.

Beyond Revenue and Financing Mechanisms: Opportunities and Potential Strategies to Realize Rail Projects with a Funding Gap 105 freight railroads need to cover themselves. Next, imposition of an arbitrary limitation on dam- ages has not been fully litigated and may not be acceptable under the U.S. Constitution. Finally, despite the intent of ARAA that Amtrak be able to accept all of the liability of the freight owner, the STB has ruled that transfer of responsibility when the freight carrier is guilty of gross neg- ligence, recklessness, or willful misconduct would not be consistent with good public policy. Non-Amtrak passenger operators (e.g., commuter) have faced additional problems because their lack of mandatory access to freight tracks has meant that agreements and enforcement have been subjected to widely varying state laws. The result of the uncertainty has been a patchwork of agreements specific to individual states and railroad/carrier negotiating positions. 8.6.2 Challenge There has been a trend by freight railroads to limit or cap their liability where passenger ser- vices operate over what are predominantly freight rail lines. Private freight railroads have sought the highest possible coverage and the maximum transfer of liability to non-Amtrak passenger operators whenever possible.80 Freight railroads want to protect their private property and would like very much to be held harmless if there is an accident with passenger train loss of life. Rail- roads are already liable for damages from freight accidents. A passenger train accident could be even more severe. Even so, most railroads have been able to reach agreements with well-managed private passenger operators and accept much higher costs associated with maintaining a higher safety standard in areas with passenger operations. MARC, VRE, NJT, MBTA and others operate on private rail rights of way without significant problems. In most cases, freight railroads have sought “hold harmless” clauses in regard to passenger liabilities. 80 See US GAO, “Commuter Rail: Many Factors Influence Liability and Indemnity Provisions, and Options Exist to Facilitate Negotiations,” GAO-09-282, Washington, DC February 2009. See also Bing, Alan J., Eric W. Beshers, Megan Chavez, David Simpson, Emmanuel Horowitz and Walter E. Zullig, “NCHRP Report 657: Guidebook for Implementing Passenger Rail Service on Shared Passenger and Freight Corridors,” 2010, pages 29–32. These two reports contain an extensive discussion of rail passenger liability issues as of 2010. This bargaining position and the trend requiring very high liability coverage have been more serious for smaller passenger rail operators and for new operators without a well-established safety record. The net result in the United States is that insurance coverage is costly, is not always available in the desired amounts, and, in the case of tenant operators, subject to ever- increasing requirements for higher coverage limits. In short, it is challenging for passenger rail operators to increase (or obtain new) access to freight rail infrastructure. This has implications for increasing/ advancing the development of shared corridors for passenger rail services in the United States. Many observers have argued that the liability cap provisions in ARAA could be improved by the following: • Adjusting the cap to explicitly include third-party liability • Removing any doubt that the intent of the law is to cover all passenger operators, including non-Amtrak operators • Resolving the conflict on indemnification to clarify what degree of indemnification is con- sistent with national public policy and clarify, to the degree possible, the boundary between normal mistakes and gross negligence.

106 Alternative Funding and Financing Mechanisms for Passenger and Freight Rail Projects Others argue that shifting passenger liability to freight railroads would limit their willingness to agree to allow access to new passenger services. They point out that most freight railroad rights of way are private property, which has a high degree of legal protection, and Amtrak’s terms of access are clearly specified in the law, protecting their private property rights. 8.6.3 Potential Solution There may be a solution to improve the insurance regime to encourage greater prevalence of passenger services on freight railroad infrastructure: the federal (or state) government could intervene in the insurance market to encourage more passenger rail services on third-party tracks. In the United States, the federal government has intervened in two instances to influence the insurance market for services deemed critical to the public: • Nuclear power plant operators: The potential liability of private operators in the event of a nuclear accident was seen from the beginning of nuclear power to be a major hindrance to the development of the nuclear power industry. The Price-Anderson Nuclear Industries Indem- nity Act of 1957 (since renewed several times) establishes a limit to the liability the private operators of nuclear power plants are expected to bear in the case of accidents. In the event of an incident, the federal government bears responsibility for costs incurred above the minimum amount of liability coverage.81 • Weapons manufacturers: U.S. Defense Department (DOD) contractors are often required to produce weapons or equipment that could do enormous damage in the event of an accident, thus exposing the supplier to potentially huge and unpredictable risks that cannot be fully insured. Under the provisions of Public Law (PL 85-804)82 the DOD can require the contractor to obtain a stated level of coverage above which any residual liability is the responsibility of the federal government. The coverage limit is intended to reach a balance between the cost of the insurance and the risk retained by the public, along with satisfying the needs of national defense.83 One solution to improving the liability coverage regime for passenger rail in the United States would be to adopt an approach similar to that used in Price-Anderson or PL 85-804. In principle, the limit of $200 million could be extended to a new, higher amount that would include all liabil- ity, including third-party damages. The higher amount would be set at the maximum reasonably insurable amount,84 would be dealt with through a no-fault approach (to resolve the indemnity issue),85 and would require that all operators have this level of coverage. Beyond the maximum amount, the federal government would assume the liability, or state gov- ernments would assume the liability if they insisted on maintaining their separate legal regimes.86 The federal government could in turn seek to offset some of its risk through a mandatory con- tribution program as in Price-Anderson, but this would certainly raise issues of what each operator 81 See http://en.wikipedia.org/wiki/Price%E2%80%93Anderson_Nuclear_Industries_Indemnity_Act, accessed on December 10, 2013. 82 Codified at 48 CFR 52.250-1. See http://www.law.cornell.edu/cfr/text/48/52.250-1, accessed December 9,2013. 83 Significantly for rail passenger service, the FRA was allowed to use PL 85-804 to extend liability coverage for the prime con- tractor (DeLeuw-Cather Parsons, DCP) on the Northeast Corridor Improvement Project for the high-speed Amtrak line from Washington, DC, to Boston, MA. In this case, the potential liability for DCP was so large and so unpredictable that the FRA determined that the DCP liability should be limited to $400 million (for which DCP obtained commercial coverage) beyond which the liability would be carried by the US Government. 84 This could include a relationship between the mandatory maximum and some measure of operational risk. Larger operators with higher passenger volumes and higher speeds might face a larger cap, new operators might face a larger cap until they can show safe experience, and very small operators with small and slow trains might face smaller caps. 85 Issues of gross negligence rather than ordinary error would then be adjudicated as criminal rather than liability matters. 86 States could be encouraged to harmonize their legal regimes by making a portion of FTA funding dependent on establishing uniform liability requirement. This has long been done by FHWA in the Interstate Highway program.

Beyond Revenue and Financing Mechanisms: Opportunities and Potential Strategies to Realize Rail Projects with a Funding Gap 107 could be required to contribute, given the disparities in the various operations and their risks. Given that creating such pools has been difficult in the past, this would probably be no easier now. Another potential solution would be a generalized form of Owner Controlled Insurance Program (OCIP), which is generally taken by the property owner but might be taken in rail pas- senger cases by the government agency funding the rail projects. OCIP generally covers most liability and losses during the construction and operation of a property or service. An umbrella OCIP policy covers general liability, workers’ compensation, employers’ liability, and similar needs for all contractors/operators/participants involved in a project. This eliminates the need for each participant in the project to get its own insurance coverage and also eliminates the many lawsuits that could arise with different participants and insurance companies trying to parse the blame for a particular loss. An OCIP-type policy can reduce overall cost of insurance for any project greatly and can also include a self-insurance aspect (a different deductible for different participants). This structure is being used in some commuter rail services with the commuter authority purchasing the OCIP. This generally leads to lower bid costs by concession operators because they do not have to provide for insurance coverage (other than normal business insur- ance coverage). 8.7 Concessions/Funding For major intercity and HSR investments, financing can be found to the extent there is an income stream that can fund operations, maintenance, renewals, and debt service. Debt service can be reduced with grants if infrastructure is provided from a separate public authority (that has access to public debt financing) or if rolling stock can be leased. The full income stream for a train operations concession cannot reasonably be based on annual appropriations from some government agency because these cannot be promised or guaranteed for the length of time needed to earn a return on investment. Involving private financing does not solve the funding problem because private debt needs to be repaid from some identifiable and reasonably predictable funding source—it is hard to sell a concession (or a right to operate a service) if there is no assured income stream.87 Having said that, the public sector’s entering into a contract may serve to ring-fence that funding (which was a major improvement brought about by rail franchising in the United Kingdom). Based partly on European franchising experience, the following may be possible: • Set up Amtrak (and other) intercity routes for franchising; sell these concessions on the basis of the least-required income support (i.e., funding from subsidies). • Make the concessions long enough to finance the required improvements that might be needed, possibly with assets owned by other bodies than the franchisee itself (e.g., in the United Kingdom, neither rolling stock nor infrastructure are owned by the franchisee). • Guarantee the income support required in the best concession bid (subject to meeting perfor- mance metrics defined in the concession). For interstate franchises, FRA or a similar agency could be responsible for administering the program. Congress could set the size of the program by determining the division of these additional funds between “investment” and operating support. In an example of the simplest case, a tour operator might want to provide a very high-quality rail service between Chicago and Seattle, over the Empire Builder franchise across the Pacific Northwest 87 Except where the concessionaire/investor will get its money out early because they sell the equipment or infrastructure. The danger in this type of structure is the major concession partners resign the partnership after they have received payment for their rolling stock or infrastructure.

108 Alternative Funding and Financing Mechanisms for Passenger and Freight Rail Projects and its Big Sky country, including national parks and travel through the Rocky Mountains. The tour operator might team with BNSF and Amtrak to develop a train service designed like an ocean cruise line service, full of amenities and special events. To win the bid for this concession, they might propose a very expensive service that might require little subsidy. Or, imagine that NS teamed with an operator (e.g., Amtrak, or SNCF) to run the Crescent service (DC to New Orleans). To win the franchise, they might want to offer higher speeds, which would require improvements to NS lines to permit those higher speeds. NS might want to do this to increase the speed of its intermodal trains and to increase the capacity of its main line. Its partner (e.g., SNCF) might want to do this to make money in the long term as an operator of intercity passenger services. There will be many questions about whose crews, labor agree- ments, and so forth might be used; whether or not an equipment provider (or leasing company) is a member of the consortium; and whether or not to use relatively standardized rolling stock (for lower cost leases). Other questions would arise about how to/who would define the con- cessions: for example, would the concession be DC to NO, and could CSX put together its own consortium? Or might someone else (e.g., SNCF) try to use both NS and CSX tracks in some mix and have to attract their permission and put together the infrastructure, equipment, and operating plan? Could Amtrak’s access rights be transferred to the new concessionaire or might these require new rights? The whole plan would assume that the insurance problem was resolved on a commercial basis acceptable to the participants (e.g., Amtrak would take out an OCIP policy). One would hope that the lines concessioned would be those that created the highest consumer surplus (combined public and private benefits less costs), although some case could be made for “essential” services. In any event, the total to be committed could be controlled through the funding mechanism. States, local communities, and even private entities might want to sponsor and operate service franchises that serve their interests. Here, a concern would be how to gain access to private rail infrastructure outside Amtrak’s inherent right of access. Funding sources for this might come from the state or local community “share” of the funding mechanism for rail passenger services or state and local communities might vote to increase local vehicle-mile taxes to produce dedi- cated funding. Another option would be for them to implement some version of the Oregon Plan, congestion charging, or other dedicated source that would be committed to long-term rail service funding.