The Role of PPPs In Addressing Congestion
Private sector investments in the transportation system may help reduce gridlock on U.S. roadways.
Despite the growing need for congestion relief, States report a number of factors that are leading to shortfalls in the funding available to support investments in transportation. Oregon is a case in point.
"Oregon's traditional road revenues are dwindling, as the State's last increase in the gas tax was in 1993, with no expected change in the foreseeable future," says James M. Whitty, manager of the Office of Innovative Partnerships and Alternative Funding at the Oregon Department of Transportation (ODOT). "Also, Oregon's road bonding program is nearly at its capacity."
Other factors contributing to the funding shortfall in States nationwide include public resistance to increasing fuel taxes, steady climbs in vehicle fuel economy, and rising construction costs. While revenues fall, the continued growth in vehicle miles traveled is increasing congestion.
In 2005, the U.S. Congress passed a 6-year reauthorization of the Federal surface transportation program: the Safe, Accountable, Flexible, Efficient Transportation Equity Act: A Legacy for Users (SAFETEA-LU). Although the legislation provides a modest increase in authorization levels, officials with the U.S. Department of Transportation (USDOT) expect that operations, preservation, and modest renovations to the existing highway system will consume most of the SAFETEA-LU funding.
As traditional sources of highway funding fail to meet the growing demands on an aging surface transportation system, and as construction costs continue to increase, States may look to the private sector for help. "There is a general recognition among policymakers that alternative funding mechanisms are needed," Whitty says. "There is also recognition that the entrepreneurial creativity of the private sector can be accessed with effectiveness in boldly proposing significant new revenue sources for road capacity improvements."
The current growth in the number of public-private partnerships (PPPs) in the United States — as evidenced by PPP projects in Florida, Georgia, Oregon, Texas, and Virginia — hints at an impending change in the delivery of transportation projects. SAFETEA-LU helped set the stage, offering new Federal guidelines and procedures to promote PPPs and harness private sector innovations. This Federal support, combined with a positive response from the financial industry, has emboldened State and local government officials to explore new project delivery methods and financing tools. A look at new Federal and State policy initiatives and current projects nationwide in a long-term, sizable transaction pipeline helps shed light on the role that PPPs could play in helping to deliver tomorrow's highway program and relieve the strain caused by growing congestion.
Federal Financing Tools
As part of the National Strategy to Reduce Congestion on America's Transportation Network (also known as the Congestion Initiative), USDOT is committed to removing or minimizing barriers to private sector investment in the construction, ownership, and/or operation of transportation infrastructure. USDOT efforts will focus on a number of initiatives: providing technical assistance to help States enact legislation that will enable them to enter into arrangements with the private sector, helping overcome institutional resistance to relationships between States and private investors and developers, and using existing Federal program authorities to promote formation of PPPs.
The Transportation Infrastructure Finance and Innovation Act of 1998 (TIFIA) offers one of the most attractive financing approaches available for PPPs in transportation. Although TIFIA loans can only support up to 33 percent of total eligible project costs, capital markets often consider the loans' flexible features desirable as part of an overall financing package. TIFIA is often the subordinate, or "junior," lender in a transaction where commercial bank loans or bonds provide the primary financing. As a junior lender, TIFIA provides an additional level of security to the senior lenders because any shortfall in payments will affect junior lenders first. Interest rates on TIFIA loans are set at rates comparable to U.S. treasury securities, which are much lower than what most private borrowers or stand-alone projects could obtain in the capital markets. TIFIA loans also can offer payment deferral for up to 5 years after project completion. Depending on the project, TIFIA may be able to accept 1.1/1 debt coverage underwriting, which is lower than most senior lenders require. As a result of these features, senior lenders can offer more financing at less expensive rates when TIFIA is involved — lowering the overall costs of projects, and in some cases, making a project financially feasible.
SAFETEA-LU improved TIFIA's suitability to the PPP environment by lowering the threshold for project size from $100 million to $50 million, expanding eligible project types, and authorizing refinancing of long-term project debt.
To gain a better understanding of potential improvements to the TIFIA credit process, the TIFIA Joint Program Office within the Federal Highway Administration (FHWA) now is working with States through waivers and pilot projects to facilitate using TIFIA funds to participate in PPPs through FHWA's Special Experimental Project 15 (SEP-15) program. In 2004, FHWA established SEP-15 as a program to help identify new PPP approaches. Areas of experimentation include procurement procedures, contract terms, environmental review procedures, right-of-way acquisitions, and project financing.
Oregon, Texas, Virginia, and other States are using SEP-15 to bolster their PPP programs. In 2006, FHWA granted the Texas Department of Transportation (TxDOT) and Virginia Department of Transportation (VDOT) waivers in the TIFIA requirements.
Private activity bonds. One of the traditional financing sources for highway projects has been the municipal tax-exempt bond market. The governing rules generally permitted tax-exempt financing only in the absence of private involvement such as revenue sharing, private equities, and long-term operating contracts. Thus, Federal income tax laws effectively prevented projects from combining tax-exempt financing and concession PPPs. In this tax environment, States mostly opted for lower financing costs and the required investment grade ratings, which affected the amount of capital a startup revenue project could raise.
SAFETEA-LU, however, modified this financing landscape. Congress authorized the Secretary of Transportation to allocate $15 billion in tax-exempt private activity bonds (PABs) to qualifying highway or surface freight transfer facilities. Specifically, SAFETEA-LU amended Section 142 of the Internal Revenue Code to add highway, bridge, and intermodal freight facilities to the types of privately developed or operated projects for which PABs may be issued. The amendment enables private investors to participate in the construction and operation of highway, bridge, and intermodal freight facilities, while maintaining the tax-exempt status of the bonds. In addition to providing low, tax-exempt interest rates, PABs effectively eliminate the differential in interest costs between debt issued by the public and private sectors.
To use a portion of the $15 billion in PABs, the private sponsor must work closely with a State or local government, which acts as the conduit issuer of the bond. That is, a local government actually will issue the bond, but the private entity will be responsible for making the periodic debt service payments and retiring the debt.
Passage of the PAB legislation should help increase private sector investment in transportation infrastructure by providing private developers and operators with access to tax-exempt interest rates that lower the cost of capital significantly and enhance investment prospects.
In January 2006, for example, USDOT issued a public notice inviting applications for project allocations. USDOT has authorized PABs for the State Highway 121 project in Texas (though they will not be used), the Port of Miami Tunnel Project, and Missouri's Safe and Sound Bridge program. Several other States are preparing applications or their applications are pending with USDOT.
Federal Tolling Programs
Title 23 of the United States Code Section 129 allows Federal participation in selected tolling activities. Specifically, Section 129 authorizes tolling to fund construction of new noninterstate highways, reconstruction of existing toll roads, reconstruction and replacement of previously nontolled bridges and tunnels on and off the Dwight D. Eisenhower National System of Interstate and Defense Highways (interstate system), and reconstruction of nontolled, noninterstate Federal-aid highways.
SAFETEA-LU extends the ability of States to impose tolls on interstate highways through several demonstration and pilot programs. These programs also open new opportunities for States to use PPPs to construct, operate, and maintain key transportation facilities.
The Express Lanes Demonstration Program permits tolling on selected facilities to manage high levels of congestion, reduce emissions in a nonattainment or maintenance area under the Clean Air Act as amended in 1990, or finance added interstate lanes to reduce congestion. The program authorizes FHWA to implement 15 demonstration projects through 2009 to allow States, public authorities, or public or private entities designated by States to collect tolls from motor vehicles at eligible toll facilities for any highway, bridge, or tunnel, including on interstates.
"PPPs are an alternative to public sector development of congestion pricing strategies," says ODOT's Whitty. "Oftentimes, the private sector can offer political cover to the public sector in proposing tolling alternatives that the public sector would be unable to propose."
The Interstate System Construction Toll Pilot Program authorizes up to three facilities on the interstate system to toll for the purpose of financing construction of new interstate highways. A State or group of States may submit a single candidate project. Each applicant must demonstrate that financing construction of the facility with the collection of tolls is the most efficient and economical way to advance the project. Further, the State(s) must agree not to enter into a noncompete agreement with a private party under which the State is prevented from improving or expanding the capacity of public roads in the vicinity of the toll facility to address conditions resulting from traffic diverted to nearby roads from the tolled facility.
The Interstate System Reconstruction and Rehabilitation Pilot Program grants FHWA authority to allow up to three existing interstate facilities (highway, bridge, or tunnel) to be tolled to fund needed reconstruction or rehabilitation on interstate highway corridors that could not otherwise be adequately maintained or functionally improved without collecting tolls.
In addition, SAFETEA-LU mainstreamed the conversion of high- occupancy vehicle toll (HOV) lanes to high-occupancy toll (HOT) lanes. States may charge tolls to vehicles that do not meet the established occupancy requirements to use an HOV lane if the State establishes a program that addresses the selection of certified vehicles and procedures for enforcing the restrictions. Tolls under this section may be charged on both interstate and noninterstate facilities. There is no limit on the number of projects or States that can participate.
Together, these SAFETEA-LU provisions open new doors for States and private sector entities to begin exploring PPPs.
PPP Activity at the State Level
Although USDOT can facilitate PPPs, project delivery occurs at the State and regional levels; therefore, political will at these levels is critical for transportation PPPs to flourish. A brief survey of active projects offers a snapshot of the burgeoning PPP landscape at the State level.
Texas has several major projects currently under PPP contract or at various stages ranging from procurement to contract negotiations to preparations for competitive procurements. "Texas is in the midst of a transportation challenge," says Phillip E. Russell, P.E. and J.D., director of the Texas Turnpike Authority Division at TxDOT. "Congestion is mounting, our population continues to increase, and funding has not kept pace with the needs. The State's PPP program is one way we are taking action to improve our transportation system."
Texas's PPPs include Trans-Texas Corridors (TTC) TTC-35 and I-69/TTC, multibillion-dollar projects to create new multimodal transportation and utility corridors across the State. A preliminary estimate for the roughly 966-kilometer (600-mile) TTC-35, for example, is $10 billion to $15 billion for the road portion only (from the developer's master development plan). In early 2005, Texas selected a Spanish concessionaire and Texas contractor as its strategic business partners and project developers for TTC-35. The State executed its first concession for State Highway 130 (S.H. 130) segments 5 and 6. Texas also is in the procurement phase for a PPP for the S.H. 121 toll project, which, TxDOT officials say, will allow for completion of the roadway some 9 to 18 years sooner than would have been possible using gasoline tax revenues and will provide the region with a concession payment of more than $2 billion.
The I-635 Managed Lanes Project in Dallas (at an estimated construction cost of $1.5 billion) is in the active procurement stage. New legislation in Texas requires that a market valuation process be used on all new toll projects in the State. This process will determine a fair market value that the project could generate in fees. The S.H. 161 toll project in Dallas County will use the market valuation process. The U.S. 281 portion of the U.S. 281-Loop 1604 Toll Project in Bexar County (at an estimated construction cost of $1.4 billion) is subject to a 2-year moratorium passed by the Texas Legislature in May 2007.
TxDOT recently posted requests for qualifications for S.H. 121/S.H. 114, the Dallas/Fort Worth (DFW) Connector (formerly known as the Funnel and with a construction cost estimated at $1.3 billion), and the North Tarrant Express (NTE), which is a 58-kilometer (36-mile) project along the I-820/S.H. 183 corridor in the Fort Worth area (improvements estimated at $2 billion for construction costs). Both the DFW Connector and NTE are managed lanes projects.
Virginia has one of the Nation's longest histories of using PPPs, with many projects having arisen from unsolicited proposals. Among numerous projects, Virginia is advancing a PPP for the Dulles Corridor Metrorail Project and has approved transfer of the Dulles Toll Road to the Metropolitan Washington Airports Authority, which may act on existing PPP proposals to lease the road. VDOT recently granted a long-term lease for the Pocahontas Parkway (Route 895) and has negotiated an interim PPP agreement with the preferred developer for the Capital Beltway HOT Lanes project and the 90-kilometer (56-mile) I-95/395 HOT/HOV/Bus Lanes project to construct HOT lanes.
"PPPs are an important project delivery tool along with the other more traditional contract procurement methods available," says VDOT Chief Engineer Malcolm T. Kerley, P.E. "Since 1995, when Virginia's Public-Private Transportation Act [PPTA of 1995] was legislated, VDOT has completed five contracts valued at more than $750 million. The PPTA and the design-build delivery method enabled us to complete those projects sooner than planned under our traditional processes."
In 2005, Oregon signed a predevelopment agreement for three highway projects at various stages of environmental planning and feasibility analysis. The contractor committed to advance much of the cost of the predevelopment work in exchange for exclusive negotiating rights to implement concessions on those projects proving economically feasible.
For its $1.5 billion PPP for the Port of Miami Tunnel Project, Florida is proposing to make what are known as availability payments to the concessionaire for providing vehicle access through the Port of Miami Tunnel. These payments will begin once the tunnel opens for use and will continue at regular intervals throughout the duration of the concession agreement (30 to 50 years). If the concessionaire underperforms, it will not receive a full availability payment. Through the concession agreement, the Florida Department of Transportation (FDOT) will retain ownership of the tunnel, and at the end of the concession period the tunnel will be turned over to FDOT for operations and maintenance. On May 2, 2007, FDOT announced the notice of intent to award the project to a consortium called Miami Access Tunnel. FDOT and its financial partners, Miami-Dade County and the city of Miami, are completing their agreement for the shared public funding.
Georgia currently is evaluating three unsolicited proposals: improvements to the I-75/I-575 Northwest Corridor with HOV lanes and truck-only lanes; HOV lanes on GA 400; and HOV and truck-only lanes on the northwest quadrant of I-285 and I-20 west of I-285. All HOV and truck-only lanes are being considered for HOT lanes and truck tolls. As part of a PPP for the I-75/I-575 Northwest Corridor, the Georgia Department of Transportation has entered into a design services agreement for preliminary engineering work contributing to National Environmental Policy Act and feasibility studies.
PPP-Friendly State Legislation
In addition to active construction and reconstruction projects employing PPPs, several States are taking steps to legislate a more welcoming environment for PPPs in transportation projects. In January 2007, Washington State finalized administrative rules under its new PPP legislation. The State law, modeled after similar legislation in Oregon, requires the State treasurer to issue all project indebtedness, and other provisions require legislative approval for tolling. The legislation may leave the door open for State-issued PABs coupled with private equity. Separately, the Washington State Transportation Commission oversaw a recent study recommending a statewide tolling and pricing policy as a new funding source and tool for managing congestion. The legislature recently authorized a second phase to this tolling study, with an emphasis on identifying tolling projects based on the criteria in the new policy.
The North Carolina Turnpike Authority (NCTA) is authorized to study, plan, develop, and conduct preliminary design work on up to nine toll roads in the State. At the conclusion of these activities, NCTA is authorized to design, establish, purchase, construct, operate, and maintain the following projects: Monroe Connector/Bypass, Gaston County East-West Connector, Cape Fear Skyway, Triangle Parkway, Mid-Currituck Bridge, and Western Wake Parkway. Although NCTA anticipates that most of the projects will use traditional financing from toll revenue bonds, the agency is exploring a PPP procurement approach to deliver the Mid-Currituck Bridge.
In 2006, Utah passed PPP legislation authorizing the Utah Department of Transportation, with approval from the State's transportation commission, to accept solicited and unsolicited proposals for PPPs involving tollway facilities through use of tollway development agreements.
In May 2006, the California Legislature passed its first PPP bill since a 1989 law that gave birth to the State Route (S.R.) 91 and S.R. 125 concessions. Under the more recent legislation, in connection with the largest infrastructure bond program in State history, California authorized four PPP projects primarily designed for goods movement, two in northern California and two in southern California. The agreements are subject to approval by the California Transportation Commission and the State legislature. As of May 2007, a revised bill that will amend the process to address stakeholder concerns was pending in the State legislature.
Alaska adopted legislation in June 2006 granting PPP authority for financing and delivering the $600 million Knik Arm Bridge in Anchorage.
In addition, Mississippi passed PPP legislation in April 2007, and several other States including Illinois, Michigan, Nevada, New Jersey, New York, and Pennsylvania are considering PPP legislation.
In May 2007, the Texas Legislature enacted legislation that includes a 2-year moratorium on using PPPs for some current and proposed projects. At press time for this issue of Public Roads , the full implications of this decision were still being evaluated.
Outlook for PPPs
Facing limited solutions to the pent-up demand for improved mobility and congestion relief, and witnessing the success of the Chicago Skyway, Indiana Toll Road, and TTC-35 transactions, policymakers may wish to consider PPPs. "Our future PPP program focuses on solicitations for proposals to solve congestion problems on our busiest highways," says VDOT's Kerley.
The growing number of States using and considering PPPs indicates that the PPP sector may grow more robust in the coming years, adding to the collective pool of knowledge and experiences from which States can learn. Further, PPP procurements and contract terms may become hybrids of other models, using features from existing projects but modifying them to reflect the specific State's legal environment, agency preferences, available financing tools, and political climate.
"We anticipate that PPPs may address 10 percent to 20 percent of our unmet transportation needs," Kerley says. "[A PPP] is not the right tool for all projects, but we anticipate that it will continue to be an important part of our transportation program when applied to appropriate opportunities to partner with the private sector."
Types of PPP Projects
Three types of PPP projects are emerging in the United States. The first, and most common, are long-term leases of existing tolled assets, which State officials view as solutions to funding deficits. The distinguishing characteristics of asset leases are (1) available history of data on traffic and maintenance operations; (2) fairly predictable cashflows and expenses; (3) lower risk profiles with regard to traffic, revenues, and costs; and (4) acquisition of a going concern. The 99-year, $1.8 billion Chicago Skyway asset lease helped resolve Chicago's budget crisis and catapulted its credit rating to solid investment grade.
Indiana followed suit, tendering a 75-year lease of the Indiana Toll Road, fetching a $3.85 billion offer. Approved in March 2006, the agreement will fund a 10-year transportation improvement program.
The second project type is the finance, construction, and long-term operation of new facilities. Because these are startup facilities, they lack an operating history; their traffic and revenue projections are less reliable; and they pose greater risks prior to completion, traffic ramp-up, and stabilization than is posed by the sale of existing highway facilities. Examples of this type of project include the Pocahontas Parkway in Virginia, several of the Texas projects, and the proposed Newberg-Dundee Transportation Improvement Project in Oregon.
The third type, known as mixed concessions, entails reconstruction or expansion of existing facilities and long-term operations. The risk profile for mixed concessions falls between that of asset sales and construction of new projects. An example is the Virginia HOT lanes.
Michael Saunders is the FHWA program manager for PPPs. With more than 25 years of transportation experience, Saunders has worked for FHWA in the areas of transportation planning and project development. Previously, he served as a program administrator for the Organization for Economic Cooperation and Development, deputy commissioner of the Connecticut Department of Transportation, and as the program manager of the Federal Railroad Administration's Northeast corridor office, overseeing improvements between New York City, NY, and Boston, MA. He received master's degrees from the University of Virginia and Michigan State University in urban and environmental planning and civil engineering, respectively, and a B.A. from Trinity College.
This article contains excerpts from "Public private partnerships: A sea change in the US transportation sector," by Fredric W. Kessler and Geoffrey S. Yarema, which was published in Privatisation & Public Private Partnership Review 2006/07 by Euromoney Yearbooks, a subdivision of Euromoney Institutional Investor PLC. The original article is located at www.euromoney-yearbooks.com/default.asp?page=5&pcID=5530.