Public-Private Partnerships, Part 1
CMAP recognizes that our current gasoline and excise tax revenues have proven inadequate to maintain transportation funding at current levels. In order to maintain, modernize, and expand the region's transportation system, GO TO 2040 recommends pursuing innovative finance mechanisms such as public-private partnerships (PPPs), which seek to provide a greater role for the private sector in the design, construction, and management of transportation facilities. This expanded private role can range from both designing and constructing the same facility (design-build) to including broader responsibilities such as operations and maintenance (design-build-operate-maintain) or finance (design-build-finance-operate). A private operator can also assume all responsibilities for a facility through a long-term lease or concession agreement. PPPs may be applied to both new and existing transportation facilities.
This Policy Update is the first in a series on the topic of public-private partnerships and transportation. The next post will focus on public-private partnerships and federal transportation reauthorization, the following will discuss PPPs and transit, and the final post will provide a more focused look at PPPs for major capital projects identified in GO TO 2040.
CMAP issued a strategy paper on public-private partnerships for transportation in November 2008. This research led to the specific citation and recommendation of PPPs as an efficient, innovative finance mechanism in GO TO 2040. Accordingly, CMAP also supported the state Public-Private Partnerships for Transportation Act, which was passed by the General Assembly and signed by the Governor in August 2011.
More specifically, GO TO 2040 calls for the region to pursue appropriate PPPs. It stresses that all PPP arrangements must be handled with a high degree of transparency and care. The costs and benefits of recent PPP deals are still under debate, and for many of these deals it remains premature to make any final judgment on the outcome. PPP contracts can be extremely complex, and performance standards on all aspects of operations and maintenance should be stated in detail. For long-term lease agreements, the fiscal benefits of an up-front revenue infusion must always be carefully weighed against the public benefits over the lifespan of the project.
CMAP supports a case-by-case approach to implementing PPPs in the Chicago region. Each project should be studied for its own merits, bearing in mind the strengths and weaknesses of PPP as a contracting and financing strategy, as well as the overall need to protect the public interest. The following sections discuss these issues in more detail.
Pros and Cons of Public-Private Partnerships
PPPs offer many potential benefits to the public and private sectors alike. These benefits include greater efficiency, cost savings, risk sharing, accelerated project delivery, improved transportation finance policy, and large upfront revenues to the public sector for long-term concession agreements. Additionally, and perhaps most fundamentally, PPPs allow greater access to private capital. Substituting private for public dollars allows the public purse to be stretched further, supporting more projects than would otherwise be possible.
A comparison of 21 PPP projects and 30 traditional projects in Australia found cost savings of 30.8 percent when measured from project inception, or 11.4 percent when measured from contractual commitment. Cost overruns were substantially smaller for the PPP projects compared to the traditional projects, A$58 million and A$673 million, respectively. According to a second study, eight highway PPP projects built between 1993 and 2007 in New South Wales, Australia, were completed an average of 6.5 months early; time savings ranged from 0 months (on time) to 18 months. Generally speaking, PPPs' cost and time savings result from the private sector's better cost containment, more efficient project delivery, and incentives to apply life-cycle analyses to construction and maintenance costs. These advantages are more pronounced for large and complex projects.
The advantages of PPPs must be weighed against their disadvantages to the public sector. Most fundamentally, there is no "free" money. Private loans must be repaid, and private partners will require a reasonable rate of return for their investors. To achieve these objectives, private partners require a project to generate a reasonable cash flow, often through tolling. While the public sector has long operated toll roads, toll rates are likely to be higher on privately-run tollways. Additionally, if a private tollway enjoys a monopolistic market position, toll rates could rise above those required to operate and maintain the facility while providing a reasonable rate of return.
The toll rates issue illustrates a more fundamental concern: the public sector's perceived loss of control in a PPP agreement. This concern may be compounded by the dominance of foreign investment funds and large national or multinational contracting firms in recent PPPs (for more discussion, see this report and this website). In addition to a private entity potentially setting toll rates, non-compete clauses could also limit the public sector's scope of action. In order to protect its market share, a private operator may require limited or no public investment in adjacent (i.e., "competing") transportation facilities. Such a provision famously led the Orange County Transportation Authority to pay $207.5 million to buy out the private contractor for the SR-91 Express Lanes, the nation's first variably-priced, fully electronic toll road.
PPPs remain a relatively new way of financing and delivering transportation projects in the U.S. Consequently, much of the existing regulatory framework precludes PPP agreements; indeed, some states lack enabling legislation to permit PPPs altogether. These regulatory burdens represent a significant disadvantage of PPPs and include challenges in the areas of (1) contracting, (2) environmental regulations, (3) right-of-way acquisition, and (4) project finance.
- First, many procurement laws require public sponsors to choose the lowest-cost bidder, rather than the best-value bidder. While one contractor may offer a lower price for a standard design-bid-build project, the public sector may instead benefit more over a project's lifecycle from a design-build or design-build-operate project.
- Second, regulations generally restrict private participation in the environmental review process and require a specific sequencing of review activities. These regulations impose delays and uncertainty on private contractors, who are forbidden from developing environmental documents or conducting concurrent work on early design and constructability tasks.
- Third, a private entity lacks eminent domain authority and may experience difficulties assembling the land required for a transportation projects.
- Fourth, some state regulations may not allow the commingling of private and public funds, and federal regulations restrict the tolling of federal-aid highways. Relatedly, private partners face higher financing costs than tax-exempt public agencies, although access to innovative credit assistance programs can reduce this differential.
Just as hard regulations reflect the traditional project delivery and finance process, both public and private participants need to develop the appropriate soft skills to support PPP agreements. The Federal Highway Administration (FHWA) notes cultural differences between the private and public sectors, including dichotomies such as short vs. long time horizons, user vs. customer focuses, risk averse vs. managed risk approaches, and process-driven vs. product-driven operations. Public agencies may initially lack the in-house expertise to negotiate and manage a complex PPP agreement. Some PPPs involve long-term relationships between private and public entities and thus require an institutional culture of collaboration and mutual respect.
Protecting the Public Interest
Countries with longstanding experience in transportation PPPs apply systematic approaches to analyze proposed projects and to assess their impact on the public interest. Australia, Canada, Spain, and the United Kingdom use methods such as value-for-money analysis and public sector comparators to identify whether private delivery and finance represents a better value than more traditional methods. These studies may consider the potential for improved risk management, ownership and whole-of-life costing, overall asset utilization, and innovation, among other factors.
If the potential exists for a PPP, the public sponsor can protect the public interest through the terms of the PPP agreement. Commonly, these terms will define performance standards, toll rates, the public sector's ability to provide competing transportation improvements, and workforce issues. For example, a PPP agreement may require the private operator or concessionaire to meet certain standards for pavement quality or risk penalties. A PPP agreement may require regular maintenance, the implementation of advanced technologies, and, for long-term agreements, a high quality of repair before returning the facility to the public sponsor. Also, a PPP may determine the limits within which the private operator can increase toll rates. For example, the Chicago Skyway concession agreement limited toll increases to no more than 50 cents annually from 2008 to 2017, and thereafter to the greater of two percent, the inflation rate, or the growth in per capita gross domestic product (GDP).
Many public concerns can be also addressed through the design of a PPP agreement. For example, the public sector can retain tolling authority, or choose not to toll at all, in an availability payment or shadow tolling model. And a more restrained design-build or long-term maintenance contract avoids the more controversial topics of facility ownership, financing, and non-compete clauses. PPPs do not necessarily imply the long-term lease or sale of public assets.
While rigorous upfront analysis and carefully negotiated contract terms can protect the public interest from monopolistic pricing, private windfalls, and shoddy workmanship, special FHWA programs have reduced the regulatory burdens to PPPs. The Special Experimental Projects 15 (SEP-15) process allows FHWA to waive some federal regulations, such as procurement rules and aspects of the environmental permitting process, considered to be a hindrance to the implementation of public-private partnerships.