Tag Archives: Public private partnerships

P3 Mirage

tollsby Randy Salzman

With recent reporting about Norfolk’s ERC (Elizabeth River Crossings) public private partnership (P3) on top of extensive coverage of the 460 Toll Road debacle, Virginians should begin questioning “privatization” of public infrastructure.

The data is clear. The privatization of highways has not been “capitalists’ gifts to taxpayers,” as press releases have implied. Instead, the privates — or “privateers” as some call them — have negotiated contracts with, at best, clueless public officials and lawyers content to increase private profits to the tune of millions, and perhaps billions, in lost taxpayer dollars.  In general, the privates have accepted little risk and tacked on consulting, advising and debt-service charges to the point that even CPAs can’t decipher complex financing arrangements in 700+ page P3 contracts.

Around the world, citizens are grasping the prospect that, as the Royal Scottish Accountants put it in 2008, P3 toll concessions are “financial black holes” or as an Australian law professor put it last month, “legalized corruption.” Here, our present state administration, backed by new reforms, is trying to restrain future P3s with the secretary of transportation reporting the likely benefit of Virginia building and operating an I-66 toll road west of D.C. is $1 billion over leasing that concession.

That’s “billion” with a “B.” And that’s on a total project cost of under $3 billion. Secretary Aubrey Layne’s analysis indicates, in short, if I-66 becomes a P3 toll concession it will cost taxpayers one-third more.

Meanwhile, Virginia taxpayers are already out some $400 million from the 460 and ERC projects. That’s a lot of pavement or transit we will never see.

As a transportation writer, I’ve been trying to understand P3 toll concessions for three years, ever since discovering the private money – and there is relatively little of it – is primarily foreign.  Why, I’ve wondered, are Ferrovial and Cintra, from Spain, and Transurban and Macquarie, from Australia, behind so many American P3 concessions?

In general, I’ve learned that in any American toll concession, the private money is rarely as much as 15 percent of total project costs, but that tiny up-front percentage hooks the public sector before the ink is dry on contracts, which, most likely, no state official has ever even read.  The mass of the so-called private money is in the form of TIFIA (Transportation Infrastructure Finance and Innovation Act) loans from Uncle Sam and private activity bonds backed by the state.  When – and “when” is the rule; “if” the exception – the concessionaire goes bankrupt after collecting a few years of toll income, the multinationals rarely pay back the loans or bonds.

As a Canadian auditor-general’s analysis  finds private financing cost taxpayers 14 times public financing and the White House is projecting that four in 10 P3 transportation concessions will eventually go belly-up, Organization of Economic Co-operation and Development studies illustrate “procuring infrastructure services through PPP is generally far more expensive than public finance.”

Canadian taxpayers, for example, shelled out $8 billion more than if they’d have built 74 projects themselves and three University of Manchester business professors studied British P3s to conclude:

“At best, partnerships have turned out to be very expensive with the inevitable consequences for future service provision, taxes, and user charges. Not just for today but for a long time to come. These projects may burden government with hidden subsidies, diversion of income streams and revenue guarantees whose impact on public finance may not become apparent for many years and may all be triggered at the same time, precipitating a major fiscal crisis.”

Bloomberg reports that only one in five completed American P3 tollways has even begun paying interest on its TIFIA loan as most payback schemes start 10-plus years after highway completion.  However, from Virginia’s Pocahontas Parkway to San Diego’s South Bay Expressway, Detroit’s Windsor Tunnel and South Carolina’s Connector 2000, as well as The Indiana Toll Road and Texas SH 130, at least a dozen American toll roads have already arrived in bankruptcy court or announced “restructuring” of their debt – including Capital Beltway Express. Continue reading

McAuliffe Adminstration Gives P3s a Second Chance

Transportation Secretary Aubrey Layne. Photo credit: Daily News.

Transportation Secretary Aubrey Layne. Photo credit: Daily News.

by James A. Bacon

The McAuliffe administration has spent much of its first two years unwinding the legacy of botched and controversial public private partnerships inked by the McDonnell administration: radically truncating the plan to to build a U.S. connector between Petersburg and Suffolk, and revising significantly the tolling for Norfolk’s Midtown-Downtown tunnel project. Now, after the enactment of significant legislative reforms, the McAuliffe transportation team is turning to the P3 tool to help fund and/or operate its ambitious plans for Interstate 66 in Northern Virginia.

Transportation Secretary Aubrey Layne is confident that he can avoid the pitfalls of the previous administration, and that a public-private partnership can make a major contribution to improving mobility along a transportation artery that Governor Terry McAuliffe variously described Thursday as a “parking lot” and “the most congested road in America” at the 2015 Governor’s Transportation Conference in Virginia Beach.

“We’ll be a big supporter of P3s,” elaborated Layne in his own remarks to the conference. “We need to share risk with the private sector. [Virginia] will very much continue to be a leader.”

The I-66 initiative essentially consists of two separate plans: one for inside the Beltway and one for outside the Beltway. The outside-the-Beltway plan entails widening the Interstate, installing HOT lane tolls and ramping up commitment to mass transit. The Virginia Department of Transportation (VDOT) has generated 13 responses from private-sector players on how to structure the P3.

Where Sean Connaughton, Layne’s predecessor as transportation secretary, regarded P3s as a way to leverage finite public dollars with private investment, thus maximizing total dollars invested, Layne emphasizes the role of P3s in allocating risk. That feedback has been invaluable in surfacing cost and risk issues that VDOT had not considered. “Transparency is the way you have price discovery and risk discovery,” he said.

One set of risks revolves around building a major project on budget and on time. Another major risk is “demand risk” — the likelihood that traffic and revenue forecasts will materialize as projected. There also are risks associated with operations and maintenance. Layne is open to assigning those risks to a private-sector contractor. He has been far more skeptical, however, of relying upon private-sector capital. Private-sector demands for higher financial returns on investment can add hundreds of millions of dollars to the price of a project.

Layne’s approach is to establish public policy first — what does the Commonwealth want to accomplish along I-66, and how? The administration has made it clear that the I-66 corridor will be multi-modal, including transit, and that the state will not agree to covenants that would restrict for decades construction on other roads that might divert traffic, as the previous administration did in the Downtown-Midtown tunnel project. Those parameters are non-negotiable, except perhaps at the margins. Once those guidelines have been established, he said, the private-sector input can be extremely valuable.

In other remarks, Deputy Secretary of Transportation Nick Donohue told the conference that Virginia and California lead the country with their P3 laws, and that delegations from other states frequently visit the Old Dominion to see what has been done here. Stymied by transparency laws from talking to private corporations “off line,” he explained, other states cannot enact laws like Virginia’s. And that curtails the ability to put together deals like Virginia’s.

An open and transparent process is critical to Virginia’s P3 law, said Donohue, but so is the ability to engage in confidential negotiations. He believes that Virginia has done a good job, based upon its extensive experience with P3s, in threading the needle between transparency and confidentiality. “Steps we have taken in the last couple of years have addressed a lot of problems” with Virginia’s law, he said.

The decision-making process for the I-66 corridor will put the administration’s faith in P3s to the test. The issue of inside-the-Beltway tolls has exploded into a political furor. More controversy is bound to follow as the administration moves from the concept stage to specific proposals.

Layne’s Law

Map credit: VDOT

Proposed Interstate 66 improvements. Map credit: VDOT

by James A. Bacon

After spending a year and a half cleaning up the mess left by the previous administration — the Charlottesville Bypass, Norfolk’s Midtown-Downtown Tunnel, the U.S. 460 Connector in Tidewater — Transportation Secretary Aubrey Layne now has the opportunity to show whether or not he has the chops to handle a complex, politically charged transportation mega-project — the $2.1 billion in proposed improvements to Interstate 66 west of the Capital Beltway.

The Virginia Department of Transportation is focusing on two key dimensions to the mega-project, which is intended to address one of the most congested traffic corridors in Northern Virginia. The first is engineering. VDOT engineers have conceptualized a plan to build a corridor that will include three free lanes running both directions, two express lanes in each direction and high-frequency bus service  linking commuters with major activity centers. That plan will be subject to extensive environmental review and public input.

The second key question is how the state will finance and manage the project. Should VDOT use the controversial public-private partnership (P3) legal/financial structure to build and operate the project, much as it did with the Interstate 495 and Interstate 95 Express Lanes projects? Should VDOT undertake the project entirely on its own? Or should it create a hybrid approach? The question assumes tremendous urgency given the problems created by the P3 approach with the Norfolk-Portsmouth tunnels and the U.S.460 Connector.

Parenthetically, I would add that there is a critical third dimension to the project which appears to be getting less attention: What will be the impact of the project on Northern Virginia land use patterns? Will the project subsidize suburban sprawl (scattered, disconnected, low-density land use patterns) in the far western reaches of the Washington metropolitan area, which in turn will generate more demand — and more congestion — in the years ahead? In other words, will the state spend more than $2 billion to “fix” a problem that will re-emerge a decade or two after the project is completed?

In an interview yesterday, I sat down with Layne to discuss the financial dimension of the project. The transportation secretary has given enormous thought on how best to structure highway mega-projects, balancing the twin imperatives of controlling costs and limiting risk.

Layne sees transportation projects as forming a continuum between a model in which VDOT does everything, and a privatization model in which all functions are delegated to a private-sector concessionaire through an asset sale or a long-term lease. Any project is comprised of several parts:


Any one of these pieces can be performed by the state or out-sourced to the private sector. In Layne’s view, because no two projects are identical, there is no standard configuration. He tends to think that the private sector does a better job of designing and managing construction than VDOT, but not by such a wide margin that jobs should automatically default to private players. In other areas, VDOT has a clear advantage. The fact that VDOT can tap tax-free bonds, which sell at lower interest rates, and requires no private equity financing often means that the state can finance a project at less expense than a private entity.

But there is more to managing a project than driving for the lowest cost or, as the previous administration tended to do, the lowest up-front public subsidy. Costs should be viewed over the lifetime of the project, which runs 50 years or longer, after adjusted for risk. One risk is the potential for cost overruns. In the past, VDOT used to eat construction cost overruns, which meant that the taxpayer paid. But that risk, says Layne, usually should be transferred to the private contractor. Another risk is that toll revenues might not materialize as forecast. Private entities pay especially close attention to that risk, and they try to negotiate all manner of protections into a P3 project to offset it.

Express lane projects get tricky because a private entity is motivated to maximize toll-paying traffic through its tolled lanes in order to maximize revenue, while the state’s goal is to maximize the throughput of riders, which means encouraging High Occupancy Vehicles and buses. In its negotiations over Interstate 95, the original plan called for Transurban to make a $250 million up-front investment to provide a robust mass-transit component. But as the negotiations proceeded, the mass-transit piece got whittled down drastically. If High Occupancy Vehicles exceed 24% of total traffic on I-495 (35% on I-95), the state is obligated to pay 70% of Transurban’s lost revenue. Meanwhile, the state pays for mass transit on I-95 out of its own funds — an expense that was not included in the announced project cost.

Layne’s Law is to start by first defining what the state wants in a project, and only ascertaining which mix of functions it should outsource to the private sector. “I’d love to have a private-sector partner,” Layne says, “but only if the risk transfer makes sense.” In the case of I-66, bargaining away a robust mass-transit capability to protect a private entity’s revenue stream probably would not make sense. Continue reading

Coping with Risk in Highway Megaprojects

Aubrey Layne explains the concept of fiduciary risk.

Aubrey Layne explains the concept of fiduciary risk.

by James A. Bacon

As Transportation Secretary Aubrey Layne has had more time to dig into his job, he has developed an ever more nuanced appreciation of how things went wrong with the U.S. 460 Connector. There was more to the fiasco, which could cost the Commonwealth up to $300 million, than a simple failure to acquire necessary wetlands permits before opening the spending spigots and then discovering that the permits were not forthcoming. The McDonnell administration, he says, negotiated a public-private partnership deal without sufficient appreciation of risks entailed with the project.

“I can’t tell you if they didn’t know they weren’t transferring the risk [to the private-sector partner] and got out-foxed, or whether they didn’t give a damn,” Layne told Bacon’s Rebellion in an interview today. Either way, the Commonwealth was left holding the bag when plans for the 55-mile Interstate-quality highway linking Petersburg and Suffolk had to be redrawn to do less environmental damage. He still hopes to recover some of the $250 million paid to U.S. 460 Mobility Partners (over and above $50 million in sunk design and engineering costs) for pre-construction work, but that outcome is uncertain.

Layne is optimistic that public-private partnership (P3) reforms enacted with bipartisan cooperation this year will prevent recurrences of the U.S. 460 debacle and help the state negotiate better terms in future deals than it got with the Interstate 495 and Interstate 95 express lanes projects in Northern Virginia, which effectively capped bus transit on the highways for the next half century. The McAuliffe administration’s big test will be to do a better job structuring the financing and risk of $2 billion in proposed improvements to Interstate 66 in Northern Virginia.

Before 1995, the Virginia Department of Transportation (VDOT) had one way of building roads. It designed them, put construction out for competitive bids, arranged its own financing, operated them, maintained them and absorbed the risk of anything going wrong. The system got the job done but it had drawbacks. It overlooked potentially creative solutions to engineering and design problems, and it was prone to cost overruns. Then the General Assembly passed legislation enabling public-private partnerships, which provided the Commonwealth a whole new range of options for financing big projects and shifting selected risks to the private sector.

Facing a severe transportation budget crunch, the McDonnell administration made the strategic decision early on to use P3s to leverage scarce public dollars with private capital. From a high-level perspective, this made sense because the Commonwealth had limited capacity to issue road-building bonds without jeopardizing its AAA bond rating and then-Governor Bob McDonnell had not yet pushed through tax increases to bolster transportation funding. Moreover, the administration wanted to take advantage of historically low interest rates on long-term bonds.

But politics and ideology were pushing P3s as well, says Layne. There was a bias that something is always better if the private sector does it. Sometimes the private sector can do things better than VDOT, he says, and sometimes the private sector is better suited to take on certain risks than the state. But not always. The McAuliffe administration’s goal is to find the best fit — the best balance of cost and allocation of risk — on a case by case basis.

The devil is in the details. Layne, a Republican and a McDonnell supporter at the time, backed the governor’s mega-project funding priorities and voted to approve them while serving on the Commonwealth Transportation Board. Indeed, he chaired an independent bonding authority that issued bonds for the U.S. 460 project.  But now that he’s transportation secretary, he realizes the issues were far more complex than presented to him and the CTB board.

The McDonnell administration first proposed a public-private partnership for the U.S. 460 project with the hope that outsiders could devise a more creative way of building and financing the highway than VDOT could come up with. Three consortia took a look and came up with similar conclusions — there would be insufficient toll revenue to finance more than a fraction of the construction cost with bonds. The McDonnell administration then switched gears, deciding to pay for most of the project with state funds but retaining the P3 structure in order to outsource the design and construction of the project to a private-sector partner, which turned out to be U.S. 460 Mobility Partners. The state should have gone back to square one and started over, says Layne, re-defining the project and putting it up for bids instead of using the P3 structure. Instead of getting multiple bidders to compete, the state wound up negotiating with a single player, U.S. 460 Mobility Partners. Even worse, Governor McDonnell had signaled that U.S. 460 was his highest priority, and there was no back-up plan — the administration had to reach a deal with U.S. 460 Mobility Partners or the project would never get built during McDonnell’s term. U.S. 460 Mobility Partners had all the bargaining leverge.

Negotiations took place within the P3 structure, which meant that the deliberations were secret and the contract not released to the public. VDOT briefed the CTB, the state’s transportation oversight board, but failed to disclose the information that critical wetlands permits had not been obtained and might not be obtainable.

The final contract for the U.S. 460 deal was more than 700 pages long. Layne says he can’t imagine than anyone in state government read the whole thing. “I’m confident that no one person understood it all. No one person could tell you what the deal was, what risk was transferred, and what risk the state was taking. And that’s a recipe for disaster” when negotiating with sophisticated business people on the other side of the table.

The dynamic would have played out very differently, says Layne, if the McDonnell administration had set up U.S. 460 as a design-build project.  First, VDOT would have opened up the proposal to competitive bids, very likely getting a lower price even while the private contractor took on the risk of delivering the project on budget and on time. Second, VDOT guidelines would have ensured that all necessary permits were granted before the project commenced and the state started shelling out money.

Layne doesn’t blame U.S. 460 Mobility Partners for negotiating the best deal for itself that it could. It’s not a charity. The company’s managers had a fiduciary responsibility to get the best deal for its shareholders that they could. But elected officials have a fiduciary responsibility to the public. The challenge for the Commonwealth is to bring to bear an equally acute understanding of risks and rewards and to cut the best deal possible for the taxpayers. That’s where the state failed utterly with U.S. 460. If he’d had negotiated such a disastrous real estate sector when he worked in the real estate business, he says, he would have been fired.

Now it’s Layne’s turn. He has to structure a mega-project deal for I-66. Tomorrow, I’ll describe how he is approaching that task.

Juggling Risk on Interstate 66

i66by James A. Bacon

The specter of the botched U.S. 460 project will be hovering over the Commonwealth Transportation Board (CTB) today as Transportation Secretary Aubrey Layne updates the board about project financing for Interstate 66 outside the Washington Capital Beltway, expected to cost in the realm of $2 billion.

Del. Greg Habeeb, R-Salem, set the stage Sunday in an op-ed in the Richmond Times-Dispatch, in which he advocated using a Public Private Partnership (P3) to finance improvements to the critical Northern Virginia transportation corridor as opposed to a “design-build” contract. Design-build was the approach employed in the U.S. 460 connector between Petersburg and Suffolk that resulted in $300 million spent “without a single shovel of dirt being turned.”

Habeeb is asking a vital question: What is the best way to finance and operate mega-transportation projects with costs running into the billions of dollars? Under the old model, the Virginia Department of Transportation (VDOT) designed, built, financed and operated big projects entirely in-house. But with limited transportation funding available and restrictions on how much the state could borrow during the Warner, Kaine and McDonnell administrations, nothing much was getting built. The idea behind P3s was to leverage scarce state funding with private sector funding for tolled projects capable of generating a revenue stream. Toll revenues would pay off the private-sector bonds used to finance the improvements. In effect, P3s amounted to an end run around the tight strictures on how much debt the commonwealth could issue without jeopardizing its AAA credit rating. The debt, and the risk that went along with it, would be shifted to the private sector.

Habeeb likes P3s. Construction of express lanes on Interstate 495 and 95 in Northern Virginia opened on budget and ahead of schedule, he says. Further, he adds, “These two projects produced $5 billion in economic activity but because they were pursued as P3s taxpayers contributed only $492 in state transportation funds.”

By contrast, he writes, the U.S. 460 project was conducted as a design-build, in which design and construction were outsourced to a private-sector consortium but the state planned to finance and operate the highway, “leaving taxpayers on the hook if the project failed” … which it did, costing taxpayers in the neighborhood of $300 million.”

I think there’s a time and place for P3s, but the cost-benefit calculus is more complex than Habeeb acknowledges in a 750-word op-ed. The big bugaboo is risk. There are many types of risk associated with transportation megaprojects, and it isn’t always clear what they are and who is shouldering it. Virginia’s Office of Transportation Public Private Partnerships was tracking risks in the U.S. 460 project — the risk that really mattered, and ended up killing the project, whether or not the U.S. Army Corps of Engineers would not issue required wetlands permits — but the concerns were ignored by the McDonnell administration for political reasons.

Would the U.S. 460 fiasco have been avoided if it had been a P3? Undoubtedly, a private-sector partner would have taken greater precautions to get its permits lined up before expending $300 million of its own money on design and construction-mobilization costs. So, most likely, the fiasco would not have occurred. On the other hand, a P3 partnership was not practicable. Toll revenues would have been so meager that only a small percentage of the project could have been funded privately — that’s why the state decided to take over the financing itself.

It’s easy to forget that there are risks associated with P3s as well. What happens if toll revenues fail to meet forecasts, as has been the case with the 495 Express Lanes? It all depends on how a particular deal is structured. Many projects are backed by federal loan guarantees called TIFIA (Transportation Infrastructure Finance and Innovation Act) loans. Every bond financing provides a buffer for modest revenue shortfalls. But if revenues fall far short, TIFIA eats the loss before non-guaranteed loans do. Instead of state taxpayers taking the hit, federal taxpayers do. If TIFIA bond holders get wiped out, then holders of the private bonds are next in line. In the worst case scenario, as happened with the Pocahontas Parkway outside Richmond, a project can get turned over to the banks.

The commonwealth ordinarily takes great pains to protect itself from financial liabilities in case of P3 failure. But there are other risks. P3 contracts usually last 50 to 100 years, and private-sector partners negotiate terms that protect their revenue stream over the long run. Typically, they insert clauses that restrict the state from building roads, rail lines or other transportation alternatives that might divert paying customers. Unfortunately, there is no way to predict 50 years in advance how future growth and development will alter travel patterns and what options might be necessary.  P3 anti-competitive clauses could limit the ability of the state to provide adequate transportation to some of its citizens far into the future. Those are risks that may not become evident for decades.

I, for one, will be interested to see how Secretary Layne proposes to finance the I-66 improvements. Hopefully, he’s learned the right lessons from the U.S.460 experience.

Update: In an op-ed published May 27, Layne states that the U.S. 460 project was not a design-build project but a P3. “Had the U.S. 460 projet been procured as a design-build rather than a P3, it is highly unlikely that state standards for such projects would have permitted it to go so far forward as it did.”

Portsmouth Takes a Hit from Tunnel Construction


Vehicle traffic through Downtown and Midtown tunnels. Image credit: James V. Koch. Click for larger image.

by James A. Bacon

The City of Portsmouth has been clobbered by the imposition of tolls on the Midtown Tunnel and Downtown Tunnel connecting the city to Norfolk, and hammered again by construction-related disruptions to service on the tunnels. Combined, the impact of tolls and disruption have reduced quarterly taxable sales by $24 million annually, materially harming businesses and crimping tax revenue, finds James V. Koch, president emeritus of the economics department at Old Dominion University in a new study.

In the report, “The Impact of Tolls on the City of Portsmouth: The Evidence 15 Months Later,” Koch is especially critical of the Virginia Department of Transportation (VDOT) and its private-sector partner, the Elizabeth River Company (ERC), for providing motorists inadequate warning of the interruptions to traffic disruptions, thus creating widespread uncertainty among discretionary drivers “east of the river” who might otherwise travel to stores, recreation, churches or social gatherings in the city. “In many drivers’ minds, tunnel closures have become sufficiently unpredictable that they are not going to take chances,” he writes.

Koch does not criticize the decision of VDOT under the McDonnell administration to impose tolls on the formerly toll-free tunnels in order to finance construction of new tunnel lanes and related land-side transportation improvements to alleviate some of the worst traffic congestion in Hampton Roads. Benefits will be felt throughout the region. But he does note that Portsmouth is suffering disproportionately.

Says Koch: “My rough estimate is that Portsmouth is impacted 31 percent more than Suffolk by the tolls and closures, 459 percent more than Norfolk, and 616 percent more than Virginia Beach.”

Bacon’s bottom line:  It’s no surprise that imposing tolls where there were none imposes economic pain. What I find most interesting is Koch’s conclusion that the impact of construction-related disruptions was almost as severe — $10 million of the $24 million — but could be partially mitigated if ERC and VDOT did a better job of alerting drivers, either through advertising or signage, of those disruptions. That is a management issue, not an inevitable consequence of the construction project.

Koch thinks the hit to taxable sales could get worse this year and next. However, the region should start feeling the benefits when the project is complete. As Koch writes:

When all of the construction is completed (and setting tolls aside), the cost of driving in and out of Portsmouth will decline. Vehicles will be able to travel at higher speeds, fewer traffic jams will confer time savings, travel will become much more predictable, vehicle wear and tear will decline, and there will be diminished pollution.  To the extent these reductions in costs exceed the size of the tolls being paid, they will make Portsmouth a more attractive place to live and/or to locate a business.

From a macro-economic perspective, Portsmouth may wind up better off in the long run. But that won’t be much consolation to the businesses that Koch thinks very well could go out of business in the meantime. VDOT and ERC need to act quickly to mitigate what harm they can.

Injecting the “Public” Back into Public-Private Partnerships

P3sWe haven’t heard much about Public-Private Partnerships since the days of the McDonnell administration, which touted P3s as a tool for leveraging limited state transportation funding into more road and rail construction. The problem with the McDonnell team’s reliance on P3s wasn’t the grand strategy but the execution. The tolling of the Downtown-Midtown Tunnel in Norfolk proved so controversial that the state felt compelled to cough up money to buy down the cost of the tolls. Also, the U.S. 460 Connector turned into a fiasco potentially costing the state $300 million, including $250 million in payments to the concessionaire to do nothing even though the U.S. Army Corps of Engineers had balked at issuing wetland permits for the proposed route.

Trip Pollard, staff attorney with the Southern Environmental Law Center, has been one of the most outspoken critics of Virginia’s P3s. But in a recent post on the Brookings Institution blog, he says he sees them as a potentially valuable tool to supplement public funds with private capital. Rather than throw out the P3 option, he argues, we need to build more transparency, public input and government oversight into the P3 approval process. He offers several concrete suggestions.

Speaking of public engagement with P3s, here are the new  “P3 Public Engagement Guidelines” released by the Office for Virginia Public-Private Partnerships. I’m not sure it’s possible to fully reconcile the private sector’s desire to negotiate in secrecy, not in the press, and the public’s right to know. But the McAuliffe administration is making a yeoman’s effort of trying to thread that needle.

Meanwhile, occasional Bacon’s Rebellion contributor Randy Salzman is still doggedly pursuing P3s. He asks a simple question: How is it possible that so many P3s have proven to be financial disasters, and why, knowing their abominable track record, do private-sector players continue to invest in them? Do the private participants engage in behind-the-curtain financial engineering that makes P3s profitable even if revenues fall short and the projects tank? He has come up with some tantalizing leads but no definitive answers. My suspicion: Follow the TIFIA loans, federally backed loan guarantees that absorb much of the risk inherent in P3 projects. What are the underwriting standards for those loans? How many have gone bad? How much in losses has the federal government sustained?


Building the New Midtown Tunnel


Graphic credit: Virginia Business. Click for more legible image.

Building the new Midtown Tunnel between Norfolk and Portsmouth is one of the more spectacular engineering feats ever attempted in Virginia. Elizabeth River Crossings (ERC), the private-sector partner in charge of the $1.5 billion construction project, has to dredge a 95-foot-deep trench in the Elizabeth River, float 11 massive concrete tubes the length of football fields down from Sparrows Point Md., submerge them, and then place them together within one-inch tolerances in order to snap them together.

The tunnel, only the second in the nation to be constructed in this manner, is engineered to withstand the weight of a Nimitz-class aircraft carrier. Virginia Business has the story.


Highway Robbery

express_lane_camerasby James A. Bacon

I’ve always considered Transurban, operator of the express lanes on the Interstate 495 and Interstate 95, to be a pretty savvy outfit. The company may have over-estimated traffic demand for its express lanes when deciding back in the mid-2000s to build the Northern Virginia toll operations, but corporate executives seemed highly professional in the way they designed, constructed, promoted and managed the business.

At least, they did until now…  Fox News reports that Transurban has filed 26,000 cases against I-495 express lane users for non-payment. It’s one thing to dun people for $10, $20 or even $100. But Transurban is slapping some drivers with thousands of dollars in fees and fines for a single offense. Reports Fox News:

Luis Viera used to take the Express Lanes from Clinton, Md., to his job in Tysons Corner. His E-ZPass was automatically deducting tolls from his credit card.

Then one day, Luis was slapped with a summons to Fairfax County Court. Transurban was suing him for $4,500 in fees and fines for exactly $7.70 in missed tolls.

Luis went to court the first time without a lawyer. “I was nervous,” Luis said. “I didn’t get any sleep. I wasn’t eating. It was a bad week leading up to it.”

In the courtroom, a woman who said she represented Transurban approached Luis before the judge entered. She said the company would settle for $2,488.

“How does $10 turn into $2,000?”

Darn good question. How does $10 turn into $2,000? Transurban responded as follows: “Although less than 0.1% of all 495 Express Lane trips end up in court, we continue to do all we can to minimize any traveler going to court, this is why we have the First-Time Forgiveness program which has helped nearly 800 travelers. Additionally, we do not profit from the fines or penalties. As defined by Virginia law, any and all revenue collected from toll fines and penalties are cost recovery only to fund the enforcement program and we currently we do not even recover costs.”

Ah, hah! The fines cover the expense of the entire enforcement program — including lawyers, license plate-reading cameras, and IT systems to track the scofflaws. I can’t blame Transurban for wanting to cover its costs but the company has to weigh the business consequences: Charging $2,500 or more will piss off a lot of drivers — I mean really piss them off. Luis Viera says he won’t ever use the express lanes again. Who can blame him? How many other people, hearing of Viera’s experience, will refuse to ever use the express lanes? Who wants to run the risk of getting clobbered with a $2,500 fine?

Bacon’s bottom line: Conceptually, using the price mechanism to ration scarce highway capacity is one of the most cost-effective tools we have to manage traffic congestion. But the devil is in the details. Economic models that model supply and demand equations don’t ordinarily consider such grungy facts as enforcement. People make mistakes. People cheat. Toll road operators must have a mechanism for enforcing payment. If those enforcement mechanisms lead to manifestly unjust results, as appears to be happening in Fairfax County, people will avoid the express lanes and political support will wither.

Virginia authorities need to revisit the enforcement provisions in the Transurban public-private partnership contract and, ideally, induce Transurban into re-negotiating the offending clauses. It won’t be easy because traffic volumes and revenues are falling short of projections, and Transurban may not be receptive to changes that might raise its cost structure. On the other hand, the company does have a 70-year contract and it needs to consider the long-term implications of alienating its customer base. If a huge fan of the express lane concept like myself finds $2,500 fines for $10 offenses to be outrageous and indefensible, I feel like I’m pretty safe in saying that Transurban stands all alone on this one.

(Hat tip: Rob Whitfield)

Optimism Bias and Risk in Public Private Partnerships

The tolling technology is better than ever -- but traffic forecasts are a disaster.

The tolling technology is better than ever — but traffic forecasts are a disaster.

by James A. Bacon

Randy Salzman, a free-lance Charlottesville writer, has spent the last couple of years trying to understand how Public Private Partnerships (P3s) work in Virginia. If the private sector is supposed to be so much more efficient than government, he asks, how  come so many big P3 transportation projects in Virginia and across the nation have gone bankrupt? Why do private sector companies continue investing in similar projects despite the obvious risk? And what exposure do taxpayers when deals go bad? He doesn’t have any definitive answers, but he lays out a lot of good questions in the latest issue of Style Weekly.

Salz, an occasional contributor to Bacon’s Rebellion, gets closest to the truth when he mentions the “optimism bias” in traffic forecasts. In project after project across the country, private P3 companies and  their government partners have over-estimated traffic volumes on the roads they build. Writes Salz:

One study found that the projections tended to be 109 percent more than actual traffic — or more than double — and that nowhere in completed American P3s have actual traffic and toll income come close to projections.

Here in Virginia, flawed traffic forecasts were at the root of the Pocahontas Parkway debacle in eastern Henrico County and, if I’m not mistaken, the Dulles Greenway bankruptcy in Loudoun County (although that was not a P3 project). And there’s a very good chance that the Capital Beltway Express’s Northern Virginia HOT lanes project will experience a similar fate.

I think there are two things going on here. First, the private sector’s flawed traffic project models paralleled flawed public sector models. Everybody in the transportation business extrapolated the growth trends of the ’60s, 70s, ’80s and ’90s indefinitely into the future. I warned a decade ago that that was folly, but not many people listened. Reality set in in the mid-2000s when growth rates started tapering off and during the 2007-2008 recession, when traffic volume actually declined. The reasons are many and complex, as I have enumerated ad nauseum on this blog, but they are fundamental and lasting, not just a blip. We will not in our lifetimes return to the traffic-volume growth rates experienced during the post-World War II era.

The forecasts of traffic volume and associated toll revenues for the P3 projects were predicated on the assumption, now revealed to have been astonishingly naive, that traffic volume would increase on the same trajectory pretty much forever. That’s why the bankruptcies ensued, and why there will be more to come.

If experience tells us anything, the private sector will figure that out before the public sector does. As Salz quotes Lane Construction as saying in regard to proposed Interstate 66 toll lanes near Washington: Traffic projections have an “optimism bias.” Which brings us to the second reason for the wave of bad deals. Once someone, whether a private investor or a government agency, invests hundreds or thousands of man hours in analyzing a project, they get personally invested. No one likes to pull the plug. They want to see the project move forward. They tend to adopt assumptions that will make the project look more viable in order to obtain the financing needed to move it from paper to reality. This bias is so endemic in all types of projects that we can almost call it a part of human nature.

The private sector has built-in bullshit detectors. They’re called investors and bond holders. Investors want to generate a positive risk-adjusted return on investment. Bond-holders want to get their money back, plus interest. They may rely upon flawed traffic projects that no one questions, but they don’t suffer from the optimism bias of the project sponsors. They are naturally skeptical and have an interest in asking tough questions. Now, these investors and bond holders aren’t infallible by any means. They make bad investments, too. But they demand a higher standard of certainty than, say, politicians who want the glory of building a road but won’t be around to take the blame if the project falls apart.

Every toll-backed P3 project sells bonds to investors. How, then, did so many go wrong? The key is to look at how the public partner biased the outcome through subsidies and loan guarantees. Every big P3 project applies for financing from the federal Transportation Infrastructure Finance and Innovation Act (TIFIA). These federally guaranteed loans create a tranche of subordinated debt that creates a layer of protection for private bond holders. In other words, if Project A experiences a revenue shortfall, what revenues it does produce will go to bond holders first. Here’s how the Federal Highway Administration describes it: “The TIFIA lien on project revenues may be subordinated to those of senior lenders except in the case of bankruptcy, insolvency, or liquidation of the obligor.”

This layer of protection significantly reduces the risk for senior bond holders, who then demand fewer assurances than they would otherwise before purchasing the bonds. In Virginia, the commonwealth has reduced project risk by making significant cash contributions as well. Most of the P3 projects set up in Virginia in recent years have used some combination of TIFIA funding and public subsidies to make the projects work. Without these contributions, the perceived risk would have been far higher, and the chances of getting pure private financing would have been much diminished. It’s fair to say that many, if not most, of the deals never would have happened.

Combine these three factors — highly flawed long-term traffic projections embraced by the public and private sectors both, the optimism bias for specific projects, and the diminution of risk through TIFIA financing and public subsidies — and we can explain a lot of went wrong. That’s not an exhaustive list of explanations but it accounts for a lot. Continue reading