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Improving Mobility in Texas Through Public-Private Partnerships

Testimony to the Texas State Senate Committee on Transportation & Homeland Security

Leonard Gilroy
March 21, 2007

Mr. Chairman, members of the committee, my name is Leonard Gilroy. I am a resident of Houston and senior policy analyst at the Reason Foundation, a public policy research and education institute based in Los Angeles. Reason first began researching public-private partnerships (PPPs) in the late 1970s, and transportation PPPs since the late 1980s. Our experts have advised the last four presidential administrations on transportation and policy issues and numerous state governments, including many departments of transportation on how innovative road operations and financing can help relieve congestion and improve mobility, which are necessary conditions for a competitive and prosperous economy.

At a time when many states are struggling to properly maintain their existing highway infrastructure, Texas has created a whole new paradigm of how to finance, build, and operate major highways. Texas has shown tremendous leadership on this front, becoming the only state in the nation that has gotten serious and made congestion relief a top priority. It has embarked on an ambitious program for reducing congestion by focusing on a mix of managing traffic more effectively, expanding physical road capacity, and finding innovative ways to finance these transportation improvements by tapping into private capital markets.

This effort began in Texas soon after the turn of the century, when Dell Computer announced that it would no longer expand its operations in Austin because traffic congestion here had become intolerable. This prompted the Governor's Business Council to research the issue and draft the Texas Metropolitan Mobility Plan. This revolutionary document declared that metropolitan transportation plans should set aggressive targets for reducing congestion well below today's levels.

Further, over the past few years, private investors have committed billions of dollars to fund, develop, and operate a network of new toll roads in Texas. While these public-private partnerships (PPPs) are just one tool in the transportation “tool box,” they are a promising and valuable tool that is helping Texas address its mobility needs.

What are PPPs?

Public-private partnerships are collaborations between governments and private companies that aim to improve public services and infrastructure in a manner which captures the benefits of private sector involvement for taxpayers and service recipients, while maintaining strict public accountability. PPPs leverage the capital and expertise of the private sector with the management and oversight of the government to provide public services. PPPs are an effective way of financing, managing and operating roads while minimizing taxpayer costs and risks.

PPPs for complex, multi-billion dollar transportation projects have been used for decades in Europe, and more recently in Australia and Latin America. In fact, PPPs have become the conventional way to provide and fund major new highway capacity in many countries. The private sector is financing, building, and operating most of the major new highways in countries as diverse as Canada, Britain, France, Ireland, Israel, Spain, Italy, Greece, Poland, China, India, Indonesia, South Africa, Australia, Argentina, Brazil, Chile, and Jamaica.

During the 1990s PPPs began to be used in the United States. PPP toll projects are in operation in California, Texas, and Virginia, as well as several Canadian provinces. In addition to Texas, 20 other U.S. states have passed laws enabling public-private partnerships and they are looking to follow Texas’ lead in tapping the private sector to help build much-needed highways.

Advantages of Long-Term PPPs

Toll financing is already helping Texas close the financing gap for new infrastructure. In addition, the PPP model has several advantages over the traditional model of transportation financing.

1. Ability to raise larger sums for toll projects
New highway capacity is far more costly these days than it was when the Interstates were built. Given the severe inadequacies of the current gas tax and grant system for paying for infrastructure improvements, attracting private investment through PPPs is rapidly emerging as the only feasible way to raise the massive sums needed to upgrade and expand our highways. As one example, for segments 5 &6 of State Highway 130, a toll traffic and revenue study estimated the government’s ability to finance $600 million, but the project’s cost was $1.3 billion. Texas DOT turned to a long-term concession approach, in which the private sector will finance the entire $1.3 billion project, in exchange for a 50-year concession.

2. Shifting risk from taxpayers to investors
Public-private partnerships involve parceling out duties and risks to the party best able to handle them. For example, the state is the party best able to handle right-of-way acquisition and environmental permitting, so those tasks and risks are assigned to the state. The private sector in these deals nearly always takes the risks of construction cost overruns and possible traffic and revenue shortfalls. Given the poor track record of the public sector in transportation mega-projects, being able to shift construction and traffic/revenue risk to investors is a major advantage.

3. More businesslike approach
The typical U.S. toll agency and the typical European or Australian toll road company are miles apart in their approach to everyday business. Private toll road companies are quick to adopt cost-saving and customer-friendly technology and specialized products and services to meet customer needs.

4. Major innovations
One of the most important advantages of investor-owned toll road companies is their motivation to innovate, in order to solve difficult problems or improve their service to customers. For example, toll road companies are also good at value engineering—thinking outside the box to dramatically reduce the costs of new road capacity. A case in point is the forthcoming high-occupancy toll (HOT) lanes PPP project on the Beltway in northern Virginia. The Virginia DOT’s plan to add two high-occupancy vehicle (HOV) lanes in each direction on that section of the Beltway would have cost $3 billion—money that VDOT did not have. A private sector team’s unsolicited proposal called for adding two HOT lanes in each direction, the same amount of physical capacity but will cost under $1 billion, thanks to value engineering that reduced or eliminated many “bells and whistles” that added large costs but very little real benefit.

Also, in France, an unsolicited proposal from a private toll firm resolved a 30-year impasse over completing the missing link—through historic Versailles—of the A86 Paris ring road. The company is completing the link as a deep-bore tunnel underneath Versailles, and is financing the $2 billion project with value-priced tolls.

5. Access to large new sources of capital
Infrastructure has become a fashionable asset class for a host of investors that don’t invest in toll-agency bonds. Billions of dollars of private investment is available, as we’ve seen recently with the concession agreements for the Chicago Skyway and Indiana Toll Road, as well as the SH-121 and SH-130 projects here in Texas.

Misconceptions About Toll Road Concessions

Although it has been used successfully in Europe for some 40 years, the long-term toll road lease, or long-term concession, model is still novel in America. So it is understandable that people are still learning about the benefits and effectiveness these projects can bring to Texas. Here are some common concerns and my responses to them.

1. Sale vs. lease
PPPs do not involve the sale of any roads. Some forms of PPP involve short-term contracts to design and build a road or bridge, or to design, finance, and build it. The most dramatic form—the long-term toll concession—still involves only a long-term lease, not a sale. The government remains the owner at all times, with the private sector partner carrying out only the tasks spelled out for it within the contract according to the terms set by the state. Done properly, these deals are truly partnerships, in which the state does what it does best (right of way, environmental permitting, policymaking, enforcement of performance requirements, etc.) and the concession company does what it does best (design, finance, construction, operation, marketing, customer service, etc.).

2. Foreign investment
States want to deal with firms that have extensive experience as toll road providers. The simple fact is that the United States has no such industry, as yet, because we have used only public-sector agencies to build and operate toll roads. Thus, responsible governments, wanting to ensure that the toll road is in experienced, professional hands, will weigh prior experience very heavily in their selection criteria. As the U.S. toll road market matures, we will see the emergence of a U.S. industry. Already, joint ventures between U.S. and global companies are bidding on such projects. Likewise, U.S. financial institutions have been creating multi-billion-dollar infrastructure investment funds, so these deals are about to start tapping U.S. capital in a major way.

It’s important to remember that even deals that involve 100 percent non-U.S. companies are very good for the economy. This is not outsourcing. A foreign company is spending its money in Texas, hiring workers in Texas, and building permanent infrastructure in Texas. These roads can’t be packed up and taken to Spain or Australia. Attracting billions of dollars in global capital (and expertise) to modernize America’s vital highway infrastructure is a huge net gain for Texas.

We should also note this is an odd argument. Many Texans wear clothes and shoes made in foreign companies, drive cars fueled by foreign-produced fuel, watch foreign-built televisions and use computers filled with foreign-built parts.

Reducing congestion and protecting Texas’ economy and quality of life is the goal. If a foreign company wants to spend billions helping Texas do that, we should be all for it.

3. Uncontrolled tolls
Some legislators have expressed concerns that PPP deals will lead to sky-high toll rates in future years, leaving the impression that tolls are uncontrolled. That is not the case in any actual or proposed PPP toll road. Most concession agreements, to date, have incorporated annual caps on the amount that toll rates can be increased, using various inflation indices. For example, both of the major toll concessions in Texas—SH-130 segments 5 and 6 and SH-121—have clear and detailed limits on tolls. They set maximum toll rates to start with, plus contain a formula for allowable increases every two years in line with either the consumer price index or the state per capita product.

It is important to note that those caps are ceilings; the actual rates a company will charge will depend on market conditions. Before entering into any toll road project, a company (or a toll agency) does detailed and costly traffic and revenue studies. A major goal of such studies is to determine how many vehicles would use the toll road at what price; too high a toll rate means fewer choose to use the toll road, which generally means lower total revenue. So the toll road must select the rate that maximizes total revenue. That rate may well be lower than the caps provided in the concession agreement, especially in recession years.

Several years ago, Ohio learned this lesson the hard way. After a significant toll increase on the publicly-run Ohio Turnpike, the trucking industry balked and diverted truck traffic off the toll road in huge numbers. As a result, the Ohio Turnpike realized that it was taking in less revenue than before, and it subsequently cut the rate of toll increase way back and regained much of the lost truck traffic. Be assured that private toll road companies are well aware of Ohio’s experience and take those lessons to heart.

4. Losing control
The widely expressed fear that states will either fail to protect the public interest or lose control of vital highways reflects a misunderstanding of the true partnership created by the long-term concession agreement.

It’s important to remember the state owns these roads. Concession agreements typically run to several hundred pages and may incorporate other documents (e.g., detailed performance standards) by reference. The public interest is protected by incorporating detailed provisions and requirements into the contract to cover such guidelines as:

No detail is too small for these contracts. The Chicago Skyway contract specifically names the amount of time the private company has to remove road kill from the highway.

Some toll road critics have expressed concern that the recent concession agreements on SH-121 and SH-130 include non-compete clauses that would cripple the state when building new roads or improving current roads. However, this is false. Both of these contracts explicitly exempt from compensation the impact of all planned state and local road projects, as well as unplanned additions to several specified competing roads.

Potential Impact of a Moratorium

PPPs can be complex, and it makes sense to have strong state oversight to ensure that the public interest is protected in these projects. Policymakers should understand that there will be serious negative consequences instigated by a moratorium.

Texas has been at the forefront of the public-private partnership trend. But 20 other states now have laws enabling the private sector to build roads, and the Bush administration just issued model legislation showing other states how to tap the private sector for transportation cash. A moratorium would send a strong signal to the private sector that Texas now presents a risky investment climate, and it is likely that toll road companies will divert their Texas personnel and money to other high-growth states, like Florida, Virginia and Colorado. Then, if the proposed moratorium was lifted in September 2009, all of the iced projects will have to start over.

Construction costs will undoubtedly rise and interest rates may be higher. By the time the updated cost analysis and other details are worked out, and new contracts are put out to bid and signed, it will likely be 2011 before construction could begin. So let’s be clear: This is really a four-year freeze on new roads. Meanwhile, congestion gets worse every day.

The devil is in the details. PPPs can be done well or badly. State lawmakers are obligated to make sure the contracts they sign protect taxpayers from steep toll increases, allow the state to build the roads in local and regional long-range plans, and clearly state what the private companies are required to do to maintain and expand the roads. Yet, policymakers can do all of those things without endangering the state’s quality of life and economy by derailing the toll road process for several years. Toll roads certainly beat the alternative: no roads.

Conclusion

The success of existing private sector participation in transportation services highlights the potential benefits for the vast majority of transportation projects needed in Texas. Public-private partnerships offer some major advantages, none more important than relieving congestion and improving mobility. A failure to address these twin challenges will lead to even greater congestion in various forms and lowered relative reliability of service in the future. By any measure, these realities impact the state’s economic competitiveness and its citizens’ quality of life.

As the think tank that has done the most research on public-private partnerships and their applicability to transportation infrastructure, the Reason Foundation welcomes the opportunity to be of further assistance this committee and body as a whole. Please feel free to call upon us.


Leonard Gilroy is Director of Government Reform


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