This year, the future of public-private partnerships is expected to receive heightened attention amid speculations that Congress may attempt to assert oversight over public-private partnerships and place conditions on private toll road concession agreements as part of next year's transportation program reauthorization. Some interest groups, notably the trucking industry and public employe labor unions, are expected to vigorously support efforts to regulate PPPs at the federal level. Meanwhile, PPP proponents believe that the case for greater private sector involvement in infrastructure funding has never been stronger. They want to see this involvement mature free of congressional oversight or federal regulatory controls. They believe the states are perfectly competent to negotiate concession agreements with private parties that will protect the public interest. Adding to the speculations is the prospect of a new Administration and a new team at the U.S. Department of Transportation next year, whose position on PPPs cannot be known at this time.
Over the past six months we have tried to gain a better insight into the forces underlying this conflict. Of special interest to us has been the potential impact of this controversy on the prospects for greater private sector investment in America's transportation infrastructure. Funding infrastructure with private capital, a practice widely used abroad, has had its tentative beginnings here at home, but its domestic long-term future is still clouded. We undertook our initial investigation in support of a background paper for a Conference on Transportation Infrastructure held in Washington on May 15-16, 2008. (published as NewsBrief No. 12, "Rebuilding America's Infrastructure through PPPs" and in the September issue of Public Works Financing). In the months that followed, we continued our inquiry by interviewing a diverse group of individuals of varying political persuasion. They included state legislators, congressional staffers, senior U.S. DOT officials, state and local transportation officials, members of the two congressionally-chartered transportation commissions, executives of trade and professional associations, and analysts on Wall Street, in think tanks, academia and private consulting firms.
Our inquiry also drew on several congressional hearings and briefings held by the House Transportation and Infrastructure Committee, the Senate Finance Committee and the Senate Environment and Public Works Committee. We carefully examined the recent U.S. DOT publication, "An Update on the Burgeoning Private Sector Role in U.S. Highway and Transit Infrastructure" (July 18, 2008) which paints a promising future for PPPs. Lastly, we obtained valuable insights by attending press conferences on infrastructure financing held by various stakeholder coalitions and by participating in several invitational meetings. By common agreement, all conversations, briefings and interviews were held off the record in order to allow for the freest expression of views. Every effort has been made to present a fair and balanced picture of this still evolving situation.
###
Support for Public-Private Partnerships is Growing
Total reliance on public resources and the fuel tax to fund future investments in transportation infrastructure is no longer a realistic option. Such, in essence, is the considered judgment of a great majority of participants in our survey. State officials tell us they are embracing private sector financing and tolling not because of any ideological commitment to "privatization" or a philosophic attachment to market-driven solutions but out of sheer fiscal necessity. Increasingly, state departments of transportation are obliged to commit a major part of their tax-supported transportation budgets to preserving, modernizing and replacing existing infrastructure, leaving little money for new construction. "We are struggling to have enough money to hold together what we have, let alone be able to think about the level of investment that would be needed to provide new infrastructure," Allen Biehler, Secretary of PennDOT told state legislators recently.
Influential political leaders on Capitol Hill, in state capitals and in the Bush Administration have taken note of the growing need for private investment in infrastructure. House Speaker Nancy Pelosi (D-CA) stated approvingly in an address to the American Public Transportation Association that "Private investment is playing an increasingly larger role in public infrastructure. Innovative public-private partnerships are appearing around the country, bringing much-needed capital to the table." Texas Governor Rick Perry, in a keynote speech at the annual meeting of the Texas Transportation Forum, observed "I am convinced that private dollars, administered through public-private partnerships, are a significant part of the answer to our transportation infrastructure challenge." As another high-ranking state official told us, "since Congress is not likely to come up with adequate resources to help us meet our future infrastructure needs, we have no option but to move on our own and find new ways of funding our capital needs." The official in question reflected a widespread sense among state officials and lawmakers we have talked to that there is little prospect for a substantial increase in federal aid. This judgment was also shared by Sen. Chuck Hagel (R-NE) at a recent congressional hearing. "The Federal Government," he said, "does not and will not have the resources to meet our future national infrastructure needs."
Secretary of Transportation Mary Peters has been a long standing advocate of public-private partnerships. "Unleashing the investment locked in the private sector by partnering with business is the most efficient path to the transportation future this country needs and deserves," she told an audience of Arizona contractors, a message that she and her senior staff have conveyed many times before and since. The Department of Transportation, in a July 29 Concept Paper, "Refocus. Reform. Renew", reaffirmed its support of PPPs by recommending that all federal-aid projects with a total cost of over $250 million should not receive federal assistance "unless the project sponsor first compared the project's lifecycle costs under conventional public procurement with the project's lifecycle costs if procured under a P3 procurement."
The need to enlist the private sector in rebuilding America's infrastructure has been echoed by a number of private coalitions. Among them are the U.S. Chamber of Commerce, ARTBA's Public-Private Ventures reauthorization task force, the Transportation Transformation (T2) Coalition, the Council for Public-Private Partnerships, the America Moving Forward Coalition, and the Rockefeller Foundation-supported "Building America's Future" Coalition founded by Pennsylvania Gov. Ed Rendell, California Gov. Arnold Schwarzenegger and New York Mayor Michael Bloomberg. Judith Rodin, President of the Rockefeller Foundation has challenged those who are skeptical of private investment in infrastructure in these words: "Our challenges are so immense that we can't afford to think about investment and financing as an either-or proposition---a false choice between private capital or public funds. We need new partnerships, new ideas, new sources of revenue" (remarks delivered at the May 9 Rebuilding America Forum).
Also contributing to the dialogue on infrastructure and PPPs are many individual states. In Colorado, Iowa, Massachusetts, Michigan, Minnesota, Oregon, South Carolina, and Texas, governors and local authorities have convened special commissions to identify new revenue sources for infrastructure investments. In other states, such as Arizona, Nevada, North Carolina, Oklahoma, Washington and Wyoming, special legislative committees are studying "revenue enhancements" to supplement existing transportation funds. "A coalition of change agents at state level will bring about a fundamental reorientation in the way we approach transportation funding," one senior state financial official told us, adding that tolling and private investment will play an increasingly prominent role. Reflecting the state legislatures' heightened interest in private infrastructure financing, the NCSL Foundation, an arm of the National Conference of State Legislatures, has undertaken an 18-month project to develop "nonpartisan, balanced and useful materials" on public-private partnerships to aid state legislators in their decision-making.
By our count, a total of 22 states are contemplating the use of tolls to support road capacity expansion. Some of them, such as Florida, Pennsylvania and Texas may resort to long-term concession-based PPPs, while others will choose the more traditional approach of using tax-exempt debt, design-build contracts, and operation through state departments of transportation or regional public toll authorities. However, survey participants pointed out that many state and local governments will be precluded from using the municipal bond market as a financing mechanism because they have reached their statutory debt ceiling or because voters have refused to approve further bond issues. Moreover, pension funds, a potentially major source of investment capital for infrastructure, do not participate in the municipal bond market because they do not benefit from the munis' tax-exempt status.
Is Private Capital Really Necessary?
Not all of our survey participants were convinced that future infrastructure investments will require private capital. Some of those we consulted suggested that the nation's future transportation needs could be met by raising the federal fuel tax or through new federal financing initiatives. The former option, they said, has never been taken off the table and will almost certainly figure in Rep. Jim Oberstar's transportation reauthorization proposal. The latter option includes the National Infrastructure Bank (NIB)(S. 1926 and HR 3401) championed by Sens. Dodd (D-CT) and Hagel (R-NE), and the "Build America Bonds" program (S. 2021) proposed by Sens. Thune (R-SD) and Wyden (D-OR). Both initiatives would create a de facto national capital budget that could be used to fund "qualified public works projects of regional or national significance." The NIB proposal has gained political traction by receiving the support of House Majority Leader Nancy Pelosi and presidential candidate Barack Obama as part of his "urban agenda."
But many survey participants pointed out that neither initiative offers a satisfactory long-term solution. The extra revenue generated by a gas tax increase --- even assuming that such a tax increase would pass muster with the tax-writing congressional committees and obtain a filibuster-proof majority support in the Senate--- would be largely consumed by demands for preservation and reconstruction of the existing highway network and by escalating construction costs, leaving little capital for new construction. Besides, the federal program contributes only about 40 percent of the capital cost of transportation infrastructure. The remaining 60 percent comes from state and local budgets, and there is no guarantee that local jurisdictions would be able to meet their part of the bargain. As for the new federal financing initiatives, their revenue --- $60 billion over 10 years in the case of the National Infrastructure Bank and $50 billion in the case of the Build America Bonds program--- would hardly suffice to make up for decades of underinvestment. These bills could only fund a small fraction of the infrastructure deficit---deficit that the American Society of Civil Engineers estimates at $1.6 trillion. "A federal-centric approach does not offer an adequate long- term solution to closing the huge infrastructure funding gap," summed up one respected think tank analyst.
Overall Verdict on PPPs is Positive
Overall, our survey participants thought that tolling, private equity capital and long-term concession-based public-private partnerships will play a significant role in the nation's efforts to expand infrastructure capacity. The circumstances which they believe are driving states to partner with the private sector are largely fiscal in nature. They include declining tax revenues flowing into the Highway Trust Fund due to improvements in vehicle fuel economy and a possible slowdown in the growth of vehicle-miles traveled (VMTs); public opposition to higher fuel taxes; and the sheer magnitude of the infrastructure deficit which overwhelmes the bonding capacity of state and local governments. But motivation to partner with the private sector also includes recognition of some positive benefits of private sector involvement, such as willingness of private concessionaires to contribute equity capital, do the job faster, introduce innovation and assume operating and financial risks. As several elected officials have pointed out to us, engaging the private sector in the task of modernizing the nation’s infrastructure may be the best way to ensure the continued growth of the nation’s transportation capacity without imposing an unacceptable fiscal burden on American taxpayers or burdening future generations with further debt.
The viability of the partnership model depends, of course, on the willingness of the private sector to invest in public infrastructure assets. On that score there appears to be little doubt. Our inquiry has revealed an impressive number of private equity funds (72 by one count) dedicated to investments in infrastructure. In the aggregate, they are estimated to have raised in excess of $120 billion. After leveraging the estimated equity capital pool through bank loans and the capital markets, the infrastructure funds could support investments in the range of $340 to $600 billion (for a detailed discussion, see our NewsBrief No. 8, "A $400 Billion Solution?" March 10, 2008).
Cautions and Caveats
However, participants in our survey, while generally sympathetic to public-private partnerships, were careful to note several caveats. First, in the face of the spreading credit crisis, banks may be less willing to lend the high cash multiples that have made past infrastructure deals profitable. A rise in long-term interest rates could reduce the attractiveness of infrastructure investments which rely on substantial leverage to produce attractive returns. Should interest rates rise significantly, an increasing share of operating revenue would go to service outstanding debt, thus reducing yields on invested capital. It is significant to note that the proposed Pennsylvania Turnpike concession is to be financed only 59 percent with bank debt (the remaining 41 percent being equity capital), as compared with the highly leveraged Indiana Toll Road concession negotiated less than three years earlier, which was financed 81 percent with debt. However, most financial analysts we have talked to believe that the present credit crunch will not fundamentally affect the long-term prospects for leveraged infrastructure financing. In fact, a report by Probitas Partners, advisers to pension fund managers, predicts an increase in private equity commitments to infrastructure in 2008 (Investing in Infrastructure Funds, September 2007). Still, a note of caution was recently introduced by Fitch Ratings, pointing out that recent economic conditions (the credit crunch, fuel prices, traffic decline) could challenge the creditworthiness of certain toll projects (U.S. Transportation Assets: Facing a Temporary Decline or a Permanent Change?).
Second, a multiplicity of new entrants into the field of public infrastructure investments has created an intensely competitive environment. New deals coming to market have not kept up with the growth in the supply of investment capital, resulting in vigorous bidding for existing assets and new assets under development. This is driving up their prices, reducing yields and lowering the attractiveness of investments in public infrastructure as compared to investments in other, more traditional asset classes.
Third, private capital is generally available only for income-producing assets, not for maintaining existing toll-free infrastructure. "What's killing us all is the soaring cost of maintaining existing infrastructure," one senior state DOT executive told us. "PPPs don’t offer a lot of help on this score." Also, PPPs are of little relevance to rural states that do not generate large enough traffic volumes to attract private investment. This point was brought up repeatedly by officials and legislators from states lacking high-volume traffic corridors (whether future policy concerning federal highway apportionments could recognize and compensate for this distinction is a point that needs to be considered but is beyond the scope of the present discussion).
Fourth, it is not yet clear how strong or widespread interest will develop at the state and local level in long-term private leasing of existing toll facilities. Public support for such initiatives, exemplified by the Indiana Toll Road and Chicago Skyway concessions, varies from jurisdiction to jurisdiction. For example, New Jersey Governor Jon Corzine has abandoned his plans for "monetizing" the New Jersey Turnpike in the face of widespread public opposition and a lack of legislative support. On the other hand, Pennsylvania, Florida and Chicago are proceeding with plans to lease existing infrastructure assets. Governor Ed Rendell has announced a winning $12.8 billion bid by Abertis and Citi Infrastructure Investors for a 75-year concession of the Pennsylvania Turnpike. The Florida Department of Transportation is considering a long-term private concession for the Alligator Alley toll road (I-75). And the City of Chicago is in the process of negotiating a long-term lease of Midway Airport. (As this is written, the Abertis/Citigroup bid must still be approved by the Pennsylvania legislature, coming up for a vote in October, and the Midway Airport lease will be subject to a review by the Committee on Foreign Investment in the United States (CFIUS) should a foreign consortium win the Midway concession.)
Should these projects come to fruition, "the flood gates will open" speculated one senior investment bank official. "States and local governments," he told us, "will look to their portfolios of leasable assets as a source of considerable new revenue. People will come to realize that the lease of the Chicago Skyway, the Indiana Toll Road, and the Chicago parking garages were not flukes." Our bank official's optimism is understandable. The upfront fee for the Pennsylvania Turnpike concession (about $10.5 billion after existing debts and other obligations have been paid off), invested with the state employees pension fund (SERS), would yield about $1.1 billion annually to the state for transportation improvements, according to Gov. Rendell's calculations. This kind of windfall may prove to be hard to resist by other cash-strapped toll road- owning jurisdictions that are searching for new sources of transportation revenue.
But even if most states should decide not to lease their existing income-producing infrastructure assets, that does not doom the prospects for public-private partnerships. Rather, it will shift attention to what many PPP advocates contend should be the true function of public-private partnerships, namely developing more risky, capacity-enhancing "greenfield" projects. These are projects that otherwise would not be built because they do not fit the conservative financing standards of established toll authorities and do not meet the investment-grade criteria of the municipal bond rating agencies. Most such greenfield projects will require at least some public funding, our survey participants noted. The need for public "gap funding" will vary from negligible (e.g., in the case of Virginia's I-95 HOT lanes and Texas' SH 130) to substantial. For example, Maryland's Intercounty Connector in Maryland will require a 75 percent public share.
Skepticism About PPPs Persists
A final caveat, stressed to us repeatedly by proponents and critics of public-private partnerships alike, is that skepticism about PPPs and questions about the proper role of the private sector in infrastructure development persist. The two-year moratorium on PPPs in Texas and strong opposition to the "monetization" of the New Jersy Turnpike have been vivid reminders of the continued opposition to tolling and private sector involvement. A more recent example has been the failure of two bills in the California legislature to establish an Office of Public-Private Partnerships to promote PPPs among local agencies (AB 2278), and to authorize state agencies to enter into public private partnerships to support infrastructure development (AB 2600).
Further evidence of anti-PPP sentiments comes from public employee unions. The Service Employees International Union (SEIU) has been particularly aggressive in its campaign to police the authority of states' employee pension funds to invest in private equity companies---a major source of investment capital for public-private partnerships. Having failed in this effort in California, the union has switched its attention to the state of Washington. Among the union's demands is that the State Investment Board (SIB) which manages public pension money, weigh the private equity companies' "corporate behavior" before it could invest in them. By prevailing in its demands, the union would, for all practical purposes, deprive public-private infrastructure partnerships of a major source of investment capital.
Opposition to PPPs Has Many Faces
Much of the opposition to public-private partnerships is motivated by a belief that the public interest demands strong public oversight over investment decisions relating to public infrastructure. Advocates of this point of view in Congress and elsewhere argue that the national road system is "a public good" that should be provided and maintained by the public sector to serve the public needs. They contend that a series of private toll concessions would lead to "cherry picking," resulting in a patchwork of uncoordinated facilities that would undermine the integrity and connectivity of a national highway network. PPP opponents are particularly critical of contractual "non-compete" provisions, diversion of upfront lump-sum lease payments to non-transportation purposes and long-term leases of existing toll facilities. Referring to the 99-year lease of the Chicago Skyway and the 75-year lease of the Indiana Toll Road, Sen. Bingaman (D-NM), chairman of the Subcommittee on Infrastructure of the Senate Finance Committee observed, "I think we ought to reconsider the perverse incentive that the tax code creates for such long leases...If current depreciation rules lead to forms of investment that we judge to contravene public policy, then the Finance Committee should consider changing those rules...".
These concerns are legitimate and need to be addressed, observed the participants in our survey, noting that recent concession proposals provide for strong safeguards to protect the public interest. But opposition to private sector involvement is motivated by more than just an altruistic desire "to protect the public interest." Rather, we have found that it is fueled by a complex mix of motives. Some people are concerned that a widespread use of PPPs would shift more power over infrastructure development to the states and weaken the federal role in transportation. Congressional lawmakers are opposed to PPPs because they suspect private sector involvement would lead to an erosion of congressional control over public investment decisions and reduce opportunities for earmarking. Public employee unions worry that transportation facilities under private management would lead to a loss of union jobs and prevent unions from organizing workers at those facilities. The trucking industry fears that private road concessions would lead to rapidly escalating tolls. And some Beltway interest groups and lobbyists are concerned that private sector involvement would decentralize decisionmaking to the states and lessen their ability to influence the transportation program at the federal level. To the extent that many of the public-private partnerships are likely to involve foreign entities, there is also concern--- justified or not--- about foreign control of strategic transportation assets. All these sentiments will be on display next year, when Congress examines the role of private investment in transportation infrastructure in the context of authorizing a new federal surface transportation program. PPP critics may be expected to offer a barrage of testimony citing multiple reasons for their opposition--- testimony that is likely to fall on receptive ears of the leadership of the congressional authorizing committees.
PPPs at the Crossroads
There are well founded speculations that Congress may attempt to assert oversight over public-private partnerships and place conditions on long-term toll road concession agreements, ostensibly "to protect the public interest." The House Transportation and Infrastructure Committee is rumored to consider establishing a regulatory commission to oversee public private partnerships. An influential member of the Senate Finance Committee has raised the possibility of amending the federal tax code to prohibit "excessively long" concession lease terms. Some interest groups in the trucking industry and public employee unions may be expected to vigorously applaud congressional moves to assert oversight and impose regulatory restraints on PPPs. There are indications that the National Transportation Infrastructure Finance Commission also will recommend certain legislative restrictions on private toll road concessions.
Whether efforts to rein in PPPs will come to pass, and if they do, how onerous the restrictions would prove to be, remains an open question. So far, there have been few signs of any organized attempts by PPP proponents to change congressional minds. Ongoing advocacy efforts of various PPP coalitions appear fragmented and uncoordinated. This may change as we draw closer to the reauthorization deadline and as the House Transportation and Infrastructure Committee makes its intentions better known by releasing a preliminary legislative proposal (next February, we are told). Of particular importance at that time will be the posture of the governors and state legislatures. Will they go along with recommendations for federal controls over PPPs or will they assert the right to determine for themselves the conditions of locally negotiated partnership agreements? Above all, will the current level of experience with long-term concession-based public-private partnerships offer state officials and legislators sufficient confidence and comfort level to champion this novel approach in the face of determined congressional and labor union opposition?
How this complex interplay of political forces will eventually play out in the post-election environment may ultimately determine whether the private sector will become a major partner in the efforts to renew the country’s transportation infrastructure. Or will private capital (especially foreign capital), faced with mounting legal restrictions and regulatory barriers in the U.S., turn its attention to investment opportunities abroad and deprive fiscally strapped state and local governments of a much needed source of money to modernize and expand America's infrastructure? That is the bottom-line question.
###
Total reliance on public resources and the fuel tax to fund future investments in transportation infrastructure is no longer a realistic option. Such, in essence, is the considered judgment of a great majority of participants in our survey. State officials tell us they are embracing private sector financing and tolling not because of any ideological commitment to "privatization" or a philosophic attachment to market-driven solutions but out of sheer fiscal necessity. Increasingly, state departments of transportation are obliged to commit a major part of their tax-supported transportation budgets to preserving, modernizing and replacing existing infrastructure, leaving little money for new construction. "We are struggling to have enough money to hold together what we have, let alone be able to think about the level of investment that would be needed to provide new infrastructure," Allen Biehler, Secretary of PennDOT told state legislators recently.
Influential political leaders on Capitol Hill, in state capitals and in the Bush Administration have taken note of the growing need for private investment in infrastructure. House Speaker Nancy Pelosi (D-CA) stated approvingly in an address to the American Public Transportation Association that "Private investment is playing an increasingly larger role in public infrastructure. Innovative public-private partnerships are appearing around the country, bringing much-needed capital to the table." Texas Governor Rick Perry, in a keynote speech at the annual meeting of the Texas Transportation Forum, observed "I am convinced that private dollars, administered through public-private partnerships, are a significant part of the answer to our transportation infrastructure challenge." As another high-ranking state official told us, "since Congress is not likely to come up with adequate resources to help us meet our future infrastructure needs, we have no option but to move on our own and find new ways of funding our capital needs." The official in question reflected a widespread sense among state officials and lawmakers we have talked to that there is little prospect for a substantial increase in federal aid. This judgment was also shared by Sen. Chuck Hagel (R-NE) at a recent congressional hearing. "The Federal Government," he said, "does not and will not have the resources to meet our future national infrastructure needs."
Secretary of Transportation Mary Peters has been a long standing advocate of public-private partnerships. "Unleashing the investment locked in the private sector by partnering with business is the most efficient path to the transportation future this country needs and deserves," she told an audience of Arizona contractors, a message that she and her senior staff have conveyed many times before and since. The Department of Transportation, in a July 29 Concept Paper, "Refocus. Reform. Renew", reaffirmed its support of PPPs by recommending that all federal-aid projects with a total cost of over $250 million should not receive federal assistance "unless the project sponsor first compared the project's lifecycle costs under conventional public procurement with the project's lifecycle costs if procured under a P3 procurement."
The need to enlist the private sector in rebuilding America's infrastructure has been echoed by a number of private coalitions. Among them are the U.S. Chamber of Commerce, ARTBA's Public-Private Ventures reauthorization task force, the Transportation Transformation (T2) Coalition, the Council for Public-Private Partnerships, the America Moving Forward Coalition, and the Rockefeller Foundation-supported "Building America's Future" Coalition founded by Pennsylvania Gov. Ed Rendell, California Gov. Arnold Schwarzenegger and New York Mayor Michael Bloomberg. Judith Rodin, President of the Rockefeller Foundation has challenged those who are skeptical of private investment in infrastructure in these words: "Our challenges are so immense that we can't afford to think about investment and financing as an either-or proposition---a false choice between private capital or public funds. We need new partnerships, new ideas, new sources of revenue" (remarks delivered at the May 9 Rebuilding America Forum).
Also contributing to the dialogue on infrastructure and PPPs are many individual states. In Colorado, Iowa, Massachusetts, Michigan, Minnesota, Oregon, South Carolina, and Texas, governors and local authorities have convened special commissions to identify new revenue sources for infrastructure investments. In other states, such as Arizona, Nevada, North Carolina, Oklahoma, Washington and Wyoming, special legislative committees are studying "revenue enhancements" to supplement existing transportation funds. "A coalition of change agents at state level will bring about a fundamental reorientation in the way we approach transportation funding," one senior state financial official told us, adding that tolling and private investment will play an increasingly prominent role. Reflecting the state legislatures' heightened interest in private infrastructure financing, the NCSL Foundation, an arm of the National Conference of State Legislatures, has undertaken an 18-month project to develop "nonpartisan, balanced and useful materials" on public-private partnerships to aid state legislators in their decision-making.
By our count, a total of 22 states are contemplating the use of tolls to support road capacity expansion. Some of them, such as Florida, Pennsylvania and Texas may resort to long-term concession-based PPPs, while others will choose the more traditional approach of using tax-exempt debt, design-build contracts, and operation through state departments of transportation or regional public toll authorities. However, survey participants pointed out that many state and local governments will be precluded from using the municipal bond market as a financing mechanism because they have reached their statutory debt ceiling or because voters have refused to approve further bond issues. Moreover, pension funds, a potentially major source of investment capital for infrastructure, do not participate in the municipal bond market because they do not benefit from the munis' tax-exempt status.
Is Private Capital Really Necessary?
Not all of our survey participants were convinced that future infrastructure investments will require private capital. Some of those we consulted suggested that the nation's future transportation needs could be met by raising the federal fuel tax or through new federal financing initiatives. The former option, they said, has never been taken off the table and will almost certainly figure in Rep. Jim Oberstar's transportation reauthorization proposal. The latter option includes the National Infrastructure Bank (NIB)(S. 1926 and HR 3401) championed by Sens. Dodd (D-CT) and Hagel (R-NE), and the "Build America Bonds" program (S. 2021) proposed by Sens. Thune (R-SD) and Wyden (D-OR). Both initiatives would create a de facto national capital budget that could be used to fund "qualified public works projects of regional or national significance." The NIB proposal has gained political traction by receiving the support of House Majority Leader Nancy Pelosi and presidential candidate Barack Obama as part of his "urban agenda."
But many survey participants pointed out that neither initiative offers a satisfactory long-term solution. The extra revenue generated by a gas tax increase --- even assuming that such a tax increase would pass muster with the tax-writing congressional committees and obtain a filibuster-proof majority support in the Senate--- would be largely consumed by demands for preservation and reconstruction of the existing highway network and by escalating construction costs, leaving little capital for new construction. Besides, the federal program contributes only about 40 percent of the capital cost of transportation infrastructure. The remaining 60 percent comes from state and local budgets, and there is no guarantee that local jurisdictions would be able to meet their part of the bargain. As for the new federal financing initiatives, their revenue --- $60 billion over 10 years in the case of the National Infrastructure Bank and $50 billion in the case of the Build America Bonds program--- would hardly suffice to make up for decades of underinvestment. These bills could only fund a small fraction of the infrastructure deficit---deficit that the American Society of Civil Engineers estimates at $1.6 trillion. "A federal-centric approach does not offer an adequate long- term solution to closing the huge infrastructure funding gap," summed up one respected think tank analyst.
Overall Verdict on PPPs is Positive
Overall, our survey participants thought that tolling, private equity capital and long-term concession-based public-private partnerships will play a significant role in the nation's efforts to expand infrastructure capacity. The circumstances which they believe are driving states to partner with the private sector are largely fiscal in nature. They include declining tax revenues flowing into the Highway Trust Fund due to improvements in vehicle fuel economy and a possible slowdown in the growth of vehicle-miles traveled (VMTs); public opposition to higher fuel taxes; and the sheer magnitude of the infrastructure deficit which overwhelmes the bonding capacity of state and local governments. But motivation to partner with the private sector also includes recognition of some positive benefits of private sector involvement, such as willingness of private concessionaires to contribute equity capital, do the job faster, introduce innovation and assume operating and financial risks. As several elected officials have pointed out to us, engaging the private sector in the task of modernizing the nation’s infrastructure may be the best way to ensure the continued growth of the nation’s transportation capacity without imposing an unacceptable fiscal burden on American taxpayers or burdening future generations with further debt.
The viability of the partnership model depends, of course, on the willingness of the private sector to invest in public infrastructure assets. On that score there appears to be little doubt. Our inquiry has revealed an impressive number of private equity funds (72 by one count) dedicated to investments in infrastructure. In the aggregate, they are estimated to have raised in excess of $120 billion. After leveraging the estimated equity capital pool through bank loans and the capital markets, the infrastructure funds could support investments in the range of $340 to $600 billion (for a detailed discussion, see our NewsBrief No. 8, "A $400 Billion Solution?" March 10, 2008).
Cautions and Caveats
However, participants in our survey, while generally sympathetic to public-private partnerships, were careful to note several caveats. First, in the face of the spreading credit crisis, banks may be less willing to lend the high cash multiples that have made past infrastructure deals profitable. A rise in long-term interest rates could reduce the attractiveness of infrastructure investments which rely on substantial leverage to produce attractive returns. Should interest rates rise significantly, an increasing share of operating revenue would go to service outstanding debt, thus reducing yields on invested capital. It is significant to note that the proposed Pennsylvania Turnpike concession is to be financed only 59 percent with bank debt (the remaining 41 percent being equity capital), as compared with the highly leveraged Indiana Toll Road concession negotiated less than three years earlier, which was financed 81 percent with debt. However, most financial analysts we have talked to believe that the present credit crunch will not fundamentally affect the long-term prospects for leveraged infrastructure financing. In fact, a report by Probitas Partners, advisers to pension fund managers, predicts an increase in private equity commitments to infrastructure in 2008 (Investing in Infrastructure Funds, September 2007). Still, a note of caution was recently introduced by Fitch Ratings, pointing out that recent economic conditions (the credit crunch, fuel prices, traffic decline) could challenge the creditworthiness of certain toll projects (U.S. Transportation Assets: Facing a Temporary Decline or a Permanent Change?).
Second, a multiplicity of new entrants into the field of public infrastructure investments has created an intensely competitive environment. New deals coming to market have not kept up with the growth in the supply of investment capital, resulting in vigorous bidding for existing assets and new assets under development. This is driving up their prices, reducing yields and lowering the attractiveness of investments in public infrastructure as compared to investments in other, more traditional asset classes.
Third, private capital is generally available only for income-producing assets, not for maintaining existing toll-free infrastructure. "What's killing us all is the soaring cost of maintaining existing infrastructure," one senior state DOT executive told us. "PPPs don’t offer a lot of help on this score." Also, PPPs are of little relevance to rural states that do not generate large enough traffic volumes to attract private investment. This point was brought up repeatedly by officials and legislators from states lacking high-volume traffic corridors (whether future policy concerning federal highway apportionments could recognize and compensate for this distinction is a point that needs to be considered but is beyond the scope of the present discussion).
Fourth, it is not yet clear how strong or widespread interest will develop at the state and local level in long-term private leasing of existing toll facilities. Public support for such initiatives, exemplified by the Indiana Toll Road and Chicago Skyway concessions, varies from jurisdiction to jurisdiction. For example, New Jersey Governor Jon Corzine has abandoned his plans for "monetizing" the New Jersey Turnpike in the face of widespread public opposition and a lack of legislative support. On the other hand, Pennsylvania, Florida and Chicago are proceeding with plans to lease existing infrastructure assets. Governor Ed Rendell has announced a winning $12.8 billion bid by Abertis and Citi Infrastructure Investors for a 75-year concession of the Pennsylvania Turnpike. The Florida Department of Transportation is considering a long-term private concession for the Alligator Alley toll road (I-75). And the City of Chicago is in the process of negotiating a long-term lease of Midway Airport. (As this is written, the Abertis/Citigroup bid must still be approved by the Pennsylvania legislature, coming up for a vote in October, and the Midway Airport lease will be subject to a review by the Committee on Foreign Investment in the United States (CFIUS) should a foreign consortium win the Midway concession.)
Should these projects come to fruition, "the flood gates will open" speculated one senior investment bank official. "States and local governments," he told us, "will look to their portfolios of leasable assets as a source of considerable new revenue. People will come to realize that the lease of the Chicago Skyway, the Indiana Toll Road, and the Chicago parking garages were not flukes." Our bank official's optimism is understandable. The upfront fee for the Pennsylvania Turnpike concession (about $10.5 billion after existing debts and other obligations have been paid off), invested with the state employees pension fund (SERS), would yield about $1.1 billion annually to the state for transportation improvements, according to Gov. Rendell's calculations. This kind of windfall may prove to be hard to resist by other cash-strapped toll road- owning jurisdictions that are searching for new sources of transportation revenue.
But even if most states should decide not to lease their existing income-producing infrastructure assets, that does not doom the prospects for public-private partnerships. Rather, it will shift attention to what many PPP advocates contend should be the true function of public-private partnerships, namely developing more risky, capacity-enhancing "greenfield" projects. These are projects that otherwise would not be built because they do not fit the conservative financing standards of established toll authorities and do not meet the investment-grade criteria of the municipal bond rating agencies. Most such greenfield projects will require at least some public funding, our survey participants noted. The need for public "gap funding" will vary from negligible (e.g., in the case of Virginia's I-95 HOT lanes and Texas' SH 130) to substantial. For example, Maryland's Intercounty Connector in Maryland will require a 75 percent public share.
Skepticism About PPPs Persists
A final caveat, stressed to us repeatedly by proponents and critics of public-private partnerships alike, is that skepticism about PPPs and questions about the proper role of the private sector in infrastructure development persist. The two-year moratorium on PPPs in Texas and strong opposition to the "monetization" of the New Jersy Turnpike have been vivid reminders of the continued opposition to tolling and private sector involvement. A more recent example has been the failure of two bills in the California legislature to establish an Office of Public-Private Partnerships to promote PPPs among local agencies (AB 2278), and to authorize state agencies to enter into public private partnerships to support infrastructure development (AB 2600).
Further evidence of anti-PPP sentiments comes from public employee unions. The Service Employees International Union (SEIU) has been particularly aggressive in its campaign to police the authority of states' employee pension funds to invest in private equity companies---a major source of investment capital for public-private partnerships. Having failed in this effort in California, the union has switched its attention to the state of Washington. Among the union's demands is that the State Investment Board (SIB) which manages public pension money, weigh the private equity companies' "corporate behavior" before it could invest in them. By prevailing in its demands, the union would, for all practical purposes, deprive public-private infrastructure partnerships of a major source of investment capital.
Opposition to PPPs Has Many Faces
Much of the opposition to public-private partnerships is motivated by a belief that the public interest demands strong public oversight over investment decisions relating to public infrastructure. Advocates of this point of view in Congress and elsewhere argue that the national road system is "a public good" that should be provided and maintained by the public sector to serve the public needs. They contend that a series of private toll concessions would lead to "cherry picking," resulting in a patchwork of uncoordinated facilities that would undermine the integrity and connectivity of a national highway network. PPP opponents are particularly critical of contractual "non-compete" provisions, diversion of upfront lump-sum lease payments to non-transportation purposes and long-term leases of existing toll facilities. Referring to the 99-year lease of the Chicago Skyway and the 75-year lease of the Indiana Toll Road, Sen. Bingaman (D-NM), chairman of the Subcommittee on Infrastructure of the Senate Finance Committee observed, "I think we ought to reconsider the perverse incentive that the tax code creates for such long leases...If current depreciation rules lead to forms of investment that we judge to contravene public policy, then the Finance Committee should consider changing those rules...".
These concerns are legitimate and need to be addressed, observed the participants in our survey, noting that recent concession proposals provide for strong safeguards to protect the public interest. But opposition to private sector involvement is motivated by more than just an altruistic desire "to protect the public interest." Rather, we have found that it is fueled by a complex mix of motives. Some people are concerned that a widespread use of PPPs would shift more power over infrastructure development to the states and weaken the federal role in transportation. Congressional lawmakers are opposed to PPPs because they suspect private sector involvement would lead to an erosion of congressional control over public investment decisions and reduce opportunities for earmarking. Public employee unions worry that transportation facilities under private management would lead to a loss of union jobs and prevent unions from organizing workers at those facilities. The trucking industry fears that private road concessions would lead to rapidly escalating tolls. And some Beltway interest groups and lobbyists are concerned that private sector involvement would decentralize decisionmaking to the states and lessen their ability to influence the transportation program at the federal level. To the extent that many of the public-private partnerships are likely to involve foreign entities, there is also concern--- justified or not--- about foreign control of strategic transportation assets. All these sentiments will be on display next year, when Congress examines the role of private investment in transportation infrastructure in the context of authorizing a new federal surface transportation program. PPP critics may be expected to offer a barrage of testimony citing multiple reasons for their opposition--- testimony that is likely to fall on receptive ears of the leadership of the congressional authorizing committees.
PPPs at the Crossroads
There are well founded speculations that Congress may attempt to assert oversight over public-private partnerships and place conditions on long-term toll road concession agreements, ostensibly "to protect the public interest." The House Transportation and Infrastructure Committee is rumored to consider establishing a regulatory commission to oversee public private partnerships. An influential member of the Senate Finance Committee has raised the possibility of amending the federal tax code to prohibit "excessively long" concession lease terms. Some interest groups in the trucking industry and public employee unions may be expected to vigorously applaud congressional moves to assert oversight and impose regulatory restraints on PPPs. There are indications that the National Transportation Infrastructure Finance Commission also will recommend certain legislative restrictions on private toll road concessions.
Whether efforts to rein in PPPs will come to pass, and if they do, how onerous the restrictions would prove to be, remains an open question. So far, there have been few signs of any organized attempts by PPP proponents to change congressional minds. Ongoing advocacy efforts of various PPP coalitions appear fragmented and uncoordinated. This may change as we draw closer to the reauthorization deadline and as the House Transportation and Infrastructure Committee makes its intentions better known by releasing a preliminary legislative proposal (next February, we are told). Of particular importance at that time will be the posture of the governors and state legislatures. Will they go along with recommendations for federal controls over PPPs or will they assert the right to determine for themselves the conditions of locally negotiated partnership agreements? Above all, will the current level of experience with long-term concession-based public-private partnerships offer state officials and legislators sufficient confidence and comfort level to champion this novel approach in the face of determined congressional and labor union opposition?
How this complex interplay of political forces will eventually play out in the post-election environment may ultimately determine whether the private sector will become a major partner in the efforts to renew the country’s transportation infrastructure. Or will private capital (especially foreign capital), faced with mounting legal restrictions and regulatory barriers in the U.S., turn its attention to investment opportunities abroad and deprive fiscally strapped state and local governments of a much needed source of money to modernize and expand America's infrastructure? That is the bottom-line question.
###
