Rebuilding America's Infrastructure through Public-Private Partnerships

May 28,  2008

Ken Orski, Innovation NewsBriefs

Private capital and toll revenue financing will play a major role in rebuilding America's transportation infrastructure.  That is the overall conclusion that can be drawn from conversations and interviews we have conducted over the past two months with a large and diverse group of individuals of varying political persuasion. The survey was initially undertaken in support of a background paper for Infocast’s Conference on Transportation Infrastructure held in Washington on May 15-16, 2008. Since then we have received a large number of comments and reactions, suggesting  that the issues we have raised resonate strongly with our audience. In revisiting the subject we have reflected the expanded crossection of views and some recent new developments, notably the $12.8 billion bid by Abertis Infraestructuras and Citi Infrastructure Investors for a 75-year concession of the Pennsylvania Turnpike.  

Among the individuals who shared their views with us have been U.S. DOT officials, state legislators, congressional staffers, members of the two congressionally-chartered transportation commissions, state and local transportation officials, executives of trade and professional associations, members of the legal, financial and investment communities, and analysts in think tanks, foundations, academia and private consulting firms. Our inquiry also has benefitted from participating in several private briefings organized by corporate entities and financial organizations and attending several conferences, most recently a May 9 forum, "Rebuilding & Renewing America," sponsored by the Rockefeller Foundation,  the Regional Plan Association and the Lincoln Institute of Land Policy; and a May 14  Forum on America's Infrastructure sponsored by the Congressional Quarterly. 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 somewhat controversial subject.

Public-Private Partnerships Are Coming of Age

Total reliance on public resources and the fuel tax to fund 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 DOTs are obliged to commit a major part of their tax-supported transportation budgets to preserving and modernizing existing infrastructure, leaving little money for new construction. "Resurfacing pothole-scarred roads and shoring up crumbling bridges will be the main focus of the state's six-year highway plan, despite an equally urgent need to expand the transportation system to head off a looming congestion crisis," was a lead in a recent Chicago Tribune story quoting Illinois DOT officials. As one senior 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 state official was not alone in expressing pessimism about the prospects for a signifcant increase in federal aid. Similar doubts have been expressed to us by a number of congressional sources.

Influential political leaders in state capitals, on Capitol Hill and in the Bush Administration are coming to a similar conclusion. Texas Governor Rick Perry, in a keynote speech at the annual meeting of the Texas Transportation Forum on April 22, stated "I am convinced that private dollars, administered through public-private partnerships, are a significant part of the answer to our transportation infrastructure challenge."

That also happens to be the view of House Speaker Nancy Pelosi (D-CA). "Private investment is playing an increasingly larger role in public infrastructure," she observed in an address before a Regional Plan Association luncheon on April 18, 2008. "Innovative public-private partnerships are appearing around the country, bringing much-needed capital to the table. It is important to ensure that the public interest is well-served in public-private partnerships, since they are here to stay and likely to grow in importance. User fees will continue to play a major role in financing many types of infrastructure. Reliance on tolls for transportation funding is likely to continue and expand..."

Secretary of Transportation Mary Peters also 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 in February, a message that she and her senior staff have conveyed many times before and since.

Using the leverage of private capital to supplement public funding also lies behind Senators Dodd (D-CT) and Hagel (R-NE) proposal for a National Infrastructure Bank (S.1926). The proposal would establish "a powerful public-private partnership," Senator Dodd said in his opening statement at a March 11 hearing on the bill, held by the Senate Committee on Banking, Housing and Urban Affairs. "Using limited federal resources, it would leverage the significant resources and innovation of the private sector. It would tap the private sector’s financial and intellectual power to meet our nation’s critical structural needs." Added Sen. Hagel, "The federal government does not and will not have the resources to meet our future national infrastructure needs."

The intent of the Dodd-Hagel bill is to create a bond-financed federal capital budget for infrastructure that would be independent of the vagaries of the annual congressional appropriations process. Although the language of the bill is somewhat vague, it leaves open the possibility of "project-based infrastructure bonds" to finance income-producing infrastructure assets such as toll roads. Interest and principal on such bonds would be repaid with revenue generated by user fees. The bill has been endorsed by both Democratic presidential candidates and by House Speaker Nancy Pelosi. Their support has added considerable weight to the idea of establishing a federal capital budget and using it to leverage private capital. It also has ensured the idea’s continued visibility in the infrastructure debate in the months ahead.

The need to enlist the private sector in rebuilding America's infrastructure has been echoed by influential private organizations such as the U.S. Chamber of Commerce and its Let's Rebuild America campaign, and the Building America's Future Coalition launched by Pennsylvania Gov. Ed Rendell, California Gov. Arnold Schwarzenegger and New York Mayor Michael Bloomberg. Judith Rodin, President of the Rockefeller Foundation which is providing funding support for the Coalition, has responded to those opposed to tolling and 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 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 State and Wyoming, special legislative committees are studying "revenue enhancements"  to supplement existing transportation funds. 

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 private tolling concessions while others will choose the more traditional route of municipal bond financing and public operation.  "Do not assume that our legislature's positive attitude toward  tolling means necessarily an acceptance of a private tolling concession," cautioned one state legislator. Many states believe they can finance  toll facilities with tax-exempt debt, build them under design-build contracts, and operate them on their own --- using either their departments of transportation or specially constituted public toll authorities.

But overall, our survey participants thought that public-private partnerships, tolling and private concessions will play a significant role in  the nation's efforts to expand infrastructure capacity. The circumstances that are driving states to partner with the private sector include the rising cost of highway maintenance preempting funds set aside for capital improvements; low expectations of significant increases in federal aid; public opposition to higher fuel taxes (exacerbated by the recent escalation in the price of fuel); limitations on state borrowing in the municipal bond market; willingness of the private sector to contribute equity capital,  introduce innovation and assume various risks; and the sheer magnitude of the infrastructure deficit.  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 the American taxpayers or burdening future generations with further debt.

The Role of Private Capital

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 no 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 capital pool through bank loans and the capital markets, the infrastructure funds could support investments in the range of $340 to $600 billion (see our NewsBrief No. 8, "A $400 Billion Solution?" March 10, 2008).

Most of the infrastructure funds have a global reach, although many of them focus on mature markets in the developed countries where political risks and legal and regulatory uncertainties are less severe. The United States has lately become a favorite investment target because of the perception that a large percentage of its existing transportation infrastructure needs rehabilitation, modernization and expansion.

Many of the infrastructure funds tend to favor investments in toll roads. That’s because roads generate strong demand even in times of slower economic growth and produce steady and predictable cash flow relatively unaffected by economic downturns. Toll road-related investments appeal especially to long-term investors such as pension funds and insurance companies which require stable, income-oriented investments to match their long term-liabilities and payout obligations.

But ports also have come to be recognized as a sound investment by the global capital markets. Institutional investors with long-term investment horizons look upon container port facilities as safe investments that offer returns comparable to those from fixed income and real estate. A growing scarcity of deep water port capacity, environmental obstacles to building new "greenfield" ports and the prospect of the Panama Canal widening, have enhanced the value of existing port facilities on the eastern seabord and raised expectations of a higher return on invested capital.  The growing willingness of private equity markets to invest in port facilities has prompted the Commonwealth of Virginia to establish a commission to consider privatizing the public Virginia Port Authority.  

In an environment of high liquidity and low interest rates, investments in transportation infrastructure offer attractive yields with relatively little risk. Most infrastructure concession agreements include provisions for toll rate increases to keep pace with inflation, thus reducing inflationary risks. Moreover, transportation infrastructure assets offer opportunities for structural and management improvements that can enhance asset performance, stimulate demand, and hence produce more income and increase returns on the initial investment. To realize this potential, infrastructure fund investors must have the knowledge and expertise to enhance the value of the acquired or newly built assets through innovation and operating efficiencies — or strike a fruitful partnership with experienced manager-operators who have such a capability, as Macquarie has done with Ferrovial’s Cintra and Citi Infrastructure has done with Abertis Infraestructuras. It is no accident that the manager-operator in each case is a foreign company. Unlike our own fledgling private toll road industry, foreign operators have decades of operating experience under their belt that enhances the credibility of their concession proposals (for example, Spanish-based Abertis and its predecessor companies has been operating toll roads for 40 years. Its network includes toll roads in Spain, France, Italy, Portugal, the United Kingdom, Chile, Columbia and Argentina.  Cintra, an arm of the giant Spanish firm Ferrovial, and Australian-based Transurban likewise have decades of operating experience.)     

Potential Caveats

Participants in our survey, while generally sympathetic to public-private partnerships, were careful to note several potential 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. (it is significant to note that the proposed Pennsylvania Turnpike concession is to be financed with a 41 percent equity contribution as compared with only a 19 percent contribution  in the case of the Indiana Toll Road concession negotiated less than three years ago.) 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. However, most financial analysts we have talked to believe that the present credit crunch will not be of a long duration and will not fundamentally affect the prospects for infrastructure investments. 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).

Second, the 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 is killing us all is the soaring cost of maintaining existing infrastructure," one state DOT executive told us. "PPPs don’t offer a lot of help on this score." What is more PPPs are of little relevance to rural states that do not generate large enough traffic volumes to attract private investment.

Fourth,  it is not yet clear how strong or widespread  interest there will be at the state and local level in the 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 just announced the 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. 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, the Chicago parking garages and Colorado's Northwest Parkway were not flukes." (the Abertis/Citigroup bid must still be approved by the Pennsylvania legislature 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)

Events may yet bear out the bank official.  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. That kind of windfall may prove hard to resist by other 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 — 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.

The Politics of PPPs

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 has been a vivid reminder of the continued opposition to tolling and private sector involvement--- even though  it has not stopped as many as 21 local toll projects from moving forward. A more recent example has been the failure of the 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).

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 argue that the national road system is "a public good" that should be provided and maintained by the public sector to serve the public interest. They contend that a series of private toll concessions would lead to a patchwork of uncoordinated facilities and undermine the integrity of a national system. They are particularly critical of  long-term leases  of existing toll facilities and  diversion of upfront lump sum lease payments for non-transportation purposes.

These are all legitimate concerns that need to be addressed, observed participants in our survey, noting that even Wall Street and pension funds are divided about the merits of some infrastructure investments (recently reported  resignations of top level officials at the CALpers pension fund have been attributed to disagreements over infrastructure investments.)  But  opposition to private sector involvement is motivated by more than just an altruistic desire to protect the public interest. It is fueled by a complex mix of motives: concern by some that a widespread use of PPPs would shift more power over infrastructure development to the states and weaken the federal role; fear by congressional lawmakers that PPPs would lead to an erosion of congressional control over investment decisions and reduce opportunities for earmarking; concern by public employee unions that projects under private management would lead to a loss of union jobs; apprehension by the trucking industry that private road concessions would lead to rapidly escalating tolls; and a worry by the Beltway interest groups and lobbying organizations that private sector involvement would lessen their ability to influence the transportation program in Washington. To the extent that many of the public-private partnerships are likely to involve foreign entities, there is also concern about foreign control of strategic transportation assets. All these sentiments will be openly on display when the role of the private sector in infrastructure development is examined in the context of the authorization of a new federal surface transportation program next year.

There are well founded speculations that there may be attempts  to assert congressional oversight over public-private partnerships and place conditions on private toll road concession agreements, ostensibly "to protect the public interest."  But federal control over private investments in transportation infrastructure may be expected to be fiercely contested.  How that potential conflict is resolved may ultimately determine whether private capital will become a vital  partner in the efforts to renew the country’s  transportation infrastructure--- or whether the private sector will seek infrastructure investment opportunities elsewhere around the globe and deprive our state and local governments of access to much needed investment capital because  legal and regulatory barriers will have made such ventures impractical at home.