By: John H. Ma Issue: Rebuilding Our Infrastructure Section: Business
Collaborating Through Public-Private Partnerships
Much has been written recently about the poor state of the United States’ infrastructure. We endure crumbling roads clogged with traffic in our major cities, failing bridges, and airports operating near capacity and in urgent need of upgrades. Many of our water and sewer systems are over a century old and desperately require major maintenance.
Meanwhile, countries in Europe, Asia and elsewhere seem to have raced ahead of the United States in infrastructure development, boasting speedy and environmentally friendly high-speed rail systems, sleek modern airports, and huge modern container ports buzzing with economic activity. America’s poor infrastructure condition has become a point of national anxiety, reflecting broader national angst over our global competitiveness and economic strength.
Expert studies confirm the level of disrepair we experience in our daily commutes: the American Society of Civil Engineers (ASCE) latest annual report card on American infrastructure gives us a grade of “D”. According to ASCE, the country needs to spend $2.2 trillion over the next five years just to get things to an acceptable condition. Meanwhile, infrastructure spending in the United States has steadily declined since the 1950s, as a percentage of our GDP, to roughly 2.6 percent, versus upwards of 9 percent in rapidly modernizing countries like China.
While this problem looms ever larger in our national consciousness, federal and state governments continue to struggle with how to fund and finance our infrastructure deficit. Budget crises, limited appetite for tax increases, political gridlock, and challenging financial markets have all conspired to limit the alternatives government leaders have to address the problem.
However, one innovative new tool that state and local governments have begun to turn to for building and rehabilitating infrastructure are public-private partnerships, otherwise known as PPPs or P3s. In the public-private partnership model, private-sector developers partner with public agencies to design, build, operate and maintain transportation, energy, water and other critical infrastructure assets. Typically, the developers raise private financing to get the projects built, thus freeing the government from some of the direct financial burden. To ensure that everything is built and operated according to strict standards, government provides guidelines and ongoing oversight.
In bringing together governments, developers and operators, along with private capital, these projects represent innovative collaborations among groups that do not typically work together. While these partnerships have their share of critics and skeptics, many advocate that PPPs offer a useful alternative to address at least part of the infrastructure gap in America at a time when traditional approaches have been limited.
Traditionally in America, government infrastructure – a road, airport, or water system, for example – is planned, designed, operated and financed entirely by the government itself. Private contractors might be hired to do some key tasks such as the project construction. But the private sector’s role is fairly limited as government seeks to maintain control of these large public works projects. Operations, maintenance and repairs are left to government and municipal agencies as well. To finance major projects, governments look to a variety of sources, but very often issue tax-exempt municipal debt backed by tax revenues or other fees.
Under a PPP model, while government maintains overall project control and oversight, the private sector assumes much greater responsibility for the project. Agreements take the form of a long-term lease or contract period ranging anywhere from 20 to 50 or more years. The private entity collects revenues from the asset – either from direct user fees such as tolls, utility charges, or facility fees, or direct payments from the government over the lease period – in return for its upfront capital investment and responsibility for ongoing operating expenses.
What are the benefits of this approach? First, the developer takes the financial, construction, and operating risk for the asset. In other words, the pain of cost over-runs or project delays falls to the private sector. While this risk transfer may sound like an abstract legalistic benefit, one need only look at projects like Boston’s Big Dig or other major public projects to see how large an issue delays and cost over-runs can be.
Through its significant capital investment, the private entities are incentivized to manage and operate each asset very carefully, as if they were the owner. Stories abound of private developers in PPP projects who actually spend more in upfront construction costs on a road or building or utility system in order to lower long-term life-cycle maintenance costs over time. It’s not unlike how you or I might approach replacing the roof on our house, repaving our driveway, or even repairing our car. Spend a little more and have it cost less to maintain over time? Might be worth it. Spend some more time and money and have the oil changed regularly so you can get more mileage out of that engine? Of course!
You may ask what prevents our government from making these wise investment decisions itself, and operating the assets for the long-term. The answer is that, while there is nothing inherent that prevents it from doing so, the many competing and changing priorities of government and its leadership can make it difficult to manage complex infrastructure assets for the long-term. While government plays a critical role in setting priorities and long-term planning, when it comes to actually fixing ageing pipes and upgrading airport terminals it often falls victim to the latest budget gap or other legislative priority, and the needed steps are deferred. Critics argue that PPPs are just another expensive financing mechanism and that these deals are tantamount to selling assets or mortgaging the future. Nevertheless, the track record of PPPs internationally, as well as the handful of examples in the United States points to savings to the government through these partnerships with the private sector. Importantly, these PPPs offer the promise of drawing new private capital sources into a sector badly in need of investment.
Port of Baltimore’s Seagirt Container Terminal
One recent, successful example of the PPP approach was the Seagirt Container Port Terminal Project in Baltimore, Maryland, an agreement struck in early 2010. Seagirt is the main container port terminal serving Baltimore and a major trade station in the mid-Atlantic. With the widening of the Panama Canal expected to be completed in 2014, Maryland, along with other eastern states, anticipates an increase in larger container ships from Asia sailing directly to the East Coast of the United States rather than dropping off cargo on the West Coast and having the boxes make the inland journey by rail and truck.
For several years, state and local port officials saw the Panama Canal’s widening as an important opportunity to capture a greater share of East Coast container trade given Baltimore’s natural deep-water harbor. With an eye of Baltimore’s economic competitiveness as a trade hub, officials focused on having the facility open for business by 2014.
The challenge for Maryland was that to accommodate the larger container vessels, the Seagirt facility needed a major $350 million upgrade including a new deep-water berth and cargo moving cranes. But Maryland’s budgetary constraints would have meant either a delay in funding the project or raising debt and straining its valuable AAA credit rating.
Enter the public-private partnership. After running a competitive procurement process, the state selected Ports America Baltimore, a privately held port-operator backed by New York-based infrastructure investment firm Highstar Capital, to finance, design, expand, and operate the improved Seagirt facility under a 50-year lease arrangement. Ports America put significant equity capital into the project and raised an additional $250 million of financing. The State of Maryland, in addition to ensuring that the Seagirt expansion and upgrade would take place by 2014, generated proceeds to finance other state-wide transportation projects. The project as a whole is expected to create more than five thousand permanent and construction-related jobs.
Maryland Governor Martin O’Malley, writing in Politico jointly with Christopher Lee, the head of Highstar Capital, touted the project’s innovative and collaborative PPP approach: “Even as the state government must do more with less, Maryland must continue to make critical investments that build the foundation for long-term economic growth and prosperity. Accordingly, the PPP model became a crucial tool for investing in the state’s competitiveness and for creating many jobs that can help Maryland recover and grow.”
What the Private Sector Sees
From the private sector’s perspective, what is the attraction of working in partnership with governments? In recent years, infrastructure has become an increasingly attractive area for private investment. It is viewed as a stable, durable area for investment and less prone to the cyclical ups and downs of traditional asset classes such as stocks or real estate.
Importantly, for major institutional investors such as pension funds, infrastructure also offers the appeal of providing a long-term investment opportunity, matching their longer-term investment horizons. Globally, pension funds have been major players in infrastructure investment. Major financial players on Wall Street have also moved into the area, with several funds established over the last five years focused on investment in roads, ports, utilities and pipelines. Of course, given the dire infrastructure needs in America, investors also see a significant growth opportunity. While PPPs are relatively new to the country, many believe that the large infrastructure gap in the United States will lead to significantly more projects in the years to come. While the vast majority of public works remain financed through tax-exempt municipal debt and other traditional financing mechanisms, many observers believe that these traditional approaches cannot fully address the scope of the needs.
Investors, along with state and local governments, need only look to places such as Canada, the U.K., and Australia for examples of the broad role that PPPs can play in infrastructure development. In each of those countries, PPPs have been employed to develop and build not only roads and bridges, but also a broad array of government facilities such as hospitals, schools, and courthouses, as well as services such as waste collection and other utilities. In each country, the PPP approach has been woven into the fabric of how government thinks about asset delivery. Legislative frameworks are in place and contracts are well developed, leading to a steady stream of projects for government and the private sector to collaborate on together.
Denver’s RTD FasTrack’s Transit PPP
In the United States however, projects remain pathfinders, requiring significant leadership and an appetite for innovation. In addition to the Port of Baltimore, another example of a recent PPP success story can be found in Denver. The Regional Transportation District (RTD) began looking at PPPs several years ago as a way to deliver its ambitious multi-billion dollar FasTracks transit system build-out and expansion, involving over 100 miles of new transit and light rail systems in addition to expanded bus lanes and other services. FasTracks was viewed as critical to the region’s long-term economic growth prospects.
RTD saw how quickly project costs could escalate and timelines could shift, quickly upending carefully laid budgets and financial plans. Though the FasTracks program was funded through a voter-approved local sales tax increase, RTD needed to maximize the value of its dollars in order to deliver the ambitious scope it envisioned. Through PPPs, RTD’s leadership saw an opportunity to save both time and money and ensure that the agency ultimately delivered the project to the public on time and on budget.
After a long and carefully planned competitive procurement, RTD selected the Denver Transit Partners consortium, led by US-based construction and engineering firm Fluor and Australian investment group Macquarie Capital, to build and operate several key segments of its FasTracks program over a period of approximately 40 years. The Eagle project totaled over $2.1 billion and represents the first transit PPP in the country.
Through the PPP approach, RTD believes it has saved potentially hundreds of millions of dollars versus what it budgeted with a traditional government-built and operated approach; in addition, the private concessionaire committed to delivering the project nearly one year sooner than what RTD had planned on its own. “It is a remarkable achievement for RTD to get a project of this magnitude through a public-private partnership that meets our goal of contracting under our budget and ahead of our schedule,” said RTD Chair Lee Kemp in announcing the transaction. “We said three years ago that public-private partnerships would be a vital part of keeping our FasTracks program moving forward.”
Significant Barriers and Challenges Remain
Public-private infrastructure projects are not without their challenges. Perhaps the greatest barriers are distrust between the government and the private sector and the lack of an established history of these types of arrangements in the United States. PPPs, for now, remain collaborations between uneasy bedfellows. Governments and the public at large are wary of private sector profit motives. They wonder aloud whether the profit motive can be consistent with keeping promises on how the assets are built and maintained. Though critical features such as toll rates and maintenance standards are strictly regulated under PPP agreements, these deals play into public fears that toll rates will rise unchecked.
The private sector, in turn, is wary of what they call political risk – that the hue and cry from the public over toll rates or broader budget battles can lead the government to renege on its promises to make payments or not unduly interfere with how the asset is managed.
Given the relative lack of track-record and history in the United States of PPP projects, these transactions often become political debates about transportation policy, spending priorities, tolling, attitudes towards organized labor, and foreign investment, among other issues.
The roster of PPP projects that have fallen victim to the politics of such deals is lengthy: the proposed $12.8 billion long-term concession of the Pennsylvania Turnpike in 2008 was scuttled by the state legislature, the concession of the City of Pittsburgh’s municipal parking system in 2010 was turned down by the City Council, and a proposed toll road project in Texas in 2007 was awarded then reversed.
Unlike foreign countries where PPPs have enjoyed greater success and longer track records, few U.S. states have enabling legislation in place to allow PPPs on a programmatic basis. At least for now, PPPs in most states happen on an ad hoc or case-by-case basis, requiring legislative or other political approval. Given all this, it is little wonder that elected officials have been cautious in proposing these approaches. Why expend political capital and dare to be different, all for an experimental approach to something as unsexy as infrastructure, unless you have no other options?
The Outlook
Yet, given the rising awareness that we have an infrastructure crisis in America, momentum behind PPPs seems to be picking up. Our prolonged fiscal crisis has only accelerated the pressure to try something new that can accelerate the construction of projects and make them more cost-effective.
Compared to five years ago, the list of states and regions exploring PPPs is growing. California, Virginia, Florida, Indiana, Texas, and Puerto Rico have all taken steps to make PPPs an option for their major infrastructure projects. In New York, the Port Authority has begun a process to strike a $1 billion public-private partnership to rebuild and operate the aging Goethals Bridge, a critical transportation connection in the region, affecting not just commuters but also the heavy container cargo trade that emanates from the New York/New Jersey region harbors. New York City is reportedly looking at PPPs for a range of city infrastructure including energy and water and wastewater systems. Indiana and Kentucky are jointly exploring a PPP approach to build an ambitious bridge project in Louisville.
Basic infrastructure can represent many things to many groups: jobs, economic vitality, global trade, profits, stability, and effective government. In some respects, it is a measure of the country itself. As such, it has the power to bring together disparate groups from various spheres and interests.
Just recently, spurred to collaborate by the incentive of job creation, the AFL-CIO announced a $10 billion initiative to invest in infrastructure projects in partnership with pension fund managers, government and other business groups. “America’s building trades unions are ready, willing and able to work with any and all partners to map out a multi-year plan of infrastructure investment,” said Mark Ayers, president of the Building and Construction Trades Department, AFL-CIO. It is not often that you see organized labor, Wall Street groups and government standing alongside one another talking about financial investments.
Given the potential of public-private partnerships to align various needs and interests, and to provide effective solutions to the infrastructure crisis, what is needed to drive things forward? Political leadership and support are essential as long as PPPs remain new and are viewed as untested. Many groups involved in infrastructure planning and development remain wary of PPPs given their entrenched interest in how the status quo works.
And, let’s face it, while infrastructure has become a bit of a buzzword and a hot topic in recent years, it remains difficult for politicians facing a two or four year electoral cycle to get “electrified” about large public works projects that can take years to get built.
Yet, success begets success; and so, the stories of Baltimore’s Seagirt port terminal and Denver’s RTD transit program will hopefully pave the way for more states and cities to evaluate PPPs as an alternative in their arsenal of ways to tackle the broader issue: building and fixing the infrastructure of America.
John H. Ma was recently a managing director in the Investment Banking Division of Goldman, Sachs & Co. where he headed the Firm’s U.S. infrastructure banking practice.