pew center p3 study

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byDollarsDrivenWhat States Should Know When ConsiderinPublic-Private Partnerships to Fund Transpo

MARCH 200


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For more information from the Pew Center on

the States about economic competitivenessand government efficiency and effectiveness,please see:

Grading the States 2008, assessing all 50 staon how well they manage their infrastructurwww.pewcenteronthestates.org/gpp

Susan K. Urahn on Federal Stimulus for Stwww.pewcenteronthestates.org

Growth and Taxes, analyzing how states usetheir tax systems to encourage economic viwww.pewcenteronthestates.org/report_detail.aspx?id=33218

Stateline.org Economy and Business, Taxand Budgetwww.stateline.org

The Partnership for Americas EconomicSuccess, examining the economic return oninvesting in childrenwww.partnershipforsuccess.org

The Pew Charitable Trusts applies the power of knowledge to solve todays most challenging problems.Our Pew Center on the States identifies and advances effective policy approaches to critical issuesfacing states.

PEW CENTER ON THE STATESSusan Urahn, managing director

Research ConsultantsG. Edward DeSeve, Chairman, Strategy and Solution PartnersTimothy James, Professor, W.P. Carey School of Business, Arizona State UniversityDonald F. Kettl, Robert A. Fox Leadership Professor, University of PennsylvaniaKatherine Barrett and Richard Greene, Barrett and Greene, Inc.Will Wilson

ACKNOWLEDGMENTS

The following three experts served as external reviewers for thisreport. While these experts have screened the report for accuracy,

neither they nor their organizations necessarily endorse its findingsor conclusions. We thank them for their assistance.

Jennifer L. Dorn, President and Chief Executive Officer,National Academy of Public Administration

Mortimer Downey, President, Mort Downey Consulting LLC

John Sellers, former Global Head of Project Finance,Banque Paribas

We would also like to thank Kathy Litzenberg and Stephen Sheikhlifor their editorial assistance, John Tierno for his graphic assistance,and Mike Heffner, Lucy Pope and Denise Kooper of 202design fortheir design assistance.

For additional information on the Pew Center on the States,please visit www.pewcenteronthestates.org .

2009 The Pew Charitable Trusts

901 E Street NW, 10th Floor 2005 Market Street, Suite 1700Washington, DC 20004 Philadelphia, PA 19103

Research TeamMichele Mariani VaughnLori GrangeMelissa MaynardKil HuhJane BreakellAnn Cloke

Design and Publications TeamCarla UrionaAlyson Freedman

Communications TeamAndrew McDonaldJanet LaneJessica Riordan

LEARN MORE


3/42Driven by Dollars

March 2009

Dear Reader:

Americas infrastructure is in desperate need of repair. Our deteriorating highways, roads and bridgesand the increasing demands for new transportation networks have left us with an annual gap of $47billion between the projects the nation needs and those it can afford. The stakes are high: failing to closethe gap and improve our infrastructure could hurt states ability to attract businesses and compete in theglobal economy, and reduce the quality of life for millions of Americans.

In todays economic crisis, bridging the gap will take new ideas and new sources of revenues.Increasingly, cash-strapped states are considering public-private partnerships to generate new moneyfor needed projects. Public-private partnerships have been used around the world for years to underwriteinfrastructure, but theyve only recently gained a foothold in the United States. The deals are complex,

typically stretching for decades and involving billions of dollars.

In this report, the Pew Center on the States analyzed Pennsylvanias recent debate about leasing itsturnpike as a case study to determine whether lawmakers had the information they needed to make asound decision, and to highlight what other states can learn from those deliberations. Pennsylvaniasexperience will be useful to policy makers across the country as they examine public-private partnershipsand consider such deals to fund their infrastructure needs.

The Pennsylvania case and the experiences of other states and countries illustrate how long-termdeals are often debated with a short-term perspective. Pennsylvania policy makers did a lot right

in their first exploration of such a lease, but they fell short in key areas of how the deal was proposed,structured and handled. If Pennsylvania and other states want to pursue successful public-privatepartnerships, more questions need to be asked and answered.

Driven by Dollarsbuilds on the work of the Center, which grades states on how well they manage theirinfrastructure and assesses states fiscal health and economic competitiveness. We hope this report willhelp inform and guide states as they consider public-private partnerships as a way to fund theirinfrastructure needs.

Sincerely,

Susan UrahnManaging Director, The Pew Center on the States


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In 2008, Pennsylvania policy makers debatedwhether to lease the Pennsylvania Turnpike to aprivate consortium for 75 years in exchange foran upfront payment of $12.8 billion. The proposal,as structured and handled, was seriously flawedand, as of this reports release, has failedto move forward. While officials in both theexecutive and legislative branches were wellinformed and had sound information about someaspects of the proposed partnership, they lacked

crucial and accurate analysis about otheraspects. But in the aftermath of that failed deal,Pennsylvanias unfunded infrastructure needsremain, and the state may again consider leasingassets to help pay its bills. Pennsylvania is just oneof a growing number of states thinking aboutpublic-private partnerships, making it imperativethat policy makers across the country learn fromits experience.

In 2008, the federal Highway Trust Fund one of the nations primary sources of funding forhighway renovation and construction almostwent broke. States, hurting from falling revenuesof all kinds, including gas tax proceeds, lack themoney to meet their own infrastructure needs.These funding problems have turned into a crisis.Every year, the numbers worsen. Much-neededhighway repairs are being neglected, and the

cumulative shortfall between those needs andavailable funding is about $47 billion a year.1

The current trend is unsustainable. Congestionand pollution will continue to increase, publicsafety will be compromised, and stateseconomicgrowth and ability to attract and retain strongbusinesses will falter if the nations transportationsystem fails to receive the investments it needs.Policy makers are seeking all kinds of solutions.Federal funding through the stimulus package,a proposed infrastructure bank or both willhelp. But the gap remains large, and as a result,

state leaders are looking to partner with theprivate sector. Recent long-term leases of theChicago Skyway and the Indiana Toll Road toconsortiums of private operators in exchange forsizable upfront payments have heightened statesinterest; Massachusetts, Florida and New York areamong those contemplating similar deals.

To help state policy makers across the countryunderstand the information they need to haveand the questions they need to answer whenconsidering public-private partnerships to fundinfrastructure, the Pew Center on the States usedthe Pennsylvania experience as a case study. Wesought to assess what the state did well andwhere the process could have been improved. Toaccomplish this, we interviewed state officials andadvisors, legislators, representatives of the biddersand the Turnpike Commission, and transportation

and finance experts; reviewed the lease proposaland relevant documents; and researched similardeals in other states and countries.

Executive Summary

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Key Findings from thePennsylvania Experience

What Went Right?G Pennsylvania thoroughly identified its

infrastructure needs and conducted duediligence before negotiating with bidders.

The funding debate stemmed from acomprehensive assessment of the stateshighway and transit needs conducted in 2006.That report indicated that Pennsylvania needsto spend $1.7 billion more each year to maintainits current transportation system. The statecommissioned additional reports on theturnpikes finances, condition and traffic tohelp inform and guide state officials in thebidding process.

G The bidding process was well-run and produced the highest possible bid, given the lease terms set by the state and prevailing market conditions at the time .

Pennsylvania managed a competitive biddingprocess. The state whittled 14 original biddersdown to a final round of three, and through abest and final offer round, generated a $2 billionincrease in the highest bid.

G Detailed performance standards were set for thelife of the lease.

Although the proposed three-member board foroverseeing the lease drew criticism for notincluding legislative and public representatives,the lease proposal itself set out copiousperformance measures that the private operatorwould have had to meet. Similar to the public-private partnerships in Chicago and Indiana, theturnpike lease established both routine condition

standards and the condition in which the privateoperator would have to hand the road back tothe state at the end of the lease.

What Undermined the Deal?G Discussions between the executive and legislative

branches could have been handled better.

Governor Edward G. Rendell, long interested in alease of the Pennsylvania Turnpike to help thestate generate some of the cash needed to fill itsinfrastructure funding gap, opted to pursue apublic-private partnership just after the state hadenacted Act 44, a landmark transportationfunding bill. Members of the legislature,particularly supporters of Act 44, were confusedby the timing of the governors decision and feltthey had been excluded from the process. Manywere less inclined to look favorably on the lease, asentiment that grew when the winning bid wasbillions less than many lawmakers expected.

G The financial assumptions related to the deal were overly optimistic .

$12.8 billion undoubtedly would have enabledPennsylvania to invest more in its infrastructure.Governor Rendell intended to save most of theproceeds and to use the interest they generatedto pay for infrastructure projects. The stateassumed it would earn 12 percent annual intereston the principal, generating more than $1 billionin additional infrastructure spending a year. 2 But a12 percent annual return seemed highly unlikely,

and far outstripped the returns projected by boththe Pennsylvania State Employees RetirementSystem (SERS) and Morgan Stanley, the statesadvisor on the proposed lease.

Pew Center on the States

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G The state lacked a clearly ar ticulated plan for how the proceeds would have been invested and spent.

Pennsylvania developed its financial assumptionsbased on the last 20 years of SERS returns. Butnot only did the proposed legislation not call forthe state to invest the upfront sum in thatparticular pension system, it also did not set outany guidelines for how the funds should beinvested. That uncertainty extended to how themoney would be spent; unlike some other long-term lease proposals that described expendituresin detail, the Pennsylvania proposal lacked such aframework. That missing element raised

questions about how long the money couldsupport infrastructure investments.

G The proposed oversight mechanism for deciding where to invest the upfront payment and how to spend the proceeds raised questionsabout transparency, accountability and adequate planning .

The original legislation called for a three-member

board consisting of the governor, the budgetsecretary and the transportation secretary tocontrol investment and spending decisions, andoversight of the private operators performance.The lack of legislative or public representation onthe small board troubled some legislators, whoused it as a reason not to support the leasealthough they could have revised the legislationto propose a different approach.

G The debate lacked adequate considerationof the states long-term interests.

Pennsylvania considered the proposal to lease theturnpike primarily as a way to generate a large,upfront payment that could pay for infrastructure

improvements across the state. The short-termimplications of that payment dominated thedebate about whether to proceed with thelease an experience that closely resembled theprocess in other states. Although it is impossible

to know what ground transportation may look likedecades from now, policy makers need toconsider more seriously the long-term effects of alease on their taxpayers, their economies and theirenvironment.

As States Move ForwardPennsylvanias failure to lease the turnpike in 2008does not preclude another lease whether of the

turnpike or another asset from moving forward.A public-private partnership is a complex deal, fullof moving parts. No one element of it not evena massive upfront payment automaticallyrenders it a good deal or a bad deal.

What Information Do States Need?Pennsylvanias experience illuminated the centralquestions for all states: what do policy makersneed to know to make an informed decision on apublic-private partnership? Do they have all theinformation and answers they need? The keyquestions involved in leasing an infrastructureasset fall into four main categories:

1. The decision-making process. States shouldcarefully and thoroughly examine all of theiroptions to generate funds for infrastructure,including, but not limited to, public-privatepartnerships.

2. The deal-making process. If a state decides thatpursuing such a partnership makes sense, itmust ensure that the deal-making process is astransparent as possible, that the publics long-term economic, environmental and


Driven by Dollars


7/42Pew Center on the States


transportation interests are considered, andthat policy makers have all of the data andnonpartisan analysis they need to make a well-informed decision.

3. The financial analysis. The state must userealistic financial assumptions to assesswhether the potential deal is sound. It alsomust develop and articulate a sound plan forhow the proceeds will be invested or spent.

4. Oversight and management of a long-termpartnership . Finally, the state must considerhow it will ensure the public is protectedand the private operator continues to meet

its obligations in a deal that could stretchover decades.

What Lessons Can States Apply?Policy makers can learn much from their peersexperiences both good and bad. Our analysisof Pennsylvanias experience, informed by otherdomestic and international public-privatepartnerships, reveals a number of lessons otherstates may want to apply as they continue toinvestigate the feasibility of these deals forthemselves:

G Passage of enabling legislation that establishesthe states general interests and terms for apublic-private partnership before negotiationsbegin can help set the ground rules and be avaluable tool as a state considers a specificproposal. This helps ensure that policy makershave thoroughly debated the pros and cons of public-private partnerships and allows formore efficient and informed consideration of aparticular proposal. Nearly half the states haveadopted such laws.

G Transparency and inclusion are crucial toachieving buy-in from stakeholders. The statemust strike the appropriate balance betweenprotecting bidders proprietary information andsharing enough details that policy makers andthe public understand both the short- andlong-term implications of the deal.

G A states decision makers must have a clearunderstanding of the principal goals for apublic-private partnership in the area of infrastructure, because different goals willrequire different tradeoffs. A state pursuing alease primarily for immediate financial gain,for example, may be willing to extend thelease for more years and give the privateoperator greater ability to raise tolls if thatwill result in a higher upfront payment.

G A proposed deal must be based on realisticfinancial assumptions.

G A well-planned public-private partnershipproposal must thoughtfully and specificallydescribe how the revenues a lease will

generate will be invested and spent, andhow the private operators performance willbe monitored.

G A long-term deal deserves a long-termperspective. As policy makers debate the prosand cons of a public-private partnership, theyshould consider a long-term leases effects onthe economy, the environment and the nextgeneration of taxpayers.


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Americas roads need help. More than half of the nations highways are not in good condition,costing drivers more than $50 billion in carrepairs and more than four billion hours stuck in traffic per year. Theyre costing states, too, interms of economic competitiveness: companiesdont want to stay in areas where its difficult to

transport goods or for employees to get to work.3

Created in 1956, the national interstate highway

system was assigned a primary funding source:the U.S. Highway Trust Fund, which would befueled by taxes on gasoline. Since then, thebuying power of those funds has eroded,dragged down by inflation, improved fuelefficiency and rapidly rising construction costs.Today, drivers pay less than half as much per mile

traveled as they did at the end of the 1950s. 4 TheTrust Fund was slipping into insolvency untilCongress provided an emergency infusion of $8billion in September 2008. State and localgovernments welcomed the move, all the whilerealizing that the one-time injection of moneywould not solve the countrys long-term

transportation funding crisis.

State and local governments account for morethan half of highway and transit funding inAmerica, and theyve also been pinched. 5 Theshare of state government highway funding paidby user fees has declined by nearly 20 percentsince 1965, putting more pressure on statesgeneral revenues to close that gap.

Funding OptionsTo remain globally competitive, the UnitedStates must reassess its approach to fundingtransportation infrastructure, according to aFebruary 2009 report from the National SurfaceTransportation Infrastructure FinancingCommission. But some of the options underconsideration would take years to implement,others are politically unappealing, and none yet

proposed resolves the infrastructure fundingcrisis.6 Increasing state and federal gas taxes couldhelp, but that move remains politically sensitivebecause drivers voters dislike higher prices atthe pump, even as those prices have fallen.In the long run, the crisis is even more seriousbecause the current gas tax could not support

The National InfrastructureFunding Crisis

Driven by Dollars

To ensure our nations ability tocompete in an evolving globaleconomy and respond to crucialenergy and environmentalchallenges, we must not onlymaintain our infrastructure systembut also enhance and improve it.And, we must do so in a way that istransparent and accountable to theAmerican people.

Pennsylvania Governor Edward G. Rendell, chair,National Governors Association, 2008-2009;An Infrastructure Vision for the 21st Century ,National Governors Association, February 2009, iii.


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the levels of expenditures that we have becomeaccustomed to over the last several years,explains Kenneth Orski, a transportation fundingexpert who writes Innovation Briefs, atransportation newsletter. Some kind of additional resource will have to be found tosustain the needed expenditures. 7 One

alternative, a per-mile driving tax, presents manyof the same political headaches as increasing thegas tax and introduces new privacy concerns.

A national infrastructure bank a Congressionalproposal also endorsed by President Obamawould allocate $60 billion in federal loans to


Facts and FiguresG Leased in 2005G 7.8 mile toll road

G $1.83 billion upfront paymentG 99-year leaseG No revenue sharingG Annual toll increases (after 2017) capped at

highest of 2 percent, Consumer Price Index or

per capita GDP increaseG No non-compete clause

Struggling with a budget deficit in 2004, the City

of Chicago looked for ways to maximize its assets,

including the Chicago Skyway, a 7.8-mile toll road

connecting Interstate 94 to Interstate 90. During

the 47 years the citys Department of Streets and

Sanitation managed the Skyway, toll changes

were infrequent, with tolls even decreasing by

approximately 25 percent in real terms between

1989 and 2004.

Chicago accepted bids for the Skyway in October

2004; the winner, the Macquarie/Cintraconsortium, bid $1.83 billion for a 99-year lease

and took control in January 2005.

Macquarie/Cintra is able to gain more than the

city from the road in part because of annual toll

increases. A pre-established toll schedule runs

until 2017, after which annual toll rate increases

will be capped at the highest of 2 percent, the

Consumer Price Index (CPI), or the increase in

nominal gross domestic product per capita.

The city used the upfront payment for the Skyway

to pay down outstanding debt, create a reserve

fund, provide immediate budget relief and pay

for other non-transportation-related programs.

Although those expenditures did not directly

improve the citys transportation system, they led

to an upgrade in the citys credit rating, which will

reduce the costs of borrowing.

The concessionaire must follow detailed technical

specifications based on industry best practices,

addressing such maintenance and operational

issues as roadway and drainage maintenance,

safety features, toll collection procedures,

emergency planning and snow removal. While

under public control, the Skyway had no such

formal standards, suggesting that the

concessionaire is required to uphold the road

system to a better standard than the city had.

Sources: Chicago Skyway Lease and Concession Agreement,January 24, 2005; NW Financial Group, The Chicago Skyway Sale: An Analytical Review , May 1, 2006, and Then There WereTwoIndiana Toll Road vs. Chicago Skyway: An Analytical Review of Two Public/Private Partnerships: A Story of Courage and Lost Opportunity , November 1, 2006.

CHICAGO SKY WAY

T H E N AT I O N A L I N F R A S T R U C T U R E F U N D I N G C R I S I S


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Driven by Dollars

Facts and FiguresG Leased in 2006G 157 miles of roadG $3.8 billion upfront paymentG 75-year leaseG No revenue sharingG Annual toll increases capped at highest

of 2 percent, Consumer Price Index or per

capita GDP increaseG Non-compete clause

In May 2005, facing a $1.8 billion shortfall to build

necessary road improvements over the nextdecade, Indiana policy makers decided to lease

the states toll road. A portion of Interstate 90, the

Indiana Toll Road (ITR) runs 157 miles across the

northern border of Indiana. From 1981 to 2006,

Indiana DOT operated and maintained the ITR,

then an underperforming asset that consistently

lost money.

Four final bids were submitted for the same

75-year lease contract; the winning proposal of

$3.8 billion came from the Australian-Spanish

consortium of Macquarie and Cintra, which took

operational control in June 2006. With the funds

from the lease, the state allocated money toward

road projects, paid off existing toll road bonds

and established two transportation project funds,

including a fully funded 10-year statewide Major

Moves transportation plan making Indiana the

only state with such a plan. Standard & Poors also

upgraded Indianas credit rating, lowering the

states cost of borrowing, which reduces the cost

of future projects.

The concessionaire is contractually obligated to

maintain the road, which the budget-strapped

DOT was often unable to do sufficiently. Indeed,

if Macquarie/Cintra does not meet the specified

level of service standard, it can default, awarding

the asset back to the public sector at zero cost. An

oversight board, composed of state employees

and private citizens, reviews the concessionairesperformance and operations for non-compliance.

Although the concession agreement includes a

non-compete clause if Indiana builds a new

highway 20 miles or longer within 10 miles of the

ITR, it must compensate the concessionaires lost

revenue Macquarie/Cintra committed at least $4

billion in improvements to the ITR over the span

of the lease and in mid-2006 announced a $250

million toll road expansion, to be completed by

2010. Macquarie/Cintra also introduced electronic

tolling along the ITR, which will improve mobility

and allow the ITR to bear higher traffic volumes.

Sources: Indiana Toll Road Concession and Lease Agreement,April 12, 2006, www.in.gov/ifa; United States GovernmentAccountability Office, More Rigorous Up-front Analysis Could Better Secure Potential Benefits and Protect the Public Interest ,February 2008, http://www.gao.gov/products/GAO-08-1052T(accessed February 18, 2009).

INDIANA TOLL ROAD


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projects as determined by a bipartisancommission. At this writing, other federal fundingwill come through a stimulus package that willinclude $27.5 billion for road and bridge projectsacross the country. While that is a substantial sum,it is a far cry from meeting the accumulated need.The National Cooperative Highway ResearchProgram estimates that to maintain only thecurrent highway system, the funding deficitamounts to $47 billion annually. 8

Given the gap, state policy makers across thecountry are considering more seriously the ideaof turning to the private sector for help. Public-

private partnerships, whereby a private companyor consortium finances, designs, constructs oroperates government-owned infrastructure,represent one such funding mechanism.

In a concession, one type of public-privatepartnership, the government leases an existing orto-be-built piece of infrastructure to a privatecompany or group of companies (theconcessionaire), usually determined through anopen bidding process according to governmentprocurement rules. In exchange for theconcessionaires upfront lease fee or a share of future revenue, the government allows theconcessionaire to operate the asset, with contractterms detailing maintenance and performancerequirements, caps on toll increases and otherprovisions. Concessions have become moreattractive to states because at least in

concept they allow government to capture thefinancial benefits of an asset without many of theoperating challenges and risks.

Such arrangements are relatively new to theUnited States, gaining prominence in 2005 whenthe City of Chicago leased its Skyway to a foreign

consortium for $1.83 billion. Policy makers in anumber of other states, in search of similarinfusions of cash, are debating or have enactedlegislation to facilitate public-private partnerships.(See Exhibit 3 on page 16.) The private sectorappears to be interested in these partnerships,particularly transportation concessions, becausethey offer a consistent financial return andrepresent a stable investment, especially in timesof market volatility. Orski describes public-privatepartnerships as safe havens for long-term investorssuch as insurance companies and pension fundsincluding many state pension funds. 9

A January 2009 report by private equity firmsincluding the Carlyle Group, Morgan Stanley andCredit Suisse estimated that as much as $180billion in private dollars is targeted forinfrastructure investment. Using additional debtto finance projects, that $180 billion couldfacilitate some $450 billion in projects, the groupsassert.10 Much of that money will be invested inEurope and Australia, where public-privatepartnerships have long histories. Spain, forexample, plans to use them to fund more thanone-third of its transportation infrastructure needsover the next decade. The arrangements are alsobecoming increasingly popular in developingAsia, South America and Africa. India has begun toplug its infrastructure funding gap with more than$35 billion worth of highway partnership projects.And nearly one-seventh of all Africaninfrastructure, including many transportation

assets, is funded using these models.11

So why isnt that money flooding the Americanmarket, especially when investors are looking forstable, reliable returns? Some proponents of thepartnerships say there simply arent enough high-quality deals available from states and cities. The




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demand side of the equation is a little weak, saysStephen Goldsmith, director of the Ash Instituteof Government at Harvard University and theformer mayor of Indianapolis. But part of thereason is that lawmakers are not sold on the idea.Some policy makers worry, for instance, that aprivate operator might skimp on maintenance orservice to maximize profits. Other experts expressconcern about lengthy leases, skyrocketing tolls,the fate of existing public employees and theeconomic and national security consequences of ceding control of public infrastructure. 12

The discussion is complicated, too, by the volatile

economy and the fragile credit markets, whichare instrumental to piecing together complicatedpublic-private partnerships. For instance, over thelast year, what was seen as an innovative $800million public-private partnership program to

rebuild bridges in Missouri was scaled back to amore traditional financial structure, and aproposed concession of Interstate 75 in Floridawas on hold as of mid-February 2009. 13

The debate over public-private partnerships willcontinue, but given the gap betweeninfrastructure needs and available funding, moreof these deals are likely to emerge. Right now,we have some of the largest infrastructure needsfor increased capacity and rehabilitation in thepast 70 to 80 years, says John Flaherty, principalfor infrastructure at the Carlyle Group. You havehundreds of billions of dollars of private

investment that wants to participate ininfrastructure improvements. How that dialogueoccurs in the next 18 to 24 months is going todecide where our transportation public financepolicy is going for the next 20 to 25 years.14


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In 2006, Governor Edward G. Rendell conveneda Transportation Funding and ReformCommission to assess the states transportationsystem. According to the commissions finalreport, Pennsylvania needs $1.7 billion inadditional annual transportation funding tomaintain the current system. 15 The reportrecommended that the state make smarter useof existing funds, increase taxes and fees and

explore innovative funding mechanisms,including public-private partnerships.

In addition to the $1.7 billion needed annuallyto support its transportation infrastructure,the state needs more than $14 billion just tocomplete the maintenance projects it has putoff in the past, according to a March 2008 reportfrom the Pew Center on the States GovernmentPerformance Project. 16

In spring 2007, the legislature heard testimonyabout all manner of funding sources but wasunable to find common ground, says Craig Shuey,executive director of the Senate TransportationCommittee. 17 Rising gas prices complicated boththe challenges and the solutions; taxpayers werealready driving less, and it seemed politicallydifficult to ask them to pay more at the pump or

at tolls. Then Governor Rendell announced hisplan to help close the funding gap: lease thePennsylvania Turnpike for 75 years to the highestbidder, with the notion of investing the money togenerate a source of funding to support thestates infrastructure needs. 18 Administrationofficials said they believed other funding options

werent viable. We looked at tolling of existinginterstates. We looked at raising current gas taxes.We looked at adding fees. And basically everyway that we were able to think of was moneybeing taken out of the pockets of Pennsylvaniacitizens to pay for more transportation, RoyKienitz, Governor Rendells deputy chief of staff,told legislators in June 2008. The real attractionto the governor of a lease of the turnpike is that

potentially given just an inflationary series of tollincreases, by using the power of the market . . .we could bring billions and billions of dollars totransportation investment. 19

At the time, support for public-privatepartnerships, particularly for new constructionand expansion projects, had been building inthe state Senate. Broad legislation authorizing theuse of public-private partnerships appearedpoised for easy passage, but opposition toGovernor Rendells turnpike plan stalled thatmomentum. Lawmakers concerns centered

Pew Center on the States0

The Pennsylvania Story

NEW YORK

PENNSYLVANIA

Pittsburgh

Scranton

Philadelphia

Erie

LakeErie

DEL.MARYLANDW. VA.

OHIO

N.J.

Harrisburg

80

P E N N S YLVAN I A TU RNPIKE

Exhibit 1

I 80ANDTHE PENNSYLVANIA TURNPIKE

SOURCE: Pew Center on the States,2009


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around the idea of leasing the states main arteryfor three-quarters of a century and that thelease could possibly be made to foreigncompanies, such as Macquarie, based in Australia,or Abertis, based in Spain.20

Amid this stalemate, legislators began asking if there might be a way for the PennsylvaniaTurnpike in its current, state-owned-and-operated formation to play a larger role ingenerating transportation funding. 21 The TurnpikeCommission proposed increasing tolls on theturnpike for only the sixth time in its history andask the Federal Highway Administration for

permission to toll I-80, another key cross-statecorridor.22 The Turnpike Commission would turnover funds to the Pennsylvania Department of Transportation (PennDOT) for statewidetransportation needs including mass transit,bridge repair and other infrastructure elementsthat had long lacked reliable funding streams. Alltold, the proposal, which became known as Act44, would provide Pennsylvania with $116 billionover a 50-year period if the Federal HighwayAdministration approved tolling of I-80.23

The ensuing debate over Act 44 exposed anumber of geographical and philosophical faultlines. Legislators with districts along the I-80corridor worried that tolls would divert much of the commercial and out-of-state traffic and theeconomic activity it generates away from ruralareas along the corridor. 24 Many didnt like the

idea of using road money to fund mass transit, adeparture from past practice. 25 Meanwhile, somelegislators in the southeast part of the state,especially those near Philadelphia, were used todriving on toll roads as a part of their daily livesand thought it only fair that I-80 an agingroadway that costs the state $100 million a year

to maintain carry its proverbial weight. 26

And the promise of putting in place the firstpredictable funding stream for the states ailingmass transit systems was enough to win overmany urban legislators. 27

Ultimately, Act 44 passed in 2007 as part of acompromise over the state budget. 28 But to thechagrin of many Act 44 supporters, thetransportation bill didnt end the conversationabout how to best fund transportation inPennsylvania. Says Shuey: Maybe a week later,the governor said, Its not enough money andthe feds might not approve I-80 tolling. I want

to pursue a turnpike lease. And right off the batyouve got a reversal of the deal that cametogether on Act 44. 29

Governor Rendell, doubting that the FederalHighway Administration would decide inPennsylvanias favor, resurrected his plan tolease the turnpike, a process that culminatedin a request for qualifications in September2007.30 Fourteen bidders expressed interest.Reflecting on the deal, administration officialsacknowledge that they expected a range of bidsfrom $12 billion to $16 billion.31 But a number of legislators said they believed the bids would beas high as $30 billion.32

Only four bidders, including Citi InfrastructureInvestors and the Spanish firm AbertisInfraestructuras, remained during the final

months of the process; those two companiesultimately merged their proposals into a singlebid and competed against Goldman Sachs andMacquarie/Cintra for the lease. 33 When the twohighest bidders, Goldman Sachs and Abertis/Citi,submitted bids within 10 percent of each other,the state called them back for a best and final

THE PENNSYLVANIA STORY

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A LONG AND WINDING ROAD

Rendellannounces

support for a billthat would leasethe turnpike and

repeal tolls onI-80.

The TurnpikeCommission

proposes tollingI-80 as an

alternative toleasing the

turnpike.

Rendell agreesto halt

concessionplans and

support tolls onI-80.

The legislaturepasses Act 44.

Rendell reviveshis plan to lease

the turnpike.

The FHWAresponds to the

TurnpikeCommissions

application,asking for more

information.

GovernorRendell releasesan estimate thata turnpike leasewould generate$12 billion to$16 billion.Rendell asks thelegislature forpermission toseek bids.

The TurnpikeCommissionmakes its rstAct 44 paymentof $62.5 millionto PennDOT.

The Turnpike

Commissionsubmits anapplication totoll I-80 to theFHWA.

Three groupssubmit bids:Abertis/Citi,Goldman SachsandMacquarie/Cintra.

Macquarie/Cintradrops out of therunning.

RendellannouncesAbertis/Citis$12.8 billionwinning bid for a75-year lease of the turnpike.

The FHWArejects theTurnpikeCommissionsapplication totoll I-80.

Rendell sets anApril 30

deadline for bidsubmissions,

then extends it.

The HouseTransportation

Committeehears testimony

fromAbertis/Citi, the

TurnpikeCommission

and othersabout theproposal.

Abertis/Citiallow their o er

to expire.

JAN

FE

B

MAR

APR

MAY

J

UN

JUL

AUG

SEP

OCT

NOV

DEC

Pennsylvania policy makers have long sought sustainable sources of revenue to support thestates growing infrastructure needs. In recent years, two competing plans have generated

contentious debate. One would lease the Pennsylvania Turnpike to a private consortium inexchange for a large, upfront payment, while the other would toll I-80, another key east-westroute across the state, with permission from the Federal Highway Administration (FHWA).

The PennsylvaniaTurnpike opens.

Construction begins on I-80in Pennsylvania.

November ThePennsylvania TransportationFunding ReformCommission reports thatthe state needs $1.7 billion

in additional annualtransportation funding.

Governor Edward G. Rendellproposes a long-termconcession of the turnpiketo help ll that funding gap.December The state solicitsinformation from rmsinterested in leasing theturnpike.

JAN

FE

B

MAR

APR

MAY

J

UN

JUL

AUG

SEP

OCT

NOV

DEC

20082007

1940

As the nation recovers fromthe Depression, GovernorGeorge Earle signs a billcreating the PennsylvaniaTurnpike Commission, withplans to draw from NewDeal and WPA funds.

1937

1960

The Federal TransportationEquity Act for the 21stCentury is enacted,enabling states to collecttolls for reconstruction andrehabilitation on interstatehighways if insu cientrevenue is available to meetsuch needs.

1998

2006

Exhibit 2

SOURCE: Pew Center on the States, 2009




16/42

offer round. Abertis/Citi raised additional capitalfrom lending institutions that had beensupporting Macquarie/Cintra and increased itsbid by more than $2 billion in the final round. 34

Abertis/Citis winning bid of $12.8 billion wasannounced in May 2008. Because some of thiscash would have been used to pay off turnpikedebt, the final amount that Pennsylvania couldinvest to generate funding for infrastructureneeds would have been about $10.2 billion. 35 TheAbertis/Citi group intended to raise tolls on theturnpike to pay for the lease. According to termsset by the state, the private operator could have

raised tolls on the turnpike annually by 2.5percent or the Consumer Price Index, whicheverwas greater. 36 Under the agreement, Abertis/Citiwould have paid for improvements to the road,including installation of fiber optics to detectaccidents and new toll-collection technologies.

Meanwhile, under Act 44, the TurnpikeCommission had begun making payments toPennDOT.37 The Commission paid $750 million toPennDOT in 2008 and is scheduled to provide anadditional $850 million in 2009 and $900 millionin 2010.38 The Commission is relying heavily ondebt to make its payments in the near term, untiltoll increases and I-80 tolling, if it is ultimatelyapproved improve its balance sheet. 39 UnderAct 44, a 25 percent toll increase went into effecton January 4, 2009, with 3 percent increasesscheduled every year thereafter.

Against this backdrop, Governor Rendell askedthe legislature to approve Abertis/Citis $12.8billion offer. The ensuing months of debate overthe turnpike lease proposal were followed closelyby the public and the press, and organizationsfavoring and opposing the concession produced

reports to support their claims. Legislators werebesieged with information and input fromlobbyists, research organizations, media andconstituents. There was fuzzy math; there wasmisinformation; and there was pure spin, saysRepresentative Rick Geist, Republican co-chairof the House Transportation Committee and aproponent of the deal. The misinformation wasalmost to the point that people thought theSpaniards were going to take the highway andmove it back to Spain.40 Legislative debatebecame stuck around several factors, includingthe states financial assumptions and theproposed oversight mechanism, which would

have left monitoring of the private operator to athree-member board composed of the governor,the transportation secretary and the budgetsecretary. When the legislature failed to vote onthe proposal by the end of September 2008, theconsortium withdrew its bid. 41

At nearly the same time the proposed leasefailed to move forward, the Federal HighwayAdministration rejected the states proposal to tollI-80. The agency required that tolls be used tomeet legitimate operations costs for the highwayitself; the requested tolls would have supportedboth roads and transit in Pennsylvania. 42 The statemay choose to resubmit its request to PresidentObamas Department of Transportation, butunless it receives a warmer reception there, the$946 million average annual expected fundingthat Act 44 was supposed to generate over the

next 10 years will drop to $450 million.43

What happens next? Policy makers inPennsylvania are closely watching the newObama administration, both to determine thelikelihood that tolls on I-80 will be approvedand to see how the states transportation funding


Driven by Dollars


17/42

outlook will be affected by the federal stimuluspackage. With less than $30 billion dedicatedthrough the stimulus to highway improvements,many state officials optimism about a significantimprovement in highway conditions has been

tempered. 44 Major federal transportation fundinglegislation is also due to be reauthorized this year,and policy makers in Pennsylvania and otherstates are watching to see how that may affecttheir needs. Pennsylvania leaders are likely to waitfor signals from Washington, D.C., before takingdramatic action to address their challenges, butstate legislators say that all options must be onthe table. 45 We need a mosaic of fundingsources, says Representative Joe Markosek,Democratic chair of the House TransportationCommittee and an opponent of the lease. Wereone bridge failing away from a major crisis.



We need a mosaic of fundingsources. Were one bridge failingaway from a major crisis.Rep. Joe Markosek,chair of the House Transportation Committee


18/42

Pennsylvania policy makers decided not to leasethe Pennsylvania Turnpike in 2008. But the statesinfrastructure funding gap persists andPennsylvania may once again explore such a deal.Public-private partnerships are likely to come upfor debate in other states as well, as their massiveinfrastructure needs continue to lead themtoward new and different funding sources.

The complexity and implications of these dealsrequire that state policy makers be as wellinformed as possible as they pursue them. Avariety of papers have been written that canhelp leaders think critically about public-privatepartnerships. But much also can be learned fromthe experiences of other policy makers thosewho have decided to enter into a long-term leaseand those who opted not to move forward with adeal, as in Pennsylvanias case in 2008.

During the last six months, the Pew Center onthe States explored how state policy makersshould proceed as they consider a lease of aninfrastructure asset, including the questions theyshould ask and the information they shouldobtain. We examined those principles through astudy of the proposed lease of the PennsylvaniaTurnpike. Our work included reviews of the lease

proposal and relevant documents, and interviewswith state officials and advisors, legislators,representatives of the bidders and transportationand finance experts. Finally, where applicable, wealso applied research we conducted on otherdomestic and international concessions.

The process involved in the consideration of along-term lease of an infrastructure asset fallsinto four main stages:

1. Examining the options: the decision-makingprocess;

2. Lets make a deal: the deal-making process;

3. Show me the money: the financialcomponents of a public-private partnership;and

4. Who will mind the store: the oversight andmanagement of such a deal.

Our analysis describes the key elements of eachstage and assesses Pennsylvanias experience aspolicy makers debated a proposed lease of thePennsylvania Turnpike.

1. Examining the Options:the Decision-Making Process

States have different ways to raise revenues tomeet their infrastructure demands and a widevariety of factors to consider. At the outset, astate should look at a concession agreement inthe context of other methods of raising funds asystem-wide examination of options. Wouldhiking tolls be feasible without a concession? Is it

advisable for the state to take on more debt? Canthe gas tax be raised? Should there be a tax onvehicle miles traveled? Has the state examined allpossible revenue sources before settling on anyparticular one? Every funding option will haveimpacts on taxpayers; on drivers themselves, asthey decide what roads to use and how much

Analysis

Driven by Dollars


19/42

they drive; on businesses along the perimeters of roads; and on traffic congestion, public safety andlong-term environmental conditions.

Assuming that a decision is made to partner withthe private sector, there are still many choices tomake about the most appropriate deal. Each typeof partnership carries its own set of issues and

will be more or less appealing depending on thegovernments goals. Is the main object to raisemoney? Or is it to provide a more efficient meansfor service operation? Is an immediate infusion of upfront cash needed to fund currentinfrastructure plans? Or does the state prefer toensure a stable, long-term source of maintenance

dollars? The complexity of these deals requiresthat state leaders in both the executive andlegislative branches receive substantial educationabout the advantages and risks of each.

Ideally, the pros and cons of public-privatepartnerships should be weighed apart from thespecifics of any particular deal. This kind of

upfront examination is crucial for successfulimplementation of a public-private partnership.According to Deloitte Research, a firmspecializing in private sector analysis,governments interested in pursuing these dealsshould put into place the legislative andregulatory framework needed to guide the


ANALYSIS

IN

WI

UT

GA

FL

RI

NJPA

CA

AZ

NDMT

SC

KY

MS

CO

AK

HI

WA

MO

IL

OR

KS VA

LA

NM

OH

PAVING THE WAY

NY SD

NC

NH

DC

TX

IA

WY

MN

ME

MI

NV

AL

AROK

ID

NE

VT

MA

CT

24 states (shaded) have enacted some sort of legislation to allow public-private partnerships for transportation.

SOURCE: Federal Highway Administration

NOTE: Chicago has home-rule authority to lease its assets and as such did not need state legislation to lease the Chicago Skyway. Maryland does not have a statute expresslyauthorizing highway public-private partnerships; however, it established a public-private partnership program by regulation. Additionally, according to a 1996 state Attorney Generalopinion, the Maryland Transportation Authority has authority to construct toll roads using certain forms of PPPs.

MD

DE

TN

WV

Lease of theNorthwestParkway, 2007

Lease of the Indiana

Toll Road, 2006

Lease of the Chicago

Skyway, 2005

Lease of the Pennsylvania

Turnpike (proposed), 2008

Considering leaseof Alligator Alley,2008

Lease of thePocahontasParkway, 2006

Exhibit 3


20/42

ANALYSIS

Driven by Dollars

contracts because [A] poor legislative andstatutory environment will stymie a governmentsefforts to engage in [public-privatepartnerships]. 46 Nearly half the state legislatureshave approved statutes to authorize public-private partnerships, signaling their willingnessto accept the concept should the right dealemerge. 47 (See Exhibit 3 on page 16.)

How Did Pennsylvania Do?The initial analysis and assessment of

Pennsylvanias infrastructure needs happened asit should have. The Transportation Funding andReform Commission not only identified a massivegap in infrastructure funding in Pennsylvania, butalso began a preliminary exploration of optionsto solve the problem. It recommended that thestate continue to employ user-based fees such as

motor fuel taxes and motor license fees, but alsosuggested that options regarding public-privatepartnerships be explored. The commissioncounseled that principles should be establishedto guide such arrangements. 48

Roy Kienitz, Governor Rendells deputy chief of staff, says the administration explored manydifferent options to meet the infrastructurefunding crisis before concluding that the leasedeal was the best option and starting the biddingprocess in September 2007. 49 The timing of thegovernors proposal to lease the turnpikeconfused many legislators, however, because it

came just after passage of Act 44. In addition topitting privatization advocates against those whobelieved that public assets should remain inpublic control, the debate pitted the neighbors of the turnpike against the neighbors of I-80.

The Pennsylvania legislature had been exploringtransportation public-private partnerships beforethe governor proposed leasing the turnpike, butprimarily as a vehicle to build new infrastructure. AHouse task force had also recently taken a broaderlook at transportation public-private partnerships,travelling to Virginia and Florida. We were trying tolearn from their mistakes and omissions, saysRepresentative Kate Harper, a Republican memberof the House Transportation Committee whoserved on the task force and ultimately opposedthe Pennsylvania Turnpike lease. 50

The lack of agreement between the legislature andthe executive branch on a number of basicprinciples hurt the process. Legislation that wouldhave allowed Pennsylvania to pursue public-private partnerships passed the Senate in June2008, but it expressly prohibited a lease of theturnpike and failed to progress in the House. The

G Does the government have a clear sense of thefunding gap in its infrastructure needs?

G Have all revenue options been examined andcompared, both with and without private-sectorinvolvement?

G Is there understanding and agreement about thegoals of raising revenue and the ways in whichdollars will be distributed among projects or

needs?G Has the legislature adopted enabling legislation

to signal its willingness to consider a concessionagreement with the private sector?

States considering public-privatepartnerships should have clear, data-driven answers to these questions:


21/42

executive branch embarked on the deal, initiatingthe bidding process and entering intonegotiations before the legislature had signaledthat it was willing to consider a concession of theturnpike. The backward process caused a plethoraof related problems and contributed to a highlypoliticized debate that left Pennsylvania and thebidders in limbo for months and ultimatelycontributed to the failed deal.There will not beanother consortium that will proceed in any statewhere they have to put their bids in first and thengain legislative approval to lease the asset, saysJohn Durbin, the former executive director of theTurnpike Commission and now a consultant to

Abertis.51

Reconsidering enabling legislation wouldgive lawmakers the ability to debate the pros andcons of public-private partnerships and to educatethemselves more thoroughly about these dealsbefore they consider a particular proposal.

2. Lets Make a Deal:the Deal-Making Process

The deal-making process itself can determinewhether policy makers ultimately approve apublic-private partnership. From initialinvestigatory studies to assess the value of leasing a piece of infrastructure to theinvolvement of key decision makers in theprocess, these steps ensure both that the stateenters into the deal well informed and thattaxpayers and users are protected.

Due Diligence

Private-sector firms bidding on a public-privatepartnership lease run their numbers through avariety of studies and models before setting aprice with a state. States should do the same.When policy makers are considering a lease, it isimportant to commission studies that fully informthem about what they should expect from a

lease and enable them to negotiate better withbidders. States interested in leasing theirtransportation infrastructure should conduct atraffic and revenue study; a transportationengineering and cost study that examines thephysical characteristics and capacity of thesystem; and an independent and objectivefinancial assessment. The financial assessmentshould combine the information generated in thetraffic and revenue and engineering studies andconsider the value and associated financial risksof the deal in varying circumstances.

The state may already have an inventory

cataloguing the significant elements of the roadsystem, such as bridges and toll plazas. Beforeproceeding with a concession, however, it shoulddevelop an accurate asset register essentially amore sophisticated inventory that includes thecurrent state of repair of each of the elementsand what would be needed to keep them ingood condition. Such a list, while expensive todevelop and maintain, provides a guide to whatwould be leased to the private operator andclarifies the conditions in which the state expectsto receive the road back at the end of the lease.

Policy makers should also contemplate thepotential long-term effects of the lease on theenvironment and the states overall transportationnetwork. To date, concession negotiations in theUnited States have resulted in long-term leases,yet the debates about them have focused

primarily on short-term issues. Its impossible toknow what ground transportation may look likedecades from now. Its crucial, though, that policymakers think about how the transfer of a keypiece of the states infrastructure may affect othermethods of transportation, and the safety andreliability of the entire network.52


ANALYSIS


22/42

As states consider how long they might want tolease their assets, they should give thought to thepotential problems that could arise for futuregenerations. Most of the funds are receivedupfront while the payments to the private sectorin the form of tolls are gathered over time andusually increase in real terms. The currentgeneration enjoys most of the gains from theconcession while future generations face most of the bill. Its important to remember, however, thatfuture generations also will benefit from animproved and well-maintained road systemassuming this is how the state spends theupfront funds. Using them to improve the

finances of the city or state, as in Chicago, canlead to future benefits through lower borrowingcosts. Additionally, if the funds are spent on newtransportation modes or another type of infrastructure, future generations may benefit. 53

Bidding ProcessIf a state is ready to move forward with a public-private partnership, it must conduct thecompetition and negotiation according toprocurement rules, which vary from state to state.The rules often include requirements for thenumber of bidders, the process for submittingbids and the process for awarding a winner.

Private firmsupfront bids are based, to a largeextent, on the parameters the state establisheswhen requesting bids and on the tradeoffs theparties agree to during the final stages of

negotiation. Some of the parameters that drivethe value of the bid include the length of thelease term, required maintenance of the piece of infrastructure by the private firm, and the abilityof the private firm to generate revenue throughtolls or other fees.

Although governments may eye public-privatepartnerships for the money they generate, theseare not inexpensive deals to develop and finalize.Typically, the state retains external advisors, whichadd to the transaction costs of the deal, as do themultitude of studies conducted and legal feesassociated with writing and negotiating theproposal. Of course, the amount of fees varieswith every situation.

Risk Management Dozens of potential issues could materialize overthe course of a long-term lease from aprecipitous decline in revenues after a natural

disaster to an expensive lawsuit following a multi-car collision posing risks to both thegovernment and the private operator. (SeeExhibit 4 on page 20.) The risks borne by thegovernment will depend, in large part, ondecisions made when the deal was formulated.States often see the transfer of risk to a privateoperator as an appealing element of long-terminfrastructure leases. Risk and reward go hand inhand, however. The more risk the state is willingto assume, the larger the payoff the state willderive from the lease, because the privateoperator is left less vulnerable to potential costlyevents. In general, the party bearing the risksshould also have greater control over what canbe done to mitigate them. This factor, too, shouldbe taken into account when structuring a deal. 54

Contracts should generally identify and describethe different circumstances that might arise

and who bears responsibility for dealing withthem. For example, both the Indiana Toll Roadand the Chicago Skyway deals provideprotections to the concessionaire if a futurelegislature takes some action that adverselyaffects them, such as providing replacement

ANALYSIS

Driven by Dollars


23/42

compensation if the action causes the value of the concession to the private operator to drop. 55

For private operators striving to generate profitson leased, tolled roadways, competition in theform of newly built, free roads nearby is notalways welcome. States willing to commit to non-

compete clauses in which they agree not toconstruct competing transportation corridorsroads or transit can sometimes draw higher bidsfrom private operators. The two deals often citedas the precursors to the Pennsylvania proposal,Chicago and Indiana, differ in this area. Chicagodid not agree to a non-compete clause and is in


ANALYSIS

COMMON PUBLIC PRIVATE PARTNERSHIP RISKS

ALLOCATION MITIGATIONDESCRIPTION

Policy /

PoliticalConstraints /Support

Uncertainties regarding

public policy and changein law

Regulatory uncertainties Funding support

Persuasive and supported arguments for project Early regulatory agency involvement Public relations and citizen/policy maker

education campaign Community engagement and buy-in strategy

Public

andprivate

Liability Construction defects Day-to-day operational Subcontractor claims Environmental

Warranties Insurance Well-thought out allocation of liability in

contract based upon party best able to controland mitigate

Innovative insurance products

Publicandprivate

MarketRevenues

Tra c and revenuebelow projections

Competing/alternativeprojects

Excessive capitalmaintenance

Insu cient revenues tofund ongoing operations

and maintenance (O&M)

Investment grade tra c and revenue studiesaccepted by rating agencies

Adequate debt coverage ratios Adequate reserves Credit enhancement, insurance Toll adjustment exibility Careful budgeting processes and O&M controls

Non-compete protections

Publicandprivate(funders/ lenders)

Operations &MaintenanceCosts

Excessive costs of operations

Excessive capitalmaintenanceexpenditures

Unpredictability of costs

Non-recourse nancing Minimum guarantees Toll adjustment exibility Credit enhancement, insurance Careful budgeting processes Capital asset replacement assurances Warranties, incentives and penalties Financially viable private partners Use of private O&M contract Use of xed price/guaranteed maximum pricing,

with escalations and adjustments over time

Publicandprivate

RISK TYPE

SOURCE: Federal Highway Administration, December 2007

Exhibit 4


24/42

fact expanding highways near the Skyway. But if Indiana builds a highway 20 miles or longer within10 miles of the Toll Road, the state mustcompensate the private operator for lost revenue.Indiana opted for a shorter lease than Chicago;the states acceptance of a non-compete clausemay have helped keep its upfront concessionpayment high. (For more on Chicago and Indiana,see the sidebars on pages 6 and 7.)

The tensions between public and privateinterests can be seen in each partys desired levelof flexibility. Understandably, the private operatoroften wants to minimize unknowns through the

life of the lease by leaving as little opportunity forrenegotiation as possible, while the governmentmay prefer to include triggers passing certainmilestones in the contract, for example thatallow the parties to change the terms of the deal.To clarify both the true value of the agreementand the relationship the government and privateoperator will enjoy, these flexibilities and theprocess by which they will be resolved should beagreed upon prior to signing the lease.

Transparency A 2007 report by the Federal HighwayAdministration set out a number of factors criticalto the success of a concession deal. Stakeholderinvolvement, consultation and supportopenness during the deal-making process areparamount. Strong political leadership, if well-informed, can minimize misperceptions

surrounding a concession deal.56

Transparency in concession negotiations doesnot necessarily mean sharing every piece of information with everyone interested in it at alltimes. For example, a group representing thetrucking industry might want to know details of negotiations over proposed toll increases tolobby more effectively against a lease. The statemight withhold some information to protectbidders company secrets or decline to shareadditional information with eliminated bidders.

Balancing stakeholders needs for information withthe states own needs to protect its negotiatingstance is delicate and sometimes difficult for

states to achieve, but it is important for policymakers to remember that a lack of transparencyeven a perceived one can weaken theproposals chances. In 2003, Texas enactedlegislation authorizing public-private partnershipsto build the Trans-Texas Corridor, and constructionbegan. Just four years later, a two-yearmoratorium on all public-private partnerships waspassed after the legislature charged that thestates transportation department had withheldinformation about the deals. 57

ANALYSIS

Driven by Dollars


25/42Pew Center on the States2

ANALYSIS

G Did the state complete appropriate due diligence

prior to proposing a lease of the roadway?G If tolls will be increased, what is the likely effect on

traffic patterns? If increased tolls on the leased roadlead to more traffic on alternative roads, will thegovernment have to spend additional funds toimprove the non-toll roads?

G Will safety on the statewide transportation networkbe adversely affected if travelers avoid the tolls byusing alternative roads?

G Is it unfair that current users get to enjoy thetransportation system that future generationswill be paying for through higher tolls?

G Is one group of individuals being asked to financethe majority of the states transportation needs? Isthat equitable?

G What are the economic and business implicationsfor the state if the concession is allowed?

G How does the proposal take into account thepotential impact on congestion, pollution andland use?

G Was the bidding process fully competitive?

G What are the transaction costs associated with the

deal? Are they reasonable?G What provisions for flexibility are written into the

lease? Can the government and the private operatormake choices related to level of service,maintenance, etc., to reflect changingcircumstances?

G What risks do the public and private sectors bear inthe deal? Does the financial structure of the leaseaccount for risks borne by the state or the privateoperator?

G Does the party bearing the risk also have controlthat allows it to fix problems that arise related tothat risk?

G If the lease is awarded, can the state still buildcompeting and/or complementary roads ortransportation routes? If not, what are the long-termimplications?

G Is the process adequately and appropriatelytransparent, with sufficient involvement from thepublic and other stakeholders?

G Do both the executive and legislative branches haveaccess to the information they need to make a sounddecision?

States considering public-private partnerships should have clear,data-driven answers to the following questions:


26/42

How Did Pennsylvania Do?Due DiligencePennsylvania conducted extensive legal, financialand comparability analyses while consideringleasing the turnpike to a private operator. Thestates financial projections were based in part onstudies conducted by the Turnpike Commission,including a May 2008 financial report required byAct 44 that was written by Public FinancialManagement, an independent advisory firm. Each

study relied on independent traffic estimates, listsof operating and capital projects, and revenueand toll estimates supplied by the Commission. Inaddition, myriad other reports and analyses wereproduced on the lease proposal, including somecommissioned by the legislature and otherspublished by research and advocacy groups. (Thereports, which came to a variety of conclusions,may have served to add questions, rather thananswer them. 58 For example, For Whom the Road

ANALYSIS

Driven by Dollars

The Regional Plan Association, an independentregional planning organization dedicated to

economic competitiveness issues in the New York-

New Jersey-Connecticut region, suggests sensible

ground rules to help protect the public interest

throughout a deal-making process.

The first rule deals with full disclosure during the

deal-making stage. Given that concessions fall

outside the normal business process, the group

suggests that state governments should aim for a

higher degree of transparency and disclosure to

encourage public support. It recommends that

governments should:

G Disclose publicly what funding will be lost that

might need to be replaced with other

government funding if revenue from the asset is

no longer collected by a public agency.G

Disclose the full text of any contract used toestablish the public-private partnership.

G Disclose, early on, the future allowable toll

schedule, including starting toll rates and the

degree to which variable tolls may be used in

the future to help manage congestion and

performance.

G Disclose any non-compete agreements orother contract language potentially impacting

the expansion of other transportation

infrastructure.G Disclose the current performance, operation,

maintenance, environmental and labor

standards on the asset in question.G Disclose the performance, operation,

maintenance, environmental and labor

standards to which the private sector will be

held and how the contracts will ensure high

performance operation and management of the

affected corridors.G Hold legislative hearings and town hall

meetings on the subject, and allow sufficient

time for meaningful public input and legislative

review.G Disclose transactions costs, including fees to

investment banks, financial advisors, lawyers

and other professionals retained by the publicsector to analyze and craft the partnership.

Source: Regional Plan Association, Proceed With Caution: Ground Rules for a Public Private Partnership in New Jersey, January 8,2007, 13-14, http://www.rpa.org/pdf/rpappp01082007.pdf (accessed February 18, 2009).

GROUND RULES


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Tolls, a report commissioned by the DemocraticCaucus of the House Transportation Committee,spends five pages critiquing the assumptions of acompeting report by Morgan Stanley, whichadvised the administration in the deal. 59)

Bidding ProcessThe bidding process was conducted according tostate law and was fully competitive within thescope of responsible bidders; companies large andsophisticated enough to manage the concessionwere given multiple chances to refine their offersto meet the states requests and requirements.Fourteen original bidders was a sufficiently large

group; the addition of the best and final offerround allowed for a competitive process and thehighest proposed upfront lease payment.

Risk Management In its allocation of risk and reward, thePennsylvania deal was quite simple. All themoney was to be received as a single one-timepayment and there was no arrangement forrevenue sharing down the road. Unlike theIndiana Toll Road deal, but similar to the ChicagoSkyway, the agreement did not contain a non-compete clause, leaving Pennsylvania free toconstruct a competing road. Additionally, theconcessionaire bore the risk if revenues camein lower than anticipated. Although TurnpikeCommission Vice Chair Tim Carson told statelawmakers that the risk to the concessionairewas minimal because of the turnpikes historical,

predictable cash flows, ridership on the turnpikefell in 2008.60

Carson also noted the states inability to quantifyall the risks that might arise during the life of thelease. Over a 75-year period, I think we can allagree that theres the risk of the unknown

unknowns, he told legislators. If we had donethis 75 years ago, what would we have put in theconcession agreement? I think we could all agreewe wouldnt have gotten it all right. And wewont expect to do it now. 61

Ultimately, every long-term concession deal willpose questions about risk and flexibility that cannotbe easily or immediately answered. It is difficult toknow how the needs of drivers and businessesusing the turnpike may change over the nextseveral decades. The governors office believed,however, that under the lease proposal, the statecould have forced Abertis/Citi to make changes to

the turnpike that policy makers deemed necessary,and Abertis/Citi would have been allowed toincrease tolls as a result.62 Abertis/Citi agreed thatsuch changes along with the associated increasein toll revenue could be negotiated. 63

Transparency The Pennsylvania deal was rare in that a biddingprocess occurred before the legislature hadenacted enabling legislation broadly authorizingpublic-private partnerships.There was never achance for the legislators to really buy in even if theyd wanted to, says Shuey, executive director of the Senate Transportation Committee. The naturalresponse of the general assembly, having beenignored, is to get its fur up and lash out a bit. 64

Pennsylvania officials acknowledge that theylimited stakeholder involvement including with

members of the legislature and citizens duringthe negotiation phase of the proposed lease.They said they held back information about thebids and the content of the lease to ensure thecompetitiveness of the process and freedomfrom potential outside interference. 65


ANALYSIS


28/42

In the end, the perceived lack of transparency fromthe governors office may have hindered the dealschances. Some legislators felt they lacked sufficientinformation or were not involved enough in theprocess to persuade them in favor of the lease. In aMarch 16, 2008, statement, Roger Madigan, thenthe Republican chair of the Senate TransportationCommittee, said: The complexity of this issue andthe extremely limited amount of information thathas been flowing to the public and the GeneralAssembly creates a very steep learning curve foreveryone outside of the administration in dealingwith a significant public policy decision.66

The process might have benefited fromadditional information sharing, at least with thelegislature. But, as noted earlier, a number of legislators who had supported Act 44 andconsidered it the states preferred plan wereconfused when the governor resurrected theturnpike lease and were disinclined to favor it.Their transparency concerns may have giventhem another reason to oppose it.

3. Show Me the Money:Financial Analysis

Long-term infrastructure leases are complex dealswith serious implications for drivers, businesses,communities and a states economic future. Butthe money usually grabs the headlines billion-dollar headlines in the cases of the Indiana andChicago leases. Behind those dollar signs areassumptions about the assets worth, expected

investment returns and ability to generate newrevenue, and how the monies will be spent. Both astate and a private operator use these assumptionsto decide whether the deal is worth it.

RevenuesThe financial assumptions and rules built into apublic-private partnership from the outsetdetermine how much money a lease generates fora state and how those funds should be spent.Some governments want upfront, one-timepayments to last until the lease expires, but othersare content to use them as a shot in the arm toupgrade their infrastructure dramatically andquickly. (See Exhibit 5 on page 29.) In Indiana, forexample, the $3.8 billion upfront payment for theToll Road is being used to pay outstanding tollbonds and to fund theMajor Movesprogram, thestates 10-year transportation plan. A large upfront

payment does not drive deal making in all cases.Sometimes a state opts for a smaller first paymentwith the promise of additional revenue over futureyears. The Pocahontas Parkway in Virginia, forexample, features a revenue-sharing agreement. If the concessionaire achieves a pre-tax, internal rateof return of 6.5 percent, the Virginia Department of Transportation is entitled to 40 percent of excesstoll revenues. This entitlement increases to 80percent if the internal rate of return equals 8percent. 67 Other times, governments pursue thedeals because they believe the private sector canoperate the road better.

Looking at the concession prices in France

versus those paid for the Chicago Skyway

and the Indiana Toll Road, researchers Germa

Bel and John Foote concluded that the

American deals were designed to maximize

the upfront payment the government

received, with longer deal lengths and more

aggressive toll-setting allowances. 68 In contrast,

European concessions tend to be driven less

by financial gain and more by the search for

operational efficiencies.

ANALYSIS

Driven by Dollars


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States pursue long-term infrastructure leases withdifferent revenue targets and needs in mind. But if they intend to save any of the principal for futureuse, they must assume interest income into theircalculations of the leases value. These assumptionsinclude everything from the states funding needsand obligations to the expected rate of investmentreturn in 50 or 75 years if policy makers have a

goal of stretching the monies that far

For a private firm, the main value proposition restsin its ability to raise revenues through tolls. Themost significant reason for the relatively highprices paid for the Chicago Skyway and IndianaToll Road is that the private operators can usually

raise tolls at a faster rate than the governmentshad historically increased them. 69 In Indiana, forinstance, the average toll paid more than doubledwithin two years of the concessions start. 70 In allof the American road concessions, the agreed-upon toll escalation rates guarantee that, at aminimum, the real price of tolls will remainconstant or increase. In Europe, in contrast, toll

increases are functions of a combination of inflation, productivity improvements, quality of service and errors in forecasted traffic volumes.For example, in France, the concessions of itsmotorway system arrange for the real price of tollsto fall over the concession term, because rates areset to rise at only 70 percent of inflation.


ANALYSIS

France - Autoroutes de la France

Facts and FiguresG Leased in 2006G 4,654 miles of roadG Three separate deals at prices of $14.12 billion,

$10.65 billion and $28.16 billion 1

G Leases expire in early 2030sG Annual toll increases are limited to 70 percent

of the Consumer Price Index, which means that

tolls actually decline in real terms

France entered into three separate concessions

of its highway system in 2006. Each bidder hadto provide a business plan and an industrial

(enterprise) plan. With the requirement of these

two documents as part of the bidding process,

the French government required a higher level

of transparency, especially for the financial

assumptions adopted by the bidder. This step

has not been required in any of the existing

American concessions.

Within the business plans the bidders were

required to disclose their assumptions about

traffic volumes, toll revenues, required

maintenance and capital expenditures/

investments and the financial structure (level of

debt/equity). The industrial plans disclosed details

about how the bidders would approach a variety

of issues related to the roads, including how they

would be operated and maintained, and how

management and labor questions would be

addressed. Both plans were subject to review,

comment and examination of reasonableness by

the French government and formed an integralcomponent of the bid-evaluation criteria.

Source: Daniel Albalate, Germa Bel and Xavier Fageda,Privatization and Regulation of Toll Motorways in Europe (IreaWorking Papers, University of Barcelona, Research Institute of Applied Economics, March 2007).

1 Assuming exchange rate at the time of 1 Euro to $1.18.

THE FRENCH DEAL-MAKING PROCESS


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The concession agreements seen to date in theUnited States stretch over a longer time framegenerally 75 or 99 years than in Europe, wherethey tend to last 20 or 30 years. The principalreason for the difference is the desire in theAmerican deals to attract the highest possibleupfront payments. The concessionaires are morewilling to offer higher bids if they will have alonger term over which they can collectand raise toll revenue. Some experts alsobelieve that other factors, such as tax laws,drive American concession lengths. If theconcessionaire is deemed the constructiveowner of the highway by virtue of controlling

the road beyond its usable life, depreciationexpenses from the highway can be written off on federal income taxes. 71

Additional financial considerations are factoredinto the deals worthiness by both the private andpublic sectors. For example, the private sectoroften faces higher borrowing costs. Unlike thepublic sector, it cannot issue tax-exempt debt.Some proponents of such concession dealscontend, however, that the higher costs of financing are offset by improved operations andcapital efficiency, investment returns and oftenthe willingness to raise tolls higher and morefrequently than the public sector. With regard toall questions of the cost of capital, policy makersshould not base their decisions solely on taxpreferences or exemptions, or assume that it isalways more costly for private operators to

borrow consider that state interest rates formunicipal bonds have increased substantiallyover the last year just as policy makers cannotassume that the private sector will necessarilyoperate more efficiently than the public sector.

ExpendituresThe Regional Plan Association, an independentregional planning organization dedicated toeconomic competitiveness issues in the NewYork-New Jersey-Connecticut region, suggeststhat the revenues obtained from a concessionshould be used to ensure the future of the statestransportation capital program and improve thegovernments long-term fiscal stability. 72

Chicago will spend the majority of its leasepayment by 2013, eight years after it struck theSkyway deal. Although none of the funds wereallocated to transportation-only projects, they

enabled Chicago to pay off $463 million of existing Skyway debt; refund $392 million of long- and short-term general obligation debtissued by the city; create two reserve fundaccounts, one of which generates $25 millionin annual interest for the city; and start aneighborhood funds account. Those moves ledto Standard & Poors raising Chicagos generalobligation bond rating, which lowered the cityscost of borrowing in the future. In Canada,Torontos decision makers took a shorter-termview after enacting the concession of Highway407. Each resident of Ontario received a $200payment from the concession proceeds, withthe remaining funds placed in the provincesgeneral revenue fund which can be spent onnon-transportation needs. These funds werenot dedicated to long-term investment or anyspecific capital projects.

ANALYSIS

Driven by Dollars


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How Did Pennsylvania Do?The financial terms of the proposed turnpike leasefell short in several ways. First, the state assumed itwould be able to earn more interest income thanseems feasible. The turnpike lease would havegenerated less money annually for infrastructureinvestment than Act 44 if tolling on I-80 wereallowed. Finally, the state did not specify how the

lease proceeds would be spent, and the compositionof the proposed board that would make thosedecisions raised questions among lawmakers.

RevenuesPennsylvania would have received a $12.8 billionupfront payment from Abertis/Citi. After paying off

turnpike debt, the state expected to have $10.2billion left to invest. It assumed a 12 percent annualreturn on its investment; that income would havebeen used to pay for infrastructure improvements.

A number of observers questioned the statesassumption of an annual 12 percent return,which Governor Rendells administration cited asthe 20-year average annual return of thePennsylvania State Employees Retirement System(SERS). We were asked [by the administration] touse 12 percent because that was what SERS hadachieved over the last 20 years, says Rob Collins,managing director of the infrastructure banking

unit of Morgan Stanley, the states advisor.73

SERSitself does not use that average to forecast itsfuture returns but instead uses 8.5 percent, whichis higher than the median 50-state assumption of an 8 percent return on states pension fundinvestments as of December 2007, according toresearch by the Pew Center on the States. 74 In anOctober 2008 assessment of the proposed lease,Moodys Economy.com reported thatPennsylvania would have needed an averageannual return of 9.8 percent to fund $1 billion inannual infrastructure spending. 75 That returnwould be difficult to achieve, according toMoodys; the recent decline in the stock marketaffirms that belief. In fact, had the deal gonethrough, it is difficult to know how much thestate would have lost on its investment in the lastyear, because although it used the pensionsystem returns as an assumption, it would not

have been required to invest the concessionpayment in that particular fund.

Lawmakers considered the lease in comparisonto Act 44, which is projected to generate morethan $1 billion annually for the state if tolling isallowed on I-80 but only $450 million a year if it


ANALYSIS

G How does the proposed term of the leasecompare to other concessions? Does the termmake sense for the states goals?

G Should the state pursue a lease that maximizesthe upfront payment or opt for a different modelthat might include revenue sharing?

G Will the upfront funds from the concession be usedto create a sustainable source of revenue for thefuture? If so, how far into the future will they last?

G How should the revenue from the concession bespent? Who should decide?

G How were the states financial assumptions built?Are they reasonable?

G How do tax treatment and borrowing costs affectthe government and the proposedconcessionaires financial assumptions?

States considering public-privatepar

pew center p3 study

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