Monday, August 06, 2007

Reason response on private toll roads

Reason's Len Gilroy is a good friend of mine, and he wrote such an excellent and thorough comment on my recent post on private toll roads that I asked him to convert it into a full guest post:

Tory's July 30th post on public vs. private provision of toll roads obviously generated a great deal of interest and discussion among his readers. As a policy analyst at Reason Foundation, it's been my experience that there's a great deal of complexity and misunderstanding regarding public-private partnerships in transportation, several of which were raised in Tory’s post and subsequent comments. Given that, I'd like to clarify a few issues that arose in the discussion.

Non-compete clauses: Non-compete clauses are often trotted out as an argument against private toll facilities. Opponents like to refer to the SR 91 express lanes in Orange County as the prime example of why non-compete clauses are a “bad” thing, but the reality is that non-compete/competing facilities agreements have evolved a lot since those days (for reference, see my colleague Bob Poole’s analysis of the SR 91 here). Today's "competing facilities" provisions strike a better balance between the public and private interests. They rarely, if ever, ban all "free" road additions near the toll road; instead, they usually provide for compensation for reduced traffic, rather than forbidding public-sector roadway additions.

Let's look at the SH-121 project in Dallas, for example. The CDA agreement TXDOT originally negotiated with the Cintra/JPMorgan team (of course, intervening political factors make it likely that this project will be transferred to NTTA) defined a "competing facilities zone" on either side of the toll road. Certain additions of non-tolled highway capacity within this zone would be subject to compensation, but only if the private concessionaires could demonstrate reduced traffic and revenue from those new roads.

More importantly, excluded from compensation would have been all portions of major freeways, all limited-access highway lanes, and all projects in state and regional transportation and mobility plans.

A few key points:

  • The concessionaires would have no right to prohibit any future road development.
  • Their only remedy would be compensation, and that's only if they could prove a loss of revenue.
  • That remedy only applies to a narrow category of road projects other than major planned projects.
  • As a counterbalance, the agreement would have given TxDOT the right to extra toll revenues due to any positive traffic impacts on the toll road from TxDOT road improvements.

There are similar provisions in the concession agreement for SH-130 segments 5 & 6, which will extend the SH-130 toll road south of Austin towards San Antonio. Not only does this agreement exempt from compensation all upgrades and capacity increases planned in the state transportation improvement plan, the state's mobility program, and the Austin and San Antonio-Bexar regional transportation plans, but any effects of I-35 expansion are also non-compensable. (for more on this, see my colleague Peter Samuel's post on here)

Some critics, such as State Senator Robert Nichols, have complained that a 50+ year toll concession would extend farther into the future than typical metro area long-range transportation plans. While this is true, it's likely to have little practical impact. Let's look again at the SH-121 project. The reality is that by 2030, the area near the toll road will be so built out as to make it extremely costly for anyone—-be they public or private entities-—to add new highways beyond those already planned. It’s also useful to look to the example of the land near the Chicago Skyway, which the Mayor Daley leased for 99 years. The concession agreement in that case includes no protections from competition at all because the area is so heavily developed that it makes new roadways extremely unlikely. It's even been rumored that the Indiana Toll Road concession originally did not include a competing facilities provision, but that (a very limited) one was added at the request of some elected officials, not the concessionaires.

It's certainly possible that changing circumstances will require revisions to a 50+ year concession agreement, which is why they all include detailed provisions to allow changes during their term. They have detailed provisions for negotiating/arbitrating disputes and employing independent third parties to make fair financial estimates.

It's also important to remember that the state is certainly free to negotiate concession agreements that have little or no protections from competition. But the trade-off is that it would further increase the toll road company’s risk, and would presumably decrease the amount of revenue it could commit to sharing with the public sector.

Toll increases & profits: Many opponents of toll concessions point to fears that profit-maximizing firms would raise tolls to sky high levels. This is one of the most specious arguments out there. The reality is that the concession agreements negotiated to date (Indiana Toll Road, Chi Skyway, SH-130 segs 5&6, for example) include strict maximum caps on annual toll increases, typically indexing them to some measure of inflation (CPI, etc.). The agreement for the SH-121 concession even would have included a far-below-inflation cap if actual inflation levels would have risen above a certain level. Further, the actual toll rate chosen by the concessionaire may not actually reach the maximum allowed under the cap. It may indeed be the case that a lower-than-max rate would be the rate that would maximize customer usage & revenues.

Regarding profits, governments can always limit the rate of return a concessionaire is allowed to make, with surplus revenues going into a state transportation fund. California’s original pilot program for long-term concessions used this approach, as have the concession agreements here in Texas.

Costs of capital & discount rates: When comparing money flows over time, it's standard practice to use some form of interest rate to discount future flows to present value. For investors contemplating an investment, a key issue is the value of the resulting cash flows over time. From the investor's standpoint, the discount rate used reflects the level of risk associated with future cash flows. The nature of the investment will determine the appropriate rate to use, and for a toll road project, a government entity should be given a higher discount rate than a private concessionaire for reasons discussed below.

Now some observers have noted that private companies have an inherently higher cost of capital than a public authority with access to tax exempt bond funding; hence, the public sector would build a road cheaper. I'd argue that this line of thinking misses an important point. As the ultimate beneficiary representing the public, the "investor" in the case of a toll road is some government entity, say TxDOT. It has a choice between two "investments": either a private concessionaire or a public sector toll authority (like HCTRA or NTTA). From the investor's perspective (i.e., government perspective), the internal costs of capital (public vs. private) are of little concern. They're interested in the annual payment--the bottom line, so to speak. Once a private concession is signed, the annual lease payment is almost certain. It has the same priority for payment as operating and maintenance costs, and, as per the contract, must be paid before debt service, taxes, or dividends to shareholders.

But for a public toll authority like NTTA or HCTRA, future payments to the state would come only after the payment of operating costs, debt service, etc.--and only if there is money left over. A reasonable investor would be more skeptical about the value of these future payments than a private proposal, and would assign a higher discount rate to the public authority. This was a point made repeatedly by TxDOT and PriceWaterhouseCoopers' analysts regarding the risks associated with turning the SH-121 project over to the NTTA.

Add into that the conservative tax-exempt bond markets vs. private capital markets that absorb more risk. Private entities doing project-specific financing for new road projects can raise more significantly more capital than a public toll authority. Public toll authorities generally don't do project-specific financing--they have to basically leverage their entire systems to do new projects (like NTTA will do with SH-121, if they ultimately reach agreement with the RTC & TTC), with the inevitable downgrades from ratings agencies. So at some point, after leveraging up their systems repeatedly to take on new projects, they are likely to become overleveraged and increasingly find it more difficult to take on new projects.

This is a critical point, since one of the implicit goals of SB792 was to get the local and regional toll authorities like NTTA and HCTRA to take the hundreds of millions of dollars in the bank they're sitting on and invest those funds into the many new projects needed to reduce congestion and improve mobility in Texas' metro areas. The new market valuation process established under SB 792 is precisely designed to do this (see a summary of the process here--warning, large PDF).

Another interesting aspect of SB 792 is that local and regional toll authorities now have the power to do concessions (if they're reauthorized during the next session), just as TxDOT and Regional Mobility Authorities have had. Florida's toll authorities also recently got the same powers, as did a few in Virginia. So we may see more of even the public toll authorities turn to concessions to get new roads built and avoid the inherent limitations of government financing.

Lastly, it's also important to remember that the feds have established some vehicles-—TIFIA credits and Private Activity Bonds, for example-—to make tax-exempt funding available for a portion of the costs of new facilities done through public-private partnerships.

Thanks much to Tory for facilitating the discussion. I'd like to point readers to a few of Reason pieces that will help to shed more light on these and other issues surrounding public-private partnerships:

  • The Role of Tolls in Financing 21st Century Highways (May 2007)
  • Tolling and Public-Private Partnerships in Texas: Separating Myth from Fact (May 2007)
  • Building New Roads Through Public-Private Partnerships: Frequently Asked Questions (March 2007)
  • Len Gilroy, Senior Policy Analyst, Reason Foundation

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    At 11:17 PM, August 06, 2007, Anonymous Anonymous said...

    There are two reasons why I think the govertment's lower cost of capital are meaningless.

    Isnt Investment in government bonds tax free meaning that we are losing tax revenue somewhere else. Also, government bonds are a safer investment because they will raise taxes before they default.

    I think government should retain control over toll roads because theorectically they will maximize social welfare. Tolls should be a little lower on government owned roads, as opposed to the expected tolls on roads owned by a profit maximizing firm. Every extra car on the toll road is an extra car off of the surrounding roads. Thus reducing traffic on the surrounding surface streets and on other freeways.


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