Drop in Traffic Means Rise in Guaranteed Profits for Private Road “Investors”

Well, that’s not exactly the headline on the front page of the Wall Street Journal last week. The actual one was “Drop in Traffic Takes Toll on Investors in Private Roads” (subscription required). The Journal nails that part of the story, but only briefly addresses the way that the private companies that build these roads have already reacted by shifting to more favorable (to them) contracts arrangements that virtually guarantee their profits.

One of the theoretical benefits of privatizing a government asset or service through a lease or equivalent is that it hedges future risk by transferring it to the vendor. That obviously comes with a price tag, but that’s clearly because it has value. It provides predictability to the government.

In practice, these contracts have proven to be so stacked in favor of the vendor that the taxpayer retains most of the risk. For example, in the case of the Chicago parking meter lease, the city retains the risk resulting from any street shutdowns due to construction or events like the NATO summit. They have to pay the vendor compensation if anything impairs the value of the meter system. Pretty much the only risk the vendor took on was whether or not people would continue to put quarters into the machines. Similarly, when the Borman Expressway flooded and Indiana decided to make travel on the Toll Road free until it was drained, the state had to pay compensation to the vendor for this. The flood risk was retained by the state. This doesn’t mean it was a bad deal. In fact, it remains a great deal – one of the best from a taxpayer perspective. But the degree of risk transfer can be overstated. The price to construct and maintain roads is pretty well understood by the people doing these deals, so the main risk to the vendor again was revenue risk – would people keep throwing money in the toll baskets?

Well, apparently even just the revenue risk was significant. The Great Recession, a traffic drop off instead of increases, and prices stoked by irrational exuberance have put many private road operators in financial distress. According to the Journal, one such operator – American Roads, LLC – is already in Chapter 11. Their bond insurer is alleging fraud from deliberately inflated traffic projections. The Indiana Toll Road consortium may file bankruptcy. The Dulles Greenway is struggling.

Across the country, toll roads are carrying less traffic than projected. The Metropolitan Planning Council put together this chart showing the trends (via Streetsblog Chicago):

For toll roads run by the government, this is a real public risk. But for privately run roads like the Indiana Toll Road, it’s the investors problem. That’s the beauty of these deals and shows that privatization can work. As Indiana Gov. Mitch Daniels said of his state’s toll road lease, it was the best deal since Manhattan was sold for beads, only this time the natives won.

Perhaps predictably, the private road industry has responded by changing contract terms. Instead of these leases where revenue risk lies with the vendor, they’ve decided they can’t take on any risk at all, so they are now doing business with states increasingly under what’s called an “availability payments” model. What’s this? Well, according to AASHTO:

Availability payments are a means of compensating a private concessionaire for its responsibility to design, construct, operate, and/or maintain a tolled or non-tolled roadway for a set period of time. These payments are made by a public project sponsor (a state DOT or authority, for example) based on particular project milestones or facility performance standards…..Availability payments are often used for toll facilities that are not expected to generate adequate revenues to pay for their own construction and operation. In this case the project sponsor retains the underlying revenue risk associated with the toll facility rather than the private partner. Also in this manner, there is less overall risk to the private entity than with a full concession. Rather than relying on achieving certain levels of traffic and revenue, the concessionaire receives a predictable, fixed set of payments over the life of the agreement. The concessionaire also can rely on the public agency’s credit to secure financing rather than unpredictable toll revenue.

A couple things jump out immediately. First, if the road can’t pay for itself via tolls, isn’t that a flashing red light that says it doesn’t make economic sense from a transport perspective?

Second, from the standpoint of the private vendor what’s not to love? You basically have a similar deal structure as before, except that now instead of tolls that might not materialize, you have a contractually guaranteed, predictable revenue stream from the state. They’ve converted a variable revenue stream into a fixed one. In effect, these deals hand the only real risk that was outsourced, the revenue risk, right back to the taxpayer.

This immediately raises the question as to what the actual value of this type of deal structure is from a taxpayer and motorist perspective. It seems to be a sort of design/build/maintain contract with a mixture of funding sources all of which ultimately fall back on the state and its availability payments stream. Why resort to this type of structure which greatly adds to the opacity of the transaction and makes it much harder to tell if the public got a good deal or not?

Some people say that one source of value in these transaction is the fact that private entities don’t have to comply with cumbersome government procurement rules. But it took nearly three years for the Port Authority to contract its Goethals Bridge replacement project based on availability payments. And one of the parties is a major construction company so it doesn’t seem like that’s big deal here. Possibly, as with the previous leases, this will generate a bunch of tax deductions that in effect siphon off a subsidy from Uncle Sam. I don’t know.

In the case of the project to build two new Ohio River bridges in Louisville, Indiana is using an availability payments based P3 for its bridge, while Kentucky is using a more traditional toll finance system for its side. There’s been little discussion of the merits of these approaches. There are certainly questions in my mind. For example, Indiana has talked about saving $225 million. But if savings materialize during the project, who actually gets them? If the vendor has their payments stream locked in, any savings would fall straight to their bottom line. The same should be true of overruns (though with the way these contracts are written, I wouldn’t take that to the bank), but given the limited number of competitors for these mega-deals and the general lack of visibility into the transaction, I suspect that these guys know going in where they can save a lot money to juice their profits. State DOTs routinely bid projects that come in well below the engineer’s estimate, as they rightly try to be conservative on costs. But in this case the actual savings might not actually flow to the taxpayer but to the vendor.

Is that actually the case? I don’t know. Nor have I seen much in the way of discussion on this in the mainstream press. Given the huge dollars at stake and the risk in any government contract that the taxpayers might get fleeced, the use of these not very easy to understand and model contracts with non-obvious value propositions to the public makes it hard for a financially challenged media to really provide any sunshine. I’d love to see the Journal do a deep dive on this issue, because somebody needs to really trace through the value, the money flows, and the risks associated with these deals.

In the meantime, specialty sites like Toll Roads News have provided some interesting coverage. It’s clear the use of availability payments is ramping up. Here’s their piece on the Goethals Bridge project. They also note that “Indiana to take traffic and revenue risk from outset of procurement of P3 for Illiana Expressway.” Illinois appears to be gearing up for an availability payments model on their share of the Illiana.

Their piece call “Illiana P3 meaning stretched by availability payments – P3s 101” raises a number of excellent points. Here’s an excerpt:

Boosters of the Illiana Expressway in the empty countryside south out of Chicago are suggesting by their choice of words that the public private partnership (P3) envisaged puts major risk on “investors”. The Northwest Times newspaper for example had a headline that the governors of Indiana and Illinois were in town to “pitch Illiana Expressway to investors.”
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However when a P3 is not a toll concession but an availability payments deal (an AP-P3) it is fundamentally different. Now the P3 operator is entitled to be paid for having the highway available to the state regardless of traffic and revenue. The road has only to be operated and maintained – at rather predictable cost – and the payments roll in. They are quite independent of the traffic and revenue. The state may run a toll operation on the road but it assumes the traffic and revenue risk.
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The great bulk of the risk – residing in the traffic and revenue forecasts – is assumed by the state and its taxpayers just as surely as if it was a state tollroad operation. AP-P3s then don’t look for real “investors.” They look for contractors, big contractors with a big contract, but a contract all the same..

Bingo. Public officials are using the lingo “investment” when what they are really doing is creating a very complex and opaque construction contract. It’s very misleading. No one should be surprised when down the road we discover the taxpayers got pillaged on these days. Of course, these contracts no doubt have non-disclosure agreements designed to protect the “confidential” information of the vendor that make it unlikely the real financials will ever be fully known by the public.

In any event, this is emerging area clearly needs much more public scrutiny than it has gotten to date.