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The 'P3' dilemma: How effective are public-private partnerships?
By Len Boselovic / Pittsburgh Post-Gazette
August 10, 2014
The first of a four-part series.
Cash-strapped governments around the country that are reluctant to raise taxes are increasingly plunging forward with bold experiments: enlisting investment banks, pension funds and other eager investors to fund billions of dollars of highway, bridge and other infrastructure projects.
In Chicago, then-Mayor Richard M. Daley plugged a short-term budget gap in 2009 by turning over 36,000 metered parking spaces for 75 years to a private venture organized by Morgan Stanley. With little information and little time to analyze the transaction, Chicago’s city council overwhelmingly embraced the deal and its upfront payment of $1.2 billion.
At about the same time, Pittsburgh Mayor Luke Ravenstahl had considered a $452 million plan to rehabilitate his city’s woefully underfunded pension plans by privatizing parking. City council members rejected it.
Based on Chicago‘s experience, it’s probably just as well Pittsburgh didn’t go that route.
Escalating meter rates and longer meter enforcement hours are just the start of Chicago’s problems. Six months after Chicago inked the deal, the city’s inspector general conservatively estimated the city received $974 million less from the 75-year lease than it would have received by keeping the meters and operating them under the same terms it gave to the investors.
Moreover, terms of the parking meter lease and the 99-year, $563 million lease of four city parking garages to another Morgan Stanley partnership in 2006 require the city to compensate the private operators for meter revenue lost when Chicago takes actions that crimp revenue. Those actions include closing streets for festivals or parades, creating lanes for buses or bicycles, or allowing someone to build a competing parking garage.
So far, the operators have billed the city for $61 million in reimbursement.
Just how much more it costs motorists to park now is evident in the private operator’s results. While the meters collected about $24 million in the last year the city operated them, last year they took in $135.6 million, generating a $43.6 million profit for the Morgan Stanley investors.
Chicago’s experience illustrates many of issues that can occur when governments rely on public-private partnerships, or P3s. The long-term agreements are so complex that government officials often times do not realize what they are agreeing to, critics contend. They can result in unanticipated costs and limit a government’s ability to serve the public interest.
While greater private sector involvement offers the promise of delivering more efficient infrastructure sooner and at a more affordable price, critics say the widespread use of federally-backed loans makes the relationship less private than advertised and puts taxpayers at risk.
Nevertheless, Pennsylvania and other states increasingly are turning to P3s as a way to supplement limited public funding and deliver more thoughtfully designed roads, bridges and other infrastructure.
Over the next four days, The Post-Gazette will examine why states are pursuing public-private partnerships, what kinds of projects they are undertaking, the private sector players involved, and whether the partnerships are living up to their potential.
Government by another name
Public-private partnerships are the intersection where investors eager to cash in on America’s $3.6 trillion infrastructure needs collide with taxpayers and elected officials unwilling or unable to provide the money. P3s are based on long-term agreements that turn over to the private sector infrastructure traditionally built and operated by the public sector.
They are government by another name.
While P3s are common in other parts of the world, they have been slow to catch on in the United States, much to the chagrin of investors eager to provide the funds. But that‘s changing.
Texas, Virginia, Florida and other states are using such partnerships to build toll roads to relieve urban congestion. Indiana and Kentucky are partnering with private investors to build bridges over the Ohio River. A P3 was used to erect a $495 million court house in Long Beach, Calif., where private investors will operate the state-owned building for 35 years.
Denver is using a P3 to build a commuter rail line. Maryland wants to do the same in its Washington, D.C., suburbs. On the other side of Washington’s Beltway, a $2 billion ”managed“ lane P3 project allows Fairfax County, Va., commuters to avoid I-495 traffic jams by using express lanes where tolls vary based on the speed of traffic. In Baltimore, a P3 accelerated expansion of a terminal at the state port, enabling it to accommodate the larger ships expected to move through the Panama Canal starting in 2016.
Pennsylvania, after rejecting proposals to privatize the turnpike and state lottery, is getting into the P3 business. Legislation enacted in 2012 allows the state Department of Transportation to enter into public-private partnerships. The first major project involves hiring a consortium to build and maintain about 600 state bridges for about 30 years.
Underlying the debate is the fact that P3s allow government officials to avoid being blamed for raising taxes, tolls and making other unpopular decisions to generate the $3.6 trillion that the American Society of Civil Engineers estimates is needed by 2020 to restore the nation’s roads, bridges, airports and other infrastructure.
“It‘s really about a political unwillingness to do what is necessary,” U.S. Rep. Michael Capuano, D-Mass., said at the March hearing. “As a former city councilman, mayor, and congressman, none of us like raising taxes. ... Let’s be honest about what this is.”
“Magic pixie dust”
President Ronald Reagan‘s plea to “get government off our backs” inspired a mistrust of government’s ability to efficiently provide roads, schools and other vital services at a cost taxpayers can afford. Mr. Reagan encouraged the belief that the private sector can do a better job. The result was replacing government workers with private sector workers who mow lawns around government buildings, collect trash, operate school cafeterias and buses, and provide other services under government contracts.
P3s are more far-reaching undertakings than hiring private companies as contractors. They involve turning over infrastructure to private investors who can design it, finance it, build it, operate it, and maintain it.
The ventures are attractive to cash-starved governments, which sometimes get hefty upfront payments. Even when they don‘t, investor funds enable governments to take on projects they might not otherwise be able to afford. The deals also fit many taxpayers’ notions about cutting waste, eliminating bureaucracy, and running government more like a business.
“P3s are one of the better tools we have out there for addressing a need, and that need is a lack of state and predominantly federal funding,” said Rodger Rochelle of North Carolina’s Department of Transportation.
That state recently approved $655 million plans to add 26 miles of toll lanes along a heavily traveled stretch of I-77 near Charlotte. Cintra, a Spanish infrastructure firm, leads a group that will design, build, operate and maintain the lanes under a 50-year lease. Cintra’s other P3 projects include the Indiana Toll Road and State Highway 130, a Texas toll road that recently defaulted on bank debt.
Many believe the transportation funding deficit stems from Congress’ failure to raise the gas tax that supports the highway trust fund.
The tax has been 18.4 cents per gallon since 1993. Cars have become more fuel efficient since then, with fuel economy increasing 5.5 miles per gallon since 2007, according to the University of Michigan’s Transportation Research Institute. The institute also documented that the distance driven by motor vehicles each year peaked in 2004 and has declined since, further crimping revenue from the tax.
Rather than anger constituents by raising the tax, Congress has dipped into general funds, used pension accounting gimmicks, and relied on stop gap measures that don‘t provide a long-term solution to the funding shortfall.
“When you want to raise revenue beyond what the public would accept, you do it in a P3 contract. You can say the privatizer is the evil one because they’re charging too much,” said Cornell University’s Mildred Warner, a critic of privatization.
In an environment where tax increases can be career-ending events for elected officials, “P3s are kind of a magic pixie dust,” said Phineas Baxandall, senior analyst for U.S. PIRG, a coalition of state consumer watchdogs that is critical of such deals.
Investor opportunity
The public funding shortfall “presents institutional investors with an unprecedented opportunity,” Standard & Poor’s wrote in a January report. Pension funds, foundations and other institutional investors like P3s because they can generate predictable, long-term returns no matter what happens to the economy or inflation.
Investors have provided an estimated $200 biIlion to fund more than 100 U.S. infrastructure projects, according to Prequin. The investment research firm said investors in infrastructure funds organized in 2010 have realized median returns of 14.9 percent. Infrastructure funds have outperformed private equity funds since 2008, Prequin said.
P3 investors include government pension funds. Camelot Global Services, the British company that offered Pennsylvania more than $34 billion for the chance to operate the state lottery for 20 years, is owned by the Ontario Teachers Pension Plan. Pension plans covering Dallas police and firefighters invested in a $2.9 billion, 52-year P3 that built 13 miles of tolls lanes near the Texas city.
Financing for P3s comes from a mix of government and private funds and includes cash and debt, including billions in low-cost, federally guaranteed loans that P3 operators can use. How much each party puts in and how long the agreement lasts depends on how the deal is structured.
Private investors like longer agreements because they supply a cushion should revenue fall short of projections. Agreements lasting 50 years or longer provide tax benefits that sweeten investor profits. Another factor is how risk — from cost overruns, construction delays, revenue shortfalls and other potential problems — is divided between the public and private sector. The riskier a P3, the more cash private investors generally have to contribute.
The agreements detail how often and how much private operators can raise tolls and parking rates, at what point the government receives a cut of the profits, and how well the project must perform.
Performance-based P3s call for investors to receive government funds only when a project is completed and payments based on standards included in the agreement. Because private investors want to ensure return on their investment, the agreements specify when they are to be reimbursed for government actions that threaten their revenue — provisions that haunt Chicago officials.
Another figure that investors rely on is projected revenue. Texas’ State Highway 130, which defaulted on about $686 million in loans on June 30, is not the only P3 where traffic forecasts exceeded reality.
“Optimistic projections falling short is a bit too common in this space,” said R.J. Gallo, head of Federated Investors‘ municipal bond investment group.
Terms of the deals
Because of the complexity of concession agreements, negotiating terms can take months as each side seeks to identify problems that could occur over the decades-long life of the project and protect themselves from those risks. A cottage industry of consultants, attorneys, financial experts, lobbyists and public relations professionals has sprung up. A November meeting about Pennsylvania’s P3 bridge project drew representatives from nearly 150 engineering and construction companies, investment banks, law firms and other organizations.
Many feel governments are at a disadvantage in negotiating long-term deals because private industry can better afford the high-priced expertise.
“The knowledge level of the private side is so far above the knowledge level of the folks at state departments of transportation, well above the level of state lawmakers, and well, well above the knowledge level of the average voter and motorist out there,” said lobbyist Ryan Bowley of the Owner-Operator Independent Drivers Association, which represents professional truckers hard hit by toll increases on P3 roads.
The Government Accountability Office concluded in 2008 that state governments aren‘t capable of providing the proper oversight.
One of the problems, critics contend, is the lack of public information about terms before agreements are approved and, in some cases, the rush to approve them. Chicago’s City Council only had a few days to consider the parking meter deal. Privatization of the Indiana Toll Road was also approved after a short debate.
“Everybody had a deer-in-the-headlights look,” Indiana state Rep. Terri Austin told the House Transportation committee at a February hearing.
Earlier this year, a group of Colorado lawmakers and a clean energy group protested after lawmakers and the public were not allowed to review terms of a 50-year P3 involving U.S. Highway 36 near Denver.
Officials of the Colorado Department of Transportation withheld details, saying they did not want to reveal proprietary information to competitors of Plenary Group, the Australian infrastructure developer leading the investor group that was awarded the concession.
The claim that some terms should remain confidential bothers Lee Cokorinos. The Silver Spring, Md., public interest research consultant describes it as “the biggest loophole for proper vetting.” Columbia University professor Elliott Sclar, a P3 critic, agrees.
“If it’s such a good deal, why do they have to hide all of this? That’s a warning flag,” he said.
■ Part 2: The 'P3' dilemma: Partnerships often fall short of taxpayers' expectations
■ Part 3: Pennsylvania is moving ahead with P3 plans
■ Part 4: The 'P3' dilemma: States learn partnerships come with hazards