The Route to a Financeable Toll Road

The Route to a Financeable Toll Road

June 01, 2004

By Douglas M. Fried and Jonathan Finklestone

Toll road development on a public-private partnership basis is expected to increase in various regions of the world in the months and years ahead. This article discusses issues that toll road developers should address in order to have a financeable project.


Many countries in Europe, Latin America, Asia, the Middle East and Africa are exploring road development through the use of public-private partnerships. Just before the European Union expanded from 15 to 25 member states on May 1, the European Commission published a “green paper” discussing the compatibility of European Union law and public-private partnerships. The green paper observed that over the last decade, countries have resorted with increasing frequency to public-private partnerships, which, in “view of the budget constraints confronting Member States . . . meets a need for private funding for the public sector.” The green paper noted that trans-European transport networks that have fallen behind schedule for lack of funding could benefit from recourse to public-private partnerships.

According to Infra-News, the Irish public-private partnership road sector “looks set to gather pace again in 2004 with several DBFO (design, build, finance and operate) pre-approved projects being prepared for tender and a few others expected to reach financial close in the next few months.” Infra-News noted that “the government reaffirmed its support for the role of PPPs in upgrading the Irish road network and did not rule out the possibility of procuring more privately financed roads projects which are not a part of the current national roads improvement program.”

A recent article in Project Finance International noted that “the central government of Mexico laid out a new plan last year to attract nearly US$2bn in investment to an ambitious toll road construction program modeled on the European private-public partnership (PPP) scheme.” According to the article, the Mexican government is planning to issue tenders for nine new toll road developments in the first instance and, overall, “the government has identified 30 individual projects that are appropriate for the concession regime.”

The Brazilian Senate, according to the Economist magazine, is considering a public-private partnerships law to allow for the development of roads. The Economist explained that “Brazil has 1.5 million km of road, but just 11% of that is paved” and to keep the economy growing at a healthy pace, “Brazil needs to invest 15 billion reais ($5.1 billion) a year in transport.”

The Moscow Times recently reported that the deputy prime minister, Vladimir Yakovlev, announced that the Russian government plans to enact a federal law on toll roads in 2004. He is reported to have told the European Investment Bank that Russia needs to build approximately 1.5 million kilometers of new roads in order to normalize the situation on Russian roads. He stressed that roads transport development requires huge financing and that the development of toll roads could be the solution.

The Treasury Department in South Africa recently announced that standardized PPP provisions, which govern public-private partnerships for toll roads and other projects, have been finalized. An article in the Sunday Times newspaper noted that the new “provisions aim to optimize private-sector investment in modernizing public services and infrastructure through a common approach to risk transfer, risk-sharing and reducing the time and cost of negotiating deals.”The newspaper noted that one of the active steps the government has taken to address the infrastructure backlog is “strongly backing the development of public private partnerships.”

Finally, the Polish News Bulletin reported recently that the transport industry in Poland faces an “historical opportunity, as entry barriers to the huge and lucrative EU market are about to be removed.”

Financeable Project?

Recognizing that there may be an increase in development of toll road projects on the public-private partnership model is an important first step, but once the markets are identified, then the relevant question for the toll road developer is, “ What key factors determine whether a particular project will be financeable?”

Strong government support at the national, regional and local levels is essential. Toll roads can become a “hot potato” in political campaigns with opposition parties vowing to cancel a project if elected. Lenders will be concerned about the risk that a project will be cancelled if there is a change in government. Since the development of a project can take many years and demand significant resources in order to achieve financial close, broad crossparty support is important. A developer might also consider asking the government to reimburse certain development costs in the event the project is cancelled.

One of the principal features of a public-private partnership is that the private sector enters into an area that was previously the exclusive domain of the public sector. The government might have to enact special legislation to support the toll road development. Legislation may be needed authorizing the private sector to charge, collect and enforce the payment of tolls or authorizing the government to enter into the necessary contractual arrangements with the private sector to provide financial support, tax incentives or other benefits to the project. If government support is required, potential lenders will make an evaluation of the ability of the government to provide such support and to pass the necessary legislative programs. A toll road needs a solid legal foundation. Problems have arisen. For example, in Hungary, soon after a new toll road opened, litigation ensued over the level of tolls that could be charged. The project ended up with a cap. The cap impaired the ability of the developer to repay its lenders.

One of the greatest risks in any toll road project is how sound the forecasts are of road use. A developer might try to mitigate this risk by arranging for government support or guarantees of minimum traffic levels or revenue. As a quid pro quo, the government might ask to share in upside revenues if use of the toll road or revenues are above those originally forecast.

An important factor that will affect traffic volume is whether the public enjoys easy access by use of connecting roads and interchanges. Another factor is what alternative routes are available to drivers who do not want to pay the tolls. The lenders will want to know what plans the highway department and other private developers have to build other roads that might siphon off traffic. If the road is a “greenfield” development project with little or no supporting transportation infrastructure, then a developer might need an undertaking from the government to build a network of connecting roads and interchanges within a certain time frame. Connecting roads have the potential to funnel traffic onto the new toll road from existing roads. The location of interchanges could determine whether a highway will serve local traffic as well as intercity traffic. For example, interchanges just a few miles apart will encourage more local use of a highway, whereas interchanges that are many miles apart could discourage local traffic. A pristine highway will be of little benefit if the public cannot gain access to it.

Conversely, a developer might want the government to impose restrictions on competing modes of transport such as parallel roads and railways. The consequences are obvious if, following completion of a new toll road, the government decides to build a new freeway running parallel to the toll road or if the government decides to develop a rapid transit network in close vicinity to the project. The natural instinct is for governments to resist such demands. However, if a government retains the right to build parallel roads or alternative modes of transport, then the developer should consider asking the government to provide some form of compensation or support if competing modes of transport are put in place. A government traffic or revenue guarantee will not only mitigate the “traffic” risk inherent in the toll road project, but also, by its nature, compensate a developer for the impact of a failure by a government to build connecting roads or the development by the government of competing modes of transport. A traffic or revenue guarantee will also act as an incentive to the government to build connecting roads to help increase traffic flow on the toll road.

The Concession Contract

The concession contract is a central feature of a privatelyfinanced toll-road concession. The concession contract grants the developer, or the concessionaire, a concession to develop, construct (or improve), operate and maintain a road in exchange for the right to collect tolls during the concession period. The concession contract lists the respective rights and obligations of the government and the concessionaire. It might also address the rights of the lenders to receive termination payments and under what circumstances the lenders may step in to remedy defaults or replace the concessionaire.

The period of the concession should not be any shorter than the term of the debt. It is preferable for the concession period to be longer than the term of the debt in the event the concessionaire’s debt is not repaid as originally anticipated. There may also be circumstances when the term of the concession will be extended automatically in order to preserve the revenue generating period of the road, such as in the case of events of force majeure and other events that are recognized to be beyond the control of the concessionaire.

The project lenders, among other things, will focus on the termination rights in the concession contract and ways to mitigate their risk in the event of early termination of the concession contract. Careful analysis of the circumstances requiring the government to make termination payments and the amount of such payments will be required. The amount of the termination payment will vary depending on whether the termination occurs as a result of a breach by the government or by the concessionaire or is due to no one’s fault. In projects where a government termination payment is possible, the creditworthiness of the government will be an important factor in attracting project debt. Even if a government agrees to make termination payments, if the country’s credit rating is not high enough, the project still may not be able to raise project debt without additional credit support. Lenders will also want the right to cure concessionaire defaults and, if necessary, to replace the concessionaire with a substitute entity.

Another critical issue is whether drivers will be willing to pay tolls. In many countries, a privately-operated toll road could be a driver’s first experience with the concept of paying tolls to use a road. Developers rely on outside experts for traffic forecasts. An expert will review the projected traffic trends in the country and the particular region of the country where the road is to be located, historical trends in road usage, economic expectations and forecasts and finally the impact of the level of the toll rate on the projected usage of the road. While traffic studies are necessary, it is important to keep in mind that they are only projections of future traffic flow and not guarantees of future traffic levels. Frequently, downside scenarios of varying levels of forecasted traffic are used to assess whether a project will be robust enough to repay its debt if some or all of the basic assumptions in a project’s base case change. Due to a general unwillingness of drivers to pay for sharp increases in toll rates and political considerations to keep tolls low, if traffic levels drop, it may not be possible to keep increasing the toll rate to compensate for the loss of revenue caused by lower than projected traffic.

Since concession periods are often long term, the manner in which the toll is adjusted will be of great significance. The concession contract might provide for toll adjustments in several ways. One option is to tie the level of tolls to certain costs of the concessionaire. For example, if the concessionaire has a foreign currency debt facility, it may want the toll rate (which will be payable in local currency) linked to changes in the relevant foreign currency exchange rate. Another option is to adjust the toll for inflation. Other adjustments to the toll rate might be made to guarantee a pre-determined minimum return on equity to the sponsors. The government might prefer that the sponsor keep tolls low to increase traffic volume, especially if a traffic guarantee is provided by the government. Regardless of how tolls are adjusted, at some point, increases in the toll will deter people from using the road (if there are other options) and will cause a decrease in traffic, reducing overall toll revenues. The lenders will want to see an analysis of how sensitive demand is to the toll charged.

The method of charging the toll will also have an impact on overall revenues. The concessionaire should analyze whether different classes of vehicles should be charged different rates. Should the toll be a flat rate or should it be charged by distance traveled? Should there be different tolls depending on the day of the week, the time of day, or the time of year that a journey is made? Complicated toll structures might optimize revenues in theory, but may be too complicated for the public to understand and deter drivers from using the road.

At the end of the day, both the sponsor and the lenders have a similar goal of finding the right toll to ensure revenues will cover all of the concessionaire’s obligations plus a reasonable return on equity that is not too high for the market to bear.

In order to make a concession more attractive and to further bolster revenues, the concession contract might also give the concessionaire the ability to receive revenues from other activities along the road, such as from service stations, fiber optic cables, real estate development (such as hotels and retail outlets), advertising and other rights. The concession contract should specify the additional activities the concessionaire will be able to engage in, in addition to developing and maintaining the toll road and collecting a toll. If the government reserves the right to grant third parties the right to undertake such activities, the concessionaire should make sure that the granting of such rights to third parties will not interfere with the toll road or depress revenues.

Site and Permits

Private toll roads are usually built pursuant to fixed-price, lump-sum, date-certain turnkey construction contracts. The construction schedule and related deadlines are linked to deadlines in the concession contract. The construction contracts provide for payment of liquidated damages by the contractor if the road is not completed on time. They may also give the contractor a bonus if the road is completed ahead of schedule. If the project site has not yet been delivered by the government, the government should have a deadline to deliver the right of way over the site to the concessionaire so that the construction can stay on schedule. The site may either be delivered on one occasion or in stages during the construction period. A concessionaire should be compensated for late delivery of the right of way by the government.

The concession contract should address environmental sensitivities and should also include provisions addressing country-specific issues that require special attention. For example, the consequences of discovering archaeological artifacts in countries like Italy, Greece and Israel may require specific treatment. The route of the road may be through environmentally-sensitive areas and there may be opposition from local communities, landowners or environmental groups. The government should be better equipped than the concessionaire to manage such opposition.

Some governments, recognizing the importance of a quick and efficient permitting process,may introduce a streamlined approval process just for this project. A quick and efficient system to obtain permits and approvals can help avoid unnecessary delays and costs.

Design Modifications

A common problem in toll roads is time and cost are both of critical importance to a private developer while government officials might not be as focused on completing construction on schedule and might feel that they have the continual right to require the concessionaire to make changes in the design of the road. Design or operational modifications can have a “domino” effect on the construction schedule and add to future operating expenses.

A concessionaire should analyze the extent to which the government’s engineers may be involved in the continuing design of the road and the basis for compensation payable by the government (including the timing of payment) in the event design or construction changes are made at the government’s request. A concessionaire should protect itself against an unlimited obligation to implement design changes requested by the government. A concessionaire will also want to be satisfied that the construction specifications and operational criteria are clearly established. Ambiguous criteria could lead to frequent disputes between the concessionaire and the government. Governments and concessionaires frequently have different expectations. It is better to identify these at the start of a project by making the contract as detailed as possible.

Some concession contracts require the concessionaire to expand the toll road by increasing the number of lanes or lengthening the toll road. A concessionaire may take future expansions or extensions into account in its original design of the project. For example, to reduce the future expansion costs, it may build the highway “outside-in,” meaning that minimal disruption of the highway will result from the addition of lanes on the median. If the concessionaire has an obligation to lengthen the highway, careful consideration should be given to how the extension will be financed. For example, will the revenues from the extra sections of road be enough to finance construction of these sections or, if new sources of income are introduced, what will be the intercreditor arrangements among the different tranches of lenders? This can get extremely complicated.


Ultimately, a successfully-structured toll road project can make a significant contribution to the development of a country and the overall welfare of its citizens. A careful balance must be struck among the competing interests of the developer, the government and the lenders. The challenge is to find an equitable balance where the risks and responsibilities are allocated to the party best able to handle them. A well-structured toll road project can be a rewarding enterprise for all concerned.