Outlook For Private Investment In US Infrastructure | Norton Rose Fulbright
The panelists are Gregory Carey, chairman of the public sector and infrastructure department at Goldman Sachs, Jacob S. Falk, acting director of the office of infrastructure finance and innovation at the US Department of Transportation, Stuart Marks, senior investment director for Meridiam Infrastructure North America, Fadi Selwan, chief operating officer of VINCI Concessions/Development, James S. Simpson, commissioner of the New Jersey Department of Transportation, and Thomas Suozzi, a senior advisor to Lazard Frères & Co. The moderator is Doug Fried with Chadbourne in New York.
MR. FRIED: Greg Carey, the Port of Miami Tunnel and the I-595 highway were structured as availability-based transactions in which Florida will pay the private concessionaires an amount based on the availability of each project rather than having each concessionaire take traffic risk by tying its compensation to the tolls it can collect.
The Goethals Bridge replacement project is also expected to be an availability-based deal.
Canada has a market structured around availability-based deals.
Do think this will become the predominant model in the United States?
MR. CAREY: No, it will not be the predominant model, but you will see it in certain places. Each of the 50 US states has its own politics. You will see availability payments when a state is looking to shift risk. Look at the Denver FasTracks deal, which is availability based. You will see a lot of availability-based deals in transit because people will not take the fare box risk.
I believe you will see a lot of the new builds, greenfield-type projects like the West-by-Northwest highway in Georgia and the Midtown tunnel in Virginia. Each is different. The trend is for greater private sector participation in new builds. If you look at LBJ (I-635) and the North Tarrant Expressway in Texas, Texas put about a billion dollars of equity into both of those deals. Five years ago, it would not have done so. The market has evolved. Availability deals shift construction and operating risk to the private sector.
As the states get more tight fisted with dollars, they will look for alternative delivery methods.
MR. FRIED: Stuart Marks, is there a future for traffic-based deals in the US?
MR. MARKS: Yes. The procuring authorities have to consider a range of financial and political considerations when deciding whether to undertake a project. They play into the decision first whether to do a public-private partnership. P3s are just one method of procurement that governments consider across a range of different tools. Once the decision has been made to do a P3, financial and political considerations determine whether to do a traditional toll risk-based deal or an availability-based deal or a managed lane deal, which is a unique product in between.
MR. FRIED: Will there be more managed lanes projects in the US going forward?
MR. MARKS: I think so. It is a new and innovative procurement methodology. The fact that two projects have now closed successfully — LBJ and North Tarrant — has built investor confidence in the model. However, it is not for the faint hearted.
Investors benefit from having an existing data base of traffic performance.
MR. FRIED: What was the greatest challenge you faced in trying to close LBJ and North Tarrant?
MR. MARKS: The fact that it was a relatively new product. We spent a lot of time educating funders and the credit agencies about why we think it made sense. It helped that the Dallas Police and Fire Pension Fund invested as it shows support of a local pension fund. We expect to see more pension funds involved in projects.
MR. FRIED: Fadi Selwan, how does your analysis of a managed lanes project differ from a pure toll deal or some other transaction?
MR. SELWAN: For me, managed lanes are a service we are providing to the commuters. When we build managed lanes, it is usually on existing roads. You add two lanes and you manage them, or you extract two lanes from the road and you put them in the managed lanes system. They are just a service you provide commuters.
MR. FRIED: How reliable are the traffic projections given the nature of a managed lanes project?
MR. SELWAN: I know that of all the traffic studies that have been done in the last 20 years, almost none has been right. The managed lanes are on an existing road. You know what the traffic is today, and you know that by improving the road you might increase the traffic. Then you have to estimate how many drivers will decide to switch to the managed lane. How many will be prepared to pay $5, $10 or $20 just to gain 15 minutes?
The main issue is to calculate the value of time. It varies by country, state, city and suburb. If you can calculate the value of time, then you can evaluate how much of the traffic will switch to the managed lanes.
MR. FRIED: Do you think managed lanes are an easier sell politically because use of the lanes is optional?
MR. SELWAN: Yes. We are operating a managed lanes project in California, and it is working well. The toll can increase by a factor of five in the course of the day. No one is complaining because they know that they have a choice.
MR. SUOZZI: A single driver’s behavior can change from day to day depending on whether he has a meeting that day, what is going on with his job and the economy.
The politics may not be as straightforward as the question suggested. Some drivers will see more choices. Others will see a reduction in free lanes.
MR. FRIED: The demographics of the area and the average income of the people in the area will have an effect.
MR. SIMPSON: It is very difficult in a dense urban area to
take away one lane. You just can’t do it. It is a lot easier to add capacity.
A lot of up-front work needs to be done by the private sector before coming in to see public officials about a potential project. Developers should focus on the problem they are trying to solve. Are we trying to fight congestion or we are trying to improve performance or improve operating costs?
MR. CAREY: When managed lanes started being discussed 10 years ago, they were called Lexus lanes. People complained, “You are only doing it for the rich.” Has that complaint disappeared or are you still hearing it in northern New Jersey?
MR. SIMPSON: It is still an issue.
MR. FRIED: Jake Falk, there is PR-22, a brownfield procurement underway currently in Puerto Rico. People are also waiting for the brownfield procurement for the Luis Muñoz International Airport in Puerto Rico. What do you think the prospects are for brownfields in the US market going forward, or will the US be mainly a greenfield market?
MR. FALK: I will call it an existing asset rather than a brownfield so that we don’t have any confusion with Superfund sites. The trend in the last few years has been to move away from big privatizations like the Chicago Skyway, the Indiana Toll Road, the Northwest Parkway and the Pocahontas Parkway, toward greenfield or new-build projects. However, this will vary ultimately by jurisdiction.
We may also see a hybrid or joint model in the future that has some brownfield components and some greenfield components. There are benefits from the standpoint of public sector acceptance to combining these components into a single project where you can see we are not just selling an asset, but we are also getting additional new infrastructure in return.
MR. FRIED: Jim Simpson, last year Richard Zimmer of the New Jersey Privatization Task Force said that the state was preparing P3 legislation. What is the status of the task force’s recommendations?
MR. SIMPSON: We need P3 legislation. New Jersey Transit has P3 legislation. We are doing an RFP for parking. We have so many parking facilities that are run like mom-and-pop organizations. Some are free, some charge, but there is no overall plan. New Jersey Transit is not in the parking business, so we put out this RFP for parking.
As far as the other recommendations, we have a proposal that just went out for the Turnpike because our costs are so high. They are high across the state. This is where the opportunities are for P3s. The backdoor way is to come in and handle all the maintenance first, lower the costs and inject the DNA for a profit motive. There is no penalty for nonperformance in a lot of the states. I have been a private sector guy most of my life, and my DNA is about bottom line and cost efficiencies. There is none of that in government.
Transit agencies across the country are the most inefficient operations in the United States.
MR. FRIED: This is why we need the private sector.
MR. SIMPSON: I am leading up to that point, but the public doesn’t always like it. When I go to public meetings, we have to have bomb-sniffing dogs. There are 500 protesters. I do not use the term privatization. I call what we do outsourcing. The public does not understand the difference between privatization and P3. Both have become dirty words, at least in New Jersey.
We are moving forward, but we do not yet have P3 legislation. We are looking at how Pennsylvania did it as a possible model.
MR. FRIED: Let’s shift gears. Stuart Marks, how do we fill the funding gap?
MR. MARKS: With a number of sources — taxable and tax-exempt debt, private equity and federal funding like the TIFIA program. It would help if private activity bonds were available for social infrastructure projects.
MR. FRIED: Jake Falk, tell us what is happening with TIFIA. Will it be expanded? Will it expire?
MR. FALK: Demand for TIFIA funds is several times the available funding.
The Obama administration is asking for an increase of $450 million in funding for the program in fiscal year 2012. That would triple the amount of loans that the program can handle. Both Republicans and Democrats pressed the Department of Transportation last week in a Senate hearing to expand the program. There is also significant support among House Republicans for an expansion.
MR. FRIED: So we are heading in that direction?
MR. FALK: It is too early to say. With Congress focused on deficit reduction, it is not clear whether there will be additional money for anything.
MR. CAREY: Congressman John Mica, who heads the transportation committee in the House, is making a push to shorten the environmental process and move projects more quickly through the selection process. His big issue is how long it takes these projects to get done. Look at the SR 125, road project near San Diego. The environmental process took 11 years. Jake, can you talk about that?
MR. FALK: There is a broad agreement that the project delivery mechanisms are inadequate.
We have fallen into a pattern of the design-bid-build environmental process, and it is an approach that needs to be updated. The administration definitely hears that. President Obama talked a lot earlier this year about the regulatory process and how we fix it. There is a lot of interest on the Hill to deal with that.
P3s have done a very good job over the last few years demonstrating an alternative delivery approach that works. Looking back on the last five years, we have some really positive experiences with P3s. For example, the Capital Beltway project and the innovation that the private sector was able to bring to that project changed the view of the public sector about how project delivery can work.
We expect the issue of how to fix the delivery process to be an important part of any reauthorization discussion this year in Congress.
MR. CAREY: All the TIFIA money over the last 18 months seemed to go to mass transit projects that have metal wheels.
MR. FALK: To be fair, not all the money went to metal wheel projects; there have been others. An example is the TIGER program where we are working with the US 36 road project near Denver. The trend with TIFIA until recently was that it was much more of a toll road type of program. The administration has brought in a lot of other types of infrastructure that would not have received TIFIA funding before. TIFIA is much more of a multi-modal program now. Highway projects will continue to receive funding, but expanding TIFIA to mass transit projects and multi-modal facilities is a good thing.
National Infrastructure Bank
MR. FRIED: Senators Kay Bailey Hutchison and John Kerry introduced the BUILD Act recently. It would create a national infrastructure bank to provide financing for transportation, water and energy projects. They want the bank to have $10 billion in initial funding. People have been saying that the bill could leverage up to $600 billion in private infrastructure investment.
Tom Suozzi, what are your thoughts about a national infrastructure bank, and do you think it could fill the funding gap?
MR. SUOZZI: It would help fill the funding gap.
People have been talking about a national infrastructure bank for decades. Felix Rohatyn in our office has been pushing for such a bank for a long time. The President came out last year in favor of a national infrastructure bank, but he wanted to house it in the Department of Transportation and focus on transportation projects. Representative Rosa DeLauro has been talking about it for a long time. She wants to do a $50 billion national infrastructure bank.
Now two Senators — a Republican and a Democrat — have taken up the cause in the Senate, and they have co-sponsors, including Senator James Inhofe, a very conservative Republican. The focus is no longer just transportation.
One of the things you see in the Kerry and Hutchinson proposal is that a certain percentage of the funding has to go to rural projects. The politics of the Senate, with two Senators from each state, mean that any bank that emerges will have to make sure that some of the money is directed to smaller states like South Dakota. The figure is on the order of 5% or 10%.
There are two major parts to any national infrastructure bank: how do we fill the funding gap and how do we take politics out of deciding which projects get funded?
The bank will be government owned, but it will not be a federal agency. It will be managed by a board with seven outside directors — private sector types of people — that will pick projects. This is itself a political issue because we would be taking away a prerogative that members of the transportation committees in Congress have enjoyed in the past to direct federal funds to favored projects.
MR. FRIED: President Obama offered his own infrastructure bank proposal as part of his 2012 budget. Are all these proposals evidence that our national political leaders are becoming more aware of the potential uses of PPPs?
MR. SUOZZI: Certainly there is an awareness in Washington. You have a guy like John Mica who is very good and understands his stuff. You have Kerry, Hutchison and Inhofe. You have the Obama administration. They all get this stuff. But Congress is dealing with some very large issues this year. The issues include Libya, federal budget deficits and high unemployment. It is hard to break through that fog and talk about a policy issue like funding for toll roads.
I talked with a colleague of mine in our office in Spain. I asked, “Why do you think the rest of the world has been so much better at getting the private sector involved in public infrastructure when compared to the United States?” Very simple answer: America never had to do it before. We always had the money. Other governments could not raise the capital in the public sector, so they had to go to the private sector. America is now in a new situation. It needs new approaches. The job for people who want to see more deal flow and want to see these projects happen is to do a better job educating the policymakers and the public about how the private sector can help fill the funding gap.
MR. FRIED: Fadi Selwan, you have done projects around the world, so you have a broad perspective on what makes these projects work. From your perspective now coming to the United States and trying to develop projects, do you think that the states and the federal government are doing enough to help finance infrastructure projects?
MR. SELWAN: It is a tough question. I am not able to say how US policies are doing. However, what I can say is that we have been here for two or three years now, and in those two or three years, we have already had two bad experiences. The first was in Pittsburgh, where we bid on a project and it was cancelled. The second was with the Florida High Speed Rail project, which was cancelled two weeks ago. The government had been pushing eight foreign companies to come, and just poof, like this, the governor said, “I don’t want it any more.”
Those examples are very hard to live with.
You have the availability scheme, and you have the traffic risk scheme. Which one is selected turns on whether the government wants the end user to pay. Neither type of project is able to support itself without some kind of government involvement. That is why a national infrastructure bank is important.
You have such arrangements already all over the world, but not in the US. If you don’t have interest from the state, then the project will die. The state may think it is saving money, but in fact it is losing a lot of money because it is not improving the local economy.
MR. SIMPSON: I do not think there is an awareness in Washington. The national infrastructure bank is a great idea, but if you look at the authorization plan that the Obama administration came out with, $10 billion for a bank is absolutely nothing for the whole country. It is two or three rail projects.
In a six-year authorization, the Federal Transit Administration had about $13 billion to give out for rail projects, and that barely scratched the surface. It frightens me that people don’t understand what $10 billion will really get you on a nationwide basis.
The high-speed rail plan is a red herring. Just take a look at Washington, DC and New York on Google Earth. Then look at Tampa and Orlando, and put them side by side. Look at the differences in density. First, there are not enough people in Tampa and Orlando to support a project between those two points. Second, there is not a large enough business community to support a high-speed rail project between those two points. Third, who wants to go 170 miles an hour with two stops when you are only going 87 miles. The project doesn’t make sense, and the costs were underestimated, which happens across the country. The estimate was that ridership would equal Acela. That’s impossible.
You need to pick the right project. The Transportation undersecretary was very proud that they put a high-speed rail project together in two days. The government was looking for a shovel-ready project. That is a recipe for disaster. Why not take that money and put it into the Washington-to-New-York corridor where that system is falling apart?
MR. SELWAN: Everywhere in the world you have high-speed trains. Everywhere people are developing them. The US government found a project that may not have been economically viable, but it was a prototype for high-speed rail to be used more broadly in the US. This is what the states and the government should support. If they do not support this kind of project, then future projects will never be built.
MR. FRIED: Stuart Marks, without a robust brownfield market, will more infrastructure funds look to invest in greenfield projects?
MR. MARKS: There is a different set of risks. Investors will have to get comfortable with construction risk, for example. The investment horizon of the funds is important. The Meridiam Fund, for example, and other greenfield funds have long-term horizons. We are a 25-year fund, and that’s important when you are looking at greenfield projects because some of them have a four, five or even six-year construction period. Shorter-term funds cannot support those types of projects.
MR. FRIED: Fadi Selwan, what fundamentals are investors currently looking for when deciding whether to invest in a greenfield project?
MR. SELWAN: We look for steady cash flows guaranteed, a high internal rate of return, and some upside without paying for it. That’s what most investors are looking for.
But most important of all is a viable project. What I mean by “viable” is an accepted project that will not be under continuing pressure from the politicians and the public because it is not the right project for them.
Investors also look for a steady partner — that’s normally an industrial partner — who will be able to handle the operations and maintenance over the long term.
Finally, the most important thing for me is that I need steady rules and regulations. I don’t want to have to renegotiate everything in two or three years because the rules have changed. We need a stable political climate.
MR. SUOZZI: Predictability, yes.
MR. FRIED: Tom Suozzi, Stuart Marks mentioned the Dallas Police and the Fire Pension System investment in the LBJ and North Tarrant road projects. We have heard that the Oregon Public Employees Retirement Fund wants to invest and the California State Teachers Retirement System may want to do so as well. Do you expect to see more pension funds entering this market?
MR. SUOZZI: When I looked into this last fall, there were about $200 billion in private funds and $30 to $40 billion in pension funds earmarked for these types of investments. The hard part for pension funds is that they don’t necessarily have the staff to evaluate these types of projects.
Pension funds are a source of long-term capital with modest rates of return. It is patient money. These projects are perfect. The problem is that it will be difficult for them to do direct investment because of the lack of confidence that these deals get done in America. Let’s say you have five or 10 people working on your staff. You can’t afford to have someone devoting all of his or her time and energy looking at a project that is very speculative.
MR. FRIED: Jake Falk, talking about politics, I need to come back to you, since I know you have become a Washington insider. How does the current administration view public-private partnerships? What’s really happening inside? Tell us something we don’t know.
MR. FALK: I don’t think you need to be an insider to answer this question. President Obama told the US Chamber of Commerce earlier this year that one of his priorities is to get the $2 trillion in private sector money that is potentially available for infrastructure invested and putting people to work.
MR. FRIED: But does the President mean it? The reason I ask is that when the stimulus package first came out, everyone was saying infrastructure, infrastructure, but the money was spent on short-term projects. That wasn’t infrastructure. If the administration wants to build infrastructure, it will create jobs and attract private investment.
MR. FALK: Clearly, in the current economic situation, there is a tension between short-term investment to create jobs and long-term reinvestment in infrastructure. It is the long-term area where I understand you think the private sector can play a significant role. The administration’s 2012 budget calls for a large investment in traditional road work. The budget also calls for an infrastructure bank and transportation leadership awards to reward jurisdictions that are reforming the way they do business and working effectively to adopt private sector best practices.
It may be that $30 billion sounds like a drop in the bucket, but to get the private sector involved in infrastructure, you have to reduce the percentage of funds that is allocated through traditional formulas. The main thing the administration has done in its proposal is to start incorporating more programs that rely on discretion and competition to reward state and local jurisdictions for making tough choices.
MR. FRIED: What is happening with reauthorization of federal transportation programs?
MR. FALK: The reauthorization debate is underway. The administration provided an outline of what it would like in the budget. The committees on Capitol Hill are talking about reauthorization. Obviously any spending measure faces an uphill battle in Congress with the current focus on deficit reduction. However, the national infrastructure bank, TIFIA and similar programs have an advantage because of the amount of private sector funds they can leverage.
MR. SUOZZI: I am advising states to create their own state infrastructure banks instead of waiting for Washington to act. South Carolina has had success with its bank, and other states are looking at it as a possible model.
MR. FRIED: Where would the money for state banks come from?
MR. SUOZZI: They can raise money for a bank by issuing bonds or by privatizing or monetizing brownfield projects.
MR. FRIED: Fadi Selwan, what approaches are other countries using to stimulate private sector investments that the United States should adopt?
MR. SELWAN: Just to give you some examples, France decided, when the economic crisis started, that it could not afford to slow down capital investment in high-speed trains, so it put up 8 billion of guarantees. That was enough to keep 20 to 25 billion in projects on track. We are closing an 8 billion project within the next few weeks based on the fact that the lenders have a bank guarantee of 1.5 billion, and we have additional subsidies from the state for about 3.5 billion.
Other countries rely on the European Bank for Reconstruction and Development for direct funding of projects. Russia is asking government banks to finance projects.
Another thing these countries understand is that the more competition you have, the more the prices go down. There is a lot of competition in Europe. You have huge competition in India where you sometimes see up to 40 concessionaires compete in bids. You have four to five competitors in Russia. These countries put a lot of projects on the market, they see them through and they sign contracts at the end of the bid process. They are modernizing their infrastructure in a way that will improve their economies in the long term.
MR. MARKS: I agree with Fadi. State guarantees like we have seen in Australia and the UK are an underpinning of financing that also addresses the risk of nonappropriation. Dedicated procuring agencies like Infrastructure Ontario in Canada would be a great benefit in the US.
The US also needs to establish a more robust track record. Every time a project is pulled from the market, it has huge ramifications, not just for the state that withdrew the program but also more broadly.
Opportunities in Particular States
MR. FRIED: Jim Simpson, how has the financial condition of New Jersey affected your infrastructure plans? We know that the governor cancelled the Access to the Region’s Core. What’s next?
MR. SIMPSON: The ARC project was the largest public works project in the country. It was an $8.7 billion project. There is a lot of risk associated with a project that size. The forecasts were unrealistic, both in ridership and cost.
We had a project that started at $5 billion and, while still in preliminary engineering, escalated in cost to $8.7 billion. The costs always go up further from preliminary engineering to final design to construction and then to completion. We just couldn’t afford it. The risk was too great that the project would end up costing $15 or $16 billion dollars. It would have broken New Jersey.
No one has the money for these mega projects. Florida did not have the money. We do not have the money.
Our strategy in New Jersey is safety — safe bridges, safe highways — fix the potholes, keep everything in a state of good repair, focus on system performance, and expansion.
The benefits for that project were not there. Transportation projects exist for one reason: to get people from point A to point B as quickly as possible. This project didn’t do that, and the cost vastly outweighed the benefits.
The fatal flaw with that project was that it dropped the Penn Station connection, so Amtrak would not have been able to use the new track. This was done to get the shovel in the ground two years faster on a 100-year project. The advocates said just build it and don’t worry about the finances. You can’t do that in this world that we live in.
Unfortunately, the federal government only offered us a TIFIA loan for support. This was the number one public works project in the country. We could not do it ourselves.
We would have had to cannibalize the rest of Jersey Transit to build the project. We would have been deferring maintenance on all the other transit stations, all the other parking lots,
and so on.
MR. FRIED: What opportunities will there be in the future for private investment in New Jersey infrastructure?
MR SIMPSON: The opportunities are you have to come to New Jersey or any place else and tell us where you see the opportunities. At the end of the day, we are caretakers for the public dollar. You can’t just tell us here is some up-front money. Tell us the business purpose, how the project will be financed and how it will benefit the state. We can borrow in the bond market to build our own projects. Tell us why what you are proposing is better.
The New Jersey Turnpike is a good example. Tell me the business reason why I should grant a concession on the Turnpike. Take a look at our balance sheet. It is on line. Let’s say it is costing us $300 million a year to collect $1 billion. It will cost us $300 million a year to collect $1.5 billion next year when the tolls go up. What can you do that will let us collect the same or more revenue at lower cost?
The opportunities in New Jersey are probably more on the operating side. A dollar I spend in labor is a dollar I don’t have for the capital plan, because when the fare box revenue comes in, I have two choices. It can go to fund operations or it can go for capital improvements.
New York City Transit and the Metropolitan Transportation Authority are paying for the equivalent of 120,000 workers because of all the pension benefits and work rules. That’s where I think the private sector can do a better job. We are tackling the problem one project at a time.
The opportunities are on the operations side and some selected new capacity projects, like Scudder Falls Bridge, the Goethals Bridge and maybe the Bayonne Bridge. They are not to buy the New Jersey Turnpike.
MR. FRIED: Greg Carey, Texas was an early leader in the industry and then it imposed a moratorium. Is Texas coming back?
MR. CAREY: Even with the moratorium, a number of deals got done. I think the vilification of the Texas DOT is over.
However, the problem with Texas is that the projects that made the most sense have now been done. The next tier of projects will require a joint effort by the state and private sector to get done because you don’t have a road that makes a lot of sense apart from the Grand Parkway in Houston. You have stuff in El Paso, but that’s a tough place to get things done.
California will always be difficult; every project in that state has stops and s