The Five Faces of Public-Private Partnerships

A colleague from the D.C. area who is an expert in road finance wrote an insightful, concise and sobering note about Public-Private Partnerships. As I have written before about monetization of Toronto’s parking assets, and as I have found myself defending Ontario's 407, I found this valuable.

With Dan’s permission, I share this unaltered and unabridged.

Here is how Dan connected his work regarding what he prefers to call Public-Private Collaborations to my work in congestion pricing. I kept the original term to be sure his article is discovered by more people... 

"The relevance of the Many Faces of Public-Private Partnerships piece to road or congestion pricing is that many believe that P3s are the best way to implement road pricing on new alignment or HOT lanes. If so, it is best they understand the way certain detractors may use the negative rhetoric about P3s to undo worthy road pricing initiatives."

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THE MANY FACES OF PUBLIC-PRIVATE PARTNERSHIPS

Daniel L. Dornan, P.E. — 2012.07.21

Let me begin by noting that I am a strong supporter of public-private collaboration to help address the fiscal and infrastructure needs of our nation. However this support is predicated on having both public sector and private sector participants benefit from the arrangement relative to the degree to which they each contribute to its success. In addition, such an arrangement should be made in a fully transparent manner with the respective parties held accountable for their responsibilities and promised results.

When politicians and public officials turn to the private sector (including investment-banking firms and venture capitalists) to help them finance public use infrastructure as part of a public-private partnership (P3), it is prudent to understand the short-term motives and the long-term consequences of these deals before they are finalized.

This paper discusses the various ways in which P3s can be viewed, depending on the nature of the deal, the roles and responsibilities of all parties to the deal, and the point of view of those assessing the deal. Understanding these differing views can help private firms become better positioned to successfully compete in the emerging and rapidly changing marketplace for P3s.

P3s as White Knight

Public-private partnerships are often touted as a panacea for addressing the transportation infrastructure needs of states and municipalities facing fiscal challenges during the continuing Great Recession. Proponents of P3s point to enhanced access to private capital as a major benefit of these arrangements. They paint P3 teams as White Knights able to rescue needed but fiscal-constrained infrastructure projects by providing ready access to financing, innovative project delivery, and cost-effective life-cycle asset management. These are the major advantages of successful P3s. Unfortunately most public sector agencies are unable to apply these processes to gain these benefits for their constituents since their time horizons for infrastructure management are much shorter than the service lives of these assets.

P3s as Pied Piper

In some P3 contracts, the concessionaire teams are asked to provide a sizable up-front concession fee in return for assuming control of public use infrastructure assets through long-term leases supported by tolls or other revenues. These deals inevitably involve a long-term repayment schedule that is significantly more than if the sponsoring public entities financed the projects using tax-exempt public bonds. This is because private consortia will only do a P3 deal if they are relatively sure that the project can generate the level of proceeds to more than cover the up-front payment; their own capital, operating, and maintenance costs, and an acceptable rate of return on the investment made by the financing members of the P3 team. The revenue potential of the facility under private management must be significant since the rates of return on private capital are much higher than interest rates associated with tax-exempt bonds, typically by 300 to 400 basis points (for example 6.2% versus 10.0%).

Those who oppose P3s out of concern that the private sector will make a profit on the deal fail to realize that when it comes to private financing, the profit motive is what makes these deals possible.  In all but the most altruistic cases, the Pied Pipers of capital finance expect to be paid for their services.  

P3s as Robin Hood

A particular problem arises when the up-front proceeds from a P3 concession payment are diverted to other unrelated purposes. This occurred in 2006 when the City of Chicago leased its rights to the Chicago Skyway and it’s future toll revenues to a P3 consortium of Spanish and Australian firms for 99 years in return for an up-front cash payment of $1.83 billion. In this case, the only transportation-related use of concession proceeds was for the City’s Meals-on-Wheels program. None of the up-front payment was dedicated to any other transportation projects or services, except to pay off the remaining City debt on the Skyway itself.

As a kind of Robin Hood, the City of Chicago took the proceeds from the Skyway lease and distributed it to a wide variety of social programs and causes. At the time, residents of Chicago did not pay much attention to this deal, even when it promised to significantly increase tolls on the Skyway. This was because most users of the Skyway, who would pay these higher tolls, lived in Indiana. Like a commuter tax, Chicago effectively tolled the citizens of Indiana to pay for social programs benefitting the citizens of Chicago.

P3s as Alchemist

To public officials desperate for fiscal relief, P3s could appear like the alchemists’ dream of turning lead (i.e., current debt, deteriorated infrastructure) into gold (i.e., debt relief, rehabilitated or new infrastructure). The reality is that these deals generally rely on a transfer of future revenues to the private sector that is better able to take the risks and secure the benefits of long-term asset stewardship. Since the public sector is typically unable to generate these future proceeds from their maturing public-use infrastructure, today’s public officials are more likely to embrace P3s by swapping a much larger revenue stream that will take decades to accrue for a smaller but immediate capital infusion in the form of an up-front concession payment.

P3s as Trojan Horse

The history of transportation infrastructure is replete with examples of megaprojects predicated on overly optimistic projections of public use and benefits and grossly underestimated estimates of costs.  By the time the actual usage and costs are known, these projects are too far along to be stopped. Another 10-15 years must elapse before the induced economic development spawned by these megaprojects is realized.

Likewise, the negative consequences of P3 agreements generally only become apparent long after the dealmakers leave office. When these arrangements enable opportunistic officials to lease out existing public use infrastructure for many decades, future generations may be denied access to windfall revenues these assets might generate over the long term. In such cases, those public officials responsible for pushing through these quick cash-out deals, their current constituents, and their private sector partners may be the only ones who benefit financially from these agreements. Subsequent generations may be left to feel the gambler’s remorse resulting from these deals.

If P3s are Trojan Horses designed only to enable private interests to assume responsibility for public infrastructure assets where profit and return-on-investment are their primary concern, we may see the wholesale transfer of the nation’s most critical and strategic highways to international consortia accountable only to their investors or stockholders. As the saying goes, Beware of Greeks Bearing Gifts.

Conclusions

Pubic stakeholders will be better served if they fully understand the nature and details of these agreements as they evolve over the short term and mature over the long term. The public will be best served when P3 contracts are developed and executed in a fully transparent manner, with all participants held accountable for their respective contractual commitments throughout the terms of these agreements.

Private sector firms interested in pursuing P3 opportunities in this country will be better prepared and more successful if they understand how different stakeholder groups view P3s. It is only by first understanding the diverse and sometimes contrary perspectives of both advocates and detractors of P3s that private sector firms can take the appropriate actions to be successful in pursuing these innovative financing and project delivery approaches over the long term, to the mutual benefit of the public and private enterprise.

Daniel L. Dornan, P.E.

Dornandaniel at gmail…

+1 703-625-2152