TRANSPORTATION LAW [Opinion]
Miles and Miles of Texas
A look at delivery methods and the funding shortfall in complex highway projects.
By Rodney Moss
According to the Texas Department of Transportation, or TxDOT, in its Texas Transportation Plan 2040, Texas is at a turning point. The population is expected to double to 54 million by 2050. At current funding levels of $5.5 billion per year, all state and federal highway funds will have to be dedicated to preventive maintenance and capital rehabilitation of the current roads. TxDOT estimates that an additional $10 billion (a total of $15.5 billion per year) is needed to fund the road expansion required to achieve a state of “good repair and economic competitiveness” over the next 20 years.
Proposition 1 (passed in 2014) and Proposition 7 (passed in 2015) could provide around $3 billion annually in excess tax revenues for highways to address some of the strategic needs, but the amount of those funds is speculative and, in any event, those funds will be addressing investment backlog for the near term and will be woefully inadequate to address future needs. The Texas A&M Transportation Institute estimates that congestion in the state’s large metro areas is costing the average commuter more than $1,000 per year now and will progressively worsen if the needed additional investment in our roads is not made. The problems are not just concentrated in the large metropolitan areas. The roads in the rural areas with significant oil and gas production are exposed to 20 to 50 times the amount of truck traffic for which they were designed, and the roads are failing rapidly.
In any scenario, Texas’ funding shortfall for highway capital improvements alone is at least $7 billion per year for at least the next two decades. A common sense business analysis of the economic value of transportation infrastructure investment and the risk of not delivering it when it is needed to support the Texas economy is necessary. For example, the Texas comptroller estimates that for each $25 million investment in highways in the Houston area now, the Texas economy would benefit between $16.7 billion and $43.4 billion by 2040.
To overcome our $200 billion shortfall in road infrastructure investment over the next two decades, we will need to look at all of the tools available in the toolkit, including public-private partnerships, in addition to traditional financing, toll roads, and budget surpluses. Objective analysis of Texas’ successful history of alternative delivery of 17 road projects valued at over $22.5 billion shows the benefits of delivering this infrastructure with alternative finance delivery or public-private partnerships that transfer more of the cost of ownership to the private sector.
This article will examine first principles of public-private partnerships and address the funding shortfall in large, complex highway projects.
Understanding and Allocating the
The contractual allocation of risk in each of the three phases of the life of an asset—development, delivery, and operations risk after construction—is the essence of any procurement, public or private. Generally, the larger, more complex and urgent the project is, the greater magnitude of risk that must be allocated among the contracting parties. When the magnitude of risk is perceived to be extraordinary for the owner or the lenders (that ultimately may have the risk of performance of the asset), understanding and modeling the cost of the three categories of risk at the outset of the procurement is critical.
Once the cost of risk for the project that is to be carried on the balance sheet of one of the contracting parties is modeled, TxDOT and its advisers are able to identify the party best able to manage the risk and empirically compare the value of the various “source selection” or “delivery” methods. More importantly, they are better equipped to ensure that the project pro-forma and the overall balance sheet accurately reflect the risk and that the various agreement terms are aligned with the risk allocation strategy.
Case for the Delivery Method Selected
TxDOT is responsible for determining which delivery method, from the various methods allowed in the applicable procurement laws, creates the greatest value for the taxpayer over the life cycle of an infrastructure asset. Best practice for source selection method is to establish a “capital threshold” that triggers rigorous, objective analysis of all delivery options to determine, with a reasonable level of accuracy, which procurement method is likely to yield the greatest value under the particular circumstances through accelerated schedule and more efficient risk transfer.
The primary objective of the capital threshold process is to reduce or eliminate subjectivity in the assessment of the state’s balance sheet risk of a project and any inherent bias in favor of one delivery method over another. In other words, a capital threshold is the point at which the apparent scale and complexity of the project are presumed to make worthwhile the investment of time and resources to perform, outside of the procuring agency, a completely objective analysis of the life cycle cost of ownership of the asset. To the extent the TxDOT officials desire to rebut the objective recommendations and choose a different method, they always are able to make the business case for the delivery method they recommend. A capital threshold would mandate objective financial analysis of life cycle cost in TxDOT’s capital planning and procurement processes. Most importantly, the capital threshold process equips the TxDOT commissioners to make an informed decision and establish the necessary commitment to move the project forward with whichever method is chosen.
Cost of Capital vs. Cost of
Are financial advisers assessing the true cost of capital achieved under traditional public financing?
A definitive study on this critical issue is a September 2013 study published by the C.D. Howe Institute based in Toronto, Canada, titled The Valuation of Public Projects: Risks, Cost of Financing and Cost of Capital. In this study, expert economists make a compelling case that the cost of capital in financing infrastructure projects is the same or greater for publicly financed projects as privately financed projects. The authors attribute the widespread “analytical illusion” of the lower cost of public funds to “confusion between the cost of financing and the cost of capital (or discount rate)” and analogize government’s ability to absorb risk through its power to tax to an “insurance policy” that erroneously discounts the cost of borrowing on the public balance sheet to a “risk-free” rate.
The Howe study opines that the quantification of risk is the same for whomever owns the project and that the lenders are not directly interested in the owner’s identity, only the probability of default and the loss in case of default. The effect of using an interest rate paid by the public sector is a reflection of the implicit transfer of risk to a virtual loan insurance policy, where the taxpayers act as an insurer and the lenders are able to require only a small-risk premium. However, for the taxpayer, this loan insurance policy comes at a cost, which is real, but is not acknowledged and accounted for on the government’s balance sheet. This unaccounted risk premium must be included in the analysis to compare the true cost of funds and cost of ownership of a traditional publicly financed project.
To address the funding shortfall in road infrastructure projects, we should examine all delivery methods, including traditional financing, and public-private partnerships. The first step is to implement a “capital threshold” for every project. An objective analysis of the cost of ownership is necessary to make the best decision on delivery methods for the benefit of taxpayers.TBJ
is a senior vice president at Hunt Companies in Dallas, where he is responsible for sourcing investment and development opportunities in U.S. infrastructure projects.