Are PPPs The Answer to the U.S.’s $1.5 Trillion Dollar Infrastructure Plan?
In the State of the Union address, President Donald Trump called for $1.5 trillion in infrastructure spending from a combination of federal, state, and local government sources working along with the private sector.
A unique part of the framework of the U.S. infrastructure plan is that it will likely encourage increased use of the public-private partnerships (PPP or P3) model—a formal arrangement between a government body and private-sector organization to design, finance, build, and operate projects. PPPs have been used in the past, especially in privately operated toll roads, but they have also been responsible for some high-profile US infrastructure projects such as the $4 billion renovation of LaGuardia International Airport and the $852 million Presidio Parkway in California.
The U.S. lags behind Canada and Europe when it comes to the use of PPPs to rehabilitate and upgrade its infrastructure. This is due to a number of factors, including: a lack of enabling legislation in certain states, a shortfall in government expertise in managing PPPs, and the prolific use of municipal bonds to fund local infrastructure.
What’s more, there are big disagreements over the benefits and drawbacks of PPPs. Depending on whom you talk to, PPPs are either a miracle cure for the country’s ailing infrastructure or a potentially thorny arrangement that can leave governments and taxpayers on the hook for decades.
As governments look to mobilize their resources to repair existing infrastructure or take on new projects, they need to understand how PPPs have been used in the past, and how they could be beneficial in the future. We’ll take a look at five considerations government officials and other stakeholders should keep in mind as they weigh whether or not to use PPPs for that next big infrastructure project.
To date, PPPs have accounted for a small portion of all infrastructure projects executed in the U.S. This arrangement has been used more frequently for toll roads, but, according to the Congressional Budget Office, PPPs made up just 1 percent of total spending in this category from 1989 to 2011.
And while 37 states had passed PPP-enabling legislation as of January 2017, to date, the entire U.S. has a total of only 42 surface transportation projects procured as PPPs. Indeed, 35 states have never undertaken a single public-private transportation project.
To benefit from the increased spending in the proposed federal infrastructure plan, state and local governments must become more familiar with how to use PPPs and manage their complexities. Tariq Taherbhai, Chief Operating Officer, Global Construction and Infrastructure, Aon, offers five considerations to keep in mind when evaluating PPPs as an option.
Clearly define the immediate and long-term risks and rewards of PPPs
While PPPs are often praised for the way they mobilize resources to undertake ambitious projects that would otherwise have remained on the drawing board, determining their total costs and benefits can be difficult. Complicating factors include:
- Duration of contracts
- Financing terms
- Responsibility for construction and maintenance
- Usage volumes
- Guaranteed margins
For example, in the $1.4 billion Goethals Bridge replacement, the Port Authority of New York and New Jersey will collect toll revenues, but has committed to pay the private developers more than $56 million a year for 40 years, contingent on the performance of the bridge. Such arrangements, in which local governments promise substantial payments, are common, but they run the risk of diverting much-needed funds from public coffers.
Governments can structure PPPs to shift the risk for construction, maintenance, and even revenue to private entities. For example, in Indiana, a private consortium in 2006 purchased a 75-year lease on a 157-mile toll road for a $3.8 billion upfront payment. When the global financial crisis and low traffic volumes pushed the consortium into bankruptcy, Indiana got to keep the money from the purchase while the toll road continued operations.
Build PPP management capabilities
One of the reasons that relatively few PPP deals have closed is that many government entities do not have the capacity or capabilities to negotiate and manage them. Taherbhai explains: these agreements can be complex and include terms for everything from maintenance standards, fee setting, and other risk sharing elements. Further, negotiations can often stretch on for months, putting significant burden on agencies whose staff is already stretched thin.
Some government agencies have formed dedicated units tasked with procuring, negotiating, and managing PPPs. Such teams can handle quality control, policy formulation and coordination, and selection and negotiation with the private entities interested in entering into PPPs. For example, the state of Virginia, an early adopter of PPPs, has governmental units dedicated to managing these projects.
Look beyond just financing
Low interest rates and the robust U.S. municipal bond market mean that public financing of infrastructure projects can be cheaper up front than private sources, meaning PPPs are often promoted as a key funding source for infrastructure projects if public capital is not readily available for that project. However, Taherbhai advises that viewing these arrangements purely through a monetary lens can overlook other potential benefits.
Instead, government officials should also be aware of the other benefits PPPs can offer, namely expertise in sourcing, procurement and project delivery. For example, many public infrastructure projects suffer from delays and cost overruns—issues that the private sector, with its focus on efficiencies and cost-savings, can help mitigate.
Factor in total cost of ownership
Governments should be taking into account the total cost of ownership of the infrastructure project through the entire life of the asset, rather than focusing purely on the initial cost of construction.
“PPPs can be used to build new infrastructure, but one of the key benefits is bringing certainty to the public sector of the cost and quality of infrastructure throughout its life,” explains Taherbhai.
For example, Pennsylvania’s recent decision to use a PPP to replace over 550 structurally deficient bridges means the state will only pay the contactor when a bridge replacement is complete and there are financial consequences if the work is not completed on time. In addition to these measures, the private partner will only be compensated in the 25-year operations period if it adheres to the robust and measurable performance standards set out in the original agreement.
Explore how to use the appropriate federal programs
In an effort to promote the use of PPPs and attract private investment, the federal government has created multiple programs. Passed in 1998, the Transportation Infrastructure Finance and Innovation Act (TIFIA) provides low cost direct loans and lines of credit to local government, with an emphasis on infrastructure projects that serve a regional or national interest. Private Activity Bonds are tax-preferred debt instruments that allow private entities to borrow at rates comparable to state and local governments for highway and freight transfer projects. The Water Infrastructure Finance and Innovation Act (WIFIA) was established in 2014 to provide funding for eligible water and wastewater infrastructure projects. Such federal support can make projects more feasible. For example, financing for the $658 million South Bay Expressway in San Diego included $140 million in TIFIA funds along with $130 million in private equity and a $340 million bank loan supported by future toll revenues.
The details of the infrastructure plan are likely to come into sharper focus in the coming days and weeks. Initial indications suggest that private funding sources, including PPPs, could play a prominent role. Government officials seeking to determine how to harness more resources for infrastructure should evaluate PPPs and ensure that this arrangement is well-suited for the needs of their projects.
“PPPs are a powerful investment tool and must be a core tenet of any domestic infrastructure plan. They are only one piece of the puzzle, however, and the United States must employ an “all of the above” approach in order to successfully address its needs.” – Chris Heathcote, CEO of the Global Infrastructure Hub
“The universe of projects that offer the possibility of profit for private investors is considerably smaller than the universe of projects that represent our infrastructure needs.” – Jacob Leibenluft, Senior Adviser at the Center on Budget and Policy Priorities
“UK public-private partnerships have to change to be effective” Financial Times, January 25, 2018
“The rising advantage of public-private partnerships” McKinsey & Company, July 2017
“How and when to use private money in infrastructure projects” Economist, April 22, 2017
“Can P3 fill the infrastructure gap?” Aon, The One Brief