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Leveraging Private Capital for Infrastructure Renewal (2019)

Chapter: Chapter 2 - The Use of P3 in the United States for Highway Projects

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Suggested Citation:"Chapter 2 - The Use of P3 in the United States for Highway Projects." National Academies of Sciences, Engineering, and Medicine. 2019. Leveraging Private Capital for Infrastructure Renewal. Washington, DC: The National Academies Press. doi: 10.17226/25561.
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Suggested Citation:"Chapter 2 - The Use of P3 in the United States for Highway Projects." National Academies of Sciences, Engineering, and Medicine. 2019. Leveraging Private Capital for Infrastructure Renewal. Washington, DC: The National Academies Press. doi: 10.17226/25561.
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Page 10
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Suggested Citation:"Chapter 2 - The Use of P3 in the United States for Highway Projects." National Academies of Sciences, Engineering, and Medicine. 2019. Leveraging Private Capital for Infrastructure Renewal. Washington, DC: The National Academies Press. doi: 10.17226/25561.
×
Page 11
Page 12
Suggested Citation:"Chapter 2 - The Use of P3 in the United States for Highway Projects." National Academies of Sciences, Engineering, and Medicine. 2019. Leveraging Private Capital for Infrastructure Renewal. Washington, DC: The National Academies Press. doi: 10.17226/25561.
×
Page 12
Page 13
Suggested Citation:"Chapter 2 - The Use of P3 in the United States for Highway Projects." National Academies of Sciences, Engineering, and Medicine. 2019. Leveraging Private Capital for Infrastructure Renewal. Washington, DC: The National Academies Press. doi: 10.17226/25561.
×
Page 13
Page 14
Suggested Citation:"Chapter 2 - The Use of P3 in the United States for Highway Projects." National Academies of Sciences, Engineering, and Medicine. 2019. Leveraging Private Capital for Infrastructure Renewal. Washington, DC: The National Academies Press. doi: 10.17226/25561.
×
Page 14
Page 15
Suggested Citation:"Chapter 2 - The Use of P3 in the United States for Highway Projects." National Academies of Sciences, Engineering, and Medicine. 2019. Leveraging Private Capital for Infrastructure Renewal. Washington, DC: The National Academies Press. doi: 10.17226/25561.
×
Page 15

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9 C H A P T E R 2 This chapter provides an overview of different project delivery methods and their attributes. It also includes a summary of highway and bridge P3 projects implemented by state DOTs and local transportation agencies in the United States. 2.1 Summary of Delivery Methods This section gives an overview of three project delivery methods: • Design–bid–build (DBB): traditional delivery, • Design–build (DB): traditional delivery, and • DBFOM: P3 delivery. While design–build–finance (DBF) contains a finance element and is a P3 alternative delivery method, it does not usually involve equity and is therefore not a focus of this synthesis. 2.1.1 DBB Project Delivery For projects delivered through DBB, the public sector is responsible for developing the full project design, which may be done in-house or contracted out to a design firm. Following com- pletion of design, the public sector then solicits separate bids from contractors for the construc- tion of the project based on the completed design. In Figure 2, the areas shaded in gray represent public-sector responsibilities, and white represents private-sector responsibilities/scope. Under DBB, the public sponsor is ultimately responsible for any issues arising from the design, such as incomplete plans or conflicts and dimensional errors. The public sponsor exercises significant oversight of construction since most of the construction delivery is based on a means-and-methods approach. The public sponsor retains certain responsibilities for right-of-way acquisition, permitting, and construction risks not passed on to the construction contractor. The public sponsor is also responsible for financing, operating and maintaining the asset. This structure, the retention of certain risks, and the amount of public-sector control often result in more change orders and cost overruns for the public sponsor during construction and lack of budgeting for life-cycle costs of the project (Canadian Centre for Economic Analysis 2016). Further, the public sponsor retains the risks associated with the usage (forecast volume of traffic) and, for projects that generate revenue through user fees (such as tolls), the pub- lic sponsor retains revenue risk over the life of the asset. In DBB, committed funding is often required before bids for the design contract (if contracted externally) are procured as well as the construction contract. Typically, DBB contracts are procured on the basis of the lowest cost. The Use of P3 in the United States for Highway Projects

10 Leveraging Private Capital for Infrastructure Renewal An example of the DBB delivery method is Phase I of the Presidio Parkway Project in San Francisco. The overall project replaced the Doyle Drive approach to the Golden Gate Bridge, which was seismically vulnerable and structurally deficient. Doyle Drive is the southern access to the Golden Gate Bridge, which connects Marin and San Francisco counties and provides a crucial regional link between the San Francisco and the North Bay Area counties. In 2009, the public sponsors began to evaluate the overall project as a potential P3 under California’s newly approved P3 legislation. However, given the concerns regarding the seismic vulnerability of Doyle Drive, which was constructed in 1936, the public sponsor decided to phase the project, using DBB for the construction of the southbound portion. In Phase I, about one-third of the overall project was constructed, including environmental mitigation, utility relocation, an interchange/viaduct, and a battery tunnel. The design was completed first. Sub- sequently, the four contracts included in Phase I were further grouped and bid as two separate construction contracts to two different contractors. 2.1.2 DB Project Delivery Under a DB approach (see Figure 3), the responsibilities for design completion and construc- tion of the project are included under one contract with a DB consortium or contractor. The procurement process for the DB approach typically includes the public sponsor issuing a pre- liminary design to the proposers. The public sponsor advances the preliminary design (usually 30% of overall design) during the bid phase, and proposers submit pricing based thereon. Key: gray rectangle – public entity; gray oval – public-entity responsibility; white oval – private-entity responsibility. Operations & Maintenance Public Sponsors Construction Construction contract Design Replacement & Refurbishment Figure 2. DBB organizational structure. Key: gray rectangle – public entity; gray oval – public entity responsibility; white rectangle – private entity; white oval – private entity responsibility. Public Sponsors Operations & Maintenance Replacement & Refurbishment ConstructionDesign DB Consortium Design-build contract Figure 3. DB organizational structure.

The Use of P3 in the United States for Highway Projects 11 Under this structure, most risks for design and construction are transferred to the DB con- tractor selected to perform both functions under one contract. The DB contractor is responsible for completing the design from the bid stage level. Because the DB contractor has a signifi- cant role/responsibility in the design, DB contractor selection is generally based on a best-value assessment using preliminary design documents and including qualitative evaluation criteria. Integration of design and construction can mitigate some of the schedule risk associated with project delivery. However, risks still exist with respect to final cost, depending on the specific commercial provisions included in the contract and how much risk there is and how effectively this risk is transferred to the DB contractor under the DB contract. As with DBB, the public sponsor generally has responsibility for the financing, operations, and maintenance of the asset. The public sponsor will share responsibilities for right-of-way acquisition and permitting. The public sponsor will also retain the risk of construction cost increases as a result of change orders as well as all risks associated with usage (forecast volume of traffic) and, for projects that generate revenue through user fees, revenue over the life of the asset. As mentioned, the public sponsor has responsibility for operations and maintenance under both the DB and DBB delivery models. As a result, the potential for the private sector to incor- porate innovations to optimize up-front construction costs with whole life-cycle operations and maintenance costs into the project’s design is limited. This is because, generally, DBB and DB contractors’ proposals are evaluated primarily based on the lowest cost to deliver or construct the asset. In other words, a disincentive may exist for these contractors to consider innovations to optimize construction and whole-life costs in their proposals if/when any such innovations may result in a higher up-front cost to deliver the asset (even if the net present value of the whole-life cost of the project is lower). An example of a DB procurement is the Texas Department of Transportation’s (TxDOT’s) Grand Parkway Segments F-1, F-2, and G, which were procured in 2012 and completed in 2016. The Grand Parkway System is the third loop around the Houston metropolitan area. TxDOT managed a two-step procurement process for the DB construction contract. During the request for qualifications (RFQ) stage, TxDOT accepted seven DB statements of qualifications and shortlisted five bidders. TxDOT subsequently received four detailed proposals at the request for proposal (RFP) stage and ultimately selected a consortium to complete design and con- struct 37.8 miles of toll roads, including five major highway interchanges. In contrast to a DBB procurement based solely on the lowest cost, the DB procurement incorporated several factors, including base cost, option cost, technical solutions, and the projected time saved compared to a predetermined benchmark schedule. 2.1.3 DBFOM P3 Delivery Under the DBFOM P3 approach (see Figure 4), a single contract is awarded to a P3 developer, a private-sector consortium, for the design, construction, financing, operations, and routine and major maintenance of the asset for a fixed contract period. The P3 developer generally sets up an SPV to carry out the project, and the public sponsor enters into this single contract with the SPV. As described, the P3 developer generally invests equity in the SPV, potentially alongside other equity investors, and debt providers provide debt financing (loans or bond proceeds) to the SPV as borrower. During the DBFOM contract term, which typically ranges from 30 to 50 years, the public sector exercises control of the asset through the contract requirements, an oversight role, and performance specifications accepted by the P3 developer at commercial close. Because the specifications are output/performance based, generally less scope exists for change orders and

12 Leveraging Private Capital for Infrastructure Renewal schedule or cost relief than under DBB. At the end of the contract term, the asset is handed back to the public sponsor in a condition as specified in the contract. An increase in the maintenance requirements or stricter handback requirements at the end of a project naturally translate to increased costs and thus higher bids in procurement. However, the precise relationship between maintenance requirements and procurement costs is often unclear because stricter maintenance or handback requirements increase costs long after the project is completed. Because these costs are in the future, bidders must convert them to present value in determining their bids in procurement. These maintenance or handback requirements can affect bids or pricing in procurement in two primary ways. First, an increase in maintenance costs due to these requirements will be priced and included in proposals by investors during pro- curement. Second, an increase in handback or maintenance requirements may, depending on the situation, increase the risk for investors in the project and would thus increase the expected return required for them to invest in the project. This factor will also translate to higher bids or prices in procurement. An alternative to DBFOM is design–build–finance–maintain (DBFM), where the private sector has routine or major maintenance in its scope but does not have operations. The DOTs and trans- portation agencies interviewed did not discuss or had not employed this alternative structure. Two categories of DBFOM exist, and they can be divided into two main categories according to the revenue that the SPV receives for designing, building, financing, operating, and maintain- ing the project. 2.1.3.1 AP DBFOM One subset of DBFOM is AP DBFOMs. In addition to milestone payments that the public sponsor may make to the SPV when targets are achieved during or at the end of construction, the public sponsor makes APs to the SPV during the term of the contract. The AP is generally fixed (sometimes with escalation over time); however, deductions can be made to the AP for periods of underperformance, nonperformance, or lack of availability of the project (e.g., lane closures and incident management). The public sponsor makes these payments throughout the P3 agreement term. The term of an AP contract (typically 30 to 50 years) is usually less than that of revenue risk DBFOM (described later). These payments can be secured by a revenue pledge or may be subject to appropriations. An AP DBFOM can be used for projects that do not generate revenue through tolls, such as the Presidio Parkway in California. Phase II of the Presidio Parkway project (discussed earlier in this chapter) was developed as a P3. The project encompassed three cut-and-cover tunnels, landscaping, routine operations and Key: Gray rectangle – public entity; white rectangle – private entity; white oval – private entity responsibility. Source: FHWA (2013). Operations & Maintenance Replacement & RefurbishmentConstructionDesign Public Sponsors Finance P3 Developer P3 contract Figure 4. DBFOM organizational structure.

The Use of P3 in the United States for Highway Projects 13 maintenance, and life-cycle maintenance over a 30-year contract term. Golden Link Conces- sionaire (GLC), a private consortium, was selected to deliver Phase II. The P3 agreement was signed with GLC on January 3, 2011, and substantial completion was achieved in September 2015. Phase II was funded through a complex financing structure that included bank loans, TIFIA funds, and GLC private equity at a debt-to-equity ratio approximating 87.5:12.5. The Presidio Parkway P3 represents California’s first AP contract for transportation infrastructure as well as the first TIFIA loan to be repaid in part with a milestone payment at or following substantial completion. The P3 procurement approach allowed for a reduction in construction costs, transferred financial risks to GLC, freed up state funding for other projects, and provided a high level of maintenance, including handback requirements (at the end of the contract term), over the 30-year life of the contract. Since the Phase II P3 project interfaced with the Phase I DBB, the design specifications for Phase I were prescriptive and limited the use of alternative technical concepts. However, Phase II was able to employ alternative technical concepts (ATCs) in terms of both constructability and long-term operations and maintenance. The Phase II project cost approximately the same as Phase I even though Phase II included twice as much construction scope as Phase I. AP DBFOM can also be used for projects that generate revenue through tolls. In such cases, the public sponsor may apply the toll revenues toward the APs, and it bears the risk of variabil- ity of project revenue. Projects such as the Florida Department of Transportation’s (FDOT’s) I-4 Ultimate Managed Lanes in Tampa and the Goethals Bridge Project in New York/New Jersey are tolled facilities that were procured using the AP DBFOM delivery model. 2.1.3.2 Revenue Risk DBFOM In a revenue risk (or demand risk) project, the P3 developer bears the risk of project revenues not meeting initial projections and bears the consequence of this in terms of the SPV’s ability to repay debt and achieve target equity return. In this case, protections may be put in place such that the P3 developer is still assessed damages for poor performance, and, if revenue exceeds forecasts, it may be required to share some of this excess with the public sponsor. Examples of the use of revenue risk DBFOMs are U.S. 36 in Colorado and the I-495 HOT lanes in Virginia. U.S. 36 is a four-lane divided highway that connects Boulder to Denver at its intersection with I-25. U.S. 36 had significant congestion and had been targeted for improve- ments by the Colorado Department of Transportation (CDOT) since the late 1990s. The U.S. 36 Express Lanes Phase 2 project extends the 10-mile Phase 1 express lane facility 5 miles further northwest to Boulder, and it includes multimodal improvements, including bus rapid transit, a bikeway, and an intelligent transportation system for mobility information and inci- dent management. Phase 2 was delivered as a revenue risk DBFOM. Following a competitive procurement, Colorado High Performance Transportation Enterprise (HPTE) selected Plenary Roads Denver Ltd. in April 2013 for the DBFOM of Phase 2 and to provide routine and life-cycle maintenance on Phase 1 and the existing I-25 express lanes under a 50-year agreement. If the projected toll revenues are lower than expected, Plenary Roads Denver will be at risk for losses. The P3 enabled the entire project to be delivered years earlier than originally planned. The P3 developer was able to implement several ATCs, including for improving road quality and providing bike lane improvements, drainage, and pavement. The general-purpose lanes as well as express lanes were improved, which increased peak-hour speeds by 20% to 29% (Bolaños et al. 2017). Another relevant project is Transform 66. Transform 66 will expand the I-66 in Northern Virginia with three toll-free general-purpose lanes and two tolled express lanes [free for high- occupancy vehicles (HOV) 3+ and buses] in each direction. The project is intended to relieve

14 Leveraging Private Capital for Infrastructure Renewal congestion, improve safety, and provide more predictable travel times in a critical Northern Virginia corridor. Construction began in 2017 with substantial completion expected in 2022. Effectively, VDOT ran three procurements in parallel for the same project scope: one was DB with ATCs, one was DBFOM, and one was design–build–operate–maintain (DBOM). VDOT chose the 50-year-term DBFOM, which required bidders to meet a minimum up-front public funding requirement, provide transit service, and provide support for mandatory corridor improvements. The benefit for the Commonwealth of Virginia is expected to be $2.5 billion compared to the original P3 analysis. The consortium is investing $2.3 billion in construction, making a $500 million up-front payment to the Commonwealth of Virginia to fund additional corridor projects, $800 million to expand transit services in the corridor, and $350 million for other improvement projects over the next 50 years. 2.1.3.3 Concessions These are projects where assets are leased under long-term concessions. Brownfield projects, which can involve the lease of existing publicly funded toll facilities to a concessionaire (some- times referred to as asset monetization or asset recycling), are another subset of revenue risk DBFOM P3s. In exchange for up-front payments, the private concessionaire will take over the facility operations and maintenance as well as life-cycle costs over the long duration of the lease (usually 50 to 99 years) as well as make contracted improvements, to allow time for the conces- sionaire to generate sufficient revenues generated by the project. The emphasis on a concession is to generate the highest proceeds for the public sponsor. As examples, the Chicago Skyway and Indiana Toll Road (ITR) have leases of a 75-year minimum. There are only five of these types of P3 concessions in the United States, as shown in Figure 5. One of the first of these types of concessions in the United States was the ITR. Completed in 1956, the ITR stretches 157 miles across Northern Indiana from the Ohio border to Illinois, Source: FHWA (2013). Figure 5. Map of U.S. DBFOM P3s in project data set.

The Use of P3 in the United States for Highway Projects 15 where it connects with the Chicago Skyway. The state of Indiana began to explore leasing ITR in 2004 around the same time the City of Chicago was exploring the lease of the Chicago Skyway. Pursuant to a competitive RFP during 2005 that lasted 1 month, the 75-year lease of the ITR was awarded in 2006 to a consortium that bid the most of four proposers at $3.8 billion. As part of the concession, the winning consortium pledged to spend $200 million on capital improve- ments to the facility during the first 3 years of the lease and approximately $4.4 billion over the life of the concession. By leasing the facility, the state of Indiana was able to retire $225 million in debt. It allocated the remainder of the lease proceeds to several funds used solely to pay for infrastructure projects throughout the state. In 2014, the consortium SPV went bankrupt and the state of Indiana ran a new procurement process for the remaining term of the concession in 2015, which saw a 66-year lease concession awarded to IFM Investors for $5.725 billion, with most of those funds being used to pay back creditors holding the bankrupt SPV’s debt. IFM has plans to invest $260 million in capital improvements over the first 5 years of the concession to address deteriorating pavement, bridges, and travel plazas. The state of Indiana has benefited by having the ITR well maintained by concessionaire as well as being able to use the significant concession fees for transportation infrastructure around Indiana. Of the 34 U.S. P3s included in the map in Figure 5, 21 were revenue risk DBFOM projects, eight were AP DBFOM projects, and five were brownfield concessions (referred to as “conces- sions” in the figure). Each project delivery method offers certain advantages and disadvantages, and no single method is appropriate for all projects. During the evaluation of the Presidio Parkway P3 project, the California Department of Transportation (Caltrans) reviewed 9,000 of its historical projects at varying total project cost intervals; it determined that projects under $100 million did not have any cost increases, but projects of greater than $300 million had cost increases of over 70% when done under traditional delivery methods. The selection of a particular project delivery method is a function of several factors, including the project timeframe, the expected risk allocation, the funding plan, and the expertise of the state DOT or local transportation agency with project delivery models. The use of a P3 DBFOM usually occurs for projects that are more complex, have significant unknown elements, and cost more than public sponsor’s typical projects. One of the critical reasons that P3s are chosen for more complex projects is the presence of private equity and how that can help P3s achieve public sponsor objectives.

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Public–private partnerships (P3s) can provide solutions to the project delivery challenges faced by state departments of transportation (DOTs) and local transportation agencies in delivering surface transportation infrastructure by aligning risks and rewards between public and private sectors, accelerating project delivery, improving operations and asset management, realizing construction and operational cost savings, and attracting private-sector equity investment.

P3s are becoming an increasingly important option for financing and implementing critical improvements to U.S. surface transportation infrastructure. As interest in P3s grows, U.S. transportation agencies and stakeholders evaluating the potential benefits of P3s have raised issues relating to the role of private equity in these transactions.

Recognizing the complexity and challenges of structuring a highway or bridge P3 compared to a conventional procurement, the objective of NCHRP Synthesis 540: Leveraging Private Capital for Infrastructure Renewal is to bridge the knowledge gap on the role of equity in surface transportation P3 projects and to document current practices relating to private-equity investments in small-scale and large-scale transportation infrastructure projects.

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