Securing the Financial Health of New High-Speed Projects

» The recent failure of Taiwan High-Speed Rail raises questions about the role of private investment in new trains systems.

The California High-Speed Rail Authority projects that it will need about 33 billion in 2008 dollars to complete its initial San Francisco-Anaheim link, a reasonable estimate considering the cost of peer systems. In addition to the $9 billion in state funds devoted to the project by last November’s referendum, the Authority is banking on $2-3 billion in local money and $12-16 billion in federal contributions. Because this aid won’t be enough to cover the full costs of the line, the state will also demand $6.5-7.5 billion in help from public/private partnerships. In other words, the Authority is hoping it can raise 20% of construction costs with the help of corporate interests that would be able to benefit from some of the line’s operating profit.

The international experience, however, could put a damper on hopes for private involvement. This week, Taiwan High-Speed Rail fully revealed its fiscal impotency; the national government will have to take over the operating company, three years after the project opened to the public. The Taiwanese system, which cost more than $15 billion, was the first in the world built entirely with private funds — 80% of which were secured through bank loans at high interest rates. Though the line’s fare revenues, lower than projected, make up for operations, maintenance, and even most interest payments on the initial capital costs, elevated depreciation charges put the railroad into its misery. The recession, which decreased interest in travel, put the final stake in the company’s heart.

A government bailout plan will essentially force the public to assume the costs of paying back loans that provided for the system’s construction. No one would argue with the fact that pure government spending on the line’s construction, either direct through tax-based spending or with the support of loans at a low marginal rate, would have cost less money in the long-term, simply because of lower interest payments.

Taiwan’s experience is directly comparable to that of the United Kingdom’s High-Speed One, which was undertaken by London & Continental Railways under the initial presumption that the project would be entirely a product of private investment. Earlier this year, however, the European Union agreed to allow the British government to bailout the operation, which had gone bankrupt after construction was completed in 2007. Incompetence on the part of the corporations involved with the project had already forced the government to support £3.7 billion of bonds in 2006; aid this year amounts to £5.7 billion, compared to the initial capital cost of £5.8 billion.

In both cases, one wonders why private industry was involved at all if the respective governments were eventually going to to have to find the money to cover the price of the whole project anyway — plus pay interest on debt accumulated by failed companies.

Of course, California’s plans are different. While both the Taiwanese and British projects relied on bank loans that accounted for 80% of construction costs, the U.S. project will only be dependent on a 20% private investment. Revelations last week of SNCF’s expression of interest in involvement in the California system demonstrate that foreign companies see U.S. high-speed systems as potential money makers — and the French company’s report specifically argues that the U.S. project’s economics are sound. But just how much private money is an acceptable risk? Having the California High-Speed Rail project default on its obligations is unacceptable, because it would put a dent in plans for train systems throughout the country by dramatically illustrating “wasteful” spending in action — specifically the kind of example we cannot give anti-infrastructure conservatives.

The two experiences cited above indicate that a fully private project is very risky, and that makes sense; making up a huge initial capital cost like that of a rail line through loan back payments requires enormous revenues and limited operating needs. California’s estimates demonstrate annual fare revenues ($2.3-2.5 billion) that are about double operations costs ($1.1-1.3 billion); Taiwan’s system has similar financials, but paying back the bank has bankrupted the company.

Is a 20% private share acceptable? A $7 billion private investment would require roughly $560 million a year in payments at 5% interest over a short 20 year-period (totaling about $4.2 billion in interest). California’s system would provide a generous profit of $500 million for the operating company if revenues and operating costs are as expected; in bad years, or if ridership estimates are too high, the system could sustain revenues 20% lower than projected without going into the red. This seems reasonable.

California’s interest in a limited private involvement, then, avoids the risk inherent in a fully private project like that in Taiwan. Even so, one wonders whether there’s any point in taking the risk at all. The Authority projects a high benefits-cost ratio of 2.84 when considering passenger revenue, benefits to rail travelers, and reduction of road congestion, air pollution, car accidents, and airline delays. There is a clear government interest in building the high-speed line — so why do we need corporations to get involved?

California’s inclusion of private cash is a reflection of political reality: it is easier to claim that a project is financially viable when it has private money backing it up. In addition, the federal government is limited in the amount it can be expected to contribute, since it must also provide for projects in other parts of the country. It’s a good thing, though, that no one’s promoting a fully private system for the state, because that would likely result in more costs to a government forced to bailout a bankrupt company.

22 Comments | Leave a Reply »
  • ?

    Go read this book. It answers your question:

    http://www.amazon.com/Megaprojects-Risk-Ambition-Bent-Flyvbjerg/dp/0521009464

    The correct amount is about 33%. The reason you use private money is that they are better at controlling cost overruns. The average cost overrun of rail projects world wide is 45%.

  • Deacon

    I think the best way to approach a project like this would have been for the government to build the infrastructure and let the private company/s buy the trains and then lease the track from the government for a period of at least 20 years. Giving the company/s a chance to make the business a viable one.

    What you can also do as an additional source of revenue is to get corporations involved in naming rights for stations and even getting sports teams to brand a train ie if it were in NEC here Have a train Named THE PATRIOT EXPRESS, THE GIANT, THE FLYING JET and have it all decorated in their colors etc. There’s a lot you can learn from the Japanese way of railway ownership as well. They have it down pat, no reason why it can’t be done anywhere else.

  • Taiwan isn’t exactly a failure of private construction. It’s a failure of construction financed by high-interest loans. I believe the banks in question were mostly in the subprime lending business, so they charged subprime interest rates to THSR. A similar thing happened with the Channel Tunnel, which the Thatcher government denied low-interest loans, and which unsurprisingly found it hard to stay above water.

  • Deacon

    Alon nailed it right on the head.

  • EngineerScotty

    Of course.. the interesting question is this one: If infrastructure provides a public good, then why do we expect that it make money?

    The roads don’t “make money”, in the sense that road-based revenues (fuel taxes, weight-mile taxes, tolls, license and registration fees) don’t cover the costs of construction in maintenance. Yet they’re viewed as a public good that government ought to fund. Likewise with numerous other services such as police and fire. Likewise with aviation infrastructure. Even the airlines, judging from the number of bankruptcies they go through, often fail to make money.

    But many expect that rail transit should be self-funding.

  • Of course the failure of a company to succeed is a reflection of the environment within which it has been placed. In other words, if there had been lower interest loans provided to the company, it wouldn’t have failed. But the whole argument in favor of privatization is based on the idea that private companies will somehow do things more efficiently and more effectively than the public sector: the willingness of the Taiwan organization to take loans at high interest rates is a perfect example of private sector failure, because the company knew what it was getting into from the outset and took the risk. That risk is now transferred to the Taiwan government, which could have sponsored the project from the beginning at lower costs either by providing itself low-interest loans or simply using tax dollars — there is the guaranteed benefit of public involvement.

  • The argument for private ownership comes less from funding questions and more from managerial ones. Public companies often choose routes and stations for political reasons. JNR was plagued with this problem until it was broken up and privatized. If SNCF avoids the same issue it’s only because its TGV profits have made it independent of political pressure.

    There’s a difference between expecting HSR to be self-funding and expecting all rail to be self-funding. HSR is a premium service, used mainly by the middle class and rich, providing benefits to people who travel by choice. It can and should make money. Local and regional rail is necessary for commuters, who may be of any social class, and helps relieve highway congestion and reduce air pollution and sprawl. It delivers social benefits even when subsidized.

  • I don’t agree — generally the explanation put forward for why privatization is necessary is that it will provide consumers of a certain good cheaper prices and a better product. While it is true that services provided by the public sector can be influenced by politics, a well-managed public agency (such as the California High-Speed Rail Authority, for example) can be perfectly independent, as you showed in your example of SNCF

    As a side note, there are also very good reasons for politics to get involved at times — that’s the reason we generally believe in democracy.

    HSR can make money — it’s just that the constraints put on private industry, as demonstrated by this article, make it difficult for it to be self-sustaining without eventual public involvement. For major infrastructure projects, the point is that the government should probably be the lead player.

  • The cheaper prices and better products come precisely from the lack of political meddling. The best example here is airline deregulation. Before deregulation, airlines were forced to serve many underperforming city pairs and keep short-haul prices artificially low; this required jacking up prices on the busiest, most profitable routes. After deregulation, airlines started dropping low-ridership routes, which allowed them to reduce prices on routes people used more often.

  • jon

    it hard to have two (or more) competing rail operators share a single rail line. the only way to have effective competing railroads is to build separate competing rail lines in the same corridor as was done 100-150 years ago but is completely out of the question now. with rail it has to be one operator per rail line, which has its political problems… one company will be selected to run the trains and it will seem that the state built the expensive infrastructure for the exclusive use of a single company to make a profit off of. its very different with highway, air or sea travel.

  • Erik

    What are the implications for the privately-funded Desert Xpress then?

  • EngineerScotty

    Responding to Alon in #9–is this really better?

    If you are an air traveler between New York and Los Angeles, then yes, deregulation is good for you. If you are a traveler between Chicago and Des Moines (a route better served by modes other than air, but never mind); deregulation probably wasn’t very good for you. Would it be a good thing or a bad thing were the postal service to charge different rates to different areas of the country–so that if you live in a rural area, you (and/or those who mail you) have to pay a premium for postage?

    “Fair” service, where rates and availability are independent of profitability for the vendor, generally requires either regulation or public participation; any attempt by an unregulated private entity to subsidize expensive service with cheap service will eventually be undercut by competition and/or arbitrage.

    Now, to what extent public transit, of various classes, ought to be “fair” as in interesting question. I’m certainly not going to suggest that HSR or scheduled air service ought to be provided to every corner of the country; and there is a good argument to be made that the US subsidizes rural lifestyles far too much as it is. OTOH, a big reason that public transit loses money is because it is expected to be “fair”, and a big reason that the road network costs so much is that it, too, is expected to be “fair”. But when these networks do become fair and useful–that’s when they start to see patronage which justifies the investment.

    After all, 100 years ago, paved roads were highly limited in scope, and (mostly private) rail lines went damn near everywhere in the US. Would the US have developed the extensive auto-centric infrastructure that it did, had not policymakers decided that fairness and efficiency demanded a publicly-built network of highways and farm-to-market roads?

  • I don’t think the low-ridership routes in question were like Chicago-Des Moines. They were more like Des Moines-Kansas City: point-to-point routes connecting small cities, which the legacy airlines have replaced by a hub-and-spoke system; Southwest retains its point-to-point structure, but without deregulation it would never have been more than a regional Texan airline.

    I disagree with your postage example. Mail is a basic form of communications. I wouldn’t mind government subsidies to help the poor purchase computers and cell phones, either. However, the plane is an optional mode of travel, which the government should not subsidize any more than it pays people to buy cars.

    Public transit and roads don’t lose money because they’re fair. They lose money because of overexpansion – commuter rail overexpanded in the 1920s and 30s, and roads overexpanded in the 1950s and 60s. In neither case did this expansion do much to serve the poor, who were cut off from commuter rail by high prices and were later evicted to make room for highways serving the rich. Modern-day urban transit loses money for completely different reasons, namely that it’s badly run and that the government subsidizes the competition.

  • calwatch

    The other issue with Taiwan that people don’t mention were the teething issues in starting up the rail. There were rides that felt like roller coasters with sections of high speed followed by sections of moderate speed, switching problems, locating stations in major cities like Taichung and Hsinchu out of the city center and adjacent to the regular speed rail stations, and so forth. Most of the initial problems were ironed out after a year or so, but regular speed rail has always been popular and express buses are luxurious and useful when it is not a holiday weekend. The other issue is the hypersensitivity of the Taiwanese media. They have three times as many all news networks as the US, most of which show rolling news, meaning that the casual viewer might think that HSR is unsafe or a failure when in reality they are just rerunning the same story over and over again.

    Overall if the line were given a few more years to counteract negative public perception of the first year, on a less accelerated payment schedule, it would like still remain in private hands. For the government, it is a counterweight to freeway expansion. Traffic in both the big cities and the “suburbs” (which are nothing like the ones in the US or Canada) is atrocious at all hours of the day, and there is never any parking unless you go to a big box store. Most Taiwanese use scooters or motorcycles for day to day commuting, but keep a car for visiting the country or big errands. This will help quell the demand for more automobiles, which the island does not need.

  • Glen

    The private/parternship was pushed hard for inclusion by Governor
    Schwarzenegger for his support for the bond . The bond issue amount was never raised since its first draft back in 2002 and now covers less of the cost of construction. unless the Federal funding covers 80% we will need some amount of private/public pension investment to finish the system. its far less than the others that used this plan so its more
    workable no matter what the anti-HSR crowd shouts ie…”no one is going to invest in this.”.

  • All the commentary on the fallout of Taiwan HSR bailout by the Govt missed the important point: the project was setup to fail financially almost on purpose by the private company that build the line.

    The Taiwan HSR was constructed using build-operate-transfer model with a 35 year initial lease. What this means is that the Govt will end up owning the line regardless of what happens after 35 years of operation. However, the Taiwan High Speed Rail Corp (THSRC) was also granted 50 year exclusive rights to develop properties around the train stations… land that were given to it for free. So there was a huge financial incentive for THSRC to construct the line as fast as possible with sub prime loans because it will allow them to develop the properties sooner. Essentially, THSRC was really in it for the real estate speculation… the HSR line itself was a mean to the end, not the main financial interest of THSRC.

    The financial incentive of the private company that constructed the line was not properly aligned with the long term viability of the line.

    http://www.thsrc.com.tw/en/about/ab_comp.asp

  • EngineerScotty

    That bit of corruption sounds a lot like how many railroads got built in the US–except in most cases the lines are still in private hands.

  • -Dwid

    OT: Yesterday, Christof Spieler wrote about the passenger rail and transit status quo in a post about the viable HSR megaregions. Very good maps. It also shows how thin the existing service is. It makes one wonder whether there will be good feeder service to put HSR on top of.

  • Woody

    Dwid — Off topic or not, your link doesn’t work.

  • -Dwid

    Strange. Direct linking doesn’t work but copy&paste does. Whatever, the post “Megaregional transit” is under
    http://www.ctchouston.org/intermodality/
    or alternatively
    http://www.ctchouston.org/intermodality/2009/09/22/megaregional-transit

    By the way, that post brings me to another aspect that is not so off-topic. I wonder whether it’s really fair to have a private company “skim” some of the profit from HSR that not only requires a majority public construction outlay but also an existing local/regional transit network financed by government. Hmm.

  • Adirondacker12800

    That bit of corruption sounds a lot like how many railroads got built in the US–except in most cases the lines are still in private hands.

    The bankruptcy part sounds familiar too.

    …that not only requires a majority public construction outlay but also an existing local/regional transit network financed by government…

    Transit systems around the long distance train station are nice to have. No one worries about having mass transit to the airport. No one every says “we shouldn’t expand the airport until there’s light rail to the airport” or anything like that.
    Wilmington has almost no mass transit other than what happens at the combined SEPTA-Amtrak station. Wilmington is Amtrak’s 11th busiest station. People manage to get to and from the station. The main complaint up here is that there’s no way to get to the Amtrak station in Rennselaer, other than to use a car. There are a few buses a day as there are in Wilmington, supposedly there’s a bus route that stops there once in the morning on an outbound trip from Albany but.never goes by inbound. Albany is Amtrak’s tenth busiest station. Both Wilmington and Albany have an advantage. It’s faster to take the train than it is to drive or fly. So people take the train even though it doesn’t have mass transit to the station.

  • James

    bzcat: “The financial incentive of the private company that constructed the line was not properly aligned with the long term viability of the line.”

    bzcat’s comment was in the right direction, but the reason given is wrong. The financial incentives weren’t aligned because the holding company in charge of running THSR’s main shareholders were the very companies doing the construction. They didn’t care about bankrupting the company because they saw a safe bet with overcharging the holding company for construction, making their dough then, and then allowing the holding company to go into bankruptcy. In the accidental case the holding company could actually make money, they would make an even bigger profit.

    But if we look at the total benefit to society:
    Taiwan High Speed Rail is an amazing transportation system when you are moving long distances north-south through Taiwan. It makes Taiwan, already at a very high density and without US-style suburban sprawl, very competitive in Asia with transport from Taipei to Kaohsiung in only an hour and a half. Many of the stations in the middle are outside city centers and that is a very big drawback, but even in its form now, it is completely revolutionizing transportation in Taiwan. The domestic airliners are almost all gone with limited service only to areas without THSR. The reason for the loss is only that the ticket fares and the real estate development can’t capture the entirety of benefit of everyone that has done well because of THSR in terms of profit, but if you looked at it from a societal perspective, it is a total win.

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