Doing Right by the Public: PPPs in High-Speed Rail

» As the retrenchment continues in the American public sector, private-sector investors are likely to play an important role in paying for fast train systems.

California Governor Jerry Brown, a longtime supporter of the development of high-speed rail, has not given up on his state’s plans for an extensive network stretching initially from San Francisco to Los Angeles, and then on to Sacramento and San Diego. Despite cost estimate increases, opposition to the line among residents of some affected areas, and a total loss of new federal funding thanks to anti-investment Congressional Republicans, Mr. Brown has made evident in recent weeks his support for the line.

Construction on a segment in the Central Valley between Merced, Fresno, and Bakersfield is still planned to get under way next year. Funding for that initial link is mostly lined up, thanks to state commitments and federal grants resulting from the stimulus of early 2009.

But because of more detailed projections, the 178-mile first phase of the project is now expected to cost far more than initially envisioned — $10 to $13.9 billion instead of $7.1 billion — and it will need an injection of funds from another source to be constructed. With a promise to the state’s citizens that another demand for California-wide funds will be avoided, few local dollars to contribute, and an utter inability to rely on Washington for practically anything, that means the system will have to find private investors to join in. Whatever the relative merits of allowing private companies to invest in what is fundamentally public infrastructure, California has no other place to turn for the successful completion of its system.

California is not alone; with a depressed economy and few public sector funds available, there is increasing recognition of the importance of engaging private-sector funds in the creation of infrastructure. Illinois Governor Pat Quinn signed a bill this week authorizing public-private partnerships (PPPs) to be used for the creation of infrastructure in his state.

Critics of the California High-Speed Rail Authority have repeatedly argued that the agency would be unable to locate businesses that might be willing to contribute to the system, but international examples suggest that there is significant private sector interest in infrastructure construction. The Authority will release a request for qualifications soon and select a winning bidder in early 2012. But it has yet to clarify the manner in which it would structure its relationship with private companies in terms of financing, construction, and operations.

For precedents, the state should to look at France, which has recently signed two very large deals with private financing and construction conglomerates for the completion of two new extensions of its already large high-speed rail network. They provide two different models for engaging PPPs.

The first is the Bretagne-Pays de la Loire (BPL) high-speed link, which will connect Western France to the existing northern branch of the Atlantique line with 182 km of new tracks between Le Mans and Rennes for a cost of €3.4 billion. The connection will reduce running times from Rennes to Paris by 37 min, making it possible to travel on 320 km/h TGV trains between the cities in less than 1h30 by the time construction is complete in 2016.

The PPP contract here is being mostly funded with public sector sources; RFF, the public infrastructure owner, will contribute €1.4 billion, with state and local governments paying about a billion Euros more. 30% of the costs will be financed by the private sector group Eiffage. These loans will be paid back over twenty years with pre-determined fees from RFF and the government.

Like the Rhônexpress project in Lyon that connects the city center to the airport, this PPP arrangement essentially keeps the operations risks in the hands of the public sector; if ridership comes in under estimates, it will have to scrounge up funds from elsewhere to pay Eiffage its standard due. If ridership is higher than estimates, RFF will make a profit on its investment.

The other much larger project soon to begin construction in France is the Sud-Europe Atlantique line, which will extend the southern branch of the existing Atlantique line 302 km from Tours to Bordeaux. This €7.8 billion program will by 2017 bring Bordeaux within 2h05 of Paris, about an hour faster than today. Ridership to and from that city and Toulouse, planned to be about four hours away from Paris, is expected to rise substantially.

Because of the expected profitability of the line, RFF signed a concession contract earlier this year with a private consortium called LISEA made up of Vinci construction company (33.3%), the Caisse des Dépôts (25.4%), SOJAS investment company (22%), and AXA bank (19.2%). The 50-year contract, which includes construction, operations, and maintenance, is the largest-ever PPP for a high-speed rail construction project in Europe.

LISEA will contribute €3.8 billion to the project, with the remainder of costs being financed by the public sector, from local, region, national, and European sources. Much of the private funding will come from low-interest, long-term loans that will be repaid through charges on TGVs and other trains using the line, which will eventually be passed on to the ticket-paying passenger. The public sector funds are grants, so about half the line’s construction cost is expected to be paid back through ridership over the course of fifty years.

Unlike the BPL line, which limited risks of operational profitability and line ridership to the public sector, in this case the private investors will be responsible if initial estimates fall short.

If it wasn’t clear, the business case for Sud-Europe Atlantique line, like that for the California High-Speed Rail Authority, assumes operational profitability. Considering that the international record shows that high-speed rail systems have little difficulty achieving self-support, these are not unsound predictions. In both cases, the advantage of acquiring private-sector support for the project is delaying public investment and using future revenues to pay back construction costs. Each approach has its advantages, especially in terms of where risk is directed.

It would be a mistake to conclude from these examples that private-sector involvement will save any significant money over the long-term. Fundamentally, the creation of PPPs to fund projects such as California High-Speed Rail does not mean that the public at large will end up being responsible for a smaller percentage of overall costs. Indeed, the U.S. Department of Transportation’s Office of Inspector General released an under-recognized report last month that expounded on this fact significantly.

By considering a series of PPP highway projects in the U.S. and abroad, the study noted that they “have a higher cost of capital than traditional public financing… [and] involve equity investors who own stakes in the projects, share in the profits, and expect to earn higher rates of return for the risk they undertake,” in addition to having to pay taxes public projects do not have to pay. Even if PPPs have lower design and construction costs, may be able to more effectively increase tolls, decrease percentage of evading users, and take more advantage of concessions*, they are usually not able to offset the higher costs resulting from the formerly noted issues.

Some states like Illinois and Indiana have “made” billions by leasing off highways to private investors for billions for fifty years or more, but the report argues that “the funds paid upfront to the public sector under a PPP are paid in exchange for future revenues, often in the form of tolls.”

In other words, while the taxpayer may appear to be getting a discount now by having a business group pay for infrastructure, users of that same infrastructure will inevitably have to face the costs of future tolls. In the case of high-speed rail, replacing public sector investment during the construction phase with privately financiers using loans means higher ticket prices in the future to pay back a portion of the costs of construction. There is no free lunch.

The question is whether benefits of a transportation investment advantage the entire public or whether they are reserved to the specific people who take direct use of it. Transportation economists are convinced of the value of user fees, which assume that it is inefficient to carry out redistribution through indirect means, and for them, it makes perfect sense to charge users the full cost of not only the operation but also the construction of the infrastructure they are using. (Many economists would also argue that high-speed rail projects have significant positive externalities like pollution reduction and land use prioritization attached to them that demand direct grants from the government to cover some costs.) This user-fee approach is the method being used in the financing systems of the PPPs discussed here.

Others, however, would argue that the benefits of infrastructure like high-speed rail are economy-wide and that they should be paid for not only by users but by all members of the population through taxes. If we take this side of the argument, it becomes less clear that the best value for the society is to divert most costs to users. A grant-based system assumes that benefits of a transportation investment are felt by people throughout a country (such as through economic growth) and therefore just charging the riders for the costs of capital investments would be inappropriate.

Encouraging private investment in the California high-speed system now may make it more feasible to envision its construction in the short-to-medium-term. Delaying using future public sector revenues to pay for a project today is the basis of much long-term investment, so there is nothing particularly out of the norm about this idea. But the use of such investment will realistically mean a future of higher ticket prices resulting from the need to pay off the bonds taken out for the project’s completion.

Nor is the involvement of private-sector groups in a public-sector project risk-free. In fact, the devastating example of the United Kingdom’s High-Speed 1 line, connecting London to the Channel Tunnel, suggests that any decision to incorporate private investors in public infrastructure should be approached with skepticism — even trepidation.

A report from the Public Interest Research Group, also released this summer**, established a number of valuable principles for PPPs that are useful to consider in evaluating whether or not to include private groups in the funding process for a high-speed rail line. These suggestions include aligning “private sector incentives with public sector goals,” only pursuing PPPs “where ample competition exists,” ensuring “clear public accountability,” retaining public control over system decisions, limiting lengths of contracts, and guaranteeing transparency in the contracting process.

In addition to considering the French examples for PPP contract models, these are helpful suggestions that should be taken to heart by the California High-Speed Rail Authority as it develops its plan to bring fast train service to the state.

* Many of these fiscal advantages may (or may not) stem from the ability of private sector groups to avoid paying workers living wages, comply with minority workforce inclusion programs, fulfill expectations expressed by the public in the democratic system, and so on.

** For the sake of full disclosure, I served as a reviewer for the PIRG report.