With U.S. infrastructure aging, public funds scant, more projects going private
By Cezary Podkul,
When the city of Chesapeake, Va., considered closing a crumbling, 80-year-old bridge over the Elizabeth River in 2008, local officials knew that neither the state nor the federal government would pay for a replacement. Just tearing down the old one would cost millions of dollars. So they sold it.
“We paid them $10,” said Bob Hellman, one of the investors, but “what we gave them wasn’t just $10.”
Hellman’s investors group, American Bridge Partners, agreed to remove the old bridge — and to build a brand-new one, solely with private money. Tolls of about $2 a trip, up from the old 75-cent fee, will pay back the company’s $130 million investment in the new South Norfolk Jordan Bridge, due to open in the spring.
“This is a Christmas gift for the city,” said Chesapeake Mayor Alan Krasnoff.
It’s a gift cities and states are asking for more than ever. The goal is not to raise cash by selling public infrastructure but to tap into the private sector for money to build new bridges, roads or tunnels — possibly faster and cheaper than the government otherwise could.
There are at least 70 privately funded and managed infrastructure projects across the United States in various stages of development, according to a list compiled by the law firm Allen & Overy. These are part of a vast network of roads, bridges and tunnels — to say nothing of the subways, ports, airports and water systems — crying out for attention. Consider this: Over the past 60 years, the United States has built a 46,876-mile federal highway system that is now in dire need of repair. As a result, states have had to pour more of their transportation dollars into fixing aging highways and even in good times have little or nothing left over for new construction.
The Great Recession made that harder. In many cases, financially strapped states and cities have little choice but to turn to the private sector, even if it means giving up revenue and selling off an asset normally seen as belonging to the public.
In Chesapeake, “they were looking at our bridge versus no bridge,” said Hellman, who previously invested in pipelines, coal, landfills and even cemeteries. “That’s ultimately what you’re looking at in many of these circumstances.”
“States are facing a transportation funding crisis,” said Jaime Rall, transportation policy specialist at the National Conference of State Legislatures (NCSL). But she does not pin the blame for the crisis on the recession alone. She also points to the “political reluctance to raise the gas tax,” she said.
The gasoline tax, which feeds into the National Highway Trust Fund for highway projects, has stood at 18.4 cents a gallon since 1993. Adjusted for inflation, it would need to be 29 cents a gallon just to buy what it did then, according to the Bureau of Labor Statistics. But Congress and the White House oppose any increase.
As a result, federal transportation finances are in even worse shape than many states’. The highway trust fund ran out of cash and had to be rescued in 2008, 2009 and 2010 at a total cost to taxpayers of $34.5 billion. It is expected run out of cash again next year.
“There is no public money,” said D.J. Gribbin, a former chief counsel to the Federal Highway Administration who works at Macquarie Capital, a large Australian investment bank.
While public coffers have been running dry, a cottage industry has been built around the concept of investing private money in infrastructure. It has grown exponentially over the past decade thanks largely to the world’s largest pensions, which have come to view infrastructure as a separate investment category, much like a stock or a bond.
Precise estimates are hard to pin down, but in the past five years, the 30 biggest investors in infrastructure have channeled as much as $180 billion into these types of investments, according to Infrastructure Investor magazine. These investors include Macquarie, as well as some of the largest pension plans in Europe, Australia and Canada.
More capital is on the way. There are 100 private funds seeking to raise $95 billion for infrastructure investments globally, according to a tally by San Francisco-based fund adviser Probitas Partners, though not all of them will succeed. Of that, about $11.5 billion would be targeted for the United States, with fund sizes ranging from $100 million to $3 billion.
“In 2003, nobody in the U.S. talked about infrastructure,” said Kelly DePonte, a partner at Probitas. “We really have seen a sea change in interest.”
The main draw for investors, DePonte said, is the steady, predictable income that infrastructure assets can provide. People need to get to work, use electricity and flush toilets, so a toll road, an electric utility or a water utility tends to deliver cash no matter what happens in the stock market on any given day. Recent research by Macquarie shows infrastructure has outperformed the global stock market by an average of about 0.5 percent per month in the past 10 years.
“Traffic on the road is highly insensitive to stock market levels,” said Chris Camarsh, head of investment process at Australian fund manager CP2. That makes infrastructure a good way to save for one’s nest egg, since “there is good predictability that the cash will be there when you’re older,” he said.
Camarsh, for example, holds shares in Transurban, an Australian toll road developer that owns an 85-year contract to build and operate an expansion of the Capital Beltway in Fairfax.
“It’s my retirement,” he said.
That has helped lure Canada’s $52 billion Ontario Municipal Employees Retirement System, which provides retirement benefits to more than 400,000 members. It has devoted about $8.25 billion, or 16 percent, of its portfolio to infrastructure because it “matches the long-term returns that we need for the pension plan,” said Michael Nobrega, chief executive of OMERS. The pension fund bid — unsuccessfully — for the Chicago Skyway and the Pennsylvania Turnpike.
Nobrega is putting together the $20 billion Global Strategic Investment Alliance with other large pensions around the world, including up to $5 billion from U.S. pension funds, to jointly buy some of the largest assets in the world.
“Any pension that does not have allocation to large-scale infrastructure assets . . . I think is missing a real opportunity,” he said.
In the United States, he sees a $1 trillion shortfall for infrastructure investment.
“But,” Nobrega said, “I think the government framework has to be there to encourage us to be there.”
‘Open for business’
States are increasingly rolling out the red carpet to attract big investors to their infrastructure projects. Thirty-one states and Puerto Rico have laws on their books authorizing private investment in infrastructure, according to the NCSL’s Rall.
But the laws vary so much from state to state that investors often refer to the United States as a patchwork of 50 separate countries. Nevada, for example, has approved private investment in one toll road, while Puerto Rico’s 2009 law created a menu of opportunities across water, energy, transportation and education sectors, as well as a separate office to administer them.
So far, Virginia has had the most success attracting private capital to its projects. The state was among the first to pass legislation enabling private investment for transportation in 1995. It has since built three projects with the help of private capital. Five more are under construction, and another four are in various stages of development.
One deal sealed in July is a $1.9 billion tunnel project directly north of Chesapeake’s new Jordan Bridge. It is what people in the business call “a public-private partnership.” A private consortium led by Macquarie will invest $1.2 billion, one quarter in direct equity, more than a third covered by commercial loans or bonds, and a third to be provided through a direct Transportation Department loan that has yet to be approved.
As in the privately financed Jordan Bridge, tolls from the Midtown Tunnel expansion will go to covering the finance costs and providing a return to the investors.
“You have to look at this from a business perspective,” said Tony Kinn, who heads up a new division for privately financed projects at the Virginia Department of Transportation. “If we could afford to do all these projects ourselves, we would do them.”
The state is also a partner in the Midtown Tunnel expansion. It will contribute a $395 million subsidy to the project. It gets two things: a new tunnel without laying out the extra $1.2 billion and a lower toll than the private investors would have demanded otherwise. But it gets no revenue unless certain revenue-sharing provisions kick in later in the 58-year contract. Under the deal, Virginia capped tolls initially at $1.84 and will let them rise at roughly the rate of inflation.
“We have to leverage the available state funds,” Kinn said.
That does not mean every new highway project in the state will be a toll road or involve private capital, said Dusty Holcombe, Kinn’s deputy. Where all-public financing makes sense, the state will do that.
But, where appropriate, the state will be “proactive, aggressive and active” in getting the private sector involved in building new infrastructure, Kinn said. “Virginia is open for business.”
Initially, private investment in U.S. infrastructure took the form of buying or leasing rather than building projects.
Six years ago, Chicago got $1.8 billion for leasing its Skyway toll bridge. A year later, Indiana raised $3.8 billion by leasing a toll road.
“Following a couple of the catalyst transactions — the Skyway, the Indiana Toll Road — there was clearly an expectation in the private sector that the public sector couldn’t resist doing these transactions,” said Tom Lanctot, head of infrastructure investment banking at William Blair in Chicago.
Only a handful of the private funds were geared toward new-construction projects, said Ryan Orr, a professor at Stanford University who studies investment in infrastructure.
Large pensions and sovereign wealth are more inclined to buy existing assets rather than taking on the many risks of building new ones, Orr said. New-construction projects also take a long time to develop.
Sovereign wealth funds also like to bid for existing big-ticket assets. In 2009, when Chicago leased its parking meters for $1.15 billion, the Abu Dhabi Investment Authority, the investment arm of the oil-rich Abu Dhabi government, took a minority stake.
The sale or leasing of big visible infrastructure — especially to foreigners — has provoked resistance from the public.
“Do you really want to be selling off your assets?” Rolling Stone writer Matt Taibbi asked a New York audience in March. He had elicited laughs while recounting an anecdote about officials from a Middle Eastern sovereign wealth fund trying to decide whether to bid for the Pennsylvania Turnpike. “I think its absolutely nuts,” Taibbi said.
Orr dismisses such sentiments.
“We live in a globalized economy,” he said, and as a result Middle Eastern investors make all kinds of investments in American assets, such as U.S. Treasury bonds. “Why is a toll road any different? Has there ever been a case where we’ve ever had a problem with an Arab sheik interfering with the operation of one of our assets?”
Public officials have also questioned the financial wisdom of selling off the crown jewels of public infrastructure and of giving up, sometimes for decades, key revenue streams such as parking fees.
Proposals to lease toll roads in Pennsylvania and Florida died after public debate. A plan to lease Chicago’s Midway Airport fell apart, and proposed parking leases in Los Angeles, Pittsburgh, Harrisburg, Pa., and Hartford and New Haven, Conn., were tabled or shot down by local politicians.
Some municipalities and states — such as Ohio, which is mulling whether to lease its turnpike — have come back to the private market with deals on existing infrastructure. But plans for new-construction projects are moving along, mostly at the state level.
Not ‘black and white’
Even when governments embrace deals, the math does not always add up for private investors. The classic example: a short California toll road called the South Bay Expressway.
The road made history in 2003 when it became the first privately backed toll road to secure a loan from a Transportation Department program designed to provide financing for innovation. The $140 million loan helped kick-start construction on the 9.2-mile road, which links the southern San Diego suburbs to an industrial area near the Mexican border.
But when the $658 million project opened to traffic in November 2007, things did not go as planned. The subprime-mortgage crisis roiled Southern California. Expected housing developments were canceled, and recession-battered motorists turned to neighboring freeways. Traffic was about half of what investors had expected, said Greg Hulsizer, the toll road’s chief executive.
To make things worse, the company got tied up in costly litigation with its contractors. By March 2010, with the economy still weak and the litigation draining its coffers, the South Bay Expressway filed for bankruptcy.
When the South Bay Expressway emerged from bankruptcy, the Transportation Department wrote down its loan to about $95 million, costing taxpayers $55 million. But it also received a one-third ownership stake in the road company, Hulsizer said.
To some analysts, it showed why taxpayer funds should not go to such projects.
“The public ends up taking the bath,” said Phineas Baxandall, policy analyst at the U.S. Public Interest Research Group.
To others, the Transportation Department made out well. Dale Bonner, who served as California’s highest transportation official during the bankruptcy process, said the whole episode was “a sign of the strength” of the private investment model. The initial investors were wiped out while the lenders, including the government, were compensated.
“I didn’t have one troubled night of sleep about having to explain to the legislature or the taxpayers that we are going to have to come up with extra money to bail anybody out of the project,” Bonner said.
Now the South Bay Expressway is going to be sold — to government. The San Diego Association of Governments recently decided it was worth it to just buy the expressway and lower the tolls, which have pushed droves of motorists onto a parallel, congested freeway. The association approved a $345 million buyout offer in late July, cheap compared with the initial development cost or what it would have cost to widen the neighboring freeway.
“These lanes are available now and at half the price, so it’s a smart play,” said Jerome Stocks, chairman of the governments association.
Once the local governments take over the expressway, Stocks hopes to cut tolls by half from the current $4 per trip.
“We don’t need to make a profit. We’re not in business to make a profit,” he said. “So our cost of doing business is quite a bit lower than the private sector.”
And what about the Transportation Department? It chose not to sell out to the local governments, opting to remain invested in the deal, according to a spokesman. The department also expects “to fully recover its investment in the toll road” and will continue to make similar loans in the future, the department spokesman said.
Stocks isn’t so sure.
“There is a very good possibility that they will be made whole completely,” he said. “There is also a very good possibility that they won’t.” Like the whole issue of private investing in infrastructure, he added, “it’s not black and white.”
How the U.S. ranks in quality of roads Behind France (1), Oman (4) and Malaysia (18).
How the U.S. ranks in quality of air transport infrastructure Behind Singapore (1), Barbados (10) and the Czech Republic (23)
Railroads Behind Switzerland (1), Taiwan (12) and Canada (15).
Port infrastructure Behind Singapore (1), Estonia (18) and Namibia (22).
Source of rankings: The Global Competitiveness Report 2011-2012, World Economic Forum