NORFOLK — The private proposal to build a new underwater tunnel in this congested port city was originally billed as a way for Virginia to get a crucial piece of infrastructure without having to put in a single dollar of state money.
Instead, Virginia officials have agreed to spend slightly more than $580 million on the project, more than twice the investment from the companies behind the deal. With no competition, the companies won the right to collect billions of dollars in tolls over 58 years.
The state also agreed that the companies — Swedish construction giant Skanska and Sydney-based finance group Macquarie — are entitled to large government payouts if Virginia builds or expands other bridges or tunnels nearby, making fixing other traffic woes more costly for generations to come.
From Florida to California, public-private partnerships have proliferated as a bipartisan cure-all for the nation’s plugged-up politics and sagging infrastructure. The idea is that market forces can slash waste and speed projects, delivering much-needed improvements without soaring taxes. Maryland officials are seeking such a deal for the Purple Line light-rail project, and another is being considered to widen Interstate 66 outside the Capital Beltway in Virginia.
But whether the much-touted projects are good for the public today, or decades from today, often depends on arcane provisions hashed out between global financial titans seeking maximum returns and state officials hungry to get deals done. And sometimes things go wrong. An Indiana toll road went bankrupt last year after falling short of traffic projections; in Chicago, a 75-year deal privatizing parking meters has been denounced by critics as an unnecessary giveaway.
“The goal for government in these types of deals is to create as much public value as possible. That is their job. But that only happens when you examine the details and fine print of these partnership agreements really closely,” said John Forrer, an associate research professor of strategic management and public policy at George Washington University. “It looks like that didn’t happen here.”
For the military doctors, shipbuilders and teachers who struggle to get in and out of Norfolk, the promise of relief was alluring. The traffic-choked Navy hub is both enriched and hemmed in by its shipping channels and vast expanses of water, and marine vistas are perpetually blemished by the serpentine glow of inching taillights.
The details of the Midtown Tunnel project, which connects Norfolk with the city of Portsmouth under the Elizabeth River, were blurry from the outset, and they have continued to change.
“We got jammed with that project,” said longtime Norfolk Mayor Paul Fraim, adding that local officials were excluded from negotiations as top leaders worked with the private firms.
“The whole idea was to keep the political people out of this business deal, that they’d just sort of muddy the water,” he said. “It turns out there was no check on the guys who were trying to strike the deal.”
Sean Connaughton, who was transportation secretary under former governor Robert F. McDonnell (R) when the agreement was signed, declined to comment. But Tony Kinn, who was brought in by the McDonnell administration to aggressively pursue such deals, said the tunnel, set to open next year, will save commuters valuable time.
“I think it was a good, solid deal. It’s a good, solid contract,” Kinn said, declining to address questions about the project.
In the depths of recession, the Skanska/Macquarie partnership’s original proposal had an enticing pledge at its core.
“We declare the following: The only public financial support required would be in the form of” low-cost federal loans and bonds for private business use, according to the 2008 document. “No other subsidy or payment would be needed.”
So how did the state end up spending $490 million so far, with an additional $91 million to come?
“The proposed conceptual amounts were adjusted to the Commonwealth’s preference,” said Leila Rice, a spokeswoman for the Skanska partnership.
Rice said the state wanted commuters to pay less. The toll rates assumed in Skanska’s original declaration were between $2 and $3, she said, over a 50-year concession.
When the deal was signed in 2011, the off-peak toll rate was set at $1.59 and the peak rate at $1.84.
In announcing the deal, McDonnell said that Virginia was “recognized as a national leader in leveraging limited public dollars to attract significant private-sector investment and innovation, making complex transportation projects possible.”
That was nearly three years before McDonnell was convicted of public corruption and sentenced to two years in federal prison for taking lavish gifts from a dietary supplement maker. He is appealing the decision.
But in 2011, McDonnell was being mentioned as a possible vice presidential candidate, and he had sought to make partnerships with the private sector on the tunnel and other transportation projects a central part of his legacy. The Midtown Tunnel was lauded by an industry publication as one of the top toll projects in North America.
In fact, poor dealmaking by government officials eroded the promised public benefits, according to interviews and project documents. And the complex financial terms were at times described to the public and local officials in shorthand that could be misleading.
A month after the agreement was signed, an official with the Virginia Department of Transportation presented the “key business terms” of the deal between the state and the Skanska/Macquarie partnership, which is known as Elizabeth River Crossings OpCo LLC, or ERC.
“ERC to provide $1.7 billion investment,” read the PowerPoint slide, accounting for the vast majority of the $2.1 billion total.
In fact, the original deal called for the company to provide $220 million in equity. It also called for $51 million in “contingent equity,” but company figures indicate just 1 percent of that is expected to be used.
The company, indeed, spearheaded the financing.
It took out $1.1 billion in loans from the federal government and the Virginia Small Business Financing Authority, which sold bonds to fund the project. But those debts are guaranteed by the toll revenue — ERC’s corporate parents, Skanska and Macquarie, aren’t on the hook to pay them back.
Last year, a congressionally appointed panel cited confusion on just what public-private partnerships bring to the table. They “are not a source of funding,” it concluded — instead, they are financing and procurement tools. They can help deliver complex projects, but with higher financing costs that are “borne by the public — there is no free lunch.”
In addition to providing the new tunnel, the Skanska partnership is responsible for rehabilitating two old tunnels and maintaining all three of them for more than five decades. It also assumes the “revenue risk.”
That means if the Skanska partnership’s traffic projections are wrong, and fewer people use the tunnel, it is the company that would lose out by making less money. The state would still have a tunnel it didn’t have before.
In frenzied final negotiations in 2011, Virginia made a series of promises it couldn’t keep, raising questions about the soundness of its overall approach.
Representatives from the private firms and the state hit a wall during marathon sessions in a Richmond conference room, participants said.
“We found ourselves in Richmond for a solid week, working with VDOT and the developer and us,” said Wade Watson, a Skanska vice president representing the company’s construction arm in the talks. “And what the governor said was, ‘If you guys can’t get this project to a certain toll, we’re done.’ ”
In exchange for the lower toll, the Skanska partnership demanded sweeteners elsewhere.
And got them.
The negotiations were shaped by a critical fact: This was not a competitive procurement.
“A decision was made to advance the project with one bidder, which was a decision of that administration at that time,” said Dusty Holcombe, who as deputy chief of the state’s public-private partnerships office was a key negotiator. “Under any procurement, we’d rather have multiple bidders competing against each other for the price of it.”
They didn’t, and a series of concessions followed.
First, the state agreed to let the company impose tolls on the existing Midtown and Downtown tunnels running from Norfolk before the new, parallel Midtown Tunnel was completed.
Second, the state said the company could raise tolls by 3.5 percent each year or the rate of inflation, whichever was higher.
State negotiators also agreed that if Virginia built competing tunnels or bridges, the Skanska partnership would be entitled to compensation for lost tolls. And officials made the commitment without calculating what it could eventually cost, Holcombe said. Chances were deemed too remote, and, in any case, timing would be critical, he said.
“There is no specific value assigned to them because that value would be only specific to the date” something was built, Holcombe said.
The private sector was less laissez faire.
An analysis provided to outside investors put the potential price tag at between $269 million and $774 million, depending on which project is built when and how high the tolls are.
In Virginia, one of those possible future competitors is a major bridge-tunnel known as Patriots Crossing. For years, that project has been a priority of Norfolk Mayor Fraim, who said a new dedicated stream of transportation funds in his region has added momentum.
But “at the time, the administration did not feel that there was a risk associated with building Patriots Crossing. They just felt it was so far out, it was a risk that the administration was willing to take,” Holcombe said. He noted that the burden of proof remains with the company to demonstrate that its revenue is lower than it would have been without a competing tunnel or bridge.
Shortly after the Midtown Tunnel deal was signed, it began to fray.
Facing fierce opposition, the state in 2012 decided to delay the new tolls until a new governor took office. That added $112.5 million to the $308 million the state originally put into the project.
Then, in 2014, shortly after Gov. Terry McAuliffe (D) came into office, his administration decided to temporarily lower tolls during the construction period, adding an additional $82.5 million to the state’s total.
And this summer, officials agreed to pay the Skanska partnership $78 million more to permanently buy down the tolls on a short stretch of the Martin Luther King Jr. freeway that was part of the overall toll project.
The new infusions gave some relief to drivers, and they benefited the Skanska partnership by allowing it to delay — and probably decrease — its own investment, which reduces its risks, company documents and interviews show.
Akash Deep, an infrastructure financing expert and senior lecturer at Harvard’s Kennedy School of Government, said that particularly lengthy public-
private agreements such as Virginia’s raise important political questions — and can lead to significant new costs down the road.
A 58-year commitment “spans administrations, it spans generations,” he said, and “public priorities change over time.”
“If you do things using traditional public procurement, it’s easier to make changes,” Deep added, noting that governments can change their budgets year to year. With public-private partnerships, “you write contracts with private entities, and changing contracts can be expensive.”
Virginia’s current transportation secretary, Aubrey Layne, said the state would have been better off spending its own money to build the tunnel and keeping the decades of potential upside to itself.
The state agreed to put $273 million more into the project after the deal was signed. The Skanska partnership originally committed $220 million.
“The reason the state supposedly sold this asset — that’s what we really did for 58 years — is we felt we didn’t have the money,” said Layne, an accountant who has been sharply critical of the deal. In fact, he said, it’s now been proven that the state could find the money.
“We didn’t need their equity. If we didn’t need their equity, we wouldn’t have had to agree to all these other provisions,” Layne said, including the company’s internal rate of return of 13.5 percent on its investment. “There is a hell of a lot of money over 58 years.”
A separate Skanska entity was recently fired by Apple, which wanted changes in how its new space-age headquarters was being built in Cupertino, Calif. Virginia officials say the quality of the company’s construction work on the Midtown Tunnel has been excellent.
But Virginia is stuck with the deal it made.
The state can cut off the agreement, Layne said, but given how the contract is written, “doing so would be just as expensive.”