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Public-Private Partnerships: The Value of Puerto Rico

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July 18, 2017
Michael Athanason, Ariel Ramirez, and Ben Nolan
BRG

Version en español.

Infrastructure costs in the United States (and around the world) are on the rise. As population grows, so too does the need for increased and well-maintained infrastructure. The vast majority of money for infrastructure comes from federal, state, and local taxes, special taxes, and municipal bonds. In this paper, we will discuss whether this is sustainable in the long run, and if alternatives exist to both reduce the risk of these projects and lower the long-term debts of cities.

A public-private partnership (P3) is a public infrastructure project done in partnership with a private entity. Financing, constructing, and/or managing the project are handled by the private entity in return for a promised stream of payments from the government or public users for a specified period of time. A P3 is not a sale of public land; it is more like a lease. The land or public service is still owned by the public, with full rights and operational responsibility reverted to the public at the end of the specified term.

In the last five years, P3s have increasingly become a solution for governments around the world to fund infrastructure projects. The United Kingdom, Canada, Australia, and Spain have completed P3 projects in areas such as highway toll roads, airports, hospitals, tunnels, and public transit. Other areas that have engaged in P3 include aerospace; stadiums and sporting venues; highway maintenance and street lighting; roads, tunnels, and crossings; rail; ports; energy; prisons and social justice; healthcare; and education.

However, the United States has been slow to adopt P3. Reasons for this include the lack of a uniform national legal framework, competing political agendas, and a general lack of understanding of how the concept works and whether it has been successful. There is a great need for extensive infrastructure improvements, but the method to solve this crisis is still being debated on federal, state, and municipal levels.

This article discusses how public-private partnerships operate and then examines the value of Puerto Rico in future P3 projects across the United States.

How P3s Work

A public build project is contracted to a private company to design, develop, build, and maintain for a set period of time (usually 30 years), during which the public still owns the project and after which the project is returned to the public. It is basically a “lease” to the private company. Funding for the project is sourced by a combination of money directly from the private company, outside investors, or funds from the public.

Possible advantages for the public include lower upfront cost and faster completion. There is no need to raise public funds through bonds, higher taxes, special taxes, or other measures. Financial risk of project cost overruns is passed to or shared by the private company.

Potential advantages for the private company include a steady source of income, public good will, and relationships built with the government. Legal and regulatory risk for the project is kept by the public.

Many P3 projects have used a model in which parties mutually designate a neutral, individual “decision maker.” If a dispute arises, the sides present their cases to the decision maker, who makes a decision within an agreed-upon time. All parties then adhere to that decision in the interest of continuing the project.

An increasing number of P3 projects in the Latin America region (Metro Lima in Peru, for example) have formed consortiums to execute complex projects. These consortiums are legally complex and risky, as partners frequently have not worked together previously. Differing goals and needs make management an ongoing, complicated negotiation. Both project cost and schedule can be compromised. These factors not only make management troublesome, but also highlight the need for experienced, knowledgeable P3 partners and consultants to provide a strong foundation. The public gains an advantage in having one responsible party in charge of the overall project, instead of having to manage all details.

A P3 should benefit all parties, from the private investors that help with initial costs to the public that uses the resulting infrastructure.

P3s appear in many forms depending on the source of financing, scope of work by the private company, transference of ownership rights, and long-term operations, maintenance, and/or operating agreements of the public property. Basic forms include Operations and Maintenance (O&M), Design-Build-Operate (DBO), Design-Build-Operate-Maintain (DBOM), Design-Build-Finance-Operate-Maintain (DBFOM), and Build-Operate-Transfer (BOT).

P3 Project Examples

While a federal P3 policy framework has yet to have been put in place, individual cities and states have implemented P3s at lower levels, to varying degrees of success.

Chicago Parking Meters, Illinois

In 2008, to help cover a budget shortfall the City of Chicago leased maintenance and upkeep on parking meters and city-run garages to a private consortium led by Morgan Stanley for $1.1 billion. The deal was to run for 75 years. A year after the program started, the City recalculated potential earnings for this project and found that its initial projection fell far short of reality. This was great news for Morgan Stanley and its investors, but aggravating to the public. This P3 was a success for the private entity, but a long-term source of frustration to the public side.

South Bay Expressway, San Diego, California

The South Bay Expressway (SBX) is BOT franchise for a 9.2-mile toll road east of San Diego that runs north–south beginning near the Mexican border. The road opened to traffic in November 2007, and the contract lasts 35 years. In 2010, barely two years after opening, the private company operating the road declared bankruptcy. Traffic and revenue fell more than 50 percent short of projections due to a combination of the financial crisis, ensuing recession, and lowered demand of truck traffic from Mexico.

In 2011, the San Diego Association of Governments (SANDAG) purchased SBX from the private operator for $341.5 million. To help pay for this purchase, the planned expansion of the parallel I-805 (a non-toll highway with severe congestion issues) was canceled. This P3 was a failure for both public and private entities. The public entity lost on the needed expansion of I-805, while the private entity fell into financial distress.

I-595 South Florida

An example of a P3 project that balanced public and private interests involves the recent upgrade of 10.5 miles of Interstate 595 in South Florida. This DBFOM project improved the existing road and added reversible, pay-for-use express lanes to alleviate traffic during peak hours. The road itself remained a state-owned asset, with policing and laws unchanged. The road fully opened to traffic in 2014, and the $1.8 billion contract is under a 35-year concession. Revenue from the high-speed toll lanes will be collected and retained by the Florida Department of Transportation and then used to make availability payments to the concessionaire, based on quality and future maintenance requirements.

With the ongoing success of I-595, the same P3 model, in which a high-speed center toll lane is used to pay for repairs and upgrades to the main non-toll highway, is now being utilized to make improvements on adjacent Interstate 75.

The Presidio Parkway, San Francisco, California

This project replaces a heavily traveled, worn out, obsolete, undersized, and hazardous stretch of road, high viaduct bridges, and tunnels that lead up to the toll booth of the Golden Gate Bridge. The California Department of Transportation (Caltrans) is the owner and Golden Link Concessionaire is developing the project. Federal and state agencies are involved in the oversight of virtually every aspect of the project, which required extensive upfront planning and decision-making. Once the decisions had been made, actual design and construction were performed. The new Parkway was opened on time and is meeting availability requirements.

Value-for-Money Analysis

The central question for a private entity considering the P3 market is: Will the investment be worth it? The market for P3 is relatively young, but as data from P3 projects around the world is amassed, one key measurement emerges as the penultimate analysis for whether a public-private partnership is the best method to address infrastructure needs: Value-for-Money (VfM).

VfM analysis is a comparative assessment between delivering the same service (to the identical output specifications) as a conventional public-sector procurement (a Public Sector Comparator, or PSC) or as a P3. In a typical comparison of a P3 against a PSC, the consultants’ efforts concentrate on the costing of each procurement option in the form of a discounted cash-flow model adjusted for risk.

A PSC model needs to accurately focus on the costing of a project with specified outputs with the public sector as the supplier, where costs will be based on recent, actual costs of a similar project or best market-related estimates. Comparing the P3 and PSC models will enable both governments and bidders to yield the best VfM for the public.

VfM analysis consists of three steps:

1. Determine Risk Framework

The Risk Framework analysis intends to ensure that major risks to all parties are identified and that the following questions are answered:

  • Do both the PSC and P3 models reflect the requirements of the output specifications?
  • Have capital, operating, and maintenance costs required to deliver the service according to the output specifications been included?
  • Have material and quantifiable risks been identified and accurately valued?
  • Have risks been summarized in the risk matrix, including their consequences, financial impacts, and proposed mitigation strategies?
  • Have risks been appropriately assigned to the party best able to manage them?
  • Are all assumptions used reasonable and appropriate?
2. Conduct VfM Analysis

If all the questions above are answered in the affirmative, facts are gathered to begin the VfM analysis. The PSC project (if developed by the public sector) is compared against a theoretical P3 model to determine whether the P3 alternative might bring more value to the public over the PSC model.

3. Conduct Affordability Assessment

VfM is a necessary, but not sufficient, condition for P3 procurement. If a project is unaffordable, it undermines the institution’s ability to deliver other services and should not be pursued.

For most government expenditures, affordability is assessed by considering the annual budget constraint. Project selection therefore involves an early assessment of what payment structure is feasible; the amount the government or users can afford to pay (and when); the impact on the project’s scope, service level, and structure; and associated risks the private sector might be prepared to accept.

This approach typically includes the assessment of both absolute and relative measures of affordability:

  • Determine institutional budget available for the project
  • Examine level and structure of a project’s overall revenue requirements in relation to the capacity of users and the public authority to pay for the infrastructure service
  • Assess private sector’s capacity and willingness to deliver on the forecast basis
  • Estimate expected capital, operating, and maintenance costs of the project
  • Incorporate cost-escalation indexes into the future
  • Estimate levels of cash flow required to repay the loans and provide a return to investors
  • Forecast cash flows over the proposed term of the P3 contract

The Value of Puerto Rico

The US is the largest potential market in the world for P3 projects. About $416 billion (2.4 percent of GDP) was spent in infrastructure in 2014. The Trump administration has expressed a desire to increase the use of P3s to an ambitious $1 trillion plan to overhaul the US infrastructure.

Currently, P3 decisions are made at the state level, meaning policy can vary from state to state. This can make it difficult for companies to get involved in a P3 project. However, one part of the United States has had a P3 policy framework in place for almost a decade: the Commonwealth of Puerto Rico.

P3 Act of 2009

The P3 Act of 2009 (“the Act”) created the Puerto Rico Public-Private Partnership Authority (“the Authority”) as a public corporation affiliated with the Government Development Bank of Puerto Rico. The Act detailed a robust legal framework for the implementation of P3s. Any public entity that proposes to enter into a P3 contract with a private entity submits the plan to the Authority, which determines whether a P3 is the best method for that specific project. Once a contract is entered into, it goes to the governor for final approval. Further, the Act favors and promotes P3s as a public policy and authorizes departments, agencies, public corporations, and municipalities to use the establishment of P3s.

This could make sense for the Commonwealth, as Puerto Rico is mired in a $73 billion debt crisis. The timing of the Act, three years after US Congress finished unwinding various favorable tax laws in 2006, shows foresight by the Puerto Rican government regarding the challenges it would face on infrastructure. The only way Puerto Rico could continue to build infrastructure—and the basis for any economy—was through P3s.

This was emphasized by Governor Ricardo Rosselló, whose first act when he assumed office was to expand the P3 Act to include more options to both submit proposals and participate in P3s.

P3 Projects in Puerto Rico

The two main projects since enactment of the P3 Act of 2009 have been the Luis Muñoz Marin International Airport and the highways PR-22 and PR-5 toll roads. These were “brownfield” projects, meaning that existing infrastructure was being modified or improved, versus “greenfield” projects, which take place on unused land.

Luis Muñoz Marin International Airport

This was structured as a 40-year lease agreement between the Puerto Rico Ports Authority and Aerostar Airport Holdings LLC to operate the airport. 

Aerostar entered into a P3 contract with the Ports Authority by making an initial payment of $615 million. Other Aerostar commitments include investments to upgrade airport facilities and annual payments to the Ports Authority equal to a percentage of airport revenues. All other revenues related to the airport belong to Aerostar for the duration of the lease. 

Toll Roads

This was structured as a 40-year concession agreement between Autopistas Metropolitanas de Puerto Rico LLC and the Puerto Rico Highway and Transportation Authority (PRHTA) for the maintenance and operation of highways PR-22 and PR-5. 

Autopistas Metropolitanas de Puerto Rico made an upfront payment in the amount of $1.08 billion and committed to investing in certain upgrades to the toll roads. All remaining revenues generated by the toll roads belong to Autopistas Metropolitanas de Puerto Rico.

A public-private project built before the P3 Act of 2009 was the Teodoro Moscoso Bridge. The success of this project for both the private and public sectors led to the advancement of the P3 Act.

Teodoro Moscoso Bridge

Considered the first modern highway P3 project in the US, the 1.4-mile-long Teodoro Moscoso Bridge opened in 1994, linking Rio Piedras in San Juan to Isla Verde in Carolina. The toll bridge connects roadways on both sides of the San José Lagoon to Luis Muñoz Marin International Airport. 

Autopistas de Puerto Rico entered into a 35-year concession agreement with the PRHTA. The PRHTA issued Special Facility Revenue Bonds to facilitate the financing of the bridge. The total cost of the project was $126.8 million. 

The concession agreement was extended in 2009 until 2044, a full 50 years after the initial opening of service. 

Other ongoing projects include the Caguas-San Juan Commuter Rail project and the Maritime Transportation Services project. Future needs include healthcare, schools, ports, energy, water, social infrastructure, and agriculture.

Future Public-Private Partnerships

As the concept of P3s grows and takes hold, each successful P3 project will help garner interest for future partnerships.

Companies that have successfully planned, built, and operated P3 projects will have the competitive advantage in this emerging field. Those with experience will be counted on to make proper calculations of cost, value, long-term potential, and risks.

Given the relative lack of a uniform policy framework on the US mainland, Puerto Rico’s value is high. Puerto Rico is actively seeking and developing P3s and has adopted a world-class legal framework to move projects forward.

The recent debt crisis has only increased the need for public-private partnerships. Given Puerto Rico's economic and fiscal challenges, P3 projects could be a tremendous tool to improve its residents' quality of life and strengthen its economic situation,” said Luis G. Fortuno, a senior partner at Steptoe & Johnson LLP and former governor of Puerto Rico.

By inviting private companies to take on the responsibility and risk of needed infrastructure projects, the Puerto Rican government could redirect funds to other much-needed expenditures to help the Commonwealth rebuild a stronger economic foundation.

For private companies, successfully developing and executing P3 projects in Puerto Rico now will be invaluable experience in bidding for potential future projects on the mainland.

The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinions, position, or policy of Berkeley Research Group, LLC or its other employees and affiliates.

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