The concept of public-private partnerships (PPPs) has captured the attention of the U.S. public transit industry in the last few years. Faced with growing challenges to the traditional method of financing transit projects with public monies, and a steady increase in riders that is straining transit system capacity, many transit leaders are looking closely at PPPs as a potential solution to the funding problem confronting the industry.

The funding difficulties at the federal level are enormous. The recent economic crisis and the allocation of billions of federal dollars to support
U.S. banks (and possibly other industries) will further expand the gap between transit funding demand and available monies. States are facing similar economic hardship, with California recently asking the federal government for billions of dollars to cover its budgetary shortfall. These funding constraints have encouraged many state and local government officials to explore alternative ways of financing transit projects.

PPPs have emerged as an important alternative with tremendous potential upsides, but virtually no track record in the U.S. transit industry. Several major transit systems, including Denver’s Regional Transportation District (Denver RTD) and the Metropolitan Transit District of Harris County (Houston Metro), are actively engaged in efforts to facilitate private investment in their transit projects. Both systems are participants in a pilot program sponsored by the Federal Transit Administration (FTA) to encourage the use of PPPs. Other transit systems have been approached by private sector companies that are making unsolicited proposals to finance the design, construction, operation and maintenance of certain transit projects, in some cases without using federal or even state and local funds. The outcome of these and other pending transit projects is likely to determine whether PPPs will be a viable option to address the transit funding gap.

Overview of PPPs
The term “public-private partnership” generally refers to a range of project delivery arrangements between the public and private sectors on infrastructure projects that differ from traditional public procurements. Under the traditional “design-bid-build” approach to building a public works project, the public sector designs the project, contracts with the lowest responsible bidder to build the project, operates and maintains the project, and finances the entire capital cost and large portions of the operating and maintenance budget for the completed facility with public monies. As noted above, the lack of sufficient transportation funding at the federal, state and local levels — and the increasing competition for such limited funding — has prompted many public transit agencies to consider PPPs as an alternative project delivery method to the traditional approach.

In a typical PPP, the private sector assumes greater financial, construction or other risks in exchange for a greater potential return on its investment. Depending on the particular type of project delivery structure implemented, the potential benefits to the public transit system include capital cost and schedule savings, greater use of private sector innovation and technology, and the ability to finance all or part of the overall lifecycle costs of the project with private funds. One of the key objectives of a PPP is to allocate various project risks to the party best able to manage those risks. Thus, the private sector often will be responsible for cost, schedule and quality risks while the public sector will maintain responsibility for regulatory approvals, environmental review and right-of-way acquisition.

For analytical purposes, PPPs can be divided into two separate categories: (1) innovative contracting arrangements, and (2) innovative financing arrangements. Innovative contracting methods, such as design-build or design-build-operate-maintain (DBOM) arrangements, involve the private sector’s assumption of greater cost, schedule and quality risks, but do not involve private sector financing of the project. In contrast, innovative financing arrangements, such as long-term concessions and design-build-finance-operate (DBFO) contracts, involve some level of private sector financing of the project.

 [PAGEBREAK] Landmark Deals
The use of PPPs in the U.S. transportation sector has been most pronounced in connection with toll road projects. The City of Chicago’s 99-year lease of the Chicago Skyway, in January 2005, to a consortium of Australian and Spanish investors in exchange for a lump sum payment of $1.83 billion captured the attention of the transportation industry. The State of Indiana’s subsequent grant of a 75-year concession on the Indiana Toll Road to the same investors for $3.8 billion intensified the interest in such arrangements.

Since these two landmark deals, there have been several similar but smaller-scale concession transactions in the U.S. highway sector and considerable debate at both the federal and state level about whether such arrangements adequately protect the public’s interest in such infrastructure. The City of Chicago has continued to subscribe to this approach. It recently agreed to lease Midway Airport for 99 years to the Midway Investment and Development Co. consortium for $2.5 billion. Subject to final approval from the Federal Aviation Administration (FAA) and the Transportation Security Administration (TSA), the Midway transaction would be first major U.S. airport to be leased to the private sector in this manner.

In contrast, a proposal to lease the Pennsylvania Turnpike for $12.8 billion has failed to obtain state legislative approval. The winning consortium selected by the Pennsylvania Department of Transportation in the Turnpike concession procurement recently indicated that it was withdrawing its bid, leaving the future of the Penn Turnpike lease effort very uncertain. The State of Texas imposed a moratorium earlier this year on highway PPP projects after political pressure mounted against such transactions.

The debate over the wisdom of PPPs and their potential role in financing transportation infrastructure is likely to continue as incoming President-Elect Obama and the new Congress evaluate how surface transportation programs will be funded in the next highway and transit reauthorization bill and individual states struggle with declining tax revenues and increasing funding commitments. The transportation reauthorization debate is likely to produce several program changes to the public transit regulatory framework, and PPPs are likely to be included in any legislative changes that arise out of that policy debate. Questions already have been raised by Democrats on Capitol Hill about whether increased reliance on private sector financing is good public policy. The recent problems that many transit agencies have faced with railcar sale-leaseback arrangements following the downgrading of AIG’s credit rating, have contributed to the concerns expressed about greater private sector involvement in transit projects.

Transit Sector Application
Unlike a highway toll road, which can generate positive cash flow over a long-term period and, therefore, may be conducive to a long-term concession arrangement, rail transit systems typically recover much less than half of their operating and maintenance expenses from the farebox and must rely heavily on public subsidies for both capital and operating costs. Therefore, a long-term concession to lease and operate transit service in exchange for an initial lump sum payment generally will not work in the transit sector. The nature of transit economics dictates that different innovative financing techniques must be used by the private sector to invest in transit projects.

One of the most likely innovative financing structures for a transit project that will be designed, built, financed, operated and maintained by the private sector involves a concept known as an “availability payment.” This refers to a regular (e.g., monthly) payment that is made to the private consortium during the operating and maintenance phase of the project in exchange for providing a facility available for public use at a pre-determined level of capacity and quality. This financing technique has been used frequently in the U.K. and is also being used in the Port of Miami truck tunnel project.

Availability payments often do not depend on the volume of passengers using the facility. Instead, the private sector operator typically receives an agreed-upon regular payment during the operating and maintenance phase of the contract, less any deductions it is assessed as a result of failure to meet performance standards relating to availability of the system, service quality and safety. The public sponsor of the project typically provides financing for the availability payment through public funding sources and government credit enhancements. Since availability payments typically do not start until a facility opens for business, they create a strong incentive for timely completion of the construction by the private sector consortium. In addition, availability payments provide an incentive for continued high operating and maintenance standards and can lower the private operator’s cost of capital by eliminating ridership risk.

The use of an availability payment mechanism allows the public transit system to competitively award a design-build-finance-operate-maintain contract (or variations thereof) to the responsible bidder wiling to accept the lowest availability payment over the life of the contract. This “subsidy minimization” approach enables the transit system to reduce the amount of the subsidy that it would have to provide to sponsor the service.

 [PAGEBREAK] Limited Experience
There has been limited experience to date with PPPs in the U.S. transit sector, particularly with respect to innovative financing approaches. Many transit agencies have begun using innovative contracting approaches, such as design-build arrangements, on a regular basis for large construction projects. The Hiawatha light-rail transit project in Minnesota was constructed pursuant to a design-build contract. Dallas Area Rapid Transit (DART), Utah Transit Authority (UTA) and several other systems are in the process of procuring or implementing design-build, construction manager/general contractor and other innovative contracting arrangements for their rail infrastructure projects. There have been fewer instances of incorporating the operating and maintenance services into such arrangements, although New Jersey Transit (NJ Transit) successfully implemented a DBOM contract on its Hudson-Bergen Light Rail Project. The DBOM approach reportedly saved significant time and money for NJ Transit by creating economic incentives for the contractor to complete the project in a timely and cost effective manner.

In terms of innovative financing projects in the transit sector, there are several in various stages of development, but very few completed. One notable completed project is the Las Vegas Monorail, the construction of which was financed entirely by the private sector hotel and casino owners that stood to benefit the most from the implementation of train service along the Las Vegas strip. One of the pending projects is the planned extension of the Washington Metro system to Dulles Airport. This controversial project, which has endured a fierce debate over the feasibility of building a tunnel through Tyson’s Corner in Virginia and the withdrawal of federal support at various points, appears to be back on track but far from completion. A private consortium was retained to design, build, operate and maintain this project using a mixture of funds from various sources, including federal New Starts funding and revenues generated by tax improvement districts in the area to be served by the extension.

Federal program
Last year, the FTA initiated a PPP pilot program known as “Penta P” to encourage greater use of such project delivery methods in the transit sector. It selected three transit systems to participate in the pilot program, which makes available certain expedited review and other benefits to the participants as they proceed through the federal funding process. The systems include Denver RTD, Houston Metro and the Bay Area Rapid Transit District (BART). Denver RTD is planning to procure a series of commuter rail projects through a PPP arrangement. Likewise, Houston Metro has been negotiating with a private sector consortium to develop certain fixed-guideway projects with extensive private sector involvement. BART structured its Oakland Airport Connector procurement as a design-build-finance-operate project for a driverless train connecting BART’s existing service and the airport.

It is important to note that none of the three participants in the FTA Pilot Program has started building a selected project through a PPP. Each of the systems are in various stages of procurement or negotiation with private sector parties. Denver RTD is in the early stages of its procurement process, and both Houston Metro and BART have encountered challenges in negotiating acceptable arrangements with the private sector consortia selected to develop their respective projects. In fact, BART recently announced that it had ended discussions with the joint venture team selected to privately finance the project. The recent financial crisis and the lack of a model framework for implementing innovative financing arrangements in the transit sector are two of the biggest challenges that transit systems and private sector investors will have to overcome in the short term as they evaluate whether transit projects can be financed by private funds.

 [PAGEBREAK] Potential solution
One potential solution to the infrastructure funding crisis facing the nation is the increased reliance on private sector funding of public infrastructure projects. There are differences of opinion on the extent to which PPPs should replace traditional funding mechanisms, and whether these arrangements adequately protect the public interest. The recent financial crisis also has complicated efforts to obtain private sector financing of transit projects, at least in the short-term. It seems clear, however, that PPPs will remain one important option for transit systems as they contemplate ways to finance new capacity improvements.

The outcome of pending efforts in Denver, Houston and elsewhere to implement PPPs will determine whether the arrangements can thrive in the transit environment. The lessons learned from those projects, and the outcome of the transportation reauthorization debate in Washington, D.C., likely will shape the future of PPPs in transit.

Ed Fishman is a partner with Washington, D.C.-based law firm K&L Gates LLP.