In the economist's ideal world - one with a large number of informed competitors bidding in a free and open process - the question of proper market valuation of a project would resolve itself. Unfortunately, however, the world is not always ideal, and thus the state needs some mechanism to ensure that the public receives the best value for any given project.
The market valuation process mandated by SB792 sets forth a number of parameters for defining the "market valuation" of a toll project. These consist of:
• Terms and conditions to be mutually agreed upon by TxDOT and the relevant TPE
, which must include:
o Initial toll rate and toll escalation methodology; and
• a valuation, which must take into account:
o A traffic and revenue study using agreed upon assumptions
o An agreed project scope
o Market research
o Estimated financing, construction, maintenance and operations costs
o "Other information deemed appropriate by the TPE and [TxDOT]"
(Note that under the provisions of SB792, if TxDOT and the TPE are unable to mutually agree upon a market valuation, neither TxDOT nor the TPE may develop the project as a toll project, which would be an unfortunate outcome given the growing shortfall in conventional highway funding sources.)167
The current market valuation process has come under heavy criticism. Participants in market valuation negotiations over the past year have identified a number of deficiencies, namely:
• The parties approach the negotiations with widely different assumptions regarding the proper levels of maintenance and other service quality issues. Apples are not being compared to apples.
• The process is time-consuming and costly (with millions being spent on consultants), devouring resources that could be better spent elsewhere;
• The process pits two agencies (TxDOT and the TPEs) in an adversarial position, whereas ideally, they would work together as partners;
• The process is useless for the vast majority of the 87 TxDOT identified toll-viable projects, since most of these will not generate sufficient toll revenues to pay for their total costs.168
In addressing these criticisms, it is important not only to examine the existing market valuation process, but also to understand why such a process is desirable from a public policy perspective. We must also consider whether alternative approaches would better protect the public's interest while simultaneously furthering the state's transportation goals.
The language of SB792 points to the maximization of cash flow to a particular region's other transportation projects as the focus of the market valuation process. SB792 mandates that upon exercising its option to develop a toll project (within two years after legal and environmental requirements are fulfilled), a TPE must enter into a contract for the construction of the toll project, and either:
• Commit to make a payment equal to the value of the toll project (as determined by the market valuation); or
• Commit to construct additional transportation projects in the region whose estimated construction costs equal the market valuation of the toll project.
Similarly, if TxDOT exercises its option to develop the project as a toll project, TxDOT must commit to spending the market value of the project in that particular region, either by making a payment into a regional sub-account or by constructing projects of equivalent value.169
Most overseas jurisdictions look at project valuation from a different perspective. The most common approach is known as the Public Sector Comparator (PSC), pioneered in the U.K. and now utilized across Europe, Australia and Canada. The PSC offers a simple test: does the private investment proposal offer better value for money in comparison with the most efficient form of public procurement?170
This distinction is not mere semantic hair-splitting, but rather reflects fundamentally different policy objectives. Rather than move to extract the maximum amount of up-front cash from project bidders, the PSC sets a threshold level of value required for private participants to meet or exceed.
Sophisticated PSCs strive to achieve true apples-to-apples comparisons, recognizing the difference between public and private entities. The Australian state of Victoria, for instance, mandates the consideration of at least four factors when developing a PSC, with the base costing of the project itself as developed by the public sector as only the first step.171
For stand-alone economic infrastructure, such as roads, the PSC will also adhere to the principle of competitive neutrality (i.e., make adjustments to remove public competitive advantages such as property tax exemptions and lower regulatory burdens),172 utilize the private sector's cost of capital,173 adjust for a commercial capital structure,174 and adjust for credit rating differentials between the specific project and the state's higher (one hopes) credit rating.175
The PSC, however, is not simply a quantitative algorithm. It is one step (though a key one) in the process of determining a private proposal's overall Value For Money (VFM). Factors not purely quantitative, such as timeliness and safety, are also significant in assessing VFM.176 Wider social benefits, including the earlier or more flexible provision of important infrastructure than would be possible under a public procurement, are also important considerations in the PSC/VFM process, 177 as is the value of the risk transfer itself.
Where a PPP adds more value than an outright public procurement will vary according to the nature of the particular project, as well as the specific circumstances in which a public entity finds itself at a given moment in time. For instance, the threshold for private value will be higher if the public entity has a pristine balance sheet and demonstrated ability to oversee the construction and operation of a project. The threshold will be lower - making it easier for a PPP to add value over its public comparator - if the public entity is heavily indebted, has spread itself too thin, or is less able to manage the project in an effective manner (this latter point is especially true when considering new, inexperienced RMAs planning greenfield toll roads - the riskiness of which was discussed in earlier segments of this report).
Some American states utilize a PSC-like process,178 but our investigation found none that do so in the same manner as practiced overseas. As a recent Government Accountability Office report noted, "governments in other countries, including Australia and the United Kingdom, have developed systematic approaches [emphasis added] to identifying and evaluating public interest before agreements are entered into, including the use of public interest criteria, as well as assessment tools, and require their use when considering private investments in public infrastructure."179
This last point is critical and intersects with other governance related issues noted in this report. The physical steps and calculations required to conduct a PSC are well understood and do not vary in any meaningful way across the developed world. Texas could adopt, without significant change, the PSC methodology used in New South Wales, Victoria or British Columbia. However, the questions of who conducts the PSC and how to resolve jurisdictional conflicts between the various entities involved in Texas toll road finance present a more difficult challenge.
Finally, proposed changes in federal regulations will impact the Texas market valuation process. Current federal law requires that a state receive fair market value for sale, lease, use, etc. of real property acquired with federal assistance.180 Regulations list certain exceptions this general rule,181 and the FHWA has expressed concern that one of these exemptions could be construed to exclude toll project concession agreements from the fair market value rules.182
The proposed changes to federal regulations serve three primary purposes:
• To clarify that concession agreements fall within the existing fair market value rules.
• Address the needs identified in the appropriate local, regional or state transportation plan;
• Identify that public needs may not be wholly satisfied with existing methods of public procurement;
• Result in the availability of the facility to the public on a more timely, more efficient or less costly fashion (italics added);
• Provide for cost and/or risk sharing with private entities.
Under the current approach, the Virginia quality control procedures form Phase 1 (of six) of the Proposal Submission and Review process. Phase 1, however, must take place within 30 days, a time frame shorter than a full-blown Public Sector Comparator analysis. Source: VDOT, The Commonwealth of Virginia Public-Private Transportation Act of 1995 (as Amended) Implementation Guidelines (Revised October 31, 2005).
• To allow a public agency to bid in competition with private contractors (though only in the context of a concession agreement)
• To permit contracting agencies to incorporate unsuccessful bidders' ideas into a contract upon payment of a stipend
Regarding market valuation, the proposed rules require that a highway agency - defined as a state DOT or a public authority with jurisdiction over a federally funded highway - receive "fair market value" for any concession agreement, which is defined as either "best value" or the highest bid received pursuant to a competitive process.
The proposed federal regulations state explicitly that "any concession agreement awarded pursuant to a competitive process shall be presumed to be fair market value."183
For concession agreements awarded on a "best value" basis, the regulations state that the concession offering "best value" is "the proposal offering the most overall public benefits as determined by the amount of concession payment and other appropriate considerations." These other considerations consist of:
• The qualifications and experience of the concessionaire;
• The quality of the services to be provided;
• The track record of the concessionaire;
• The time lines for delivery of services;
• Performance standards;
• The complexity of services to be rendered; and
• Revenue sharing184
The proposed rules make explicit the policy choice to encourage competition between public and private toll project entities.185 At the same time, they also raise some troubling questions - such as whether federal policy could be construed to mandate the extraction of the maximum up-front payment from private concessionaires, or whether federal policy will require the users of the minority of profitable roads to provide the maximum subsidy to other highway projects.
The background indicates that the proposed rules are intended to expand local options regarding toll project concessions - that the regulations will "provide States an opportunity to expand the range of potential bidders for concession agreements." Nevertheless, "the States will retain an option to award these agreements exclusively to public agencies in accordance with their own policy objectives, provided the States can demonstrate to the FHWA that fair market value for the concession has been obtained."186
It is unclear, however, whether a local Toll Project Entity, following the principles set forth by these federal regulations, would be able to maintain its current policy of keeping toll rates low to enhance mobility. The comment period for these proposed regulations ends on November 21, 2008 and their final form may not be known for several months.
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167 SB792 carves out exceptions to the general market valuation process for projects either underway or in the advanced planning stages, mostly in the Houston area.
168 Costs include construction, finance, O&M, etc. See minutes of the Texas Transportation Commission, 29 May
2008; comments of Ted Houghton, Jr.
169 See SB792; Sec. 228.0111 (g), (i).
170 See Partnerships Victoria: Public Sector Comparator, p. 1.
171 Partnerships Victoria: Public Sector Comparator.
172 Partnerships Victoria: Public Sector Comparator, p. 7.
173 Partnerships BC (British Columbia), Project Report: Achieving Value for Money - Sea to Sky Improvement Project (December 20, 2005), p. 20.
174 A commercial capital structure is the level of debt and equity that optimizes the value of the project while maintaining an investment grade credit rating for the project's debt, including constraints such as minimum debt service coverage ratios and appropriate reserves for debt service. See Working with Government: Guidelines for Privately Financed Projects (December 2006), p. 55-56, published by the state of New South Wales (Sydney, Australia).
175 Ibid.
176 The Sea-to-Sky project from Vancouver to Whistler in British Columbia is one example where the PPP for the project cost slightly more than the reference PSC, but where the PPP provided better overall value via the PPP's agreement to provide additional highway improvements beyond the PSC baseline. See Project Report: Achieving Value for Money - Sea to Sky Improvement Project (December 20, 2005).
177 New South Wales, Working with Government: Guidelines for Privately Financed Projects, p. 54
178 Virginia has adopted a PSC-like approach in the Quality Control phase of its proposal mechanism. Specifically, VDOT's quality control evaluation "will consist of, but not be limited to, the following criteria: Does the proposal:
179 GAO, Highway Public-Private Partnerships: More Rigorous Up-front Analysis Could Better Secure Potential Benefits and Protect the Public Interest, GAO-08-44, February 2008.
180 23 USC § 156.
182 Federal Register, Vol. 73, No. 196, October 8, 2008, Proposed Rules, pp. 58908-58912.
183 Proposed 23 CFR 710.709(c). Under these regulations, a competitive process must be "on the market for a reasonable period of time" as well as "an arms-length transaction," but the proposed rules do not elaborate further on the precise meaning of these terms.
184 Proposed 23 CFR 710.703(a). Note that the burden of proof is on the highway agency to demonstrate to the FHWA that the proces used resulted in fair market value being received. 23 CFR 701.703(d).
185 The SH 121 project is mentioned in the context that the state would have benefited from a direct competition between NTTA and a private developer - something that then-existing regulations did not allow. Source: Background to Proposed 23 CFR 710, et seq.
186 Federal Register, Vol. 73, No. 196, October 8, 2008, Proposed Rules, p. 58910.