RISKS ASSOCIATED WITH TRANSPORTATION PPPs

While providing a variety of advantages, there are also risks to consider when using PPPs for transportation projects. There are many types of risks that can influence dramatically the viability of a PPP project and the relative interest of the public sponsor and the private provider team. Exhibit 34 provides a summary listing of the major types of risks associated with transportation projects. It is one of the purposes of a PPP that the risks are allocated to those partners best able to manage those kinds of risks.

Exhibit 34 - Summary of Major Risks Associated with Transportation Projects

Various risks that can impact the cost and feasibility of a transportation project, as well as the revenue potential and financial feasibility of a PPP and its ultimate success are described below. One of the features of a PPP is the ability to allocate project risks to the partner best able to manage and mitigate these risks. All members of a PPP should understand these risks and how they can affect a proposed project to determine how to best structure the PPP arrangement.

• Public Acceptance - perhaps the greatest risk to a proposed PPP project is the degree of public acceptance of the project, its procurement as a PPP, and the means by which the project will be paid for (tolling or value pricing), with greater public acceptance and political support reducing the risk of project development failure or default following completion.

• Control of Assets - the public and many local politicians have expressed concern over the perceived loss of control over transportation infrastructure assets, particularly the level and frequency of toll rate increases, the physical condition and appearance of the facility, and protection of the public interests in these public-use facilities (such as personal mobility, commercial accessibility, promotion of public safety, and discounted access to public transportation).

• Protectionism - an emerging factor in the United States is the nationality of the firms comprising the PPP provider team, especially the lead project development firm and financing companies, which may result in either legislative efforts to limit foreign involvement in certain types of PPP projects (such as the long-term lease of established toll highways, especially those included in the Interstate System) or state or local political and public grassroots efforts to oppose PPP projects with significant and highly visible foreign company involvement and control.

• Political Stability/Support - even in the United States where the political framework of the nation is quite stable (unlike a number of nations overseas), the continuity of political support for a PPP project remains an essential ingredient for successful development and implementation and should there be a change in the political structure or composition in the area served by the PPP project and to which the sponsoring agency is accountable, this can significantly impact the potential of a PPP project to proceed or continue, particularly if the status of the PPP project becomes a major issue in a political campaign.

• Moral Hazard - the sensitivity of using PPP approaches to deliver transportation projects in the United States makes it imperative that the public sponsor of the project maintain complete integrity and transparency of the PPP procurement, selection, and contract administration to avoid conflicts of interest and fraudulent activities during procurement and execution phases of the project. This requires the public sector to hold the PPP provider publicly accountable for the proper execution of the project consistent with the terms of the contract agreement. Unethical behavior in one PPP project can negatively impact the potential for successful development and implementation of proposed PPP projects by the sponsoring agency, as well as in other parts of the nation where PPP approaches are novel and subject to greater scrutiny and doubt.

• Demand/Volume - level and timing of traffic or transactions on an annual basis and at peak travel periods.

• Revenue - level of timing of proceeds from tolls or congestion (variable) pricing of highway use, concession and other non-toll revenues (advertising), or transit fares.

• Environmental/Archeological - site conditions that raise environmental, archeological, historic preservation, and other issues (munitions on the site) that may require mitigation and the costs of mitigation measures and their responsibility.

• Right-of-Way Cost - a major area of uncertainty for transportation projects is the amount and cost of acquiring parcels of land needed for the project right-of-way. The costs of real estate can vary significantly depending on the strength and expansion of the local economy, the level of demand for new development relative to the available supply, whether a full parcel is required or only a portion of the parcel (called a partial take), and the influence of speculators who recognize the potential for increased land values in the vicinity of the project due to the added accessibility to be provided by the project.

• Construction Cost - the cost of project construction costs which may be impacted by changes in the availability and cost of materials, labor, and maintenance of traffic, plus the cost of performance bonds required by the sponsoring agency for the full value of the project (also called surety bonds).

• Maintenance Cost - for PPP contracts including operations and maintenance, the cost of maintenance and repair activities which may be impacted by the quality of the design and construction, changes in traffic volumes (auto and truck), the weight limits of trucks using the facility, geological (subsurface) conditions, and adequacy and condition of drainage structures.

• Liability/Latent Defects - potential for defects in the design or construction, due to poor workmanship or unknown site conditions and the effect on project costs and the responsibility for paying for these costs.

• Life-Cycle Cost - for PPP contracts with long terms (45 years or more), the cumulative costs of facility maintenance, rehabilitation, and reconstruction or expansion over the term of the contract and its effect on project cash flow and reserves, which are affected by the quality of the design, construction, and inspection as well as the preventive maintenance program implemented by the PPP provider team.

• Regulatory/Contractual - changes in regulations or contract provisions that impact the cost exposure of one or more of the partners and their responsibility for their costs.

• Payment Structure/Mechanism - effect on value of project participation based on source, method, and timing of project cost reimbursement or availability payments.

• Transaction Cost - the level of costs associated with completing the various transactions involved in completing the PPP contract agreement and subsequent financial actions and responsibility for payment of these costs.

• Changes of Law - new statutes or regulations, including design standards or construction specifications, which impact the cost and profitability of the project and delivery timeframe.

• Compensation and Termination Clauses - how the PPP provider team will be compensated for work completed if the project or the contract agreement is terminated, depending on the reasons for termination, and any penalty clauses for early termination by the sponsoring agency.

• Economic Shifts - changes in the economic activity and demography of the region served by the facility which could impact the level of usage and the proceeds to cover the costs of the facility over the term of the contract and the responsibility for accounting for the difference.

• Currency/Foreign Exchange - changes in the relative value of national currencies that can impact the cost of the project and the value of revenue proceeds to a PPP provider which is based in another country with a different currency than that used for project reimbursement or payment of revenue proceeds.

• Taxation Constraints - national, state, or local taxes on the materials used in developing a transportation facility and the proceeds derived from operation of a priced facility can impact its financial viability, especially when using taxable debt and/or equity and/or when the PPP production team is based overseas.

Each of these risk factors can raise or lower the viability of a PPP project, producing a range of potential outcomes that the financial community has recognized need to be incorporated into financial feasibility studies of PPP projects to show the estimated upper and lower limits of financial results for the project. Managing these risks is an important consideration in selecting the right PPP approach and project team.

Exhibit 35 identifies the project responsibilities and risks that can be fully or partially transferred to the private sector partner for each alternative PPP approach considered in this document.

Exhibit 35 - Functional Responsibilities and Risks of Private Partners by PPP Approach

1 Functional responsibilities and risks noted with a may be transferred in whole to the private partner or shared with the public sponsor, depending on the contract

2 Refers to long-term risk of asset failure or physical obsolescence

3 Refers to private developer portion of infrastructure

Each partner to a PPP has a level of tolerance for risks and a capacity to manage certain types of risks. Risk transfer to the partner best able to mange it is a way to reduce the cost of the project and improve its potential for success. The public sector is typically best equipped to manage environmental, right-of-way acquisition, statutory/regulatory, and public acceptance risk factors. The private sector is typically best equipped to manage construction cost, project delivery time frame, maintenance cost, latent defects and project quality risk factors. Other risk factors are more difficult for either partner to manage and become part of the uncertainty that needs to be accounted for in evaluating the PPP project by all parties to the partnership.13

Exhibit 36 highlights the potential consequences of a number of these risk factors for members of a PPP and suggests ways to mitigate these results.

Exhibit 36 - Consequences and Mitigation Strategies for PPP Project Risks

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13 Global Toll Road Rating Guidelines. Project Finance, Criteria Report. Fitch Ratings, New York City, NY, September 12, 2006.