By Jim Rush
One of the emerging trends in the North American tunneling industry has been the use of public-private partnerships (P3s or PPPs) for underground projects. Examples can be seen in Miami, Norfolk, Va., San Francisco, Toronto and other areas – with more to come. As the economy has continued to sputter and government agencies of all shapes and sizes are struggling to find ways to build and maintain infrastructure, P3s are gaining traction as a viable alternative.
Since this type of project delivery mechanism is fairly new in the North American market, we at TBM decided to gather international experts engaged with P3s to shed light on their potential and pitfalls, and the role they may play in the future.
Vice President, Geotechnical & Tunneling West Region Manager, Parsons Brinckerhoff
Vice President-Alternative Delivery Group, AECOM
Project Director, Skanska Infrastructure Development
Principal and Chair Transport Market, Arup
Business Development and Marketing Consultant, Dr. Mole Inc.
TBM: Please describe your background with public-private partnerships.
KIRSTEN: My background when I first started with the AEC industry was with P3s in the early 1990s. I served as the Team Communications and Public Involvement Coordinator on a dozen projects ranging from water treatment to major transportation initiatives. The most notable projects included the Hoover Dam Bypass, Greenville Southern Connector, the Virginia Truckee Railroad, the Sonoran Global Transpark (a 20,000 acre multi-modal global trade zone facility), and the SR 522 from Woodinville to Monroe (part of Washington’s DOT Public/Private Initiatives in Transportation.) Unfortunately a lot of the projects were killed due to public opinion. Additionally, I worked with Robert Farris, Ronald Regan’s Highway Administrator; to create educational presentations geared towards State Representatives on how to create legislation to take advantage of P3’s. It was a great time to be a part of the industry.
GORDON: I am currently working on the Bosporus crossing project in Istanbul, which is a P3. The project is a 14-km toll road that includes a 5-km undercrossing of the Bosporus connecting Asia and Europe. It is a very challenging project. Istanbul is a city with 14 million people and there are currently only two bridges crossing the Bosporus, so as you can imagine those bridges are pretty congested most of the time. There is a need to build additional crossings while also preserving the ambiance of an ancient city, which is why it is going underground.
GUNA: I have had recent experience working with P3s including the project in Istanbul and in the United States on the Midtown Tunnel in Virginia and the Presidio Parkway project in San Francisco. From my perspective, I see the industry slowly starting to move in the direction of P3.
CHRIS: My most recent P3 tunnel project is the Midtown Tunnel project in the Hampton Roads area of southern Virginia that crosses the Elizabeth River. The existing tunnel is quoted as being the busiest two-lane highway east of the Mississippi, congested some 70 percent of the time. The concern for the Hampton Roads area is that without expanding the capacity of the tunnels across the Elizabeth River between the cities of Norfolk and Portsmouth, you start having an adverse impact on further economic development. It is a very busy port, well situated for the expansion of the Panama Canal, and is home to an important naval base. It is a serious reality to the military that if they’re trying to work into an area that is becoming more and more congested that maybe they have to start to think about looking elsewhere. The Midtown Tunnel was procured as a design-build-finance-operate-maintain project with the Virginia Department of Transportation as the authority. The concessionaire company, who I represent, takes full risk on the traffic. VDOT sets the tolls within the project agreement, but we collect them. We worked jointly with VDOT, the developer, the construction joint venture, the operators and maintainers to develop a project with a single aim, and it was to provide new capacity across the Elizabeth River itself without producing tolls that would be unaffordable to the traveling public. And that is the reality when you suddenly realize just how transparent you have to be in these procurements – the amount of attention that is paid, particularly by people who don’t like to pay tolls.
DON: My most recent project is the A30 in Montreal. It is essentially a highway bypass to the island of Montreal. It is about 40-45 km long and has about 6-7 km of bridges within it. That project is now complete and it has been operational since December 2012. It was finished at an aggressive pace, which – along with being completed within budget – is characteristic of P3.
TBM: How do you see the future of P3s in North America? Do you see a potential increase in the use of P3 going forward?
CHRIS: The P3 model can be very beneficial in accelerating new infrastructure project procurement. When we went to Hampton Roads, the last time VDOT had built a tunnel was the Downtown Tunnel years ago. So they didn’t really feel that they had enough expertise within the department to be able to take on the procurement of that size by themselves. Going P3 gave them the ability to leverage the private sector and also augment their own staff with a sizeable team. Additionally, these are very complex projects technically and they cost a lot of money and you want to be able to use every piece of financing that you can to be able to put them into place.
DON: Every year we see ASCE give poor grades to our infrastructure across the board, and I believe that it is not an unreasonable representation. And if you look that, along with how the population is expected to grow in the next 20 years, we need to be able to sort out our infrastructure or we are not going to lose our position in the world. And it is not just transportation; it’s energy, schools, courts, hospitals – the whole works. I really believe that unless we get P3 going in a big way in America, we’ll start falling behind.
CHRIS: But P3 is not a panacea. In the United Kingdom it is a mature market and maybe 10 to 15 percent of government procurement is done P3. So it exists as a just another tool in the toolbox, but it is a great tool for certain projects.
TBM: P3 projects are somewhat new in the tunneling market in North America. What issues are associated with using P3?
GORDON: There is always a question of who owns the risk. These are large, complex projects, and when you’re dealing with tunnels some of the biggest risks are associated with ground conditions. The owner will try to put the risk on the concessionaire who then tries to put it on the construction team. Then of course the contractor in turn wants the engineer to design the risk away. To complete the circle, the designer will say he is basing the design on the geotechnical documents and projections developed by the owner. You have to continually look over your shoulder to see how much risk is getting put in your pocket.
DON: One of the reasons for this mess is the agencies don’t take these risks. They don’t have enough technical horsepower to deal with some of the projects that they have, and I don’t think they bring in consultants in a proper manner.
GORDON: I look at the tender agreement in Turkey and the fine print in effect says: ‘We take no responsibility for the quantities or the quality of the information that we just gave you.’ For P3 to be successful people have to stand up and accept the risk they have the best control over. If everyone did that then this could really work. But as long as we play this musical chairs of risk, we’re going to go in circles.
GUNA: One thing that could help is the developing a good procurement document for P3. It boils down to understanding performance-based specifications and expectations because risk doesn’t go away. It is a question of who owns it.
CHRIS: It is also about opportunity. If the private sector is not seen to take sufficient risk, then it can’t really justify margins and profits.
GUNA: When we are looking at a potential project, we go through an exercise internally to evaluate the contract and the agreements. We try to cap our risk with our teaming partners with a good dialogue. What are the risks they inherit from the prime contract, and what are the flowdown conditions? We sit down and go through our own internal risk analysis. Then we get back to the table to sit down with our partners. As consultants there is nothing that we can’t do for a buck. So the question is how we approach the project. If the concessionaire or builders wants uncapped liability, there is one price, but if they want to share in the liability, then the price is different.
DON: But the reality is you are never to win a bid with a design that would cover all the liability. To win a project you need innovation, which entails some risk. Everybody wants to win projects, but few are prepared to take the risk for it.
TBM: How does P3 and the changing risk change the role of the engineer?
GORDON: To put it into perspective, I had a contractor turn to me the other day and say ‘you know, in this design-build I am working up my budget, your cost is less than my concrete cost.’ I think his message was that he looks at engineering as just another commodity.
DON: That’s not true. If you are not very well and you have a bad heart, you’re going to see a doctor to seek professional services from him, and you’re putting your life in his hands. A contractor is doing exactly the same thing on a design-build; he is trusting you to do the right thing. If he picks the wrong engineer, he’ll get the wrong answer and he’ll die, so to speak.
GUNA: There was a contractor I worked with at one time who said it best. He said for all these years bidding typical design-bid-build job he paid a lot of attention and respect to his subcontractors and suppliers because they could either make or break the job based on their price. He said in this new world with alternative delivery and P3s that he needs to start better respecting the engineers. This is because the designer, based on the design, even though they may only be a small fraction of overall project value can make or break the project.
DON: You will see some contractors worrying about whether the engineer cost is 4.5 percent or 4.6 percent, but they should be thinking about whether the project comes in at 100 percent of budget, or 150 percent or 200 percent. If you had the druthers, which of those two would you look at? You would be making sure that the 200 is 100.
GORDON: Not only that but will the project last 25 years the way it is designed? Is it designed in such a way that the concessionaire can get a payback on its debt?
GUNA: The term I use is not dollars, it is the value that the engineer brings to the team. You cannot put a dollar to it, but it is the value to help the team win a proposal and project.
TBM: One key component of many P3 arrangements is the maintenance and subsequent handback at the end of the agreement? How does one ensure that the facility is maintained in a proper way?
CHRIS: Taking a whole life-cycle approach is fundamental to P3. As a concessionaire, we know how long the project’s design life is and all the different components within that. We actively look at the design and pricing upfront to ensure that we have a balanced maintenance budget throughout the concession period.
DON: I see examples, however, of owners who do not properly value the facility. Everything is directed at the lowest capital cost, but in many cases you would be happy to pay more capital costs if you’re going to get a piece of infrastructure that will last 100 or 200 years. If you took the subways in new York which have been there for the better part of 100 years and said sorry, the design life is 100 years, they’re going to stop working tomorrow and we’ll build some new ones to replace them. A, that’s impossible, but what would the cost of that actually be? How many billion dollars would it take? The Second Avenue Subway project is about $17 billion alone and that’s a small piece of the overall system.
GUNA: One of the problems is that we use terms like ‘100-year design life’, but that means that there has to be some maintenance to achieve that life. There is a caveat that you have to come in there at Year 45, for example, and perform concrete maintenance and repairs to keep it from deteriorating. And in some cases the people putting these documents together put restrictions in regarding the handback conditions and think that it would be the same condition as when it was originally constructed, but that is not realistic.
KIRSTEN: With the current economy states and local communities have to become creative in how they manage their infrastructure. P3’s can be very helpful in that they can provide necessary funds through user fees and/or tolls to help with the long-term maintenance of the facility. The life-cycle approach of P3’s is a major shift from traditionally developing infrastructure and takes the burden of figuring out how to finance the maintenance of a facility after it is developed. P3s are a major benefit and a good way to solve some of the funding issues.
CHRIS: One of the problems that we have come across, particularly in performance regimes, is that the people who are being consulted on performance criteria aren’t necessarily the people who are going to be actively involved in seeing the project procured and managed as it goes forward. Sometimes a person is going to be asked what they think about the performance requirements, and they’ll go to what they think would be an ideal, which actually could well be gold-plated. All you’ve done is add cost onto the project when the facility could actually be provided with lower performance standards but in every respect able to meet what the traveling public needs.
TBM: What types of projects are well-suit for delivery by P3?
GUNA: One thing that I have seen is the P3 only works only if a project is a certain size. Now I think you’re looking at P3s being a billion dollars or bigger. That’s kind of the starting point.
DON: In Canada any project over $200 million has to be tested to see whether it would be more appropriately procured by P3, but we don’t have that kind of a guideline here.
GORDON: Just because a project is that big doesn’t mean it automatically qualifies for P3. There are a number of other requirements in terms of guaranteed revenue stream.
CHRIS: It seems to me that a way of saying, ‘is this project good for P3,’ aside from the size aspect of it, is if it delivers a win for all the parties at the end of day.
GUNA: Despite the fact that this is a capitalistic country, people still cannot accept a private-sector firm that does its job and makes a reasonable return on its investment. They think that people are making a killing on public infrastructure and they shouldn’t. They think that anything in the public-sector realm should be free.
GORDON: I think it is just a matter of getting there. We have had P3s in this country going back to 1600s. This has been going on for a long time. It is just that we are starting to apply it to areas of our society where we didn’t before. If you look at electric companies, gas companies, steam companies – they are private entities yet the government is involved in setting the rates. P3s for tunnels is just an extension of that.
DON: America wouldn’t be half the size that it is if it hadn’t trusted itself to the railways to open up the West.
CHRIS: P3s should be looked at in terms of their ability to deliver value for money. Best value for money is certainly taken into account on UK projects by the Authorities’ procurement teams. Date certainty, fixed price and quality to meet the standards of the contract are all considered. But P3 is not a panacea for all major procurements as we all well know; it is not a cheap procurement method. The P3 project evaluator has to take into account the cost of financing, transaction costs of developing the project itself, and tax issues. The P3 project itself has to provide better value than perhaps procuring it under a more traditional route, taking into account the additional transaction cost, or it is not the best route.
DON: On the Presidio project in San Francisco we looked at what the outcome might be if it went the usual process by the usual procurement route and what the outcome might be if it went by P3. The outcome was quite clear that using P3 the project would be finished on time, it would be finished on budget, and the way that that project is going indicates that that is likely to be the case. Where as if it has gone the other route that wouldn’t have been the case and the differentials would have been 10s of percentage points out. So in terms of value for money for the public, I think the evidence is out there that P3 does bring value.
GUNA: The analysis to determine the time value of money needs to be done to determine whether P3 is the right way to go, but the problem is that a lot of agencies don’t have the expertise that they need to go through a detailed and thorough analysis before a decision is made. Additionally, many of the decisions are based on a political life-cycle. Because somebody is in office, he wants to let this contract out and get this project built.
TBM: What obstacles exist that limit a more widespread implementation of P3 projects in North America?
GUNA: Right now the documents are really a mixed bag. It’s not a true performance-based contract and nobody really knows what’s going to happen at hand-back 35 years or 50 years from now. In many cases, the requirements concerning the condition of the asset at hand-back are unrealistic. In order for P3 to be successful, we need to be able to monitor the condition of the asset, get data on performance criteria and then be able to articulate that in a way that it is more reasonable. It seems at the present time that requirements are based on intuition rather than on data.
GORDON: a majority of states have legislation that allow P3, but there are still states that don’t. And each state has its own flavor of what they allow and how they allow it. I would like to see the federal government come out with a standard package that says how P3 works, and let the states buy in because it is still a pretty mixed bag out there.
CHRIS: That was the shock for me, coming from the United Kingdom to the United States. I always remember Ken Daley from Transurban being quoted as saying, ‘When you come into the United States you are actually dealing with 50 different countries.’ Reflecting on that, why can’t we get to stage where we can be a bit more standardized in the P3 contracts, particularly for transportation. But the reality is that transportation infrastructure really is down at the state and locality level so it tends to be pretty fragmented. Much as we’d like commonality of P3 procurement , when it gets applied in individual states or in a locality the rules can vary widely.
GUNA: I think one of the messages should be all of the assets as they are being built now, there is not enough upfront funding to instrument and monitor performance over a period of time so that that information can be used later to help put out better contracts. The issue also comes back to if you monitor something there is always this stigma saying, ‘Well are they going to find something wrong and I am going to be held liable in the process?’ So it is two-edge sword in there that causes problems – there is no money and there is concern about liability immediately following the completion of construction. If there is enough money spent to monitor and instrument and develop performance data, I think it will be helpful.
TBM: How does public perception and dealing with the public impact the success of P3 projects?
KIRSTEN: Public Perception plays a major role when a P3 project is in the planning phase. It can have a dramatic impact on the success or failure of a P3 Project. In the case of a toll road project built as a P3, the public can tend to view tolls collected to develop and maintain the project as unfair taxation. And, they tend to voice their concerns quite loudly. The public believes that they have already paid for these facilities through taxes.
CHRIS: In the United Kingdom most taxpayers accept that the public infrastructure does not come free. The United Kingdom is a small island with a big population and cities that are built out. Anyone who uses a private vehicle inside these cities tends to accept that you have to be prepared to pay for choice especially where there is perfectly good public transportation in most cities.
GORDON: The United States is becoming Europe, whether we like it or not. We are becoming built out, especially on the East Coast. And there seems to be an insatiable demand for transportation. As cars become more efficient, the gas tax per mile is actually going down, other funding sources are tapped out and there seems to be much less of an appetite for more new taxes. As a result we’re starting to see new tolls being put into place. Washington State has recently begun tolling some bridges in the Seattle area, and I think it is being generally accepted. If they were to introduce a new tax, there would be a huge kick back. So as long as there is a pent-up demand for infrastructure, then there is an opportunity for P3, especially with the combination of “I want more infrastructure but I don’t want more taxes.” A toll is a tax but the perception is not the same because if you don’t want to cross that bridge, you don’t have to. If you want to use the facility, you pay for it. It seems more fair and people and are more willing to accept that.
KIRSTEN: It is crucial to educate the public about the value of our infrastructure and what it means to their quality of life. With the P3 model, communities are able to build a much needed infrastructure project sooner rather than waiting for the traditional funding that could take years. Time is valuable; showing the public that a toll road could reduce their commute time substantially could mean the difference between a working parent waiting in rush hour traffic or being able to spend that same time playing ball with their children.
CHRIS: For the Midtown Tunnel we certainly did an amount of outreach during the project development period, but honestly you are always going to end up with opponents. The thing about Hampton Roads is that it is very complex politically. There are seven different cities around a stretch of water with very different demographics on each side. There are always going to be people who are never happy about what is being proposed, but by and large if you try to create a network of allies and opinion formers. Effective stakeholder management is utterly key to success in any of these procurements.
TBM: It seems that P3 is used more for roads and bridges. How well suited are they for tunnel projects specifically?
GUNA: In the last decade or so we have seen quite a few projects: the Midtown Tunnel, Port of Maimi, the LBJ project in Texas, Limerick, Brisbane, Istanbul. The added complexity to a tunnel project with a P3 goes back to the risk issue and being able to identify the existing ground conditions. That is where the issue comes in in trying to be able to put together the procurement that treats everybody fairly, otherwise you are not able to come to a financial close.
GORDON: Large tunnel projects are notoriously underpriced. I don’t think this is done intentionally but I think in the planning stages, people don’t fully grasp the complexity of a large underground project. As a result you commonly see underground projects that come in 30 to 50 percent over budget. It is also critical that you don’t overestimate the demand for the project, you don’t overestimate the revenue stream for the project and you don’t underestimate the cost and the risks. We sell a tunnel for $300 million to the general public and then find that the price doubles in the five years it is being developed but the public expectations and political momentum require that we move forward as best as we can. You can’t do that in a P3; it doesn’t work. The design-builder can’t figure out halfway into this that it costs twice as much because he has just agreed to a lump sum price. Also the revenue stream of the concessionaire if fixed. So there has got to be more realistic and conscious effort to get at a real price that everybody agrees to and can live with.
DON: Tunnel projects can add a tremendous amount of value to a city. The Crossrail project in London changed during the course of its development to follow a northern alignment along the Thames, and in doing so added ridership, provided access to underserved areas of the city and connected more readily with north-south rail routes. The result of the changes added maybe a couple of billion dollars onto the construction costs, but when you look at the extra revenue that the City of London and the United Kingdom is going to get over the life of the project, it is absolute peanuts. You cannot even price the value of it. Mayor Bloomberg in New York initiated the No. 7 Line extension in New York City to revitalize the West Side of New York. There was no value in it as far as the railway operator was concerned; but the benefit for the city will be huge.
TBM: What are some of the key considerations in developing a successful P3?
GORDON: In Istanbul, there is tremendous demand for transportation infrastructure. P3 works best when you have a combination of a huge demand, an opportunity for a continuous revenue stream and a government that needs additional resources. Ultimately it is a balancing act because the government sets the term and the toll rate, and thus the overall budget that must cover the cost of design, construction, debt service, and concessionaire profit.
GUNA: Each project is unique so I think a key to procurement is to have an industry outreach with a draft document to get input to see what is going to be feasible, what the market can bear, because a lot of things, if you don’t write it correctly it is not insurable.
DON: I think the issue about P3 is that it draws all those issues together, essentially at the beginning of the project. So for that project, wherever you set the bar, that bar will continue, no one will try to increase it or decrease it. It will essentially continue on. And if you are looking on a project basis, which is really what we’re doing, I am pretty confident P3 achieves that goal. I would say that provided you write what you want at the beginning and don’t tinker with it, the public agencies could get to the end with a P3. Unfortunately, many of them seem incapable of doing it.
GORDON: If P3s are going to be successful in this country – or anywhere for that matter – personal relationships are critical. If your contractor doesn’t trust the designer, or if the designer can’t go and talk with the tunnel operator, the project is bound to fail. Trust is essential to the success of any project but it is absolutely essential for a successful P3. All the parties around the table have to be committed to a success that is defined at the very beginning.
CHRIS: As a bid director, 80 percent of my job and maybe more was actually managing relationships. It was so key to the process. It’s been said that if you want to sell P3 to the public, you shouldn’t see people as end users but rather as tax payers and you need to be able to explain P3 in ways that they can understand and relate to their everyday lives.
TBM: What happens if a project goes bad?
GORDON: At some point the concessionaire has to come back to the government and say I’m bankrupt. I can’t make by debt payments.
GUNA: The thing is most of these contracts are Special Purpose Vehicles that teams come together to form but there are no assets with these companies. They come together, cook up a deal, and say this is how it’s going to be, and if it doesn’t they say, ‘can’t do it’ and it reverts back to the agency.
GORDON: That’s the way it was in Turkey. These companies came together and formed a separate corporation to take on all that risk.
CHRIS: The project agreement between the authority and the concessionaire anticipates this possibility with step-in arrangements if the SPV or contractor is unable to meet their obligations.
GUNA: There are terms and conditions in the agreement that allows for an offramp because toll-based revenue is subject to assuming certain traffic volume and so on. On one project in California when the economy collapsed there was no development, so there was no traffic and no revenue. It was beyond the control of the concessionaire. Sometimes these projects are a little like voodoo magic.
CHRIS: The important thing from the traveling public’s point of view is that although there may be a bankruptcy, they can still enjoy the level of service from the facility itself.
TBM: What makes a P3 work? How is it really different from other delivery approaches?
GORDON: It’s a multi-headed thing. On a P3, the financier is looking in with their own engineer and making sure that the risks are bankable and that the group that is proposing the project can indeed design and build it, operate it and collect the tolls so they get their debt serviced. One of the healthy things about a P3 is you’ve got a lot of different parties interested in it success and watching it closely. It’s not one guy who goes off in a corner and is either successful or is not; you’re got a lot of people involved. The government wants to make sure it works, they’ve got the public to provide this facility for. The financer wants a return on his money and obviously the concessionaire wants to be successful so you’ve got a lot of people involved.
CHRIS: That’s the beauty about P3: everything is connected in a single solution encompassing technical, commercial and financial components. If you don’t do this, then you won’t be able to bank it.
GORDON: In many cases, these projects are made possible because there are government grants and state monies to help reduce the cost needed to be covered by tolls. If you had to cover the real value of some high risk or very expensive projects only through tolls, no one could afford it. Who can afford transit at the real cost? It has to be subsidized. By having the government step in and partner with private enterprise, the combination can work.
CHRIS: The Midtown Tunnel project depended on TIFIA loans from the U.S. DOT, state subsidies, private activity bonds, and, last but not least, equity being put in from the developer.
TBM: Any concluding thoughts?
GUNA: To summarize, probably we need to legislation in every state to allow of PPPs. We need to have federal standard practices to be able to help the state agencies execute these contracts.
CHRIS: The whole education and outreach process is important, starting with legislators, public officials and the public itself.
GORDON: What is also going to help is the uniformity in approach so that each state is doing it the same way which would make more of an even playing field. There are some basics that can be standardized while still allowing for flexibility.
GUNA: As the saying goes, when design-build came into the world of tunneling, that was a small step, but P3 for tunnels is going to be a giant leap. It is here to stay. And I think the key is that success builds on success. The Miami job, the Midtown Tunnel, the Presidio Parkway – if they finish and perform successfully people will get more comfortable with the process, and the more comfortable they get with the process it perpetuates other projects.
KIRSTEN: At that point it becomes tangible. You can say, ‘We have done it here, and here is what the benefits were.’