PWF Blog (12/5/14)
The Role Of Performance-Based Infrastructure
by William G. Reinhardt, editor, Public Works Financing newsletter
As money and power are increasingly concentrated in Washington, the line of supplicants stretches all the way to the U.S. Mint. That has created a “barbarians at the gate” mentality among the congressional conservatives and budget experts who guard the Treasury. Infrastructure advocates of all stripes claim great benefits from more federal grants, budget leveraging and tax help. But so do many others for their programs.
We’re in the fifth year of the current business cycle. The 3.9% increase in GNP last quarter hopefully is a sign of stronger growth to come. But ability to pay does not translate into willingness to pay higher gas taxes needed to rebuild our Interstates. User fees for municipal water and sanitation services are too low to support capital needs. Public buildings chronically suffer from deferred maintenance, hugely inflating future operating costs.
“We’ve hit the ceiling in our ability to extract wealth and spend the money wisely,” says Chris Ward, former executive director of the Port Authority of NY and NJ, and now with Dragados USA.
Getting more bang for the buck is an obvious answer to capital scarcity, though it’s one not often cited in the larger discussion about infrastructure spending. Performance-based infrastructure, in the form of public-private partnerships (PPP), is one approach being used by public works agencies to reduce or eliminate schedule and budget overruns on large projects.
PPPs are long-term contracts that align incentives to ensure the greatest whole-life value to taxpayers. As such, Washington wants to encourage their use. The Federal Highway Administration has been a strong backer. The White House just received recommendations from the Treasury Dept. on ways the Obama Administration can support PPPs. An executive order is said to be on the President’s desk that would direct the White House Office of Management and Budget to change the way it scores the budget impact of PPPs in order to support private development of new federal buildings.
But expecting the White House and Congress to lead the way on PPPs isn’t realistic. The federal infrastructure agencies responsible for spending are necessarily cautious about “innovative finance.” For them, mistakes can kill.
Besides, federal gifts come tightly wrapped with red tape and good intentions that inflate costs, and nearly all big projects get some federal help. The full price of compliance with environmental and worker protections, prevailing wage rules, and set-asides for minority, women and small businesses, etc. is paid by taxpayers, not contractors. These social spending add-ons are are not going to go away.
U.S. construction companies are carrying a much heavier regulatory burden under the Obama administration than ever before. EPA is an untethered driver of regulations. Owners are as likely to find themselves in court as under construction. Enforcement actions under the various federal set-aside programs have grown exponentially since the start of the Obama administration. Dept. of Labor audits were up by 25 times during the first term.
The social costs and benefits of this wet blanket are unknowable. Here’s what the Government Accountability Office (GAO) wrote in a report on the National Environmental Policy Act (NEPA) this April: “Little information exists on the costs and benefits of completing NEPA analyses. Agencies do not routinely track the cost of completing NEPA analyses, and there is no government-wide mechanism to do so.”
The Politics of MegaProjects
Powerful advocates for smaller government charge that federal infrastructure programs are so skewed toward insiders and political ends that any increase in public investment from taxes should be opposed as wasteful. They have a large and growing audience of believers because they are partly correct.
Consider this from the director of a major U.S. infrastructure investment fund: “Every big transportation project in America is political now. It has very little to do with delivering infrastructure projects when there’s big money involved.” As a result, he says, too little actually gets built because too few decisions are made on the merits of a project.
New York’s governor Andrew Cuomo held a vanity press conference last month in which he proposed to conduct a three-month design competition and pay the winner $500,000 to overhaul New York City’s airports. On the same stage, Vice President Joe Biden called Cuomo Lincolnesque for having such a big idea. In truth, there’s no money in New York or Washington to pay for Cuomo’s grand vision.
In the real world, Cuomo’s vision confounded the Port Authority’s plans for announcing the winner of a three-year-long competition to replace the Central Terminal at LaGuardia Airport using a DBFOM approach. There are indications that the Port Authority wasn’t ready anyway. But that carefully planned project is now on hold until the political control issues get sorted out.
We are at a crossroads. No amount of “needs” surveys will spur voters or politicians to support a national commitment to meet future demands for transportation, water, public buildings and other critical infrastructure services. That will come at the state and local level when the public and private planners, designers, builders and operators of needed facilities convince a skeptical public that they are getting the services they pay for at a fair price and without political favoritism.
Public Works Optimism Bias
Most critically, the “fair price” piece is not happening. Macquarie’s value-for-money (VfM) report done for I-70 East in Denver cites research on optimism bias that shows that only 47% of U.S. transportation projects delivered by the public sector are on budget and only 55% are completed on time.
A GAO study in 1997 found the average overrun on publicly procured transportation projects at that time was 41%.
An appendix to the Value for Money study done by Arup and Parsons Brinckerhoff in 2010 for the Presidio Parkway P3 in San Francisco analyzed Caltrans cost estimates for 114 projects in 2009. Among the findings:
• Budget vs. actual costs were generally accurate 80% of the time for projects up to $100 million.
• Projects from $100 million to $300 million had an 80% chance of overrunning estimates by 15%.
• There was an 80% chance that projects estimated by Caltrans to cost $300 million or more would overrun by 55%.
The five projects in Arup’s data set excluded outliers like the replacement of the eastern span of the San Francisco-Oakland Bay Bridge, which was completed last year at a cost of $6.4 billion. The design-build estimate by Caltrans engineeers at the start of construction in 2002 was $1.4 billion, and called for the project to be completed over a five-year period. That’s a 400% overrun and a seven-year delayed opening on a project intended to correct seismic deficiencies that were dramatically exposed in 1989 when a section of bridge deck collapsed during the Loma Prieto earthquake.
The Social Costs of Poor Performance
The social costs of big mistakes on big infrastructure can be profound.
The East Side Access tunneling project in New York City is spiraling out of control. The Federal Transit Admnistration’s most recent estimate is for completion in 2023 at a cost of $10.8 billion. That’s 14 years later than first planned and $4.5 billion over the original estimate. “The issue of budgeting and scheduling has been constantly eluding us,” said Metropolitan Transportation Authority Chairman Tom Prendergast.
The overruns on this one project would be enough to fully fund New York City Mayor Bill DiBlasio’s entire early education program—putting 60,000 four-year-olds in pre-K classrooms—for eight years.
The huge cost overruns on the Big Dig cemented a political rift between the commuters north and south of Boston, who pay no tolls, and users of the MassPike west of Boston, who do. Turnpike customers are saddled with long-term debt to cover Big Dig overruns while most of the mobility and safety benefits go to the higher-income free-riders closer to Boston.
New Jersey Gov. Chris Christie used the high probability of large overruns on the ARC tunnel to Manhattan as his reason for killing the long-planned NJ Transit rail project and using the money elsewhere. All agree that new rail tunnels are desperately needed in the region.
Service shutdowns to repair hurricane damage to Amtrak’s Hudson River tunnels will choke capacity between Boston and Washington, D.C., by about 25%. A broad economic shock is possible—about 65% of the U.S. GNP is generated in the northeast corridor. Yet Christie’s fear of overruns sent everyone back to the drawing board.
Finally, there is great social value in not deferring maintenance, as many public infrastructure agencies do. A study by the Cornell Local Roads Program estimated that every $1 of deferred maintenance on roads and bridges costs an additional $5 in necessary future repairs.
In DBFOM contracts, public agencies effectively prepay for regular maintenance and repairs so that privately operated roads, bridges and buildings are in good condition after 30 years or so when they are handed back to governments.
There are many factors that contribute to the high probability of construction overruns on large projects. At the top of the list is the very large number of project interfaces between contractors. “At each intersection of all these elements you have decision points on the critical path and some will be missed, causing a domino effect” on cost and schedule, says José Luis Moscovich, former executive director of the San Francisco County Transportation Authority.
To manage the process, “you need experienced public managers who have done it before,” he says. “But they don’t exist.” Salaries for public transportation agency employees in California are 60% of the private sector, he says. “It’s the system, not the people. We’re bleeding talent and generating projects that can’t be done” using traditional DBB delivery.
In a PPP, responsibility for all the components of project delivery—design, build, finance and operation and maintenance (DBFOM)—is held by a single financially strong developer with skin in the game. There is only one throat to choke when things go wrong.
The Proper Role of PPPs
The PPP model is part of the answer to the megaproject cost and schedule problem. By incentivizing private equity to organize and manage large, complex projects (and with sophisticated lenders as the major stakeholder), PPP developers meet deadlines and budgets, or they lose money and someone gets fired. Once the project financing commitments are signed, there are no construction contract disputes that affect schedule, no excuses for poor performance, no scope creep, and no state senators demanding leniency for a campaign contributor who also bends rebar.
Governments demand far higher performance and innovation from their private PPP partners and far stronger financial guarantees than they do from contractors on conventional public works projects. In addition to the normal surety bonds for public works, design-builders in a PPP must also provide a parent-company warranty equal to 40% of the construction cost, and a letter of credit equal to 10% of construction costs to cover any liquidated damages for late completion. Penalties for under-performance get paid, not litigated.
There is growing evidence in Canada and the U.S. that PPP projects are being built for considerably less than public projects. In the most recent example, Pennsylvania’s DOT figures it saved $300 million by bundling 558 bridge replacement projects into a single DBFM contract and asking the most capable contractors in the country to compete for the work. Which they did, and very aggressively—the top two bids were $10 million apart on an $890-million DB contract.
Brian Kendro, who ran the “Rapid Bridges” procurement for PennDOT, explains the tight bids this way: “I think it shows the US PPP market is continuing to mature both on the public side and the private side. Public agencies are presenting a well-defined scope and more than enough information to bidders to accurately price projects which helps to minimize the amount of contingency cost baked into their price proposals and improve value-for-money. On the private side it shows just how intense the competition is and will continue to be. You simply can’t afford to leave any stone unturned in terms of innovation because it will likely be the difference between winning and losing.”
On average, Macquarie found that PPP projects in the U.S. are approximately 15% less expensive than traditional public sector procurements, even for more complicated projects like the Denver FasTracks Eagle P3 (see p. 5). For this project, the winning bid was $300 million below the estimate and a year shorter than the schedule.
To summarize, DBFOM delivery of big infrastructure combines the public benefits of accelerated delivery of service improvements, on-time completion, a growing record on first-cost savings, and public budget certainty on both capital and long-term maintenance costs. Public agencies are transferring some risks of ownership, and for the first time are getting valuable information from private bidders on price, schedule, quality, accountability and other aspects of megaproject management. Competition for projects has never been greater, and the availability and price of investment capital is optimal for well-structured projects.
And yet, though PPPs may be the best tool in the toolbox for restoring faith in big infrastructure, PPPs probably won’t take a major share of the public works delivery market in the U.S. Distrust of private profit motives, public agency inertia, and deal complexity are some of the reasons.
PPPs and Charter Schools
In some ways, PPPs and charter schools have a lot in common. Neither are going to replace a powerful public bureaucracy whose outcomes are heavily disguised. By building a record of measurable success, however, both alternative delivery models are raising the bar on what is an acceptable outcome and how to get there.