Excerpt from the June 2020 Edition of Public Works Financing
What may become one of the largest privately financed infrastructure projects in US history is wrapping up NEPA. Texas Central, the company developing a high-speed rail line between Dallas and Houston, received its Final Environmental Impact Statement this month. The project is now just waiting on its biological opinion from US Fish and Wildlife, and its Programmatic Agreement for mitigation to get to Record of Decision, which is scheduled for the end of July per the federal permitting dashboard.
The Dallas-Houston corridor has been eyeballed for a high-speed rail opportunity since the industry became emergent in the US. Unfortunately, and just like almost every other high-speed rail corridor envisioned in the United States, it has never been realized. The Texas Central project has been, from the beginning, privately financed, and brings all of the benefits and hindrances of that designation as it potentially moves into development. On the surface, the Dallas-Houston corridor is arguably the most attractive HSR link in the United States. It connects two of the top-10 metro areas in the United States, with an extremely high amount of intercity business travel and a cadre of “super-commuters” navigating by car or plane. The drive is four hours, the flight is one hour, and Texas Central is planning on a 90-minute travel time, with a stop near College Station. There aren’t any major geographical obstacles en route. More than 16 million people make the trip each year, by road or air. For high speed rail, you would be hard pressed to beat those underlying conditions in the US.
The project will use the Shinkansen bullet train technology in partnership with Japan Rail Central (JRC), capable of achieving speeds up to 205 mph. Japan Rail Central operates its high-speed corridors as “closed” systems, and Texas Central plans to apply the same principle. That means zero interoperability, and no exceptions. Trains in a closed system do not share track with slower train sets or freight, and there are no road crossings or other junctions. There is plenty of debate in the rail industry around whether closed or interoperable systems are optimal, all things considered. But there is a reason Japan Rail’s network still hasn’t recorded an accidental fatality after all these years, and that its average annual delay per train is measured in seconds. Yes, it is difficult, but it is not complicated.
The project’s Final EIS weighed in at 65 pounds. The project took 6.5 years to get from Notice of Intent to Final EIS, which sounds like a very long time but is shinkansen-fast in comparison to its peer set. A late request for additional biological surveys delayed the Final EIS by approximately a year.
Greenfield HSR has long been considered a subsector earmarked for public financing and federal support, and for good reason. Massive capex, lower margins due to higher operating expenditures relative to other sectors, complex Right-of-Way issues and network effects all point to scale. It is just too big. The dream of US high-speed rail has thus always tended to gravitate towards public delivery and management, and most importantly federal money. Congress has thus been appropriating funding for high-speed rail for a generation (see this edition). In short, our biggest public works could only happen with our biggest public money.
Texas Central has taken another approach, and almost dogmatically so, as only a train in Texas could. Since its inception, the project has advertised that it would happen without a public subsidy from the state. Regardless of the project’s future, it will serve as a useful example of the pros and cons of private financing in what is arguably the largest-scale and most heavily regulated sector for public works.
As we’ve noted, the project still needed to complete NEPA, and through the Federal Railroad Administration (FRA), which often takes a very long time to complete NEPA. Still, the project and its consultant AECOM managed to push the draft EIS through in 2.5 years at the end of 2017. Since then, they’ve responded to more than 20,000 public comments and held 11 public meetings.
The care taken by the project and the FRA team to address comments during planning may reduce the possibility of litigation. In May, the project won an important ruling from a Texas appellate court, which confirmed its power to use eminent domain in acquiring land if necessary, avoiding another potential pitfall facing private financing.
The suit was brought by a landowner, and challenged the project’s authority to use eminent domain on the grounds that it was not a “railroad company.” Under Texas law railroad companies can use eminent domain, but the suit argued that Texas Central is not (yet) operating a railroad. If affirmed the suit would have created a nearly impossible catch-22 for the project, or any other future new railroad venture in the state.
Eminent domain was a necessary authority for the project, even if the project has opted to use it as sparingly as possible. Carlos Aguilar, CEO of Texas Central, said “we had several processes pending when I first joined the project, but over time we opted to stop all of them and simply negotiate with landowners.” The project has currently optioned or owns forty percent of the necessary parcels for the development, and, through its investor group, controls all three planned station locations.
The project has already gotten further than the state’s past attempts at the high-speed rail, the most prominent of which was cancelled in the mid-90’s. That project was publicly planned and a 50-year concession was awarded to develop a network between Dallas, Houston and San Antonio. The project was opposed by an alliance of restaurant and hotel chain businesses with locations between the cities, and anchored by Southwest Airlines, with a concentrated book of business between cities in Texas. Between the opposition and other challenges with fundraising, the project was eventually cancelled.
The world has changed since the 90’s. Today point-to-point service between Dallas and Houston is a much smaller part of Southwest’s business than it was then. And Texas Central has still faced challenges and opposition – the recent appellate ruling wasn’t the project’s first trip to the courtroom, nor is it likely to be its last. But the project does appear to enjoy wider support from the community and elected representatives, and it is even bipartisan. All of the mayors along the line have indicated support, and the state legislature has so far refrained from throwing down procedural roadblocks. The governor supports the project and congressional representatives from both parties have advocated for it.
Since the transcontinental project opened up the West of the country 160 years ago, passenger rail in the United States has undergone a complete transition from privately funded networks to one of the most heavily regulated and federally funded infrastructure sectors. In that time, the sector has shifted along the hazy spectrum between what is yours (an investment) and what is ours (a public work). In the US, despite many domestic efforts and significant global growth, the high-speed rail sector is still virtually non-existent. Still, the old rules may still carry some weight. If a private company wants to build a railroad, and bet on its economics, and is willing to navigate the extremely arduous regulatory processes we’ve created to do so, why shouldn’t we let them?
About those Economics
There is a decent argument that high-speed rail, at least in the US, is simply unbankable and impossible without massive government subsidies. If the unit economics work anywhere, though, it is mainly a function of population density and distance. And on those metrics, the Texas corridor likely ranks right behind the Acela corridor in terms of the sector’s potential nationwide. In the 90’s the economic Achilles heel of a potential Texas project was the relatively undeveloped public transportation systems in Dallas and Houston to act as a “feeder network” for the rail nodes. That argument was obliterated along with the balance sheets of most urban metro systems by the rise of ride hailing networks like Uber and Lyft. The same technological trends hammering urban rail systems today actually improve the case for regional systems. For what it is worth, Texans also like their cars.
The project has commissioned numerous ridership studies, and the FEIS forecasts ridership of 2.8 million trips in 2026, growing afterwards as more drivers and fliers transition to rail. By 2029, the project forecast includes a 29% capture of total trips, the majority of which would come from captured business travel. And that market may be growing even faster than anticipated in the EIS. Taken as a region, the Dallas-Houston economy would be the second largest regional economy in the nation, behind the New York City metro area. And the region’s economy is expected to continue growing at a faster clip than the US average.
Traffic forecasting does not have a particularly good track record in the passenger rail sector. An important differentiator in this case is that a company, rather than elected officials, are using them and taking that risk. That governance arrangement ensures that the operating forecasts for this project will undergo considerable scrutiny from both Texas Central and the lenders and service providers it will partner with. That is no guarantee, but incentive alignment is one of the best tools we have to derive reasonable projections.
It is also true that few rail barons ever got rich selling train tickets. Regional rail projects have massive externalities which effect the economies, and thus property values, along the projects and especially around the stations. Texas Central has pointed out that development and secondary services at stations are only a small part of their proforma operating forecast, but one that will require careful additional planning during development. This is especially true as transportation norms evolve in the wake of COVID-19. “We’re regularly evaluating our balance of secondary services and facilities like parking and rental cars. We’re designing to base case and developing contingencies just like everyone else” says Aguilar.
Now on to Sources and Uses
The coming months will give an indication of how bankable the project is, with a financing that is sure to be north of $20 billion. The sum total will likely be driven, in large part, by the financing terms themselves. At this scale small swings in rates can add hundreds of millions, even billions, to uses.
And “private financing” may turn out to be a bit of a misnomer. The project will be serviced by a veritable united nations of rail service and technology providers, all of which may bring some component of bilateral financing. Japanese lenders may play the biggest role due to the use of Japan Rail’s Shinkansen technology for the project, but that is just one component. Renfe (Spain) is onboard for operations and maintenance, and is the largest HSR operator globally outside China. Salini Impregilo (Italy) is in the consortium for the project’s civil works. US companies are part of the team too – Bechtel is the Program Manager for the project and a Kiewit / Mass Electric team is on for the rail systems construction and installation.
A portion of the financing may also come from the Federal Railroad Rehabilitation & Improvement Financing (RRIF) program. The program is administered by the Build America Bureau at DOT, and can give direct loans or guarantees to rail projects and rehabilitations. Loan amounts can go all the way up to total project costs, and at interest rates equivalent to similarly dated Treasuries. The program is currently authorized to lend $35 billion, only $6.3 billion of which is currently loaned out. Other projects such as Gateway in New York are likely to be earmarked for the program. Risk deposit requirements, slow approval times, and application fees have been cited as reasons for the lack of lending under the program. Another likely reason is the fact that few greenfield rail projects have been financed in the US since the program began lending in 2002.
Concessional bilateral financing will likely be necessary early on, with the potential for future investment as the team continues to de-risk the project. “It has been a journey to get to the point where we are now, but this early investment in planning and outreach will pay dividends as we move through each milestone getting to financial close” says Aguilar. That journey isn’t over, and there will likely be many challenges for the project ahead. Still, this month’s milestone is a light at the end of the tunnel – the long, arduous if not impossible tunnel that is high speed rail development in the United States. At the end of that tunnel, Texas Central gets to start laying track.