This is the final piece in a three-part series about privately-financed roads. In the first two parts of this series, we looked at the Indiana Toll Road as an example of the growth in privately financed highways, and how financial firms can turn these assets into profits, even if the road itself is a big money loser. In this piece, we examine the shaky assumptions that toll road investments are based on, and how that is putting the public at risk.
For privately financed toll road deals, traffic projections are critical. These forecasts tell investors how much revenue a road will generate, and thus whether they should buy a stake in it, and what price to pay. While traffic projections have underpinned the rapid growth in privately financed highways, the forecasts have a dismal track record, consistently overstating the number of drivers who will pay to use a road.
Private toll roads have been sold to the public as a surefire something-for-nothing bargain — new infrastructure with no taxes — but it turns out that the risk for taxpayers is actually substantial. The firms performing traffic projections have strong incentives to inflate the numbers. And the new breed of private finance deals are structured so that when the forecasts turn out wrong, the public incurs major losses.
Given the large sums of money involved, even small errors in traffic projections can result in huge problems down the line — and, as Streetsblog has reported, traffic projections everywhere have tended to be wildly off-target. A whole financing scheme, meant to last for generations, can easily be sunk in just a few years by exaggerated traffic projections. The Indiana Toll Road, purchased in 2006 for $3.8 billion, is a great example. The firm that owned it, ITR Concession Co. LLC, declared bankruptcy in September.
Wilbur Smith Associates had predicted that traffic volumes on the Indiana Toll Road would increase at a rate of 22 percent over the first seven years. Instead, traffic volumes shrank 11 percent in the first eight. The result was financial disaster for the concession company, owned jointly by Australian firm Macquarie and Spanish firm Ferrovial. By the time they filed for Chapter 11, debt on the road had ballooned to $5.8 billion.
The company blamed the recession for putting a damper on truck traffic. The same story was offered on another bankrupt Macquarie-owned project, San Diego’s South Bay Expressway. But is that explanation sufficient?
UK-based consultant Robert Bain literally wrote the book on traffic projections, warning in 2009 against forecasters who blamed faulty predictions on the economy [PDF]. Commenting on the flurry of global toll highway bankruptcies that was just starting then, Bain said they had “less to do with the present economic climate, and more to do with a market readiness to be seduced by hopelessly optimistic traffic and revenue projections.”
Bain went on to list 21 ways in which forecasters systematically overestimate future traffic. Each one may tilt the forecast by a tiny amount, but cumulatively they result in significant errors. Some of the typical mistakes indicate that forecasters have not yet acknowledged the broader decline in driving and sprawl underway, while others “underestimate the reluctance of some to paying tolls.” Bain argued for a paradigm shift in the use of traffic projections, recognizing that many of them “resemble statements of advocacy rather than unbiased predictions.”
Phineas Baxandall, a senior researcher with the U.S. Public Interest Research Group who’s written extensively for Streetsblog on trends in driving, says the engineering firms that provide the figures know how things work. “Companies seeking investment for privatized toll roads shop for the forecasting they want,” he said. “[There’s] no incentive to tell bad news. And if the deal appears promising, then the forecasting company gets other opportunities to sell further analysis, legal advice, raising debt, selling equity, etc.”
In 2012, the Reston (Virginia) Citizens Association completed a study [PDF] examining traffic projections provided by engineering firm Wilbur Smith (the company that did the very wrong Indiana Toll Road projections, now called CDM Smith). The group collected data from 26 toll road projects on which Wilbur Smith had produced the traffic projections. During the first five years that were forecast, traffic projections overshot actual traffic every single year, and by an average of 109 percent, according to the report.
Randy Salzman, associate editor at Thinking Highways North America, has studied these types of deals for years. He’s never seen a case where a private consulting firm like CDM Smith or AECOM underestimated toll revenues on a privately-financed highway. “If there was honest predicting, some percentage of them would under-predict traffic,” he said. “There would be a bell curve. Instead… what we have is these projections that are always immensely above what the actual traffic is.”
There is ample incentive for these firms to inflate numbers. Firms that predict high levels of traffic attract investment dollars and regulatory approvals, which lead to construction projects, and the same firms often end up directly cashing in.
An investigation by the Denver Post examined 23 toll roads built between 1985 and 2006. Five of them sold bonds based on traffic projections that were prepared by companies that were promised, or granted, future business after their projections were sold to investors. Among those firms: Wilbur Smith, the company that did the Indiana Toll Road and South Bay Expressway projections.
One example cited by the Post was the traffic forecast for the $200 million Southern Connector in Greenville, South Carolina. In that case, Wilbur Smith was offered $12 million in contracts if the bonds to finance the project were sold. Toll Roads News reports the road only saw one-third to one-half of the traffic predicted by Wilbur Smith, and declared bankruptcy in 2010.
In some cases, engineering firms producing traffic projections have been sued for fraud by investors who lost money on projects that seemed like sure bets. Investors in the CLEM7 toll tunnel in Brisbane, for example, launched a class action suit against Los Angeles-based AECOM after actual traffic was as much as 70 percent below expectations. But other than the threat of liability, there is little to deter these companies from putting a rosy spin on the numbers.
In Bain’s research for the Australian government [PDF], he recommended that “independent peer reviews” of traffic projections “hold the potential to reduce over-optimism, or at least detect it in advance of a contract award.”
As the U.S. government wades ever more deeply into privately financed roads through its giant TIFIA lending program, federal taxpayers can end up on the losing end when projections come up short and deals go bad. As illustrated by the South Bay Expressway — a San Diego highway that received a second federal loan after it was unable to pay back the first — TIFIA has no built-in protections against inflated traffic projections and the financial fallout that can follow.
When he was still a Congressman, the late Jim Oberstar (D-Minnesota) tried to establish an accountability office at U.S. DOT specifically to evaluate these private finance projects — but his suggestion was never enacted. That may be especially important in new private finance deals, where the risk has been largely shifted to taxpayers.
Following the Indiana Toll Road bankruptcy, financial ratings agency Standard & Poors issued a press release that seemed to be aimed at settling toll road investors’ nerves. The item noted that the Indiana Toll Road “was an early-stage public private partnership,” and that “current-generation transportation P3 projects… have different risk characteristics.”
Soon afterward, S&P held an event unsubtly titled “Traffic and Revenue Forecasting: Is This Risk Too Much For The Private Sector To Bear?” The answer appears to be “yes,” according to a recent Bloomberg article, “Private Toll Road Investors Shift Revenue Risk to States.” Potential investors in the Illiana Tollway — a billion-dollar highway proposed for cornfields beyond Chicago’s suburban fringe — and numerous other proposed roads are demanding that states assume the risk if traffic or tolls don’t meet expectations, by guaranteeing “availability payments” whether or not the cars show up.
Availability payments, the latest trend in privately financed infrastructure, guarantee a fat annual check from the state government to reimburse the private partner for their construction and maintenance costs. That amount is locked in even if the state collects no revenue at all.
“We are seeing more of that because investors are a bit skittish about the U.S. market,” Cornell professor Richard Geddes told Bloomberg. In states like Texas, where toll roads have recently turned into fiascos, investors are pushing to change laws to have the state — a.k.a. the public — assume the risk of lower-than-projected traffic.
The financial industry truly has learned some lessons from the Indiana Toll Road, the South Bay Expressway, the Pocahontas Parkway, the Greenville Southern Connector, or numerous other road investments gone bad. They’ve learned not to bet on rising traffic volumes, or on rising interest rates, and that the best way to privatize the profits is to stick the taxpayers with the bill as traffic volumes continue sinking.
Marketed to taxpayers as infrastructure they never have to pay for if they don’t want to, many privately-financed highways are actually bailouts waiting to happen.
Edited on November 21 to add more context about availability payments.
Other posts in this series: