A Better Way to Finance Infrastructure

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An article on page 1 of Thursday’s Wall Street Journal describes the financial problems faced by some private infrastructure owners because of reduced demand from the Great Recession. The story features the Foley Beach Express bridge in Alabama built as a toll concession in the early 2000s. The bridge filed for bankruptcy in July after traffic volumes were lower than projections leaving taxpayers on the hook for millions.

How can private infrastructure financing manage demand uncertainty?

Cato’s Regulation answered the question in 2002 with an article entitled “A New Approach to Private Roads.”  Traditional private infrastructure concessions utilize a Build-Operate-and-Transfer contract in which a private company builds and subsequently collects tolls and operates a facility for a specified term (20 to 30 years). At the end of the contractual term, ownership of the infrastructure is transferred to the government. The problem with this contractual design is that it involves a combination of “front-loaded investment and substantial uncertainty about demand for the road.” This demand uncertainty increases the probability that revenues fall short of required bond payments causing insolvency.

The authors replace the traditional contract with what they term “Present-Value-of-Revenues” franchising. This method gives the concession to the firm that bids the lowest present value of toll revenues.  The franchise is not for a fixed term but ends instead when the present value of the bid is reached.  If toll revenues fall short of projections, the term of the franchise lengthens and bond payments are delayed contractually.  If revenues are higher than expected, the government can buy out the concession for the difference between the revenues received and the present value bid. The latter contingency avoids the problems found in Orange County (California) Route 91, where traffic volumes were higher than expected, but contract terms barred the county from increasing the capacity of the toll road.

For a good overview of infrastructure and prospects for more private involvement see Chris Edwards’ recent essay at Downsizing Government.