Toll Roads: One Possible Solution to Limited Public Finances
The need for infrastructure spending is omnipresent, especially in the area of transportation. Credit Suisse Asset Management is examining ways to benefit from such opportunities e.g. listed companies that might profit from government contracts in the area of transportation.
President Trump has promised to increase infrastructure spending – USD 1 trillion over 10 years – while lowering taxes. This will require alternative means of financing if he does not wish the US budget deficit to spin out of control. Therefore, drivers could be asked to bear an increased share of the cost of new interstate highway construction projects, but on a voluntary basis by means of added toll lanes. The companies that might profit from government contracts in the area of transportation infrastructure also include some from Europe that are listed on the stock exchange.
When I see the crumbling roads and bridges, or the dilapidated airports ... I know these problems can all be fixed ... but only by me.
Donald Trump, 45th President of the United States1
US Infrastructure Spending on Transportation and Water
According to the Congressional Budget Office (CBO), the USA spent USD 416 billion on infrastructure investment in 20142, with highways accounting for the largest share, at USD 165 billion. Combined with mass transit, airports, water transportation, and rail, total spending on transportation infrastructure amounted to USD 279 billion.
Spending on highways amounted to USD 92 billion, or 43% of spending, while the annual maintenance and operation accounted for 57% of funding. Altogether, the federal government contributed 28%, or USD 46 billion, to highway funding, with states and local governments covering the remaining 72%. Federal subsidies were used mainly to support new construction projects.
As a share of GDP, the United States invested roughly 2.4% in its transportation and water infrastructure over the past 30 years. This percentage is slightly below the historic peak of 3% in 1959 and less than the amount spent during the last increase in outlays resulting from the American Recovery and Reinvestment Act in 2009, when the percentage temporarily hit 2.7%. However, if you consider only federal spending on transportation, the share has fallen from almost 2% in 1959 during construction of the Interstate Highway System to less than 1% in 2014. It is also worth mentioning that, while nominal spending between 2003 and 2014 rose by a total of 44%, the real figures have dropped by 9%. For example, the prices of infrastructure inputs, including asphalt, concrete, and cement, have shot up at an above-average rate over the past several years. In real terms, that means less construction output for each dollar spent in recent years.
It should also be mentioned that federal appropriations in recent years have also been somewhat below average, a result of the 2011 Budget Control Act, which limited spending growth to the general rate of inflation and was applicable to roughly half of transportation infrastructure investment.
State of Toll-Funded Construction in the US
The CBO is convinced of the benefits of a well-developed transportation network and cites productivity gains by businesses and the economy thanks to shorter and more predictable travel times and reduced freight costs. Private households value reliable access to public institutions like schools and hospitals as well as lower costs of commuting, while society in general appreciates reduced pollution and the time gained from avoiding traffic jams. In this regard, the CBO views the continued use of road tolls as one of three feasible methods:3
- Collect road tolls, with the amount varying based on the traffic congestion. Charging a direct fee would enable highly valued transportation to move more quickly. Drivers could decide for themselves whether the time they gain is worth the fee.
- Allocate funds to states on the basis of the benefits and costs: High-traffic roads in urban areas would receive more funding compared with those in rural areas with little traffic.
- Allocate federal funding according to target criteria for road quality and traffic flow. Minimum standards of road and bridge quality as well as traffic safety may, however, result in funding being spent where it does not lead to increased efficiency.
Proponents of toll roads argue that private investors (construction companies and operators) can execute and operate projects faster and at lower cost than the public sector, which cannot be proven conclusively based on recent projects in the US on account of insufficient data. However, awarding contracts for planning and construction to a single company or consortium avoids the subcontracting process, which saves up to a year. Through private-public partnerships (PPPs)4– in various forms – projects worth USD 60.5 billion were carried out between 1989 and 2014, equal to roughly 1.5% of the total spending on highways during that period. According to the IBTTA (International Bridge, Tunnel, and Turnpike Association),5 37 US states are already collecting at least one toll, and over 50 million electronic meters have been installed in vehicles. In 2014, the road tolls amounted to over USD 14 billion, collected on 182 sections of highway, 136 bridges, and 13 tunnels with a total length of just under 6,000 miles. Road tolls in the US were first introduced in 1656 with a bridge toll in Newbury, Massachusetts, followed in 1785 in Virginia by a toll on the road from Alexandria to the Blue Ridge Mountains.
The current PPPs are mostly being carried out as build-operate-transfer (BOT) arrangements, with ownership being handed back to the seller once a predefined lease term expires. With the traditional construction contract award process, the focus is on the price bid and not on the quality of construction or the useful life of the structures. This encourages companies acquiring leases to not only build for the lowest possible cost but also as sturdily as possible because costs of repairs, maintenance, and operation over the term of the lease have to be included in the total estimate. The lease may be valid for 50 or even 100 years. At the same time, this increases the lease holders' risk of not forecasting future traffic growth correctly.
The IBTTA has a generally positive view of the future of toll roads. The reasons for that include limited public finances and expected future investment related to self-driving cars. While it is assumed that interstate highways will continue to be owned by state and local governments, new construction projects involving toll lanes are growing fastest, with one reason being that raising taxes in the form of higher gasoline prices is generally unpopular. Particularly in urban areas such as Washington, D.C., or those in California, Virginia, and Texas, toll lanes help increase the flow of traffic. Drivers themselves have the choice of paying a fee to use an express lane or remain in the existing toll-free lanes. The payment collection process is carried out conveniently via electronic meters installed in the vehicles. If the system does not detect a signal, the vehicle's owner receives a bill based on a photograph taken of the license plate. Operators appear to suffer no losses on receivables since non-payment of a toll can lead to cancellation of the vehicle's license plates. The Dallas police are impressed with the system. After all, its pension fund holds a 10% stake in the North Tarrant Express (NTE) project and 7% of the Lyndon Baines Johnson (LBJ) Express project.
The profitability of a project is determined by growth in the volume of traffic and toll rates. The higher the levels of regional economic growth and disposable income and the lower the number of options for choosing alternative routes free of charge, the greater the willingness is to pay a fee to travel while avoiding traffic jams. Permitted speed limits and tolls can be adjusted depending on congestion.
Listed European Companies Doing Big Business in the US
Among those European companies listed on the stock exchange6, Ferrovial is involved with the highest number of projects, namely five, with two of those already operational: the NTE and LBJ Express in Dallas. They recently acquired a 50-year lease on I-66 in Virginia, the largest toll lane project given to a private investor. For the time being, the most important toll road lease held by the Spanish company remains Highway 407 ETR in Canada (99-year lease with 81 years remaining until expiry), while its stake in the Chicago Skyway was recently reduced. According to the company, it will, over the next three to five years, bid on 60 leases being offered in the US, Canada, Australia, and the United Kingdom. Spain's ACS has three US leases in its portfolio, with two projects under construction: SH 288 in Texas (end of lease in 2067) and the bypass in Portsmouth, Ohio (end of lease in 2053). Interstate 595 in Florida is already being operated (end of lease in 2044). In addition to the lease to operate the new terminal at La Guardia Airport in New York, Skanska owns two highway projects: the Elizabeth River Tunnel in Virginia (end of lease in 2070) and Interstate 4 in Florida (end of lease in 2054). The latter is being conducted as a joint venture with John Laing.
Risks Should Not Be Underestimated
Infrastructure stocks centered around tunnels, bridges, and road tolls benefit from a variety of factors, including campaign promises in both the US and Europe to place more emphasis on fiscal policy. At the same time, traffic volumes – both in the private and the business sector – have recently begun rising with the recovery in the euro zone. Not surprisingly, the stock prices of Spanish and French companies have soared over 20% since the beginning of the year. Besides engineering and financial uncertainties during the construction phase, the long leases on the advertised projects force companies to make careful estimates of future traffic volumes, especially when drivers have cheap alternatives available and no regulator guarantees a minimum return on investment. At the same time, the long-term business model of the lease holders is subject to a higher interest rate risk.
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