Aubrey Layne | Secretary of Transportation for the Commonwealth of Virginia United States

Aubrey Layne

Aubrey Layne, Secretary of Transportation for the Commonwealth of Virginia in the United States, reflects on the reforms to the state’s transport funding base amid ongoing revenue challenges.

Key points:

• Despite having the nation’s third-largest state-maintained road network, until recently, Virginia was ranked 40th of all the states in terms of collecting revenues for transportation. • Ongoing budgetary constraints at a federal level have forced the Commonwealth of Virginia to adopt additional revenue measures to try and mitigate an anticipated shortfall in federal road funding. • Partnerships with the private sector will be increasingly important if Virginia is to deliver the infrastructure that is needed to meet growing demand pressures.

In Virginia, we have around eight and a half million citizens, and 70 per cent of the growth expected in Virginia is in our northern area, next to the capital, in six localities.

It’s a lot like Melbourne, where there is a central business district but lots of area to expand, so I am very familiar with some of the challenges being faced in Melbourne’s inner city.

Our gross domestic product in Virginia is about US$426 billion (A$486 billion) – slightly above Victoria and slightly below New South Wales.

We have the nation’s third-largest state-maintained road network, which means that we are in charge of around 130,000 miles of lanes. And while we are the third-largest network, until recently, we were the 40th ranked state for collecting revenues for transportation, so we had some challenges to deal with.

We have a US$5 billion (A$5.71 billion) budget in transportation, of which US$2.5 billion (A$2.85 billion) is for new construction and US$2.5 billion (A$2.85 billion) is for maintenance of the current system. Of the total US$5 billion, around US$3.8 billion (A$4.34 billion) is raised by the Commonwealth of Virginia, and we depend on our federal partners for US$1.2 billion (A$1.37 billion). The latter is the most significant threat to our programme.

One of the impressive things about Australia is that, regardless of party, it appears that there is the political will for infrastructure investment. That is not what I find currently in the United States, particularly at the federal level. With our budgetary issues and our ideological issues, it seems that the need to invest in infrastructure has taken a back seat.

Since 2008, the federal gas tax – the tax raised per gallon – has not been sufficient. There have been general fund appropriations that have been put in several times, six to eight months at a time, which makes it very difficult to fund long-term construction projects.

Complicating this, Virginia is also lagging behind the nation in economic vitality. In the United States, we are the state most dependent on federal spending. Our Department of Defense spending makes up almost 40 per cent of Virginia’s economy, and that is particularly debilitating as we go through the drawdown from the wars in Iraq and Afghanistan, and the budget crisis.

Virginia is focused on changing its economy, and, quite frankly, we have to. Transportation has to play a big role in that, not only in how it supports industry and the livelihood of our citizens, but also in the sheer number of jobs that it generates.

Right: The dynamically priced 95 Express Lanes will open for traffic in late 2014.

Source:

Transurban

The importance of P3s

Public Private Partnerships (P3s) have been a big part of our economy. Virginia has been a leader in P3s over the years, and our goal is to build a strategic programme to attract private investment.

We have learnt significantly from the Australian experience, and Australia is our most significant investor in terms of foreign dollars.

Many of the large Australian firms have invested not only in our country, but also in our state, and we are very grateful to be able to share the experiences that we have had with our Australian friends.

We realise, though, that the delivery of projects is changing and that global competition is increasing, so that’s why we’re focusing on revising and enhancing our P3 transactions.

I’d like to talk about two P3 projects in particular – not in terms of how they were delivered, but in terms of the public policy discussion that surrounded them.

The first is the I-95 Express Lanes project in Northern Virginia. This project saw the introduction in the Commonwealth of Virginia of the managed lanes and dynamic pricing concept. This is a concept in which tolling is used to deliver new capacity, but if a motorist is driving and does not want to pay the toll, they always have a free alternative.

The traffic flow on the managed lanes is managed by pricing, and the partner (Transurban) is encouraged, and mandated by contract to maintain a certain flow of traffic.

As that traffic flow degrades, the pricing for the road goes up. Our citizens have found this to be a great bargain for their toll dollar, because they have a free alternative should they choose not to use the managed lanes, but if they want the efficiency of moving faster, they are able to do so.

This has been a revenue generation and a traffic management model that you will see Virginia continue to encourage as we go forward in delivering these projects.

The next project I’d like to highlight is the Elizabeth River Tunnels project. This project is in the Hampton Roads region, and those familiar with Norfolk or Virginia Beach on the eastern seaboard

will know that the area is heavily dependent on river crossings.

The area houses the Navy’s Atlantic Fleet, so it is very dependent on mission readiness.

The Elizabeth River Tunnels project cost a little over US$2 billion (A$2.28 billion), and it was undertaken with our partners from Macquarie and Skanska.

In this project, we used a static toll, and there was no free alternative. In fact, the project also included the tolling of the tunnels before the expansion actually occurred.

From a public policy standpoint, this project has not seen the acceptance of the new tolling that the project in Northern Virginia has. In fact, when we came to office in January 2014, we used transportation dollars to buy the tolls down, which, quite frankly, was a fairly inefficient use of the monies; but from a public policy perspective, we didn’t think that it was appropriate to charge for those tolls before the additional capacity was put on.

It’s going to be a great project, but I wanted to highlight the differences between public policy and making financing decisions in that regard. Public acceptance of this project will require us to do more as we move forward, in terms of explaining how tolls will benefit the region.

Certainly, it’s a vital project that had to get done because the Navy told us that if we did not increase transportation investment, they were not going to continue to invest in the area.

So, I’m glad the project was done, but it is a completely different use of policy in determining how to use tolling.

Another project I wanted to highlight is the intermodal improvements that we are going to implement on Interstate 66 outside our nation’s capital. This will be the next large P3 project in the Commonwealth of Virginia, and it is expected to cost between US$2 billion and US$3 billion (A$2.28 and A$3.42 billion), depending on the design, and managed lanes will certainly be a component of this project moving forward.

All of these projects carry demand risk. In the Commonwealth of Virginia, we do not have the ability to take availability payments. Whether the legislature will allow that in the future remains to be seen, but, right now, the only way that we’re allowed to do P3s is through the transfer of the risk to the private sector.

Solving the transport funding challenge

I’d like to talk about the historic step taken last year by Virginia to increase transportation funding in the Commonwealth. It was a programmatic approach; we believed that a single silver bullet did not exist.

So, we decided to use a combination of revenues generated from user fees, and general fund revenues.

At the user fee level, Virginia used to charge a cents-per-gallon levy on its gas (fuel). We converted that to a wholesale tax per gallon, so as economic activity and driving habits increased, that particular levy on the consumer would also increase.

In addition, there were statewide taxes – sales taxes – that were raised to fund transportation sources and projects across the state.

That was done on a revenue-neutral basis because, quite frankly, it was the only way, politically, it could get done. But it did set us up to increase revenue as economic activity picks up in the future.

We also adopted two other measures for the two most congested areas of our state, and that’s where the real money was invested.

In Hampton Roads and in Northern Virginia – the two large urban areas – additional taxes were raised at a local level and the monies were allocated to stay right in those areas to deliver critical projects. We’re talking approximately US$300 million (A$342 million) per year in Northern Virginia, and US$200 million (A$228 million) per year in the Hampton Roads region.

These monies are given to entities like the Hampton Roads Transportation Accountability Commission (HRTAC) and are not considered obligations of the Commonwealth, so if the monies are used to raise debt, they are not considered against our triple-A credit rating. It’s an off-balance sheet financing for the Commonwealth by raising these revenues to deliver these projects.

The entities that also raised these monies are P3 eligible, meaning that they can participate with our private parties in terms of delivering these projects.

For an organisation like the HRTAC, there is approximately US$12–US$15 billion (A$13.72–A$17.15 billion) worth of projects that will be delivered in that region over the next decade or so.

These are projects that we have been talking about for several decades, and that can now come to fruition because of the steps we’ve taken in raising the revenues.

I’d like to also talk about our port. I’ve visited with some port officials in Australia, and the privatisation process that your ports have gone through here – and the process that the Port of Melbourne will be going through – have been explained to me.

Privatisation was attempted in Hampton Roads and it was unsuccessful. In fact, in the nation – and particularly in the Commonwealth of Virginia – privatisation outside of transportation is limited, and that’s one of the things that I’ve enjoyed learning about in Australia.

The second issue about our port is how important it will be to our economic development and in driving the transition of our economy.

The projects in Hampton Roads that I outlined before are key for this port to get the goods in and get the goods out.

Without the support of the transportation system, the economic benefit we hope to derive from the Port of Virginia will not be realised.

The Port is centrally located on the east coast of the United States, and it is within two days’ drive of two-thirds of the United States population. We are served by multiple railroads, so, logistically, the Port is set up to be a significant economic driver for the Commonwealth of Virginia.

We are blessed with no overhead obstructions from the Atlantic Ocean and a 55-foot channel, so, already, we are deep enough to take advantage of the Post-Panamax vessels coming with the expansion of the Panama Canal.

But there’s one key thing that I think will set the port up for future success, and that is that if you look at coming to this part of the world through the western route, or the eastern route, we are approximately the same distance from either.

We believe now that with the expansion of the Panama Canal, in times of economic or political turmoil, vessels can always reach us; and, long-term, that’s what is going to set us up for success, but only if we invest in infrastructure so that we can get goods out of the port.

The right projects for the right reasons

Let me now turn to the future of the P3 programme in the Hampton Roads area and in the Commonwealth of Virginia. The key will be picking the right projects, and there are two components to that.

This year, legislation was passed that mandated our Commonwealth Transportation Board – the agency that is charged with allocating monies in the Commonwealth – to mandate that projects that had previously been promoted for political reasons, or created with the guidance of the administration, would now have to be prioritised according to five criteria.

The first is congestion mitigation, and the law requires that in urban areas, it has to be the most heavily weighted issue that’s considered.

The second is economic development, and the law requires that in rural areas, that has to be the most heavily weighted.

The three other criteria are mobility, environmental concerns and return on investment. The latter is not necessarily a return on equity, but an incremental benefit to the taxpayers and the Commonwealth.

All projects selected, even our P3s, will have to go through this process, and the law requires that the next incremental benefit project, the highest scoring, should be the next one that is funded in the Commonwealth.

That’s a significant change to what we’ve done in the past. We have elections every four years in the gubernatorial elections, and every two years in our House of Representatives, so hopefully this will keep the political process from pulling away at the efficiencies of delivering projects, if we can get it right. We have until 1 July 2016 to get this in place, but if we can get there, the benefits should be immense for our Commonwealth.

By law, if we don’t fund the project that scores the next highest in terms of the criteria, we must

disclose why we didn’t, which makes us much more transparent in explaining why we are funding particular projects.

The second thing that we are doing to ensure the right projects are selected is revising our P3 programme.

We’ve had this programme in place for over a decade. We’ve had similar experiences to you in Australia where some have done very well, and some we wish had done a little better.

But the key will be to improve the process to increase transparency and to increase competitiveness, while reducing political risk. That’s going to be a tall order, but we think that we have ways by which we’ll be able to do that.

We’ve defined political risk as something that occurs late in the process. We believe that if we can get our politicians involved early in the process, we can actually reduce political risk. Then we can go back and certify to the politicians that what we intended to do, we actually did. If we can’t do that, then we have to use another procurement vehicle.

It is imperative that private industry knows that once we enter into an agreement with them, there is certainty of closure. That’s key to any type of programme that will attract the type of investment from the private industry that we’re going to need to get these projects done in the Commonwealth of Virginia.

The next step will see us rewrite our P3 guidelines. We’ll brief our General Assembly, and our Commonwealth Transportation Board will adopt these new guidelines in the coming months.

We’ve learned a lot of lessons as we’ve gone through the process.

First of all, we’ve learned the importance of having a permanent office, with 16 full-time staff dedicated to being the champions for these projects.

One thing that I’ve learnt in Australia is that you have a much better programme of assessing projects with financial input. Projects in the Commonwealth of Virginia over the years have come through the transportation secretariat. I’m one of the first transportation secretaries that is not an engineer. My background is in business, and in finance.

So, it’s key, if we’re going to continue to do this, that we understand the risks that we are taking so that we can appropriately compensate the private party.

The way government, at least in Virginia, evaluated risk in the past was different to the way I evaluated it when I was working in the private sector.

In the private sector, I wanted to know how I was going to get paid and what was going to happen to me if something went bad. In the public sector, I’ve learned that it’s a process, and we identify the risk and say, ‘Yes, we’ve identified it,’ and we continue with the process.

Left: IPA Chairman Adrian Kloeden; Victorian Premier the Hon Dr Denis Napthine MP; Virginian Secretary of Transportation Aubrey Lane; and IPA Chief Executive Brendan Lyon

You will see that we will act more like a business partner in working with you in innovative ways to deliver these projects. There need to be consistent and detailed guidelines, so that every time you enter into an agreement, it’s going to be the same process. You don’t have to guess about what’s going to happen next.

We’re going to continually review our assumptions to improve the process, and a big part of this is about communicating the benefits of these programmes to the public.

Many members of the public still think that a P3 is a black box; something goes in and something pops out the other side. They really don’t understand what the benefits are.

Before this role, I served five years on the Commonwealth Transportation Board, and I learnt that I might as well get the public involvement up-front, because I’m going to get it anyway, and it’s better to deal with it up-front.

It’s the quickest way to bring these projects to fruition – to engage up-front, and not try to explain afterwards, so that’s something we’re going to focus on.

We’ve also recognised that others have a lot of good ideas. I’ve already mentioned that availability payments are being done around the world. We don’t have that ability, but we certainly recognise that the way these projects are being funded is changing.

We understand there will be some challenges; public funds are shrinking and traditional delivery methods are more and more difficult.

In the Commonwealth of Virginia, we have the traditional design, bid, build model; the design, build model; and then the P3 model. That has caused some issues with our legislators in the past. So, now we have to certify that when we use a P3, it doesn’t fit these other procurement methods.

That is also to safeguard the taxpayers, because those other procurement methods have guidelines as to when payments can be made, when construction can start, et cetera.

We’ve had a high-profile project in the Commonwealth that was said to be a P3 that was really a design-build; that didn’t go well, and we were out $US300 million (A$343 million) without a permit.

Now the P3 process has taken the brunt of the criticism, but really it was the risk of getting the permit that wasn’t done. Had we chosen to do this as a design-build project, the law would have kept us from putting those monies out for construction until we had received the permit.

So, we realised that getting the right procurement method is key.

Governor Terry McAuliffe and I recognise that we cannot deliver the Commonwealth’s transportation projects without the help of the private sector, and without using private investment.

So we will be a proponent of the process, and we look forward to working with you.

Aubrey Layne, Secretary of Transportation, Commonwealth of Virginia, United States

On 22 November 2013, Governor Terry McAuliffe appointed Aubrey Layne as Secretary of Transportation for the Commonwealth of Virginia. He was sworn into office on 12 January 2014. Secretary Layne oversees seven agencies with more than 10,000 employees and combined budgets of more than US$5 billion (A$5.71 billion). Prior to his appointment, he represented the Hampton Roads area on the Commonwealth Transportation Board from 2006 until January 2014.

Secretary Layne most recently served as President of An Achievable Dream Academy in Newport News, Virginia – a unique partnership between public schools and the local business community providing at-risk students with opportunities to succeed.

Prior to joining An Achievable Dream, Secretary Layne was President and Principal Broker of Great Atlantic Properties. He joined the company in 1994, and was responsible for operational activities, new business acquisition and capital improvement strategy. Before joining Great Atlantic, he held various positions at Hofheimer’s Inc., and ended his tenure there as President. Secretary Layne began his career as a Certified Public Accountant with KPMG.

Secretary Layne earned a Bachelor of Science in Accounting from the University of Richmond, and received an MBA from Old Dominion University with a concentration in International Business. In 2011, he completed the University of Virginia’s Sorensen Institute for Political Leaders programme.

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STAYING ON TRACK: LESSONS LEARNED THROUGH THE AUSTRALIAN AND UNITED KINGDOM RAIL FRANCHISING EXPERIENCES

Almost 20 years on from the first generation of rail franchising in the United Kingdom, and 15 years on from the introduction in Victoria, enough trains have passed over enough tracks to provide a robust body of insights into the process. Stan Stavros, National Head of the Infrastructure and Projects Group at KPMG Australia, shares the lessons learned along the way.

The public transport sector in Australia is ripe for reform. Governments are searching for better service for constituents and better value from their assets.

Against this backdrop, the issue of rail franchising as a mechanism to achieve the value and service that government desires is naturally on the agenda again. ‘The good news is that rail franchising efforts in the United Kingdom and Australia are now 20 and 15 years old, respectively, providing a rich repository of experience for public and private sector participants to draw on as they jointly consider the best public transport solutions for the future,’ comments Stavros.

KPMG has identified five key lessons that may help to inform the public transport reform agenda: • context is king – so is strong leadership • franchising is not an asset sale • structuring correctly is critical – so is avoiding too many franchises • the approach to risk transfer has fundamentally changed • contract management is a daily process.

Context and leadership can help to drive implementation

The first lesson learned is that what precedes the process is just as important as the process itself. Rail franchising in Victoria occurred in a very specific context. The KennettStockdale Government had a cross-industry reform agenda, and reforming public transport was part of the bigger picture.

This overall commitment to reforming government ownership generally helped to drive the rail franchising process; however, a critical part of the equation was both political will and clear leadership, based on real vision for what reform in the sector could achieve. Stavros notes, ‘There’s no doubt that strong leadership drove change right across public transport systems in Victoria in this period. You need strong politicians that are committed to the cause to really make it happen and to guide the process’.

Franchising is not an asset sale

A second key lesson borne out of the United Kingdom and Australian experiences is that franchising is different to other types of reform and public divestment – specifically, it is not an asset sale. Franchising is a process of seeking the best global operator to operate a network in partnership with government – to bring a better customer experience at a lower ongoing cost to government. ‘While it seems like the line between privatisation and franchising is clear, the approach adopted to the initial franchising process in Victoria, while recognising the importance of delivering high-quality service, was heavily influenced by the very successful electricity and gas privatisation process that preceded it, in terms of its approach to the market,’ says Stavros.

A clear distinction between franchising and asset sales is that government cannot separate itself from the assets. Typically, the economics of running major rail systems requires significant subsidies from the government – and that’s before the delivery of major capital projects. This means that the state remains the purchaser of public transport services and can never fully remove itself from responsibility, including retaining ownership of the rail network assets, setting fares, setting broader transport policy, and planning and delivering, sometimes in partnership with the franchisee, large capital projects. ‘It’s a massive risk if you just see it as a cost-saving exercise, because there are broader considerations and expectations involved in public transport,’ says Stavros.

Franchises are not highly capitalised; in fact, the franchise arrangements have to artificially create the minimum capital in business, supported by bonds and parent company guarantees. ‘Unlike when a toll road goes pear-shaped and market forces come into play to appropriately recapitalise the business, if this happens with franchises, eventually, the state will ultimately bear the residual risk, and remain the operator of last resort,’ explains Stavros.

Unlike asset sales, maximising price – or minimising subsidies – should not be the primary consideration. While government may want savings, the objectives of customer experience (such as on-time running, reliability and innovation), patronage growth, and ability to help with development and implementation of capital projects are also important. ‘The initial process in Victoria

placed significant weight on subsidy savings – and history shows those savings were not sustainable,’ comments Stavros.

Structuring of the franchise and the franchisee is critical

The Victorian and United Kingdom experiences both demonstrate how important it is to implement the right franchise and franchisee structure.

Victoria adopted a vertically integrated model (where the franchisee is responsible for operations, rolling stock and infrastructure), which has proven to be extremely effective. In contrast, the United Kingdom approach has created some issues. ‘The separation of operations, rolling stock and infrastructure in the United Kingdom, while to some degree the product of circumstances, has created some challenges,’ says Stavros.

A less successful feature of the initial Victorian franchise model was separating the metropolitan train system into two train franchises, and the tram system into two tram franchises. ‘The split did not really drive the intended behaviours from competition, by comparison, and required significant inter-operator agreements and reduced the flexibility in the system,’ says Stavros.

Overall, the lesson learned is: the fewer interfaces, the better. Where possible, the number of franchises should be contained – too many operators, some of whom have operating responsibility over small parts of the network only, limit the operating efficiencies and network-wide customer benefits that can be achieved. The consolidation of the United Kingdom and Melbourne franchises into a smaller number over time supports this.

The 2009 refranchising process in Victoria also provided some other positive structural lessons. ‘The refranchising recognised the importance of the operator and attracting the best participants internationally,’ explains Stavros. ‘It also placed more weight on operating experience over infrastructure and rolling stock capability as part of the expression of interest process.’

The internal structure of the franchisee is equally important. The Victorian experience suggests that an equity model – where all key parties delivering the various components of the vertical franchise have equity participation in the entity contracting with the state – is preferable to a model where a pure operator contracts with the state, and then subcontracts infrastructure and rolling stock to other parties.

A shift in the risk paradigm

Of all the lessons learned about rail franchising over the last 20 years, the shift in the general philosophy around risk transfer has been the most profound. In the 1990s, contracts pushed almost all risk into the private sector, which embraced it – there was no real concept of risk being taken by the party best able to manage it.

‘A good example is revenue or demand risk,’ says Stavros. ‘In the 1999 Victorian arrangements, not only did the state transfer full-fare box risk, there was an additional payment – the Passenger Growth Incentive – that supercharged the risk.’ More recent contracts still transfer revenue risk, as this provides a strong incentive to drive good behaviours rather than just rely on contract provisions; however, now they include a sharing of this risk with a level of upside and downside protection.

‘There is also significantly more focus on the sustainability of bids, and ensuring that there are appropriate arrangements in place around the stewardship of assets that have a life well in excess of any franchise term,’ notes Stavros.

Contract management is a daily process

Throughout the Victorian and United Kingdom rail franchising experiences, an important relational lesson has also been learned: managing ‘by the contract’ is not the most effective approach. A pragmatic partnership approach is a far better paradigm. ‘If you run things by the letter of the contract, you can end up with an unworkable relationship,’ notes Stavros.

That’s not to say that structure isn’t critical. Both the United Kingdom and Victorian franchising examples show that appropriate governance structures are important. The United Kingdom cycled through a number of different models – moving from the Office of Passenger Rail Franchising to the Strategic Rail Authority, then to the Department of Transport. In Victoria, the establishment of Public Transport Victoria in 2011 to manage franchise contracts has been highly effective.

Having the right structure to govern contracts is critical, but so too is the practical application of a contract. ‘The team managing the arrangement needs to be able to match it with the franchisee on a day-to-day basis,’ comments Stavros.

This hasn’t always been the case in both Victoria and the United Kingdom, where continuity of people through the process, right through to operations has not always occurred. ‘Often, one team, armed with advisers, comes in to do the procurement, and then hands over the management of the contacts to another group,’ Stavros explains. ‘That applies not only to government, but to bidders, as well.’

The Australian and United Kingdom rail franchising programs provide a significant body of knowledge and experience to draw on to inform the decision to franchise, the franchise structure, the procurement process and the management of contracts; however, equally, it’s dangerous to apply models from other jurisdictions without appropriate consideration of unique characteristics of the system and government’s objectives.

What’s clear is that there are major benefits and major challenges to overcome – but the journey can be worth it.

Other considerations

In addition to the five key lessons outlined in this article, KPMG has identified some additional matters that the United Kingdom and Australian franchising experiences have taught the rail sector.

Contract extensions

Arrangements that have adopted an earned right to renegotiate an extension have been effective in motivating good performance by the franchisee, and provide flexibility for the government in the context of procurement requirements. In the latest franchises in Victoria, in addition to fixed key performance indicators (KPIs), flexible KPIs were introduced as part of this earned extension right and have worked well. Flexible KPIs can be changed from year to year to ensure focus on the most relevant needs of the day.

End of franchise arrangements

These need to be appropriately covered as part of the contractual arrangements to ensure continuity of services and the ability to competitively tender out the services in the future. This includes ensuring ringfenced special-purpose vehicle structures, appropriate access to assets, employees and information, and the ability to novate key contracts.

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