Friday 14 September 2012

Toll traffic and revenue studies fraught with difficulties

It's an issue that has most recently been highlighted by the court case in Australia around the bankrupt Clem 7 toll road.  It has also been highlighted by the poor performance of the Pocahontas Parkway in Virginia.  It is the accuracy and reliability of traffic and revenue forecasts for toll roads that are public-private partnerships.

The Bond Buyer has a good article summarising some of the history behind the Pocahontas Parkway and several other unfortunate projects, including comments from a range of consultants on some of the key issues and concerns.  

The Pocahontas Parkway is only meeting 60% of its predicted traffic levels, resulting in concessionaire - TransUrban - substantially writing down its value in the investment as it struggles to raise enough revenue to service the debt on the road.  

Of interest is the:

National Cooperative Highway Research Program report examining the practice of toll road revenue projections. It examined how projections of toll road revenue compared to the actual revenue obtained for 26 toll road projects between 1986 and 2004.

The report showed that only one project generated between 90% and 110% of the revenues projected within the first two years of operation. But none of the projects were on target with their projected revenues in each of the first five years of operation.

A few roads in the review, such as the GA 400 in Atlanta, were actually chronic overperformers.

What is suggests is less that there is chronic inaccuracies in forecasting, but more a systematic optimism bias in the forecasts, perhaps driven by a desire to please those touting for investment to present a positive case for the projects.   It's not about the recession either, as this study predates that.

Whilst it suggests a market failure, it is important to remember that most of the projects that get advanced are not initiated by entrepreneurs, but by governments wanting a specific project to proceed.  Of course if the project will not generate enough traffic to pay for itself, then investors need to make it clear that without government subsidies a project wont proceed.  If roads really were developed in a free market setting, then it is likely that investors would be significantly more conservative, as they would not be advancing projects for political, but rather financial reasons.

Ratings agencies are becoming sensitive to the failings of such forecasts as well:

A Standard & Poor's analyst who scored the BBB-plus Dulles Toll Road in Northern Virginia said his agency is inclined to just analyze existing historical debt without relying on a third-party revenue estimate.

Fitch analysts announced earlier this year that because of the evidence of high volatility in the earnings of managed lanes — an increasingly popular type of toll project allowing cars to pay a toll to use traditional "carpool lanes" — it will use "conservative growth estimates" for such projects in the future.

Fundamentally, new toll road projects are usually about attracting people who are using existing roads to pay more for a better trip, or to attract new trips onto a road.  If the growth in development in an area does not proceed, or motorists do not perceive enough benefit to pay for the new route it will fail.  Unless a new route offers substantial time savings for significant numbers of users, it wont generate enough revenue to pay for it.

My personal view is that Traffic and Revenue forecasts should always be peer reviewed, with the key assumptions and risks around forecasts clearly highlighted by that review and considered critically.  Investors who rarely give such forecasts much scrutiny must ask for this in the future, and take a bearish view of traffic growth in mature markets where traffic growth has tailed off in recent years.  People's willingness to pay a toll on a road has a different perceived value to their willingness to pay for other things they buy.  In addition, it should never be forgotten that trips on a road are utilitarian, they are driven by a desire to travel to a place, not to use the road per se.  Understanding the prospects for growth in those trips is critical to knowing the veracity of claims that there will be an ongoing trend of more road vehicle trips.   Is it vehicle ownership? Population growth?  Increased incomes (so increasing scope for discretionary trips)?  Tourism?  Freight?

The court case over Clem 7 is being closely watched by toll revenue forecasting consultants in many countries, and will be a key test case to see where liability lies for reliance on such forecasts and the assumptions underlying them.   Whatever the outcome, it should result in consultancies involved in this activity taking additional care to be transparent on the basis of their forecasts, but should also mean that those who commission them understand that these studies are likely to need to be longer and more intensive, if the risks and variables that affect demand are to be thoroughly evaluated.

FOOTNOTE:  The Australian Federal Government Department of Infrastructure and Transport has just released a new report called Disincentivising Overbidding for Toll Road Concessions, undertaken by Dr Robert Bain and Oxera Consulting.  I have not read it in detail, but will review it shortly.  To my knowledge it is the first substantive piece of work on this issue released by a government body (but I am happy to be corrected on it).  

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