Asset Management, Opinion, Planning, Policy, Road, Sustainability, Transport, Trends, Urban Development

Beyond tolls: new alternatives for funding our roads

by Professor David Hensher, Founding Director, Institute of Transport and Logistics Studies, The University of Sydney Business School

Toll roads in Sydney, Melbourne and Brisbane historically have been a response to government’s desires to improve infrastructure through participation of the private sector. This served to remove debt from state government accounts while opening up opportunities for private equity into what are still believed in the main to be attractive commercial investments. But the timing is right to look at new alternatives for road funding.

While toll roads have traditionally funded new infrastructure projects, there are other alternatives - such as use-related pricing mechanisms for all roads - which can be equally effective.

While toll roads have traditionally funded new infrastructure projects, there are other alternatives – such as use-related pricing mechanisms for all roads – which can be equally effective.

Many lessons have been learnt as both the public sector and private interests have grappled to understand the different (and often conflicting) objectives of social welfare and profit maximisation. Central to the understanding of how tolling works is the allocation (or sharing) of risk.

The key risk is patronage (hence revenue) risk, which has had a controversial history shrouded in optimism bias and strategic misrepresentation in order to make the numbers look good. While lessons have been learnt the hard way (i.e. toll roads going into administration, class actions being settled out of court on the day of legal decision, private equity investors feeling they have been misled), the appetite for more tolling investment remains. Sydney currently has 135km of tolled routes (or 270 directional km), increasing to 185km (or 370 directional km) with current and pending construction.

Many lessons have been learnt, but the key ones relate to:

  • Whether society gets value for money from private sector participation
  • Whether the toll level is appropriate for the offered travel time savings relative to non-tolled routes
  • Whether the risks (patronage in particular) are managed appropriately
  • Why we continue to require forecasts to reflect actual traffic so soon in the settling in period of a tolled road (ramp up)

Private equity investors want their returns under what can only be described as badly advised expectations of early returns. Advisors to private equity investors should learn from the accumulated experiences, and promote a more realistic timeline (in my view no earlier than the fifth year), in which equity related returns start to be more reliable.

On top of this, we need to recognise that actual patronage levels, even over this period, will almost certainly be lower than typically obtained. My advice tends towards estimates closer to 60 per cent of forecasts for new road infrastructure. Indeed, I am aware of at least one major bank which acts as a banker to the equity market doing just this. This starts to resolve optimism bias and strategic misrepresentation, and will hopefully reduce the risk of administration and legal action.

Even under these conditions, there is a case to made for focusing on debt financing until the risk profile of patronage is better established and stabilises, and then inviting private equity; or writing in more binding conditions if this timing sequence is not adopted.

One of the great errors in the current tolling model has been the political decision to prescribe a unit toll rate, which is indexed over time by the consumer price index. This has resulted in ring fencing on the crucial mechanism that is capable of recognising the need to adjust the rate to ensure that the travel time savings are delivered relative to the non-tolled route, given travellers’ value of travel time savings.

Consultants have struggled to establish the best outcome in relation to patronage forecasts because of this seriously problematic imposition. Added to the fact that consultants associated with the bidding consortia are often told to improve the patronage forecasts in ways that require what might be best described as imaginative futures, extending the range of time related benefits (such as the toll quality bonus) in the search for even higher patronage forecasts for a fixed toll regime.

This becomes a commercial proposition in contrast to a network efficiency solution, resulting often in the loss of network welfare gains. There currently exists a complete failure across all tolled roads in Australia to optimise the level of toll. I believe this is generally opposed by the operating companies of tolled roads on many grounds, but specifically their liking of the greater certainty of revenue flows, even if these flows are a mismatch in delivering a better performing road network.

One consequence is that we observe high levels of congestion on tolled roads that are meant to deliver noticeably better travel time savings than non-tolled routes. Meanwhile the competing (as per the contract with the toll road operator) roads tend to deteriorate to support investment commitment in the tolled routes. The criticism of this model is not in having private sector participation and a user-pays pricing regime, but in the public-private partnership model in place that has historically been used to deliver the much needed additional road infrastructure. It may be time to rethink the way we fund user-pays road infrastructure that removes the commercial imperative, resulting in a disconnect in delivering a network wide efficient road system.

Use-related pricing mechanisms have the potential to reduce peak hour traffic in major cities.

Use-related pricing mechanisms have the potential to reduce peak hour traffic in major cities.

A significant strategic question is whether the time has arrived to recognise that tolling has served an important (transitional) role of highlighting the need to have a use-related pricing mechanism for roads (like other utilities such as water and electricity). But specialising the charging regime to a single class of roads amounts to no more than a commercial imperative for investors in contrast to the need to ensure that the road system delivers efficient (and equitable) service levels.

This requires government to consider the next step of road pricing reform, in which tolling is seen as nothing more than an important transition strategy to reinforce the merit of user pays. But determining efficient prices for the entire road network is an order of magnitude more complex than fixing a toll price as part of a business case for commercial appeal into the private equity market.

There have been numerous inquiries into the way roads are funded and an increasing recognition that we need to move to a broad based user-pays regime for all roads, ideally with variable distance-based pricing. We know that continues to be out of scope of political agendas, even though many politicians espouse its merits, commission inquiries, and then in the main ignore the recommendations. Meanwhile politicians (at least in Sydney, Melbourne and Brisbane) are quite happy to support tolling of specific parts of the network as a mechanism to fund new infrastructure (broadly defined to include upgrades of old infrastructure).

I and colleagues have undertaken research over many years to find ways to get buy-in from users that can translate into appealing propositions for politicians (through growing support at the ballot box). One reform model for passenger cars in metropolitan Sydney involves halving annual vehicle registration fees, introducing a 5c/km peak period distance-based charge, no such charge in the off peak, while preserving the fuel excise. We find that the great majority of motorists are financially no worse off (the hip pocket test), and state treasury is revenue neutral. The Federal Government is slightly worse off on fuel excise collections as a result of some reduced car use, while the peak traffic levels improve by 6-8 per cent. This reduction in the amount of traffic is equivalent to the levels of traffic and travel times experienced in school holidays, which we know is greatly improved over other times. This model involves removing the tolls on existing tolled routes and compensating the toll road operators over the duration of the concession with the distance-based revenue raised on the tolled routes and additional funding if required.

Is it time we start to seriously consider this method of funding our roads?

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