Since taking office in January 2009, Puerto Rico Governor Luis Fortuño's administration has taken bold actions to address the territory's chronic deficits and unsustainable debt, including dramatically cutting expenditures, optimizing government operations and passing a broad-ranging new law in 2009 inviting private investors to modernize or develop new infrastructure across a variety of sectors.
That law, Act No. 29, authorizes any government agency to enter into public-private partnerships (PPPs) with private firms for the design, construction, financing, maintenance or operation of public facilities, with a set of priority projects that include toll roads, transit, energy, water/wastewater facilities, solid waste management and ports. The law also established a new Public Private Partnership Authority (PPPA), a new center of excellence within the Government Development Bank responsible for identifying, evaluating and selecting PPP projects and for monitoring and enforcing the terms of PPP contracts.
In two short years, the PPPA has built a world-class PPP program and has already seen some major successes that other states can learn from. For example, to help modernize K-12 school facilities and improve academic performance, the PPPA has launched the "Schools for the 21st Century" PPP program, under which Puerto Rico is contracting with with private operators to design, build and maintain approximately 100 schools across Puerto Rico; over 60 of these contracts were already in place by July 2011. And in June 2011, the PPPA selected a winning bidder for a 40-year, $1.08 billion concession to operate the PR-22 and PR-5 toll roads. PPPA officials have also been laying the groundwork for a long-term lease of San Juan’s international airport, and the Authority expects to initiate a procurement in the fall of 2011.
In this August 2011 interview with Reason Foundation's Leonard Gilroy, Puerto Rico PPPA executive director David Alvarez discusses the development of Puerto Rico's PPP program, the benefits of having a centralized PPP program with a broad scope across infrastructure sectors, and the central role of the PPP program in Puerto Rico's economic development strategy.
Leonard Gilroy, Reason Foundation: Over the last two years, Puerto Rico has significantly shifted its approach to infrastructure development by embracing public-private partnerships as a major component of the state's strategy to fill the funding gap. Can you describe the fiscal and economic factors that prompted that shift and what the role is for PPPs moving forward?
David Alvarez, Puerto Rico Public-Private Partnership Authority: There were very clear and recognized needs for restoring investment in infrastructure. It's not a secret that our share of investing in infrastructure (as a percentage of GDP) has declined substantially since the early-2000s. So we have a very clear need to put money back into infrastructure. This also included a need for recurring maintenance for infrastructure.
Given that need, there was a huge limitation, which is Puerto Rico's credit and fiscal situation. Along with having among the largest deficits in the nation, our bonds are not AAA-rated, so we have a very limited credit facility and capability at this point. So we had to look for alternative ways and were in that sense obligated to look at PPPs and make it work for us.
The first thing that everyone—including Reason Foundation, who participated in the very early stages—recommended was that we approve PPP-enabling legislation as the initial step. Then we realized that we had the opportunity to create a true PPP program, as opposed to doing one project here and then another five years later.
So we decided to build a program, and that's how we look at it and the Governor [Luis Fortuño] refers to it—a program.
Gilroy: Up to this point, most states have taken piecemeal approaches to PPPs, with a heavy focus on transportation projects. However, Puerto Rico's PPP program goes much further than most states, extending beyond transportation to other types of infrastructure. Can you describe the scope of the Commonwealth's PPP program?
Alvarez: The scope of the program is very broad. We decided to include in the legislation—not the projects themselves, but the areas that we can pursue, the different infrastructure types. We actually have nine areas listed in the PPP legislation in Puerto Rico. We can go from transportation to energy to water. We can do schools, social infrastructure, corrections, information technology—so it's a very broad scope.
We decided to start the program with the projects that were most ready to go into the pipeline and out to the market. For example, we focused first on "brownfield" projects [Editor's note: "brownfield" PPPs cover the operation and/or capital investment in existing public assets]. The schools project [Schools for the 21st Century] was one where the need was high for investment in school infrastructure, so we knew that this was a priority project. A lot of these are renovations of existing schools, so this is not like a "greenfield" project where you need a lot of permitting, etc. [Editor's note: "greenfield" PPPs cover the private sector construction, operation and/or financing of new public assets.] All of the greenfield PPP opportunities that Puerto Rico has need a lot of permits and environmental work to be completed.
So we started with something that we could manage well. Then we moved into the toll roads project with another brownfield transaction. And that's how we started to move across different asset classes.
We can do a variety of different projects, which is fascinating and gives the opportunity to talk to the public about the PPP concept without attaching it to a project—a toll road or an airport. So you can do a lot of education about the PPP concept itself, which is very useful. Then when you get to a particular project, you can relate to your concept again and how it applies to a toll road or a school or a correctional facility. So that gives us a lot of room for action.
Gilroy: Another interesting aspect of Puerto Rico’s PPP program is that it utilizes a centralized structure for all PPP decision-making, as opposed to having individual agencies pursue PPPs on their own (common in other states). Can you describe the role of the PPP Authority, and what benefits you expect to see from a centralized approach?
Alvarez: In the centralized approach, the role that we play is the coordinators of the entire process. For example, if we’re working on a project with the Puerto Rico Aqueduct & Sewer Authority, we offer a process that is transparent, we offer in-house knowledge on PPPs, and we work with their teams to ensure that they’re following a process that has been proven to be successful. And when I say “process,” I mean the actual steps of a procurement.
We also work in the very early stages in the pre-planning of a project if it still needs some structure. Continuing with the same example, if the Aqueduct & Sewer Authority comes to us with an idea for a potential PPP project, then we can help them finalize and put the idea together in a way that will be welcomed by the private market, rather than they themselves running the project, which is the traditional way.
So we help in different areas. First, we offer a clear process to follow that everyone knows. We also provide help in the very initial stages if the project is not yet defined. We can help reinforce agency efforts and even hire consultants to finalize the structuring of the project and run it through the process.
And then at the end, we work at that end tail of the process, which is the awarding and even the communications of the project, helping to explain the project to the people. There’s a lot of assistance that we can provide, and the agencies find that very valuable.
Gilroy: Given that you started with a blank sheet of paper, how did you go about setting up the PPP Authority? Did you rely on internal experts well versed in PPP issues, did you hire outside advisors, or some sort of blend?
Alvarez: The PPP Authority was created in the PPP Act, and to set it up we borrowed some resources from the Government Development Bank for Puerto Rico. What helped us a lot was that in the early stage we looked for a consultant. We ran an RFP process where we tried to look for consultants who had experience in setting up programs. So at this point, we were not looking for a consultant that was an expert in transportation projects. We were looking for a consultant that had experience in dealing with government on the sell side and had experience building PPP programs.
So we hired consultants with that kind of profile, and they helped us build up the program. And that was very useful, in that what we did at the very beginning has been kept all along with the program. We have made little tweaks in the process based on experience, but the essence of the entire process and the program has stayed close to what the consultants helped us develop.
What they did is really nothing that we couldn’t have done, but if we would have done it ourselves, it would have taken us a much longer time. For example, the consultants put together all of the best practices from around the world. So they gave us a class, a course, in their recommendations on best practices in PPPs. And we borrowed from that, and we took the best practices from different areas, applied them and made them ours. The consultant put this together for us in a week and a half. For us, it would have taken much longer to put together, so the consultants really helped us expedite setting up the program. And at the end of the day, in setting up a program, focusing on best practices is essential.
Gilroy: What would you say makes Puerto Rico an attractive place for PPP investors, relative to other states?
Alvarez: First of all, we have the legal framework that we've put around PPPs that provides certainty and requires a clear process. That's the most important part.
There are still things we can do to improve the process and the PPP legislation. As we learn, we're thinking about different amendments that could be adopted to improve the PPP legislation in Puerto Rico. But to have it in place, and to have a specific process that goes beyond the act and into details—we have procurement regulations, for example—we offer a great process that provides certainty to investors.
The second thing is that as a program, we have more opportunities. We can have a pipeline and won't run a risk of running out of projects. Or just doing one project one year and another project in three years. I'm not criticizing those types of programs, but Puerto Rico is a small island, so we need to go across assets with a pipeline of opportunities.
Also, we have proven the process to be successful. We had the toll roads PPP, for example, and the schools PPP, so we had quick wins early in the program, and that has helped us a lot at building a reputation in the market. And we look forward to continuing to deliver successes.
Last, the political commitment is there. Everyone in the administration is behind PPPs and wants to see them work, so they put in all the effort to make them work and that speaks for itself. It's important to have that commitment, and it’s attractive for investors.
Gilroy: Can you describe the process that the Authority uses to advance PPP projects? How do you evaluate whether a PPP makes sense in a given situation, and how do you ensure that the public receives good value for money?
Alvarez: Among the best practices we adopted, an important one was the use of Value-for-Money (VfM) analysis, which we run for every project—before issuing an RFQ, before internally deciding whether the project is a good PPP opportunity, we run a VfM analysis.
And before getting to the VfM analysis, we do a thorough screening of the project. Prior to VfM we do a three-step process that allows us to evaluate the project. We start first with an initial review. What is the public reaction or acceptance of the project? Is it commercially viable? Has there been precedent? Have other jurisdictions done it before?
The second step is a fatal flaw analysis. Are there legal impediments to doing the project? If there's one project that does not require additional legislation, and another one that requires additional legislation for doing a PPP, or additional permitting or legislative approvals, then we will put those on the scale and will probably go with the one that does not have those legal impediments.
And the last step before VfM is a more detailed review of the project or asset in which we have more extended criteria. We do that even before moving into the VfM analysis, so there's a lot of discussion that goes into a project before deciding that a PPP is what we want to do.
After doing the VfM analysis we still have to go to the board of directors of the PPP Authority and meet their test and prove why a PPP makes sense. So once we get to the market, we have done a great amount of homework regarding the project and a lot of the topics have been studied and looked at, so it has to go through all of that process before we decide that.
The VfM analysis has to be released to the public, so we always have a transparent point of reference to refer citizens to. I can say that citizens like to see that, and they feel more confident that it's a transparent process and that gives them comfort. And every time we do a VfM report and put it on the website, we also do a roundtable with the local business press and explain the results. Communication with the public is ongoing. We do it at the very early stages, we never stop doing it until we award the contract, and it's always an ongoing effort.
So in deciding whether a project is a PPP we want to take to the market, we go through this type of analysis, and we think the approach offers us discipline and prepares us for the procurement.
Gilroy: Though your PPP program is still young, you've already negotiated a 40-year, $1 billion lease of the PR-22 and PR-5 toll roads and are nearing a procurement for a long-term lease of the Luis Muñoz Marín International Airport in San Juan. Thus far, can you point to some of the demonstrable benefits you’ve already seen from competition and public private partnerships?
Alvarez: One clear example that we have is accelerated investment. In the schools program, for example, we were able to bring a project that was going to be procured 10 years from now and make it happen today. We dedicated a lot of time up front in the project analysis, but once we put it out to the market and were able to award the contract, the construction started quickly. They started designing at the same time they started working at the schools to take the windows apart, removing doors, and preparing the site. So action and investment started happening very quickly, and citizens could see it happening.
And that's a good example. I'm still amazed that at this same time last year, we were just thinking about this project. We were doing an RFQ then, and now we have more than 60 schools under construction with contracts already awarded. And that's what we want—we want jobs being created and investment happening.
On the toll roads, we're still working on reaching the financial close, but the same thing will happen there. We will require investment to happen on the front end so that people start seeing the difference. So we're expecting that within three months after financial close we'll start seeing differences in those toll roads. We'll start seeing new pavements. We'll start seeing new signage, and the lighting along the toll road will be renovated.
And that's very different from the traditional methods, where you have to wait until one step is completed before you start the next one, and you have all of the different bureaucratic steps that you have to take within government to proceed. PPPs are more expedited. The procurement takes a little longer on the front end, but the project becomes expedited once you award the contract, and that's a major difference.
Gilroy: Puerto Rico is going beyond other states by bringing PPPs to K-12 education through a large-scale facility modernization program, the Schools for the 21st Century initiative. What prompted this initiative, and what do you expect to achieve through PPPs in K-12 education?
Alvarez: There was a clear need. Public schools were highly deteriorated, and we had a very deficient maintenance program. In Puerto Rico, the traditional way we had done maintenance is a "design-bid-build" type of program, where maintenance is conducted by the public sector in several steps. So our maintenance was very deficient, and there was deteriorated infrastructure across the public school system. We needed to do something, and that was the first trigger.
There wasn't the time to expend in contracting the full, 100 percent design, and then doing a bid process, and then doing the construction—we wanted to do it fast because there was a sense of urgency. That's why we designed a PPP procurement in a way that the design, build and maintenance elements were all consolidated and transferred to the private sector.
The incredible need for investing in schools brings other things that are difficult to quantify, but you know they are there. For example, underperformance in academics, and students dropping out of school because they don’t feel comfortable in the facility, or they don't feel encouraged or motivated by the type of school they’re going to. Maybe it's a deteriorating school or an old school that was built 30 years ago, and they want to see new things.
So at the end of the day, with this school program we're tackling infrastructure challenges, but the ultimate goal for us is to improve academic performance of students. We're trying to go in an indirect way towards academic performance by providing and delivering better infrastructure, with the goal for students to perform better at school—to keep more people in school and to get better results. That's the ultimate goal of the program, really.
Gilroy: Puerto Rico is actively pursuing a long-term lease of Luis Muñoz Marín International Airport in San Juan. What are your goals with this airport PPP, and what factors do you think prompted the airlines to support the project (a key requirement for airport privatization under federal law)?
Alvarez: Today, we have an average airport. We have the busiest and largest airport in the Caribbean, but it's not really what we would like to have. We have aspirational goals, and we want to make it a world-class airport.
But there was the limiting factor that the Ports Authority did not have the funds to take it to that level, so we decided to look for a PPP to partner with the private sector to finance and undertake the renovation, operation and management of the airport.
Besides having a lack of funds to invest in infrastructure—to have renovated terminals and things like that—there was also the maintenance aspect. We have a high cost facility, and at the end of the day, the maintenance is not the best. So there's an operational part—a maintenance component—to it in which we want to ensure that the airport is better kept, run more efficiently, and run with a focus on making the traveler experience better.
So all of those factors combined to make us decide that partnering with the private sector made sense for this infrastructure, and the airlines generally agreed with that analysis. And they were looking for a better traveling experience for their customers, and they wanted to have a better operational landscape. And like us, they were tired of having a new director come every time the administration changes and changed plans, trying new and different plans for the airport. The lack of continuity is a difficult challenge for an airport, which needs continuity in order to take it to the next level. The airlines agreed with that, and they were willing to endorse that approach and are willing to look at new ways to deliver the airport now.
And we appreciate their support. We want to increase traffic—being on an island, your main airport is a major driver of economic development and economic growth. So we want to increase people coming to Puerto Rico. They don't even have to choose Puerto Rico as their final destination, but we want them to stop here or do a connecting flight here.
The airlines have told us that they're approaching this project with open mind, because they agree with us and believe that partnering with the private sector will make more sense for Puerto Rico's international airport.
Gilroy: Outside of roads, schools and the airport, what other types of PPPs do you expect to advance in the near term? Where do you see the PPP program going from here?
Alvarez: There are two areas that we want to explore more: social infrastructure and "greenfield" projects. And those can be combined, of course—you can have a greenfield project that’s also a social infrastructure project.
In social infrastructure, we're definitely not finished with the schools. The 21st Century schools program is an initial step in the right direction, and I think we would like to expand this program over time. But we're not finished with the schools.
We're also looking into areas in social infrastructure that have been proven before. We're not trying to invent the wheel. We're looking into correctional facilities. We're increasingly educating ourselves on hospitals and how PPPs have been used in Canada and other places. We're not ready to structure a project in hospitals yet, but we're doing the learning now on how those are done.
In transportation, we will increasingly look to greenfields. Puerto Rico has some very interesting greenfield transportation opportunities, including an extension of PR-22 that's been in Puerto Rico's pipeline for 20 years. We would like to find ways to put that into our pipeline and make that happen.
So we're increasingly looking to greenfields and increasingly looking to social infrastructure. Also, energy is an area we'd like to move into, and also water. We're continuing to develop the pipeline.
Gilroy: Can you describe what the transition was like from an institutional perspective? Puerto Rico had been doing things a certain way for many years and then embarked on an entirely new course. What was the learning curve like, and what lessons would you offer to another state preparing to undertake a similar process?
Alvarez: In terms of our program, the learning curve has been very steep, but you have to dedicate time to it. You have to educate yourself and your team about the precedents, what other projects have been done out there, what you can borrow, what you don't like—you have to dedicate time to your internal education.
In terms of the rest of government, now you have a centralized office chasing projects to put into a PPP procurement pipeline, and we have found some internal resistance to the idea within government. The best solution for that is to have quick wins at the beginning.
In the schools program, now our Department of Education can say, "why not do the rest of the schools this way?" If you can, take 15–20 schools in your state, try to procure them as PPPs, see the results, and learn from that. And once people start seeing the results, they will want more of it.
The same thing happens with toll roads. If people see a good program that delivers results, that allows us to pay down debt, and that will deliver world-class highways, they will want to see more PPP projects.
But at the beginning, there's some resistance. We work with the different government entities to make it work for them and make sure that the projects will respond to their needs. We dedicate a lot of time to that.
If I could recommend something to other states, I would suggest that they try to start with a project that they can handle as a PPP, learn the lessons from that one, and take those lessons and replicate that with other projects and assets. That’s a good way to start a program. Try to get those quick wins.
Also, you need to have good consultants on board that will not only educate you on U.S. precedents but also international precedents. There’s a lot to learn from international precedents—Canadian, European, Latin American experiences with PPPs, for example. Try to learn from those, discuss all of those ideas internally, and see what direction your state wants to go.
And you should make a commitment to creating a centralized program. You will have a more robust pipeline, more opportunities, and more investment coming into your state in different areas. For example, we wanted to have one project going in each particular area. Now we have one in schools and one in toll roads, and we expect to have one in the airport sector soon and another in corrections. All of a sudden you put that together and it's over $2 billion in investment that will be in different areas going simultaneously. And that's a large benefit.
Gilroy: You’ve framed Puerto Rico’s PPP initiative in terms of economic development being the primary focus. Can you explain that further?
Alvarez: In that sense we have departed from precedent. We're not doing PPPs because they're a financial transaction. Now it's important to get cost savings—that's important. And when you're doing a brownfield transaction, you should maximize your lump-sum payment—that's important too.
But for us, we really want to deliver investment and fresh capital and investment to the local economy—that's economic development. At the same time we want people to sponsor that infrastructure—we want people to use the toll roads, to feel better at the airport, and to choose the schools we're renovating as their preferred schools. It should be a clear decision in the mind of the users.
And for us, that goes a great deal further than just the financial aspect of the project. Yes, it is a transaction in its essence. And yes we want to maximize value and lump-sum payments.
But we want to bring new capital to be invested in infrastructure, and we want people to perceive infrastructure differently. We don’t have to do projects the traditional way if we can have better results through an alternative way. Once people start embracing that, they will want more—more world-class infrastructure—and they will continue to support the PPP concept.
In terms of economic development, all of our projects will have requirements for capital improvements—fresh capital and new investment. People want jobs being created, and we have told people that PPPs create jobs—and they do—but they might not if you only care about the financial transaction, because then you might be trying to reduce capital investment—or not have any requirements for investment. And that probably would not create as many jobs as if you had the capital investment requirements in the project.
For us, it's a major economic development measure. We like to put it in the context of new jobs, new investment, new capital, and new partners for Puerto Rico too. We're not purely interested in the financial transaction, because we don't think that approach will get us the results that we want in economic development.
David Alvarez is the Executive Director of the Puerto Rico Public-Private Partnerships Authority. Prior to his appointment at the Public-Private Partnerships Authority, Mr. Alvarez served as Senior Advisor and Special Aid to the Chairman and President of the Government Development Bank for Puerto Rico and as Chief Analyst at Santander Securities and Santander BanCorp Puerto Rico. Mr. Alvarez holds a Master of Science in Urban and Regional Planning from Florida State University and a Bachelors degree in Economics from West Virginia University.
This article will be featured in a forthcoming edition of Reason Foundation's Innovators in Action report.