The Financial Risks of
California’s Proposed
High- Speed Rail
Project
A Review And Assessment Of Publicly
Available Materials On
The California High- Speed Rail Authority’s
Financial Plans
October 12th 2010
“ We do not oppose high- speed rail in concept. It seems to work
in parts of Europe and Japan and possibly elsewhere. The 2008
Prop 1A promise that captured many voters was that the
California High- Speed Rail ( CHSR) would not cost the taxpayer a
penny. After months of work on this report, we are forced to
conclude that the Authority’s promise seems an impossible goal.”
The Financial Risks of California’s Proposed High- Speed Rail
October 12, 2010
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We are grateful to the Community Coalition on High Speed Rail for
providing a virtual ‘ home’ for this review. For downloadable copies of
this report and attachments, visit their website www. cc- hsr. org
AUTHORS
Alain C. Enthoven – Marriner S. Eccles Professor of Public and
Private Management ( emeritus), GSB Stanford; President,
Litton Medical Products; Economist, Rand Corporation;
President's Award for Distinguished Federal Civilian Service;
Baxter Prize for Health Services Research; Fellow American
Academy of Arts and Sciences; Founder, Jackson Hole Group
( BA Economics, Stanford; Rhodes Scholar– Oxford; PhD
Economics, MIT)
William C. Grindley – World Bank; Associate Division Director,
SRI International; Founder and CEO, Pacific Strategies, ret.
( B Architecture, Clemson; Master of City Planning, MIT)
William H. Warren – 40 years of Silicon Valley finance, sales
and consulting experience, management, including CEO of
several start- ups, Director/ Officer at ROLM, Centigram, and
Memorex ( MBA, Stanford)
The Financial Risks of California’s Proposed High- Speed Rail
October 12, 2010
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TABLE OF CONTENTS
Page
CONTEXT- SENSITIVE OVERVIEW . . . . . . . . . . . . . 4
PEER REVIEW & VALIDATION . . . . . . . . . . . . . . . . . 5
EXECUTIVE SUMMARY . . . . . . . . . . . . . . . . . . . . . . 14
INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
BACKGROUND OF HIGH- SPEED RAIL IN
CALIFORNIA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
CONCLUSIONS & RECOMMENDATIONS . . . . . . . . . 25
1.0 Broken Promises And Unmet Demands
From The Legislature Diminish The CHSR
Project’s Credibility . . . . . . . . . . . . . . . . . . . . . . . . . . 38
2.0 CHSRA’s Ridership Forecasts – Central To The
System’s Financial Outcome – Are Far Too Optimistic. . 45
3.0 CHSRA’s Estimated Phase I Capital Costs
Should Be Significantly Higher . . . . . . . . . . . . . . . . . 52
4.0 CHSRA’s Revenue Assumptions Are Too High
And Its Operating Expenses Too Low . . . . . . . . . . . . . 56
5.0 Using The CHSRA’s Data On Revenues And
Expenses, The System Will Never Achieve Positive
Cash Flow Without The Assumed Federal Grants . . . . . 64
6.0 Complete CHSR Funding Has Not Materialized,
Nor Is Likely To Be Forthcoming . . . . . . . . . . . . . . . . . 74
7.0 CHSRA’s Job Creation Forecasts Are Too
Vague And Too Large To Be Credible . . . . . . . . . . . . . . 85
REFERENCES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89
The Financial Risks of California’s Proposed High- Speed Rail
October 12, 2010
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CONTEXT- SENSITIVE OVERVIEW
While our findings focus only on the California High- Speed Rail
( CHSR) project, they must be put into the context of a continued
shortfall of State of California revenues to meet its financial
obligations. State issued IOUs, employee furloughs and salary
reductions, significant cutbacks to education, closed parks, a
deferred proposition on water projects, unrepaired potholes, and
deferred maintenance on railroad signaling systems, bridges and
highways are symptoms of the State’s desperate financial
situation.
As an example, the impact of financing the high- speed rail
system on funding for our state’s education system is sobering.
Cutting back on both public school and university funding,
forcing layoffs and increasing tuition is compromising the future
of what was once the model for other state educational systems.
To put the real cost of the CHSR in perspective, debt- servicing
costs on only the voter- approved $ 9.95 billion of general
obligation ( GO) bonds represents more than $ 60 million per
month of principal and interest commitment. If California can
get someone to buy those approved $ 9.95 billion of bonds,
servicing that debt alone will wipe out one medium- sized primary
school each month, or over 100 schools before the proposed
CHSR would carry its first riders in 2020.
We respectfully submit our findings for public review. We
recognize that many dedicated consultants and employees have
prepared the California High- Speed Rail Authority’s ( CHSRA)
materials. However, we find the quality of the CHSRA’s work
product to verge on being promotional. CHSRA financial
documents are not of a quality that would attract investors
concerned about risks, returns on investments and the long term
financial sustainability or economic viability of the proposed
CHSR system as demanded in the Authority’s 1996 charter.
Until these financial questions are answered and Californians can
be assured that the CHSR project can meet its financial
obligations to produce operating surpluses, require no operating
subsidy, and create the hundreds of thousands of jobs it
promises, we believe the entire project must be postponed or
terminated.
The Financial Risks of California’s Proposed High- Speed Rail
October 12, 2010
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PEER REVIEW & VALIDATION
This Review is the product of the efforts of experienced corporate
business practitioners, economists and finance experts who
volunteered their time to try to understand the California High-
Speed Rail Authority’s ( CHSRA) documents on financing the
proposed California High- Speed Rail ( CHSR) project.
These individuals worked without corporate, government or
private sponsorship. They read considerable materials from both
proponents and opponents of the proposed California High- Speed
Rail ( CHSR) project. They met individually and in groups to give
direction for the paper and reviewed and commented on drafts.
Over several months of mid- to- Q3 2010, the paper came
together to reflect the common themes and conclusions that
arose in these discussions.
The authors shared drafts with professionals who understand
finance and comprehend the implications of the analyses.
Over seventy Principal Reviewers have read the report and agree
with the Authors’ findings and endorse their conclusions.
Principal Reviewers
Michael Armacost – Shorenstein Fellow, Stanford University
Asia/ Pacific Research Center ( PhD, Columbia)
Skip Bacon – CTO, late stage start- up; SVP, Vendavo; VP.
Applications Technology, Siebel ( now Oracle) ( BA, Johns
Hopkins; Program for Management Development, Harvard
Business School)
David Barca – GM, Keller Williams Realty; Director California
Association of Realtors, Director National Association of
Realtors; and Special Consultant for the Privatization Effort of
British Rail ( MA, Santa Clara University)
Don Barnby – Co- Founder and Director ( retired President and
CEO) Biolog, Inc. Co- Founder, past President and CEO,
Cymed, Inc; US Executive Office of the President ( BS, MS
Chemical Engineering, MIT; MBA, Stanford)
Joseph Baylock – Veteran Technology Analyst ( BS, Rensselaer
Polytechnic Institute; MBA, Wharton)
The Financial Risks of California’s Proposed High- Speed Rail
October 12, 2010
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Brian D. Belchers – Partner, Ernst & Young Management
Consulting ( head of US Technology Industry practice) ret.,
Vice President Cap Gemini, ret., Director of companies,
( B. Comm, University of Natal, South Africa; Chartered
Accountant SA; MA, Oxford University, Rhodes Scholar)
H. Raymond Bingham – Chairman, Flextronics International;
Managing Director, General Atlantic LLC; EVP, CFO, CEO and
Executive Chairman, Cadence Design Systems; Chairman,
TriNet; Director, Oracle Corporation; Director, Dice Holdings;
( BS, Weber State; MBA, Harvard)
James H. Boettcher – General Partner, Focus Ventures ( BS/ EE,
University of Wisconsin; MA/ MBA, Stanford)
Anthony Bonora – VP, Advanced Technology, Crossing
Automation; Co- founder, EVP, CTO, Asyst Technologies;
awarded seventy US patents; Recipient of SEMI award for
North America ( BS, Mechanical Engineering MS, UC Berkeley)
Sheldon Breiner – Chairman, UBIQ Networks, Inc; Chairman,
Founder of Potential Energy; Founder, President of
GeoMetrics, Inc; Co- founder and CEO of PML, Inc; Interim
CEO of 3DGeo; Founder and CEO of Syntelligence; Fellow,
Explorers Club of New York; Advisory Council, School of Earth
Sciences at Stanford ( BS, MS and PhD in Geophysics,
Stanford)
Sam Bronfman – Chair for Global Wines, Diageo, plc; Bacchus
Capital Management; Board of California Cancer Center;
Board Jewish Museum of San Francisco ( BA, Williams College)
Kelly Bronfman – Former Director of Marketing, Photo Drive-
Up; Board, Eagle Valley Land Trust ( ret); Trustee to Board of
Colorado Conservation Trust; Director, Gore Range Natural
Science School ( BA, Rice University)
Michael G. Brownrigg – Founder and Managing Partner, Total
Impact Advisors; Managing Partner, ChinaVest; US State
Department, Foreign Service; US Trade Representative's
Office; Board, Foundation for A College Education; ( BA,
Economics Williams College)
Alan H. Bushell - Management consultant, McKinsey & Co.;
CEO/ COO/ CFO of several technology companies; ret. ( BA
Stellenbosch University, Chartered Accountant SA; MBA
Harvard)
The Financial Risks of California’s Proposed High- Speed Rail
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Scott T. Carey – Chairman and General Counsel, Cornish &
Carey Commercial, Newmark Knight Frank; Former
Councilman and Mayor, Palo Alto; Advisory Board for the
Berkeley Center for Law, Business and the Economy ( BA, LLD
University of California)
Jerry Carlson – Division GM and Corporate Controller, Hewlett-
Packard, ret; CFO, Triad Systems; Mayor, Vice Mayor,
Councilmember, Town of Atherton ( MBA, Stanford)
Peter Carpenter – EVP, Alza Corporation; Director, Federal
Assistance Review, US Office of Management and Budget;
Planning Commissioner, City of Palo Alto; Director, Leadership
California; ( AB, Harvard; MBA, University of Chicago)
Jane Shaw Carpenter – Chairman of the Board, Intel
Corporation; Chair and CEO, Aerogen Inc.; President, COO,
EVP, Alza Corporation, ret.; 2010 ODX Outstanding Director
Award; 2009 Outstanding Woman of Silicon Valley; American
Association for the Advancement of Science; holder of
thirteen US patents ( BS and PhD Physiology, Birmingham
University, England; D. Sc. Worcester Polytechnic, Mass)
Robert C. Chiles – Senior Partner, Chiles and Prochnow LLP;
Fellow, Litigation Counsel of America; ( JD, Santa Clara
University)
Tench Coxe – Partner, Sutter Hill Ventures ( MBA, Harvard)
Thomas Lyman Chun - Board of Directors, Maxtor Corporation;
Board of Advisors, Logitech International S. A.; Chairman of
the Board, Corporation for Open Systems; Vice President,
Tandem Computers & SyQuest Technology; CEO of several
start- ups ( BA Yale; JD, Harvard; MBA, Stanford)
Douglas DeVivo – General Partner of Alce Partners, LLP ( Ph. D.
Northeastern; MBA, UC Berkeley)
William C. Edwards – Pioneer Silicon Valley venture capitalist;
ret.; Executive Committee, Hoover Institution ( BS Eng.
Stanford; MBA, Harvard)
Erik T. Engelson– Managing Partner, The Foundry, LLC; CEO,
Cierra, Inc; CFO, Fluidigm Corp; Venture Partner, Versant
Ventures; SVP, Target Therapeutics, Inc. ( MS BioEngeering
UC San Diego; Stanford Exec Program)
The Financial Risks of California’s Proposed High- Speed Rail
October 12, 2010
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Sanford Fitch – CFO of SanDisk, Komag, and Concept, ret., ( BS
and MBA, Stanford)
Norm Fogelsong – General Partner, Institutional Venture
Partners ( MBA/ JD, Harvard)
Kenneth C. Frederick – CEO, Molecular Imaging Corp;
Director, Family & Children Services ( BS, Engineering,
University of Pittsburgh; MBA, Harvard)
Philip H. Friedly – VP International, H2O Inc; Sr. Research
Mgr., Allstate Research & Planning Center; Business Research
Director, Fireman's Fund; SRI International; HUD; OECD,
Paris ( PhD Economics, USC)
Lani Fritts - General Partner, Trumpet Ventures, Managing
Director/ CEO, Trumpet Behavioral Health; former VP
Lockheed Martin; former CEO, Savi Performance Logistics;
COO Savi Networks, Member; US Chamber of Commerce
Infrastructure Security Task Force; Program Manager, Smart
and Secure Tradelanes ( BA Econ. Georgetown, MBA Stanford)
Will Griffith – General Partner, Technology Crossover Ventures;
Associate, Beacon Group; Investment Banker, Morgan
Stanley; Boards of 2Wire, Orbitz, TravelPort, and Whitepages
( BA Engineering, Dartmouth; MBA Stanford)
Morton Grosser – Venture investor, founder and director of
technology companies; Director of L. H. Alton & Co., Chroma
Energy, Chroma Medical, I- Flow Inc., Lazer- Tron Corporation,
Microfabrica Corporation, etc.; Member of Gossamer Albatross
team; Associate Fellow American Institute of Aeronautics and
Astronautics; Fellow American Society of Mechanical
Engineers; NIH Fellow UCLA Medical Center; Multiple patent
holder; NASDAQ Financial Principal ( BS, MS Eng. MIT; PhD,
Stanford).
J. Michael Gullard – Founding Partner, Cornerstone
Management; President of the Board, Boys & Girls Club of the
Peninsula ( MBA, Stanford)
Steve Halprin – General Partner, OSCCO Ventures, ret.; Chair,
Audit Committee Landec Corp.; Prior Board member Hybrid
Networks, Oceaneering International and numerous private
companies. Past Trustee Memorial Drive Trust; Founding
board Peninsula Conservation Center ( BS, MIT; MBA,
Stanford)
The Financial Risks of California’s Proposed High- Speed Rail
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Ralph H. Harnett – CEO Ensign- Bickford Industries, ret.; Sr. VP
Raychem Corporation; Board Director Dyno Nobel
Corporation; past Trustee McLean Home. ( BS, Purdue
University; MBA, Harvard)
Bob Hellman – Managing Director & CEO, American
Infrastructure MLP Funds; former Managing Partner, McCown
De Leeuw & Co; Associate Consultant, Bain & Co. Japan;
Board Member of American Midstream Partners, Stonemor
Partners, OnStage Entertainment, Stanford Institute for
Economic Policy Research ( SIEPR), ( BA, Stanford; MSc,
London School of Economics; MBA, Harvard).
Tom Holt – CEO, VORT Corporation; Founder, Surfwax Inc.;
holder of three US patents; past Deacon and Elder, Menlo
Park Presbyterian Church; past Chairman, Menlo- Atherton
High School Technology Committee; ( BS Chemistry, Stanford)
Richard Holt – Founder, CEO Micro General Corporation ( acq);
( BS, Stanford; MBA, UCLA)
James R. Janz – Partner, Sideman & Bancroft LLP ( BSCE
Purdue; MSUP, Columbia; JD & MBA, University of Chicago)
Robert Jaunich II – Founding Partner Calera Capital, Chairman
Palo Alto Medical Foundation, former Chairman Coldwell
Banker Corporation, former President Sara Lee Corporation,
Board Member Con- way Corporation, Board Member Direct
General Corporation, ( BA Wesleyan University; MBA, Wharton
Graduate School).
Robert L. Katz – former CEO U. S. Natural Resources, Inc;
former Chair, California State Parks & Recreation Commission
( AB, UC Berkeley; MBA Stanford; DCS, Harvard)
Lee M. Kenna, Jr. – Chair and CEO, SIMCO Electronics; Past
President, Nor Cal Chapter of World Presidents Organization;
Past President, Pacific Skyline Council, BSA. ( BS, Mech. Eng.
Duke; MBA, Harvard)
W. Keith Kennedy Jr. – Chairman of the Board, Con- way;
President and CEO, Watkins- Johnson, ret.; Former Chair,
Joint Venture: Silicon Valley Network ( BSEE, MS, PhD, Cornell
University)
Al Krizelman – Director of Sales: Raychem; Director, Siemens
Medical; Director, Acuson Corporation; Founder, Bay Area
Bladder Cancer Advocacy Group ( BA, University of Nebraska)
The Financial Risks of California’s Proposed High- Speed Rail
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Herbert Lechner – Senior corporate positions American
Express, The Singer Company, Fireman’s Fund Insurance
Companies, and SRI International; CEO and Board Member of
several technology start- ups ( BA Math & Physics, University
of Kansas; Graduate work Business and Computer Science,
Stanford and Columbia)
James E. Moore – Professor, Public Policy Management, Daniel
J. Epstein Department of Industrial and Systems Engineering,
USC; Immediate Past President, Transportation Science and
Logistics Society; Research affiliation, Norman Y, Mineta
Transportation Institute ( BS, Industrial Engineering,
Northwestern; MS and PhD, Engineering, Stanford)
Michael J. Murray – President, Global Corporate and
Investment Banking, Bank of America Corporation ( ret);
Director, Eloyalty Corp; Director, Con- Way Inc; Past
Chairman, United Way of the Bay Area; Past Vice- Chairman,
California Academy of Sciences; Advisory Council for the
College of Business, University of Notre Dame ( BBA, Notre
Dame; MBA, University of Wisconsin)
Jami Dover Nachtsheim – Director, Affymetrix and Southwall
Technologies; VP, Worldwide Marketing, Intel Corporation,
ret.; Director, Tech Museum of Innovation ( BA, Arizona State
University)
Stephen Nachtsheim – Intel Corporation, Corporate VP ret.
( Director, Intel Capital; GM Intel Mobile and Handheld
Products; GM Intel EMEA.) Chairman of the Board, Deluxe
Corporation; Trustee, University of St. Thomas; Former
Faculty University of Minnesota and University of St. Thomas
( MS and MBA, University of Minnesota)
Howard Neff – Group Vice President of Global Product
Operations, Applied Materials Corporation, ret.; Board Digital
Divide Data Foundation; Advisory Board, Jhai Foundation ( AB
Economics, Dartmouth College)
Alex Osadzinski – Member Executive Board and EVP Product &
Solutions, Kudelski Group; Venture Partner, Trinity Ventures;
CEO, Katmango; VP Marketing Vitria Technology; VP
Marketing & Sales, Be; VP Market & Product Strategy, Sun
Microsystems ( UK education equivalent to US BSc Computer
Science)
The Financial Risks of California’s Proposed High- Speed Rail
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Humphrey Polanen – Managing Partner, Sand Hill Management
Partners; Chairman, UCirrus Corp; Managing Director,
Internet Venture Partners; Co- Founder, Heritage Bank of
Commerce; GM, Sun Microsystems; Chair, St. Bernard
Software, Inc; ( BA, Hamilton College; JD, Harvard)
Robert J. Prantis – Treasurer, Xilinx, Inc, ret.; Chair,
Supervisory Committee, Technology Credit Union ( BS,
University of Illinois; MBA, University of Chicago)
Robert Saldich – CEO of Raychem Corporation, ret.; former
Chair, Commonwealth Club of California; former member Bay
Area Council; Visiting Committee, National Institute of
Science and Technology ( BS, ChemE, Rice University; MBA,
Harvard)
David E. Schnedler – Director of Corporate Planning, Sun
Microsystems; Manager, Planning and Development, Hewlett-
Packard; Professor of Management, St. Louis University ( BS
Industrial Eng. and BS Business, University of Missouri; MBA,
Harvard)
Bill Schroeder – Past CEO, Diamond Multimedia, Inc. ( acq);
past President and Vice Chair, Conner Peripherals, Inc. ( acq);
President & Co- founder, Priam Corporation; Management
Consultant, McKinsey & Company; various high- tech boards
of directors ( MSEE, Marquette University; MBA, Harvard with
honors)
Sharam Shirazi – CEO, fotoflexer. com: Former Chairman &
CEO, Teknekron Systems; CEO, Empact Software; CEO,
Verification Technologies; Director, Zilog, Inc.; Consultant,
Bain & Co. ( BS, MS, EE MIT; MBA, Stanford)
John C. Shenk – President, Argus Financial Corporation; VP
Union Bank; Board Silicon Valley NAIOP; Board of Trustees,
Menlo College ( BS, UC Berkeley)
Bruce D. Smith – Founder, Former Chairman & CEO Network
Equipment Technology ( NYSE); Executive positions at
GigEpath, Silicon Wireless, Nomadic Systems and COMSAT
( MEE University of Florida; MBA, Harvard)
Carol F. Smith – CEO, Exceptional Wines International National
Marketing; Executive Director Hewlett Packard Grants ( SV),
CMO Oak Grove Enterprises; Founder, Eco Green Group;
Corporate Council, United Way of America; Director, San
Mateo County Parks Foundation ( MBA, San Jose State)
The Financial Risks of California’s Proposed High- Speed Rail
October 12, 2010
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George Sollman – Chairman, Corticon Technologies; Chairman
and Founder, Arabesque Investments LLC; Co- founder, CEO
@ Motion ( acq); CEO, Centigram Communications; VP,
Shugart Corporation; Board of Advisors, Leavey School of
Business Santa Clara University; Former Chair American
Electronics Association; holder of five US patents ( BSEE,
Northwestern; MSEE, Northeastern)
Timothy R. Warner – Vice Provost for Budget; Stanford
University, Senior Advisor for Management Reform, State
Department 2006- 2008; Board, Independent 529 Plan; Board
co- chair, Western Reserve Academy ( BA, Wesleyan
University; MBA, Stanford)
Robert P. Wayman – Interim CEO, former CFO, EVP and
Member of the Board, HP ( BS Engineering and MBA,
Northwestern University)
J. M. “ Mike” Wells, Jr. – Chairman of the Board, North Valley
Bancorp 2005- Present; Attorney, Redding, CA 1966- 2005
( BA Economics, Stanford; JD Hastings College of the Law)
William R. Widmer – Deputy VP, Orange Business Services-
France Telecom; Deputy CEO Aerospace Systems Division,
CSC; COO Cadence Design ( MBA, Texas Christian)
Robert Wilkie – Investor; CEO, Continental Hydraulics, Inc. ret.
( BA, Stanford)
Robert C. Wilson – Corporate Vice President, General Electric,
Executive Vice President, Rockwell International, CEO, Collins
Radio, CEO Memorex; Numerous Boards, including Chrysler
Corp., GAF Corp., Western Digital, Televideo, and Resound;
Twice named one of the top ten CEOs of the year; US Navy
World War II. ( BSME, UC Berkeley).
William Wilson III – Founder WMS Partners; ( BS, Engineering,
Stanford)
Will C. Wood – EVP– International, Wells Fargo, ret.; Principal,
Kentwood Associates; Director, Pefco; Director, Banco Latino
de Comercio Exterior ( Bladex) ( MBA, UC Berkeley)
John W. Wu – CEO, John Wu & Company; CFO, Modernsoft Inc;
Director of Planning, Crown Zellerbach ( BA, MBA, Harvard)
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Paul M. Wythes – Founder, Sutter Hill Ventures ( BSE Princeton,
MBA, Stanford)
Eric Young - General Partner, Canaan Partners; SVP, GE
Venture Capital; Boards of several successful high- tech
companies ( BSME, Cornell; MBA, Northwestern)
The Financial Risks of California’s Proposed High- Speed Rail
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EXECUTIVE SUMMARY
After months trying to understand the available evidence and
forecasts from the California High- Speed Rail Authority ( CHSRA),
our general conclusion is that there is little if any chance the
system will pay for itself. That requirement is the baseline of
AB3034.
The 2008 and 2009 CHSRA business plans asserted the system
would earn an operating surplus, the most recent stating it would
do so in the system’s first year of operations. The private sector
was supposed to be a financial partner, local governments were
supposed to pitch in, and the Federal Government was to have
funded about 45% of the presently estimated costs. The stark
conclusion, of this financial Review, based only on CHSRA’s
Phase I plans and supported by these pages, is that CHSRA’s
financial promises can’t be kept.
After reviewing this paper and documents in the End Notes, the
Authors and Principal Reviewers cited in the Preface agree on the
following specific conclusions.
1.0 Broken Promises And Unmet Demands From The
Legislature Diminish The CHSR Project’s Credibility
1.1 The CHSR Project That Voters Chose In 2008
Promised To Link Seven Cities, But Links Only Three.
Although San Diego, Riverside, Oakland and Sacramento were
part of the official ballot description for Prop 1A, what emerged
after the vote as Phase I is only for Los Angeles/ Anaheim to
downtown San Francisco
1.2 The Prop 1A $ 33 Billion Capital Cost Promise
Morphed Into A $ 42.6 Billion Capital Cost. How did the
CHSR project drop routes but increase its costs?
1.3 The Promised $ 55 One- way SF- LA Ticket
Morphed Into A $ 105 One- way Ticket After Prop 1A.
Voters chose what looked like an attractive fare, but a year later
were presented with a fare that nearly doubled.
1.4 Five Months Before Prop 1A Passed, The
Authority Knew That Private Sector Participation Was
Conditioned On Near Total Federal And State Capital
Building The CHSR Project. IMG told the Authority that
The Financial Risks of California’s Proposed High- Speed Rail
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private sector firms were really only interested in building the
CHSR if the government paid for it.
1.5 Five Months Before Prop 1A And Three Months
Before AB3034 Passed, The Authority Learned The Private
Sector Would Only Operate The CHSR If Given A Revenue
Guarantee. IMG and Goldman Sachs told the CHSRA Board that
the private sector considered the ridership risks too high to
finance CHSR without a revenue guarantee
1.6 The CHSRA Did Not Meet The Senate’s Demand
For An Investment Grade Business Plan Prior To The 2008
Proposition 1A Vote. Although demanded by September
1,2008, the promotion- oriented document submitted to the
Senate came after the election.
1.7 CHSR Proponents Promised Prop 1A Voters The
Project Would Pay Its Way; But By Mid- 2008 The CHSRA
Knew The State Would Have To Guarantee The Operators’
Revenue. Proponents promised “ THE USERS OF THE SYSTEM
PAY FOR THE SYSTEM”; that is riders, not taxpayers, would pay
for the system.
1.8 Despite The Senate’s Demand, CHSRA’s Business
Plans Have Still Not Met The Criteria Or Quality For
Investment Grade. The Senate still does not have an
investment grade business plan two years after demanding one.
1.9 A Year After AB3034 Passed, IMG Again Told The
Authority That Private Sector Financing Would Only
Become Available With A Revenue Guarantee. There was
little or no change in the private sector’s view of the financial
worthiness of the CHSR project in the intervening year.
1.10 Although Twice Demanded By The Legislature
And Promised Before September 2010, CHSRA Has Not
Produced A Risk Mitigation Plan. This is the sine qua non of
finance; what needs to be done if the scenario as presented fails
to take place.
1.11 Despite The Demands Of AB3034 More Than
Two Years Ago, No Independent Peer Review Group Has
Reviewed And Assessed The CHSRA’s Financial Plans. How
the Authority can ignore that essential condition of AB3034 is a
mystery.
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2.0 CHSRA’s Ridership Forecasts – Central to the
System’s Financial Outcome – Are Far Too Optimistic
2.1 Evidence- Based Analyses Contradict CHSRA’s
Forecasts. Empirical precedents from the USA and Europe
suggest CHSR ridership by the tenth operating year ( 2030)
should be 5- 10 million, not the 39 million annual passengers
claimed in the CHSRA models.
2.2. Independent Experts’ Refute CHSRA’s Ridership
Model. Three independent economists and transportation
groups have found significant flaws in the CHSRA consultant’s
ridership model involving uses of coefficients and inappropriate
data series. These findings have already produced calls for even
more independent reviews of this critical planning element.
3.0 CHSRA’s Estimated Phase I Capital Costs Should
Be Significantly Higher. The history of cost overruns on
megaprojects such as high- speed rail suggests the CHSRA has
seriously underestimated the price tag for Phase I ( Los Angeles
to San Francisco). Using overruns from recent infrastructure
projects as a guideline suggests the present $ 42.6 billion
estimate could reach $ 100 billion or greater. 1
3.1 Megaproject Histories Show Costs Were
Substantially Underestimated. Transport projects’ build- out
costs can be anywhere as high as 600% of their original
estimates.
3.2 The Costs Of Phase I Of The CHSR Project Could
Fall Between $ 62 Billion And $ 213 Billion. Comparing the
CHSR’s estimated costs to real world outcomes gives a sobering
view of how high the build- out costs could go.
4.0 CHSRA’s Revenue Assumptions Are Too High
And Its Operating Expenses Too Low
4.1 CHSRA Used Inflated Auto And Airfare Prices To
Capture More Riders And Revenue. A detailed analysis of
actual automotive and airline ticket costs between Los Angeles
and San Francisco concludes that the CHSRA’s input prices to its
revenue model for auto and air travel should be at least 25%
lower. Even using the Authority’s ridership forecasts, the CHSRA
would not gain enough revenue to avoid requiring an operating
The Financial Risks of California’s Proposed High- Speed Rail
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subsidy to service its operating debt, a situation strictly
prohibited by AB3034.2
4.2 If CHSRA Had Used An Evidence- Based Pricing
Approach, Ridership Estimates Would Have been Lower.
Empirical analysis of the per- passenger mile ticket charges for
five European and Japanese high- speed rail systems suggests
ticket pricing assumptions should be about $ 190 for a one- way
SF- LA passage, about 80% higher than the $ 105 CHSRA’s
present model uses.
4.3 CHSRA’s Assumptions On Operating Expenses Do
Not Reflect Real World Practices. Many of CHSRA’s
assumptions about operating expenses do not conform to
rigorous accounting and financial practices. CHSRA’s documents
fail to distinguish between variable and fixed costs, do not
recognize that maintenance costs increase yearly, do not include
insurance costs, and do not acknowledge that labor cost
increases will be extremely difficult to manage.
5.0 Using The CHSRA’s Data On Revenues and
Expenses, The System Will Never Achieve Positive
Cash Flow Without All The Assumed Federal Grant
Monies
5.1 The Warren Financial Model Of The CHSR
Highlights The Costs Taxpayers Will Have To Bear. Without
independent access to the CHSRA’s financial model, several of
the authors built a surrogate model based on the assumptions
stated in the CHSRA’s 2009 Business Plan, with particular focus
on the issue of ‘ if and when’ the CHSR might achieve positive
cash flow. This ‘ Warren Model’ of CHSR’s prospects for being
financially self- sustaining assumes the point of view of the State
of California’s obligations, not the Authority’s view that it can
‘ off- load’ its financial obligations to other entities.
The model finds that unless the Federal Government supplies the
CHSR with the complete package of $ 19 billion of grants towards
the supposed $ 42.6 billion of capital costs currently needed, the
CHSR will never achieve positive cash flow.
Any other finance scenario will require visible or seriously large
debt servicing. Debt servicing becomes an operating expense.
Therefore, if built, the CHSR will require a continual and reliable
subsidy, now referred to by the CHSRA as a ‘ revenue guarantee’.
The authorizing legislation for the system, AB3034 ( Galgiani),
The Financial Risks of California’s Proposed High- Speed Rail
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18
explicitly prohibits such a subsidy. 3 Meanwhile, the CHSRA
commissioned the Infrastructure Management Group Inc. to
outline how to interpret a revenue guarantee as something other
than an operating subsidy. 4
In this Review, numerous scenarios are analyzed to show the
sensitivity and magnitude of the peak cumulative negative cash
flows to various combinations of financing, various degrees of
successful operating results, and the ‘ guaranteed’ or ‘ at risk’
returns for the private equity investor.
5.2. High- speed rail systems do not break even. The
Director of High- Speed Rail at the International Union of
Railways ( IUR) stated that only two segments of two high- speed
rail systems in Europe and Japan break even. A 2004 DOT study,
then a the Congressional Research Service study reconfirmed
this. In 2009 Amtrak’s Inspector General documented the on-balance
sheet and off- balance sheet subsidies European rail
operators receive. Recently a World Bank report said the same
thing. This reality should have been reflected in the CHSRA’s
2008 promotion of Prop 1A. CHSRA’s negligence of these facts is
neither understandable nor excusable.
6.0. Complete CHSR Funding Has Not Materialized,
Nor Is It Likely To Be Forthcoming.
As of third quarter 2010, the prospects for obtaining the funds
listed in the Authority’s 2009 Business Plan do not seem bright.
There is a large and real funding gap between the sizes and
sources the CHSR needs and what it has or is likely to get.
Others have also pointed out this discrepancy. For example,
within weeks of the April 2010 ARRA allocation that looked so
hopeful, State Auditor Howle reported to the Governor: “ The
program risks significant delays without more well- developed
plans for obtaining funds.” 5
6.1 CHSRA’s Proposed Capital Budget Sources Are
Heavily Skewed To ‘ Free’ Government Money. The 2009
CHSRA Business Plan specified four sources of capital prior to the
start of operations in 2020.
Federal Grants $ 17- 19 billion
State Grants ( actually Prop. 1A bonds) 6 $ 9.95 billion
Local Grants $ 4- 5 billion
Private Debt or Equity Funding $ 10- 12 billion
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6.2 Purchasers For The $ 9.95B Of Guaranteed GO
Bonds Have Not Come Forward. Even with a State of
California guarantee, the future of bond sales is questionable.
State Treasurer Lockyer said, “ I would be reticent to try to go to
market to issue bonds to finance the state’s share. The only
discretion I have is to say, ‘ You can’t sell this.’” 7
6.3 The Probability Of CHSRA Receiving The Full
Complement Of Federal Grants Is Small. As of August 2010,
the total the Authority could use for building the project is $ 4.7
billion -- the sum of the $ 2.34 billion ARRA grant from the
Federal Government and the dollar- for- dollar match authorized
by Prop 1A, less the $ 400 million earmarked in the Federal grant
for the San Francisco Transbay Terminal. This totals about 11%
of the currently estimated $ 42.6 billion projected cost. We have
found no provision for financing above that projected cost.
6.4 CHSRA’s Assumptions About Local Government
Assistance Have No Historical Basis. CHSRA’s assumptions
about the ability of California’s fiscally strapped cities and
counties to provide $ 4- 5 billion ‘ local contribution’ grants for the
CHSR project fail to take into account the financial distress of
those governments. They are furloughing or laying- off police
officers, teachers and other employees. Local governments have
almost never funded transit projects outside their jurisdiction.
The prospect of gaining such local funding through grants or
secured debt within the foreseeable future is doubtful.
6.5 Twenty- three Months After Passage of
Proposition 1A, There Is No Private Equity Or Debt- Based
Financing for the CHSR. The United States’ risk capital
providers, of which California- based companies are leaders, have
not come forward in the past 23 months for the CHSR. This
suggests there is little appetite for either a guaranteed or non-guaranteed
return on investment in the CHSR project. Given the
State’s continued budget shortfalls, investment in California
State projects, particularly of the order of magnitude of Phase I
of the project ( the segment between San Francisco and Los
Angeles, without the Oakland, Sacramento or San Diego
destinations) entails far greater risk than normal. Moreover, our
analysis suggests the risk- adjusted return profile of CHSR will be
highly unattractive to private investors. This further undermines
the project’s financial plans.
6.6 At Present California Is In The Least Favorable
Position Possible To Go To Debt Markets To Fund The
CHSR Project. Even if the Great Recession had not happened
and the Federal Government was not purposely and rapidly
increasing its debt through fiscal stimulus, the State’s profligate
The Financial Risks of California’s Proposed High- Speed Rail
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20
spending even in ‘ good times’ has put it at a disadvantage
relative to other borrowers. Add to that the new dimensions of
increased scrutiny by the State Treasurer and the SEC, and
California will be hard pressed to attract bond buyers.
6.7 Discussions With Sovereign Governments Or
Others About Using ‘ Creative Financing’ To Fund CHSR
May Not Be In The Best Interests Of California. Discussions
by the CHSRA with sovereign financiers ( such as China, France,
Germany or Japan), or such sovereign financiers in combination
with foreign builders, operators and private financiers, could be a
dangerous foray into using ‘ creative financing’ to fund CHSR.
This could result in an excessively leveraged CHSR if the
projected federal and city/ county grants are indeed
supplemented by foreign loans requiring ongoing debt service
payments. What could be helpful to get the CHSRA’s project
built may be bad for California in several different ways.
7.0 CHSRA’s Job Creation Forecasts Are Too Vague
And Too Large To Be Credible. The CHSRA predicted
600,000 jobs would be created over the course of the CHSR
construction period. Whether that is 60,000 jobs for ten years or
600,000 for one year or some other possibility is not defined.
The CHSRA forecast of 450,000 permanent jobs is
unsubstantiated by either methods or evidence presented in the
CHSRA’s reports.
7.1 CHSRA Is Silent On Exactly When Or Where Jobs
Occur, Or How Many FTE Jobs Each Year Their Forecasts
Represent. Promises of construction and permanent
employment should be accompanied with information about
whether these are Full Time Equivalents ( FTE’s); what the
average income per job would be; what years these jobs would
be created, and how long – if not forever – would these
permanent jobs last.
7.2 CHSRA’s Forecasted Employment For The 8- 10
Years Of Construction Is Seriously At Odds With Estimates
Based On Bureau Of Labor Statistics Data. The 600,000
construction jobs forecast differs significantly from other
forecasts using Bureau of Labor Statistics ( BLS) data.
7.3 If ‘ Permanent Jobs’ In CHSRA’s Lexicon Means
Both CHSR Employees, As Well As Those Employed
Permanently Because CHSR Exists, Their Forecast Is
Beyond Believable. In August 2010, there were 15,968,000
jobs in California while there were 239,586 active State of
The Financial Risks of California’s Proposed High- Speed Rail
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21
California employees. To claim a train would create twice the
number of employees as the entire State government, whether
engineers, maintenance workers, local coffee shopowners or
rental car agencies is highly questionable.
7.4 If ‘ Permanent Jobs’ In CHSRA’s Lexicon Means
Only CHSR’s Employees, Then Few Jobs Will Be Created. If
CHSRA means ‘ permanent’ to be jobs created over a 40- year life
of the project, the impact – 0.1% – is miniscule.
7.5 There Are Inconsistencies In CHSRA’s Forecasts
That Raise Questions About The Rigor Of Their
Methodologies For Computing Employment. CHSRA appears
to be confused about its CHSR Phase I employment forecasts.
The Financial Risks of California’s Proposed High- Speed Rail
October 12, 2010
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INTRODUCTION
This report came about because professionals conversant with
finance, economics, urban planning and business operations
found claims by the California High- speed Rail Authority
implausible. Extremely high ridership forecasts coupled with
assertions of low fares and construction costs just didn’t pass
‘ the smell test of my professional experience’ as one executive
put it. To claim the system was to have an operating surplus in
its first full year of operations surpassed both historic evidence
and credibility.
We believe the CHSRA Board, which successfully promoted the
project to voters in 2008, has become captive to its own
thinking. Consultants to the CHSRA seem to be repeating the
same conclusions, despite credible challenges. This pattern has
continued throughout 2009 and deep into 2010, despite serious
questions from key State Senators, the Legislative Analyst’s
Office ( LAO), the State Auditor and independent experts’
publications. Once the flow of Federal time- dependent American
Recovery and Reinvestment Act ( ARRA) funds seemed imminent,
the Authority appeared reluctant to ask the hard questions that
private and public sector due diligence demanded.
This report challenges most of the key assumptions and findings
that would affect the financial performance of the CHSR. To find
answers we could rely on, we asked:
• Do the Authority’s ridership forecasts have a chance of ‘ being
roughly right’ or are they unrealistically optimistic?
• How realistic are CHSRA’s estimated capital costs for Phase I?
• How reliable are the CHSRA’s assumptions about operating
expenses and revenues? Are they based on real- world
experience?
• Based on CHSRA’s financial model, can an operating surplus of
$ 370 million in the first year of operations ( 2020), supposedly
growing to $ 3.9 billion by 2035, be substantiated?
• What is the likelihood that all Federal and local government
grants assumed by the CHSRA will actually be made?
• Why haven’t California’s world- beating risk capital firms
stepped forward with their share?
• How realistic are CHSRA’s forecasts of temporary and
permanent job creation?
The Financial Risks of California’s Proposed High- Speed Rail
October 12, 2010
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As we prepared this document, we realized we were ‘ peeling an
onion.’ The more we pursued a topic, the more we were
frustrated by the lack of a data trail. Still more frustrating were
the contradictions between the CHSRA’s conclusions and the
history and evidence of planning and operating high- speed rail
systems throughout the world. We were also disturbed by the
lack of precision in key aspects of fiduciary audits prepared by
the Authority’s consultants. Repeated instances of such poor
work products also diminished our trust in their conclusions.
This report is not kind to the CHSRA or its consultants’ work. It
should not have been necessary to spend the many weeks we
did researching documents, drafting analyses, checking
conclusions with peers and editing our work. Voters in 2008
deserved a financial plan that was clear and up- front about the
challenges of getting Californians to abandon their autos for a
new transport mode. We expected transparency on how
operating surpluses could be made when high- speed rail’s history
and our financial model showed otherwise. We expected that
assertions of ridership and ticket pricing would be grounded in
real airline fares and real high- speed rail ticket prices. Because
few of those expectations were realized in the CHSRA’s
documents, we lost confidence in its ability to plan -- much less
operate -- a financially viable system.
We do not oppose high- speed rail in concept. It seems to work
in parts of Europe and Japan and possibly elsewhere. But it
works in those places due to unique combinations of higher
population densities, long histories of train travel, less- dominant
car cultures, shorter distances between metropolitan centers,
and higher tax rates that provide subsidies. The 2008 Prop 1A
promise that captured many voters was that the CHSR would not
cost the taxpayer a penny. 8 After months of work on this report,
we were forced to conclude that the Authority’s promise seemed
an impossible goal.
We hope this report is widely read and becomes a source
document for others concerned with the many unsubstantiated
claims the CHSRA has made. Those who believe California should
have the proposed system will challenge this report. Those who
think they stand to gain from rail system construction,
equipment or technology sales, or operations and maintenance
will scorn it. We only ask supporters and critics to take the time
to read our material and the source documents. Don’t take our
word or those of others uncritically. Draw your own conclusions.
But draw those conclusions after carefully studying the financial
viability of the State’s single largest infrastructure project, one
that could change the State’s financial future for a long time.
The Financial Risks of California’s Proposed High- Speed Rail
October 12, 2010
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BACKGROUND OF HIGH- SPEED RAIL
IN CALIFORNIA
In the mid- 1990s the State began exploring a possible high-speed
rail system. Governor Pete Wilson and the Legislature
created the California High- speed Rail Authority ( CHSRA) in 1996
and tasked it ” to prepare a plan and design for construction of an
economically viable high- speed train line linking major
metropolitan areas.” 9 [ emphasis added]
By 2008 the Authority had produced what it considered
“ investment- grade forecasts of ridership, revenue, cost and
benefits of the system” for 800 miles of high- speed rail
“ designed to carry over 100 million people a year by 2030.” 10
CHSRA had also produced a certified statewide program level
Environmental Impact Report/ Environmental Impact Study
( EIR/ EIS), selected general track alignments and stations, and
developed an institutional structure to manage construction and
system- wide operations.
By a two- thirds vote in August 2008, California’s Legislature
approved AB3034 ( Galgiani) to place a referendum on the ballot
to commit the State to issue up to $ 9.95 billion of General
Obligation ( GO) bonds to support the system’s development. 11 A
similar bond measure had been scheduled for the November
2004 ballot, but was postponed twice. 12
Three months after AB3034 passed, Prop 1A received 52.7% of
Californian’s votes. With the exception of the California Rail
Association and the Howard Jarvis Taxpayers Association, there
was little organized opposition. Prop 1A’s advocates largely
came from labor unions, engineering and construction
companies. 13
To date the Legislature has spent about $ 300 million on all types
of work. This includes filings under the California Environmental
Quality Act, detailed studies of right- of- ways and alignments,
public relations consultants and the CHSRA’s management and
administration of their Project Management Team, Parsons
Brinkerhoff. The CHSRA FY2011 budget request of over $ 400
million was lowered considerably. However the budget is under
review again because in August 2010 the Authority proposed to
have the Federal Railroad Administration ( FRA) select one of four
of the Phase I segments for a pilot program as opposed to its
Phase I plan of LA/ Anaheim to the San Francisco Transbay
Terminal. 14
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CONCLUSIONS AND RECOMMENDATIONS
REGARDING FINANCIAL RISKS ASSOCIATED
WITH THE PROPOSED HIGH- SPEED RAIL
PROJECT
At the close of September 2010, the Authority had both a $ 2.34
billion grant commitment from Federal ARRA funds and $ 194
million from the FY2011 Fiscal Christmas. If matched with bond
financing authorized by Prop 1A of 2008, currently CHSRA has
about $ 5.1 billion. That is not nearly enough to start
construction on its $ 42.6 billion Phase I plan – LA/ Anaheim to
San Francisco. Nor is it enough to build one of the more
expensive urban segments. 15
The CHSRA’s prospects for meeting AB3034’ s requirement not to
require an operating subsidy are dubious. The prospect for
gaining the full $ 18- 19 billion of Federal grants has virtually
vanished. Only with all of those assumed grant dollars can the
CHSR hope to ever have a positive cash flow. California’s
counties and cities are struggling financially and are unlikely to
be able or willing to find the $ 4- 5 billion the project requires of
them.
Twenty- three months after Prop 1A no private lenders have
come forward with an arms- length proposal for the $ 10- 12 billion
earmarked from that source. To not have secured one private
lender’s commitment in a state that houses the world’s largest
and most successful risk capital companies speaks volumes.
Why the CHSRA finds itself in this predicament after spending
over a quarter- billion dollars of State of California monies is
answered by one word: credibility. The Authority successfully
sold voters on a new mode of transport that would cost ‘ only’
$ 33 billion and would allow them to travel in less than three
hours from Los Angeles to downtown San Francisco at a cost of
$ 55 for a one- way ticket. A year later the capital costs had risen
by $ 10 billion and the publicly advertised ticket price was $ 105.
Similarly, the financial model went from ‘ not costing taxpayers a
penny’ to the need for a legally prohibited subsidy, now called a
revenue guarantee. 16 Those changes gnawed at the CHSR
project’s credibility.
Many rail experts had long questioned the plausibility of what the
CHSRA was selling. 17 The next credibility gap came when hard
questions were asked about the Authority’s ridership model. To
independent transport economists the forecast of 39 million
annual riders for a de novo system in its tenth operating year
The Financial Risks of California’s Proposed High- Speed Rail
October 12, 2010
26
stretched beyond their imagined possible outcomes. Ridership
forecasts on both transit and high- speed rail mega projects
around the world are known to be overestimated, and most with
serious financial consequences. 18 Since the CHSR must operate
without a subsidy, the predictions should have been on the
conservative side. To propose that four of every five Californians
would ride the CHSR in 2030 is not plausible. Consequently, the
CHSRA has faced challenges in both the popular and professional
press for the credibility of their ridership forecasts.
CHSRA’s ticket pricing assumptions were also scrutinized. We
found that by using higher than publicly available price estimates
for air transport and then pegging the CHSR ticket price at 83%
of the average air ticket price, the CHSR model could always
achieve a price advantage over air travel options. But these
assumptions do not reflect the reality of personal or corporate
budget choices, nor does the CHSRA’s model reflect realistic
choices for driving with several passengers. To achieve the
forecasted ridership levels, the system would need more
passengers and a cheaper per ticket cost. But assuming a higher
than realistic airfare, and pegging the CHSR ticket at a
percentage of that higher airfare is not a credible approach.
We know that every high- speed rail system in the world is
subsidized. Only two segments worldwide, one in France and one
in Japan, supposedly break even. By looking at the ticket prices
for five routes in Japan, we found that the CHSRA’s ticket pricing
model used the same per passenger mile rates as Japan’s
Shinkansen system – $ 0.24/ mile. The only supposedly break
even French TGV segment, Paris- Lyon, charges $ 0.399/ mile,
two- thirds higher than the CHSRA’s pricing model input. One
might build CHSR, but in order to be profitable, ticket prices
would have to be much higher – 80 % higher – and higher ticket
prices mean fewer passengers will ride. Fewer passengers mean
even less probability to operate without the prohibited subsidy.
Assumptions about the CHSR’s revenues and operating
expenses, coupled with their ridership forecasts, produced their
projected operating surpluses – claimed to be $ 370 million in
their first operating year, 2020. Since there is no publicly
available edition of the CHSRA’s financial model, we constructed
one based on the same revenue and expense assumptions
provided in their 2009 Business Plan. As the Authority did, we
also focused on cash flows. Our model tells us that unless the
full $ 18- 19 billion is a non- repayable gift from the people of the
United States, and the CHSR achieves 100% of its revenue and
operating costs’ forecasts, the project will never achieve positive
cash flow. This finding stands in stark contrast to the Authority’s
The Financial Risks of California’s Proposed High- Speed Rail
October 12, 2010
27
assertion of an operating surplus in its first year of carrying
passengers and onwards.
Similarly, any other mix of bond or equity financing to cover a
portion of the $ 18- 19 billion will cause the CHSR project to
accumulate negative cash flows with grim consequences for the
State’s treasury. Other forensic analyses of the CHSRA’s finance
statements showed that insurance, inflation, labor, maintenance
and fuel costs were either poorly calculated or assumed to be
minimal, in contrast to generally accepted accounting practices.
Likewise, CHSRA treated all operating expenses as variable
expenses, in contradiction of real world experience and standard
accounting practices. These findings again stretched the
credibility of the CHSRA’s assertion that it would achieve an
operating surplus.
Should the State Subsidize High- Speed Rail For The Public
Good?
Some will ask, “ Why shouldn’t California subsidize the CHSR?”
The obvious answer is that Prop 1A sold the project on the basis
of no subsidy and AB3034 prohibits an operating subsidy. That
is the law. Period.
Second, even in past times with good economic performance in
California, the State ran a fiscal deficit. This has worsened
during the Great Recession and no easy solution is in sight.
State and local budget cuts have put many services, but
particularly education, at risk. While California was once the
envy of the world and its education system a major generator of
prosperity, with a less- well educated workforce, State tax
revenues from lower skilled labor who are paid less will decrease
and business will have to turn elsewhere within or outside the US
for skills. Raising taxes to close the fiscal deficit in a relatively
high tax state risks the same results: fewer new businesses,
fewer private sector jobs and less revenue for the State.
Any subsidy ( or revenue guarantee) for CHSR must be paid for
somehow. But the State doesn’t even have the income to cover
several prior years’ or this year’s budget. Any CHSR subsidy
could only come from higher taxes or GO bond sales. The
State’s voters don’t seem to be in the mood for a tax increase.
And since private bond investors have put California on par with
several Third World nations, more debt would make a subsidy
expensive. 19 And a subsidy – or short- term revenue guarantee –
once granted, is likely to live forever.
The Financial Risks of California’s Proposed High- Speed Rail
October 12, 2010
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However, the point about the State’s fiscally flagrant behavior is
moot. AB3034 ( Galgiani) disallows an operating subsidy. Prop
1A advertising promised the voters the system would make
money, not lose money. The 2008 CHSRA Business Plan
promised, “ an annual operating surplus of more than $ 1.1
billion”, clearly a sign of self- confidence. 20 The 2009 Business
Plan downgraded that assertion but promised an operating
surplus of $ 370 million in 2020, the first year the trains run, and
four times that three years later. 21 The CHSR was supposed to
make so much money that private investors should have stood in
line to get a ‘ piece of the action’.
If those promises could be kept, there should be no worry. But
nothing the CHSRA has released to the public, nor analyses done
by consultants independent of the Authority’s payroll has built
confidence those promises will be kept. We find evidence that
the project’s construction is likely to cost much more than
present estimates, ticket prices will have to be lower to be
competitive with air and auto travel costs, and its operating costs
and ridership forecasts are highly unrealistic. Conversely, if
CHSR wants to have an operating surplus, ticket prices must be
raised; but that will reduce ridership. The net result of these
findings is that the CHSR will require a subsidy – which is
prohibited.
What Would Be The Cost To The State If It Subsidized
High- Speed Rail?
The Legislature and the Governor must approach the next steps
on the CHSR project as investors – investors of California’s
wealth. This document’s analyses reveal many ways in which
the current CHSRA 2009 Business Plan is overly optimistic. Like
a venture capitalist ( VC) asking an eager entrepreneur for a
forecast, we should not be the least surprised that CHSRA
continues to err on the side of optimism, notwithstanding that
the Legislature has demanded peer review, an investment- grade
plan, and generally more rigorous financial analyses. In our
hundreds of person- years of experience running businesses, we
have only rarely had the sales team beat their forecast at the
end of the year.
As long as the entrepreneur, in this case CHSRA, does the work,
we can expect the same outcome. It is not surprising that the
truly dispassionate analysts with no vested interest, such as UC
Berkeley’s ITS and the Legislative Analysts Office, should have
been so much more critical of the plan than the CHSRA’s own
inside panels, consultants and Board. This happens every day in
The Financial Risks of California’s Proposed High- Speed Rail
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29
the business world too. So we posited the question “ What might
happen if things go wrong for the CHSR project?”
A ‘ Low Case’ Scenario Approach To Understanding The
Impacts On California Of Underestimating Capital Costs
And Overestimating Revenues. “ Hope for the best but plan
for the worst” is an expression heard frequently in VC and
private equity boardrooms. So, if the CHSRA’s business plan is
the best case for the high- speed rail system, and its investors
including the citizens of California, what is the low case? This
part sets out and combines two ‘ low case’ scenarios; one on the
capital costs, ie the costs to build- out and equip Phase I, and one
‘ low case’ on operations. These are not a “ worst case” scenarios,
which would be appreciably more dire. These ‘ low case’
scenarios are based on real world experiences with cost overruns
and revenue shortfalls. Section 5 discusses the implications of
various mixes of financing and operating costs, and they all show
cumulative peak negative cash flows between 2020 and 2035 in
the tens of billions of dollars. The purpose of the following
exercise is to generate an overview of the fiscal impacts not
achieving the CHSRA’s revenue and operating goals for this
complicated financial situation.
Learning from a ‘ low capital build- out case’ and
subsequent debt finance costs. In Section 3 we noted that
the worldwide experience with megaprojects is that they cost
more, or much more, than estimated to build. The proposed rail
system’s regulator, the US Department of Transportation ( DOT),
estimates the average capital cost overrun is sixty percent.
Given this is the first high- speed rail system in the US; the early
evidence of litigation up and down the CHSR’s proposed routing,
and the high degree of technical complexity associated with
running through so many built- out areas ( rather than ‘ green-fields’),
we might assume that CHSRA’s capital cost overruns will
be even greater than currently forecasted. This would probably
be much less than Boston’s Big Dig overrun ( 3.6 times
estimates) and less even than the recent Bay Bridge rebuild ( six
times estimates); so as a ‘ low capital build- out case’ scenario we
believe a 100% overrun ( 1.0 times estimates) is a sensible
analytical parameter.
How would the build- out be paid for? As discussed in Section 5,
CHSRA assumes $ 18 billion in “ free” money from the US
Government, plus local funding, and additional private sector
financing ( presumably financed by the CHSR’s profitable
operations). The cost to California of debt payments will depend
on this final mix of federal grant money, foreign government
money on concessionary terms ( not in CHSRA’s plan but clearly
on the radar), and whether private investors step in.
The Financial Risks of California’s Proposed High- Speed Rail
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30
For the purposes of creating our ‘ low case’ estimate, we assume
no private investment for the capital ( build out) budget. As cited
in Section 1 CHSRA’s consultants interviewed finance firms in
May 2008 and found there was little appetite for this debt at that
time without a guarantee from the State. In essence the debt
becomes a State debt if you assume, as we have found, that the
CHSRA’s operations will not be a profitable train service ( see
‘ Low Operations Case’ that follows).
We do not distinguish between State bonds and local bonds –
which the CHSRA does. We think it highly unlikely that local
jurisdictions in today’s economy can raise enough money to even
make a dent in the CHSRA Business Plan’s estimated $ 42.6
billion of build- out and equipment costs, even if they wanted to,
let alone the estimate our model uses of $ 80 billion. But more to
the point, for the California taxpayer, he or she is agnostic as to
whether it is their city budget or their state budget that is
encumbered with debt. They pay in both cases. The notion of
sharing build- out expenses with localities may be appealing in
Sacramento, but it’s ‘ a wash’ to the citizen. In fact, we judge
that most citizens would rather lose State- provided services as a
result of CHSR- induced debt expense than their local police or
library services. We also believe it would be a gross blunder to
assume that the current extremely low interest rate environment
will exist for the next 10 years of build- out.
Here we describe the total debt payments that someone will
have to make. CHSRA would argue that the robust cash flow
from the operation of the CHSR will provide a significant portion
of this debt payment. In our ‘ low operating case’ scenario, and
in Section 5, we foresee zero to marginal Operating Surplus,
which means that there would be zero or only a marginal
contribution from CHSR operations to the repayment and interest
cost of the CHSR capital budget’s debt.
The ‘ Low Build- Out Case’ scenario and its
implications for California. The assumptions used to
understand the costs and implications of a ‘ low build- out case’
scenario are:
a) a near- doubling the build- out cost estimate: from $ 42.6 to
$ 80 billion build- out for Phase 1
b) we assumed 20% of the build- out capital is provided by
grants and assumed certain concessionary features to the
debt, but that this is all ultimately public debt ( State or
local)
Our first conclusion, based on using the same modeling as the
CHSRA, but altering the build- out inputs with the above
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assumptions, is this ‘ low capital build- out case’ scenario
would result in $ 64 billion in new debt to be issued to
complete building and equipping the CHSR project.
As a point of reference, the total debt of the State of
California was $ 68 billion as of August 10, 2010.22 This
includes all outstanding bonds issued for all for all purposes
( education, transportation, clean air and water, veterans, health
care, stem cells, etc). Therefore, a ‘ low build- out case’ outcome
for the CHSR would nearly double the State’s debt load to
construct this one project.
Our second conclusion about the impact of a Phase I CHSR ‘ low
build- out case’ scenario is about the increase in the State’s debt-service
ratio. Our ‘ low build- out case’ financial mix assumptions
are:
a) 25% of the capital cost, or $ 20 billion, would be priced at
market rates,
b) 25%, or $ 20 billion, is raised at concessionary rates; ie
50% of market rates
c) 30%, or $ 24 billion, is raised at market rates + 75%
( accounts for rising interest rates), and
d) 20%, $ 16 billion, is “ grant” or free money.
We also attempt to stage the debt raise over 10 years.
Under these ‘ low build- out case” assumptions, the total debt
repayments and interest payments would equal $ 134
billion, or $ 4.5 billion of debt servicing costs per year for
30 years, assuming a flat distribution for simplicity, as shown
below:
Itemized Debt Servicing From A ‘ Low Build- Out Case’
25% of the capital cost priced at market rates $ 40 B
25% raised at 50% of market ( concessionary loans) $ 30B
30% raised at market + 75% ( for rising interest rate) $ 64B
20% is grants or ‘ free’ money = $ 0B
Total debt and interest costs = $ 134B
Simply servicing this debt ( principal repayment and interest
costs) would increase the State of California’s Debt- Service ratio
60% – from today’s already high 6.9% to close to 11%.
The ‘ Low Operations Case’ scenario of the CHSR
project and its implications for California. The CHSRA
Operating Plan, although devoid of the kind of detail needed to
independently construct an accurate Operations Expenses model,
shows a very strong cash flow forecast that leads to a robust
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Operating Surplus. Again, this must be treated as a ’ high case’.
And the CHSRA has already reduced its ridership forecast after
certain flaws were pointed out. 23
For a ‘ low operations case’ forecast about operating revenues,
we make the following adjustments:
a) Revenues are just 50% of what CHSRA forecasted and
b) Operating Expenses are 25% higher than CHSRA
forecasted.
The reasons for these adjustments are discussed in Section 4.
The CHSRA might argue that in a lower revenue model, the
Operating Expenses variable should be adjusted downwards.
However, lower revenue could result from fewer riders, or it
could result from discounts on tickets, or both. Furthermore,
operating expenses are highly unlikely to scale linearly. Whether
the assumed private sector operator runs one train or a hundred
a day, they still need to have customer service, maintenance
operations, drivers on salary, and many other costs that are
essentially fixed.
CHSRA’s model also appears to overlook a large number of
Operating Expenses, insurance and wage rises above the
inflation rate for example. Intuitively the model seems to also
underestimate Sales and Marketing expenses. For example, the
CHSRA already has spent on public relations and does not even
have a operating train to advertise ticket sales. For our purposes
the CHSRA Operating Model does not have enough visible data to
accurately and independently compute even their ‘ best
operations case’ scenario. But to make an estimate in which
Operating Expenses run 25% higher than forecast and revenue
grows more slowly seems like a reasonable approach for a ‘ low
operations case’ scenario.
In Year five of this first ‘ low operations case’ scenario ( 2025) the
CHSR Phase I operations generate about $ 1.28 billion ( in 2009
dollars) in revenue and about $ 1.28 billion ( in 2009 dollars) in
Operating Expenses. This is roughly breakeven on a cash flow
basis. This calculation is based on the Warren model, as
discussed in Section 5. This breakeven performance becomes
mildly positive over the ensuing decade. This means that while
the CHSR operations may be at breakeven, they make no
significant contribution to debt service. It also means that
private equity investors will be unlikely to participate unless they
can be convinced in due diligence that this ‘ low operations case’
is too pessimistic, or unless the State of California guarantees a
return on their investments.
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A second way to generate a ‘ low operations case’ cash flow
forecast would be to assume that CHSR operations might
generate 60% of its Operating Costs from the fare box. This is
above what the DOT reports across the country for transit
operations, that is fares pay for 40% of the Operating Expenses:
but we use a 60% revenue generation target since the CHSR
service is to be a premium service. 24 In our ‘ low operations case’
we hold Operating Expenses constant, as does the CHSRA Plan,
and revise revenues downwards; assuming either lower ticket
prices, and/ or lower ridership as the cause for lower revenues.
In Year 5 ( 2025) of this second ‘ low operations case’ scenario,
there would be $ 1.02 billion ( in 2009 dollars) in operating
expenses and $ 0.60 billion ( in 2009 dollars) in revenue; leaving
an Operating Deficit of $ 400 million. 25 This breakeven
performance also becomes very mildly positive over the ensuing
decade. But again this means there is no significant contribution
to any debt service. Again it also means that private equity
investors will be unlikely to participate unless they can be
convinced in their due diligence that this “ low operations case” is
highly unlikely, or unless the State guarantees a minimum return
for their investment.
Implications for the State from combining ’ low build- out
case’ and the ‘ low operations case’ scenarios. Many astute
and experienced investors are among this document’s Authors
and Principal Reviewers. They know, and perhaps have learned
the hard way, that failures happen even with good financial
backing and the best possible management. In their practices
they require entrepreneurs, like the CHSRA is for this totally
new- to- the- USA rail system, to set up combined build- out and
operations low case scenarios to understand what could happen
if or when things don’t go according to plan.
As one can see from looking at the two types of low case
scenarios; servicing debt from the build- out is costly but would
need be done without a contribution from operating revenues.
Therefore, the combination of both low case scenarios could
create significant negative impacts to the State of California’s
budget. With a negative cash flow of $ 4 Billion to $ 5 Billion
every year for the next 30 years to service the costs of
construction, and no ‘ Operating Surplus’ to reduce the impact of
these debt repayment requirements, the impact on the State’s
budget is massive.
Using the Warren model, as discussed in Section 5, we see that
in the period between 2020 and 2035, that negative annual cash
flow could reach a cumulative peak negative cash flow of $ 70
Billion to $ 80 Billion. Given the great difficulty the State has
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raising taxes, and assuming that the State’s leadership will not
want to ‘ turn off’ the CHSR’s operations a few years after it is
running, one is left to presume that the necessary subsidies in
the combined low case scenarios will come from the General
Fund. This would have to displace other spending. But as shown
in this combination of both build- out and operation low cases,
with higher than planned construction costs, ‘ turning off’ CHSR
operations would financially do no good. So much financial
damage will already have been done by spending construction
dollars that there is no way to repay the debt from a non-existent
operating surplus.
A logical target of displaced spending could be other
transportation services. But providing CHSR operations with that
subsidy the State would have to significantly reduce spending for
new or maintained roads, commuter rail, buses and other
transportation systems. However, as no such subsidies are
authorized by AB 3034 and Prop 1A, bond or taxation measures
would have to be taken back to the voters to solve this CHSR
cash flow problem.
PRACTICAL RECOMMENDATIONS TO BRING DISCIPLINE
TO THE CHSR PROJECT’S FINANCIAL PLANS
As investors, the Legislature must act as the fiduciaries to the
State and taxpayers of California. Independent reviewers of the
CHSRA’s ridership, revenue and expense assertions have asked
enough serious questions and received no or vague answers that
serious action needs to be taken soon. Every day hundreds of
thousands of CHSRA dollars are funding studies, surveys and
public relations efforts that are possibly the wrong priorities if the
financial plans for the construction and operation of the CHSR
are not realistic. It is the Legislature’s responsibility to protect
the financial well being of the State; and if the CHSR project is
not financially sound, that responsibility is not being executed.
We offer four modest recommendations to bring more rigor into
the strategic as well as practical aspects of financial planning for
the State’s largest infrastructure project.
First, slow the spending rate until the CHSRA has a
credible financial plan. Much of the ‘ rush’ of 2009- 2010 has
been predicated on the possible availability of free- to- the- CHSRA
federal grants. Now that it is clear that fiscal issues have
overwhelmed the Obama Administration the Legislature should
recognize that the chances of ever getting $ 17- 19 billion in
federal grants is a remote possibility. We believe the CHSRA has
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recognized this. Otherwise why would they have changed course
in August 2010 and made separate applications to the Federal
Railroad Administration for four separate segments and not the
entire Phase I project? The reasoning behind the rush to gain
federal grants before their application deadlines expire is now
void.
In line with the need to more deliberately take stock of the
question “ Where is the CHSR project financially” is the need to
compare the Authority’s budget with what they now have to
manage. If the Authority is to manage only one of the four
segments that will be chosen by the FRA, why would they need
the several hundred million dollar budget discussed in mid- 2010?
The CHSRA might need only a fraction of that. But to pay to
continue studies of alignments up and down the state, and to
finance statewide community outreach programs and public
relations seems disproportional to the tasks of planning for one
segment.
Second, the Legislature should immediately
nominate and convene an independent peer review panel
with deep financial expertise. SEC. 2. Section 185035 of the
Public Utilities Code demands a peer review panel, but none has
sat in deliberation. AB3034 says the Treasurer is to nominate
two members, the Controller two, the Director of Finance one,
and the Secretary of Business, Transportation and Housing
nominates one. While four of the six- person panel are elected
officials’ nominees, the Treasurer and Controller, and only two
are nominated by the Governor’s appointees, the Legislature is
not represented at all. It seems curious that neither the Senate
nor Assembly committees responsible for transportation or
budget are able to exercise fiduciary oversight on a project this
large, and on which they have no representation.
Since there has been no peer review panel meeting, the
Legislature should establish its own, through its appropriate
committee structure. That panel would be independent of the
Governor and should have a budget large enough to do serious
work including its own research staff and administration. And
that panel should convene and develop an agenda focused on
the CHSR project’s finance in an expeditious and professional
way.
Third, bring in a high- speed rail builder and operator
to advise the Legislature on the financial realities of
building and operating a system. We hope it is common
sense that the entrepreneur who wants money from an investor
does NOT have an incentive to make low forecasts. But most
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often they succumb to what has been called ‘ optimism bias’. The
sales team always thinks they are going to hit a home run. On
the other hand, we know that our ‘ low case’ analysis will be
criticized as biased or uninformed.
If the Legislature and Governor share our concerns that perhaps
CHSRA is ignoring the potential downside risks, then it may be
appropriate to insist that CHSRA find a private sector Operating
Partner who would be prepared to invest their capital in this
plan, or else help craft a plan the private sector can believe in
and get behind. We could feel that there was more discipline
being brought to the financial plan and forecasts. At present, the
only “ skin in the game” is the California taxpayers’ and that of
their children’s future – and with the federal grants, Americans in
general.
The Legislature needs to insist that CHSRA find a credible
potential Operating Partner and ask this Operator to develop a
business model for the operation. While this is still not ideal
since, with no investment at stake, the private operator will not
bring the same discipline to the analysis as would someone
about to invest their money, at least it would create the sort of
dispassionate analysis that we would do as private sector
investors.
Fourth, California and its municipalities should
contain the growing financial risk and stop funding for the
CHSR project. The environment for raising debt financing for
California is clearly going to be tougher, likely limiting California’s
ability to market its bonds while raising the cost of servicing new
debt. This is a time some economists are calling ‘ The New
Normal’ where California’s political leaders and citizens need to
make priorities about what can be afforded by State’s taxpayers
today and tomorrow. As discussed in this report, the CHSR
project clearly does not meet the legislated standard of not
requiring a subsidy. Therefore it does not merit funding on an
absolute, stand- alone basis.
It also does not make sense to fund the CHSR project on a
relative basis in the context of the State’s other, more pressing
needs and existing liabilities. Arguments by the CHSRA that the
debt contemplated by their business plans is a worthwhile risk
for the State to assume based on the California- based jobs that
the project purportedly will create are tenuous if not facetious.
The limited number of net new jobs that CHSR will create for
Californians is overstated, as discussed in Section 7. And as
discussed in detail in Section 5, the benefit of such few jobs
pales in comparison to the demonstrated downside financial risks
posed by to the State’s financial future.
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In summary what every California voter should be asking
themselves and their elected representatives in
Sacramento and Washington? At least two relevant
questions should be in the public arena.
What reasonable milestones exist to make realistic
Go/ No Go determinations in order to guard against
continuing to waste desperately needed State funds on
a project that might become partially completed; un-financeable,
inoperable, and stranded?
How much planning, public outreach and design
expense will be consumed without sufficient
committed financing to complete the optimistic $ 42.6
billion required to bring Phase I to operational status?
This is a dangerous time for the CHSR project since its assumed
financing sources have not materialized. The Federal grant funds
and AB3034- initiated GO bonds, if buyers for those bonds can be
found, bring the project’s available capital to about 11% of what
it needs for Phase 1. But there are no known local government
and no private sector monies in the project at present. New
federal grants will be a fraction of the Obama Administration’s FY
2010 bold plans. The CHSRA could be desperate for funds to
keep their project alive and the temptation to promise more than
the law allows high. Without the money, and with diminishing
confidence in the CHSRA’s plans, this becomes a dangerous time
to risk the State of California’s financial future.
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1.0 BROKEN PROMISES AND UNMET
DEMANDS FROM THE LEGISLATURE DIMINISH
THE CHSR PROJECT’S CREDIBILITY
During the course of promoting high- speed rail for California, and
afterwards in its planning, the CHSRA made certain promises to
Californians and were required by the Legislature to complete
certain tasks. The following eleven items describe how CHSRA
has come up short on meeting its promises and the demands of
both the law ( AB3034) and the Legislature.
1.1 The CHSR Project That Voters Chose In 2008
Promised To Link Seven Cities, But Links Only Three
Although San Diego, Riverside, Oakland and Sacramento were
part of the official ballot description for Prop 1A, what emerged
after the vote as Phase I is only for Los Angeles/ Anaheim to
downtown San Francisco. 26 While the official ballot description
promised connections to seven metropolitan areas, Phase I links
only three. 27 The promise to connect seven cities, given to
California’s voters by CHSRA proponents and repeated in the
CHSRA’s 2008 Business Plan ( submitted after the ballot) was
broken. 28
1.2 The Prop 1A $ 33 Billion Capital Cost Promise
Morphed Into A $ 42.6 Billion Capital Cost
The Federal Railroad Administration ( FRA) is the CHSRA’s
benefactor and regulator and the two have worked together for
years. In December 2009, the capital costs of Phase I, not the
entire system as proposed in Prop 1A and the 2008 business
plan, increased by thirty percent. While there were some new
capital elements, the CHSRA attributes most of that $ 10 billion
increase to having to meet FRA rules that capital expenses must
be calculated in the year of expenditure, thereby accounting for
inflation.
Two questions remain unanswered between 2008’ s capital cost
promise and the 2009 cost estimate. First, since the 2009
project was only for a portion of what was promised in 2008,
why didn’t the cost estimates decrease instead of increasing?
Second, if FRA and CHSRA have worked together for years, why
didn’t the CHSRA use the FRA cost estimate guidelines in the run
up to AB3034 and Prop 1A?
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1.3 The Promised $ 55 One- way SF- LA Ticket
Morphed Into A $ 105 One- way Ticket After Prop 1A
Voters were promised they could go between the state’s
metropolises for about $ 50.29 That sounded like an inexpensive
way for families and the budget- minded to travel between SF
and LA. Yet, thirteen months later the one- way fare estimate
had increased ninety percent. And the fare is unlikely to
decrease. With the State’s Attorney General increasingly
aggressive about companies’ price promises not reflecting their
final prices, the Legislature might ask when the CHSRA knew the
ticket price would increase. 30
1.4 Five Months Before Prop 1A Passed, The
Authority Knew That Private Sector Participation Was
Conditioned On Near Total Federal And State Capital
Building The CHSR Project
In May 2008, near the peak of the worldwide credit bubble,
CHSRA had the Infrastructure Management Group ( IMG) survey
private sector firms’ interest in helping finance the project.
Thirty firms and individuals – builders, equipment makers,
financiers and operators responded. Only five of the firms were
from financial institutions – Babcock & Brown, Carlyle, Goldman
Sachs, HSH Nordbank, and Meridiam. IMG and Lehman Brothers
compiled, reviewed and analyzed the data.
Five months before Prop 1A passed, the Authority’s Board heard
the survey conclusions. 31 In that June 2008 Board presentation,
CHSRA learned that all the operators and equipment
manufacturers, and nine out of ten builders, were reluctant to
invest unless a large portion of the capital costs were from State
and Federal sources; “ Nearly all RFEI respondents noted that
they would be unlikely to commit the resources necessary to
participate in a procurement of this magnitude until after strong
financial backing for the Project was provided by the public
sector.” In other words, ‘ off- load all the project’s capital risks
onto the public and we’ll come aboard’. This doesn’t seem
consistent with the Authority’s later claims of support for public
private partnerships ( P3). 32
1.5 Five Months Before Prop 1A And Three Months
Before AB3034 Passed, The Authority Learned The
Private Sector Would Only Operate The CHSR If Given
A Revenue Guarantee
In the same June 2008 presentation, IMG reported that private
firms were reluctant to take risks based on the Authority’s then-ridership
forecasts; “. . respondents argued that interest in
equity investment would increase if the risk to the concessionaire
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were decreased, perhaps through some form of revenue
guarantee . .” This mention of the need for a subsidy, the first of
four in that presentation, is most dramatically shown on top of a
table as “ Public Funding/ Guarantees” in the IMG report. 33
Therefore, nearly five months before Prop 1A went to the voters,
the Authority knew the CHSR P3 participants wanted public
monies to cover nearly all the capital costs. And they knew the
then-$ 33.6 billion project would need a revenue guarantee to
attract private equity and operators. 34 Despite the CHSRA’s later
claims of thirty private firms’ expressions of interest, the
Authority knew when AB3034 was under deliberation, that
private sector participation was conditioned on a forbidden
subsidy – aka a revenue guarantee. 35 If the CHSRA Board knew
in mid- 2008 of the problems of attracting private participation in
both CHSR’s capital funding or operations, why wasn’t the
Legislature aware of this major missing element to the project’s
feasibility prior to passing AB3034?
1.6 The CHSRA Did Not Meet The Senate’s Demand
For An Investment Grade Business Plan Prior To The
2008 Proposition 1A Vote
While debating AB3034, both the Senate and Legislative
Analyst’s Office ( LAO) called for an investment grade business
plan by September 1, 2008.36 CHSRA submitted its 2008
Business Plan shortly after the November vote on Prop 1A. 37
Only six of that Plan’s thirty- two pages addressed capital and
operating costs and sketched out possible mixes of public and
private finance. 38 That sine qua non of public and private
investing is still absent, despite the demand in AB3034 that such
be presented to the Legislature by September 1, 2008. 39
1.7 CHSR Proponents Promised Prop 1A Voters The
Project Would Pay Its Way; But By Mid- 2008 The
CHSRA Knew The State Would Have To Guarantee
The Operators’ Revenue
Part of what sold voters in 2008 on Prop 1A was that the project
would not depend on the government after they approved the
$ 9.95 billion bond authorization. Proponents promised “ THE
USERS OF THE SYSTEM PAY FOR THE SYSTEM”; that is riders,
not taxpayers, would pay for the system. 40 But the June 2008
presentation by IMG showed that none of the then- expected
$ 6.5- 7.5 billion from the private sector would be forthcoming.
The thirty surveyed builders, equipment makers, operators and
financiers essentially said ‘ no private capital for construction and
no participation unless we are guaranteed an income by the
government.’ 41 All five of the operators who participated in the
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survey were very clear about this point. 42 If the operators
weren’t willing to risk their firms’ futures on the data supplied
them in the May briefings and survey, that is a good indication
they didn’t believe the CHSR project would at least break even.
And in June 2008, IMG told the CHSRA this result. Why the
operators’ distrust of the promise of a profit for operators wasn’t
passed on to the Legislature prior to the vote on AB304 remains
unanswered.
1.8 Despite The Senate’s Demand, CHSRA’s
Business Plans Have Still Not Met The Criteria Or
Quality For Investment Grade
Thirteen months after Prop 1A’s passage, the Authority
submitted its 2009 Business Plan on a project of more than
$ 40,000,000,000. In sixteen pages of text and summary tables,
the CHSRA made no reference to spread sheets, or how results
were calculated. The Senate seemed less than satisfied with the
Plan’s vagueness, “ The business plan of the HSRA points to the
risk that the project may not be found creditworthy by banks or
private equity funds. … the HSRA correctly acknowledges, but
does not discuss, some of the critical risks involved for both
government and private sector funding.” 43 The Legislative
Analyst’s Office was less circumspect, citing fifteen deficiencies of
that 2009 Plan to address either financing sources, assumptions
or risk mitigation techniques. 44
CHSRA’s answers to these criticisms were in an April 2010
Addendum. 45 Shortly afterward, the State’s Auditor found
significant problems both with the way CHSRA managed its funds
and the Authority’s assumptions concerning the system’s funding
sources. 46 Since then, little has been done to expand publicly
available information or clarify finances for the CHSR project.
1.9 A Year After AB3034 Passed, IMG Again Told
The Authority That Private Sector Financing Would
Only Become Available With A Revenue Guarantee
Eighteen months after the IMG’s survey, in a September 2009
IMG- Goldman Sachs workshop, the CHSRA Board learned:
“ Private appetite for ridership risk is limited without revenue
guarantee or until ridership proven
Potential for substantial non- recourse financing is likely to
be limited to the Anaheim- San Francisco section, based
on forecast of operating surplus ( emphasis theirs)
It is unlikely that a private partner will take ridership risk at
this early juncture “ 47
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That presentation goes on to point out a logical fallacy. It says
“ Earlier this year, the Board adopted San Francisco to San Jose,
Merced to Bakersfield, and Los Angeles to Anaheim as “ stimulus
sections . . While none of these sections are forecast to generate
significant operating surplus to attract P3 financing, vendor
financing may be available for rolling stock and core systems
requirements” If each of those segments are not able to
generate an operating surplus to attract private capital, then how
can the sum of those segments – presently Phase I – generate
an operating surplus and avoid a subsidy? 48
Supposedly, and without reference to how this would happen,
additional financing would be provided for the other segments in
Phase I, ie San Jose to Merced, Bakersfield to Palmdale, and
Palmdale to Los Angeles. If that happened the entire corridor
could be built and be operational by 2020. This would then allow
the forecasted ridership to occur between San Francisco and Los
Angeles/ Anaheim; thereby producing an operating surplus. To
any investor, these preconditions represent insurmountable risks
without a guarantee of income. That is what CHSRA knew fifteen
months before the September 2009 presentation.
1.10 Although Twice Demanded By The Legislature
And Promised Before September 2010, CHSRA Has
Not Produced A Risk Mitigation Plan
Any business seeking investors must address financial risks –
and offer remedies to each identified. The investors’ fiduciary
responsibility is to perform due diligence on such a proposal.
Without that investigation they stand liable to shareholders. For
them it is essential to ask, “ What specifically is Plan B if one or
more assumed variables in Plan A fails?” The Legislature foresaw
this need in 2008, and Section 185033 of California’s Public
Utilities Code, i. e. AB3034, demanded that the Authority’s
“ business plan shall also include a discussion of all reasonably
foreseeable risks the project may encounter.” 49
A technical memorandum was all that constituted a risk
management plan in the 2008 plan. When finally submitted after
Proposition 1A was passed, it was not acceptable even to KPMG,
the Authority’s auditor contractors. 50 This should have ‘ raised
flags’ in the Legislature that something was seriously amiss.
When no such risk mitigation strategy was forthcoming in the
2008 plan, the Legislature instructed the Authority once again
that its 2009 “ business plan should be modeled on a financial
prospectus of the type that is required to be prepared for
investors in new stock or bonding offerings.” 51 It was to address
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the types and level of risk the State of California would be
assuming for the CHSR project.
The Legislative Analyst’s Office ( LAO) commented on the 2009
Plan: “ To avoid the risk of failing to win credit approval from
investors, the Authority’s strategy is to ‘ clearly communicate the
project and obtain up- to- date feedback’.” 52 The LAO said of the
2009 risk strategy, “ The Authority plans to avoid the risk that
governments are not able to follow through on their
commitments ‘ by carefully assessing how each government
funding source affects the build- out of each segment’.” 53
Four months later, in April 2010, the Addendum to the 2009
Business Plan stated that mitigating risk “ will require on- going
communications efforts with the financial markets,” 54 and the
“ Authority needs to continue to monitor the federal budget
process.“ 55 It further stated, “ To mitigate state risk, the
Authority needs to monitor both the State’s [ sic] overall financial
situation and its continued ability to sell GO bonds.” 56 The
Authority’s risk mitigation plan “ can be summarized to be as
flexible as possible on which segments it funds and when.” 57
The Amended Plan repeats the same ‘ communicate and monitor’
approach found wanting by the LAO in the December 2009
document. Monitoring and communicating are not mitigation.
There is no outline of what the Authority will do in case one or
more financial source fails to provide part or all of their funding.
In short there is no ‘ Plan B’ in any submission or amended
submission by the Authority. Despite promises to have
quantitative risk analyses done in 15- 18 months ( June -
September 2011), to date it is impossible for private investors –
on whom the project depends for $ 10- 12 billion – to perform
their due diligence. 58 And it is impossible for the Legislature to
exercise reasonable fiscal prudence without a risk mitigation
plan.
1.11 Despite The Demands Of AB3034 More Than
Two Years Ago, No Independent Peer Review Group
Has Reviewed And Assessed The CHSRA’s Financial
Plans
AB3034 and Section 185035 of the Public Utilities Code, demand
the CHSRA establish an independent peer review group that,
among other tasks would review the finances for the project and
each segment of the project. The law clearly requires “ . . the
authority to establish an independent peer review group for the
purpose of reviewing the planning, engineering, financing, and
other elements of the authority's plans and issuing an analysis of
appropriateness and accuracy of the authority's assumptions and
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an analysis of the viability of the authority's funding plan for
each corridor.” 59( emphasis added) The peers were to include a
representative from a financial services or consulting firm and to
have reported to the Legislature no later than 60 days after
receiving the Authority’s business plans60
The CHSRA website documents a peer review, done ten years
ago ( 2000) by the French national rail carrier ( SNCF), Japan
Railway’s Technical Services ( JRTS) and DE Consult, a Berlin-based
engineering company controlled by DB, the German
national rail company. 61 No report on their findings is available
and none of these companies are considered financing experts. 62
Moreover SNCF, JRTS and DE Consult have potential conflicts of
interest as their parent companies are in the business of building
and operating high- speed rail systems.
The CHSRA also mentions a pre- Prop 1A peer review by the
Metropolitan Transportation Commission ( MTC) but confined its
focus to the ridership model with a “ panel comprised of local,
national, and international travel model experts to provide an
objective and independent review of the modeling assumptions,
methodologies, and results”. The CHSRA web site does not say a
report was issued. Nor does CHSRA mention any financing
expertise on the MTC panel. 63 Although the Senate has once
again called for an independent peer review, none had been
convened by early October 2010, more than two years after it
was demanded by AB3034.
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2.0 CHSRA’S RIDERSHIP FORECASTS –
CENTRAL TO THE FINANCIAL OUTCOME – ARE
FAR TOO OPTIMISTIC
At the heart of any financial forecast for a high- speed train are
two issues: how many riders will there be, and what each is
expected to pay. The CHSRA added on to those the benefits of
job creation. Ridership, price and job creation forecasting
techniques are not an exact science. However, one should
expect that plausible estimates be made on the basis of
surrogates or prior experience. The Authority’s ridership
assumptions drive many of our questions on financial
sustainability.
2.1 Evidence- Based Analyses Contradict CHSRA’s
Forecasts
Perhaps the first alarm that something was questionable about
the ridership forecasts on which CHSR income projections were
based was the 2008 assertion that about 94 million riders
annually would board the CHSR by the system’s completion date
in 2020.64
Since California’s population in 2030 is projected to be about 46
million, that CHSRA ridership forecast suggested that every man,
woman and child in the state would ride the train at least two
times each year, whether they lived near or hundreds of miles
from a CHSR station. 65 This 2008 CHSRA ridership projection for
its tenth operating year constituted slightly less than one- third of
the 2008 United States population.
Even a year later, when CHSRA downward- adjusted its 2030
ridership number to 39 million, something still seemed amiss.
The U. S. experience with accelerated rail service is telling. In
2009, about twenty years after its inception, the combined
ridership on all segments of the Boston- NYC- PHL- WDC Acela
route was 3.02 million. 66 Acela draws riders from combined
metropolitan populations over 28 million, attracting about 11%
of the residents of its market catchment area. 67 If the CHSR
were to achieve after a decade what Acela has attracted in a
generation, it might draw 11% of all of California’s residents –
about 5 million, not 39 million riders.
CHSRA claims that population and employment growth in
California will “ increase interregional travel by 65 percent to 911
million trips a year . . . including a nearly five- fold increase in
conventional rail trips”. 68 Even starting from the miniscule basis
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of California’s interregional rail trips today, such a percentage
increase is difficult to understand.
2.1.1 CHSRA’s forecasts don’t account for technology
changes that are diminishing commuting and business
travel.
Nowhere do the Authority’s ridership forecasts account for
relative downward shifts in commuting due to technologies such
as telecommuting, video conferencing, etc. These technologies
have increased productivity and lowered capital costs, with fewer
dollars spent on space for offices, office equipment ( HVAC, office
furniture, etc) and parking areas. Today, fewer and fewer
corporations have ‘ fixed’ offices for their sales forces, or
dedicated workspaces for those who spend only part of their time
at a ‘ home’ site. And because fewer on- site employees require
less office space, these innovations have also decreased
operating expenses through lower utility bills, lower physical
plant maintenance charges, and fewer administrative support
and security personnel.
Likewise, such technologies have already decreased both short-haul
and long range business air travel, even without the
presence of high- speed rail. Business travel represents the
second or third largest operating expense for many medium and
large corporations. Corporate finance officers are keen to see
that expense category decrease in relative importance.
Relatively fewer business trips per employee also suggest that
the CHSRA’s extrapolation from the growth of air and auto- based
travel over the past few decades may itself be a logical fallacy.
Both commuting and business travel are undergoing radical
changes. Deploying these new technologies – regionally and
globally – is and has been a priority. But nowhere does the
CHSRA report on this shift in paradigms about where and how
work gets done.
Nor does the Authority address the ramp- up of corporate social
responsibility – shown in the annual reports of Cisco, Symantec,
Intel, etc – to decrease the environmental impacts of business
travel by all modes. This includes the growing importance of
hybrid and soon- to- be electric autos as part of Californians’
options. To assume Californians will travel to work in autos or
vans with today’s mileage and at dramatically increased
percentages in an age of telecommuting and environmental
sensitivity is a questionable proposition. 69
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2.1.2 The CHSRA’s ridership forecasts also fail to take into
account the absence of a history of rail travel in California
or the impact of low population densities on use of the
CHSR.
These urban geography factors could easily make or break the
system. The only train currently operating between the two
metropolises ( San Francisco and Los Angeles) is an Amtrak
coastal route service, a leisurely and partly scenic ride, but not
one that has generated enthusiasm for train travel. More
importantly, any successful rail system depends on significant
densities per square mile to help its fare box revenues. While
much can be said about the importance of trains and high- speed
trains in Europe and Japan, those nations’ densities per mile are
higher than California’s. In Japan, density is 880 people per
square mile; it's 653 in Britain and 611 in Germany. By
contrast, plentiful land in California has led to suburbanized
homes, offices and factories. Density in the Golden State is 236
per square mile. 70 Thinking that safer, faster and reliable high-speed
rail will attract riders is not the same as actually getting
them out of their autos or reducing their need to use autos once
they arrive at a CHSR destination. 71
2.1.3 CHSRA’s forecasts fly in the face of real world
evidence of actual versus forecasted ridership.
Actual experience with high- speed rail ridership forecasting is
also instructive. Flyvbjerg, Bruzelius and Rothengatter stress the
lack of reliability of those forecasts: ”( rail) forecasts were
overestimated on the average by 65%.” 72 Using the average
‘ overshoot’ from the prior forecasts analyzed by those authors
suggests the CHSR should attract about 11 million riders in
2030, its tenth operating year, not 39 million as the CHSRA
forecasted. 73
Eurostar’s actual versus projected ridership through the Channel
Tunnel provides further perspective. In 1992, the Eurostar
Business Case Forecast projected “ 15 million passengers per
annum in 1995 and growing”. 74 In 2009 Eurostar carried 9.2
million passengers, only 60% of what forecasters said it would
carry at its start fourteen years earlier. 75 In Megaprojects and
Risk, Flyvbjerg and colleagues conclude, “ Rail passenger traffic
forecasts are consistently and significantly inflated.” 76 The World
Bank’s recent report on high- speed rail concluded that, “ High-speed
projects have rarely met the full ridership forecasts
asserted by their promoters, and in some cases have fallen
woefully short. A whole new area of behavioral research has
been generated by the phenomenon of over- forecasting in
transport, known as ‘ optimism bias’.” 77 Whether the CHSRA’s
forecasts are the result of optimism bias, poor modeling methods
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or some unstated motive, their published results need more
critical scrutiny than the Authority has been willing to concede.
2.2 Independent Experts Refute CHSRA’s Ridership
Model
Forensic analyses by a macro- economist and two transportation
planning organizations have brought to light possible reasons for
the divergence between CHSRA’s ridership forecasts’ and other
model builders’ findings and methods.
2.2.1 Findings from Californians Advocating Responsible
Rail Design ( CARRD) on CHSRA’s ridership are disturbing.
In late 2009 and early 2010, statistician and macro- economist
Elizabeth Alexis of Californians Advocating Responsible Rail
Design ( CARRD) analyzed why the CHSRA ridership model
seemed to disproportionately favor a Pacheco Pass routing. What
she and other CARRD members found was also applicable to the
general CHSRA ridership model.
After repeated attempts to obtain what was supposed to be
publicly available data, Ms. Alexis secured a visit to the SF
Metropolitan Transportation Commission ( MTC). She later
stated, “ CARRD recently made a site visit to MTC and was able to
obtain what are believed to be the actual headways [ time
between trains] used in the analysis . . . . It is clear, however,
that the headways in the publicly available documents are NOT
those used in the ridership study.” 78
Other concerns expressed by CARRD concerning the ridership
model include:
• Sampling issues: There were only 27 long- distance commuters
surveyed, which resulted in a decision to constrain the long
distance commute market to the same coefficients as the
business model.
• Reliance on stated preference data for main mode choice
model: Stated preference data has known issues that bias
estimation results. Because of this, the study design
specifically stated that both revealed preference and stated
preference data would be used. For some reason, only stated
preference was used. In the calibration process, this resulted
in very large mode specific constants that highlight the bias
that in fact was present in the study sample.
• Frequency coefficient: The frequency coefficient was arbitrarily
constrained to be the same as the time coefficient.” 79
In late January 2010 CHSRA’s Deputy Director, Jeff Barker
emailed CARRD the final coefficients, along with a surprise -- a
transmittal memo from George Mazur of Cambridge Systematics
( CS). The CS memo placed direct blame on the MTC for
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withholding these documents from the public for the prior thirty-three
months and said: " The client, MTC, elected not to update
the Task 5a report nor to include the final coefficients and
constants in the final project report." This is a remarkable
assertion for Cambridge Systematics. The final coefficients and
constants were substantially changed from those peer reviewed
and published. The revised coefficients and constants never had
been seen by the public. Nor, according to CHSRA, had they
been seen by the CHSRA’s internal peer review group. Mr.
Barker continued "... this material as presented did not
previously exist and significant amounts of sub- consultant staff
time went into preparing it." 80
Why the data provided to the public were different than used in
the CHSRA model, why various coefficients were changed, and
why stated preference data were used inappropriately are
serious questions that have yet to be answered. These answers
should be in the public realm before the State provides further
funding for the CHSR project.
2.2.2 Smart Mobility’s work challenged both the CHSRA
model’s methodology and findings.
Later in the spring of 2010, Norman L. Marshall of Smart Mobility
Inc, a transport planner with 25 years experience, provided
expert testimony in which he challenged the CHSRA’s model. He
claimed the variables available for the ridership peer review were
not the same as those later used and published by the CHSRA.
Specifically Mr. Marshall said:
1) The model coefficients used in developing the ridership and
revenue forecasts are different from those disclosed to the
public during the environmental review period;
2) The final frequency ( headway) coefficients used in developing
the ridership and revenue forecasts are invalid;
3) The use of these invalid frequency ( headway) coefficients
biases the alternatives analyses in favor of the Pacheco
alignment ( Pl) as compared to the Altamont alignment ( Al);
4) Mode- specific constants were misrepresented during the
public review process;
5) The mode- specific constants in the final model that were used
to forecast ridership and revenue are invalid. 81
Mr. Marshall concluded, “ The California high- speed rail ridership
and revenue forecasts used in the selection of a preferred
alignment were based on modeling that was misrepresented and
invalid.” 82
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2.2.3 The ITS- UC Berkeley review and report should have
made those responsible for fiduciary aspects of the CHSR
project suspend its funding.
In April 2010, after a critical report by the State Auditor of the
CHSRA’s operations and funding assumptions, the Senate
Transportation Committee empowered the Institute for
Transportation Studies ( ITS) at UC Berkeley to analyze the
CHSRA’s model.
At the end of June 2010, the ITS reported, “ The forecast of
ridership is unlikely to be very close to the ridership that would
actually materialize if the system were built. As such, it is not
possible to predict whether the proposed high- speed rail system
in California will experience healthy profits or severe revenue
shortfalls.” 83
Other problems highlighted in the ITS- UC Berkeley report include
the use of inappropriate data at inappropriate points in the
Cambridge Systematics ( CS) model. For example the ITS says
the CS model used:
• A sample of long- distance travelers that was not sufficiently
representative, and of a statistical method to adjust for that
difference that has since been proven unreliable
• Statistical adjustments that were valid for intra- regional
ridership models, but not for inter- regional ones, thereby
exaggerating the importance of having frequent service
• A structure that predetermines which high- speed rail station
travelers will choose rather than allowing travelers to make
the choice themselves
• Restrictions that were based on professional judgment instead
of on observed data” 84
At the July 2010 CHSRA Board meeting, Professor Brownstone,
representing the ITS- UC Berkeley review, criticized the sampling
procedures used in the CS projections and the failure to include a
potential error range in the estimates. He said such methods
have ". . caused, I think, a lot of problems when it turns out later
on the actual ridership is way off from the forecasts. This is a
problem with almost all existing work." 85 Lance Neumann,
President of Cambridge Systematics, emphatically supported the
methods and results in the ridership forecasts and stands behind
the projections " without reservation." 86 The CHSRA Board
declined to seriously question the methods or results of their
consultant’s ridership forecasts.
At best, the Cambridge Systematics ( CS) model’s output is not
reliable for such a large investment in the CHSR. Tens of billions
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of dollars will be risked based on a forecast that is counter-intuitive,
and that doesn’t agree with common sense or with
empirical and historical analyses. Nor are the CS methods in
accord with recent professional methods and standards of rail
transportation model experts not dependent on the Authority. It
is dangerous to continue to assume the CHSRA model’s outputs
are not inflated and that they can be used to support financial
due diligence.
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3.0 CHSRA’S ESTIMATED PHASE I CAPITAL
COSTS SHOULD BE SIGNIFICANTLY HIGHER
Megaprojects are notorious for cost overruns, and the CHSR is
probably no exception. Within a year, CHSRA increased its
Phase I, pre- Prop 1A cost estimate of $ 33 billion by thirty
percent – to $ 42.6 billion. CHSRA claims most of the extra $ 10
billion was due to Federal Railroad Administration ( FRA) demands
that costs be inflated to their estimated value in their year of
expenditure.
CHSRA assumes three percent annual construction cost inflation
during the 2012- 2020 build- out of Phase I, which is in line with
manufacturing construction cost rises over the past seven
years. 87 However, that assumption might not stand, as the CHSR
will “ create the equivalent of 600,000 full- time, one- year jobs
over the course of its construction” between 2012 and 2020.88 If
these jobs are located in California, the project would surely
increase local demand for materials and workers, stimulating
inflation. While no one knows what Phase I construction inflation
will be, the Authority did not assume the impact would be above
average while continuing to assert the project’s job creating
virtues. The assumption that construction inflation would be the
average of the last few years is certainly questionable.
3.1 Megaproject Histories Show Costs Were
Substantially Underestimated
However difficult it may be to forecast increased prices for Phase
I, hard evidence illustrates how much a high- speed rail system’s
estimated costs can go askew. Some examples:
The Channel Tunnel – “ Total investment costs for this
originally privately financed project were estimated at GBP 2,600
million ( 1985 prices). Upon completing the project in 1994 actual
costs had turned out to be GBP 4,650 million ( 1985 prices)
resulting in a cost overrun of 80 percent” 89
This financial history should make private sector investors
pause. Share prices, originally at GBP3.50 in 1987, rose two
years later to GBP11.0; then fell to 65p in 2001, a loss for
investors at the peak of between 95% and 80% from the
opening price.
Germany’s Intercity Express ( ICE) – The high- speed
rail between Cologne and Frankfurt was also to be a private for-profit
system. Originally estimated to cost DM5.4 billion, then
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DM7.8 billion, then DM10 billion, the net result of almost twice
the estimated costs meant fewer passengers due to higher ticket
prices. The cost for the Nuremberg- Munich link of ICE was
originally estimated at DM3.8 billion, but ended up being about
DM5.4 billion. The final costs for these sections of ICE were 42%
to 85% higher than their original estimates. 90
US Department of Transportation – A DOT study of
transit projects in 1990 concluded the median of total cost
overruns for ten rail projects was 61%, ranging from - 10% to
+ 106% of the original estimates. 91
3.1.1 Construction cost escalation is likely to be higher
than assumed and jobs not likely to come before 2012.
The wage inflation impacts of such a surge of construction
workers is difficult to estimate. However, they would probably
increase the CHSRA’s cost estimates above their universally
assumed 3% per annum. The proposed system will need
professional high- speed rail design, estimation and construction
expertise; the proposed system’s operators will need skills that
don’t exist in California or the US. Foreign- owned companies
such as Parsons- Brinkerhoff, the CHSRA’s current project
management contractors, will need to import these types of
workers, at best only partially alleviating California’s
unemployment problem.
While we can sympathize with construction workers suffering
from high unemployment rates, hiring probably won’t begin until
construction starts, which is planned to begin during 2012. By
that point, the US economy probably will be growing again, and
construction unemployment decreased. That will put wage
pressure on construction estimates; a danger if builders or
operators require cost- plus contracts. We also wonder about the
purpose of using ARRA monies if unemployed construction
workers have to wait for two more years to work?
These findings from actually building large projects, not
estimates by engineering firms, should cause financiers and
Legislators to pause and ask probing questions about the
underlying assumptions of the CHSRA’s financial models.
3.2 The Costs Of Phase I Of The CHSR Project Could
Fall Between $ 62 Billion And $ 213 Billion
In the absence of cost histories for US high- speed rail projects,
we must turn to surrogates. 92 Figure 1 gives a few examples of
overruns in construction megaprojects. 93
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In their seminal survey of 210 transport mega- projects ( 27 rail,
183 road), Flyvbjerg, Bruzelius and Rothengatter found that “ For
rail, actual costs are on average 45 percent higher than
estimated costs.” 94 A look at what the range of possible overrun
costs might imply is sobering. Figure 2 shows what the Phase I
of the CHSR ( presently estimated at $ 42.6B) costs would be if it
were to increase like that of other, real world examples.
Some may argue that project costs estimates have improved.
Engineers have computers, previous histories have established
benchmarks, and planners are more cautious about prices than
in the past. But Flyvbjerg et al conclude “. . . cost overrun has
not decreased over time. Cost overrun today ( 2003) is in the
same order of magnitude as it was ten, thirty or seventy years
ago.” 95
The consequences of cost overruns on the finances of a project
of this size can be devastating; particularly true for a project that
in 2008 declared that ““ The current financial plan assumes that
an annual operating surplus of more than $ 1.1 billion . .“ 96 While
a year later the Authority decreased its estimated operating
surplus to $ 370 million in its first operating year, it increased the
estimated surplus to $ 1.5 billion in its third operating year. 97
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The history of cost overruns does not bode well for these CHSRA
claims. Other governments have suspended interest payments,
refinanced the projects, stretched out private sector operators’
bond payments, and extended the operators’ concessions.
However, those options are not available to CHSRA; since
according to the provisions of AB3034, they would be considered
a prohibited operating subsidy.
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4.0 CHSRA’S REVENUE ASSUMPTIONS ARE
TOO HIGH AND ITS OPERATING EXPENSES
TOO LOW
Ticket sales will constitute nearly all of CHSR’s revenues. If
tickets were free or nearly so, we could safely assume that more
people would choose high- speed rail than if costly. When the
Authority changed its assumptions on ticket prices from 55% to
83% of the average airline ticket price between Los Angeles and
San Francisco, ridership estimates for the tenth year of
operations ( 2030) fell from 94 million to 39 million.
In 2008 the Cambridge Systematics’ ( CS) ridership model
proposed 94 million riders for 2030, although a model prepared
in 2000 by Charles River Associates had proposed only 34 million
riders. 98 A year later CS had dropped the 2030 estimate from 93
to 39 million riders when the ticket price assumption for the CS
model for one- way LA- SF ticket increased from $ 55 to $ 105.
Clearly, higher fares thwart ridership.
The CHSRA ticket price is not computed from an operating and
capital cost basis, or from a large- scale random sample survey of
what a wide spectrum of potential riders in different places would
pay for air, auto or high- speed rail. It is based on unproven
assumptions with dangerous financial impacts. The Authority
assumed that ticket prices would be less than both airlines’ fares
and automobile transport between the two major metropolitan
destinations, and used those assumptions to build its ridership
forecasts. The lower the price, the more riders.
But more riders riding cheaply would require higher operating
costs, so ticket prices must still be high enough to keep the
system with an operating surplus, since no subsidy is allowed.
Here the CHSRA’s pricing model faces a conundrum: to seek a
balance between attracting enough riders and a price that will
produce an operating surplus, but not deflect riders to other
transport modes. A lower ticket price will gain riders but not
meet the legal mandate to not require an operating subsidy. A
higher ticket price could perhaps make the CHSR financially
sound, but will in turn divert price- sensitive riders – families,
tourists, business travelers – to travel by other means.
4.1 CHSRA Used Inflated Auto And Airfare Prices To
Capture More Riders and Revenue
William Warren, in a model of the Authority’s financial plan
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shown in Appendix A, has concluded that the way the CHSRA’s
prices were constructed results in an unrealistically high $ 72
average ticket charge for both interregional and shorter- distance
travel. This CHSRA assumption, geared to 83% of the average
airline fare, makes annual revenues stronger than they might
otherwise be by using inflated base data on airline fares and auto
operating costs. 99
By using actual airline ticket prices and reviewing how the
Authority’s automobile trip costs were determined, Mr. Warren
calculated more realistic prices for air and auto travel. He then
applied the CHSRA’s 83% rule – that CHSR prices would be 83%
of the price of competitive alternative transportation modes – to
those more realistic costs. Warren’s work concluded, “ CHSRA’s
planned prices will need to be reduced at least 25% to reflect the
competitive market’s actual pricing and costs.” 100
To put it another way, in order to get the market share the
CHSRA says the high- speed system can get at 83% of the
competition's prices and costs, the train’s fares would average
only about $ 50 per ticket, not the $ 72 per ticket selected by
CHSRA’s consultants. That decrease in revenue, a risk not
counted in their analysis, would do serious damage to CHSRA’s
revenue assumptions and therefore their ability to operate
without a subsidy. This is because, while the price per ticket
would drop, the operating costs per ticket would not decrease.
Higher operating expenses coupled with lower ticket prices
equals financial trouble. This pricing analysis was incorporated in
the financial analysis discussed in Sections 4.1.3 and 4.1.4.
In its Addendum to their 2009 Business Plan, the Authority
recognized that airlines can and do drop their prices when facing
economic downturns or competition. The Organization for
Economic Co- operation and Development ( OECD) also recognizes
this: “ Low- cost carriers might respond to the emergence of a
high- speed rail alternative by increasing the frequency of service.
A similar improvement on the rail side would be very costly given
the cost of trains, and this would reduce rail’s market share and
profitability.” 101 But CHSRA did not incorporate this new ( to
them) finding into their ticket- pricing model, which appeared a
year before and has yet to be altered.
Since CHSRA does not know what its real ticket prices are to be,
high- speed rail is vulnerable to a price war, one that Southwest,
United and other airlines can cross- subsidize in California
through other domestic or international fares. A mid- 2010
television advertisement by Southwest Airlines offers a peak
season one- way SF- LA ticket at $ 49 ($ 54 with taxes and fees).
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It is difficult to see how high- speed rail, whose one- way ticket
price assumption is 83% of the LA- SF airfare, ie $ 105.00, would
be able, as claimed in the Addendum, to cut prices and meet its
expenses without a prohibited operating subsidy. 102
The Authority assumes the cost of an automobile trip between
the two metropolises – representing 95- 96% of all trips – is
$ 118.103 The probable cost is somewhere between $ 70-$ 85
counting depreciation, maintenance and operations of the auto.
While it is not clear how many passengers the Authority assumed
per vehicle, it was probably only one. If that were the case, then
the high- speed train would have to compete with trips being
made by groups like families in vehicles with three to six
occupants. In those cases, the marginal cost of another
passenger is small, perhaps $ 10-$ 15 per trip. For a family of four
traveling the same route, the probable total cost by auto would
be less than $ 160, while even using the CHSRA’s fare
assumptions, high- speed rail tickets would be more than three
times that amount.
4.2 If CHSRA Had Used An Evidence- Based Pricing
Approach To Be Financially Sustainable, Ridership
Would Have Decreased
One way to look at how much the CHSR must charge to be
profitable – as opposed to attracting riders – is to compare
actual subsidized or unsubsidized fares in Europe and Japan with
what the Authority proposes. In the