California has never been known for thinking small. It was home of the gold rush, manifest destiny and more recently, the Silicon Valley, the High-Tech boom and more recently still, the High-Tech bust. California has also been on the forefront of mega-projects that benefited the nation and our economy, from the transcontinental railroads, to the highway system and the State Water Project. Over a year ago, California voters took the plunge on the next mega-project, a high-speed rail system to link San Francisco and Los Angeles. The project will be the biggest since the highway system, and the most expensive to date, but despite committing to spend $10 billion in state bond funds, it remains unclear if the project will ever be built.
In December 2009, the High-Speed Rail Authority (HSRA) released its updated business plan in an effort to quell concerns from the Legislature over the viability of the project. Rather than assuaging concerns, the new business plan has come under fire from the media, from the Legislative Analyst’s Office (LAO) and from members of the Legislature. Lining up in favor of the project are Governor Schwarzenegger and the Obama administration that recently dedicated over $2.5 billion in stimulus funds to the project. But significant questions remain. Is the project a responsible use of public revenues, is it even possible? In the words of Ernest Hemingway, “wouldn’t it be pretty to think so.”
The HSRA Business Plan – Bait and Switch
At the heart of the controversy is the HSRA’s business plan. Does the plan represent a blue print for an ambitious, ground-breaking rail project larger than anything built in California in generations, or is it simply a glossy work of fiction that will create a funding black hole, promising decades of public subsidy for big construction contractors and the companies tasked with building the trains and locomotives needed to achieve the speeds required in the plan?
The business plan provides the latest moment-in-time picture of what the Authority believes the project will look like once completed. According to the plan, the entire system will cost an estimated $45 billion, will carry 13.5 million riders per year in its first year of operation (2020) and 41 million riders per year by 2035, and will turn an annual profit of $2.87 billion. The train will make the trip from San Francisco to Anaheim in 2 hours and 40 minutes and will cost each passenger about 80% of the cost of a plane ticket. In addition, the project will be powered 100% by renewable electric power.
However, the plan remains long on vision and short on details. For one thing, the numbers keep changing. When the Authority was advocating for the passage of the bond, it cited far more optimistic statistics, including total ridership levels of 117 million per year by 2030 and a per trip cost of only $55, and all this for a total price tag of $32 billion. It would appear that in the last year, the cost of the system has increased by $13 billion, projected ridership has dropped by 60 percent and the cost of a ticket has doubled.
The dramatic swing in the cost of the program has drawn appropriate concern from the LAO and the Legislature, but those concerns have, thus far, just scratched the surface. Even a cursory review of the details of this plan uncovers a host of additional problems, specifically with the ridership projections, the cost of the construction and operation, the speed of the train, and the feasibility of the financing scheme.
The cornerstone of the business plan and the development of any transportation system is, by necessity, the ridership estimate. “Sufficiently accurate ridership projections are essential because they serve as the basis for revenue projections… Specifically the ridership and fares need to be high enough to pay for the infrastructure costs, debt interests and return on investment for costs not covered by taxpayer subsidies.” (The CA High Speed Rail Proposal: A Due Diligence Report, Reason Foundation, September 2008.)
However, when testifying before the Senate Transportation Committee, HSRA representatives downplayed the importance of ridership estimates, asserting they were simply an estimate for the purposes of environmental permitting and that these projections are not critical to the eventual development of the project. At the same hearing, the Executive Director of the HSRA admitted that the Authority had not run any additional ridership models, stating that any ridership projection that fell below a break-even point was simply impossible, calling it an “end of the world option.”
This failure seems the height of irresponsibility, given the fact that most high-speed rail systems across the world have been unable to meet their ridership projections. “Projecting more passengers than show up is not unusual in high-speed rail. For example, the Eurostar service from Paris to London attracted less than one-half of the ridership that was forecast… The new high-speed rail system in Korea is carrying little more than half the passengers that were projected. All this is ominous news to California...” (High Speed Rail: An Unprofitable Train Wreck, by Wendell Cox, Freedom Politics, 6/16/09.)
What is more, recent media coverage has revealed that significant elements of the ridership projections were based on assumptions that were never even peer reviewed. “California officials’ rosy ridership forecasts for the state’s planned $45 billion high-speed rail system have been based on previously undisclosed statistical assumptions that differ from those published for peer and public review…the discrepancy raises questions about the validity of the forecasts, which the state has relied on for everything from its selection of the rail line’s route to its application for billions in federal stimulus dollars. The numbers were also used to sell the project to voters ahead of the November 2008 election…” (San Jose Mercury News, 2/6/10.)
If ridership projections fall below the predictions, it will mean that the private revenues needed to pay off the debt will not materialize. The only option left will be to either raise the cost of tickets, or find an alternative funding source, i.e. public subsidies, which have been specifically precluded in Proposition 1A. In either case, if ridership falls below projections, the burden of paying the balance of the cost of construction and operation of the system will fall on the taxpayers.
Risk & Public Subsidies
Another critical element that was left intentionally hazy in the business plan is the issue of risk. With the construction of such a massive project, particularly one that is the first of its kind, there is an open question about the ability for the project’s consumers to pay for the costs of constructing and operating the system. In order for investors to make informed decisions, they must have a clear analysis of the likely customer support for the system and an understanding of who will bear the risk if these projections are higher than expected.
Despite the fact that there are several third-party ridership projections that show much lower numbers of passengers, the Authority has failed to provide an accurate assessment, or make financial projections under a number of more realistic scenarios. As a result, large questions remain. According to the Legislative Analyst’s Office, “The plan contains no detailed discussions or considerations of even the most significant risks to the project, such as ridership and funding.” The LAO also highlights the fact that the business plan appears to be in conflict with Proposition 1A: “The plan assumes some form of revenue guarantee from the public sector to attract private investment…The plan does not explain how the guarantee could be structured so as to not violate the law.”
Absent a clear assessment of potential support of the system, private investment will never materialize, particularly when an analysis of other high-speed rail systems is completed. The same high-speed rail lines that the HSRA has used as its hallmarks of success when selling the public on its plan, all receive significant subsidies from the taxpayers and most have yet to achieve their original ridership projections. “Proponents claim that high-speed rail is profitable, but this too is way off the mark. Internationally, only two segments have ever broken even.” (Wall Street Journal, The Runaway Subsidy Train, 1/31/10.)
Cost of Construction and Operation
The HSRA’s latest cost projection is $45 billion, but that number will likely escalate. The plan calls for close to $20 billion in federal funds from programs that do not even exist yet and another $12 billion in private investment. All these sources are speculative. The only one that is guaranteed is the taxpayers of California, and the Legislature must ensure that those revenues are not committed until the feds and the private sector ‘Show us the money!’
In just over one year, the cost estimates for the program have risen by $13 billion. Is the Legislature really supposed to believe that in the two decades it’s going to take to complete this project, that costs will not escalate? Over the past several decades, projects from the Eastern Span of the Bay Bridge in San Francisco to the Big Dig in Boston have seen cost inflation and project delays dramatically inflate the final price tag.
In addition to the escalating construction costs, the cost of operating the system may be significantly higher than predicted. Although the HSRA has never broadcast the energy consumption of the system, it is estimated at over 3,300 gigawatt hours per year, about one percent of the state’s entire electric consumption. The HSR will use almost as much power as every household in the entire Sacramento area in a year. The cost of powering this one project will destabilize the entire grid unless significant additional generating capacity is brought on line. This investment in additional capacity is not reflected in any of the cost estimates for the system.
Travelers seeking to ride a train at speeds approaching 225 miles per hour may have to wait a long time. “The CHSRA’s anticipated average speeds are not being achieved anywhere in the world including in the most advanced systems. Additionally, incomplete consideration has been given to California’s urban and terrain profiles…” (The CA High Speed Rail Proposal: A Due Diligence Report, Reason Foundation, September 2008). The fastest trains in the world are in China and currently are able to reach speeds of 195 mph. However, this system does not face the same geographic challenges that California’s system will face in the Tehachapis. According to analysts, given the speeds that could be achieved using current technology, a high-speed train in California would not only fail to achieve 225 mph, but may also fail to achieve the maximum trip time established in statute by Prop. 1A.
Cutting the State’s Losses
High-speed rail travel as envisioned by AB 3034 in 2008, and as sold to the voters in Proposition 1A (when Californians voted YES: 52.7% and NO: 47.3%) still appears to be more science fiction than reality and comes with a cost of construction and operation that the state cannot afford to bear alone. So the Legislature needs to develop a plan to keep the state from throwing good money after bad without jeopardizing the $2.5 billion in federal stimulus. There are several options that members should consider.
An investment grade business plan. The HSRA is asking California’s voters to be investors in a highly speculative venture on nothing more than their good word. Before entering into such a venture, the private sector would demand an investment-grade business plan to ensure the viability of the project, to assess scenarios, ridership and a host of other variables. Without that third-party report, not a single private dollar would be invested. Why should the Legislature spend the taxpayers’ money any less responsibly?
Make use of the experts. Rather than building the system, the state could request bids from the leading firms for a fully operational high-speed rail system. The firms that built the systems abroad would have a much better idea of the viability of the system, the cost of construction and operation and also the likely ridership, risk and rate of returns that are feasible. These bids would have the advantage of better information and would be developed in a manner in which the private sector would bear the burden of risk, not the taxpayers.
Incremental Approach. Rather than paying for a state-of-the art system that may never be completed, the state could instead invest federal stimulus and bond revenues to upgrade rail systems that are already successful. Corridors like San Francisco to San Jose, Los Angeles to San Diego and Sacramento to San Francisco already support successful intercity rail systems. These corridors could be expanded and transformed into high-speed rails systems. As ridership increases to pay off the investment, the system could be expanded into the Central Valley and eventually connecting San Diego to San Francisco and Sacramento. This would have the advantage of using existing rail technologies at 110-150 mph; broadening the customer base for the system as it is developed to help pay construction costs up front; and would help address the real issues facing voters: congestion in the urban areas, not in the Central Valley, which appears to be the target of the current plan.
There is significant support for high-speed rail in California. If the state is transitioning away from the automobile as the preferred method of transportation, high-speed rail for intercity travel and transit systems that are linked to create a seamless transportation network may become the wave of the future. The important question is how to get from our current transportation system to the most efficient future system for transporting people and goods without bankrupting the state or overburdening the taxpayers. As it stands today, it is unclear whether the business plan put forward by the HSRA represents the most efficient transportation system of the future or whether it is even feasible. Until these questions are resolved, it would be premature for the Legislature to appropriate any funds for construction of the system.
For more information on this report or other Transportation issues, contact Ted Morley, Senate Republican Office of Policy at 916/651-1501.