Last month the CHSRA Peer Review Committee issued a very interesting and, I believe, insightful report that was sent to Speaker John A. Pérez. The report looks at a number of issues that the authors believe should be addressed for the project to be successful. Unlike previous reports such from the Legislative Analyst’s Office, the State Auditor, and the Berkeley Institute for Transportation Studies, the Peer Review Report makes sensible conclusions, refrains from using their report to make unfounded and baseless attacks on the project, and is offered in a spirit of making the project better rather than tearing it apart.

The areas covered by the report are as follows: Authority Staffing, Business Model, Management of Risk and Uncertainty, The Financial Gap between Currently Available Resources and Total Project Cost, Demand Modeling and Estimating, Need for a Revenue or Demand Guarantee, ROW and Alignment Availability, and Technical, Safety, and Seismic Issues. I’ll take each in turn.

Authority Staffing: The report says what we all know: the CHSRA does not have the staffing they need to make this project a success. Rather than attacking the Authority, they recognize that the staffing problem lies with the Legislature, and that the Authority can only be helped if it gets more staff to improve communications. The report relates this to the question of the Business Model, which is actually the most important part of their report – depending on the model chosen, there will be options available to the Legislature to reshape the Authority so that it is properly staffed, whether as a government agency or as something else entirely.

Business Model: As I said, this strikes me as the most important part of the entire report. Almost everything else flows from this. I’ll quote at some length from the text:

Although we will discuss a number of points below where we agree with comments submitted by the LAO or the State Auditor, we believe that the proposed business model for the HSR project has not received enough attention and yet is probably the critical organizing principle around which most issues will need to be resolved. By “business model” we do not mean “Business Plans” or “Strategic Plans,” or other reports by the Authority. Rather, we view the business model as a clear statement of the Authority’s intentions as to the roles to be played by each of the parties in owning, constructing, financing and managing HSR in California. Thus far, the Authority’s reports have discussed some of the options for a business model, but are lacking in the decisions that will be needed to establish the actual business model to be deployed.

In fairness to the Authority, it would have been premature to make these decisions prior to the implementation phase of the project. The Authority itself has recognized, however, that the project now has to move beyond planning and promotion to implementation and that will require that the business model for implementation be selected.

I’m almost shocked to see a report actually be fair to the Authority – the LAO, State Auditor, and Berkeley ITS all chose to make unwarranted attacks on the CHSRA, deciding to use their reports to attack the HSR project itself rather than make constructive suggestions.

And this is the most constructive of all suggestions. The Peer Review report is totally right when they say the problem isn’t the “business plan” (so no, Senator Alan Lowenthal, you have not been helping when you demand this) but the “business model” – how is the project going to be built and operated? This question hasn’t been answered yet, mainly because we’re only now at the point where it needs an answer. And the answer determines everything else, from Authority staffing levels to oversight to the business plan and funding.

The Peer Review report lays out the 5 different “business models” they envision:

1. “The fully public, mass transit model.” BART is their example here, where the HSR system is run the same way a public transit agency is run.

2. “The management contracting or “gross cost” franchising/concessioning approach. Under this approach, the Authority would plan, build and finance the entire system, but would contract with a separate, usually private, entity to operate and maintain it.” The report notes this is the model that Amtrak, Caltrain, and Metrolink use.

3. “A long-term “net cost” concession. The Authority would plan and construct a system to the basic capacity level expected by the Authority. Potential concessionaires would compete for a long term (15 to 30 years or longer) exclusive concession to operate the system.” The report notes this model is used in Brazil and the UK.

4. “The separated infrastructure approach. Under this approach, the Authority would design and construct the infrastructure and then allow (subject to control over schedules and dispatching by the Authority or its agent) a single operator or competing operators along with complementary operators to provide service.” This appears to be the model the EU is now mandating for HSR owners.

5. “An essentially private approach” – sometimes known as DBOM (design, build, operate, maintain) although in this case the private entity finances it as well. The model here is PG&E, a private monopoly which provides the electricity and natural gas services for Northern California.

The report also notes that there are any number of variations on these models that could be employed – but so far the Authority hasn’t yet made the choice. That choice shouldn’t be made by the CHSRA alone, I would argue – it needs to be made by the Legislature and the governor, and should be made in 2011 so that the rest of these project issues can be resolved. The report explains where matters stand now:

We understand from discussion with the Authority that adoption of the fully public model is unlikely. Other analyses have argued forcefully that a fully private model is also unlikely, because the balance of public and private benefits is not suited to purely private financing.

I’ve been making that latter point since the very beginning of this blog in March 2008. This project is not at all suited to purely private financing, unless we all want to relive the Taiwan HSR debacle (the system itself is successful, but the private funders had to be bailed out). I would much prefer a fully public model, but some kind of private operator would probably be acceptable.

Next up is risk:

Management of Risk and Uncertainty: Hope for the Best, Plan for the Worst

Both the LAO and the Auditor emphasize their belief that the Authority’s discussion of risk and uncertainty is too brief and too vague. We agree….

Risk management consists of assessing the expected cost and the variability in all the major cost and demand categories and identifying ways in which the cost and variability can be reduced. Both the estimated cost and the variability in the cost for each component of the project should be adjusted based on the stage of design, actual award prices and the stage of construction. Doing so will give the Authority and the public a much better sense of the reliability and variability of the engineer’s estimates. At this stage of the project, use of traditional methods such as an arbitrary 20 percent or 30 percent contingency applied to the engineer’s estimates affords no such confidence.

I would agree as well, but I don’t really see this as important. As part of a financial plan for investors, sure. But for the public? The bigger risk is that we do nothing, consigning our state to long-term recession as rising oil prices strangle our economy. It would be nice to see “risk” discussed in that broader context.

But in the end, this project is a political decision. The “risk” is that somehow the political will to build HSR will fail. I’m fine with the Authority adopting stronger risk management practices, but the CHSRA has no control – as the report acknowledges – over what Congress does regarding HSR funding, or whether a deal can be cut with China (for example) to fund the project.

Ultimately, I am very uncomfortable with the discussion of risk at all. I believe we should build this project anyway, even if the cost spirals out of control. I believe our society has erred significantly when it started believing that lowest cost was the most important factor in any decision, especially major infrastructure decisions. That doesn’t mean I expect huge cost overruns or that we won’t see efforts to keep costs down; there’s every reason to believe costs will be controlled. What it means is that I personally do not care about cost overruns or making this as cheap as possible, because I believe that’s a terrible way to build for the future.

The Peer Review report shines when it discusses the question of available funds. Whereas the State Auditor took a cheap shot at the project by blaming the Authority for the uncertainties around federal funding, the Peer Review committee gives a much more informed, and therefore useful, discussion of the matter:

The Financial Gap between Currently Available Resources and Total Project Cost

The lack of a clear financial plan is a critical concern. The group fully realizes that developing a credible financial plan is difficult depending, as it does, on a large number of decisions not yet made and on factors far beyond the control of the Authority. For example, in a deteriorating budget climate in which even large and highly beneficial projects such as the new rail tunnel from New Jersey to New York City are abruptly canceled because of a shortage of state funds to cover a potential overrun, and in which the likelihood of new large Federal funding programs appears small, there is an air of unreality about a plan that includes $17 to $19 billion in “free” Federal funding from programs that do not yet exist. The same can be said of the expectation for large local or State funding for stations and area development when local governments are highly stressed and when the finances of the State are sufficiently weak that a sale of $9 billion in State General Obligation bonds might only be possible (if at all) at unusually high interest rates.

For these reasons, the project, as of now, has only limited credibility with private investors. The demonstration of firm Public Sector financial commitments will be an absolute necessity, prior to approaching sources of private capital. In our discussion with Roelof van Ark, it is clear that the Authority recognizes the “chicken and egg” nature of the conundrum: the Authority cannot get private investment without a solid prospect that the project will be completed and it cannot complete the project without private investment that would make the project successful.

Overall I think this is right, but I have a huge quibble here. There is, right now, no reason at all to believe the Prop 1A bond money can only be sold at high interest rates. Treasurer Bill Lockyer has consistently been able to sell California debt at good, affordable rates. California is constitutionally barred from defaulting on its debt, and every other recipient of state funds except education takes a back seat to bondholders when it comes to spending money in California. So there’s no real risk that our bonds will face the kind of attack that Ireland and Greece have.

That being said, the report is quite right to note that there remains uncertainty about where the money will come from. The Authority will have to be upfront about it, and as the report acknowledges, this is a “chicken and egg” problem that the Authority is helpless to resolve.

Demand Modeling and Estimating

Both the LAO and the State Auditor point to the importance of having the best possible demand estimates. We agree that improvements should be sought both in the models themselves and in the transparency of the results….

The Authority must have demand and revenue forecasts that are reliable for policy and financial analysis; without them there is little basis for proceeding. We recommend that the Authority work with UC Berkeley and Cambridge Systematics on an expedited basis to complete the analysis of the issues in the demand modeling, especially biases in model coefficients and the reliability of the estimates, in order to develop estimates that are generally agreed to be the best that can be obtained. This does not mean that completely reliable estimates will ever be possible; instead it requires that the estimates should be improved as much as possible, and the likely range of error should be clearly defined and stated.

This is all quite reasonable and something I have expected the Legislature to insist for at least a year now. The project can only benefit from further refinements to the ridership model.

However, I do have to criticize the following section:

It is also important to assess what the risk of a poor demand estimate is and who should carry it. At one level, if the demand estimates are grossly optimistic (not an unknown result) then there could be an actual demand level below which the system should not have been built at all.

No, there won’t be. This outcome is not at all realistic. There is zero chance that the actual demand level would be so low that the system shouldn’t have been built, unless maybe there’s a superflu virus that kills 99.44% of the population and the survivors are too busy taking part in an apocalyptic war between good and evil to build a bullet train system. We have an overwhelming amount of evidence from around the world that HSR is very popular, and given our knowledge of both global warming and peak oil, we have further reason to believe that Californians will need and will use this train.

The question isn’t whether or not there will be enough riders. The question is instead exactly how the ridership estimates match the funding plan, which is again a function of the “business model.” The report does a much better job of describing other far more realistic demand outcomes:

There could be a somewhat higher demand level at which the operating costs can just be covered so there would be no “subsidy,” though a public contribution to capital might be needed. There could be a higher demand level at which the sum of the public and private benefits clearly exceed public and private costs, justifying building the system with an appropriate balance of public and private contribution. Finally, there might be a very high demand level at which the system is financially profitable and no significant public contribution is needed. The current demand estimates are not capable of defining these levels or of assessing the likelihood that any might be met.

This is correct, and if we want demand estimates that are designed to answer these funding and business model questions, then I’m all for getting those estimates.

I would add that this is another example of the shortcomings of CEQA: the current ridership numbers were created to satisfy the EIR/EIS process and not to actually plan the system operations. I’ve written before of the need for major CEQA reform, and this is further evidence of the need to dramatically change how we plan infrastructure in California.

Need for a Revenue or Demand Guarantee.

Both the LOA and the State Auditor challenged the possibility raised by the Authority that some of the initial demand risk will need to be shifted from the operator to the Authority by having the Authority guarantee a stated level of revenue or demand below which a payment would be triggered. Such a payment could be considered to be an “operating subsidy” that is prohibited under the terms of AB 3034.

We believe that this question is primarily relevant within the type of business model adopted.

Agreed again. The issue of the business model will help resolve this question. But what I really liked in this section is that the Peer Review committee took the opportunity to go after that absurd Alain Enthoven study. This is priceless:

The “Financial Risks” study also highlights the confusion between financial analysis, which is the basis for private sector involvement, and economic analysis, which is the basis for public involvement. The study makes a series of critical comments on the 2009 Business Plan and deserves careful attention and response from the Authority, as we share many of the same concerns. At the same time, the study is limited to financial analysis, while ignoring all of the reasons – consumer surplus, reduction of congestion on rural and urban highways, airports and airways, reduction of pollution and carbon emissions, and reduction of accident costs, among others – that would be included in an economic analysis to evaluate public involvement in the project. The treatment of public benefits was much more detailed in the 2008 Business Plan than in the 2009 Business Plan. The 2008 and 2009 Business Plans appeared to show that public benefits might be a significant multiple of purely financial benefits (revenue minus operating and private financial costs). Given the importance of the issue in the overall evaluation of the project, and the close interrelation of public benefits with demand forecasts, we strongly encourage the Authority to include a thorough and updated treatment of public benefits and costs in the 2010 Business Plan and to link these results with the definition of “operating subsidy.”

Exactly. HSR deniers are adept at talking about the financial issues, but they almost always leave out the broader economic picture, and as a result are either intentionally or unintentionally attacking the very basis of future prosperity in California. I strongly urge the Authority to take up the Peer Review committee’s challenge to continue discussing these public benefits, because they are enormous and vital.

We continue on:

ROW and Alignment Availability

One of the most important remaining physical and investment cost uncertainties in the project is the availability and cost of the ROW. This is partly because of the extreme opposition that the building of urban railroad segments always engenders (aggravated by the need of high-speed trains for an unusually straight and flat alignment), partly because of concerns previously expressed by the Union Pacific Railroad, , partly because of the continuing controversy of the Pacheco versus Altamont routes, and partly because of the uncertainty in the type of service to be provided between Anaheim and Los Angeles. The importance of these questions has thus far been minimized by the retention of alternatives, either for routes, or by use of tunnels or raised tracks….

It will be critical that the Authority move as quickly as possible to finalize the alignment. In addition, given the uncertainty of the resolution of litigation over the alignment, which might cause alignment re-routings or use of more than expected tunneling, the Authority should acknowledge the risks and develop an explicit approach to managing and minimizing them.

No argument here. It would be nice to see some sort of reform to CEQA that takes away NIMBYs’ power to use CEQA to undermine a project, but until we get that reform, this recommendation is one I strongly agree with.

And finally:

Technical, Safety and Seismic Issues

There has been limited information from the Authority regarding such issues as the type of track to be used. For example, what proportion of the project will be at-grade, in tunnel and/or elevated? These decisions will have significant cost implications. For example, analysis of the cost of the high speed rail project in China revealed that the cost of elevated track was approximately double the cost for at-grade track and the cost of tunnels was double the cost of an elevated configuration. Any decisions made by the Authority in this area will have significant financial implications for the project. The same can be said of train speeds and seismic-related issues. Specifically, train speeds in China, due to safety reasons, mandated that the track be grade- separated, either in tunnel or elevated. Also, given the seismic issues in California, larger foundations will be needed, resulting in higher system costs, perhaps by as much as 60 percent. The Authority needs to make a clear decision on these issues.

This is obviously related to the question of ROW and alignment as described above, and I’m all for making a quick and clear decision on this as well.

So overall I think this is a great report, laying out some issues that need to be addressed in order to get HSR built, and I hope the Legislature works in a positive, constructive way to get these resolved. As the report indicates, most of these issues aren’t a sign that the project is badly managed or that the Authority is evil. Instead it’s a reflection of a variety of factors that have brought us a point where reform, clarification, and decision is needed to ensure HSR is done right.

Ultimately, this report shows how you make constructive suggestions about the project, and illustrates the difference between studies that are merely vehicles to attack high speed rail (like the LAO, State Auditor, and Berkeley ITS reports) and those that are actually interested in making things better. There’s a lot to consider here, and as we head into a new year, with a new governor and a new Legislature, there are opportunities to fix what has to be fixed in order to get HSR built.

After all, the people of California have given their mandate that the project be built. There is no turning back and no quitting – there is only forward progress, to build California’s sustainable and prosperous future.