A Shadow Toll System consists of a concession awarded to a private contractor who has then the responsibility to Design, Build, Finance and Operate (DBFO) a road section for an agreed period of time. One of its special characteristics is that the Administration will pay the contractor on an annual basis depending upon the volume of traffic using the road. The term "shadow tolling" is used as there are no visible tollbooths and the users do not actually pay charges to the operators.

Shadow tolling is a tolling approach initially adopted in the United Kingdom (UK) where governments pay tolls rather than motorists. Unlike traditional tolls paid by motorists for the use of a specific transportation facility, a government makes shadow toll payments to a private concessionaire for a highway facility's construction, operation, or both. The payments are based on traffic volumes and service levels. Motorists see no visible evidence of government payments to the facility's contractor or operator.

The advantages of the shadow toll system are that it:

• minimizes traffic risks, making it easier for private investment partners to find more advantageous financing;
  
• accelerates construction and implementation of capital projects;
  
• captures the profit-seeking motives of the private sector, often resulting in capital construction costs savings;
  
• capitalizes on cost efficiencies of life-cycle costing;
  
• if structured properly, can dampen down the effect of lower than expected traffic volumes;
  
• transfers operating and maintenance risk to the concessionaire;
  
• caps the public sector's exposure, thereby eliminating the risk of super-profitability by the concessionaire;
  
• reduces public equity requirements; and
  
• avoids the need for toll plazas.

Most, but not all, shadow toll projects involved upgrades of existing roads. This has important attractions for private investors: historic traffic data reduce traffic risk and the need to depend on forecasts for revenue projections. In certain cases, it can also provide opportunities for generating cash flows during construction. As with conventional tolling, shadow tolls can amortize capital costs over the useful life of the investment and can create early completion and other incentives by sharing traffic forecasting and other risks with the private partners. An important advantage of a shadow toll structure is its creation of incentives for the contractor to construct a road quickly and with high quality. Because payments to the contractor are based on traffic volume, the contractor benefits by completing the project early, avoiding construction delays and ensuring a well maintained and long-lived road.

A typical shadow toll agreement is made between a government and a private contractor/operator for the construction or reconstruction of a specific project. Under a DBFO arrangement, the contractor/operator might agree to provide some or all of the financing for the project by raising independent capital. The private partner has a set period, possibly 30 years, to recover costs and earn a reasonable return on investment from shadow tolls. At the end of that term, the road would revert to public ownership, and the shadow toll payments would cease. During the concession period, the host agency pays the concessionaire based on the number of vehicles traveling on the road. It does so using banding structure based on roadway usage. Bidders for shadow toll projects must define their own banding structure, where they receive pre-specified compensation levels from the government for different traffic increments. Precedents in the UK for financing road projects in this way suggest that bidders use each band to cover different elements of the project's cost profile. Band 1 has typically been used to cover fixed operating and maintenance costs and senior debt service. Band 2 covers variable operating and maintenance costs and subordinated debt service. Band 3 tends to be used to pay dividends and for quasi-equity debt service. Any traffic above an agreed level (Band 4) receives no toll, thereby capping toll payments and the concessionaire's potential returns.

• The Selective Use of Shadow Tolls in the United States
  This recent report commissioned by the FHWA describes the UK's experience with shadow tolls, analyzes shadow toll-related financial and capital market issues, and explores the potential applicability of this technique in the United States.
  

The report draws no firm conclusions, but its analysis can help communities determine whether this financing approach can enhance their transportation programs. While the entire report can be viewed on the FHWA website through the resource link provided below, a summary of findings is discussed here briefly.

The report notes that it is difficult to evaluate the effect of a shadow toll payment structure on net public sector financing costs, particularly if tax-exempt debt is available through a government agency or non-profit conduit. In general, the security of shadow toll debt is directly related to the perceived security of the underlying revenue source that a government pledges for repayment. However, contractor incentives and limits on financial risk provided by the shadow toll structure may lower the financing costs for shadow toll debt, in comparison to an issue that does not involve a shadow toll structure.

The report suggests that shadow tolls may work best under the following conditions:

• The project has access to non-taxable debt;
  
• Underlying repayment source(s) are stable and creditworthy;
  
• The project sponsor agrees to accept traffic risk associated with a variable usage-based payment; and
  
• Projects identified have already proven traffic demand, such as an extension to an existing road and not a start-up facility.
  

The report extends preliminary research in the area of shadow tolls conducted in 1995 by the FHWA report, "The Applicability of Shadow Toll Concepts in the United States" - FHWA P.O. No. DTFH61-95-P-00499. This follow-up study to that work analyzes capital markets as well as transportation policy. The FHWA report is available at the following address:
http://www.fhwa.dot.gov//////innovativefinance/shadtoll.htm

• The Highways Agency, United Kingdom
  The U.K. Highways Agency is responsible for motorways and major roads in England and has been very involved with the development of "shadow tolling" or DBFO projects. The agency's website boasts a robust search engine that returns many links regarding the history of BBFO in the agency, as well as relevant case studies. Query "DBFO."
  http://www.highways.gov.uk/

• United Kingdom
  Great strides have been made in the UK in encouraging new types of public/private partnerships, where the introduction of the shadow tolling concept has brought new meaning to the concept of risk sharing. In 1992, the British government established its Private Finance Initiative (PFI) to encourage the use of private finance in providing public infrastructure and services. The PFI has involved hospitals, schools, prisons, transport, and more, and its many success stories have attracted the attention of governments around the world (See Nicholas Timmins, "UK's experiment attracts worldwide interest," Financial Times, July 24, 1998, p.10.).
  

In November of 1992, the Highways Agency began coordination with the Treasury's recently established PFI Task Force to explore ways to involve the private sector in the development of DBFO road projects. The Highways Agency formally launched its DBFO Road Program in August of 1994, and since then ten projects involving 770 kilometers of roadway with an estimated construction value of US $1.9 billion have been brought to financial close, and other projects are pending (Table 1).

The following report issued by the UK Highways Agency in late 1998 provides a comprehensive overview of the first eight DBFO shadow toll projects in the UK. It documents the Highways Agency's procurement process, which involves a detailed comparison of costs associated with developing projects using traditional government financing and shadow tolling. The Highways Agency only procures a roadway improvement project on a shadow toll basis when this comparison indicates that there will be a significant cost savings to the government. The report concludes that on the average, the first eight DBFO shadow toll projects have resulting in an overall savings to the Highways Agency of approximately 15 percent.

DBFO - Value in Roads: A Case Study on the First Eight DBFO Road Contracts and Their Development. Government of the United Kingdom. London: Department of Transport, Highways Agency, 1998.

This earlier report reviews the British experience with shadow tolling or DBFO transportation projects. The National Audit Office found that there were uncertainties inherent in the assessment of the value for money of these projects, but that the contracts examined appeared likely to generate net quantifiable financial savings of around 13 percent. For information on the report, click here.

• Portugal
  Portugal has the boldest shadow toll program of any European nation, with seven projects currently proposed at an estimated cost of $2.7 billion. The Junta Autónoma de Estradas (JAE) received bids on its first three shadow toll, or "SCUT" projects in the summer of 1998, and a fourth and fifth later in the year. As of mid-2000, five of the SCUT projects have been awarded and three have reached financial close (Table 2).

To learn more about the Portuguese shadow tolling program and how it compares with that of the UK, read this comprehensive and informative article by Nigel Purse with PriceWaterhouseCoopers in London.

• Finland
  Although the concept remains relatively new, several European nations are interested in the shadow tolling concept, and three are actually in the process of procuring concession contracts. The most advanced is the 70-kilometer Järvenpää-Lahti highway in Finland, north of Helsinki, which involves a 15-year concession for a US $255 million upgrade of an existing roadway. The following links provide additional information on the Finnish shadow toll experience.
  

This article from the April 1997 Quarterly Newsletter of the Finnish Highway Transportation Technology Transfer Center provides excellent background on the Järvenpää-Lahti highway, including access to maps.

This link provides a concise description of the project, as well as its developers and financiers.

• Spain
  While national regulations in Spain do not currently allow the implementation of shadow toll projects, the Regional Government of Madrid is currently tendering four DBFO shadow toll roads around the city. In October of 1998, it awarded three separate 25-year concessions for segments of the 40-kilometer M45, which will form a semicircular route to the southeast of Madrid.
  
  
• Canada
  The provincial government of New Brunswick is preparing for the inauguration of a shadow tolling on the Fredericton-Moncton highway. It has awarded a five-year contract for the design, supply, installation and maintenance of an innovative 'Shadow Toll System' for the Fredericton-Moncton, New Brunswick highway. The contract was awarded by Maritime Road Development Corporation (MRDC) and has a total value in excess of $1 million including associated services.
  
  
• Other Countries
  In addition to the shadow toll projects in the UK, Finland, Spain, and Portugal described above, private sponsors in Sweden are also encouraging their government to investigate the possibilities of undertaking major highway expansions there on a DBFO shadow toll basis. Shadow tolls have also been considered in India, Ireland, and Australia, where at one point they were considered for the Brisbane City Valley By-pass in Australia (Nigel Purse, "Toll roads - the way ahead," Project Finance, June 2000, pp. v-vii.). Read an Indian interpretation of the UK shadow tolling experience.