Highway 407 East: Will they still come?

The Ontario Ministry of Transportation has announced its intention to build extend Highway 407 East to its natural terminus in Clarington, where it would like with Highway 35/115. This would achieve the government’s goal of a complete multi-lane divided highway route ringing Toronto. Highway 407 is now a privately operated toll-road, with 90 years left on its 99-year lease and with – thanks to numerous court challenges the McGuinty Government lost – a virtually free rein on setting tolls. For the extension, the issues of ownership, financing, and relations with the current concessionaire, Highway 407 International, will be critical.

My co-author Chandram Mylvaganam and I argued in If you Build It …. that public ownership would have been preferable to the Harris Government’s privatization. The McGuinty Government agrees, but the question now becomes how to run a highway that is half-private and half-public.

The Government’s plans call for private sector construction and financing of the road and the tolling technology. Given current capital markets, could they find private sector bankers willing to put up the necessary billions? The private sector developer-operator is to be compensated by publicly-regulated tolls and a shorter agreement than the 99 year lease 407 International received. The question is whether this would be enough to cover their loans, or whether, under these circumstances, their break-even tolls would differ very much from the current tolls.

Who would likely win the competition for the contract? 407 International must be the favoured competitor because it has the experience designing and maintaining the current road as well as the tolling technology. In addition, Highway 407 East will generate additional traffic on the existing Highway 407 (for example Kawartha cottagers who shift their summer trips from 401 to 407). These construction and network economies of scale should enable 407 International to make the lowest bid. On the other hand, we can imagine other bidders, such as major construction companies and, on the technology side, operators of similar road pricing projects, for example IBM, which played a major role in London and Stockholm. If the technologies are not integrated, the user would be presented with the inefficiency of carrying two different transponders and receiving two bills for a trip using the two different parts of 407.

So the devil is in the details on this one. My bet, at the end of the day, is that 407 International will win the contract to build, design, and operate the Eastern extension, and while their tolls on that portion will be regulated, the fact they are deregulated on the rest of the highway will enable them to make their target rate of return on the Eastern extension.

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