Rail 439: Let’s stop playing ‘pretend capitalism’ with the railway

With the taxpayer effectively bankrolling and bearing the risk for the new Network Rail, why try to play semantic name games by claiming it is anything other than a nationalisation, asks CHRISTIAN WOLMAR.

So farewell Railtrack and hello Network Rail. The transition has been about as smooth as a ride on a branch line in a Pacer. Last-minute constipation meant the announcement, scheduled for June 22/23, did not actually emerge until the following Thursday.

And you can see why. The whole thing is horrendously complicated, with so many loose ends that it is going to take, on Network Rail’s admission, 18 months to begin to sort them out during which the company will be finding its feet (or its tracks).

Press coverage has tended to focus on the fate of shareholders who, actually, are not getting a bad deal – around £2.50 per share, compared with £2.80 at which it closed in October, though those who bought the shares three years ago at £16 or £17 may not think so.

There are a myriad of obfuscations surrounding the birth of the new company that do not augur well for its long-term future. Right at the outset, there were two lies surrounding the demise of Railtrack. First, the Government insisted that Railtrack was bankrupt when it was ‘forced’ to step in to rescue it. In fact, Railtrack was always a political construct supported by large amounts of taxpayers’ money and therefore everdependent on Government benevolence. Once the Government decided to turn off the tap – quite rightly, as it turns out – the company was effectively bankrupt, but it was dishonest to pretend that it had not been the Government which made it go bust.

Secondly, the transfer of Railtrack to NR was a rigged process. The proof is the absence of any other bidders. Why were there no bidders? Why did the about-to-belaunched Harris Wolmar Rail decide not to express an interest? Simple – no-one knew what they were buying. The Government never set out a clear proposition for what was on offer in terms of Whitehall support to enable anyone else to come forward. Because Stephen Byers and the Treasury chose the indirect form of nationalisation – of forcing the company into administration instead of simply coming to a deal with the shareholders over pulling the plug – they had to go through a pretend process of seeking other bidders. But they never wanted anyone else to bid and, indeed, then reneged on a promise of no taxpayers’ money going to shareholders in order to hurry the process along.

And now the creation of NR (I suppose we better get used to the initials) is a nationalisation in all but name, despite Government promises to the contrary. The key point is: who is taking the risk? Since there are no shareholders and the company can only borrow at reasonably cheap rates if the loans are supported by the Government, then it is clear that the risk is being taken by the Treasury and ultimately you and me. All the smoke and mirrors which NR executives use to explain that really this is not a Government company are a ridiculous barrier to a proper discussion about the state of the railways and their future.

In a speech to the Railway Forum, Iain Coucher, the Managing Director of NR, said it would very much be a private company but then in the next breath he confirmed it would be a subsidiary of the SRA. Now, in my world, rather than Planet Fantasy, a company that is a subsidiary of a Government organisation is not in the private sector. Or I am being very stupid?

He reiterated, as did Alistair Darling, making his debut speech as Transport Secretary, that the industry did not need any more structural changes. But, my dears, it is currently undergoing a structural upheaval and there is only one thing that is certain: the industry is not in a stable situation.

Indeed, to say that the future is uncertain is a gross understatement. This new creature which we must learn to love in the same way as its predecessor is a strange construct. Indeed, it is yet another unique experiment, something the rail industry has suffered too much of in the past decade. In a brilliant lecture at a recent Oxera conference, Dieter Helm from the department of Economics of the University of Oxford, argued that the new organisation was neither fish nor fowl. Helm was concerned that NR would neither have the disciplines of a profit-making company, which would be forced to behave efficiently because of its dependence on private capital, nor be subject to the kind of rigorous control by the Treasury endured by BR in its 50-year history.

When pushed, Helm said that in an ideal world he would favour an equity-funded Network Rail, backed by a steady and constant stream of Government cash which did not vary according to the whims of ministers and the short-term circumstances of the economy. Given that this ideal world would never exist, he accepted that the best option was a renationalised Network Rail because it would have access to cheaper borrowing.

Instead, we have a kind of ‘pretend capitalism’ where NR will be expected to build up a store of capital – an equity buffer, it is called – in order to be able to ride future risks. An excellent paper by the Office of the Rail Regulator* (dated June 14, which shows when the NR announcement should have been made) outlines the issues facing NR, which include its stewardship of the network, the adequacy of funding and future funding, its structure and its role in enhancements.

Money is the overriding issue. The sums now being talked about in relation to the new organisation are staggering – the total available to NR in the first five years will probably be around £20bn and yet that amount is talked about as if it were what your grandmother kept under her bed. The establishment of NR is being funded by borrowing from banks, supported by the SRA, to the tune of £9bn. Most of that is being eaten up by the debts of Railtrack which have risen to more than £7bn and the rest is working capital. In the long term, NR is to be funded by securitisation of its future revenue.

That means the Government will promise to pay, say, £x billion to NR every year for, say, 20 years and on that basis NR will be able to raise around £10x billion to fund its work on the railways. One may ask, in passing, why London Underground cannot do that rather than be subjected to the crazily complex Public Private Partnership, but I must be missing something. Perhaps someone from the Treasury will explain. The key point for NR, however, is that this arrangement implies it will be receiving a guaranteed amount of money from the Treasury for a long period, something BR was never allowed.

The fundamental issue is whether NR will manage to bring costs in the industry under control. This has major implications for the future of rail investment. I suspect that the Treasury is already getting itchy about the amount of money going into rail and is asking whether it is getting value for money. The answer must be no. Indeed, as the Regulator puts it, “Railtrack has spent and is spending far more on OM&R [operations, maintenance and renewal] than envisaged at the time of the periodic review”.

The Regulator then says: “It is important that NR funding reflects the cost to a well-managed and competent operator and that there is transparency about the way in which the Regulator intends to deal with any additional costs.” Given that Network Rail is a creature of Government, it seems to me that whatever the Regulator says, at the end of the day, it will be the taxpayers coughing up, just as we have had to do as a result of the demise of Railtrack. Do we really need a regulator to spend a lot of time determining what NR should get through a lengthy and costly review only for it to be rendered irrelevant, as the current one was, because costs are out of control?

This raises questions about the role of the Regulator. The current incumbent, the deeply cerebral and knowledgeable Tom Winsor, reckons he has ensured the future of the organisation, given the announcement that a board will be appointed to oversee his work but that his future independence will be guaranteed. Personally, I’m not so sure his glee is justified. We are in uncharted waters. No other regulator controls an organisation which is, effectively, nationalised. His decisions will have a direct impact on the Treasury which is not known for allowing others to have their hands in its till. Winsor may have convinced himself that he remains independent, but let us see when he comes up with the results of the interim review of the current access charge regime which, despite denials from NR, is bound to be undertaken.

Finally, there is the structure of NR. Dieter Helm was pretty sceptical about the ability of the stakeholders – the 100 or so members of the company who oversee its work – to do much. They will meet infrequently and their role will be limited, he reckons. Anthony Smith of the Rail Passengers’ Council disagrees. He thinks that the independent representatives such as his organisation and Railfuture can work together to effect real changes to NR policy. Again, we are in uncharted waters.

The issues facing NR are incredibly complex and the organisation will take a couple of years even to begin to settle down. Meanwhile, the whole refranchising process seems to be stalled with very little progress, even where preferred bidders have long been selected. As I write this, a press release plops into my inbox explaining that a £29m benefits package has been secured for South West Trains passengers. What, in fact, the release says, is that SWT is to receive a further £29m in subsidy to help introduce new rolling stock and to get a few extra trains. Now SWT is one of the most profitable franchises on the network but its appetite for more money is insatiable.

It raises the question – what are franchises for? We know they don’t take the risk, as eight have thrown in the towel and Virgin’s two will effectively follow suit. And, on the upside, they just pocket the cash from an industry that is inherently loss-making. In simple terms, this means that instead of the industry crosssubsidising itself, now the profits are taken out by the private sector while the rising losses are met by taxpayers. It is difficult not to argue that we were better off a decade ago.

* The proposed acquisition of Railtrack plc by Network Rail, a statement by the Rail Regulator and proposed licence modifications, June 2002

  • RapidAssistant

    Thought it was worth revisiting this article – given it was nearly 8 years ago, but with recent mutterings implying that Network Rail will be coming under the coalition government’s microscope in a way that it evidently didn’t under its New Labour creators – interesting to reflect on how the problems it faces today were effectively built in from Day One.

    Perhaps it demonstrates the real problem lies in the way in which this phoney nationalisation of Railtrack was done in the first place – our old friend Gordon Brown trying to sweep its debts under the carpet – out of sight is out of mind after all, and like a lot of his other financial policies – where has it got us? Nowhere. In fact in an even more perilous state than even was predicted here.

    NR is a company that bleeds hundreds of millions a year – we know that. It is not a profitable company, and it never can, and it never will be because railway infrastructure is an inherently loss making business. Is that a recipe for a privatisation? No. That is why the industry was fragmented in the first place to disguise this fact.

    There is only one other way to go, and that is for the coalition to swallow its pride – let the Treasury take direct responsibility for the debt – OK the Tories may not want to utter the dreaded “N-word” – they may want to take a leaf from Boris’ book who has managed to take London Underground back into the public sector through the aquisition of Tube Lines and get a backslap from the right wing tabloids in the process. In fact maybe the final nail being hammered into the PPP’s coffin may be a preamble for dealing with the financial problems of the national train set (we can hope….)

    Whatever happens next, there should be a major management and cultural shake-up to get costs under control, with a view to maybe getting the overall subsidy back down to the equivalent BR level within 5 years. Plenty of other (genuine) private sector companies have had “management bonfires” during the recession – and still managed to operate just as well!!!

  • Dan

    The creation of the coalition in theory permits the issue to be re-visited, but of course the porblem is the Tories can’t be seen to be ‘ N ing ‘ something they privatised (although if Cameron wants to detoxify the Tory brand this would be the single easiest way to do that) – if the architects of the coalition had had more strategic sense Cameron could have dobbed transport to the Lib Dems and made them make the decision – that would have allowed the Tories off the hook.

    Boris could do away with PPP on the tube as people a) did not understand it and b) thought it was something to do with Brown (rather than a privatisation, which is what it really was). As a result the uninformed press could simply be conned into thinking Boris had rejected what Brown did – rather than understanding that Brown had privatised, and Boris had Nationalised.

  • RapidAssistant

    The problem Dan, about this whole nationalisation argument is that people use the term without really thinking of what it means – when it comes to the railways I think perhaps what they really want is reintegration first and foremost, with some private sector involvement where there is a genuine (i.e not the “pretend capitalism” as mentioned) economic benefit for both sides – it works for other public services. The arguments for public ownership of the core assets and rational regulation of fares and the services have already been made clear. So too is having an experienced management who know everything about how to run a railway, and not how to maximise profits at the expense of everything else.

    Bringing back British Rail is still largely a populist policy clouded by nostalgia for restoring another “golden age” that never was – why has it suddenly become fashionable to repaint locomotives and coaches into old BR colours?? BR was of course integrated, but neglected by governments, starved of cash and vilified by the press and public – sometimes deservedly, sometimes not. A retrograde step, probably – but the essence of any reform must be to restore vertical integration to the industry. Otherwise this money-pit of a system will just keep on turning into a self destructing black hole.

  • Dan

    http://www.rail-magazine.com/news/default.asp?storyID=162&nid=4

    http://www.rail-magazine.com/news/default.asp?storyID=163&nid=4

    Couple of interesting posts above, although I’m not sure much of the analysis points to exactly what the cause of the problems are.

    It strikes me that the options are:
    – Nationalise it
    – Privatise it
    – Close it down

    I wonder if the coalition can think of another way? Probably not so I suspect we will get the third option or parts of it (in the form of network closures).

    You make a good point rapid – I think that whatever the benefits of the current system (and there are not many) the public view the TOC led ‘customer interface’ as one of overpriced, overcrowded trains, byzantine fares and no great improvements in customer service as so poor that they would be happy to see BR back (despite the rose tinted specs views you point out). It’s remarkable – as you don’t see any other privatised industry seen in this way (it’s like people being nostalgic for the old GPO run BT for example – not a lot of people argue for that. If rial was re-nationalised it would actually be a popular policy (even if not the right policy)!

  • David

    I’m not sure I fully understand the point Rapid Assistant is making in his second posting, but if he is expressing the view that what many people want is reintegration of the passenger rail network, then I fully agree with him; many must be put-off from using rail by the complexities of purchasing reasonably priced tickets for journeys which cross franchise boundaries, and having a single network would certainly solve this problem. Why should potential passengers have to juggle their journey plans and either spend a considerable amount of time sitting at their computer or else visiting their nearest station with a booking office to get the best deal for their journey? But the reality is that; unless you have bottomless pockets and can afford to pay for some kind of through ticket, you have to spend a significant amount of time just to purchase a ticket (or tickets) before you set off.

    However, I don’t think many rail passengers will really think about the organisation of rail in Great Britain; most won’t be aware that track and signaling is owned and operated by Network Rail, and that their passenger train service is operated (probably by a bus company) under an agreement with central government. They will have read in their local newspaper, or seen on their local tv news, that a new franchise operator will take over their local train service on a particular day, but they won’t have thought about what goes on behind this; all they want is for a train to come when they want it, and to pay a reasonable fare for their journey.

    They will also have seen the hype about the benefits privatisation has brought; and many will have asked themselves the question “where is it?”, for to them – apart from changes to colour schemes – nothing will really have changed.

    Most passengers won’t realise how much more they are now paying in taxes to support the rail system than they did when it was nationalised; I guess this has probably been one of the best kept secrets of the last 15+ years! Certainly, for those of us who pay UK taxes, the last tears of BR were a “golden age”; and to get us back to something similar, the government needs to be prepared to admit they got it wrong back in the 1990s, and to fundamentally restructure our railways – again!

    I think there were two major errors/omissions in the plans drawn-up by John Major’s government in the early1990s; firstly, they didn’t realise how efficient BR was (typical view of the time was that all nationalised industries were inefficient), and secondly, they either forgot or deliberately overlooked the good old Common Law concept of damages. They then created a myriad of companies, all contracting with each other; so when one entered into a contract with another, it obviously included a risk contingency to cover potential damages (as well as profit) into its price, and so the upward spiral in costs began. Perhaps government thought that costs saved by eliminating inefficiencies within British Rail would balance out these increased costs, but this didn’t happen because many of the perceived inefficiencies just weren’t there.

    Railtrack then increased the demand for contractual relationships by outsourcing work which had, in BR days, been carried-out in house; obviously, this resulted in more cost being brought into the railway network. But not only that, it meant that many rail staff with essential expertise left the industry; this was to have a major impact later as there were disasters with loss of life (like Potters Bar, currently once more in the news) and also by poor management of investment projects like the West Coast Main Line modernisation.

    Following the creation of Network Rail, some of these issues have been addressed; some of the work out-sourced by Railtrack has been taken back in house, but a whole raft of contractual relationships remains in place. Moreover, by separating infrastructure ownership from train operation, a whole raft of what I’ll call non-commercial agreements have to be established; a good example is the need for licences to be granted to TOCs to enable their staff to enter Network Rail property. And when a franchise is transferred from one TOC to another, a Transfer Scheme is necessary; legal costs don’t come cheap!

    My understanding of English Law is that an organisation cannot contract (in a legal sense) with itself. So if a holding company was established with Network Rail as one division, passenger TOCs as another, much of the cost present in the present structure would be eliminated immediately; contingency costs and the profit element would disappear, and compensation payments between divisions would also go (project costs have been shown to be considerably enhanced by such payments). Who owns such an organisation is a separate issue, but if there are financial benefits from it being owned by the state, then this route should be taken.

    So lets see how serious this new government really is about making savings; how they approach rail will be a good indicator.

  • RapidAssistant

    I didn’t reply to this thread because at the time we didn’t know what was going to happen. On one hand good that NR is coming under the microscope, the shelving of GWML electrification and the imminent cancellation of IEP are largely unsurprising.

    David – the key phrase you mention is “admitting they got it wrong”. Something which despite everything that has happened – politicians and a number of so-called ‘industry experts’ seem to be reluctant to do. Until that happens there will be no changes. As I said in another post – we have Tom Winsor now saying that we should reprivatise Network Rail!!!!

    Outside of the specialist railway press, and for avid followers like ourselves, the public don’t know. Arguably they don’t care either given the huge percentage that never gets on a train, even though the railways touch everyone’s lives indirectly in some way. Until the whole scandal is exposed for what it is will politicians stand up and take notice.

    Network Rail is bankrupt already – never mind the projections to 2020 – a company that has to borrow just to service its debt is technically insolvent. I just wonder what the serious discussions are going on in the background – it will be interesting.

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