Rail 471: Will the SRA take the risk to end the Rosco monopoly?

The three rolling stock leasing companies are effectively a cartel, and have it easy, with long contracts and little competition argues Christian Wolmar who says the SRA could bring them in line…if it had the money.

The rolling stock companies have frequently been viewed as one of the few unquestioned successes of the privatisation of the rail industry. The way that they function, however, is complex and their future role is in question given the changes taking place in the industry. Sure, they have invested some £4bn in new trains but do they offer good value and is the continued functioning of the existing structure for rolling stock leasing the best way for the future?

Such issues were raised – implicitly rather than directly – in the Strategic Rail Authority’s rather thin but nevertheless thought-provoking consultation document in June on the future of its rolling stock policy. These are, indeed, interesting – in the Chinese sense of the word – times for the industry. New orders are largely drying up because the SRA no longer expects the massive growth previously predicted and the boost to the manufacturers brought about by the replacement of Mark 1 rolling stock, for safety rather than operational considerations, is now over. Moreover, the eight to ten year leases created at privatisation are now running out, necessitating renegotiation. Add to that the fascinating problem of what will happen to the Mark 3 rolling stock being displaced by Voyagers and Pendolinos, currently starting to clog up sidings around the country, and the related question of the new generation of High Speed Trains.

The role of the Roscos is being questioned in parts of the rail industry. The Rail Passengers Council, for example, has been considering the issue as has the newly formed support unit for the Passenger Transport Executives who feel that they are paying too much for life-expired rolling stock, such as £48,000 for the capital charge – in other words, not including any maintenance – for a two car Pacer whose value was written down to nothing by British Rail before privatisation.

Here, an aside about numbers. Hitherto, the roscos have been reluctant to release information about cost of their leases, but since most of the money to pay for them is coming from the state and it is already a very limited and flawed market, there is no sound reason for hiding behind ‘commercial confidentiality’. This should be an open debate with numbers on the table.

There are two ways of looking at the roscos. One is that they are private organisations bringing huge amounts of capital into the industry, operating in a competitive environment which ensures that their customers, the train operators, get a good deal. The other is that they are monopoly suppliers who are in a position to take advantage of their dominant market position.

The latter is certainly the view emerging from the PTEs. Take, for example, West Yorkshire’s pacers. There are no alternative vehicles because leasing the alternative, say Turbostars class 170s, would cost £180,000 per year and the extra would not be offset by any potential savings on maintenance because new trains are actually more expensive and thus the SRA would never sanction such a deal. Moreover, there are no pacers available from the other rosco, Angel, (the third, HSBC is all electric) so West Yorkshire has to take what is offered by Porterbrook, the relevant rosco.

What the PTEs object to that the SRA is suggesting that the large amount of subsidy paid to run their local services may not be justified when, in fact, it is the complex system of railway finance which means their subsidy is three times what it used to be under BR because of having to pay these leasing costs and track charges.

The roscos say they have no choice but to levy this charge for the pacers because that was the expected income taken into account when the company was bought (Porterbrook has been through three owners since privatisation). Therefore, for the pacers’ remaining life, which is expected to be until 2012, they say they have to charge that amount in order to get the expected return on their money. If, however, a contract for the pacers to continue operating for another four or five years after 2012, then the annual lease would be cheaper, say £30,000, because the roscos would still get their money back.

But could the SRA not say, tough luck, you made the wrong call and we are going to impose a cheaper price? No, because then the price of any rolling stock would quickly soar because the greater political risk would have to be paid for.

At the time of privatisation, it was envisaged that the rolling stock market would open up well beyond the three roscos and that there would be lots of new entrants, creating a genuinely competitive situation. This has not happened. There are too many risks – such as the reliability of new rolling stock – in entering the market against the established suppliers and, in any case, there is now little scope for new orders.

Not surprisingly, there have been no significant new entrants. Another reason for that is because to be a successful rosco you have to play the tax game. Roscos need to be able to take advantage of the huge potential capital allowances on new rolling stock – 25 per cent per year – by offsetting these against profits. Under the rules, companies can only claim these allowances on profits – it’s a bit like income tax allowances which you can only obtain if you actually earn the money. So roscos have to be part of banking groups that make large profits elsewhere in their business. There are only a limited number of such banks, which is why Abbey National has failed to find a buyer for Porterbrook despite touting the business around the City for the past year.

While all this suggests that regulating the roscos is the way forward, this was rejected five years ago, despite strong pressure from ministers. In 1998, the then regulator, John Swift, examined the rosco market, but rejected the idea of bringing them under his ambit because he feared that investment would no longer be forthcoming from the banks. However, he was nevertheless worried by the ‘potential for abuse which could increase around the time of the next round of franchising when a significant number of leases come to an end’. In other words, now.

That is why the SRA has taken a renewed interest in the issue and must formulate a coherent policy. The roscos may not be regulated but any contracts they sign with train operators have to be sanctioned by the SRA to ensure that operators are getting a fair deal in what is a restricted and utterly flawed market. But the SRA does not want to want to be seen to control the market too much because that suggests nationalisation.

But this is already happening. Not surprisingly, given the collapse of various franchises and the general dithering about refranchising, increasing numbers of contracts between operators and roscos are under Section 54 agreements, which mean that future franchisees will be required to take on the existing rolling stock to operate the train service. This effectively removes the long term residual risk from the rosco which, in effect means the risk has been renationalised. Of course it could be argued the cheapest way of leasing rolling stock would be to dispense with the roscos entirely, with the state taking on the risk and borrowing the money, which it can do so more cheaply than anyone else. But this is politically unacceptable to the government and would be barred by Gordon Brown because he tries to restrict what is counted as government spending in his accounts.

Section 54 is a type of halfway compromise. The roscos don’t like them because it means that they are no longer able to price – and make profits from – the risk. On the other hand, they mean that the state is not having to pay for offsetting risk and overall the cost of franchises is cheaper. The SRA’s consultation paper suggests that the SRA is unwilling to have many more Section 54 agreements. However, ending them will cost money and we all know that the SRA is broke. Is the Treasury really prepared to cough up more money for the SRA to keep up the pretence that the rolling stock market is free from government control?

The killer point, surely, is this: the risk which the SRA is seeking to pass on is entirely in its own hands. It can determine long term rolling stock strategy by ensuring, say, that a particular route uses the same trains until they are life expired. So therefore is it not the residual value risk a daft one to seek to transfer at vast cost to taxpayers? But even if Richard Bowker wanted to, how could he sell the notion of more Section 54 agreements to his to his political masters who are obsessed with not being seen to renationalise the railways? So this is yet another item in his burgeoning in tray marked ‘tough decisions’. As I said at the beginning, we live in interesting times.