Down the tube – the biggest PPP

As Saddam Hussein might say, the Public Private Partnership for the London Underground is the mother of all Private Finance Initiative deals. At one point, its estimated £17bn value over the first 15 years, eclipsed all other PFI deals put together and even now this one scheme represents at least a sixth of the total already signed.

It is not just the scale of the Tube deal that is different from any other PFI, but its scope. Indeed, it is difficult to overemphasise the extent this attempt to manage a huge set of assets over a 30 year term is so much more ambitious than anything attempted so far through the PFI. Whereas most PFIs involve the creation of a new asset which is then managed by the contractor over two or three decades, the Tube PPP requires the infrastructure companies to take over and refurbish an existing asset in poor condition and bring it up to standard but does not require them to provide any new lines.

The Tube scheme has been so shrouded in rather crude political controversy over whether it is a backdoor privatisation that little light has actually been shed on the real nature of the concept. That is also because it is stunningly complicated with even a cursory outline of the scheme requiring a great deal of patience on the part of the listener. As a result, there has been precious little attempt to explain the notion to the public apart from the ludicrous sight of ministers shouting ever more loudly that it is a good deal, in much the same way that their Tory predecessors tried to persuade the public about rail privatisation.

The cause for the complexity of the deal is not merely its novelty, but is also a result of the political fudge that was its genesis and from which the bulk of the subsequent problems emanate. When Labour was elected in 1997, the manifesto guaranteed that the Tube would not be privatised and mentioned a concept called ‘ public private partnership’ (it had not yet acquired capitals) which was ill-defined. In reality, it was a more friendly name for the PFI and the details needed to be fleshed out.

But John Prescott, the then transport secretary, faced a dilemma. He knew there was no money to be had from the Treasury given that Labour had promised to stick within the Tories spending limits for the first two years in office. The Treasury, in fact, really wanted to privatise the whole system but were constrained by Labour’s manifesto.

So, Geoffrey Robinson, the Paymaster General, was deputed by the chancellor, Gordon Brown, to cut a deal with Prescott and after lengthy negotiations they came up with a compromise which has been at the root of all the PPP’s problems ever since. The Tube was to be sliced up into four parts, three (although initially the number was not known but the Treasury loves splitting up things into three as it feels this creates competition) infrastructure companies, each covering three or four lines, which would be let to private contractors, and one operator, London Underground which would remain in the public sector.

Just about everything about this arrangement is awkward and unwieldy. Splitting infrastructure from operations has already been shown to be a bad idea in the national railway. Moreover, the wrong bit seems to have been left in the public sector. The obvious way to have split the system would have been for the operations to have been privatised since it is a people business where private sector expertise is at its best. To hand over the infrastructure to private companies, who have to pay a premium compared with the Treasury to borrow money, makes little sense. Especially as the national rail equivalent, Railtrack has, effectively, just been renationalised because the private sector proved to be a bad steward of a decaying asset.

It was precisely the fact that two thirds of the staff worked on operations that led Prescott, remembering momentarily his trade union roots, to refuse to allow them to be handed over to private companies. Therefore, this strange split was created. The PPP’s designers stress that it is not like the disastrous situation on the national railway where the infrastructure is controlled by Railtrack (now Network Rail) and some 30 passenger and freight operators run services. Instead, they argue, the interface is a temporal one – every morning the trains, having been maintained overnight by the infracos, are handed over to the operator until the evening when they are stabled back at the depot. While that is true, splitting up an intense operation like a busy urban metro is a big risk, untried anywhere else in the world.

The second problem with the PPP, its complexity, is, in part, a direct consequence of the political deal stitched up between Robinson and Prescott. Because of the split, it was not possible to set simple performance indicators to measure the performance of the private companies such as the number of trains operated or their punctuality because the operator obviously is a key determinant of those factors. Therefore, the principal performance indicator which determines the level of payments to the infracos is ‘lost customer hours’. This is known, just to make life a bit more complicated, as ‘availability’ on the basis that it is the non-availability of assets which causes delays.

The trouble with this concept, as Susan Kramer, the former Libdem candidate for London Mayor and a merchant banker, put it, ‘is that they have gone for very high level criteria and that when you have boards concentrating on high level criteria, by the time they catch a problem, what has happened underneath is so awful that it is too late to get out of trouble’.

This is even truer of the other main measure which, in fact, will have a much greater impact on the level of payments made under the contract which is the way that investment schemes are to be paid for. Instead of agreeing to pay set amounts for, say, a new signalling system or the introduction of new trains, this will be paid for through a measure called ‘capability’.

The concept is based on the idea of capturing customer benefits in terms of reduced journey time. These are calculated on the basis of £6 per hour (or 5p per minute) and therefore, to cite the example given in the Invitation to Tender, a two minute reduction, say through better signalling, on the Victoria Line would earn an increased payment of £12m per annum – 120 million passengers times 10p.

There are all sorts of difficulties with such a scheme, not least that it has not been tried anywhere in the world and that drawing up contracts to try to ensure that the infracos are not over or under paid for their investment seems an impossible task. There are also patent nonsenses. One of the factors determining the level of payments to the infracos is, amazingly, the distance between the driver’s cab when it is parked at the terminus, and the staff toilets. This is justified on the notion that cutting the distance will allow drivers to turn trains round more quickly and, as the managing director of London Underground, Paul Godier, explained to Radio Five last week, ‘we do not want those kinds of costs driven into our cost base.’

That is the sort of thing that gives PFI a bad name. The notion of a whole lot of overpaid advisors sitting round a table to device the precise formula needed to ensure that the contractors are incentivised to produce the right number of toilets sounds as sensible as those parish meetings in the Vicar of Dibley.

This makes the noisy opposition to the PPP by the London Mayor, Ken Livingstone, and his transport commissioner, Bob Kiley, more understandable. It is easy to portray their opposition, as ministers have, as mere political game playing, but this is clearly not the case. Their objections are well-rooted and have attracted the support of just about every independent expert who has investigated the scheme.

Moreover, the terms of the deal have worsened over time. Initially, there was supposed to be substantial risk transfer, a rapid series of improvements with 15-20 per cent improvement in capacity on every line within the first 7.5 year period and it was not supposed to cost the taxpayers a penny once the deal was signed.

Karen Buck, the chairwoman of the London Labour MPs group recalls how, at first, the scheme seemed great as it delivered improvements how she and her colleagues ‘were very, very pleased’ when the deal was first announced in March 1998 but quickly became disillusioned when it emerged that large amounts of public money would be required and that the improvements would be much slower in coming. Indeed, there are doubts over whether many of the promised investment will ever see the light of day given that the contract can effectively be totally renegotiated after 7.5 years, the first review point.

Of course, what Londoners and visitors to the capital want to know is – irrespective of all the crazy details – whether the scheme will work? It depends what that means. Of course, such huge amounts of money pouring into the Tube will bring about some improvements but there is no way this can be described as a sensible approach to refurbishing a decaying urban metro. What was striking in researching my book is that with possibly the exception of one or two people at London Underground, none of those involved in the development of the Tube PPP really believes that it is the best solution for renovating the Tube. The words ‘sub-optimal’ tend to come out quite quickly once the conversation goes ‘off the record’.

Even at this late stage, there are still doubts over whether the deal, which was supposed to be finalised on November 7, will go through. The City is replete with rumours that the winning consortia, Tube Lines and Metronet, whose members include the two troubled organisations, WS Atkins and Amey, are having difficulty raising the cash but this is firmly rejected by them. However, Livingstone still holds a trump card. Although Brussels has ruled against his appeal that the deals were illegal under European law, he could appeal which would result in a protracted dispute. As a result, he is trying to lever out of the government last minute concessions to ensure that the payments to the consortia will, effectively, be underwritten by the Treasury. There has been a fierce exchange of letters between Livingstone and the Department for Transport with Livingstone attempting to wrest a guarantee that the government should underwrite the deal, just as it has issued ‘comfort letters’ to the infracos guaranteeing that they will not lose their investment, provided they have been ‘economic and efficient’, whatever that may mean.

This has put the government in a potentially embarrassing position. Having negotiated the contracts before they are handed over to the Mayor, how can ministers object to such a demand which seems to embody natural justice. Livingstone has little to lose by holding out especially as Londoners blame the government, rather than the mayor, for the fiasco.

Another rumour sweeping through Whitehall is that Gordon Brown, having belatedly realised that he is signing up to a less than brilliant deal, would not mind seeing the PPP collapse. In fact, this makes little sense. The collapse of the deal would be the most embarrassing episode for the government since, well, having to bail out Railtrack, National Air Traffic Services and British Energy in the space of less than a year.

Despite these last minute shenanigans, it remains odds on that the PPP will eventually go through, and start in April next year. Then Londoners will have 30 years to find out if the deal is a good one.