Are GNER’s premium payments sustainable?

The new franchise contract for GNER on the East Coast Main Line, announced in April, marks a radical departure from existing arrangements and suggests that the government is seeking to reduce sharply the current subsidy of nearly £2bn to train operators.

GNER’s won because it such high commitments over the level of premium it was prepared to pay the government that it completely blew away the competition the other bidders. Overall, the company has said it will pay premium worth a total of £1.3bn net present value (i.e. the amount you get by rolling up the payments and discounting them back at 3.5 per cent).

The Department for Transport initially refused to release the detailed annual figures of what premium payments GNER was committed to make during its franchise, arguing that since these were sums were being paid to the government rather than subsidy being disbursed, it was not a matter of public interest. Yet figures on previous commitments to pay premiums had been released by the Strategic Rail Authority and its predecessor, not least Virgin’s original commitment to pay £200m per year by the end of its original West Coast franchise in 2012/3. It was perhaps embarrassment over this failure which had prompted the new policy of secrecy. However, this change in policy was challenged under the Freedom of Information Act by rail journalists and on April 27, the SRA retreated and released the figures.

An accurate version had already been leaked to the Daily Telegraph and confirmed that Sea Containers, GNER’s parent company, has set itself fiercely ambitious targets in the later years of its 10 year deal. While in the first year (to March 2006), GNER will only have to pay £58m this rises to £164m by 2010 and a staggering £396m in the year to March 2015.

Indeed, the first four years of the franchise are relatively unambitious, with only slow rises in expected premium payments, but after that the increases are much more marked. This is because after 2009, the risk is shared between the Department for Transport and the company, if targets are not met in a complex formula that involves the government taking responsibility for 80 per cent of any shortfall in revenue – or getting the profit from any excess – over 6 per cent.

Is this realistic? Chris Garnett, the head of GNER, believes so. He says: ‘We’ve just taken revenue growth and projected it forward. Why should rail demand peak out, when cars and planes don’t?’

However, Roger Ford of Modern Railways reckons that the load factor in the trains would have to be 83 per cent, a figure that is extremely high for long distance railways. Garnett disputes the figure, arguing it is closer to 65 per cent, nevertheless a sharp rise on the current situation in which about five out of ten seats are occupied.

This sets a very high standard for other franchises, particularly for former InterCity lines, to follow. If the government is going to expect bids on the basis of such high load factors, then bidders are going to have to set themselves very ambitious targets.

Moreover, not surprisingly, GNER’s commitment has raised questions over both job losses and increased fares. While the unions are understandably concerned, the need for GNER to maintain its high good reputation by providing a high standard of service, together with the requirement to cater for such a rapid increase in passenger numbers makes the likelihood

Passengers, however, are likely to fare less well. The government has barely tried to shield the fact that it sees higher fares as making a significant contribution to reducing the huge subsidy to the rail industry. We are, effectively, back to the days of British Rail raising fares by above the rate of inflation, though this time the aim is not so much to squeeze off excessive demand but to raise income. But that is a difficult game to play and it is buy no means certain that GNER’s need to raise fares will not deter the very off-peak passengers it must attract in order to meet their financial targets.

Indeed, such massive premium payments beg the question of what is the government’s rail policy. These payments are effectively a tax on rail users, although admittedly they will go towards subsidising other passengers in subsidised franchises. In Labour’s first term, ministers announced the aim of increasing rail passengers by 50 per cent during the course of this decade, but that target has been quietly dropped. Now the emphasis is clearly on reducing subsidy and, cutting costs, possibly through line closures.

The new franchise also raises questions about the viability of the current structure of the railway. The concept of franchising out the whole railway, an idea invented by the Conservatives but continued by Labour, has still yet to prove itself as either a robust or economic way of running a railway. It entrenches the separation between track and infrastructure which is at the root of many of the current problems of the railway, not least the soaring cost base. Moreover, it is unclear what the franchisees bring to the party, especially since the concept of 20 year franchises, developed during Sir Alistair Morton’s tenure at the head of the SRA in order to encourage long term investment, was abandoned. The train operators do not invest in the railway which is perfectly understandable give that they are short term incumbents and would not get a return.

Sure, the franchisees provide a bit of private sector expertise is useful, but their record has been very patchy even between franchises run by the same group. GoVia recently did not even make the shortlist for the Thameslink franchise and yet it appears to be performing quite well in neighbouring Southern, admittedly with new rolling stock. Similarly First ran Great Eastern very well (though it lost the franchise) while its performance on Great Western has been mediocre.

Moreover, South Eastern Trains, run by a specially created subsidiary of the Strategic Rail Authority since Connex was booted out in 2003, has performed well and it seems obvious that why retaining one or more such in-house arrangement would be a useful cost comparator, even if the government is reluctant to abandon the whole idea.

Given that the rail review which resulted in the abolition of the SRA is still in the process of being implemented, any major change to the franchise concept is unlikely in the short term. But if GNER fails to deliver on its very ambitious targets,the whole issue may well come to the fore around the time of the next election.

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