Rail 531: Dishonest GW deal signals cash crisis by end of decade

The Greater Western franchise, with its massive premium payments, is just a cynical attempt to cash in on the good years before the operation goes belly-up in 2010, warns CHRISTIAN WOLMAR.

T he detailed fi gures for the Greater Western franchise which have just been issued are an amazingly revealing guide to the government’s real intentions on the railway. And sorry, dear reader, they have sent me into rant mode, but please bear with me.

The figures have not attracted much press attention because regular readers will recollect that a new game is being played by the DfT when announcing the result of franchise bids. Instead of giving the fi gures for premiums and subsidies at the time, a Net Present Value fi gure (which represents the annual amounts discounted for infl ation rolled up into one number) is issued. This is then used as the basis for news stories the following day, even though it does not mean very much since it is very diffi cult to assess the basis on which the bid has been made.

A couple of weeks later, the department releases – inevitably on a Friday afternoon when the world’s press are in the pub – the detailed figures of the annual amounts. Bizarrely, the reason for the delay is that the failed bidders have to be debriefed fi rst. Now why these fi gures should be deemed to be too sensitive to be shown to the public before they are shown to the winning bidders’ rivals, who have the most vested interest in seeing ‘commercially confidential’ material, is another one of these inexplicable paradoxes about the franchising system.

The figures reveal the depth of cynicism about the way the railways are being run, and ensure there will be an almighty fi nancial crisis towards the end of the decade. First will receive £97m subsidy in 2006/07 and this will be transformed into a £427m premium by the last year, 2015/16. These are today’s fi gures and therefore, in money terms, First will supposedly pay the Exchequer £600m at the last year.

Broadly, the £97m subsidy for next year represents pretty much the level of fi nancial support which the three franchises combined received during 2004/05. Then over the next three years this changes into a premium of £20m, and then it gets silly – the following year it leaps to £111m

Why? Not because we know the economy is going to boom suddenly in that post-election year but because that is when the capand- collar arrangement comes in which pushes most of the risk of any shortfall on to the government. This works in such a way that, broadly, 80% of any large shortfall – or excess profi ts – will be borne by the government. The formula is that First takes the whole risk of the fi rst 2% shortfall, then half the risk of the next 4%, but only 20% of all the rest. So it loses little if there is a really big shortfall.

What is so infuriating is its opaqueness and the lack of honesty on the part of those involved. From First’s point of view, it clearly is a pretty naked attempt to cash in on the good years (its profi ts are capped so that after a certain level, which the company says it will reveal later, the company shares the ‘upside’ with the government right from the start of the franchise) and to do all right until year five when the cap-and-collar arrangement comes into play.

From the government’s point of view, the DfT is making the Treasury happy by showing the massive sums going into rail can be reduced. But it is an old trick – simply infl ate the growth fi gures and the bottom line looks good. Mark my words, the Treasury will not be happy in 2010 or whenever this deal falls apart.

First is confi dent these numbers can be achieved, even though it has subsequently discovered it overbid massively. Although there is essentially going to be the same number of trains, Adrian Lyons of the Railway Forum says economic growth in the Thames Valley area is so strong that “people are piling on to the trains.” He reckons the targets are achievable, with the key factor being the ability to fi ll trains in the off-peak. Moreover, with little improvement in passenger facilities in the early years (until HST2 is delivered), First’s strategy (and indeed government policy) seems to be pile them high and sell them not so cheaply. Watch out for massive hikes in car parking, minimal service and premium-price food.

Even then, will it work? First’s bid is based on a combination of high growth and above-infl ation fares rises, over the whole franchise. A bad year, brought about perhaps by too much cost-cutting, will have a massive knock-on.

The company says it needs 8-9% revenue growth annually, and that is split equally between fares rises and extra passengers. To illustrate, passengers on FGW over the past decade went up annually by an average of 4.8%, but remember that was an unprecedentedly long period of constant economic growth which has delivered record numbers to the railway. However, this was during a time when Saver fares and season tickets were regulated to 1% below the rate of infl ation not, as now, 1% above.

A few numbers will illustrate the point of how diffi cult the targets are. They are slightly crude because it is diffi cult to get up-to-date information on the fi nances of the railway and First would not co-operate in this exercise, but broadly, these three franchises will generate around £630m this year, carrying around 75m passengers, giving an average fare of around £8.50. To have any hope of meeting these targets, by the end of the franchise there will need to be 110m passengers each paying over 50% more, say £13. Where are all these extra travellers going to come from, especially for a service that will be more expensive and that will receive little investment?

The other aspect of this franchise process that is so disturbing is the complete lack of focus on investment. Sure, there is supposed to be Crossrail, but that is such a distant vision that it does not really affect this tenyear franchise – except watch out for First making massive compensation claims if work affects its services. Moreover, Crossrail actually prevents any other growth, as a little- noticed document released by the DfT shows. Under the legislation, the company which owns Crossrail will be guaranteed that First and its successors on GW will not be allowed to expand the number of trains for 30 years after the new line is completed, to allay concerns about revenue abstraction.

In other words, the financial case for Crossrail will be based on squeezing all the available growth out of the railway and again shows that the government has no real interest in providing a major expansion of the rail network, even in the Thames Valley.

Oh, and First is supposed to be putting in £200m investment, but that is really little more than the company will be receiving in subsidy in the early years of the franchise and, in any case, will mostly go on longterm maintenance of the ageing HSTs.

Worse, when the franchise goes wrong, as it inevitably will, it will be the government that has to pick up the bill – and that money will come out of the railway’s overall budget. First will, therefore, get four good years in which it can make a healthy profi t, then two or three bad ones and by year seven it will throw in the towel.

Governments of the past 60 years have vacillated almost continuously over the key issue of what the railways are for. For alltoo- brief periods they have occasionally recognised their social value but for the most part the railways have been perceived as an expensive irritation which most ministers – especially those in the Exchequer – rather wish had never been invented.

It is clear from what is happening on the railways that Labour is now falling into the latter pattern. The cost of adding capacity is too high and even in areas where there is a fantastic demand for rail, as in the Thames Valley, the government is only interested in extracting as much as possible from franchisees with as little provision as possible for expansion.

History is repeating itself; very similar things were said by me in 1997 when Virgin promised to pay massive premiums for the West Coast franchise seven years down the line and is, in fact, today getting hundreds of millions in subsidy, but hardly anyone except a few of us old hacks has noticed.

But don’t be fooled. There is trouble ahead – the only question is when will First come back to the government and ask for more?

Will the fi rst renewal of the Great Western franchise with First lead to cuts and increased fares? M E L HOLLE Y .