Rail 544: Rail’s Da Vinci Code: lots of nice theories, few hard facts

A triple-pronged battle over the financial future of the railways will be fought during the next two years between the Government, Network Rail and the ORR. But CHRISTIAN WOLMAR believes it’s more like an exercise in fantasy economics.

Let battle commence. Network Rail’s Initial Strategic Business Plan Control Period 4 is much more interesting than its mind-numbing name might suggest. It is the fi rst serious shot to be fi red in a three-cornered battle that will rage over the next two years and will determine how much the railways will receive in government funding in the period April 2009 to March 2014, known as Control Period 4 because it is the fourth five-year period since the creation of Railtrack.

The fact that the dates don’t match up is because Control Period 2 had to be curtailed as a result of Hatfi eld and the subsequent collapse of Railtrack, and Tom Winsor, the then rail regulator, reassessed the amount of money Network Rail would receive (upwards, by £7.5bn). This was after the chairman, Ian McAllister, had initially said Network Rail would not need extra cash during that period, but then he was new to the job at the time and used to the car industry where economics makes more sense.

I relate this bit of history for a purpose, which is to show that the railways, like politicians, are at the mercy of what Harold Macmillan called ‘events, dear boy, events’. That is why the whole structure of how the industry is to be fi nanced seems like an exercise in fantasy economics rather than a coherent iterative process. It is such a convoluted, complicated and arcane method, which to some extent is being designed on the hoof – does anyone know what a High Level Output Specification looks like? – that the chances of delivering anything sensible at the end of it seem remote.

Network Rail’s document is in essence the fi rst part of preparing a bid for funds. It will be revised later this year after discussions with various stakeholders, and will eventually be submitted to the Government as part of the consultation process for the High Level Output Specifi cation (HLOS), to be published next summer along with the Statement of Funds Available (SoFA). Essentially these two documents represent a statement of what the Government wants from the rail network together with the amount of cash that is available. It will then be up to the Offi ce of Rail Regulation to determine whether the two documents stack up, and it will issue, in October 2008, its determination of how much money Network Rail will be allowed in Control Period 4.

Donald Rumsfeld has wrongly been castigated for saying there are ‘known unknowns and unknown unknowns’ as it is a very apt analysis. We can only guess at the latter, such as the Hatfi eld crash which, without exaggeration, will have probably added some £10bn (around £1bn per year) to the cost of running Britain’s railways by the end of the current control period in 2009.

However, the ‘known unknowns’ proliferate throughout the document, ranging from the cost of enhancements (which Network Rail hopes to reduce) to the price of electricity, which has certainly been leaping around in recent years. Then, conversely, there are very detailed fi gures on other aspects of running the railway: for example, Network Rail promises to cut spending on maintenance, renewal and operating the railway from around £5bn in the current control period to just over £4bn a year in Control Period 4 and to just over £3.5bn a year in Control Period 5. This will be achieved by cuts in costs which the document says will amount to 5% in the fi rst year of Control Period 4 to 2% in the last year.

There is a fundamental problem with such fi gures. On the one hand, it is welcome that a lot of effort is going into planning on the railway. On the other, they do seem to be taken more from the Da Vinci Code than Whittaker’s Almanack – lots of nice theories but few hard facts. These kinds of fi gures are, at best, vague targets and are merely designed as the fi rst markers in the bidding war. I bet that by the time the fi nal document is published, Network Rail will be promising much bigger cuts in the costs of maintaining, renewing and operating the railway.

In the fi rst couple of years of the present Control Period, Network Rail accumulated about £1bn underspending, largely because it did not let any large signalling contracts. But fi nding out the precise reasons for such huge sums not being spent is a diffi cult process, as witnessed by the fact that the Offi ce of Rail Regulation published a 35-page document on the subject in January!

To add to the confusion, the document has a baseline and a base case requirement. The baseline means virtually no enhancements, while the base case is seeking nearly £10bn-worth in Control Period 4, which would include mostly projects in the South East commuter area such as Thameslink 2000 (which, the elephants among us remember, was originally to be funded through the 1996 Railtrack fl otation when some £800m-worth of its debt was written off to allow for this ‘growth’ project); platform lengthening on the South West Trains network; and improvements to the North London Line. (Again, the elephants remember, the Government wanted to close this in the mid-1970s because no one apparently used it and now the line is one of the most overcrowded on the network.) The rebuilding of Reading and Birmingham stations, too, is on the list and the case for many of these, in a growing railway, seems unanswerable.

However, as the news coverage in this issue shows (page 6-7), to fund the base case requires an extraordinary increase in debt, from the already very high £21bn expected by the end of the current control period to more than £29bn.

Network Rail is, in fact, deeply worried about this potential debt mountain. That kind of debt level is really unsustainable – no private sector organisation would be able to borrow so much on the basis of such a thin balance sheet – and means that the railways are costing £1.5bn annually before a single passenger is carried. Permanently hanging over both the Government and ministers is the threat that the debt may suddenly land on Gordon Brown’s desk. At the moment it is kept off the Government’s balance sheet because the Offi ce for National Statistics has deemed that Network Rail is sufficiently independent, even though it can borrow money at almost the same cost as the state (though it does cost an extra £30m or so because the debt rating is not quite as good).

“Network Rail is deeply worried about this potential debt mountain.”

Network Rail’s concern over the way the City views this debt is so great that it is currently interviewing fi nancial PR companies in an attempt to fi nd one that will be able to represent its case to the Square Mile for continued borrowing at cheap rates. All the document says about this is a rather airy statement: “We are currently considering the mix of debt instruments that we are likely to have in place for CP4. The range of options is very broad at present and we have simply assumed that our average interinterest payments will be approximately 5%.”

In fact, the PR company has an impossible task. On the one hand, it will have to try to convince the City that the debt – however huge – will continue to be underpinned by the Government, but on the other it will have to argue, in line with Network Rail’s mythology, that really the not-for-profit organisation is a private company. I presume it will be paid handsomely to juggle those two hot potatoes.

There are some little gems buried deep in the document: I bet few people know that Network Rail spends more on its IT systems (around £60m a year) than it does on plant machinery (around £50m, though falling to £35m during control period 4) or that the company makes more than £500m annually from property and station income (which, thanks to the system quaintly known as ‘single till’, offsets the cost of access charges).

And remember the notion that Network Rail would eventually start to make profits that would be reinvested in the railway. Well, that seems to have gone out of the window: “We have made no assumption about surpluses being used to fund enhancements. Clearly such funding would need to be discretionary and conditional on achievement of our expenditure projections in other areas.”

Speaking to people inside the industry, it is clear that this process is probably a one-off. By the time Control Period 5 is on the agenda, a different way of determining the funding of the railways will have been developed. In the current system, for example, the role of the independent regulator is very unclear – why should the ORR second- guess what Network Rail and the DfT think is the appropriate sum to fund the Government’s requirements of the railway? And who are the private investors it is supposed to protect, given that, apart from the odd freight company – and, controversially, open access operators – there are none? For the moment, however, we are stuck with this system and we may as well enjoy watching it unfold, but there will be a lot of bitten-down nails at Network Rail and in Marsham Street as the process reaches its crescendo in October 2008.