Rail 550: Smoke and mirrors conceal premium myths

After the latest huge premium-payment deal is signed, it’s time for the ORR to bring transparency to the opaque finances of franchising, contends CHRISTIAN WOLMAR.

THE South West Trains franchise awarded to Stagecoach at the end of last month gives us a pretty good picture of what the Department for Transport likes to see from its bidders, but it still fails to answer that perennial question asked in this column: ‘What is franchising for?’ The department wants ‘plain vanilla’ bids with no enhancements and the biggest headline figure on premium payments.

As Chris Garnett, the departed head of GNER, pointed out in the last issue, bidders are not encouraged to suggest enhancement because that is not seen as their job. The department specifies tightly, and the bidders keep in line, which, as he stressed, means a very restrictive role for the private sector.

But is that a bad thing? Do we not want a railway that is value for money and delivered at the least possible cost to taxpayers? Indeed, on the face of it, this is a much better deal for the Government than the interim three-year arrangement agreed by Richard Bowker at the Strategic Rail Authority in 2002 which was far too generous to Stagecoach. Under that contract, Stagecoach has been making super-profits at the expense of passengers and the taxpayer, netting a fabulous £58.9m in the last year on turnover of around £500m. That’s 12% of turnover. As I mentioned in my book, On the Wrong Line, a senior Stagecoach executive told me privately that the SRA had been a pushover and the company had been delighted by the deal.

Now, Stagecoach’s rate of return will be much tighter, some 3-4%, giving the company a profit of £15m-£20m. Moreover, Stagecoach, realizing it was the preferred bidder, tried at the last minute to gain some concessions out of the deal but the department stood firm.

I have no problem with the department playing hardball. It has a duty to protect the taxpayer. The trouble is that franchise capitalism is such a bizarre game that no-one quite knows what is a good rate of return. Profitability is not expressed like in a conventional business as being the rate of return on capital employed, since train operators have no assets, but, rather, as a percentage of income. It is, presumably, a reward for risk, but that has been greatly circumscribed by the capand-collar arrangement. Interestingly, the fact that the cap on profits kicks in immediately – while the collar, which limits losses, only applies after four years shows just how much the department bared its teeth.

Subsidy will still be on offer for the first two years and then Stagecoach will have to pay everincreasing premiums. But there is still far too much smoke and mirrors surrounding the real economics of these arrangements. This is the fourth recent deal that offers big premium payments on franchises that originally were in receipt of considerable amounts of subsidy.

GNER was the first, then First Great Western and Thameslink (or First Capital Connect, as we must call it). All make heroic assumptions about the ability of the railway to grow yet more traffic at the rates of the previous decade.

But those huge premium payments, which are such a burden for the operators who then promptly impose huge car park charges or restrict cheap fares, are a myth. Network Rail is receiving around £2.5bn a year directly in grants from the Government. Now, as a rough calculation, these big premium payments for these four franchises only add up to around £500m a year (evened out over their ten-year length), assuming of course that they will actually be paid which is pretty unlikely in the case of GNER. Even accepting that these are only four out of 20 franchises, they do not cover the real access charges of these companies.

“These big premium payments look very clever but have the damaging effect of pricing people off rail…”

It is a daft way of running a railway, which Tom Winsor, the former rail regulator, approved under pressure from the Government, and surely it is time for his successor to bring clarity into the opaque world of railway finances by making all Network Rail funding go through the operators who have to pay the access charges. (Alternatively, as I have long suggested, it would be better if the operators only paid marginal access charges and the rest was covered by government grant, just as it pays for the roads, but that unfortunately is too sensible for running the privatised railway.)

These big premium payments therefore look very clever on the face of it but have the damaging effect of pricing people off rail as they become more expensive (and in the case of SWT losing seats, more uncomfortable) in a world where for environmental and other reasons, getting more people on to trains must be the Government’s aim.

In a sense Garnett is right that the private sector role has now been too circumscribed. However, it is still difficult to find franchise heaven: long – say 20-year – franchises would be the best for investment but no company will take on all the revenue risk for such a long period.

Chiltern, the only one with a 20-year franchise, is currently suffering badly because of the very unlucky collapse of the Tesco store being built over the railway, which meant passengers migrated to the West Coast or Great Western lines during the blockage and have not returned.

Short franchises are disruptive, take up huge amounts of management time in the bidding and rebidding processes and do not allow for innovation or enhancements, but enable transfer of revenue risk, though reduced by the collarand-cap arrangements.

Is it any surprise that the brighter sparks at the Office for Rail Regulation are now considering a world without franchises, where there would simply be contracts with operators to provide set amounts of service, but no guarantee that they would be exclusive. Their ideas have yet to be thrashed out, but every franchise deal that is signed seems to ask yet more questions about the purpose of the arrangement.

The sad death of an idea

My sceptical column about Maglev (RAIL 548) now seems worthy of Mystic Wolmar given the terrible accident in Germany at the end of last month in which 23 people were killed. At the time, I wrote that both the costs and the risks of the project were likely to have been underestimated by those proposing it. That has proved horribly prescient.

The disaster was probably not caused by a technical failure (though there have been questions about radio communication), but it nevertheless raises many doubts about the concept. The manner of the accident in which the Maglev train hit a maintenance vehicle shows that much care would have to be taken to ensure there were no foreign objects on the track.

Moreover, given how the train was completely wrecked and there were very few survivors, there are questions as to whether lightweight material could be used for vehicles however much its promoters say that crashes are impossible.

Would the Railways Inspectorate approve any design that did not include crumple-zones, for example?

Then there is the issue of evacuation. Clearly a walkway would have to be attached all along elevated sections of the track, but then that raises further risks of vandalism and trespass. How much damage, indeed, would be inflicted by some poor suicide who wanted to make their final bow using the newest technology?

All of these considerations would greatly increase the cost of any project for a Maglev line. Further, the crash shows there are greater risks – financial as well as safety – than expected. The same is true of all new technologies. Six months before the Concorde crash in the summer of 2000, I wrote an article for a national newspaper warning that it was still a relatively untested aeroplane with a number of faults that could cause it to crash. The reason for my concern was that there were so few Concordes in use that even though it had been in service for more than 20 years, the technology was still relatively untried.

The Maglev disaster is a similar case in point. Although the technology itself is quite old and well-established, there are very few systems in operation and therefore the concept remains largely untested. That is why it would be a very brave politician who would put forward a Maglev scheme instead of a conventional railway for a new high-speed North-South link. Maglev is now a very dead duck, I am afraid.

Elsenham critics vindicated

I am delighted that Network Rail has agreed to install a footbridge at Elsenham, the station crossing where two teenage girls were killed when running for a train last December.

I visited the site and wrote at the time (RAIL 529) that this was a shabby arrangement where common sense dictated that it should be changed, even if the box-ticking risk assessment did not. In fact, the official risk assessment was later found to be fl awed because the crossing keepers had not been properly interviewed, and had it been carried out properly, then action should have been taken.

I received flak from inside the industry because I featured prominently in a piece for The Sun as this was seen to be rabble-rousing in the tabloids. Now it appears that those of us who highlighted the dangers – who included Chris Randall, now of this parish but at the time editing another magazine – have been vindicated and Network Rail has been forced into retreat. It is a victory for common sense.

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