Rail 565: DfT can’t have it both ways on rolling stock

The failure of the rolling stock market is largely down to the franchising structure and not the ROSCOs’ behaviour, argues CHRISTIAN WOLMAR.

The battle between the rolling stock companies and the government has escalated into an all out war which could threaten the industry’s ability to meet the demand for extra trains as passenger numbers continue to grow. The decision of the Office of Rail Regulation to refer the rolling stock companies to the Competition Commission suggests that behind the scenes attempts to negotiate a settlement have broken down and that ministers increasingly envisage a future in which roscos have no role.

This was hardly unexpected given the ORR’s preliminary view which was to refer the decision to the Commission but the move does beg an awful lot of questions. There are big stakes here. The outcome may result in the withdrawal of the roscos from future rolling stock investment or even lead to a shake up in the franchising system. Given that the rolling stock companies, for all their faults and, I would argue, largely risk free position, have been the only major private investors in the rail system since privatisation (Network Rail does not count!), then it is slightly odd that ministers have it in for them so much. Capitalism, after all, is about making profits and getting a good rate of return but ministers have been deeply critical of the roscos for some time.

Indeed, this present dispute goes back the 2004 rail review which had some harsh words to say about the rolling stock companies and the rates they charged for leasing out trains, particularly the older ex-BR stock known in the trade as MOLA (because there was a Master Operating Lease Agreement governing the contract). A consultants’ report was drawn up and its findings, much disputed by the roscos suggested that leasing costs were indeed too high. The government suggested that the excess amount being charged, in an industry that earns around £1bn per year, might be as much as £160m.

In fact, I suspect that the hostility of ministers and some Department officials towards the roscos goes back much further, to the initial privatisation and resale. It was, indeed, a scandal which, as the National Audit Office said back in 1998, cost the taxpayers at least £700m because the roscos were sold hastily and far to cheaply. But this is history and the money that was lost in now in the hands of a lucky few like Sandy Anderson and John Prideaux who became millionaires by being in the right place at the right time. Whatever ministers do now, they cannot get that money back and the rosco system is a necessary part of the system if ministers want to continue keeping the investment in rolling stock off the government’s books and franchise lengths remain so short.

The issue, however, is not a simple. There is no doubt that in one respect the ORR is absolutely right – there is no proper market for rolling stock and it may well be that some leases are too high though the extra being paid is nothing like the amount suggested by the Department.

However, the reasons for that market failure mostly have nothing to do with the roscos. The one consistent criticism is that they are not sufficiently transparent about exactly what operators are paying for – in other words, how much of lease charges are down to maintenance and how much a result of capital costs. There is, it seems, a reluctance by roscos to allow train operators to ‘dry’ lease trains – in other words, for the operators to carry out the heavy maintenance normally done by the roscos. In the various responses to the consultation process, this lack of transparency is a recurring theme.

However, apart from that, most of the reasons for market failure given in the ORR’s determination are down to the structure and history of the industry, and the franchising process, not because the roscos are behaving badly. There are a dozen reasons given by the ORR for the referral to the Competition Commission, too long to list here, but they are all largely nothing to do with the roscos’ behaviour.

For example, the ORR says there is little spare stock available (which is a result of government policy); different franchise end dates make transfers more difficult (ditto); Invitations to Tender limit choices available to operators (ditto); the TOCs have no incentives to drive down costs because their payments are covered by the subsidy payments (or reductions in premiums) obtained from the Department (ditto); and so on.

While the roscos opposed referral to the Competition Commission, they appear pretty relaxed about its outcome. Although the decision was released before the stock market opened, it is fair to say there was little impact on that day’s FTSE index, not least because they all belong to big banks with bigger fish to fry. Their current lease prices are mostly protected for several years and any decision by the Commission is unlikely to have a great impact on their overall profitability. Even the ORR hints that the upper end of the Department for Transport’s estimates of the excessive costs is rather fanciful.

Ironically, it may be the Department which gets a bloody nose for two reasons. First, having announced that it wants to a thousand extra coaches on the tracks within the next five years, a refusal by the roscos to fund any new deals would leave civil servants struggling to find alternative sources of finance. They may be forced into the Transport for London option of simply buying or leasing the stock direct from the manufacturers which has the major disadvantage of showing up on the government’s books.

Secondly, as stressed above, most of the causes of the market inefficiencies have little to do with the roscos behaviour but, rather, are rooted in the franchising structure. Indeed, one of the companies that the Department might have expected to be an ally in its struggle, FirstGroup, stressed this point in its submission to the consultation process: ‘To describe these as “features of a market” that prevent, restrict or distort competition seems incongruous. The reality is that many of these are constraints inherent in the franchising structure within which the market is expected to operate. The issue is one of market design, not just with market operation within that design.’  (First did not, however, strengthen its waning reputation for competence by dating their response 28 February 2006 when clearly it was written this year!)

The Competition Commission may, therefore, find that the only remedy for market failings is to be found in the franchising structure, rather than in trying to change the roscos’ behaviour. The Department specifically says in its submission that this would be an unwelcome outcome: ‘Restructuring the rail industry in order to try to create competition in relation to the supply of rolling stock (and so reduce capital rentals) would either be of only marginal impact in promoting competition or would impose costs on Government and on consumers which could not be regarded as delivering value for money’.

The Department has had numerous opportunities to try to sort out the rosco market and attempt to make it more competitive, such as the suggestion back in 1998 that rolling stock leases for new franchises should be renewed for only a year while possible alternatives are found.

The truth of the matter is that the rosco market can never be truly competitive. Moreover, as the recent announcement for a 1,000 new coaches suggests, it is the government that determines how much rolling stock should be ordered and where it should be used. It would be far simpler and cheaper for the government to accept the political risk, which is its responsibility anyway, and simply take responsibility for deployment of rolling stock. DfT Rail – or preferably a recreated rail agency – could simply specify levels of rolling stock to be used throughout the industry and then ask for companies – either manufacturers or roscos – to bid for the contracts which could be either through leases or owned direct. Instead we have the kind of ‘pretend capitalism’ that is a result of the semi-privatisation of the industry and which is detrimental to passengers and taxpayers because it creates extra cost as well as uncertainty and unnecessary risk. However, ministers cannot have it both ways. If they want the private sector to be involved, then profits and margins are the price they have to pay. If they try to regulate the industry so tightly that margins are too tight, the roscos will simply walk away.

Victory over trainline.com

Nearly three years ago (Rail 499) I mentioned the battle being waged by a friend of mine, John Carr with Trainline.com. He had made a mistake while booking an online ticket between London and Sutton Coldfield by putting single instead of return. Since the return only cost an extra £1 on top of the £35 since, he was anxious to save the money and he rang up straightaway to correct the error. He was told there was nothing he could do except cancel the whole operation and start again and be charged £10. In addition, Trainline said he had to go to Euston to pick up the tickets, which were then worth only £25. He never did, reckoning that he would be able to get reimbursed more easily if he never picked up the tickets. In fact, unbeknown to him and not explained in ‘the terms and conditions’, there is a time limit on refunds.

He was understandably aggrieved that he should have to pay £10 when clearly there was no cost to the booking agency, since no tickets had been printed out, and since it was an open saver, no one else was precluded from travelling on the train. It was, he reckoned, something akin to the banks charging extortionate amounts, that bear no relation to costs incurred, when their customers go overdrawn.

Trainline would not reimburse him, so Carr took up the complaint with the LTUC, the local rail watchdog (which is now called London Travelwatch) and found that it was unable to help him. To cut a (very) long story short, Carr found out that a booking agency like Trainline is effectively outside the regulatory regime which governs the behaviour of train companies and operates its own rules which, incidentally, he found were not properly set out in the huge contract published on the web.

After three years, Carr was eventually offered a refund of the £10 by Trainline who then became extremely friendly when they discovered he is married to Lady Thornton, a Labour member of the House of Lords, a fact he had deliberately kept hidden, offering to reimburse the cost of the whole ticket. That was, of course, the last straw as the thought that the company was only prepared to act when they discovered his connection with Parliament. angered him even more.

Carr’s victory, however, does not disguise the fact that there is clearly a loophole, here, which needs to be investigated as more and more tickets are sold online and by organisations other than the train operators. How many other people have been charged a tenner quite unfairly for making a mistake that has not cost Trainline any money?

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