Rail 729: ORR tries to make sense of the impossible

You can’t fault the Office of Rail Regulation for trying. Trying, that is, to make sense of an industry structure which every experienced railway managers knows is inherently dysfunctional and full of perverse incentives. And trying, too, to turn the railways into a normal conventional business like selling soap or Coca Cola with competition at its heart when, in fact, that is a hopeless task.

The latest effort from the ORR is the publication of a document with the uninspiring title of Opportunities and Challenges for the railway, ORR’s long term regulatory statement. Don’t be put off by the dullness of the title. This is an important consultation document examining the risks facing the industry but also setting out an agenda in which competition is crucial to the future success of the railways.

Let’s look first at the emphasis on competition. The ORR says that as the industry becomes ‘less dependent on subsidy…[it] ought to become freer to take its own decisions on how best to meet its customers’ expectations and grow demand’ Yet, within a couple of paragraphs, the ORR contradicts itself: ‘As efficiency improves, there is an opportunity for rail businesses to work together in a commercial way to deliver for their customers, potentially with less intervention from ORR and government.’ So is it to be ‘working together’ or competing?

In reality, the railways will always be constrained in terms of competition by the very nature of the industry: train paths are limited, huge investments are required to enter the market, and massive government subsidies are required which means competition could waste taxpayers’ money. Consequently co-ordination should be the default option since competition can be disruptive and lead to a misallocation of resources. Much as I love the open access operators, their presence on the East Coast actually leads to all kinds of complexity over the allocation of train paths that, perversely, means some towns are less well served than if the whole service were provided by a single operator. And open access, which was responsible for the way the industry was structured, is a dead duck on the rest of the network.

While there is competition in the supply market for Network Rail, it is dominated by a small number of big players with the equipment and experience to provide what is a very specialist service. Rolling stock can really only be supplied by a limited number of manufacturers and the roscos do not have fleets of trains ready to replace existing ones. So the competition they supply is limited and mostly restricted to the financial package they can offer. Even the supposedly most competitive area of the industry, the franchising bidding process, is dominated by the same old players with new entrants effectively disbarred by the rules specifying the need for experience.

So, much of this emphasis is misplaced and ideologically driven. The ORR recognises that a future government may not be interested in furthering competition but it still drives the regulator towards devising schemes aimed at reaching a non-existent Nirvana.  It would be much better employed simply focussing on the key day job of making Network Rail efficient not least, as I have mentioned before, a crisis looks in the industry over the infrastructure provider’s ever growing debt.

And that’s the most important aspect of this report. Already, according to the ORR, ‘a quarter of industry costs now directly relate to the capital costs of historic infrastructure investment incurred by Network Rail through debt financing costs and the amortisation of past investment’. And that proportion will only grow as the debt is set to reach £50bn by the end of the decade. Thank God the governor of the Bank of England is now promising low interest rate for several years to come, or otherwise there would be a real crisis looming in the industry

Even so, the ORR suggests that the present model of simply adding to Network Rail’s credit card (not that it is expressed in those words). The ORR warns that ‘The challenge for rail is to ensure that the current funding model remains sustainable and affordable in light of the continued high level of investment that is anticipated to be needed to keep up with demand on the existing network, in addition to the need to fund significant additional new investments like HS2’. It recognises that ‘the burden on future generations to pay for the costs of historic investment will continue to rise as

Network Rail’s debt grows to fund further investment’. In other words, there is a warning that this is not really sustainable. My notion is that at some point the debt will simply be absorbed by government but that may well come at a price for the railways, in terms of reduced investment. Otherwise, the debt will become such a huge burden on Network Rail – or its successor – that reduced investment levels will become inevitable.

The key point is this: successive governments tacitly accept that the railways need to be subsidised because of the huge benefits they bring which cannot be captured through the fare box both social and economic. Yet, politicians never speak up and spell that out in so many words. The Network Rail debt has been a way of disguising the real cost of the railways to the taxpayer. What ORR is saying between the lines is that one day this will have to be stopped and that the economics of the railway will, in its words, have to become ‘more transparent and accountable’. There’s no sign of that yet.




School report cancelled but DfT in the firing line


For many years I have devoted one of my August columns to an annual assessment of the performance of the rail industry presented as a ‘school report’. Like all good things, this must come to an end as it was in  danger of becoming repetitive and instead, this year, I will merely confine myself to a few choice remarks about the performance of the Department for Transport which has been so lamentable that it defies belief.

Actually, that is not fair to some of the civil servants in the Department who are hardworking people with an understanding of the industry. However, the collapse of the West Coast franchise bid process nearly a year ago and the subsequent revelations show a department in crisis and the finger has to be pointed somewhere. And that must be at the politicians who created this mess.

There is no doubt that the man now in charge for the nation’s defence, Philip Hammond, bears much of the blame. It was on his watch that the Department was reorganised and its resources cut back in such a way that it was unable to cope. It was Hammond, too, who tried to change the way franchises are let, with 15 year deals without understanding the implications.

The industry is still suffering terribly from the fall out of this crisis. Anyone with the slightest knowledge of franchising has been pulled in to help sort out the mess and rewarded with 6 month contracts at £500 per day (the equivalent of £125,000 annually). The man put temporarily in charge, Peter Wilkinson, has an excellent track record, and has recently been given an extension to sort out the franchising process, but he has a near impossible task.

The difficulties are illustrated by the fact that schoolboy errors are still being made by the Department which, it seems, is still struggling over basic figures. Hansard reveals that the calculations over the amount of money payable when National Express was given an extension for the Essex Thameside until September 2014 were wrong prompting the hapless Rail Minister, Simon Burns into having to issue a correction. On June 5, he said the subsidy amounted to £2.4m but as the correction issued three weeks later revealed, it should have been £1.7m. Pah, £700,000 is peanuts in these days of billions but you can bet a few teacups flew in Great Minster House after that embarrassing episode. As an aside, this was originally a premium paying contract and is now a subsidised one, due to the rolling stock requiring extra maintenance and other factors but that does show how difficult it will be for the Department to force down these contract prices.

It is not just the numbers the Department is getting wrong. There is still, at root, a lack of clarity about how to respond to the review conducted into franchising by Richard Brown, now, incidentally, rewarded with a place on the board of the Department. In particular there is confusion about how to incorporate the notion of quality and past performance into the bidding process. Brown suggested that between 20 – 40 per cent should be related to improving passenger quality. Determining how this would work in practice is proving particularly hard, which is hardly surprising given that we live in austere times and the Department’s default option will be to give the contract to the cheapest bidder. This quality aspect is proving a stumbling block to speeding up the franchising process and there are doubts about whether the East Coast franchise, the one which ministers have, for ideological reasons prioritised, will be got away before the election.

Just remember this key point. In three years of Coalition government, the Department has so far managed to complete just one franchise deal, the 29 month Greater Anglia contract, now, like almost all the others, subsequently extended. There is only one word for it: scandalous.