Rail 530: 2006: ‘plain vanilla’ franchise

Fare increases, ‘lowest subsidy’ franchises with unachievable targets
and the start of a cash squeeze on Network Rail all herald an eventful
year ahead, predicts CHRISTIAN WOLMAR.

There was so much happening in the run-up to Christmas that it was difficult to keep track. Indeed, the various announcements – which included three franchise lettings, two route utilisation studies, fare rises, two openings, scrapped tram schemes, and publication of Network Rail’s possible future budget – came so thick and fast that it will take months for
the full implications to sink in.

First, the easy bit. The opening of the Docklands Light Railway extension to City Airport and the reopening of the three-mile Larkhall line, reconnecting an isolated and decaying small town with Glasgow, are part of a trend: most new lines will be in Scotland and London because devolved government has given them an extra source of funds. Trams will be considered in the next issue.

Then there were the franchise announcements. After some hassle, we were given the annual subsidy payments relating to the Integrated Kent franchise, but those for Great Western and Thameslink were not available as RAIL went to press because “the failed bidders have to be debriefed first.” I suspect that is just a ploy to prevent any non-nerds from ever bothering, because the IKF figures show that we are back to the bad old days of OPRAF (the SRA’s predecessor) when the lowest bidder won irrespective of its chances of being able to fulfil the deal in the franchise’s last years. 

IKF goes from receiving £136 million next year – which is virtually the same as the state-run company got this year (notionally it is £60m more, but that is to take account of increased track access charges), suggesting yet again that the whole disruptive and costly business of franchising is not worth the candle – to paying a premium in the last year of the eight-year deal. Richard Bowker introduced the concept of deliverability into franchises (RAIL 525) but while the recent franchises are supposed to have taken account of this, the Department for Transport is intending to return to the old system of merely seeking the lowest public subsidy supposedly to transfer more risk to the private sector, a concept that proved unworkable in the first round of franchises. What a dispiriting tale as we watch these supposed very clever ministers and civil servants fail to learn from history. 

As for the letting of the franchises, Govia which ran Thameslink so badly that it was not even shortlisted, won the Kent deal while, remarkably, First, for which the troubled Mike Mitchell, the director general of the railways at the DfT used to work, won both the other two franchises. This was despite the fact that First’s stewardship of Great Western has been so bad with the high rate of failures of its HST fleet and its unimaginative operations that its Managing Director Alison Forster recently publicly apologised to passengers (RAIL 529). At least, thanks to the campaign, the ‘sleeper’ between London and Penzance was retained so let’s hope First markets it better. 

In sum, franchises continue to bemuse: watch this space for the first operator to go back to the department with a begging bowl. The rductions in subsidy and increased premium payments are also dependent on a high fares increase. In Kent, despite a plethora of marginal parliamentary seats, they will rise by 3% above the rate of infl ation annually, which suggests the idea of a growing railway is no longer a political priority. Didn’t BR get slagged off for trying to price off demand?

The Office of Rail Regulation’s preliminary ‘assessment of Network Rail’s future revenue requirement in 2009-14’ sounds unbelievably obscure but this is to be the battleground in years to come. The document suggests that NR might need between £17bn and £20bn during those five years, compared with £22.7bn now, and that annual cost reductions of 2-8% should be achievable. All in all, a hefty reduction. The process is that the ORR will determine a figure priced against a High Level Output Specification set by the DfT, together with a statement of finances available. The ORR will then assess whether it is realistic for NR to provide these outputs with the money available and, if not, there will have to be an ‘iterative’ process – that is, a big row behind closed doors.

I have always argued that since the demise of Railtrack, this whole game is a sham, part of the expensive pretence that NR is a private company. This was well demonstrated at the press conference where the assembled suits were a bit taken aback when we asked about the Regulatory Asset Base. This is supposed to be a figure representing the capital of the company on which it is supposed to get an annual return of 6.5%, and therefore determines the level of access charges. As Railtrack’s sole aim was maximising returns to its shareholders, the company tried to ensure everything it spent became part of the RAB so that it would obtain more lolly in the future.

Railtrack was sold for a mere £2.5bn a decade ago but the RAB grew rapidly every year and will be worth £35bn by 2014. In any case, the RAB rate of return is now supplemented by grant notionally to pay for investment but, in reality, to cover up the fact that the whole process is arbitrary and fell apart post-Hatfield.

Chris Bolt, the chairman of the ORR, is a jolly nice chap, extremely bright and personable, but he was a bit nonplussed at the press conference when he was pressed on the meaning of the RAB given that NR does not have any shareholders. He explained that it incentivises the company to be more efficient since the government had chosen to structure it like that, rather than simply giving an annual grant when there would not be such incentives. But the incentives do not work. The top managers get ridiculously high bonuses in addition to their already stratospheric salaries and there is no real downside if the company fails to be effi cient. It will simply get less to spend, but there are no shareholders to share the pain, only passengers. Sure, if it gets really bad, the board will get the boot, but so they would under a simpler system.

Moreover, none of his assembled suits with titles like director of regulatory economics was able to answer off-the-cuff about how much NR had underspent so far. It is a bit odd that these highly intelligent and wellpaid regulators who live with these issues every day are not more on the ball. The answer is around £1bn, but NR promises to spend all the money by the end of the current regulatory period in March 2009. I am not reassured by that. If they do not need the money, and the railway has been functioning better this year, why can it not be spent on something more urgent – like wiping out the NHS defi cit of £632m at a stroke?

Meanwhile, NR’s debt will soar to more than £20bn, requiring £1bn in interest to be spent on the railway before a train moves. The rise in debt is a hidden subsidy and while ORR says the railway received £3.5bn from the government in 2003/04, that fi gure is almost doubled if NR’s increase in debt is taken into account, which reduces the political embarrassment of such huge amounts being spent on a supposedly privatised industry. Oh, and it allows Alistair Darling to say £80m of largely private money is being invested in the railways every week. The mask slipped the other day when in announcing the Kent franchise the DfT claimed that the government had invested £600m in new trains. Oops.

The ridiculous nature of this process, which is designed to try to allow ministers to say that cuts in the railways are nothing to do with them, should be scrapped. The ORR could be cut down to half a dozen people who would turn down open access applications and keep an eye on any monopolistic behaviour, and the government should be honest enough to determine the railway’s budget on its own.

The year, therefore, starts with the picture of the future becoming clearer. Fare rises, plain vanilla franchises with unattainable targets, and the beginnings of a squeeze on Network Rail all point to an eventful time over the coming months.

Mystic Wolmar reprieved

Despite Mystic Wolmar’s inability to see properly in his crystal ball, the editor has decided to give him one last chance to redeem himself with predictions for 2006:
1. Mike Mitchell, the director general of the railways, will have plenty of time to tend his
2. Alistair Darling will have a new job, as Tony Blair fi nally decides not to stick it out after the summer break.
3. Passenger numbers will grow by a modest 1-2% as the economy stutters, fare rises bite and London’s job market becomes less buoyant, pushing several companies into the red.
4. At least one senior executive of Network Rail will depart as pressure mounts on the company to be more effi cient.
5. Stagecoach will lose the South West Trains franchise, ending the company’s involvement in the railways, except through its near half-share in Virgin Trains.

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