THE SKYE BRIDGE
INTRODUCTION
AND
SUMMARY
OF
CONCLUSIONS
AND
RECOMMENDATIONS
1. The Skye Bridge is one of the earliest examples
of an infrastructure project carried out under the Private Finance
Initiative (PFI). The Scottish Office Development Department (the
Department) signed the contracts for the bridge in December 1991.
Under the deal the private sector designed, raised capital for
and built the bridge, and they opened the bridge to users in 1995.[1]
2. The cost of the bridge to users will take the
form of tolls which they will pay until the total revenue collected
reaches some £24 million. In addition, the Department
spent £15 million, of which £12 million went on
approach roads and other costs, such as design modifications and
£3 million on negotiating the deal. See the Table.
Table
Expenditure on the Skye Bridge project by the
Department and users
|
|
|
Payments to Skye Bridge Limited
|
£ millions |
Note |
Toll payments by users to be received by Skye Bridge Limited over the lifetime of the concession, together with payments agreed in December 1997 by the Department to subsidise tolls for regular users
| 24 | 1
|
Payments by the Department to or on behalf of Skye Bridge Limited for constructing the approach roads, and compensation for the cost of design changes and delay following a public inquiry
| 12 | 1
|
Other direct project expenditure by the Department
Including advisers' fees, survey work, land purchase and staff costs
| 3 | 1
|
| Total payments by users and the Department
| 39 | 1
|
Indirect public expenditure reflecting loss of ferry revenue
by Caledonian MacBrayne
|
£1 million
a year
| |
|
Source: National Audit Office
Note 1: These figures are expressed in constant
1991 prices discounted at 6% a year to 1991 base year. This is
how toll revenues are measured within the Skye concession contract
and allows the figures to be compared on a common basis
3. In December 1997, to assist regular users such
as local residents, the Department amended their agreement with
the operator to allow the introduction of new lower discounted
tolls from January 1998 for those who purchase books of toll tickets
in advance. As a result, the Department are likely to make further
payments of some £3 million to the operator over the remaining
life of the concession[2]
which will substitute for higher tolls which these users would
otherwise have paid. The precise amount to be paid will depend
on the number of users of the bridge but, as these new payments
will count against the £24 million target revenue for
the operator, they will not increase the total expenditure on
the bridge project.
4. In addition to this expenditure the Department
are also forgoing the income previously generated for the public
sector by the ferry service which the bridge replaced (about £1 million
a year).[3]
5. On the basis of a report by the Comptroller and
Auditor General the Committee took evidence from the Department
on how far they had achieved their objectives, on the costs of
the bridge, on the value for money, and on the limited extent
of the competition achieved for the project. In doing so, we had
regard to the fact that the Skye Bridge contract was agreed in
1991, before some of the guidance on privately financed projects
which now exists had been developed.
6. Our examination of this case provides many important
lessons for departments and other public bodies implementing future
PFI projects.
7. Overall our main conclusions in this case are:
(i) A better comparison of alternative options
was needed
In negotiating the deal with the only acceptable
bidder to emerge from the competition, the Department did not
make a systematic comparison of the costs and benefits of the
proposed deal with alternative options (such as continuing with
the ferry service). This was a serious omission in their evaluation
of the project which leaves a question mark over its value for
money. We note the Department's undertaking to consider making
such comparisons in future projects. We expect them to do so.
(ii) Toll payers' interests were insufficiently
protected
For many users the bridge is now the only practicable
means of reaching Skye: the operators are in effect monopoly providers
of an essential public service. We are not satisfied that the
Department paid sufficiently close attention to the need to protect
the toll payers from having to pay tolls for longer than necessary.
(iii) The financial terms of the deal were
not fully satisfactory
We are not satisfied that the costs of the bridge,
which are being met over time by toll payers and by the taxpayer,
are reasonable. In particular, we are concerned that the terms
on which the bridge has been provided, including the real rate
of return to equity investors of 18.4 per cent a year, were not
determined competitively. As the financial market for PFI deals
develops, we look to Departments and their advisers to seek ways
of securing improved terms in such contracts.
8. Our further detailed conclusions and recommendations
are as follows:
On the achievement of the Department's objectives
(i) The Department achieved their primary
objective, the provision of a privately financed tolled crossing
to Skye. Compared with the former ferry service this has brought
a number of benefits to people travelling to and from Skye, including
shorter journey times and a more reliable service in bad weather.
The Department did not fully achieve their other objectives in
relation to the level of tolls, the duration of the concession
or the design of the bridge. Our reservations on these are set
out below (paragraph 26).
(ii) The Department expect traffic to continue
to grow at a rate that will allow the bridge to become toll free
within 14 and 17 years from opening, with tolls kept below the
level of the former ferry fares. But we note that the contract
does not guarantee either that the bridge will be toll-free within
the Department's 20 year target period, or that tolls will remain
lower than their target level (paragraph 27).
(iii) Following the Government's decision
to set lower tolls for regular users of the bridge, the Department's
further payments to the operator of some £3 million
over the remaining life of the concession will count towards the
£24 million target revenue for the operator. While the
new payments do not increase the total revenue the operator will
receive, they may increase the operator's profits from the project.
This is because, given the target toll revenue, the operator's
profits depend on the length of the concession: the shorter the
concession, the shorter the period for which the operator must
bear the operating costs of the bridge, and hence the higher the
profits (paragraph 28).
(iv) We would have expected the Department
to have negotiated a revised agreement for tolls which minimised
their own extra costs and which was financially neutral for the
operator. But there is no assurance that this will be the case.
Because the new lower tolls are likely to generate extra traffic,
over and above the levels there would have been under the original
toll regime, the operator is likely to reach the £24 million
target revenue sooner than previously expected. And because the
new agreement does not take full account of this likely earlier
flow of revenue, this means that the operator's profits are likely
to be higher than previously expected (paragraph 29).
(v) The principal test of the Department's
objective to ensure a satisfactory design of the crossing was
the outcome of the public inquiry which in 1992 examined the proposals
put forward by the operator and the objections that had been made
to them. The Department were not wholly successful here, since
the design did not attract unanimous support, and while the report
of the public inquiry endorsed the design this was subject to
a number of modifications which were carried out largely at the
expense of the Department (paragraph 30).
On the costs of the bridge
(vi) The £39 million cost of the bridge
falls directly both on the toll payers and on the taxpayer. Together
they will pay the amount the winning private sector bidder estimated
as necessary to cover the cost of construction, the cost of operating
the bridge over the lifetime of the concession, and the cost of
financing the concession. It follows that to minimise the costs
to toll payers and to the taxpayer, it would have been necessary
for the Department to have persuaded the winning bidder to accept
the lowest estimates of likely costs (paragraph 54).
(vii) In the event the estimated costs rose
rather than fell during a period of exclusive negotiations with
the winning bidder. The Department accepted the bidder's argument
that traffic flows might not increase over the concession period
in line with the Department's own expectations. The effect of
this and other concessions made during exclusive negotiations
is that the target toll revenue figure rose to £24 million
from £22 million increasing the burden on toll payers
by some £2 million. It also means that the operator will
get the benefit of this additional income if, as now seems likely,
their own more pessimistic traffic forecasts are exceeded (paragraph 55).
(viii) This upward pressure on the costs
of the bridge arose because the Department were negotiating this
aspect with a single bidder as a result of financing difficulties
encountered by that bidder. The Department did not detect the
risk of such difficulties before entering into exclusive negotiations
because they relied on an assurance from the Bank of America,
who were the financial adviser to the bidder, that the proposed
method of finance was achievable. In the event it was not and
we criticise the Department for relying on an assurance, which
provided no real security (paragraph 56).
(ix) Following objections to the preferred
design on environmental and aesthetic grounds, the Department
agreed with the operator to pay an additional £4 million
in real terms to cover costs arising from the delay caused by
the need for a public inquiry and from the recommended changes
which resulted. The Department were unable to persuade the private
sector to accept the risk of such additional costs. We note that
subsequent Treasury guidance is that such risks should be retained
in the public sector as being best able to handle them. This guidance
casts doubt on the practicality of awarding contracts for privately
financed projects before statutory planning procedures have been
concluded (paragraph 57).
(x) The Department believe they would have
encountered the same level of construction costs had they promoted
the bridge at a public inquiry before, not after, proceeding with
a competition. But if the competition had followed the public
inquiry then the additional costs would have been subject to competitive
pressure. We note the Department's assurance that lessons have
been learned from this project, though they have not said what
these are (paragraph 58).
(xi) The Department consider that the financing
terms on which the bridge has been provided are not out of line
with other private sector projects concluded at the time. But
neither the real rate of return to equity investors of 18.4 per
cent a year nor the terms of the index-linked bonds which formed
the next tier of financing were determined competitively. The
terms of neither of these forms of finance were readily capable
of being benchmarked against the market. There was, moreover,
clear evidence of market imperfections, such as the fact that
at the time of the deal there was only one potential provider
of the index-linked bonds. This calls into question the validity
of such benchmarking as may have been possible (paragraph 59).
(xii) The experience of privatisation has
shown that Departments are able to learn from experience and put
pressure on the market to deliver increasingly good value for
money in successive deals. We therefore look to Departments and
their financial advisers to secure improved terms, as the financial
market for PFI deals develops (paragraph 60).
(xiii) In those cases in which negotiation
cannot be avoided, Departments should protect themselves from
making unnecessary concessions to the bidder by developing a clear
negotiating limit and by taking steps to avoid unwelcome surprises,
for example by seeking independent confirmation of the likely
viability of bidders' financing proposals (paragraph 61).
On the limited extent of competition for the project
(xiv) Departments must try to secure effective
competition as the basis for any commercial deal, whether for
privately financed projects, public private partnerships or for
other types of procurement. Shortlisting too few bidders or failing
to maintain competitive tension throughout negotiations, as in
this case, will increase the risk of poor value for money. But
there is a danger too that the high cost of tendering for private
finance projects may discourage bidders if too many are shortlisted,
and this may also weaken competition (paragraph 69).
(xv) For this reason Departments must consider
carefully the balance between having too few and having too many
bidders, and how this is likely to affect value for money. Departments
must also try to minimise the cost of tendering in order to maximise
the number of potential final bidders. It will be very important
to keep these aspects in view as experience of projects grows
(paragraph 70).
(xvi) The Department decided not to apply
competition for the appointment of their advisers. This was contrary
to good practice, unfair and imprudent. Competition would have
been no barrier for getting the best people for the job. Indeed
it would have reinforced the selection of the most suitable advisers.
And the way in which they were appointed makes us all the more
concerned that the Department failed to set budgets for their
advisers. As our predecessors' reports have noted, this is an
elementary element of sound financial control. Departments must
ensure that they carefully assess at the outset their likely costs
in managing private finance deals, and set budgets and manage
and monitor costs accordingly (paragraph 71).
On value for money
(xvii) The Department decided against calculating
a public sector comparator for this project on the grounds that
such a comparison would have been false and misleading since they
had no intention of funding the Skye Bridge except as a privately
financed project. But it is highly unsatisfactory that a Department
can seek to avoid having to carry out a thorough comparative evaluation
of a proposed project merely by asserting that public finance
would not be available for a conventional solution (paragraph 78).
(xviii) The Department took a narrow view
of the amount of taxpayer's money in the project, looking only
at their direct contribution to the project. But the project involved
the public sector forgoing the income from the former ferry service,
which was generating profits at a rate of £ 1 million in
its last year of operation, to the benefit of the taxpayer. We
expect Departments to consider the full implications of projects
for the taxpayer, including not just direct expenditure but also
indirect costs, such as income forgone. We also expect Departments
to seek good value for those users, whether or not taxpayers,
who will be required to pay for monopoly services (paragraph 79).
(xix) Because every decision to proceed
with a privately financed project must involve rejecting some
alternative, systematic comparisons are the key to prudent decision-making
in this area. We criticise the Department for not having carried
out such a comparison. We note their assurance that, in similar
circumstances, they would now look carefully at preparing a comparator
(paragraph 80).
(xx) In the absence of such a comparison,
and given that competitive tension did not apply in the final
stages of the negotiation of this deal, a question mark must remain
over the extent of value for money obtained by the taxpayer and
the toll payer from this project (paragraph 81).
1 C&AG's Report (HC 5 of Session 1997-98) para 1 Back
2
Evidence, Appendix 3, p26 Back
3
C&AG's Report paras 4, 5 and Figure 2 Back
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