Examination of Witnesses (Questions 1
- 19)
MONDAY 23 FEBRUARY 1998
MR LAWRIE
HAYNES and MR
JON SEDDON
Chairman
1. This afternoon we welcome Mr Lawrie Haynes
to the Committee to discuss the C&AG Report on the First Four
Design, Build, Finance and Operate Roads Contracts. Welcome, Mr
Haynes. Can I ask you to introduce your colleague to the members
of the Committee?
(Mr Haynes) My colleague is Mr Jon Seddon, who
is the Finance Director of the Highways Agency.
2. Thank you very much. Let's get straight
into questions. I am going to start with paragraph 1.13 of the
report which shows that two of the highest ranked consortia for
the two largest projects were not invited to bid for those projects.
Might better deals have been obtained if they had been invited
to bid for those projects?
(Mr Haynes) I think the process we went through
in order to establish the companies which could bid was a fairly
comprehensive process. We went through a position where we would
try and get the quality of each one of the pre-qualification companies
high enough so we could choose any of those companies and they
would still be of a quality sufficient to put a potentially winning
proposal in. At the first stage, the pre- qualification stage,
we were not looking to pick winners.
3. But you did exclude two potential winners.
Others may come back to that, I will move on for the moment. Paragraphs
1.14 and 1.15 and following show that the scope for innovation
by the bidders was constrained by the complex core requirements
against which they were required to bid. Bidders, as reported
in paragraph 1.27(f), say that the Agency appeared to show little
enthusiasm, for innovation other than in respect of financing.
Why could you not have done more to encourage innovation?
(Mr Haynes) In the first instance we were constrained
to some degree because the schemes we brought forward, or ministers
decided to bring forward, had already gone through the public
inquiry process, had gone through orders, and decisions had been
made by the Secretary of State. By definition we had made undertakings
at the public inquiries and at other meetings and that would,
of course, constrain us in the core requirements which we could
put to the DBFO bidders.
4. Was it the case that you did actually
vary some of the requirements after the bidding process had started?
(Mr Haynes) We did indeed. We varied some of the
requirements subsequently when there has been an obviously demonstrable
case for us changing those requirements. Since the contracts had
been awarded, we have had about 3,400 claims for variations of
standards, for example, and we have elected to pursue about 3,000
of those, or allowed the DBFO companies to pursue about 3,000
of those. In terms of innovation, we have had 372 requests for
variations to bring in innovations and we have allowed 94 per
cent of those.
5. So you do accept it is possible to allow
variations post the statutory process?
(Mr Haynes) Yes, but in each one of those cases
we have kept to the Secretary of State's statutory obligations
which we had to keep to in order to sign the orders in the first
place.
6. Again, others may want to come in on
that at some point. Paragraphs 1.11 and 1.28 to 1.33 and Figure
2 show that the procurement process took a long time and cost
both the public and private sector players considerable sums of
money. Why was this and what steps did the Agency take to improve
on these points for current and future projects?
(Mr Haynes) Yes, the process was a long one. These
were pathfinder schemes, they were experimental schemes, and we
had gone through a great deal of consultation with the industry
and the city before we commenced them. Their complexity, given
that they were 30 year contracts, necessitated us to have extremely
clear financial models. We elected to create a model contract
with terms and conditions before we went into the competition
fully and that did indeed extend the time it took us to complete
the deals. I think the time taken was extremely long. We have
learnt some lessons from that. We now have our model contract
which we are using or will be using for subsequent contracts,
we have the direct agreement which is now with the banks, and
is now going to be used as a normal document, and indeed we have
passed those documents at no cost to local authorities and other
authorities who wish to use the DBFO approach. So hopefully for
industry we will be reducing the cost and time required for future
transactions.
7. From memory your adviser costs were pretty
high as well, were they not?
(Mr Haynes) Yes, they were £8.3 million for
the first eight DBFO contracts.
8. Why so high for that?
(Mr Haynes) There are basically three elements
in there. Firstly it was a development of the policy. Ministers
had asked advisers to give some advice on the policy generation
of whether the schemes were viable or not. Secondly, they were
giving us project advice on the first four, which is within the
NAO report, and thirdly they gave us project advice on the second
tranche, tranche 1A. So those costs were all encompassed in those
three elements of the price.
9. Paragraph 1.16 states that bidders were
required to bid on the basis of shadow tolls. Paragraph 2.9 explains
that the private sector is not in a position to manage traffic
volume which underpins the use of shadow tolls. Why was this approach
chosen? Could bidders have been offered the opportunity to bid
on a different basis?
(Mr Haynes) This approach was chosen primarily
because ministers wished to follow a policy line of getting the
industry used to the potential of real tolls. In fact the Chancellor
in 1992 had suggested a real motorway tolling system was being
considered. It was subsequently followed by the Secretary of State,
and the DBFO-design, build, finance and operate-was an opportunity
to test the market on that. Linking that policy approach to shadow
tolls was a direct connection. It would get the industry familiar
with the role of being a network operator, a road operator, and
maintain that. So that was one of the primary reasons for using
shadow tolls.
10. Do you accept that imposed greater risks
on the private sector than would otherwise be the case without
particularly reducing your risks?
(Mr Haynes) I think there were new risks involved
here, yes.
11. Paragraph 2.21 states that the discount
rate you used overstated the net benefits of these projects. Why
did you appraise these privately financed projects using a discount
rate which the Treasury recommended for publicly financed roads?
(Mr Haynes) We used the 8 per cent discount rate
on the guidance and instruction of HM Treasury. I believe they
gave us that advice because we would be comparing roads with rail
at that time, in other words two infrastructure industries would
be comparable on a similar basis.
12. I will let others provide a flood of
questions for you and the Treasury on that subject. Paragraph
2.16 to 2.19 and Figure 14 show that had the correct discount
rate of 6 per cent been used, the A69 project was significantly
more expensive using private finance, and the A419/417 was marginally
more expensive. Would you agree that in the light of these figures
these deals do not represent value for money?
(Mr Haynes) Well, there are some non-quantifiable
benefits which come from these deals as well as the value for
money element which is generated by the 8 per cent or 6 per cent,
the minus 5 or minus 12 million. Ministers were clearly involved
in this and were very much aware of the fact these potentially
would not be value for money on an arithmetic basis. We took the
view that on a wider basis, in other words generating a road operating
industry, it was a reasonable approach to go ahead with these.
On the A69, one of the things we wished to do, within assessing
the overall industry which would be generated with tranche 1,
was to look at the A69 as a maintenance-led contract, in other
words a small capital element but a very large maintenance element,
and it would give us an opportunity to benchmark that contract
in the long-term future.
13. That is an interesting answer on qualitative
matters, but can you give me a yes or no answer on this, that
according to these figures the A69 would have been cheaper to
build under public control?
(Mr Haynes) Yes.
14. Thank you. How far does the experience
with these first four contracts confirm the Agency's assessment
of the benefits of the private finance approach to road projects?
(Mr Haynes) I think we have been very pleased
with the way the contracts have gone to date. The A419/417 was
delivered early, the A69 was delivered early, so the economic
benefits of those projects have come forward earlier than we could
have expected. The risks we would have expected under the conventionally
procured systems have not come forward. We would normally, as
this Committee reviewed some years ago, expect a cost over-run
on the contracts. I actually visited the A1(M) about three weeks
ago to talk to the chief executive of RMG and he informed me that
if we had procured under the normal, traditional contract at this
point he would have been putting in a claim for £40 million
for unforeseen ground conditions, and indeed would also have been
negotiating an extension of time on that contract of one year.
So those non- quantifiable benefits have already come forward
to date. We have also seen a change in the attitude amongst the
companies involved and they are very clearly looking on a whole
life costing basis to put long-term maintenance regimes in place
and higher standard capital in place. I think that will be beneficial
over the life of the contract.
15. Paragraphs 3.1 to 3.17 set out the monitoring
and legal arrangements in place to ensure service requirements
are delivered. Are they working in practice?
(Mr Haynes) Yes, they are. We have teams, both
at the departmental agent and the departmental representative
levels who are working extremely well with the contractors. The
systems for monitoring the shadow tolls due to be paid and the
auditing systems are working very well. So things are working
reasonably well at the moment.
Mr Hope
16. Can I begin by raising the fact that
the whole of the bidding process and so on relies on the payment
of these shadow tolls, as set out on page 15. On page 63, the
annex describes the three scenarios-high growth, medium growth
and low growth traffic volumes-and then on page 30, paragraph
2.10 says, "If traffic volumes vary significantly ...[this
could lead in an extreme case] to financial collapse or .... unexpectedly
high profits ...", and that this could alter significantly
up or down with all the implications that has. Do we have any
actual estimates of what those unexpectedly high profits or unforeseen
high costs might be for each scheme rather than theoretical or
hypothetical models?
(Mr Haynes) Within the document it gives a range
of expectation of where we expect the shadow tolls to be paid,
a low and high range, and the expected NPV is on the median. One
of the things we have done in the banding is to put Band 4 at
a zero toll rate, thereby limiting the liability of the Secretary
of State to that high peak of growth on traffic.
17. So that if we get the maximum growth
on, say, the A1-M1 link road or the Alconbury-Peterborough upgrading,
there will be a strict limit on the profits which might be gained
by the companies and on any cost to the Agency if the reverse
were true?
(Mr Haynes) Exactly.
18. Do we know what these figures are in
specific terms over a period?
(Mr Haynes) Sorry?
19. The cost of the unexpectedly high profit
we might see?
(Mr Haynes) We do not expect there to be exceedingly
high profits because we have capped our liability and therefore
the DBFO companies' revenues at a given figure. If the traffic
grows beyond Band 4, in other words where the zero toll is payable,
in fact the profits for those DBFO companies will come down because
they will still be having to maintain the roads although there
is a greater traffic flow.
| 
