Examination of Witnesses (Questions 60
- 79)
MONDAY 23 FEBRUARY 1998
MR LAWRIE
HAYNES and MR
JON SEDDON
60. It says in paragraph 2.18 over the page
that: "Rationing of total public spending on roads is decided
mainly on criteria other than the net present values", which
I understand in that there are lots of environmental and other
issues related to roads projects and I hope to come back to this
question, but is the methodology we are using with net present
values robust enough to take decisions relating to whether we
should use the PFI route or alternative routes?
(Mr Haynes) I think it is a reasonable basis to
test the market, yes.
61. In paragraph 11 right at the beginning
you talk about the comparison with "traditionally procured
and conventionally financed projects". Could you just describe
to me what are "traditionally procured and conventionally
financed projects"?
(Mr Haynes) The traditional procurement method
is to have the design paid for and contracted with one company,
the construction paid for and completed by a second company, the
operation and maintenance contracted with a third or more companies
and the operation and maintenance contracts are negotiated on
a three- or five-year basis.
62. Because I wanted to ask you the question
that comes out at the end of that sentence whether you made a
public comparator with design and build contracts and whether
you think it would be appropriate in the circumstances to use
that as a comparator?
(Mr Haynes) We did actually look at the design
and build elements. The transaction teams that made up part of
the evaluation team had experience in design and build as well
as in the ICE 5th terms of contract, so we did have
that basis for comparison in the experience and expertise and
professionalism of the transaction team.
63. You have not put any of that into the
Report. What did that show? Did that show that design and build
would be significantly better or worse in terms of being an alternative
public comparator?
(Mr Haynes) The A1(M) scheme was actually going
to be procured under the design and build concept anyway so we
had a direct comparison there. The other schemes were going to
be contracted under the ICE 5th terms and conditions
and therefore we would not have done a direct comparison on design
and build.
64. Can you tell us what that showed for
the A1(M)? What I am really trying to get at is was that closer
to the private sector alternative, the PFI alternative, should
I say?
(Mr Haynes) It is on page 34 in figure 14. The
A1(M) shows that using design and build as the basis we generated
at eight per cent a £50 million benefit and at six per cent
a £30 million benefit to the taxpayer.
65. I am sorry, I thought that the figures
in figure 14 were for the PFI route as compared with the traditionally
procured and conventionally financed.
(Mr Haynes) The conventional procurement was £96
million but I think we have to be careful that we compare apples
with apples because within here there is also a risk transfer.
I made a mistake, it is £167 million, not £96 million.
66. The issue I am trying to get at if you
look at figure 11 on page 27 my understanding is, forgive me for
not being someone who is involved in the construction industry,
that the design and build contract would allow you to transfer
the risk on numbers 1 and 3 (that is design and construction and
delivery and time) to go to the private sector over and above
what would be conventional procurement and in those circumstances
what I wanted to ask you was how much of the value of risk transfer
was associated with those parts of the risk transfer?
(Mr Haynes) I do not have that precise information
for design and construction or delivery/timing with me.
67. Would it be correct that the risk would
be transferred in the design and build contract?
(Mr Haynes) Yes.
68. Do they make up the majority of the
risks transferred? Is the majority of those values for risk transfer
related to those parts rather than the other risks that you outline
in figure 11?
(Mr Haynes) Again, I do not have the detail of
those two with me.
69. Do you think we could have some figures
in relation to what the alternatives would be in the design and
build contract? [2]
(Mr Haynes) Yes, I am sure we can
provide them.
70. Can I move you on to figure 3.20 which
is on pages 42-43. It says: "On the tranche 1 schemes contract
costs allow for shadow tolls to be rebased to compensate the operator
for the effect of any reduction in traffic." Can you tell
me in what circumstances that would come into force?
(Mr Haynes) In the event that real tolls were
brought on to the DBFO road we would take the shadow toll model
from the contractor which was generated at the beginning of the
contract and that would be used as the basis for determining if
there had been a shift of traffic from that road and the contract
then would be rebased so as to ensure the contractor in this case
is protected in the event of any change in legislation.
Mr Love: Right. Thank you very much,
Chairman.
Mr Leslie
71. When I am confronted with a barrage
of statistics and explanations and numbers and amounts of money,
particularly in the way that I read through this Report today,
I must admit I start to smell a rat a little bit because I think
for anybody trying to read through this document and look at the
public sector comparison that you make between the cost of building
these road schemes under private finance versus the costs under
normal procurement standards to the taxpayer, it is bewildering
because by the information I have got at least I have found it
very difficult to make that comparison. What I want to know is
what is the cost to the taxpayer almost in cash terms if you had
built those roads during that 30-year period normally versus how
much you are having to pay to these DBFO contractors over that
same period and I cannot seem to get it because you skew the public
sector comparison in two different ways, first of all, this business
about risk transfer and, secondly, this business about the real
annual discount rate. Do you not agree that this is a very important
thing you should be trying to get and looking at the costs to
the taxpayer in cash terms? How can you help clarify this matter
for me today?
(Mr Haynes) I have tried to explain that they
are complex deals. It is important in this to understand that
it is not simply a capital cost involved here; there is the capital
cost of building the new road, there is the operation and maintenance
cost over a 30-year period. It is not considered under the normal
simple capital cost of any road construction. There is the risk
transfer that was priced by the Highways Agency, it was then audited
by a risk consultant and then tested against the market with the
bids that were brought in. Bringing in the capital costs with
the O&M costs and the risk costs gets us to the public sector
comparator.
72. I appreciate, of course, that the operation
and maintenance costs have to be bundled in and that is why I
said that the total cost to the taxpayer over 30 years versus
how much cash you are paying out through these shadow tolls to
these private developers, and I really have to question some of
these risk assumptions you put in here because that takes a lot
of those comparisons. If you look, for instance, at the M1-A1
and you are saying that the risk is £106 million, I do not
believe it, I find it very difficult. You say there have been
delays, but paragraph 2.11 talks about how you skew some of the
traffic projection risks in favour of the developer in terms of
the M1-A1 and does not this explain a large part of the value
of this risk transfer in this case? It is overblown, is it not?
(Mr Haynes) No, as I tried to point out to the
Chairman at the beginning, the A1(m) was the contract that when
I spoke to the Chief Executive of RMG[3]
he pointed out a risk that neither he nor I had taken into consideration
of £40 million which would have been claimed against the
Agency and against the Secretary of State and against the taxpayer
if we had gone through traditional procurement.
73. That leaves the other £66 million
which is the skewing in favour. Compared to the other four schemes
you have got here paragraph 2.11 says that in the M1-A1 project
involving the sorts of things it does you changed what you call
the "sculpting factor" of the shadow toll scheme in
their favour.
(Mr Haynes) The sculpting factor--
74. Just to get the point, the M1-A1 scheme
is treated differently in terms of risk analysis from the other
schemes.
(Mr Haynes) No, they are all treated exactly the
same and in each one of these the transaction teams developed
a risk model. It was independently verified or checked by a risk
consultant and in all cases there was a very close similarity
between the Highways Agency's assessment of risk and the consultants'
assessment of risk.
75. All this risk is very difficult to quantify
in cash terms, is it not? I do not see how you can project the
specific figures over 30 years and say that this is the risk we
have managed to hand over to the private sector. It is a guessing
game, is it not?
(Mr Haynes) It is a matter of judgement because
the transaction teams we had assessing these were both the designers
of the original road, they were my staff and their advisers, who
had been worked on these roads on an operational and maintenance
basis for so many years, are professionally qualified people.
76. They are still guessing at it.
(Mr Haynes) They are making a judgement.
77. Right. Let's go to this other factor
that seems to skew the comparator. How much cash are you going
to be spending normally and how much are you going to be paying
to the DBFO contractors, this business about the real annual discount
rate. I have been trying to pin this down. On page 46 there is
a glossary of terms. Discount rate: "The percentage rate
applied to cash flows to enable comparisons to be made between
payments at different times. The rate quantifies the extent to
which a sum of money is worth more to the Government today than
the same amount in a year's time." I think that concept is
awfully confusing and difficult to understand, at least for my
simple brain. That, again, is a bit of a guessing game, is it
not? It is a stab in the dark of a figure?
(Mr Haynes) Again, it is the advice that we have
had from Treasury as to the right rate to use.
78. You cannot have absolute certainty about
that, can you?
(Mr Haynes) I have absolute certainty on the rate.
79. Maybe I should ask the Treasury that
question.
(Mr Mortimer) I agree, these things are very much
a matter of judgement. On the basic question of whether you need
to apply discounts rates I think the answer is clear. If someone
offered me £100 now or £100 in five years' time I would
say, "I will have the money now please". I could invest
cash received now, do all sorts of things with it and the money
is safer. Discounts rates are a way of taking into account the
extra value of having the money up front. The standard approach
within economic theory when you look at costs and benefits extending
over a number of years is you apply discount rates. Having said
all that, I quite agree the appropriate discount rate to use is
a matter of judgement.
2 Note: See Evidence, Appendix 1, page 16 (PAC 232). Back
3 Note
by Witness: RMG refers to A1(m). Back
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