Supplementary memorandum submitted by
the Department of the Environment, Transport and the Regions (PAC
1. The following explains the Department's
position on the NAO's conclusions on the cost benefit case for
the CTRL. It covers the analysis that was undertaken in 1998,
which is the subject of the NAO's comments, and also more recent
information that has been generated during the recent work on
Section 2 of CTRL.
THE 1998 ANALYSIS
2. As noted in the NAO's report, the Department
and NAO did not agree on the appropriateness of the inclusion
of monetary regeneration benefits. The report notes the Department's
view that the methodology was sufficiently robust to allow inclusion
of these benefits in the value for money assessment. Recognising
this difference of view, the NAO report records appraisal results
with and without the regeneration benefits.
3. The NAO also queried some of the assumptions
made in 1998, as discussed at paragraph 3.35 of the NAO report.
The Department's position on each point is set out below.
(a) "the Department used out-of-date
economic growth assumptions to estimate time saving benefits"
4. The 1998 appraisal updated the appraisal
undertaken in 1996, but did not incorporate revised economic growth
assumptions produced in November 1997. The Department agrees that
the use of up-to-date economic growth assumptions would have provided
the most accurate appraisal.
(e) "the assessment made incorrect assumptions
of the amount of time savings"
5. The Department questioned the NAO's criticism
on two main counts:
The Department was using the most
up-to-date information that was available to it at the time.
The NAO's "corrections" are based on the LCR Key Assumptions
book which the Department provided to the NAO to inform their
study. However this book was not available until June 1998, whereas
the Department's appraisal was prepared in the period January
to May 1998.
The Department's appraisal properly
took account of the different time savings to Waterloo and St
Pancras passengers. The July 1996 timetable on which the Department
based its assessment produced a weighted average time saving of
32 minutes, rather higher than the average 30 minutes actually
assumed in the Department's appraisal. So the 30 minutes was not
an incorrect assumption at the time. (This was explained in the
Department's letter to the NAO of 1 November, which was circulated
to the Committee.)
6. Appendix 8 of the NAO report records
the differences between the Department's and the NAO's assumptions
on the level of time savings. That Appendix also notes that the
latest timetables show time savings which are close to the 1996
figures used by the Department than to the LCR Key assumptions
used by the NAO.
(b) "in the May 1998 assessment, the
Department removed costs of London Underground works and road
works which depend on the link"
7. The Department and the NAO agreed that
the costs of the King's Cross works attributable to the Link should
be included in the value for money assessment of the Link. The
NAO report notes that these costs did not appear in the Department's
final value for money assessment. The final presentation of the
appraisal adopted a simplified approach, which did not separately
identify these costs. However, previous more detailed appraisal
work had included these costs as £130 million. At the same
time that these costs were omitted, the same appraisal rounded
the total benefits figure down by some £400 million in recognition
of the inevitable uncertainties surrounding such estimates (see
Note 1 to Table 19 of the NAO report).
8. The costs of the King's Cross Underground
works have been assessed by London Underground (LUL) on a number
of occasions. The works are needed to complete implementation
of the recommendations of the Fennell Inquiry into the King's
Cross fire, as well as to provide additional capacity to provide
for future passenger growth, including when CTRL opens. As the
specification of the LUL project has developed, so the costs attributable
to the Link have changed.
9. In April 1997 the total costs of the
King's Cross LUL works were assessed by LUL to be £150 million
in present value terms. In the previous appraisal work the Department
ahs assumed expenditure of about £30 million was already
committed (to Fennell works) and would go ahead in the absence
of the CTRL. Therefore, taking account of the additional costs
the Link imposed on the design of the A2/M2 widening scheme, the
Department had been using a value of £130 million in early
appraisal work. £150 million less £30 million plus £4
million for A2/M2 comes to about £130 million.)
10. During the course of the NAO's investigation
the Department advised the NAO that the appraisal should have
been using a value of £170 million. This value took account
of proposals to take forward the Fennell works at King's Cross
in advance of Section 2, in the light of further design and cost
work that LUL had undertaken. The revised cost assessment of £170
million assumed that a proportion of the southern and western
ticket hall works, as well as all of the northern ticket hall
works, were CTRL dependent. The latest assessment is set out in
paragraph 22 below.
(d) "the calculations are inconsistent
with LCR's assumptions"
11. The NAO report notes that the Department
agrees that some provision for the purchase of additional rolling
stock should have been included in the financial modelling to
accommodate the passenger growth forecast. This would have had
implications for LCR's financial position, which would in turn
have had implications for public sector support and hence the
value for money appraisal. Since 1998 LCR has updated its business
plan to include provision for eight additional train sets and
using latest passenger forecasts would comfortably accommodate
current forecasts of passenger growth on the Link to at
12. The Department believes that the impact
of this adjustment would have been relatively minor. The present
value of a new train purchased in 2030 is about £6 million,
but the net effect on public sector support would have been less
than this, depending on the effect on LCR's annual net cash flow.
Other appraisal issues
13. The NAO re-worked the Department's appraisal
of domestic benefits to assume the phased construction of the
Link. The Department agreed that this would give a more accurate
assessment of value for money, but questioned whether the absence
of this adjustment was a legitimate criticism of the May 1998
appraisal, given that, as the NAO report notes at Appendix 8,
the phased OPRAF results came from a paper in June 1998.
14. The key difference between the Department
and the NAO, in terms of both principle and impact on the appraisal
result, was over the inclusion of monetised regeneration benefits.
The Department considers that the inclusion of these benefits
was robust and appropriate. The Department also considers that
its assumptions on international time savings were sound and that
the NAO's point about trains was not significant in a presentation
which rounded benefits and costs. The Department agreed that a
more accurate representation of the position in 1998 would be
made with the NAO's adjustments for the value of time growth rates
and LUL costs and that an appraisal conducted after June 1998
could have taken account of the phased appraisal of domestic services.
We estimate that a 1998 appraisal reflecting these points would
have shown a benefit cost ratio of 1.4:1 on the Central Case,
and just of 1.0:1 on the Downside Case.
15. In considering the case for Section
2, the Department has reviewed a number of the key assumptions,
and the main changes to items covered in the NAO's analysis are
set out below.
International non-financial benefits
16. Capacity at Waterloo: in the 1998 appraisal
we assumed that this was about 19 million passengers per annum.
We have now refined this assumption. Current advice is that the
capacity limit will be reached when demand reaches 70 per cent
of the seats available. This compares to Eurostar's management
assumption of a 65 per cent average load factor and load factors
of between 70 to 75 per cent on short haul scheduled airlines,
with business class. The maximum seat capacity at Waterloo is
22 million hence demand is capped when it reached 15.4 million
per annum. The 2001 appraisal therefore scores a greater benefit
for the release of capacity constraint at Waterloo.
17. Time savings: the most up-to-date Eurostar
timetable indicates the Section 2 time saving is 18.5 minutes
for most services; for appraisal purposes an average time saving
of 17.5 minutes has been used. In addition, on advice from Booz
Allen and Hamilton, the consumer surplus calculation has been
extended to include the benefit from increased train frequency
with completion of Sections 1 and 2. This was based on SRA's standard
method of assessing the benefits of increased inter-city services.
18. Passenger forecasts: we have used the
latest Booz Allen and Hamilton Eurostar forecasts, which, for
example, have a mid forecast of about 11.5 million passengers
for 2010the same level forecast in the 1998 Government
Downside scenario for that year.
Domestic non-financial benefits
19. The SRA has been reappraising CTRL domestic
services. Initial conclusions indicate the economic case for domestic
services is not as favourable as thought in May 1998 when OPRAF
estimated a BCR of 1.6:1. Further work is needed before firm conclusions
can be drawn.
20. Regeneration benefits have been reduced
in proportion to the reduction in international non-financial
benefits, that is by 70 per cent. NAO adopted the same approach
in their analysis of the Government downside case, at paragraph
3.40 of the report.
Reduced Thameslink 2000 benefits
21. Since the 1998 appraisal, it emerged
that considerable further work was needed on the Thameslink project,
unconnected with CTRL. It is now clear that CTRL is not delaying
Thameslink, which is still subject to the TWA planning approval
process. Thameslink delay costs have therefore been excluded from
the CTRL appraisal.
LUL and A2/M2 costs
22. At the PAC hearing of 9 April Sir Richard
Mottram quoted the Department's latest estimate of the costs of
the LUL works at Kings Cross, at £100 million. The Department's
latest appraisal work considers only the northern ticket hall
costs, plus a proportionate share of common costs, as part of
the cost of CTRL. This reflects the current view, shared with
LUL, that only the "northern" ticket hall would not
be built in the absence on the Link. The estimate is based on
LUL's latest cost estimate prepared in January 2000. Although
the total costs of the project has increased, the share of the
CTRL dependent element has reduced.
Access charge loan facility
23. The exact amount of public sector support
is still subject to confirmation. However, based on the Section
2 Statement of Principles with LCR and Railtrack, the expected
level of public sector support is £220 million in the new
"mid" case and £780 million in the new "low"
New Eurostar revenue forgone
24. This has been reduced by 70 per cent
in line with the reduction in demand between the 1998 and 2000
25. Taking account of these changes, the
Department currently estimates a benefit cost ratio (BCR) for
the whole link of about 1.5:1 on the Department's current mid
case, even if domestic benefits are excluded (pending conclusion
of the SRA's work). On the "worst case" forecast, the
benefits may not exceed costs, depending on the benefits from
domestic services; but the Department regards this forecast as
very unlikely to materialise.
26. At the time of the restructuring, the
robustness of LCR and its financial structure were tested through
a financial model, using two sets of assumptions. These were the
Government Central Case and the Government Downside Case, which
were intended to represent a best estimate of LCR's cash flow
and a reasonable worst case, respectively. The assumptions underlying
these two cases, at the time of the restructuring in 1998, were
The Government Central Case assumed
Eurostar performed per the Booz Allen Central Case forecasts (which
had a 50 per cent probability of being met or exceeded) and construction
costs of both sections followed the 75 per cent confidence levels
The Government Downside Case assumed
Eurostar performed per the Booz Allen Downside Case forecasts
(which had a 80 per cent probability of being met or exceeded,
higher in earlier years) and construction costs of both sections
were at a realistic worst case (with overall spend on construction
costs 20 per cent higher than in the Central Case).
27. Assumptions were also made regarding
interest rates, using market forecasts. Taking a set of operating
assumptions, the model is able to predict the point at which the
revenues from EUKL are sufficient to pay its operating costs,
capital expenditure, CTRL access charges, LCR head office costs
and LCR's debt service obligations (the "LCR break even point").
LCR break even was predicted to be in 2022 in the Government Central
Case, and in 2024 in the Government Downside Case.
28. The forecasts of Eurostar performance
and construction costs have been updated recently, to provide
a new central case and worst case. On the Government's current
central forecasts, the model predicts that LCR will break even
in 2029. The break even point is quite sensitive to the timing
and method of replacement of the Eurostar trainsets, on which
the assumptions have also changed since 1998. It is therefore
not possible at this stage to say precisely when, in the second
half of the 2020s, LCR would break even.
29. On the Government's current "worst
case" forecast, LCR is predicted to break even in 2032.
30. At the break even point the Government
will start to receive 35 per cent of LCR's profits. The Government's
share of expected future profits from LCR will reduce the required
level of public sector support for the Link in the longterm. Decisions
on the CTRL have been based on the expected economic benefits
that will derive from the Link, including time savings and regeneration
benefits, compared with the cost of Government support.
31. In June 1999, the Department commissioned
Arthur D Little (ADL) to make an assessment of the costs and benefits
of Regional Eurostar services. The assessment was informed by
extensive consultations with interested parties including representatives
of local councils, regional assemblies, chambers of commerce,
the Scottish Executive, local transport authorities, local development
32. The study assessed the options against
the Department's standard range of financial, social, economic
and environmental criteria, following the conventions of the New
Approach To Appraisal. ADL considered the regeneration benefits
of Regional Eurostar services using methods recommended by DETR
appraisal guidance. Regeneration impacts of Regional Eurostar
were not quantified in monetary terms.
33. The appraisal of regeneration benefits
had to take account of the likely characteristics of Regional
Eurostar services. ADL assumed Regional Eurostar services, unlike
the CTRL, would not involve the development of any new station
sites. Some infrastructure upgrading work would be necessary before
Regional Eurostar services could operateindeed some advance
work had already been undertaken. The existing fleet of seven
Regional Eurostar train sets would, for example, allow one daily
service between Glasgow, Newcastle and Paris, two between Manchester
and Paris (one via Birmingham) and one between Birmingham and
Paris. Door-to-door journey times would generally be quicker through
use of competing air services on these routes and air would also
offer a much higher frequency of service. Moreover, a combination
of domestic rail with interchange to Inter Capital Eurostar would
generally offer a faster and more frequent alternative to Regional
34. In the consultations many of the interested
parties commented that Regional Eurostar would have a beneficial
impact on regional economies. Consultees in all regions saw having
an address on the network as important if the regions were to
compete effectively within Europe. On practical grounds, they
believed that having both rail and air connections would increase
the reliability of travel services. Some took the view that Regional
Eurostar's main economic impact would be to bring new leisure
travellers into the regions.
35. ADL found these suggestions hard to
substantiate, with little evidence of pressure for regional services
from outside the political and economic development interests.
In focus groups, most individuals favoured air travel between
the regions and the Continent for business and leisure purposes.
ADL's analysis showed that the net benefits to the regional economies
from Regional Eurostar would be small, for several reasons:
the number of newly generated passengers
was expected to be small. Most Regional Eurostar passengers would
travel anyway, by air, coach, or domestic rail and Inter Capital
Eurostar services. Regenerative impacts gained through making
the journey would, therefore, be achieved without Regional Eurostar.
The benefits of an address on the
network are mainly to do with image and presentation, rather than
meeting an essential travel need or generating economic growth.
Regional Eurostar would generate
more new tourist traffic from the UK to the Continent than to
the UK, leading to a net economic loss for the regions.
The benefits at Regional Eurostar
stations, including those in assisted areas (assumed, for appraisal
purposes, to be: Newcastle, Manchester, Glasgow, Coventry, Birmingham
and Doncaster) are limited by the low frequency of services. Regional
Eurostar services would account for a very low proportion of total
passenger numbers at those stations.
36. In addition, ADL compared its analysis
for the United Kingdom with studies of the actual impact of the
introduction of TGV services on regional economies in France.
Studies of the French experience of new high-speed rail services
have found it difficult to detect substantial economic impact.
All the studies demonstrate growth in leisure traffic but the
impact on business traffic is less obvious. The services have
not had a major impact on the distribution of economic activity
between Paris and the provincial cities, or on the overall rate
of economic growth in these cities.
37. ADL concluded that "overall very
little economic benefit is expected" from Regional Services.
38. The decision to guarantee bonds issued
by LCR took account of a number of considerations, including the
Direct Government finance would have
weakened the incentives for good management of the project, and
encouraged a view that the Government would find more money if
Direct Government funding would also
have sent a signal to other PPP and PFI projects that Government
would fund future projects that went wrong.
The GGBs approach avoided the Government
bearing the risk of a more time consuming process of obtaining
EU clearances for State Aids and procurement rules, which would
have delayed the project.
Using GGBs avoided the risk that
the Government's cost of borrowing might increase over the period
in which it was funding the project.
The expected additional costs of
GGBs compared with gilts.
39. The benefits of GGBs could not be quantified
in monetary terms. At the time the decision was taken, Ministers
could not have been certain what the cost would turn out to be,
dependent as it was on market conditions at the time. They were
content that at an order of magnitude of £80 million, the
extra costs of the GGBs was justified, recognising that actual
costs could turn out to be higher. The decision was finely balanced,
and whilst a significantly higher expected cost of GGBs would
have led to a different conclusion, it is not possible to say
precisely at what point gilts would have been preferred.
40. There were three tranches of GGBs issued
in 1999 with maturities in 2010, 2028 and 2038. The 2010 bonds
are expected to be fully repaid from the cash LCR will receive
from Railtrack when it purchases the assets of Section 1. As part
of the 2001 deal securing the future of Section 2, Government
has agreed that Railtrack can securitise the access charges it
is to receive from Eurostar in order to fund this purchase. Given
that Railtrack's purchase of Section 1 is therefore effectively
self-funding and not in doubt, the guarantee on the 2010 bonds
is only likely to be called if Section 1 is not complete and available
to be purchased. This would represent a seven-year delay in construction
and is therefore considered an extremely unlikely scenario.
41. The 2028 and 2038 bonds are due to be
repaid from future Eurostar cash flow. The Government has assumed
that the Access Charge Loan would be available to cover LCR's
cash shortfall up to the point where it breaks even, and would
also provide some headroom before LCR had to call under the guarantees.
42. In the event that LCR had not been able
to build up sufficient cash to repay the bonds as they fell due,
and provided Eurostar break even was within sight, the bonds might
be able to be refinanced without a Government guarantee, ie financiers
would be reliant upon Eurostar's cash flow alone. The ability
to refinance would depend upon financial markets at the time and
the view taken by financiers about Eurostar cash flow forecasts.
However, at this time our financial advisers believe that Eurostar
could withstand scenarios which are more pessimistic than the
original Government Downside and still be able to refinance the
debt without a Government guarantee.
43. Thus the guarantees on the 2028 and
2038 bonds are only likely to be called if LCR has been unable
to build up sufficient cash reserves, if Eurostar performs well
below current, relatively pessimistic, assumptions and LCR is
unable to re-finance the debt. The point at which the guarantees
might be called is therefore a matter of judgement rather than
precise calculation, but for the reasons set out above the Government
continues to regard the likelihood of such a call as small.
44. The assessment of bids in the original
competition was carried out in accordance with the tender evaluation
criteria which were set out in the Competition Overview of August
1994. The two main criteria were the size of the Government contribution
required and the willingness of the tenderer to assume responsibility
for risk, and a central factor in relation to these two criteria
was the tenderer's proposal on the timing of the contribution.
45. The assessment included an appraisal
of whether the bidders' plans were achievable, and in particular
whether they would be able to achieve their main project financing.
46. This appraisal noted that London and
Continental was more optimistic than Eurorail both in its estimates
of construction cost and in the net revenues EPS could generate;
and that achievability of Main Financing would be affected by
the degree to which London and Continental had deviated from its
current forecasts in either or both respects by the time it reached
Main Financing. London and Continental's financial advisers, SBC
Warburg, considered that they could achieve Main Financing even
if construction costs increased by 20 per cent and forecast revenues
were 15 per cent lower.
47. Maunsell (the Department's technical
adviser) estimated that there was a one in two chance that the
London and Continental construction costs would go up by 12 per
cent but only a one in twenty chance that the cost would go up
by more than 15 per cent. This allowed for some six months' delay
in the construction period; this would increase to, say, 20 per
cent for a programme delay of one year.
48. The Department's advisers were not able
to be as precise about the downside risks on the revenue side,
because much depended on the ability of the consortium to initiate
and realise its marketing plans. The advisers assessed that London
and Continental had the most strongly led and best developed marketing
strategies for EPS of all four original bidders. Thus, whilst
London and Continental were projecting much higher EPS passenger
numbers than Eurorail (which closely mirrored the expectations
of EPS in the early years), it was considered that London and
Continental's better marketing plans could deliver the additional
revenues. The appraisal did, however, note that the EPS marketing
plan forecasts were some 25 per cent lower than London and Continental's
forecasts, and the compromise EPS/SNCF forecasts were lower still.
The appraisal pointed out that this was an indication of the improvement
which London and Continental would need to achieve.
49. The appraisal noted that London and
Continental advisers believed that the business could support
an increase of 20 per cent in construction costs and a 15 per
cent decrease in revenues and still raise the required levels
of equity. On the banking side, its supporting banks had taken
into account a downside scenario of a 22.5 per cent increase in
construction costs, a 20 per cent decrease in revenues and a year's
delay in construction. Even at these levels there were still available
bank facilities of over £400 million. Our advisers concluded
that judging by the various ratios and project returns, these
downside scenarios appeared to be at the limits of financeability.
50. The methods used to assess the regeneration
benefits of the Link are described in the NAO report in Appendix
7 paragraphs 16 to 20. Two methods were used. One assessed the
impact of the Link on development values, the other was based
on the number of jobs expected to be created and the cost of creating
a similar number of jobs through other regeneration programmes.
51. The aim of the development values approach
was to estimate the scale, nature and timing of development in
the areas of King's Cross, Stratford, Ebbsfleet, and the Royal
Docks which would be influenced by the Link and its new international
stations and hence give rise to increases in land values. This
was a speculative exercise and was based on a number of broad
assumptions and not a series of valuations. The approach adopted
Identify the main vacant and under-used
sites which will be affected by the Link and contribute to regeneration
in the area. The list of development sites considered was based
on advice from Government offices and property consultants, Llewelyn-Davies.
To assess the potential development
on each site under two scenarios; a base case (without the Link),
and a second scenario with the Link. The base case assumed likely
development with a continuation of existing trends and policies.
Assumptions were made about existing property and uses, the areas
of land capable of development, the nature of the development,
value, dates of commencement and completion. This included effects
that were already taking place from Thames Gateway policy initiatives.
52. HM Treasury guidance
on the assessment of regeneration projects contains four caveats
about the developmental values approach of relevance to this appraisal.
double counting, the land values
reflect the time saving and other benefits of the transport link
and have thus already been counted in the appraisal;
displacement, economic activity which
is engendered in the CTRL area may be at the cost of activity
displaced from elsewhere;
anticipation, land values capitalise
expected returns. Developers in the sites affected anticipate
that the Link will be built, and land values will reflect this
land market imperfections, valuation
will be very imprecise due to the infrequency of transactions
in this market, the low extent of competition, the ceiling on
local land prices and the inelasticity of demand.
53. Given these caveats, the Department
concluded that the development values approach was the less robust
of the two assessment methods used. The jobs created approach
was therefore used in the value for money appraisal. This method
was also more consistent with the usual approach adopted by the
Department in appraising regneration schemes.
54. Both methods started from a quantification
of the main regeneration outputs associated with the Link. These
were estimated to be the provision of nearly 26 million square
feet of industrial, commercial and retail floorspace, and nearly
21,000 dwellings (Table 1). These floorspace figures were used
in the assessment of development values. In addition the employment
impacts approach used standard ratios for numbers of jobs associated
with floorspace (Table 1).
Table 1: Gross Direct Regeneration Outputs
Associated with the CTRL
| ||King's Cross
55. The estimated impact of the Link on development values
was around £650 million (at 1997-98 prices). Table 2 shows
the results of the assessment by area. This indicates the uplift
in development values is equally spread between King's Cross,
Stratford and Ebbsfleet. This contrasts with the findings of the
jobs created approach which found that the majority (60 per cent)
of the regeneration impact, measured in terms of jobs created,
would occur at Ebbsfleet.
Table 2: Indicative Development Values, With and Without
| ||Without CTRL
|Uplift due to CTRL|
|Total: all areas||270
56. The Department assumed that in aggregate the displacement
effects would reduce the gross outputs of the CTRL by at most
50 per cent on the basis of evidence from the London Docklands
Development Corporation. On this basis, the net benefits using
the development values approach were at least £320 million.
Given the uncertainty concerning the actual level of displacement,
the gross additional figure of £650 million (at 1998 prices)
was considered the headline figure.
57. The second method based on the gross number of jobs
expected to be created, estimated the cost of creating a similar
number of jobs through other regeneration programmes would be
£1,000 million. The issue of double counting was addressed
by including only the proportion of regeneration benefits reflecting
the proportion of non-UK residents expected to use the Link (the
transport benefits to non-UK residents having been excluded).
A Framework for the Evaluation of Regneration Projects and Programmes,
HM Treasury, 1995. Back