Select Committee on Public Accounts Appendices to the Minutes of Evidence


Supplementary memorandum submitted by the Department of the Environment, Transport and the Regions (PAC 00-01/164)


  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.


  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(a)  "the Department used out-of-date economic growth assumptions to estimate time saving benefits"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 least 2036.

  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 2010—the 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.

Regeneration benefits

  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" case.

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 passenger forecasts.


  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 as follows:

    —  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 schedule.

    —  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 agencies, etc.

  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 operate—indeed 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 Eurostar.

  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 following:

    —  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 necessary.

    —  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 was to:

    —  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[2] on the assessment of regeneration projects contains four caveats about the developmental values approach of relevance to this appraisal. These are:

    —  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 expectation;

    —  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
Royal Docks

(sq ft):
Number of
dwellings with
Jobs created:
—With CTRL
—Without CTRL
Additional Jobs

  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 the CTRL

Without CTRL
(£m NPV)
(£m NPV)
Uplift due to CTRL
(£m NPV)

King's Cross
Royal Docks
Total: all areas

  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).

2   A Framework for the Evaluation of Regneration Projects and Programmes, HM Treasury, 1995. Back

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