Examination of Witnesses (Questions 1
- 19)
WEDNESDAY 27 FEBRUARY 2002
MR JAMES
NEAL, MR
DOUGALD MIDDLETON,
MR NICK
JOYCE AND
MR MARTIN
BLAIKLOCK
Chairman: Good afternoon, gentlemen. Before
we begin, we have a little bit of public housekeeping. Those who
have declarations, could they make them at this point?
George Stevenson: Member of the Transport and
General Workers' Union.
Chairman: Member of the Rail and Maritime Transport
Union.
Mr Donohoe: Member of the Transport and General
Workers' Union.
Mrs Ellman: Member of the Transport and General
Workers' Union.
Miss McIntosh: Interests in Railtrack, Eurotunnel
and First Group.
Chairman
1. Gentlemen, you are very welcome this afternoon.
Perhaps, for those of you who have been here before I do not need
to repeat this but, where you are in agreement, I would prefer
you not to repeat what somebody else has said; where you have
a different point of view, can you make that clear. Can I begin
by asking you to identify yourself?
(Mr Joyce) Nick Joyce, Assistant Director, Ernst &
Young Project Finance Team
(Mr Middleton) Dougald Middleton, Partner,
Ernst & Young
(Mr Neal) James Neal, Partner, Ernst & Young
(Mr Blaiklock) Martin Blaiklock, Independent Project
Finance Consultant
2. Gentlemen, in this room, there is a tendency
for the sound to be absorbed. You must not be misled by the microphones
in front of you: they are recording what you say, they are not
projecting what you say. We are going to need a great deal of
voice. May we start with Ernst & Young. Do you have a few
remarks you would like to make?
(Mr Middleton) I believe it will be helpful to the
Committee if we were to set out very briefly what our roles and
responsibilities were in preparing a report for the DTLR and set
out its broad conclusions for you. Ernst & Young was appointed
in October 2001 by the DTLR to undertake a review of the overall
robustness of the value for money assessment which was prepared
by London Underground. To be clear, we were not appointed to complete
a standalone value for money analysis, nor to make recommendations
on the way forward for the PPP. We were not asked to consider
alternative methods of raising capital, nor were we asked to review
the underlying assumptions in London Underground's assessment.
Based on this, our report has made some clear conclusions, but
these were subject to a number of issues, and I think it would
be helpful if I set those issues out as background. The first
is: at the time of completing our report, the final prices and
risk transfer proposals were not completed in terms of contract
negotiations, and we would assume that they will not change materially
between now and contractual close.
3. You are assuming that they will not change?
(Mr Middleton) That is right. The report is written
on that assumption, yes. The other issues are: the need to consider
explicitly the different levels of performance and cost between
the public sector comparator and PPP proposals; that the contract's
structure, although tested through the shadow running period,
remains to be tested in practice; the requirement that the contract
structure should operate efficiently once implemented; and we
are also working on the assumption that the efficiency gains which
were set out in the public sector comparator were a reasonable
reflection of what would have happened in practice, had the project
gone forward in the public sector. Based on those assumptions,
our conclusions are that the overall methodology adopted by London
Underground in the assessment of the value for money of the PPP
proposals was robust and appropriate. The second and linked conclusion
is that London Underground's recommendation that the Public Private
Partnership proposals deliver value for money is one which is
supported by the analysis, although it has to be recognised that
that judgment is a subjective one. That is all I really want to
say at this point, and I hope that it is helpful in your deliberations.
4. Well, it is interesting. Can I just begin
by asking you: since you consider it best practice to compare
the differences in cost between the public sector work programme
and the private sector bids, to understand where they are different,
can you tell us why the National Audit Office recommended the
analysis in December 2000, and why it has not been possible to
do this?
(Mr Middleton) Can I just clarify that question, Madam
Chair: is that a reference to the base cost comparator?
5. Yes.
(Mr Middleton) Yes. We agree with the NAO that a base
cost comparator would have been helpful in the value for money
analysis. The benefit that that analysis would have brought would
have been to demonstrate more fully what the cost drivers were,
and where the efficiency gains vis a vis—
6. But that was why you were doing the thing
in the first place. When we are talking about base costs, at page
17, you say: "Over 30 years, the base cost for upgrading
the London Underground is 14.74 billion for the PSC, and 15.35
billion for the PPP."
(Mr Middleton) Yes.
7. You are saying that the PPP costs are less
initially, but then go on afterwards. Has there been a detailed
analysis of why the base costs are different?
(Mr Middleton) To be clear on this: what London Underground
have done in preparing the public sector comparator is build up
the costs incrementally, on an element by element basis. What
they have not done in presenting the VFM analysis is set out a
base cost comparator—
8. That is rather important, is it not?
(Mr Middleton) I think it is rather important presentationally,
in that it would give a clearer, perhaps more fuller understanding
of what the key drivers are within it.
9. That was the whole purpose, surely, to get
a clear comparator that could be used to assess the different
alternatives?
(Mr Middleton) The question you are asking is about
degrees of details.
10. I am not an accountant, that is manifestly
clear, but surely, it is not simply a question of detail, it is
a question of starting from the same base that people can identify.
You set out, before you began, four different groups of assumptions
that you had used, and then you said, "We have come to these
conclusions and we think that it was a robust assessment",
and you based that on the information. All I am saying to you
is why then is there this gap on the base costs, and surely that
is rather important?
(Mr Middleton) I think the conclusion which we reached
and set out in the report on this issue is that the provision
of such a comparator would have been an aid to decision making.
11. So we are right?
(Mr Middleton) Yes, I am not disagreeing with you,
but, at the end of the day, we did not think it was a fundamental
issue.
12. Why, because you thought that you could
make other assertions which would neutralise
the difference between the base cost?
(Mr Middleton) The work which we did and the discussions
we had with LUL and their advisors satisfied us that the analysis
which they had completed was sufficiently detailed to allow them
to complete the value for money analysis. What we have said in
our report is that the presentation of that analysis would have
been improved by a base cost comparator. At the end of the day,
through spending a lot of time with them, we were able to satisfy
ourselves that the analysis had been completed.
13. What you are saying is, "We looked
at this, but our subjective judgment in the final analysis is
that it was not sufficiently important to distort the conclusion
we reached that it was a robust report". So that is another
subjective judgment. This assessment has taken four years, and
you still have uncertainty over how the private sector is going
to offer the promised savings. Is it really too difficult to establish
the potential savings of the PPP over 30 years?
(Mr Middleton) I think the question you ask is a fair
one. It is one which, through a lot of detail, we were able to
satisfy ourselves that the analysis which sat behind the presentation
of the public sector comparator value for money analysis was,
in overall terms, a robust one. Why London Underground did not
present a base cost analysis is a question which we cannot answer,
and is beyond our brief.
14. I understand that, but it is actually quite
fundamental to understanding where we are at the present time.
Mr Blaiklock, can I ask you the same question?
(Mr Blaiklock) I think I share the same kind of confusions
that you have, and I have been looking for a clear-cut recommendation,
one way or the other, for such an important project, and a proposal
which is, if anything, experimental.
15. So you do not think it is unreasonable to
say, "Why does it take four years and finish up with a result
that is not clear?"
(Mr Blaiklock) I would be disappointed if I came up
with the result that has been brought to the table. We need a
clear-cut decision, one way or the other, and I do not think we
have it.
Mr Stevenson
16. Mr Middleton, you gave us, in your opening
statement, about four areas that you wanted to clarify for us.
You said, I think in your last point, that you supported the London
Underground arguments in terms of value for money, but that they
were "subject to subjective judgments", if I can use
those terms. In terms of the social cost adjustment, is it appropriate
that such adjustments should be incorporated in such a value for
money comparison?
(Mr Middleton) Can I deal with the first point you
made before you moved on to your question, Mr Stevenson, because
I think, to be clear, what we said was that the London Underground
recommendation that the PPP proposals deliver value for money
is one which is supported by its analysis.
Chairman
17. By its analysis and not yours.
(Mr Middleton) By its analysis. Going on to the social
cost adjustment, I think the social cost adjustment is an attempt
to recognise explicitly the fact that there were different levels
for performance assumed under the PPP proposals and under the
public sector comparator, and so the inclusion of the social cost
adjustment was, if you like, to create a level playing field between
the two.
Mr Stevenson
18. Level playing field. According to the information
we have, the use of these non cost items has led to an increase
in the cost of the public sector option by 9 per cent, and a decrease
in the cost of the PPP by 5 per cent, £2.1 billion, which
equates almost exactly to the figure used by the Secretary of
State in his recent announcement. The use of the social cost adjustment
has a crucial effect on your judgments. Do you know of any other
PFI or PPP that uses such social costs adjustments?
(Mr Middleton) In our experience, we have not seen
that in other PPP projects. It is, however, standard practice
in cost benefit analysis on transport projects, and we recognise
the sensitivity of this assumption in our report, and that is
why we set out the value for money analysis with and without that
adjustment, so the decision makers were very clear about the impact
of it.
19. It may be helpful for the decision makers;
I am asking my questions to yourselves as the professionals in
your particular field. To be clear on this: your answer to my
question is you can identify no other example where such social
cost inclusions in PPP or PFI have taken place?
(Mr Middleton) That is right.
| 
