Examination of Witnesses (Questions 20
WEDNESDAY 27 FEBRUARY 2002
20. Two more questions. In the four areas you
identified in your opening statement, which I made note of, you
talked about the issues and the fact that the PPP remains to be
tested in practice and so on, and the guidelines and confines
in which you were working. Why is it that it appears that the
inclusion of social costs is outwith Treasury guidance?
(Mr Middleton) We have to be clear on this. It is
outwith Treasury guidance in terms of developing public sector
comparator and value for money analysis. As the guidance stands
just now, it is within Treasury guidance on cost benefit analysis
and project appraisal within the public sector.
21. Was not your brief, forgive me, Mr Middleton,
a value for money assessment? Right. So, it is outwith, your briefvalue
for money assessment?
(Mr Middleton) No, I think it is within our brief
because it is included as part of the value for money assessment
on this particular project. Again, our view was very clearly that
the results of the analysis should be presented with and without
22. If the inclusion of social costs is beyond
Treasury guidance, why did you decide to include them?
(Mr Joyce) We did not decide to include it, it was
included by London Underground in its assessment, and we have
commented on its inclusion in our report. With regard to the point
you made, whether it is within or without the value for money
assessment, in our experience, as Mr Middleton said, we have not
seen it included in a financial comparison before in other PFI
or PPP projects. However, a simple financial comparison of cost
would not necessarily be comparing the cost of delivering the
same level of output. You have two options then: either compare
the two in a qualitative way, and say, "I know I have a difference
here, but I know I am paying different levels of output",
or you would attempt to quantify that difference, and that is
what the social cost adjustment does.
23. I am hypothesising a little bit, if I might,
but if London Underground had not included this element, which
was outwith the Treasury guidance in your brief, would you have
(Mr Middleton) I think, Mr Stevenson, the reference
to our briefI am not sure that is the correct reference
because our brief was to look at the value for money assessment
as produced by London Underground, so it was within their value
for money assessment, so therefore it was within our brief.
24. Yes, I understand that, but I was attempting
to press you a little further, using your professional expertise
as to whether you fake, never mind about your brief, the inclusion
of such dramatic costs, as professionals. Given that there is
no other example of this happening, is it appropriate, in your
professional point of view?
(Mr Middleton) What we have said in our report, really
to build on the point Mr Joyce has just made: it is normal to
deal with these social costs as wider factors and often not to
quantify them. What London Underground have done is attempt to
quantify those benefits. I think we conclude in our report that
that was helpful to the analysis in order to promote clarity on
the points we have set out in our report, the value for money
comparison with and without the adjustment.
Chris Grayling: Can we be clear on one point
on this: you say that London Underground provided the social cost
assessments within the work that they had done, but you have not
done any work to validate that work, to see whether they have
picked the right figures for assessment
Chairman: You were not asked to do that, were
you? I think, Mr Blaiklock, we would like to have your comments.
25. Social cost benefit, to what extent is the
inclusion of such benefits justifiable in this exercise, would
(Mr Blaiklock) Social cost benefit analysis would
be a component of, you might say, project feasibility work. I
cannot recall seeing an occasion where it has been used to evaluate
bids. I have worked in the public sector, development banking
sector, and I have been in this business for 20-25 years, and
I have never seen it used as an evaluation criterion by World
Bank or European Bank or any such institution. Another feature
which I should mention is that for any kind of these public bidding
processes, they should be open and transparent and one should
lay down the evaluation criteria before you start. I am not sure
whether this has been done on this occasion.
26. Could I follow that up briefly as a lay
person: if it is right to include these social cost benefits,
why is it not appropriate to include other social cost benefits
that I can think of as a lay person, for example: the expenditure
of some of this money on buses instead of the underground? Why
just end it at social cost benefit? Why not take the principle
to its logical conclusion?
(Mr Blaiklock) I think you have answered the question
yourself. I have not seen it included before in a bid evaluation
process for the reason that it is very difficult to identify the
data and the assumptions.
27. Are we clear where this evaluation came
from in the first place? You were saying, Mr Blaiklock, you have
never seen it before, and we are not clear whether it was actually
(Mr Blaiklock) Not in bid evaluation. I have obviously
seen it in project feasibilty
28. I understand that, but it is bids we are
talking about for the moment. Are we clear whether there was any
footnote to explain why this particular change has been made in
this bid? No. Mr Middleton, you wanted to comment on that?
(Mr Middleton) Yes. I think this really is one for
London Underground to substantiate more fully. The rationale for
the inclusion of the adjustment in this case is that there were
different levels of performance assumed for the public sector
comparator and for the PPP proposals, and the adjustment was essentially
there to create a level playing field between the two.
Andrew Bennett: Or to get the result that somebody
Chairman: It could also be one of those complicated
Mr Stevenson: 14 per cent difference, a level
Chairman: Mr Middleton does not have to defend
it, because it was not his idea in the first place.
29. On page 14 of your own report, you say:
"We have reviewed the basis on which the seven and a half
year comparisons have been made and believe that they are useful
in the value for money analysis, but, as with the 30 year comparisons,
retain sufficient reliance and subjective adjustment to prevent
them from being clear detriments of the value for money."
Given this uncertainty, and it is definitely an uncertainty, what
criteria did you use to decide how important the 30 year analysis
was in the overall assessment of the value for money?
(Mr Middleton) Firstly, in answering that question,
I think we recognised, in the same ways that you recognised in
your recent report, that a value for money assessment report is
essentially a subjective process. I do not think we came to a
conclusion that the seven and a half year or the 30 year analyses
were better or worse than one another. Our view is that the seven
and a half year analysis informs decision making, the 30 year
analysis informs decision making, and that they should be viewed
in conjunction with the wider, non financial issues, not that
one single piece of analysis should be used to found the whole
decision making process.
30. You note that the commercial leverage that
London Underground can apply as their viewpoints is potentially
limited, due to the costs of unwinding the positionthat
is on page 5 of your reportand that, "This places
great emphasis on the arbiter acting efficiently." You also
say: "The arbiter has a duty to balance potentially mutually
incompatible positions of the Infraco and London Underground."
Would it be fair to say, in these circumstances, that the Infraco
is the box seat in this relationship?
(Mr Middleton) I would not put it quite as bluntly
31. Would you actually disagree that it gives
enormous power to Infraco at that point?
(Mr Middleton) The Infraco is entering into a contract
which sets out the rules of the arbiter quite clearly, and the
efficiency of the workings of the arbiter will clearly have an
impact on the overall value for money. I think, at the end of
the day, as Mr Donohoe has pointed out, the cost of unwinding
the position, should agreement not be reached, would be something
that both sides of the negotiation would be aware of, and the
arbiter would be aware of, and you would expect, in a logical
world, for the Infraco to capture some of those costs for itself
because clearly the LUL will not want to unwind the relationship
if it can avoid doing so.
Mr Donohoe: Do you think this is a logical world?
32. Are you not really saying, in a rather longer
wayforgive me, Mr Middleton"Yes, that is right,
they are in the driving seat"?
(Mr Joyce) As we said in our report, it places more
reliance on the role and operation of the arbiter.
33. You are saying that if the arbiter plays
according to the rules, then it ought to be all right, but it
is very likely that the Infraco will be in a very powerful position
because of the complicated machinery that would need to operate
to dissolve anything at that point; is that what you are saying?
(Mr Middleton) I think, Madam Chair, you are perhaps
overstating the balance of power towards Infraco because what
you have in this project is something which sits somewhere between
a PFI project and a regulated utility.
34. Something between chaos and disaster.
(Mr Middleton) So the rule of the arbiter is directly
comparable to that of a regulator in the electricity or telecoms
industry, and the balance of power, if you like, is balanced by
that. That is the intention.
35. Mr Blaiklock, do you believe that London
Underground retains sufficient leverage at this seven and a half
period for the review?
(Mr Blaiklock) I am not sure who will have leverage.
I think there will be a contractual mess. You have firm prices
for seven and a half years and uncertainty after that. I think,
therefore, that the whole process is a little bit flawed. I think,
in the analysis, from what I have seen, and the whole costs of
unwinding the financial position and the contractual position
have been underestimated significantly. I know that you have 3,000-page
interlocking concession documents of which bankers will be relying
upon for their security. You are now raising the suggestion that
those commercial contracts will be unwound and some new ones will
be put in place. You first of all have to find new companies who
will take upon themselves the contractual responsibilities of
those that have been there before, as well as bankers who will
be happy with that situation as well. It is going to be a field
day for lawyers and advisors; I think it is an unsatisfactory
way of proceeding.
36. Do you accept then, that the comparison
with a regulator is rather spurious?
(Mr Blaiklock) It is an unusual role, I think, for
a regulator to take. I cannot recall seeing a similar situation
37. By comparison to a regulator, the arbiter
has very, very weak powers. There is no comparison, is there?
(Mr Blaiklock) As I understand it, an arbiter normally
has no authority really to say who does what, but on this occasion,
he probably might have. It is a little bit ill-defined.
38. So do we need a regulator?
(Mr Blaiklock) I am not sure. We are into unchartered
territory here because I do not know another situation where you
have this kind of possibility arising.
39. Just before we leave the role of the arbiter,
could I just ask a supplement to Mr Donohoe's question: would
it be within the arbiter's power to approve an interim review
by one of the operating companies?
(Mr Middleton) The arbiter's position: he is a statutory
arbiter, so he is a creature of statute, and his or her roles
and responsibilities are defined. Within the contractual framework,
there are a series of caps, essentially, where the PPP bidders
have agreed either £50 million or £200 million as their
respective caps on changes before which they have recourse to
the arbiter. Once they have reached those caps, and can demonstrate
to the arbiters and London Underground that they have reached
those caps, then a case can be made to the arbiter for an extraordinary
review ahead of the seven and a half year reviews.