Examination of Witnesses (Questions 1-19)
DEPARTMENT FOR
TRANSPORT, PRICEWATERHOUSECOOPERS
AND LONDON
UNDERGROUND LIMITED
23 JUNE 2004
Q1 Mr Williams: We are here today to
have a hearing on the NAO Report on the London Underground Public
Private Partnerships. I welcome as witnesses Mr David Rowlands,
Permanent Secretary and Mr Paul Davies of PricewaterhouseCoopers.
Is this your first visit?
Mr Davies: To the PAC, yes.
Q2 Mr Williams: I am sure you will enjoy
it.
Mr Davies: Thank you.
Q3 Mr Williams: Also, we have Mr Tim
O'Toole and Mr Martin Callaghan from London Underground. Welcome,
gentlemen. May I also welcome this afternoon the Speaker and the
Secretary of the Legislative Assembly of Gujarat. Welcome. May
I put on record, before I start asking questions, that at one
time in the past I was a sponsored member of the TSSA and it still
sponsors my constituency party. I am a paid up but non participating
member of that union. If I can start off with the questioning
to you, Mr Rowlands. This project is starting two years later
than originally planned. The maintenance backlog was meant to
be 15 years and it is now 22 years. The 30 year programme looks
as if it will run until 2033. The Mayor of London has promised
Londoners ten years of misery; what is your estimate?
Mr Rowlands: I think you are looking
at a project that needs to recover some several billion pounds,
it is difficult to estimate it, of degraded assets. I think inevitably
we are looking to a period, certainly through to the end of the
decade, when there will be some considerable disruption in the
sense of heavy station modernisation programme and probably no
weekend in any of the coming years when there is not a part of
the Underground closed for remedial works. It is a measure of
the scale of the work that needs to be done.
Q4 Mr Williams: It has been suggested
that it may be about impact 15 years before the substantial work
is completed and from then on it should be less intrusive, is
that familiar to your calculations?
Mr Rowlands: I think Mr O'Toole
may have a better view in operational terms than I do. The position
is, as I think the Committee knows and can see from the Report,
the infrastructure companies are not required to get the assets
to optimum state and eliminate all the backlog until the end of
the third review, which is actually 22 years, although most of
that will be done before then. Yes, you may well be looking, certainly
through to the end of this decade and beyond, but Mr O'Toole may
have a view.
Mr O'Toole: I would not quarrel
with that description. The important date for me is when we finally
get upgrades on the subsurface railway. It is going to be somewhere
around 2015 when you would see a dramatically different railway
across the piece. The upgrades for, say, the Bakerloo Line are
even later, that is 2020, but I think it puts a fairly good service
forward right now. For me the change is when we finally get to
the subsurface railway.
Q5 Mr Williams: I understand from the
Report that the price, the scope and the funding of the project
is to be reviewed every seven and a half years. That means there
will be three reviews during its lifetime. Is the taxpayer being
taken on a financial mystery tour? Do we have any idea how this
will shape up?
Mr Rowlands: I do not think we
are being taken on a financial mystery tour. We were trying to
deal through the PPP contracts with the inevitable uncertainty
in a huge programme of remedial work where the state of many of
the assets was unknown. We could have sought, and the Report I
think acknowledges it, greater price certainty and in that sense
reduced the mystery tour for the taxpayer but it would inevitably
have been at the expense of higher contingencies put into the
bids by the private sector and the higher cost that way to the
taxpayer. There is a trade-off between cost and risk, I am afraid.
Q6 Mr Williams: If after the seven and
a half years there is a review and you do not agree, what happens?
Mr Rowlands: If London Underground
and the three infrastructure companies at the end of the first
review cannot agree a price for the restated scope of works that
the Underground wants pursued then the matter goes to the arbiter
for him to price on the basis of an economic and efficient Infraco
supplying whatever it is that the Underground has restated as
its need.
Q7 Mr Williams: Is his conclusion binding
contractually?
Mr Rowlands: It is binding. The
arbiter's decision, I believe, is binding.[1]
Q8 Mr Williams: Binding but not contractually?
Mr Rowlands: The contracts provide
for the arbiter, in fact the arbiter is provided for in the Greater
London Act 1999. Through that mechanism his conclusions are binding.
Q9 Mr Williams: I may have misunderstood
the meaning. Is it not a fact that even if the arbiter makes a
decision which is binding the suppliers do not have to fund extra
money?
Mr Rowlands: The lenders are not
obliged to provide new money for new requirements and, therefore,
the suppliers would have to find a new source of finance in those
circumstances.
Q10 Mr Williams: What if they say they
cannot find the funds?
Mr Rowlands: Then I imagine in
those circumstances the Underground with the Department would
look for another route through. This is a hypothetical set of
circumstances.
Q11 Mr Williams: It is not hypothetical,
it is a possibility.
Mr Rowlands: You are right. It
may be a market test of what in seven years' time perhaps the
Underground is asking for. If a restated requirement, to take
an example, produced a technologically difficult requirement,
like the original Jubilee Line extension, you may find the market
unwilling to price that because of the technology risk and the
lenders unwilling to lend, in which circumstance you may be being
told something by the market place about what at that stage might
be the Underground's ambitions.
Q12 Mr Williams: Some of my colleagues
may wish to follow up on that. We read the transaction costs,
which include the bidding costs which you accepted and took responsibility
for, came to £455 million and the private borrowing costs
£450 million, that is £900 million just on the transaction
cost, adding extra costs of the borrowing which I will come to
in a moment, that is £900 million. Could it not have been
better spent directly on the Tube?
Mr Rowlands: Yes, had it been
available, but in a very real sense it would never have been available.
This Report says that the transaction costs for the three PPP
contracts, although expensive, were reasonable in relation to
the size and complexity of the contracts. The transaction costs
are in relation to £30 billion worth of business, that is
the undiscounted cash cost over 30 years of these contracts. If
you had not had these contracts, you would have had a whole series
of other contracts, all of which have their own transaction costs
because they still require lawyers and so on. I do not believe
you would have escaped this set of transaction costs if you had
not pursued the PPP, the costs would still have been there in
a whole series of other contracts to deliver this work programme.
Q13 Mr Williams: While I do not suppose
any of us were surprised to find the borrowing costs were somewhat
higher than the public sector borrowing costs, we expect them
to be slightly higher, we read that it is actually an 18% to 20%
rate of return. To me this sounds quite huge. I cannot think of
any PFI that we have had before us—and the NAO may correct
me if I have got it wrong—at this level nor even near it,
because I think certainly this is about a third above the normal
borrowing rate. Why on earth is that?
Mr Rowlands: In terms of the rate
at which the debtors were lending I think this is a reflection
of the risk inherent in the project to them and at some stage
as we went through this project the political risk in terms of
the then TfL opposition. You have seen some of those borrowing
costs come down with the Tube Lines refinancing and some of that
gain shared with TfL.
Q14 Mr Williams: Mr Rowlands, you say
it reflects the risk but if you look at page five, paragraph 10b,
lenders are committed to advance at least £3.8 billion. They
have " . . . limited downside risk (because in the event
of termination they stand to get back 95% of what they have lent)
. . ." returned to them. Yet they are charging rates of interest
in line with a high risk development. The risk they are exposed
to is 5%, so the risk on them does not apply here.
Mr Rowlands: They are at risk
for £190 million in terms of the 95%. This debt was rated
as a low investment rate by the rating agencies and the borrowing
costs reflect that rating, I am afraid. That is the result of
what the market gives you and the justification for this level
of borrowing cost is the ability to put the risk of an uncertain
set of assets and a huge uncertain investment programme firmly
into private sector hands and out of public sector hands.
Q15 Mr Williams: Why did you accept so
low a level of risk? If the market is saying to you "Well,
we are going to treat it as high risk", why not give it high
risk? Why give a low risk project a high risk cost?
Mr Rowlands: I am afraid that
was a consequence of the negotiations in the market at the time.
They were deeply unwilling to accept anything less than originally
a 90% and then 95% underpinning in the face of the political risk,
as the market perceived it, from the Mayor's known opposition
to PPP and tested in the marketplace that is where it came out.
London Transport, in terms of evaluating the positions which were
in front of them, had to model that against the public sector
comparator. Even with those costs this was better value.
Q16 Mr Williams: Your Department has
accepted the £455 million transaction costs, the £450
million borrowing costs, it has accepted a high risk premium for
a low rate risk and then, after the competitive process is over,
it accepted price rises of another £590 million. The taxpayer
has been taken to the cleaners.
Mr Rowlands: The £590 million,
which was the increase in the cost across the three contracts
after preferred bidders were announced, is largely a reflection
of additional outputs: the ten extra trains on the Victoria Line,
two extra trains on Bakerloo and Northern and so on, so it was
not as if the price went up and there was nothing more for the
money. In input terms there was a heavy set of additional inputs
going in for that £590 million.
Q17 Mr Williams: One final question before
I throw it open to colleagues. Transport for London will have
the major responsibility for public sector oversight yet its prime
duty is inevitably to the Londoner. In that case, how can we,
who represent other parts of the country, be sure the UK taxpayer's
interests are going to be properly protected?
Mr Rowlands: We monitor on a regular
basis, on a monthly basis, TfL's performance or, through TfL,
the London Underground's performance in terms of the six performance
indicators we have agreed with the Mayor. Those indicators increase
over time as a consequence of this PPP improving the state of
the assets. In that sense we are monitoring to see that in the
overall performance of the Underground the taxpayer is getting
the improved performance you would expect for this sort of money.
Q18 Mr Williams: If the prime oversight
is with Transport for London and you, the Department, disagree
with Transport for London, who actually wins the argument?
Mr Rowlands: Can I put it this
way: what the Department cannot do is attach any conditions to
the grant which it pays Transport for London for transport; it
is ultra vires the 1999 Act. What we do have is both regular
monitoring of the Underground's performance and regular discussions
with TfL about its business plan. In the event that there was
the sort of dissatisfaction you suggest might happen in the end
that inevitably would flow through to, I guess, what the Government
was prepared to set by way of the overall grant for TfL. What
it would not impact on is the element of grant we pay to underpin
the PPP because we have set out on a seven and a half year basis
what that would be.
Q19 Mr Williams: What I am still not
clear about is where there is specific disagreement. How do you
see it, London Underground, do you see it differently from the
Department?
Mr O'Toole: I think at the end
of the day you are talking about a system that assumes the devolution
of the Underground and transport generally from Central Government
to the Mayor. The system, as we all know, is not complete. We
still have to return to the Department for our grant, for our
money. There is something of a fiction that we are completely
removed from the Government because the fact of the matter is
in order for us to do anything, fund any major project, we have
to come back, so we feel we are connected in both directions.
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