Select Committee on Public Accounts Minutes of Evidence


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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