Examination of Witnesses (Questions 100-119)
DEPARTMENT FOR
TRANSPORT, PRICEWATERHOUSECOOPERS
AND LONDON
UNDERGROUND LIMITED
23 JUNE 2004
Q100 Mr Williams: If they were converging,
what was the problem?
Mr Rowlands: There was not a problem.
They were converging because as people, I think, worked their
way through the reality of what they were bidding against, there
was a tendency for the bidders and for the PSC to begin to move
into similar territory. Mr Callaghan may be able to help rather
more than me on this, I do not know.[9]
Mr Callaghan: I will help if I
can. As Mr Rowlands has said, and clearly there has been debate
about this, one of the key issues in any transaction—this
one because of its scale more than most—is whether or not
this was the right thing to do given the alternatives that might
have existed. The alternative we tested it against was a purely
publicly funded alternative and a bond fund alternative. The analysis
that we did suggested that this was better than either. You have
to have a benchmark against which to test the prices which come
back from the market. That benchmark at the time that we did this—and
the guidance has moved on a bit—was the figure given by
the financial calculation in the public sector comparator. If
you know that is the thing that you are trying to get below and
you make it public, all you do is invite the private sector to
bid just to beat the target and you end up destroying the value
because it is actually the existence of that hurdle which keeps
the competition.
Q101 Mr Williams: Did the convergence
of a public sector comparator make the bond issue more or less
viable?
Mr Callaghan: The two things are
not directly connected. What happens in the convergence is that
the bidders' estimate of what it was going to cost to do the work
and our estimate of what it was going to cost to do the work converged
because as we were talking to the bidders about what they had
found from going out and about on the railway and looking at the
state of the assets and as the contractual terms changed in negotiation,
in order to have a like-for-like comparison you have to take the
new information you have got and recalculate your comparator to
compare it against this.
Jon Trickett: The people preparing the
public sector comparator accepted and took on board risks identified
by the private sector bid, so rather than the private sector being
aware of what the PSC wants, the PSC itself was moving and the
convergence was because the people preparing the public sector
comparator were aware of risks being identified by the private
sector. Is that not the true problem, the public sector comparator
got higher and higher so it was comparable with the private sector?
That is how it seems to me.
Q102 Mr Williams: Which way was it? Was
the convergence from the public comparator upwards or downwards?
Who can answer?
Mr Davies: I can answer. The public
sector comparator increased over time but it was a wholly separate
exercise and was not by the same people looking at the bid evaluation.
Q103 Mr Williams: If it increased over
time and was converging, therefore, it must have been below the
bidding, the private market price, must it not?
Mr Davies: The convergence means
it was increasing at a lower rate than the original bids because
the bidders were getting better information on the assets. The
process that was happening was we were getting more asset data
and, therefore, both sides were getting more accurate pictures
of what the true cost would be.
Q104 Mr Williams: It is most unusual
for us to come across a case where the public sector comparators
have been admitted to be lower than the private sector figures.
Mr Davies: It was not lower than.
Q105 Mr Williams: Why did you say it
was converging when it was increasing?
Mr Davies: Converging means both
were increasing but one at a slightly higher rate. They are getting
closer but it was never lower than.
The Committee suspended from 4.30 pm to 5.20
pm for divisions in the House
Mr Williams: My apologies to everyone
for the long delay. We will carry on straight away. Jon Cruddas?
Q106 Jon Cruddas: I have just one final
question, and that is to Mr O'Toole. You have managed to swerve
around commenting on Mr Kiley's letter but can I ask you to comment
on your own one to the secretary? Generally, just because this
is a preliminary hearing, do you want to make some comments about,
firstly, the NAO Report and, secondly, your experience of the
PPP over the last year because you have made some quite trenchant
criticisms of it in the last letter?
Mr O'Toole: When I came here I
wanted to make very plain to the parties that my interest was
in service performance, in doing what I had to do to make this
work. I did not want to reduce this to a battle of lawyers, I
wanted to see if I could work within this system, and we continue
to do that. It has been made plain to me, from working on it day
to day, this is an extremely convoluted, complex, big structure
in which to work. I would say the Infracos themselves have had
to come to grips with the fact that it is very difficult to drive
action within this structure and that we are struggling to make
sure that we are able to produce the change that you are all looking
for and we are paying for on the schedule that is expected here.
As we pointed out, we certainly have not had the turnaround in
performance in the first year of this deal that was originally
projected. We point out, also, that in all fairness you usually
see this when you have a transfer of structure of this kind but
this year, certainly, and next will be the proving ground because,
as you pointed out, we do not get the bright shiny new kit for
many years so we better improve maintenance in the near term or
London is going to have a very, very long wait for a turnaround.
Q107 Jon Cruddas: Okay, but you said,
also, that there is difficulty in obtaining information from the
Infracos, there is not yet evidence of strong planning capability
within the Infracos. You said there is little evidence of the
promised innovations of new plant and equipment for the infusion
of external engineering expertise. You said the power to require
work to be undertaken pending resolution of dispute is not available
generally to London Underground Limited. Finally, you said LUL
has little or no leverage to secure changes which are required
to deliver the Mayor's transport strategy and to improve customer
services.
Mr O'Toole: I have said all that.
Jon Cruddas: Okay. Thank you.
Q108 Mr Curry: Chairman, having read
the Audit Office Report I was inclined to wait for the video but
I am trying to find my way through the prose which seem to me
to have been subject to vast amounts of arbitrage from all sorts
of different people. I can see from the Comptroller and Auditor
General there is an imperceptible nod coming from him. Being a
journalist this did strike me as having been written by a committee,
very strongly, which is somewhat very hesitant of the prose, if
I may describe it in those terms. It meant, also, of course, we
had the time delays which have made it difficult to absorb all
this. Mr Rowlands, you said something which gave me quite a turn.
I came to work in London in 1970 and I have been using the Tube
every since. You said "Tunnels are 150 years old and nobody
knows what state they are in". Here am I travelling on the
Tube on a daily basis and I rather assume that I am travelling
on a safe system. If somebody had said "We do not know what
state the tunnels are in, and we do not know what state the bridges
are in, and we do not know what state the embankment is in"—how
come we will not know for seven and a half years—I think
I would have got on my bike. That is what I do now, thanks to
the Congestion Charge, I have never used my car so much as now
I live within the Congestion Zone. Does it not appear rather curious
that millions of people use the Tube and they must make the assumption
that the people running it know what they are running?
Mr Rowlands: I think this is Mr
O'Toole's patch not mine. I suspect they make the assumption they
are travelling on a safe system. To the extent that the state
of some assets is unknown that does not mean that the system is
unsafe. That is the Underground's responsibility as the safety
case holder and the railway inspectorate's responsibility to police
it. Where there is a problem with asset states you can, I believe,
take remedial measures like putting on temporary speed restrictions,
for example. It keeps the service safe even though the asset may
not be in anything like an ideal condition.
Q109 Mr Curry: Should there not be a
notice as you go down the escalator which is not working in any
case so you have plenty of time to read it, and the notice says
"Notice to passengers. We do not know what state the Tube
is in but we believe it to be safe"? Would that not be fair,
a notice to passengers?
Mr Rowlands: No, I think it would
be unfair on London Underground who run a safe system in the face
of—to repeat myself, I am afraid—assets, some of whose
condition is unknown and some of whose condition is known to be
less than satisfactory.
Q110 Mr Curry: It is the condition of
assets being unknown. Page 17 of the first Report says: "London
Underground knew that despite investigations by its own advisers,
Ove Arup, and investigative work by bidders, the condition of
less accessible fixed assets (tunnels, some embankments, bridges
et cetera) would not be known before award of the contracts,
and in some cases not before the end of the first seven and a
half year period". Pretty frightening, is it not?
Mr Rowlands: No, I do not think
it is frightening, I think it is a consequence of the nature of
the Underground system. Some of the long life assets are very
difficult to get at, like tunnel walls or embankments and other
structures. They are in need of remedial maintenance and renewal.
Because their actual state is unknown it is very difficult to
quantify the cost of that work. That is the problem and the risk,
if you like, that underlies the PPP.
Q111 Mr Curry: My essential point is
to say as a traveller and a consumer of London Underground services
the fact you do not know the state of the tunnels through which
the trains are running does make me feel a bit twitchy. I wonder
if you feel slightly twitchy? If you had British Airways saying
"We think the wings are all right, but we cannot be absolutely
certain about it" would you feel a bit nervous?
Mr Rowlands: I travel on the Underground,
I travel on the big railway and I am not twitchy. Mr O'Toole manages
this Underground, I do not suppose in that sense he is twitchy
either.
Q112 Mr Curry: Mr O'Toole, when you ran
Consolidated Rail Corporation, did you know the state of the bridges
over which your rail track ran?
Mr O'Toole: Yes, I did.
Q113 Mr Curry: In fact you would regard
that as a normal circumstance?
Mr O'Toole: Yes, I would.
Q114 Mr Curry: Would you regard it as
a normal circumstance for London Underground not to know the condition
of bridges?
Mr O'Toole: I think London Underground
does know the condition of its bridges. I do think it is very
important that we distinguish the points here. London Underground
knows quite a lot about its assets. It knows that it is safe.
We do not operate assets on a guess, on a hope. We are quite clear
on the safety regime we follow and why it is responsible for us
to continue to provide service. What is not known here, what should
be known as quickly as possible and what I would have liked to
have seen done at the very beginning, is a thorough asset register
that tells you the complications you are going to run in to over
time as you try to rebuild these assets. I will give you two examples
to illustrate this point. Once you take apart the sub surface
lines, which you can walk every night, you can run inspections
through it, taking analysis of it, you can know the tracks are
stable and safe, but once you take it apart you are then going
to learn the nature of the lateral support on those Victorian
walls. It is at that point unpleasant surprises can show themselves.
Similarly when you go to rebuild a station, when you tear open
the walls you learn some things that are in those walls which
when the deal was put together people did not know. I think that
is the knowledge gap and that is why at London Underground we
have been going to the Infracos and unfortunately have not had
heard good noises to say: "The first thing that has to be
done . . . " and you will note the thing that was not done
by Railtrack was: " . . . you have to have an asset register
put together". It is only then you can make an informed decision
about what you really ought to be fixing first.
Q115 Mr Curry: You want the Doomsday
Book of London Underground?
Mr O'Toole: That is precisely
what we want.
Q116 Mr Curry: Could I refer to your
own letter. These bullet points, you say "The NAO Report
places great reliance on partnership issues in the section on
success factors but there are other relevant success factors that
might have been addressed, including . . . " and then you
have got these six or seven bullet points. Had they been included,on
which side of the balance sheet would they have gone? Would they
have been included on the things that were being addressed or
would they have been included on the things which ought to have
been addressed but have not been addressed? I rather read it as
on the negative side of the balance sheet.
Mr O'Toole: Certainly if you look
at the NAO's Report or if you look at the Report I put out it
equivocated on the conclusion and said the jury is out. My point
is the parties to this deal need to be focused --- We are not
in this for a relationship, we are in this to accomplish certain
things and they ought to be told "This is how we will be
judged" not on whether we get along. Although getting along
may be good in its own right, it is not the goal.
Q117 Mr Curry: When you first arrived,
and I know you will not comment on things put together before
arrived, and you had a look at this wonderful landscape which
you have been presented with, in polite language what was your
first expression?
Mr O'Toole: That this would be
an enormous challenge and I was not sure that people understood
what they were going to have to live through in order for us to
transform it.
Q118 Mr Curry: In any private moment
did you say "If this had been the States it would have happened
like this"? How would it have happened?
Mr O'Toole: Certainly Bob Kiley
has had plenty of experience in handling these kinds of transformations
with direct bond finances.
Q119 Mr Curry: Page 26 of this Report,
just coming to that, and I guess this is for Mr Davies. It may
be that my financial knowledge has slipped a bit since I worked
on the FT but on paragraph 2.42 "Ernst & Young
advised the Secretary of State that any potential saving from
granting a public sector London Underground access to the bond
markets, based on Transport for London's credit rating, would
be an arbitrage saving . . . ." and therefore it did not
count. Could you not have done with all the subsidy you needed?
This reads to me as if you said "We are going to make sure
this playing field is skewed in favour of what the Government
wants to do". Here we are £825 million, which is a bob
or two when you really think about it, the savings, you were not
going to have them because somehow this altered the equation you
were determined to present, is that not what it means?
Mr Davies: No, I do not think
it means that. What this refers to, the arbitrage saving, was
that one of the apparent savings, if you like bond finance is
the public sector methodology for evaluating value for money,
uses a discount rate different from the price of debt. The result
is that it makes it more attractive than they are saying is really
the case. What they are saying under here is you should be looking
also at the underlying cost of the deal, i.e. not the cost of
the transaction but what is happening to the cost of the assets.
What is driving value for money is whether or not you believe
the private sector PPP option will deliver the upgrades and the
service at a lower cost not like this technical discount rate
that you see in the valuation.
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