ALLOCATION OF RISK
38. While a variety of contract structures have been
used to secure funding for light rail, past schemes have been
procured in ways which attempted to transfer risk to the private
sector. Until recently, the most favoured contract form was Design,
Build, Operate and Maintain (DBOM), in which the private sector
took over both the risk that construction would be delayed or
over budget, and the risks that patronage, and accordingly revenues,
would be lower than forecast. Initially at least, risks were successfully
passed to the private sector. Although some schemes have operated
at a profit, as the NAO report notes, "the Midland Metro,
Manchester Metrolink and the Croydon Tramlink, all operated by
private sector companies, made financial losses over the period
2000-2003"[80] and
the private sector's "losses ranged from £200,000 on
the Sheffield Supertram to £11.4 million on the Midland Metro."[81]
In addition, the private sector bore cost overruns on the construction
of some schemes, although in some cases these were borne by the
builder of the system rather than the consortium with overall
responsibility.[82]
39. We were told that at least 50% of the increase
in costs had stemmed from the fact that the private sector had
learned from these examples, and was now pricing in the risk.[83]
even though at least two of the schemes mentioned in paragraph
39 are now making an operating profit. Mr Mulligan told us that
it was not that the capital cost of light rail had trebled, but
that the perception of risk had collapsed.[84]
The equity the private sector was prepared to put into the Metrolink
extension had shrunk from £252m to £60m.[85]
Mr Ambrose told us that major vehicle manufacturers estimated
that light rail cost 60 per cent more to procure in the United
Kingdom than in other European countries, because "at the
moment the winning consortium is expected to take all the risk,
including things over which it has absolutely no control."[86]
Revenue risk, in particular, is impossible for the private sector
to control, both since the transport market is so little regulated,
and since local authority planning decisions can have profound
effects on patronage. Lenders are likely to require discounts
of 30-40 per cent to be applied to such revenues.[87]
40. The Department's own appraisal criteria now cost
in this risk. TfL told us:
Serious concerns over escalating cost estimates
for some light rail projects have resulted in the DfT requiring
an 'optimism bias' loading of up to 57% on capital costs. This
has for example resulted in the estimated cost for West London
Tram increasing from £463m to £648m.[88]
Contract forms
41. Manchester was entirely clear that it had used
DBOM because when Metrolink was first procured, it was a choice
between that and the PFI favoured by the Treasury. Although a
public-sector procurement might have been the most effective way
of financing the Metrolink, it would not have been acceptable
to central government.[89]
Some witnesses considered that there were severe problems with
the Design, Build, Operate and Maintain approach. AEA Technology
(Rail) contended that a procurement process which relied on finding
a single operator for the entire system limited the number of
companies able to bid:
Consortia will generally include a vehicle supplier
and an operator. Following recent mergers there are only three
major and about three smaller light rail vehicle suppliers in
Europe, and a similar number of transport operating groups with
light rail experience interested in bidding for UK work. There
is a wider choice of civil construction firms, but few of these
have experience of building light rail infrastructure. Since it
is very difficult for a single bidder to participate in more than
one consortium, public sector promoters seeking consortia to bid
for a light rail scheme may face a limited choice of credible
bidders and this lack of competition is likely to increase the
price.[90]
D. Scott Hellewell, a transport consultant, considered
that DBOM not only meant that expertise remained within the private
companies which had been successful in bidding for contracts,
but that that expertise became too expensive to use:
Consortia who have subsequently built LRT systems
or extensions in the UK have amassed a great deal of hard-won
knowledge and experience. This they priced into subsequent LRT
schemes for which they bid. However, this usually means that they
are under-cut by an inexperienced 'new boy'. It is significant
that every LRT scheme or extension in Britain has been built by
a different contractor. There are a number of consequences
of this: firstly, there is no transfer of experience from one
project to another and the same costly mistakes are repeated.
Secondly, there is no standardisation or commonality of large
or small elements between the schemes. This leads to inflated
costs, a perceived unacceptable degree of risk and hence the current
situation.[91]
42. Mr Hendy believed that there was "an elegance
in having the smallest number of people involved in service delivery"
and found it helpful to have a single concessionaire responsible
for delivering the service.[92]
Nottingham felt that it wished to retain a single contract in
which the consortium took the risk of ensuring that the various
components of the system worked together.[93]
Manchester considered that it was inappropriate to change its
procurement approach so far into the process, both because the
high risk premia were now a fact of the market, and were unlikely
to be avoided by alternative procurement methods, and because:
Fundamentally changing the contractual approach
would involve long contract delays. A minimum delay of 24 months
would be the outcome, which would cost a minimum increase in costs
of £75m given construction industry inflation. This would
mean the need for cost efficiencies in excess of 10% to be captured
just to stand still - a very high-risk strategy given the dynamics
of the market place now and for the foreseeable future.[94]
Nonetheless Manchester now considered that given
the assumptions the private sector was now making about risk,
and their appetite for that risk, it would be appropriate to review
procurement options.[95]
43. Other promoters are already actively exploring
new contract methods, which could bring down costs for them.[96]
Merseytravel involved the private sector from a very early stage,
and invested in ensuring that it could provide the private sector
with the most advanced and accurate information relating to the
project to give genuine cost certainty. At a late stage, it rejected
the DBOM route, and decided to split up the contract into smaller
separate contracts.[97]
44. Mr Hendy told us that one of the aims of UKTram
was to "help Government feel more comfortable about the quoted
costs and the quoted patronage" by "trying to establish
better methods of procurement … reducing the risk premium
particularly for construction and the equipment."[98]
The Minister told us the Department had no preferred form of procurement:
We have said, clearly, to Manchester and others:
"come up a procurement scheme that works for you …".
[99]
He went so far as to suggest that he would look at
a public sector scheme "if it worked", but warned:
In some of the cases where there has been a lot
of work done over some of these extant schemes, part of the process
has been simply to shift that private risk element to the public
sector, and in some cases that may mean, as you work through the
figures, no adjustment or increase in the costs in terms of the
upfront element for the public sector, but down the line, in some
five or ten years' time, a fairly substantial hit if the risk
revenue formulae and speculation does not work. So it is about
balance. If shifting all that risk revenue back to the public
sector means, in cash terms, upfront and beyond upfront, significant
increases in costs, then that is not achieving what we want …[100]
45. In principle, local authorities might shoulder
more of the cost of light rail, but they do not appear willing
to use their current powers to raise revenue to do so. Although
local authorities have powers to spend money raised from congestion
charging or workplace parking levies on public transport, none
outside London has so far chosen to introduce such a large scale
scheme. It is clear from our evidence and from the NAO report
that local authorities in France or Germany have more power to
raise funds for local transport systems.[101]
Sir Howard Bernstein, the Chief Executive of Manchester City Council,
thought that there would be scope for local business taxes to
raise funding for light rail schemes, which are clearly supported
by business.[102] Dr
John Disney similarly suggested that rateable values might be
increased along a light rail corridor, since the fixed route was
an obvious benefit to the neighbouring property and businesses.[103]
UTILITY DIVERSION
46. Further expense is caused by the cost of diverting
utilities when light rail schemes are constructed. Utility diversion
is desirable both because work on utilities once a system is built
will affect the system severely, and because it is intrinsically
undesirable to have loose electric current close to gas or water
pipes. The utilities effectively stipulate the level of diversion
required, and carry out the work themselves.[104]
The NAO said that utility companies might demand diversions which
were not technically necessary, and promoters had not been sufficiently
robust in questioning whether these diversions were really needed,
or who should carry them out.[105]
92½ percent of the cost of the new infrastructure provided
when utilities are diverted comes from the light rail scheme.
Mr Hendy told us that this provided no incentive for utilities
to try and minimise the amount of work necessary and that:
I would be surprised if you could find anybody
who has been involved in delivering one of these schemes in the
last 25 years who did not find themselves in a position of believing
that they paid for a lot of additional utilities work that in
normal circumstances would have represented the maintenance and
the renewal of utilities...[106]
In addition, a scheme or its promoters may also have
to pay heavily simply to establish the precise location of the
utility infrastructure.[107]
47. Our precursor committee, which reported before
the utilities' share of the cost was reduced to 7½ per cent
recommended that it should remain at 18%. Although the recommendation
was not accepted at the time, when the Minister appeared before
us there were indications that he was prepared to reconsider,
although he stopped short of giving an undertaking to bring forward
the necessary regulations.[108]
Innovation
48. The National Audit Office recommended that more
should be done to promote innovative light-rail technologies,
and to assess whether conversion, track sharing or substitution
of heavy rail by light rail would be possible. The Department
has already removed the threshold of £5 million below which
it would not support innovative schemes,[109]
and Mr Hendy told us that the Department was co-operating with
industry and promoters in looking at innovative forms of track
which would reduce or eliminate the need to divert utilities.[110]
49. We received a certain amount of evidence from
individuals or companies proposing new technology. The constraints
on our time meant we were not able to consider these as thoroughly
as we would have liked, but it was clear that there was frustration
at the UK's lack of support for new technology and the regulatory
barriers which hinder its speedy development.[111]
We took evidence from JPM Parry & Associates, a company which
has been involved in attempts to run a light-rail vehicle on a
branch line on Sundays when the line is unused since 2001.[112]
Although the vehicle had been passed as safe by the Railway Inspectorate
in 2002,[113] after
four years the company remained in negotiations to allow it to
run its vehicle. We are not in a position to judge whether or
not such permission should be granted; but we can say definitively
that an answer should have been given years ago. Delays like this
are not only frustrating, but they put at risk the commercial
partnerships set up to support such innovation.[114]
The Department should be prepared to intervene when non-financial
barriers to innovation occur.
58 Q 84 Back
59
LR 50, LR 87 Back
60
Q 196 Back
61
QQ 214-216 Back
62
Q 221 Back
63
LR 91 Back
64
Q 315 Back
65
Q 313, see also Q221 Back
66
LR 26, LR 30, LR 35 Back
67
LR 46, LR 57 Back
68
Q 200 Back
69
LR 25, LR 55, LR 56 Back
70
LR 55 Back
71
LR 93 Back
72
HC (2003-04) 518, para 17 Back
73
HC (1999-2000) 153, para 64 Back
74
Q 158, see also LR 87 Back
75
Q 158 Back
76
LR 77 Back
77
Q 265 Back
78
Q 275 Back
79
HC (2003-04) 518, para 1.9 and Table 2 Back
80
HC (2003-04) 518, para 2.35 Back
81
HC (2003-04) 518, para 2.35 Back
82
Q 200 Back
83
Q 322 Back
84
Q 323 Back
85
Q 323 Back
86
Q143, see also LR 35 Back
87
LR 61 Back
88
LR 77 Back
89
Qq 328-331 Back
90
LR 57 Back
91
LR 25, see also LR 50, LR 57, LR 60 Back
92
Q 227 Back
93
Q 226 Back
94
LR 83 Back
95
Qq 324-5 Back
96
LR 69 Back
97
LR 78, LR 78A Back
98
Q 204 Back
99
Q 251 Back
100
Q 252 Back
101
Q 151 Back
102
Q 352 Back
103
LR 30, see also LR 64, LR 65, LR 68 Back
104
Qq 30-32 Back
105
Qq 29-30 Back
106
Q 233, see also LR 46 Back
107
LR 51 Back
108
Qq 288-9 Back
109
Q 134 Back
110
Q 233 Back
111
LR 94 Back
112
LR 80 Back
113
Q 397 Back
114
Q 370 Back
