3 Potential exposure of the taxpayer
10. Our 2001 Report on the Link concluded that the
level of equity capital was insufficient to reflect the high level
of commercial risk in this project, which depended on inherently
uncertain forecasts of passenger numbers. If a project involves
a high degree of commercial risk, then it needs to be financed
with a commensurately high level of risk capital relative to bank
debt. LCR only had a total of £60 million in equity and was
not, therefore, sufficiently capitalised to bear the risk of a
£5.8 billion project.[10]
11. The Department considered that direct public
financing for the project would weaken the incentives for the
private sector to manage construction to time and budget and to
maximise the revenue yield from the Eurostar business. Accordingly,
as part of the 1998 restructuring of the deal, Railtrack Group
contracted to purchase Section 1 after its completion for a price
based on the actual cost of construction, and secured an option
to purchase Section 2. Following Railtrack plc's entry into railway
administration and Railtrack Group's subsequent withdrawal from
the project, the Department looked at whether it should itself
take all the risk on cost overrun. Although such an option was
the least costly over a range of possible outcomes, the Department
concluded that it was not a sensible alternative, as the Department
could not manage construction risks. The last time the Department
had borne construction risk, on the Jubilee Line extension, the
project was completed 21 months late and £1.4 billion over
budget. The Department therefore sought to layer the risks so
that the project managers would be responsible for a significant
amount of the initial overrun.[11]
12. The Department, LCR and Bechtel negotiated the
Cost Overrun Protection Programme (COPP), which the Department
thought at the time was expensive. Bechtel, a key project manager
on the Link and a shareholder in LCR, received £60 million
for arranging the proposal. It involved carrying a £100 million
share of the first £300 million of potential cost overruns,
in excess of a target construction cost for Section 2, providing
the overruns were not the consequence of inflation greater than
a contractually determined and defined cap of 3% per annum. A
group of insurers received a £27 million premium for bearing
£215 million of potential cost overruns in the range £300
million to £600 million. Overruns arising from inflation
greater than 3% a year were to fall on LCR and ultimately on the
Department. LCR was to bear the full cost of any overruns above
£600 million (Figure 3).[12]
Figure 3:
The sharing of cost overruns between the parties

Source: C&AG's Report
13. The expected cost of Section 2 of the Link has
increased. Bechtel will be called upon to cover only a very small
part of this increase in costs because the bulk of the increase
is due to railway inflation of over 6%, double that of the contractually
determined cap of 3%. Railway inflation has been higher than expected
because of a greater demand for limited labour and materials after
the Hatfield disaster and for the West Coast main line renewal.
These events resulted in higher wages and higher materials costs.[13]
14. The Department was confident that there would
be no further sizeable increases in the construction costs of
Section 2, as work had reached a point where it was over 80% complete.
Remaining costs amount to between £100 million to £200
million, against total expenditure of £3 billion.[14]
15. In 1998 the Department granted LCR an access
charge loan facility, capped at £360 million at 1997 prices
in present value terms, for it to draw down funds to meet Eurostar
UK's obligations to pay track access charges. As a result of construction
cost increases, LCR is likely to draw on the access charge loan
facility earlier than originally expected. The Department and
LCR believe, however, that over the remaining 80 years of the
franchise, sufficient revenues will be generated to enable LCR
to repay the loan.[15]
16. For the future, the Department considers that
there will be substantial inflationary pressures on projects in
London and the South East, such as the Olympics, widening of the
M25, Thameslink 2000 and Thames Gateway. The Department acknowledged
the need to phase major infrastructure projects to reduce supply
side pressures.[16]
10 22nd Report from the Committee of Public
Accounts, The Channel Tunnel Rail Link (HC 630, Session
2001-02); Q 104 Back
11
22nd Report from the Committee of Public Accounts,
The Channel Tunnel Rail Link (HC 630, Session 2001-02)
para 5 (xii); Qq 12, 15, 104 Back
12
C&AG's Report, para 3.19; Q 12 Back
13
Qq 31-33, 36, 109 Back
14
Qq 36, 39, 72, 109 Back
15
C&AG's Report, para 3.28; Qq 8, 58, 60 Back
16
Q 109 Back
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