Examination of Witnesses (Question Numbers
40-59)
DEPARTMENT FOR
TRANSPORT AND
OFFICE OF
RAIL REGULATION
Q40 Chair: Right, that is very helpful.
We are likely to be asked for a vote, but I wanted to move you
on to something. If you look at the structure in which you are
planning for infrastructure, you have got you, the Department—hopefully
we will Mr Emery in as well—you have the regulator, you
have Network Rail and you have the operating companies. Two things
occur to me out of that structure that perhaps Mr Emery would
also like to comment on. One is the position of Network Rail because
you use Network Rail to help develop your plans and then they
become the sole bidder and provider, and the other is that all
of them—except perhaps the Department for Transport, but
perhaps you get sucked in—all of you, are into growth. It
is in everybody's interest to have growth. So, at a time of public
expenditure constraints when growth will be constrained, where
is the thinking going on outside the box which will make people's
journeys easier, meet perhaps some of the environmental objectives
that we and you have as a Department, but not require always an
increase in infrastructure? Now, at that point, having asked you
that difficult question, we have a Division bell, so I am going
to have to go. So, you have a good chance to give us a sensible
answer when we come back and I think we want to develop those
structural issues a little bit more.
Sitting suspended for a Division in the House.
On resuming.
Chair: Now, it was a rather complicated
question I put to you both, and just to re-state it, it was about
the infrastructure of the four bodies that take the decisions.
It seemed to me that one of the issues is can you really get value
for money because of the role particularly of Network Rail in
providing you costings as well as then bidding. The second issue
is that the emphasis will always be on growth and, therefore,
is there a proper discussion and deliberation on other options
or is growth always seen as the only answer to some of the challenges
that you face in getting people around the country as quickly
and comfortably as they can. Who wants to start?
Robert Devereux: Can I do the
second one first?
Chair: Okay.
Robert Devereux: Let's just first
think about what we are trying to achieve here. We have, without
a shadow of doubt, long-term trends that show that people want
to travel more in the UK and that has been the case for a long,
long time. I assume you do not mean that the question is how can
I get people off trains and put them back into cars.
Q41 Chair: Not necessarily. They
might walk; they might go by bike. That is the thinking outside
of the box. That's the old "it's either trains or cars".
Are we thinking radically out of the box enough or are we just
always thinking: increase train capacity?
Robert Devereux: I am not always
thinking about how to increase train capacity because I'm not
going to have a budget to do it. So can I take it back to the
conversation that we were having earlier about what you would
get if you had rather more dynamic pricing on this network; we
will have the technology to that. Right at the moment, if an individual
has the theoretical choice from their employer to do a day's work
from home, there is no cash consequence in terms of their travel
costs if they are on an annual season ticket. If you were in a
world in which the choice of when you travelled and the choice
of whether you travelled fell straight through into the idea of
"there is some financial incentive in this", I think
that would make a difference. At the moment, the main cost of
the train system in London is having so many trains doing one
or two journeys in the morning and being parked up for most of
the day. So, the more I can do to spread demand, the better it
is. The way I will spread demand almost certainly has something
to do with thinking about the effect of pricing. That might in
itself have a bearing on people's choices about whether to travel
in the first place. Whether it would tip them into cycling or
walking, I am not sure. That is where the problem is because these
people are typically coming in 10, 15 or 20 miles on some of these
journeys. Fundamentally, that is the different way of thinking
about it because at the moment we have pretty static prices and
consequently, what you might say is a very heavily utilised network
at one part of the day and not at any other time. It is the same
on lots of other networks; it is the same on telecoms networks.
In all other networks, people think laterally about how do you
match supply and demand, typically through the use of price. I
can't help feeling that, as Oyster is beginning to demonstrate
in London, you have some possibilities down that track. As for
the Network Rail one, maybe that's one Bill would answer.
Bill Emery: Certainly, from a
regulatory point of view, having one big infrastructure manager
presents a little bit of a problem and one of the ways we tackle
that is to say, "Well, we are not going to consider Britain
as just so special that you cannot compare it," and just
have an argument with consultants against consultants, and we
push for use of international benchmarking, and that is, in some
respects, a bit of a first for regulation in the effective use
of international benchmarking and using that to test whether—
Q42 Chair: I am going to just stop
you there because we are going to come to costings later, and
we have a load of questions about costings and international benchmarking.
At this stage can we just stick to the decision-making structure,
because we think it leaves a little bit to be desired?
Bill Emery: I think the 2005 Act
that brought in a process by which the Governments both here and
in Edinburgh made a decision to inform the five-year settlement
as to what it required from the railways and, more particularly,
what public funding it was going to make available was a truly
significant step forward. The 2008 review required Network Rail,
the Department and ourselves to start to try and form the 2007
HLOS and SoFA decisions and try to get the best data that we could.
The train operators were a little bit late in coming to the party
in that, but they are truly addressing it for the next round of
decisions. So there is quite a good process of properly informing
the choices that are essentially for Government about what they
want from the railway and how much money they are likely to be
prepared to put in it. At the end of day, there is a process that
says what is the limiting factor—
Chair: You do not really deal with the
issue, because all the parties sitting round the table want more.
That is what they all want—more.
Robert Devereux: Well, let me
just build on what Bill said. Let me outline the difference that
the 2005 Act produced, and the way in which the High Level Output
Specification is, indeed, just that, because it says "I have
got more capacity that I can see coming along; I want this level
of crowding; I am not telling you how to do this." So, there
is an opportunity in the system to consider the price consequence—in
other words, could you think laterally about doing something else,
something better. So, I know for a fact—and I cannot remember
exactly which one it was—in one of our interventions, we
simply managed to achieve more capacity by a rather more sophisticated
use of existing assets. In other words, I am sweating the assets
more. I have not actually put any more carriages on, but none
the less, because I have re-timetabled and done something clever,
we have managed to get something out of it. Now, that sort of
thing comes out of the conversations between the Department that
is paying for this and the bidders who are actually responding
to what is specified as output. If I had specified that I wanted
1,300 carriages, I would indeed be locked into the notion of "Well,
I have to pay for it." If I specify I need this output, if
we can find elegant ways of doing it, which is in a sense what
the Department is trying to do in deciding whether to invest,
that relieves some pressure. Now, the more that people understand
and produce examples that do not require very heavy capital expenditure
or—
Q43 Chair: And where does that thinking
come from?
Robert Devereux: Well, at the
moment, that thinking is coming from a combination of train companies
themselves and the Department in challenging them before they
sign things off. So, I would not characterise everybody as slavishly
thinking the answer to this question is a new carriage, because
I do not think that is the nature of the beast. But right now,
it is the case that we can, through quite a bit of infrastructure
work, get more carriages on the network. The next phase is, as
I have described earlier, not going to be like that.
Chair: Stephen and then Nick.
Q44 Stephen Barclay: Yes. It just
strikes me that it is very difficult to make an assessment on
value for money, given the complexity of the structure in place
and the lack of transparency around Network Rail. So, the Report
says we have rising cost of new trains, lack of international
benchmarks, higher financing cost, complex contract structure
and a flawed model and data strategy. So, in terms of the transparency
available to you about Network Rail, are you satisfied you have
all the information that you need?
Bill Emery: As a regulator, I
am never satisfied with having all the information and that is
why we are pushing quite hard, and I am taking on board the kind
of recommendations—
Q45 Stephen Barclay: Well, what major
areas of data do you not have?
Bill Emery: Well, with Network
Rail, it relates to ever-improving international benchmarking
data to compare and contrast. Only last week we published our
most recent report on how Network Rail compared to its European
peers.
Q46 Stephen Barclay: But you have
been in post for a number of years, have you not?
Bill Emery: We have in been—
Chair: You have been in existence—
Bill Emery: We have been in existence
since the beginning, in a sense and—
Chair: And previous to that there was
something else.
Q47 Stephen Barclay: Could I go through
just a few of the numbers then, because I was having trouble just
working them out. On the £9 billion improvement programme,
two thirds of that is borrowed money by Network Rail, is it?
Bill Emery: A lot of it is Network
Rail's, yes.
Stephen Barclay: £6.1 billion; that's
what is borrowed, is it?
Bill Emery: I think that's it.
Q48 Stephen Barclay: The refinancing
costs are, is it £800 million?
Bill Emery: Yes, that cost of
refinancing—well, the annual cost of financing that level
of debt will be be continual—is what it will be, yes. That
is how it works on the cost of capital.
Stephen Barclay: Sure. I agree, the £800
million is just for the first five years, so presumably there
will be ongoing costs.
Bill Emery: It is ongoing because
in fact the capital costs of the enhancements are added to Network
Rail's regulatory assets base and that is remunerated at the cost
of capital based on all the best information we have, and that
follows on throughout, so we are buying those types on enhancements
on the basis that these are investments for the long term that
will be funded through access charges and network grants on a
long term.
Stephen Barclay: Sure, so that will pass
to their asset base—yes, we get that.
Bill Emery: Yes, and that is what
happens.
Q49 Stephen Barclay: So what are
the non-incremental infrastructure improvements? What is the refinancing
around those? If we were not doing these improvements on which
we are paying £800 million of the financing cost, what would
be the financing required just to maintain the status quo?
Bill Emery: If it is just a question
of the renewal of the existing assets, then that is covered through
the normal maintenance charges and revenue through the actual,
so it is a kind of pay-as-you-go. If it is an enhancement, then
it is in the capital exactly the same way. There are only two
ways you can get the money.
Q50 Stephen Barclay: Okay, let's
look at it differently. What I am trying to drive at is what is
Network Rail's current debt and what is the refinancing cost on
that at the moment?
Bill Emery: Its current debt is
at the £30 billion level. I have not got the exact number
in front of me[1].
(Figure taken from ORR's September 2010 publication
"Annual efficiency and financial assessment of Network Rail
2009-10", page 42).
Stephen Barclay: What? Give or take a
couple of billion or...?
Bill Emery: It is running
at around about 5% or 6% of return—5% return on the regulatory
asset base.
Q51 Stephen Barclay: Right, so what
is the refinancing cost? What I am driving at is that, earlier,
in the response to Matt Hancock's question, the answer was, "Well,
if you give more money to Network Rail, we can bring the ticket
price down." What I am just trying to establish is how much
of the money we are giving is currently going in financing costs,
and then perhaps we can go on to some of the press reports on
management costs and consultancy costs and other things. How much
of it is going in refinancing costs? You are, with respect, the
regulator; I assume you know what the refinancing costs are.
Bill Emery: I have not the precise
figures in front of me—I can provide those for you quite
happily—as to what the refinancing costs or the return that
we incorporated[2].
(Figure taken from ORR's September 2010 publication
"Annual efficiency and finance assessment of Network Rail
2009-10", page 49.)
Q52 Stephen Barclay: Because what just
struck me as slightly odd was there is this document, Information
Memorandum 2010, which talks about a £35 billion multi-currency
note programme, and there is a further £4 billion of other
notes on a different programme, and yet at page 26 it says the
issuer, Network Rail, is permitted to incur debts outside the
programme, included but not limited to bank debt. It talks about
the various banks who are involved in this—Merrill Lynch,
Deutsche Bank, Morgan Stanley, Barclays Capital, Goldman Sachs,
Citi, HSBC, UBS, Royal Bank of Scotland—and none of those
come cheap. So, how does this Committee get sight of how much
money the taxpayer is giving each year to Network Rail and transparency
in terms of how much of that is going on refinancing costs, how
much is going to Mr Coucher, who was paid significant sums, to
any consultancies, to your costs—your Chairman is on £120,000
a week, I think, for a three-day week—whatever the Chairman
of Network Rail gets, a figure of around a quarter of a million
for a two-day week has been quoted. And the elephant in the room
has to be that the more complex a structure is, on the whole,
the more expensive it is likely to be. The Report does cite that
this is a unique structure and, at the heart of it, accountability,
we are being told, is by individual members of Network Rail; well,
we are not sure that is that effective. So, really the accountability
is being driven by yourself. And so, as the Committee that is
looking at this in terms of value for money, could I come back
to the first question? This year, what will Network Rail pay in
refinancing costs?
Bill Emery: I do not have a figure
in front of me, but Robert might have.
Robert Devereux: The figure that
was published in the White Paper showed for each of the five years
not only what the taxpayer was putting in, but how much the passenger
service would cost to run, what the baseline costs of the actions
of Network Rail are in doing maintenance, operations, and so on,
and there was a third line that said, "Network Rail financing
payments"—so that's the cost annually of the debt,
call it £30 billion. Over the space of the five years, the
projection was £8.4 billion. So, that £8.4 billion is
the cost of carrying the historic debt before you start the control
period and then when you borrow a further £6 billion, which
is what we were planning, there is an additional financing charge,
which is the £800 million that you mentioned earlier on.
So, those are the numbers in respect of the financing.
Q53 Stephen Barclay: One can dwell
on that, but to move on, that is covering all debt currently owed
by Network Rail, is it?
Robert Devereux: I believe so.
Bill Emery: Yes.
Q54 Matthew Hancock: So, do you have
the interest rate—the average interest rates?
Bill Emery: No, because I do not
have with me the stock at the end of each period to be able to
do this sum, so I'm afraid—[3]
| Actual
2009-10
| PR08
determination | 2009-10
budget
|
| (A) | (B)
| (C) |
Average interest rate on nominal debt—FIM covered
| 5.4% | 5.0% | 5.0%
|
| Average interest rate on nominal debt—unsupported
| n/a | % | n/a
|
| Average interest rate on index linked debt—FIM covered
| 1.4% | 1.5% | 1.4%
|
| Accretion on index linked debt—FIM covered3
| 4.4% | 2.3% | ¸1.5%
|
| Total average interest rate on index linked debt—FIM covered3
| 5.8% | 3.8% | ¸0.1%
|
| FIM Fee rate3 | 0.8% | 0.8%
| 0.8% |
(Figures taken from ORR's September 2010 publication "Annual efficiency and finance assessment of Network Rail 2009-10", page 50.)
| | | |
Q55 Matthew Hancock: Right. And you do not know how
much Network Rail is carrying—how much debt Network Rail
is carrying.
Bill Emery: We do know how much Network Rail's
carrying—
Matthew Hancock: How much is it?
Bill Emery: We published that in a Report,
but I do not have the figures with me at the moment. Our approach
to Network Rail is to set an overall revenue requirement and leave
the means by which it finances itself primarily in own hands,
setting a limit on the expectation of the growth in the RAB, which
is a long-term liability that is going to be placed upon the taxpayer,
and hold it to deliver on all the obligations that have been set
out by both Government and myself as part and parcel of the settlement.
Matthew Hancock: I just want to press on this because
something in your earlier evidence surprised me and I wrote it
down. You were talking about how there is £15.3 billion subsidy
over five years, and you then said—you were talking about
rail fares—you said it is a choice about how much subsidy
as a country we put in, and that is a political decision; I understand
that. But it is not just about how much subsidy goes in, it is
also about how much value for money there is in the system. I
was astonished that as the person managing all this you did not
recognise that improving the service is not only achieved by putting
the subsidy in, but by getting better value for money. And now,
Mr Barclay asked a basic financial question about Network Rail
and the regulator, who is the only person to whom Network Rail
is accountable, as far as we can work out from the structure of
that very obscure—well, it is not a company; I don't even
know what to call it—does not even know the financing numbers.
Bill Emery: We do know the financing and we
get comprehensive information.
Matthew Hancock: Well, what is it?
Bill Emery: I can quite happily provide you
with the details behind all that as to where we are, and our Report
on the financial performance of Network Rail in the last year
is available, and it was published last week. It sets out exactly
what those particular numbers are and our focus is on testing
whether they are consistent with our projections, which were set
out in the public domain. It is all covered in our determination.
Q56 Matthew Hancock: You said your approach is
to set out the obligations you want for Network Rail, and then
let it get on with financing it. Well, who is delivering value
for money and driving value for money through Network Rail?
Bill Emery: We drive value for money through
Network Rail when looking at what it needs to do to operate, maintain,
renew and enhance the network. We look at its current performance
and the costs, establish what we think an efficient company could
do and then set it a trajectory based on that, and hold it to
deliver on all its obligations. So, it has to deliver on punctuality,
it has to deliver on the programmes, it has to maintain the network,
it has to operate in the normal way. We hold the company to deliver
on all the outputs that we set out in our determination, and Network
Rail then further refines that in its delivery plan. We hold to
that. We have large amounts of information on the financial flows
from Network Rail to test whether or not it is improving its efficiency.
Q57 Chair: I want to interrupt this because you
have been around, or your predecessor body has been around since
1994; you have been around since 2006. Your job has been to secure
greater value for money, yet you say in the Report, on page 20,
paragraph 2.2, there is still "a very large potential for
Network Rail to improve its efficiency". So, what we are
left wondering is what on earth have you, and your predecessor
organisation, been up to since 1994. When you come to particular
efficiencies that are mentioned in the report, they all seem based
on finger-in-the-air data.
Bill Emery: Clearly, progress was made in the
early years in Railtrack before the actual costs exploded—when
it went into administration—and there had been a progressive
drive from the Office of Rail Regulation to set challenging targets
on Network Rail.
Q58 Chair: If this is a progressive drive, how
can you say there is a very large potential for Network Rail?
Bill Emery: Because there is.
Chair: So where has the drive been successful?
Bill Emery: Well, Network Rail was set a target
to improve its efficiency by 30% in the last control period. We
have set them a target to improve its efficiency by 21%. That
represents two-thirds of the gap towards the European peers. Given
all the other challenges facing Network Rail, we felt that was
a balanced judgment as to pace of change required by Network Rail
to address that target. We have identified here—
Q59 Chair: But, hang on, what have you achieved—or
your predecessor—from 1994. What have you achieved from
2006? You have been around—
Stephen Barclay: You started in September 2005, I
thought.
Bill Emery: I started in September 2005.
Mr Bacon: This is what puzzles me. You have been there
for five years and the report says not only did you not—and
you talked about benchmarking as if you were doing it; I know
it has probably started now—but the Report says, "The
regulator did not specifically seek international benchmarks for
new infrastructure schemes to enhance capacity. It reduced costings
by removing schemes." And there is a chart—
Bill Emery: There is a chart, yes.
1
Note by witness: Network Rail's regulatory net debt in
2009-10 was £22,819 million (nominal prices) Back
2
Note by witness: The total financing cost of Network Rail's
regulatory debt in 2009-10 was £1,252 million (in 2009-10
prices). Back
3
Note by witness: Summary of average interest rates on Network
Rail's debt: Back
| 
