High Speed Rail - Transport Committee Contents

Written evidence from Professor Robert Cochrane (HSR 171)


1.  I have read the separate Evidence submitted to the Select Committee by Professor Peter Mackie of the Institute for Transport Studies, University of Leeds and agree with the points he has raised. My evidence is additional to his and does not repeat those points.

2.  My evidence sets out some of the issues, primarily organisational and financial, which I believe to be important in the assessment of British high speed rail projects. It is based on my experience of high speed rail demand forecasting and operations in England, Continental Europe, the Middle East and East Asia. This includes both the 1970s studies for the Channel Tunnel Project, when I was a consultant with Coopers and Lybrand, and the British Railways studies for this project in the 1980s. The latter studies were carried out when I was responsible for introducing financial cost benefit analysis and project appraisal within the British Railways Board and subsequently as a Deputy Director of InterCity services.

3.  My comments relate principally to the "business case" for the project—the financial feasibility, financial engineering and public sector financial support aspects of the HS2 project, which I consider to be the areas where the work to date has been weakest. In addition, I would like to amplify the comments made by Professor Mackie regarding the role of HSR in shaping land use in England.

WebTAG BCR—the Ratio of Benefits to Subsidy on an Integrated Rail Network

4.  The HS2 project has been appraised using the DfT WebTAG principles, on which it has what is referred to as a benefit/cost ratio (BCR) of about 2. What is not widely appreciated is that this is not a conventional benefit-cost ratio. Putting to one side the secondary effects of indirect taxation, it is the ratio of the present value of benefits to the present value of costs less the present value of the revenue, with the a priori assumption that costs exceed revenues. Hence it is the ratio of the benefits received by the community to the Government subsidy required. So in simple terms, the time adjusted ratio of community benefits to Government subsidy is of the order of two. The ratio is calculated over a period of 60 years, using relatively low discounting factors of 3.5% and 3%. This means it may not reflect the ratio of benefits to Government subsidy in the early years.

5.  The BCR is calculated for the rail network as a whole, assuming that the fares on the high speed trains will be similar to those on existing franchised services and that the service levels on competing services can be altered to balance capacity without changing fares. These assumptions correspond broadly to those which would be adopted for the appraisal of a nationalised railway network in which the high speed line is an additional Government owned service which does not charge a premium for what is clearly a premium service.

6.  In reality, our railway network has an entirely different financial structure. Following privatisation, we have a rail network with a two tier structure in which private companies operate services under franchise over rail infrastructure provided by a not for profit company with a very substantial Government subsidy. This structure was adopted specifically to promote competition, yet the HS2 analysis does not take it into account. The McNulty Report contains recommendations for modifying this regime, but there is no political appetite for radical restructuring, so it is reasonable to assume that high speed rail services will be introduced under an organisational structure broadly similar to the present regime.

7.  There is at present no business model setting out how HS2 services would be franchised within the existing (and, presumably, the future) structure, no discussion of the degree to which competition between franchisees would be permitted and no analysis of the impact of allowing the HS2 franchisee freedom to set fares in a profit maximising manner.

The Absence of a Financial Model of the HS2 Project

8.  Promoters of private sector projects almost invariably prepare financial cash flow models of their projects, taking account of year by year expenditure, revenue and financing costs in the case of private sector projects or financing constraints in the public sector. Both the revenue stream and the operating cost streams take account of changes in fares and operating costs due to competitive reaction within the market which is to be served.

9.  This is also the approach which we introduced into British Railways some 30 years ago at the request of the Transport Department and Treasury, to ensure that we could estimate both the short term annual financial effects and the long term benefits of rail investment. To my continuing surprise, no such analysis has been carried out of either the impact of HS2 on the overall level of annual financial support required by the railway network as a whole or of the financial performance of the HS2 services themselves. This is despite the rapid financial collapse of the two most recent Asian HSR systems, those in South Korea and Taiwan.

10.  In the case of HS2, two related cash flow analyses are needed. At the national network level, we need an analysis of the annual cash flows for the network as a whole, so that the level of subvention (subsidy) required from Government, particularly in the early years, can be forecast. This analysis needs to take account of the use which is made of the released capacity on conventional lines. If this is taken up by local services, which generally have higher operating subsidies than the long distance services currently operating on these lines, the support costs for the conventional rail services could rise. A benefit—cost ratio of two for a project dependent on long term growth over 30 to 60 years may hide an increased short term rail financial support requirement in the early years.

11.  We also need a detailed financial analysis of the HS2 services in isolation to evaluate the business structure under which it is to be operated and their separate capital and operating subsidy requirements. Economic theory indicates that there are situations (such as market failure, externalities, social justice and economies of scale) where operating subsidies may be justified. None of these arguments appear to apply to long distance travel by rail.

12.  Theory also indicates that public welfare is maximised when prices (fares and other secondary revenues in the case of rail) are equal to the marginal cost of providing a service. There may be an argument for subsidising the capital cost of providing rail infrastructure, but theory suggests that except in very special circumstances operations (including labour, fuel, rolling stock, and maintenance) should be covered by fares.

13.  This also simplifies management, since operations can be transferred to the private sector under a franchise arrangement and operated without subsidy. On average, "InterCity" services currently appear to be operating close to this important economic, financial and management boundary.

14.  In the absence of a separate financial analysis of HS2 construction and operation, it is not at all clear whether HS2 could be operated on a profitable basis without subsidy in the early years even if the Government absorbed the capital cost of the new infrastructure. Given the high level of subsidy which is certain to be needed even to provide the infrastructure, a year by year cash flow analysis which takes account of competition and assesses the change in subsidy needed as fares are varied (taking account of both revenue and operating cost changes) is essential to assess whether the service can operate without an ongoing operational subsidy, particularly in the early years, and to assess the risks associated with any shortfall in demand and revenue.

Distributional Issues - who pays and who receives the benefits?

15.  Since HS2 passengers receive the benefits of premium service without paying premium fares, there is also a distributional issue - who pays for the new transport infrastructure and (possibly) operating subsidies, and who obtains the benefits. For a new railway, there are three issues to be faced. The first is that the public funds come in a large part from taxes paid by those living in areas far from the line and who will rarely use it.

16.  The second point applies in particular to high speed lines. The benefits are predominantly obtained by those living close to the few railway stations—few, since otherwise the benefits of high speed operation are lost by frequent stops. But those living between the stations may suffer dis-benefits from construction and noise.

17.  The third issue is that of the income distribution of long distance high speed rail passengers. There is a great deal of evidence provided by the Governments own ongoing National Transport Survey that long distance travel and long distance rail travel journeys in particular are predominantly made by higher income groups. The highest income quintile makes three times as many long distance trips as the lowest, and they make a higher percentage of these trips by rail.

18.  The combination of these three factors means that the benefits of high speed train services primarily accrue to a small sub-set of the population which has to pay for the infrastructure and possibly, an operating subsidy in the early years. These are predominantly higher income personal and business travellers with origins and destinations relatively close to the few railway stations.

What will be the source of capital funding?

19.  Very large projects such as a high speed line raise a fourth distributional issue—that of the efficient and politically fair distribution of available Government funds. When funds are in short supply, a basket of small projects tends to show better value for money than a smaller number of large projects and also spread the benefits of Government spending more widely.

20.  HS2 is at the other end of the scale. In recent years, total Government financial support for railways has been of the order of £5 billion pounds per year. An analysis of the Government's responsibilities suggests that on the one hand, there would have been little likelihood of this budget being increased even without the current financial difficulties and that on the other hand, the very severe problems of rail access into London on almost all lines (not just the WCML and the a lesser extent MML which are relieved by the HS2 proposals) will require at least this level of financial support, even with fares rising in real terms year on year.

21.  Against this background, the initial stage of HS2 is likely to require capital funding of the order of £17 billion in 2009 prices with a peak expenditure of over £3 billion per year. A system covering the north of England as well would need about three times this sum. It is not clear where this money can come from. "New" money is currently unavailable and there is no scope for the transfer of existing funding for rail.

Wider Benefits and shaping National land use patterns

22.  Finally, I turn to the question of the "wider benefits" of high speed rail to the economy which many supporters have emphasised without explaining in any detail what they are and who are the recipients.

23.  The better understood additional benefits, such as agglomeration benefits, may add another 10% to 15% to the standard welfare benefits which are based essentially on reductions in travel time. There are also benefits to those with businesses or owning land close to stations, but research suggests that much of the development would have occurred over a larger area and is merely concentrated. The net incremental benefits are low.

24.  However, there can be benefits if the line is used effectively to help trigger new development. Professor Mackie has suggested a new town. Interestingly, this approach has been used in Germany. New stations are introduced in spaces between the existing cities. The extra stops reduce the "headline" time savings over long distances but may be more effective in shaping future land use. But it will require a major change in the approach to the use of high speed rail in Great Britain, away from seeking the highest speeds over the longest distances to assessing the role high speed rail can play in shaping long term land use over shorter distances of the order of 50 miles or so.

May 2011

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Prepared 8 November 2011