Written evidence from Kyn Aizlewood (HSR
44)
INTRODUCTION
The Department for Transport [DfT] has published
plans to invest in a new High Speed Rail [HSR] network across
England including an Economic Case and Business Case for HS2,
the next stage of investment. However the reports published do
not address many key areas highlighted in the Treasury's Green
Book approach re the "Five Case Model", which sets out
an approach to ensure value for money from public sector investment
projects.
This approach considers public sector investment
proposals, seeking assurance that a compelling case is made, justifying
the use of taxpayer money, under five headings:
1. The strategic case [Paragraphs 1-7]
2. The economic case [Paragraphs 8-35]
3. The financial case [Paragraphs 36-39]
4. The commercial case [Paragraphs 40-47]
5. The management case [Paragraphs 48-54]
I have presented analysis in regard to the "Five
Case Model" as it may apply to HS2, also drawing upon the
experience and lessons learned from HS1.
SUMMARY AND
CONCLUSIONS
If there is a robust Business Case for HS2, it has
not yet been made by HS2 Ltd or by DfT. In terms of the Treasury's
Five Case Model, the proposals to date are substantially deficient.
Instead, the evidence suggests that HS2 is an investment
programme built on shaky foundations and offers nothing for 15
years. More modest, incremental investments that match new capacity
to demand have been discarded in favour of a Grand Design, a loss-making
project beset with huge risks and provided at enormous cost to
the taxpayer.
Without a valid business case and in almost any other
walk of life, the proposals for HS2 should/would be rejected.
THE BUSINESS
CASE FOR
HS2—THE FIVE
CASE MODEL
THE STRATEGIC
CASE
1. In presenting the business case, at the HSR
Business Debate, 29 November 2010, the Rt Hon Phillip Hammond
MP and Minister for Transport declared a range of "strategic"
benefits of investment in High Speed Rail eg:
— [it
will become] "the preferred mode of travel for the overwhelming
majority of passengers between London and its hub airport and
Britain's great provincial cities";
— "High
speed rail will be an unbeatable option for inter-urban travel";
— "Achieve
a step change transformation of our economic geography";
— "lead
to huge regeneration opportunities…in Birmingham, in London
and in due course in Manchester, Leeds and South Yorkshire";
— "deliver
a transformational change to the way Britain works";
— "tackling
the North-South divide in economic growth rates more effectively
than half a century of regional policy"; and
— "High
speed rail will merge our great population centres into a single
economic hinterland".
2. Clearly, as the plan for HS2 is to attract
the majority of its passengers from existing inter-city, high
speed lines, if it goes ahead it will, de-facto become the main
way of connecting a small number of English cities ie a faster
connection to London from Birmingham and, latterly from Manchester,
Sheffield and Leeds. However most people do not actually live
in these cities and it is likely that most people, most taxpayers,
will never travel on HS2.
3. The original business case for HS2, prepared
by HS2 Ltd and published March 2010 is far more modest in terms
of its contribution to wider economic transformation, offering
an estimate of £3.6 billion "wider economic benefits".
This assessment looked at three areas:
— Agglomeration
benefits ie benefits of improved linkages between businesses.
— Labour
market impacts ie benefits to commuters.
— Imperfect
competition ie benefits to consumers of higher output, caused
through investment in HSR.
4. HS2 Ltd's analysis using DfT guidelines indicated
potential Agglomeration benefits of £2 billion and £1.6
billion arising from imperfect competition, with hardly any benefit
on labour markets.
5. HS2 Ltd also commissioned further work from
the Centre for Transport Studies, Imperial College to ascertain
any further benefits and DfT concluded that "this suggests
there may be some additional benefits that are not included in
our estimates of wider economic impacts, it is unlikely that they
will change the conclusions presented in this report".
6. Subsequently in the Economic Case, DfT has
increased this projected benefit to £6.3 billion, reflecting
the impact of the Y network. Whilst there has been much talk
in the media of "new jobs created", this DfT estimate
for wider economic benefits only represents 5% of the total benefit
claimed in the Economic Case and it is a modest return on the
£30.4 billion capital investment required to create the infrastructure.
7. It is also likely that many "new"
jobs - in areas close to new HS2 stations -simply represent a
re-distribution towards these centres of investment and away from
towns and cities further from the line.
THE ECONOMIC
CASE
Distributional analysis
8. One of the first questions for government
about a new, major investment programme is "who benefits;
who pays"? Some public sector projects easily gain public
support because people can see the "public good" or
they can recognise some indirect benefit eg in provision of free
education [for the next generation], the NHS [we may all become
ill one day], defence and policing [we collectively benefit from
living in a safe environment].
9. We already have a good transport infrastructure
in the UK, however the proposal for HS2 develop a new "super
system" on top of the existing network.
10. The cost benefit analysis argues that most
of the benefits of HS2 will be from passengers who use the service;
the wider economic benefits, as described earlier, are quite modest
given the scale of investment. However HS2 offers a new choice,
as the cities to be part of the y-network are already served with
relatively quick, subsidised, rail transport links to London eg
few major cities in Europe can access their capital city within
two hours, as we can in the UK.
11. So, unlike with health, education and other
"public services", the proposal for HS2 is to provide
an upgraded service, heavily subsidised by the general taxpayer,
from which a relatively small percentage of the general population
will benefit; most people living in the UK and paying the taxes
to fund HS2 will never make use of the service.
12. The Business case argues that HS2 will "free
capacity" on other parts of the network, allowing non-HS2
users to gain benefit. However [1] this only represents another
small part of the population and [2] the train operators run a
business and they will need to close down "spare capacity",
if passengers switch to HS2, as speculated.
Option Appraisal
13. No systematic appraisal of wider transport
options has been presented in the Economic case i.e. does a £30
billion investment in the rail network add more value than an
equivalent level of investment in road? In the development of
super fast broadband networks? In integration projects for existing
metropolitan areas?
14. Assuming the answer is "yes", details
of option appraisal work found in supporting papers to the Business
Case indicate that an option termed "Rail Package 2",
a major transformation programme of the existing WCML route achieved
a significantly higher benefit to cost ratio than HS2, at a fraction
of the cost. This was rejected because it did not provide the
spare capacity offered by HS2 and therefore was insufficiently
transformational. How to put a value on "spare capacity"?!
15. The criteria used in the option appraisal
on alternative routes for HS2 placed little value on local amenity
or environmental factors. For example, an earlier route considered,
using an existing transport corridor [M40] would achieve substantially
less degradation to the environment and probably much lower levels
of compensation to land/property owners affected. This was a
lesson from HS1. Instead, the route chosen is the quickest, by
about three minutes, through the Chilterns, based on a highly
questionable methodology used by DfT which [somewhat ironically,
given the positive spin placed on "modal shift to rail"]
values time spent on a train at nil.
Demand forecast
16. The economic case rests upon a complex, long-term
econometric model, predicting a future level of demand for long-distance
rail travel into London. The modelling is over 75 years and we
might say that the parameters of uncertainty around this "best
guess" get wider with every year.
17. In its White Paper, Delivering a sustainable
railway [2007], DfT identified a more progressive approach:
"While the Government must plan 30 years ahead,
it recognises that it is impossible accurately to forecast demand
that far into the future. Some cities and regions will grow faster
than others. People and firms are likely to respond to the challenge
of cutting carbon emissions by changing travel patterns and re-engineering
supply chains. The pace of technological change is equally unpredictable.
"Forecasts have been wrong before, and any strategy
that tried to build a rigid investment programme based on fixed
long-term forecasts would inevitably be wrong again. Such an approach
could well deliver additional capacity in the wrong place.
"To overcome this challenge, the guiding principles
in this strategy are:
To invest where there are challenges now, in ways
which offer the flexibility to cope with an uncertain future;
and to put in hand the right preparatory work so that, as the
future becomes clearer, the necessary investments can be made
at the right time"
18. These principles, which seem sound if unexciting,
appear to have been dropped in favour of a vision founded on a
straight line econometric forecast.
19. In estimating demand for HS1 i.e. the Channel
Tunnel Rail Link, the DfT failed to give consideration to the
potential for competition from low cost airlines and the ferry
companies, which had spare capacity. The House of Commons Committee
of Public Accounts, in its 38th Report of Session subsequently
reported in May 2006:
"In bidding for the project in 1996, LCR forecast
that passenger numbers using Eurostar would reach 21.4 million
in 2004 but actual passenger numbers were only 7.3 million. Where
future income from passengers is expected to provide a major element
of the revenue needed to repay the cost of constructing transport
infrastructure, it is crucial that realistic forecasts are prepared
from the start. Downside risks need to be given due weight, drawing
on both UK and international experience, in considering future
projects".
Pricing
20. There is little consideration given in the
Command Paper or by HS2 Ltd to pricing policy, other than assumptions
that pricing policy would be "optimised" between the
new HS2 route and the existing West Coast Main Line route and
that passenger fares will increase in real terms, year on year
above the rate of general inflation
21. Rail services are already heavily subsidised
by the taxpayer, a balance that the Coalition government has recently
pledged to change. In his speech of 14 September 2010, on Sustainable
Transport, the Rt Hon Phillip Hammond declared "We have one
of the most expensive railways in the world . . . That is not
acceptable. The taxpayer is contributing almost as much as the
farepayer".
22. The Coalition Government has since announced
plans to reduce the level of fare subsidy it offers to the rail
industry: fares for Year 1 of HS2 Ltd's 30 year revenue projection
will rise by 5.8% and from 2012 fare increases will be based on
"inflation + 3%".
23. If this new rule is applied to the business
case for HS2, the cost of a return, off-peak fare would be the
equivalent in today's money of £210, with a peak-time day
return fare at £360. Are these pricing assumptions - summarised
below - consistent with a 267% increase in demand? Is a doubling
of demand for rail travel consistent with a doubling of passenger
rail fares? Usually, more people are likely to buy a service if
the price falls.
24. Ticket Pricing Assumptions:
| Birmingham New Street to London Euston
| 2010 | 2043
Inflation +
1% pa
| 2043
Inflation +
3% pa |
| Peak, return fare | £140
| £200 | £360 |
| Off peak, return fare | £82
| £120 | £210 |
Notes
All prices at 2010 levels
Based on current, published West Coast Main Line [WCML] fares
Birmingham to London, see www.nationalrail.co.uk
25. The assumption used in the Economic Case is that the "inflation
+ 3%" formula will revert to the earlier "inflation
+ 1" after three years, restoring the principle of continued
high levels of public subsidy. Table 3 is indicative of a range
of future ticket prices. It is likely that HS2 prices would be
based on a "premium service", resulting in higher rail
fares for passengers eg reflecting the experience of travelling
HS1 in Kent.
26. Supporters of HS2 agree that demand for long-distance
rail travel is more than proportionately sensitive to changes
in income; an average demand elasticity of about 1.5 is used by
HS2 Ltd in the business case and this provides the basis for the
unusually high demand forecast of 267% growth discussed earlier.
By the same token, if government decided to reduce public subsidy
on rail ticket prices, this would be expected to have a disproportionately
large impact on forecasts of future revenues from HS2.
27. Herein lies the basis for the accusation that HS2 is potentially
a White Elephant ie it is so expensive that government will be
required to sustain high levels of public subsidy in order to
keep ticket prices low enough to generate viable levels of effective
demand.
Income, substitution and competition effects
28. The business case for HS2 combines an assumption of a
big increase in the demand for the service with rising fare prices.
However, the calculation of demand has been based upon modelling
a trend of rising incomes and takes no account of the increasing
real price of rail fares. It therefore over-predicts demand for
two reasons:
— an
income effect of a price rise - some consumers choose not to travel
eg they choose to take a shorter journey elsewhere, use the internet
or video-conferencing; and
— a substitution
effect, customers switching to an alternative, cheaper mode of
travel eg as we saw with HS1, consumers switched to cheaper alternatives
such as low-cost airlines or the cross-channel ferries.
29. The overall conclusion to be drawn from the
above is that the Economic Case over-estimates the future demand
for HS2, as it did for HS1. This over-estimate is a consequence
of ignoring the impact of potential competition and by not modelling
the impact of higher rail prices.
Cost Benefit Analysis
30. HS2 Ltd has rigorously applied DfT methodology
for cost-benefit analysis. However, does the methodology make
sense in the context of HSR? At first glance the Benefits appear
to easily justify the cost. However how much is your time really
worth?
31. HS2 Ltd's model puts a premium on business
travel, based on a generous assumption that the average business
traveller has a salary of £70,000 per year. A lower value
is put on leisure time, and a value of nil is assigned to time
spent on a train.
32. Now, many passengers read a newspaper, a
magazine or book on the train; others work on a laptop, listen
to i-pod players, make phone calls, send texts, play computer
games and so on, all of which, if they were not on a train, would
be termed either business or leisure activities. But because
passengers choose to do these things on a train, they are assigned
"nil value" ie DfT assumes that 100% of time spent on
a train is 100% wasted time. This provides the basis for calculating
huge "benefits" arising from shorter journey times:
when people stop travelling their activities are given value!
33. Clearly there is some wasted time in making
a train journey, mostly near the start and end of a journey, the
transfer points eg getting to the station, buying tickets, waiting
on the platform, finding a seat etc. However by reducing a journey
from 84 minutes to 49 minutes, there is good reason to think that
passengers are losing the most productive 35 minutes of that journey!
34. Furthermore, the impact of mobile technology
means that people increasingly utilise their travelling time,
engaging for much of the journey in some activity, business or
leisure, which they would otherwise do if not on a train.
35. Whilst the detailed CBA is complex, the assumption
that all travelling time is wasted is empirically not true and
therefore the "conclusion" that taxpayers will get a
£2 benefit for every £1 spent on HS2 is without foundation.
THE FINANCIAL
CASE
36. The level of investment required to support
the implementation of HS2 is summarised in the table below, taken
from the DfT Command Paper, updated by the Economic Case report.
| HS2 Cost Summary
| Net Present Value—£ billion
|
| HS2 | HS2 + Y network
|
| Capital cost | 17.8 | 30.4
|
| Operating cost [net] | 7.6 |
13.9 |
| Total Cost | 25.5 | 44.3
|
| Additional revenue | -15.0 |
-27.2 |
| Indirect tax | 1.5 | included
|
| Net cost to government | 11.9
| 17.1 |
37. To develop HS2 + Y network, Government requires taxpayers
to find the equivalent of £30.4 billion in capital cost at
current prices.
38. To put this into an everyday context, the National Statistics
Office estimate that in 2010 there were 30.2 million individual
income taxpayers; each would be required to contribute the equivalent
of an additional one-off tax premium of about £1000, now,
to enable the project to go ahead, with the first trains scheduled
between London and Birmingham from 2026.
39. The biggest risk to the financial case ie the affordability
of HS2 lies in the assumption of £27.2 billion [NPV] of revenues,
with:
— none
forecast for 15 years;
— revenues
based on highly speculative assumptions about growth in demand;
— a substantial
real-terms increase in rail fare prices; and
— the
value of the NPV substantially inflated by the use of discount
factors that does not fully reflect long-term commercial risk.
THE COMMERCIAL
CASE
Commercial feasibility
40. It is clear from the outset that HS2 loses
money; there is no business case for HS2 in commercial terms.
The sum of capital and revenue costs, discounted over time, is
nearly twice as high [£44.3 billion] as the projected stream
of revenues from ticket sales [£27.2 billion]. Therefore,
in commercial terms, if the project went ahead as planned, and
people behaved as predicted over the 75 year time horizon, the
project would achieve a present value financial loss of £17.1
billion.
41. It has been widely reported that London and
Continental Railways Limited [LCR], the company that operates
the lease for HS1, has been sold for about £2.1 billion to
Borealis Infrastructure and Ontario Teachers'
Pension Plan, approximately 40% of the £5.8 billion estimated
to have been invested in its development.
Commercial risk
The reliability of revenue forecasts
42. From a commercial perspective, the risks
around financial projections grow as the parameters of uncertainty
widen. The revenue forecasts for HS2 do not even kick in for
15 years, making these hugely uncertain. The commercial approach
to this uncertainty would be to adjust the forecasts through a
discounting approach. DfT has actually reduced the discount factor
from 3.5% to 3% for later years of the forecast; neither rate
represents anything close to a commercial discount rate in these
circumstances. Consequently the revenues from estimates of future
ticket sales included in the Business Case are vastly over valued.
43. With regard to HS2, there are only two certainties:
firstly, that the precise econometric forecast will not be accurate
and secondly that HS2 will achieve nil revenue for the next 15
years, as the service will not operate before 2026, at the earliest!
Spare capacity and competition policy
44. The Economic Case for HS2 + Y network predicts
that more than one in five passengers who will use HS2 will be
new passengers, people attracted by the prospect of shorter journey
times, who would not have travelled by train before. However,
when HS2 enters service this is likely to create substantial spare
capacity, at least in the short-term, a key issue in the development
of HS1.
45. It is not clear what the competitive impact
of this may be. At a meeting on 17 August 2010, officers from
HS2 Ltd confirmed that the forecasting model treated HS2 and WCML
demand "as one", therefore assumed no price competition.
Potentially government might seek to franchise the WCML and HS2
together, to create a single, monopolistic rail provider on the
route. Alternatively, government may prefer to see competition
between HS2 Ltd and WCML operatives, which with spare capacity
would serve to drive down rail prices.
46. Whilst this is conjecture, we might recall
the PAC review of HS1 and note that the lessons to be learned
focussed on issues of price competition and alternatives not considered
by econometric modelling. This failure resulted in fare-paying
revenue targets being substantially missed and further loss to
the taxpayer. The costs of HS2 + Y network dwarf HS1, so this
is potentially a key point of discussion in assessing the "strategic"
decision to invest in HS2.
Procurement strategy
47. There is no procurement strategy published
at this time. The Hybrid Bill will provide powers to acquire
land and buildings for compulsory purchase, however the land /
property owners living near the route have not been contacted
to confirm which land / property would be subject to compulsory
purchase, should the project proceed.
THE PROGRAMME
MANAGEMENT CASE
48. A business case involves assessing risks
to the investment programme and developing a strategy to manage
those risks: what are the risks to achieving the benefits? Are
costs robustly assessed? What strategies will help with these?
Neither HS2 Ltd nor DfT offer any serious, quantified analysis
of the risks or a risk management strategy as part of a plan requiring
£30.4 billion capital funding from the taxpayer.
49. Achieving most of the benefits is closely
linked to the reliability of the demand forecasts discussed earlier.
HS2 Ltd include a sensitivity analysis that concludes that if
demand is 20% below its predicted level, the Net Benefit Ratio
of HS2 falls from 2.7 to 1.5, a level generally interpreted by
DfT as a marginal investment. It is clear that:
— the
demand forecast is a very critical assumption;
— there
is considerable uncertainty over the estimate of future demand;
and
— passenger
revenue, based on demand, is related to the fares that passengers
will be asked to pay, which is scarcely considered.
50. For these reasons the sensitivity analysis
undertaken seems wholly inadequate for the purposes of assessing
programme risk.
51. The extract below from 3.2.5 of the Economic
Case summarises the government's uncompromising stance:
"One of the key uncertainties for forecasting
is the future level of demand. There are different views of the
future - how the economy will grow, and how that will drive growth
in demand. However, the rate of growth in demand actually defines
when, rather than whether, a scheme such as HS2 would be justified.
Slower growth would not necessarily mean that HS2 would not be
a worthwhile investment, though it might suggest that the opening
year of HS2 should be later and/or that a lower level of service
should be provided in the early years of operation. A higher growth
rate, by contrast, would argue for the project to be accelerated
if that were possible".
52. Government and the Treasury would not countenance
a Business Case for a hospital building programme based on this
premise! With the pace of technological change, HSR may be redundant
technology in 50, let alone 75 years time and technological risk
has to be a consideration for any long-term programme of this
size.
53. Given that the demand forecast starts in
Year 15 and runs to Year 75, the parameters of uncertainty over
the reliability of future income forecasts are very large indeed.
Conventionally, in the private sector, this would be reflected
in the level of interest rate used, higher rates reflecting higher
levels of perceived risk. Perversely DfT uses a 3.5% "discount
factor" reducing this after 30 years to just 3%. Whilst
this is standard practice for public sector transport projects,
the impact of this is to substantially inflate the discounted
value of future revenues against the projections that the private
sector would make for the same project. From a commercial perspective
this seems an entirely inadequate approach to assessing risk.
54. Any investment carries risks that the purpose
of the investment will not be realised, so a risk analysis may
be useful in comparing the relative risks of one project against
an alternative. Almost every other alternative investment strategy
eg Rail Package 2 offers:
— greater
flexibility and therefore a much closer matching of capacity to
future demand; and
— delivers
benefits sooner than HS2.
55. Other commentators eg the HS2 Action Alliance
have noted, that "Rail Package 2" meets the DfT predicted
growth in demand, through a staged approach to investment and
does so at considerably lower cost. This option was dismissed
by DfT for not providing the spare capacity that HS2 might offer.
It is unclear what benefit the DfT attaches to taxpayer investment
to produce spare capacity, particularly when spare capacity will
impact upon prices, revenue forecasts and potentially future levels
of taxpayer subsidy.
56. HS2 provides an all or nothing solution
to the demand forecast for 20 + years hence and nothing beforehand
- if the demand forecasts are correct, HS2 implies a sustained
degradation of the WCML service for at least the next 15 years.
May 2011
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