Private Finance Initiative - Treasury Contents

Written evidence submitted by Nick Collard


1.1  Introduction

1.1.1  The attached paper sets out issues related to inadequacies in PFI methodology as applied to a specific PFI project, Nottingham Express Transit (NET) Line 1 and the proposed Phase 2 extension. Although the points raised are specific to this PFI project, they may also be applicable to other projects.

1.1.2  In this instance PFI has not delivered value for money, but despite this the Phase 2 project seems to be going ahead. However Phase 2 has yet to receive final approval from the PFI Project Review Board and should not be given approval until a new funding structure for PFI can be agreed, incorporating the issues and recommendations set out below.

1.2  Summary Issues and Recommendations

Summary issues and recommendations are set out below and provided in more detail in the attached paper.

1.2.1  Issue 1—Lack of tie in of PFI credits to promised benefits

Recommendation 1—PFI credit payments should only be made by Central Government dependant upon monitoring and achievement of the benefits set out and promised in the original business case. In the case of NET this would be hitting patronage mileage targets.

1.2.2  Issue 2—Lack of Clarity in Special Purpose Vehicle (SPV) Accounts

Recommendation 2—A consistent reporting format should be adopted to distinguish between PFI credits and other income. Also costs, for the benefit of the SPV but borne by other entities, should be disclosed in the SPV accounts.

1.2.3  Issue 3—Incorrect Prioritisation of Infrastructure Requirements

Recommendation 3—PFI activities should be treated as on balance sheet and considered along with all other projects with the associated cost/benefit cases. This will ensure a level playing field exists and projects do not get priority simply because of an accounting treatment.

1.2.4  Issue 4—Willingness to extend PFI contracts without a full evaluation of existing PFI performance

Recommendation 4—A full review of any existing investment should be undertaken before providing additional funds.

1.2.5  Issue 5—Willingness to accept business cases in isolation for PFI extensions rather than comparing to existing performance

Recommendation 5—Any new business case should be compared to existing performance of the nearest equivalent service. This is especially important in the case of a business case to expand or extend an existing PFI project, which may not be performing well.

1.2.6  Issue 6—Willingness of government to increase PFI credit levels because of funding rate increases

Recommendation 6—If funding rates increase projects should be re-evaluated; credits should not simply be increased to allow projects to proceed. Allowing projects to proceed in this scenario seems directly opposite to the government objective of reducing the national debt and the interest burden thereon.


2.1  Background

2.1.1  NET is a single line tram structure operating within Nottingham funded by PFI credits from central government (NET Line 1).

2.1.2  The PFI credits are paid to both Nottingham City and Nottingham County Councils, these are then paid by these Councils to Arrow Light Rail Limited (the special purpose vehicle set up to operate the tram system) based on availability performance.

2.1.3  Arrow Light Rail also receives farebox income from customers to cover the operating costs of the tram system.

2.1.4  Nottingham City and Nottingham County Councils are the Promoters of the current Line 1, although the County Council has expressed its intention to withdraw from this operation.

2.1.5  Both Councils initially promoted an extension to this system, NET Phase 2. However the County Council has now formally withdrawn as a Promoter leaving the City solely responsible for Phase 2. Phase 2 is to be funded via PFI and the new PFI agreement will include a re-financing of NET Line 1.

2.2  Issue 1Lack of tie in of Concession to Business Case

2.2.1  The operation of the tram network is mainly funded by the payment of PFI credits based on the timely operation of the network. The balance is funded by farebox income.

2.2.2  For Phase 2, 96% of the benefits put forward in the Public Inquiry business case relate to getting people onto the tram. By tying PFI availability payments to punctuality rather than patronage there is no direct link between the benefits put forward and the authorisation of PFI payments made by central government.

2.2.3  For NET Line 1 passenger mileage targets were missed by 28% in the 12 months to end March 2010 (see 2.5.1), therefore it is key that any PFI payments made are linked to the outcomes put forward to support the business case, in this case patronage levels.

2.2.4  There is a very limited risk to the Concession because of the farebox income. However this small risk will not deliver the benefits required.

2.3  Issue 2Special Purpose Vehicle (SPV)

The use of SPVs to operate PFI structures can lead to many concerns.

2.3.1  In the case of Arrow Light Rail Limited there are several key issues.

1.  Up until the 2009 accounts Arrow failed to split income between farebox income and PFI payments. This masked the operational performance of the tram. The Promoters consistently maintained (including at the Public Inquiry into Phase 2) that Line 1 ran at an operational profit, whereas it can now be clearly seen from the accounts it generates an operating loss (Availability Payments 2005-07 are derived from Nottingham City and County Council Accounts).

    Operating costs are not covered by Farebox income (see below). It is of great concern that the lack of a breakdown of income prior to the 2009 Accounts led to the Promoters giving incorrect evidence to the Public Inquiry into Phase 2.

2.  The accounts disclose that the Concession has also loaned monies to the SPV at a fixed rate of interest of 12.7%. The PFI grants are being used to service this excessive rate of interest.

3.  The losses of the SPV are treated differently by different consortium members, ranging from incorporation of the losses in group numbers to a simple note to the accounts. However all recognise the interest income mentioned above.

4.  The consortium members can charge or not as they see fit to try and improve the bottom line result, for example the members stopped charging directors fees in 2007.

5.  The heavy advertising promotion of the tram is undertaken by Nottingham City Council (from public funds) and is not passed on to the SPV.

2.3.3  Analysis of Arrow Light Rail Financial Performance 2005-09

Costs -8,870 -9,387-9,831-9,731 -9,849
Farebox Income7,070 7,5167,8678,186 7,845
Loss on Operations-1,800 -1,871-1,964 -1,545-2,004
Availability Payments19,813 20,25620,67520,924 21,267
Depreciation-7,593 -7,583-7,947-7,483 -7,606
Interest Payments-16,994 -16,849-16,681-16,399 -16,187
Loss on Funding-4,774 -4,176-3,953 -2,958-2,526
Other Income163 14915747 -38
Total Loss-6,411 -5,898-5,760 -4,456-4,568

2.4  Issue 3Incorrect Prioritisation of Infrastructure Requirements

2.4.1  In the case of Nottingham the most pressing transport project is the widening of the A453 from the M1 into Nottingham. The priority is recorded on the Derbyshire and Nottinghamshire Chamber of Commerce website. Widening the A453 also has all party support.

2.4.2  The cost of this development is between 1/3 and 1/4 of NET Phase 2, however the A453 was put on hold for at least the second time at the latest spending review. Indeed Net Phase 2 did not make the top three regional priorities.

2.4.3  NET Phase 2 is only wanted by Nottingham City Council, the County Council has withdrawn, considering the project too risky, and expensive. Yet NET Phase 2, costing three to four times more than the Region's most important infrastructure need, gets the go ahead simply because of PFI. It will also just serve the population along the tram corridor rather than the significantly greater number of people using the A453.

2.5  Issue 4Willingness to extend PFI deals without due consideration of initial PFI performance

2.5.1  In the case of NET Line 1 there has been considerable shortfall both in terms of patronage targets (set out below) and farebox income levels (as shown in 2.3.3 above).
          Shortfall Increase to hit target
      TargetLatest Shortfall% %
Number of Passenger Journeys
(million per annum) 1822
Average Journey Length (Kilometres)  4.94.3 0.61214
Passenger Kilometres Travelled  53.938.7 15.22839

2.5.2  Freedom of Information requests have confirmed that there has been no formal evaluation of Line 1 performance against the initial business case. A need to improve on throughput by 39 % to meet target should set alarm bells ringing.

2.6  Issue 5Willingness to accept business cases in isolation for PFI extensions rather than comparing to existing performance

2.6.1  In the case of NET phase 2 the business case assumes an effective doubling of the operational performance of Line 1. Simple ratio analysis shows this.

2.6.2  As shown in point 2.3.3 the ratio of farebox income to operating cost (after 6 years of operation) is 0.80. The Public Inquiry business case for Phase 2, in isolation, over its lifetime shows a ratio of 1.49, this is a near doubling of performance (see attachment 1).

2.6.3  The patronage levels these revenues are derived from are also highly questionable. The initial business case for Phase 2 was produced at around the same time as the introduction of NET Line 1. The case was then consistently re-modelled (upwards) to produce the final patronage levels in the final Public Inquiry business case (see attachment 2).

2.6.4  This re modelling was undertaken totally in isolation from the actual performance of Line 1 which has shown a significant underperformance against target over its life. Indeed it is 28 % short of its passenger kilometre target.

2.6.5  Taking the patronage levels in the final case for Line 1 and the initial case for Phase 2 as 100% (as a constant point from which performance can be assessed over time) it can be seen that Line 1 now sits at 72% (using the 28% shortfall shown at 2.5.1) and the re-modelling of Phase 2 sits at a minimum of 127%. This again does not make sense; you would expect the re-modelling to take account of actual performance (see attachment 3).

2.6.6  This further lends support to the proposal to tie PFI credits to patronage levels.

2.7  Issue 6Willingness of government to increase PFI credit levels because of funding rate increases

2.7.1  The initial level of PFI credits available to NET Phase 2 was approximately £450 million. After the financial crash this was increased to £531 million. This additional expenditure and debt burden on the public generates no additional benefits, and effectively assumes the risk that the original PFI concept placed with the contractor. This also seems directly opposed to the government objectives of reducing public debt and the interest burden thereon.

2.7.2  The level of credits now proposed is £399 million which has been put forward as a 25% saving. In reality the saving to Central Government is no more than around £50 million compared to the original proposal. A 25% saving should be based on the original award at original rates which would equate to credits approximately of £337 million—an additional £60 million saving should be requested.

April 2011

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Prepared 10 August 2011