Written evidence submitted by Nick Collard
1.0 MANAGEMENT
SUMMARY
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.
2.0 FURTHER INFORMATION
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 1—Lack 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 2—Special 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
| |
| 2005
£000 | 2006
£000
| 2007
£000 | 2008
£000
| 2009
£000 |
| Costs | | -8,870
| -9,387 | -9,831 | -9,731
| -9,849 |
| Farebox Income | 7,070
| 7,516 | 7,867 | 8,186
| 7,845 |
| Loss on Operations | -1,800
| -1,871 | -1,964
| -1,545 | -2,004
|
| Availability Payments | 19,813
| 20,256 | 20,675 | 20,924
| 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 Income | 163
| 149 | 157 | 47
| -38 |
| Total Loss | -6,411
| -5,898 | -5,760
| -4,456 | -4,568
|
2.4 Issue 3—Incorrect 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 4—Willingness 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 |
| |
| |
| Target | Latest
| Shortfall | % |
% |
Number of Passenger Journeys
(million per annum)
| 11.0 | 9.0 | 2.0
| 18 | 22 |
| Average Journey Length (Kilometres)
| | 4.9 | 4.3
| 0.6 | 12 | 14
|
| Passenger Kilometres Travelled |
| 53.9 | 38.7
| 15.2 | 28 | 39
|
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 5—Willingness 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 6—Willingness 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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