Committee of Public Accounts - The completion and sale of High Speed 1Written evidence from AGAHST

Context: HS1’s Dismal Performance

The recent NAO report emphasises that HS1 did not represent value for money. The main factor in HS1’s financial outcome was the failure of demand levels from passengers to materialise, and yet the inadequacies of demand modelling methods have been ignored by the Department for Transport and HS2Ltd in planning for HS2. In reviewing the performance of HS1, it is striking to note the many profound differences between the two projects, which point to vastly more advantageous conditions for HS1 to succeed than exist for HS2. HS1 was considered within a unique set of circumstances, namely its link with the Channel Tunnel and the Continent.

As a first principle, this linkage represents alternative revenue sources such as cross channel travel and freight or regional commuter services. No such supplementary revenue streams would exist for HS2.

HS2 is predicated entirely on very long-term demand for long distance journeys made by affluent passengers (note, this conclusion is entirely consistent with DfT’s own analysis).

HS1 offered a reconciliation of travel speeds to those of the section from Calais to Paris. This alone may have been viewed as a non-monetisable but significant benefit, albeit purely in terms of foreign perceptions. No such potential rationale exists for HS2. Eurostar was also viewed, with reasonable justification, as offering modal shift from air travel, with resulting carbon reductions. HS2Ltd’s analysis, by contrast, suggests that new journeys would account for 24% of HS2 usage, with an attendant increase in carbon emissions.

Eurostar and its French extension meant a rational basis for bias against a classic service upgrade. No rational basis exists for the bias towards an HSR line as a solution primarily for future commuter overcrowding out of Euston. By the DfT’s own analysis, alternative schemes offer a minimum of three times better value for money than HS2.

None of the potential benefits considered in HS1’s planning phase are applicable to HS2. This takes on further significance in light of the massive sums required to build and subsidise HS2 as well as the opportunity cost associated with such an expenditure. In addition, unlike HS1, HS2 would have serious and permanent implications for the entire UK rail network.

1. Financial differences between HS2 and HS1, can HS1 be a good guide?

1.1 HS2’s capital cost is now £65.5 billion (2011 private sector prices) with 75%, £49.35 billion, being spent up to 2033. This compares to a historic cost for HS1, second stage, of £6.6 billion for a relatively short line.

1.2 The debt element, which has proved to be so problematical with HS1, has had no consideration.

1.3 Financial planning for HS2 has made use of two sources of positive bias:

(1)on passenger numbers (HS1 shows that forecasting of passenger numbers is very uncertain); and

(2)on inflation of economic benefits to make the benefit cost ratio (BCR) as favourable as possible.

1.4 Note: all FoI requests and representations from MPs for detailed financial calculations supporting the economic case document released in January 2012 have been refused. This submission accordingly uses 2009 detailed data as updated in 2011 and notes changes in relation to the top-level 2012 figures which are based on 2011 prices. This is confusing but inevitable because of DfT obduracy.

1.5 HS1 uses lower line speeds than HS2 proposes so the track will have been cheaper. HS2 specification relies upon faster High-Speed trains than are currently in service using signalling systems which do not exist and a power supply infrastructure which will have to be constructed.

1.6 HS2 requires a more highly specified and straighter route than HS1 and will traverse much more challenging topographies. This will lead to far greater costs in both construction and maintenance, as well as mitigation measures.

1.7 HS1 effectively serves three major capital cities: London, Brussels and Paris. There are intermediate stations at Ashford and Lille and two UK stations, used only by commuters. HS2 will only serve six cities: London, Birmingham, Manchester, East Midlands (Nottingham and Derby on a greenfield site), possibly Sheffield, and Leeds. London and Birmingham each get two stations but Birmingham centre is only served by a spur so will receive few trains. Yet demand for HS2 is projected at well above HS1 levels.

1.8 Compared to HS1 which links three capital cities and is highly competitive with flying times, HS2 would serve six cities and have minimal competition from air services. HS2 will have to compete with alternative viable transport modes including “classic” rail. Unforeseen competition is cited as one reason for HS1’s failure to attract forecast passenger numbers.

1.9 The conclusion in terms of similarities between the projects is that HS1 should be a more viable financial and economic proposition than HS2; yet HS2 will have much greater costs and is thus far more financially dependent on achieving the forecast passenger volumes.

2. Methodology

2.1 Public vs private debt: Traditionally, DfT cites costs at public sector prices (excluding tax) but uses private sector prices to calculate the BCR to ensure comparability with benefits. We note that costs are invoiced at private sector rates and will be in inflated prices, that many components (trains) will be imported and that some contractors may not pay UK tax. Hence, private sector prices have been used. The HS2 tax yield, whatever it is, will be gained by the Treasury but is not a separate accounting item.

2.2 Discount rates: this is a technical area but we note that the rates used, from the 2004 Green Book, are social. That is, they are a perception of money. True financial discount rates would include the long-term return demanded of the project (including the cost of debt) plus a large element to offset major financial risks and huge forecasting uncertainties.

2.3 Effect of applying true discount rates: this can be done on the 2011 figures if requested; the 2012 figures are withheld. The effect of a rate of realistically, 15–25% annually would be to make the construction costs proportionately much larger relative to benefits in the BCR. It would reduce to negligible amounts the very long term (30 years +) value of the benefits claimed. This is correct since the costs are relatively certain whereas the benefits from the middle of the 21st century onwards are highly uncertain. Treasury Green Book social discount rates minimise costs and emphasise benefits over very long time scales. Even then, a further, hidden but utterly crucial enhancement is required.

3. What are HS2’s real costs?

3.1 Ministers quote the Present Value of the costs as this is a relatively low number. What they are citing is the calculated “social perception value” of the costs, not the actual bill amount. The public sector cost of construction is now £32.6 million at 2011 prices. There is then an additional £8.15 billion for trains (these will be imported as there is no UK manufacturer). In private sector terms, this totals £49.35 billion cash in 2011 prices.

3.2. The invoiced cost of constructing HS2 in 2009 money1 is shown in Exhibit 1. Including renewal costs (£15 billion), this is £60.25 billion at 2009 prices (£65. billion in 2011 prices) before inflation. Inflation could push costs to over £72 billion by 2033 in 2011 money.

Exhibit 1

COST PROFILE OF CONSTRUCTION

3.3 The cost per Parliament is shown in Exhibit 2. This uses 2009 prices and also shows an inflation adjusted price—the Treasury budget. Note that the cash cost for this Parliament announced in December 2010 was £750 million.

3.4 The HS2 predicted expenditure will average £3.5 billion annually from 2019 though to 2028 in 2011 money. The budget is £45.1 billion in 2009 money and £49.35 in 2011 terms.

Exhibit 2

POTENTIAL HS2 EXPENDITURE (£ MILLION) BY PARLIAMENTARY TERM
(NOTE 2009 MONEY)

3.5 In 2009 money, the cost of Stage 1 is £20.3 billion (£22 billion in 2011 terms) The Y-arms are c 50% longer than Stage 1, yet costs are 27.5% lower at £14.7 billion (£16 billion in 2011 money). This excludes the £3.7 billion (£4.2 billion 2011 money) Heathrow link. With no details of the Y-route till late 2012 or 2013, these values cannot be scrutinised. This is a major risk. HS1 shows that realistic costing is essential.

3.6 Research pinpoints the worldwide average escalation of costs from origination of (rail) projects at 45%, with cost escalations occuring in 9 out of 10 projects.i

3.7 The DfT’s own prospectus asserts that no HSR project can be successful without proper integration with local transport, yet no integrating programmes are accounted for in costings.

4. Debt—the ignored issue

4.1 It is not clear how the DfT proposes to handle the debt element of the project. In HS1, the Department assumed that it would not be required to honour its guarantee at the inception of the project. This was not a correct assumption. The Department appears to making the assumption again that money is free and unencumbered by future obligations.

4.2 Exhibit 3 shows a possible cashflow for HS2. The average surplus cashflow from 2043 is £425 million on the 2011 figures (2009 money).

4.3. HS2 cannot cover the debt interest—so an interest-free subsidy will be needed. Even with interest paid from general taxation, HS2 would still “owe” c £20 billion by 2092 (in 2009 money).

4.4 What has happened to the HS1 debt that was written out of accounts but still exists? A similar situation might apply to HS2.

4.5 Even if debt is apparently written off in 2035 and vanishes from the HS2 Limited accounts, the increased national debt remains.

4.6 If a pension fund bought the revenues in 2043 (as with HS1), they might pay £8 billion requiring a £76 billion debt write off (assuming 3.5% debt interest). This would be only £8.7 billion in 2011 money.

Exhibit 3

HS2 FULL PROJECT CASHFLOWS (2009 MONEY)

5. Demand

5.1 A key factor in the planning of HS1 and the subsequent problems has been the weak demand relative to both the proposer and the DFT models. In HS2’s case, very high demand is being forecast.

5.2 The January 2012 documents (without any background spreadsheet release to date) assume 270,000 passengers a day travelling to and from London (up from 240,000 assumed in 2011 projections) and add a further 100,000 passengers travelling on the HS2 “network” between the few other destinations.

5.3 This demand forecast uses the outdated, but still current, PDFH 4.1 equation. This is known to over forecast the demand for long-distance journeys by 34%. This is a very similar error to HS1 forecasts.

5.4 HS2 demand projections depend on a sustained GDP per capita growth of 1.91% with no recessions from 2011 to 2037.

5.5 HS2’s business case requires about 93 million leisure passengers per year and 28 million business passengers. This indicates a range of between 121 million and 128 million passengers annually by 2037, compared with the HS1 figure of under 10 million annually between three capital cities.

5.6 If demand fell by 34%, the BCR of the Y-case (excluding economic benefits) could fall to 0.81 from 1.78. This is a 2011 figure. As the BCR is significantly worse on 2012 figures, the project fails all normal tests.

5.7 The definitive research available on global HSR demand forecasts indicates that as yet no project has ever met its projections. The numbers have been consistently inaccurate by an average of 51.4%.ii

5.8 The research upon which DfT guidance for projecting costs is based, also proscribes the use of reference class forecasting as the most effective method for controlling what are often wildly inflated demand forecasts. This has not been undertaken by the DfT. A reference class would position HS2 demand projections in the context of its nearest comparables, such as the most recent HSR projects in Spain, Portugal, and of particular similarity, the Netherlands. The last has recently been “bailed out” by Dutch taxpayers to avoid bankruptcy.

5.9 In reality no demand model can be sufficiently robust or realistic in the absence of the primary determinant, price. HS1 tickets average a minimum 20% premium. Due to HS2’s greater costs, its premium is likely to be higher. Depending on yield management techniques, tickets are likely to be prohibitively expensive for much of the population.

6. Wealth and benefits

6.1 The GDP growth rate is one line on one sheet of the complex HS2 Ltd calculations. Yet this line governs the entire viability of the project.

6.2 The benefits are mostly intangible time savings and these increase markedly as passengers get richer.

6.3 The HS2 business passengers need to become four times richer due to the steady 1.91% rise in GDP of average salaries. In 2009 money, by 2092 a HS2 passenger will earn around £250,000: a £272,000 salary in 2011 terms. Note that major demographic changes after 2050 make any forecasts, already unreliable, purely speculative.

6.4 Average UK income will need to be £114,093 in 2011 money to make HS2 work financially.

6.5 If the value of time was kept constant from 2011, the BCR becomes 0.89.

6.6 If passenger numbers also fall by 34% (because demand is fuelled by GDP growth): the BCR is 0.41.

6.7 Exhibit 4 shows the pattern of benefits in real 2009 money forecast from HS2 on the 2011 detailed forecast.

Exhibit 4

BUSINESS PASSENGER BENEFITS FROM HS2 TRAVEL

6.8 DfT’s own analysis show the 51 million “Optimised Alternative” would represent a minimum of three times better value for money than HS2.

6.9 A key component of the BCA is the quantification of WEIs, however such benefits are particularly subject to uncertainty, difficult to monetise and therefore vulnerable to distortion and manipulation.

6.10 Agglomeration benefits, for example, are assumed as constant when in fact studies show that such benefits are decreasing due to the advent of web technology, which can act as a proxy or substitute for geographic agglomeration.

6.11 Negative economic impacts are not factored into the BCA. Examples are 1. those impacts suffered in areas directly along the route, 2. competitive disadvantage that arises in cities not served by HSR. Much of the economic activity attributed to HSR is in fact not new, endogenous growth but merely relocated businesses from neighbouring cities and towns. In other words, for each city directly advantaged by HSR, there will be neighbouring cities whose growth rates are more likely to decline. 3. Disruption caused by construction, some of which will spur permanent resettlement patterns.

6.12 There is no tangible evidence that HS2 would aid economic growth. No evidence exists for HSR reducing the North-South divide. Globally, only very immediate areas around HSR stations have enjoyed tangible benefits in the form of increased retail activity serving passengers and property development, but again, much of the associated activity is merely displaced from elsewhere.

6.13 The disbenefit of delaying congestion relief until 2026 is not accounted for.

Conclusions

The mistakes made that accounted for the dismal financial outcome of HS1 are being repeated in planning HS2, but on a far larger scale. To be financially viable, HS2 is far more dependent on achieving the forecasts of demand, which were grossly overestimated for HS1 and have been shown to be consistently inflated in virtually all HSR projects worldwide.

The costs associated with HS2 are such that the project poses a significant risk to DfT balance sheets, which will inevitably lead to reduced resources being available for other projects, many of which would in fact represent far higher value for money. This danger was one of the main reasons for the Eddington Report’s recommendation that HSR be rejected in Britain. The Transport Select Committee echoed this concern, and called for the government to demonstrate that HS2 proceeding would not be at the expense of improvements to the rest of the network. The government, in its response, was unable to make any such assurances. Beyond transport, there are other policy areas and departments that could institute economic growth stimulus initiatives for similar or lesser sums and whose impact would be immediate. The diversion of enormous sums to a high risk, low return project would be difficult to justify at any time; at a time when it means forgoing opportunities to induce immediate growth and thus reduce government debt, it must be strenuously challenged.

Note: the authors are happy to provide verbal evidence if required.

References

i B Flyvbjerg, M Garbuio, D Lovallo. “Delusion and Deception in Large Infrastructure Projects: Two Models for Explaining and Preventing Executive Disaster” California Management Review, Winter 2009, p. 172
http://eureka.bodleian.ox.ac.uk/688/1/36866390.pdf

ii B Flyvbjerg. “From Nobel Prize to Project Management: Getting Risks Right”, Project Management Journal, August 2006, p. 6 http://flyvbjerg.plan.aau.dk/Publications2006/Nobel-PMJ2006.pdf

6 April 2012

1 2009 figure are used as the detail is available; the profile in 2011 costs will be similar but 8.9% higher per year.

Prepared 5th July 2012