Annex B: Government cash input to the
rail industry
Note by Robert Linnard and Richard Goldson, Specialist
Advisers to the Transport Committee, 1 November 2012.
Summary
1. This note shows the increase in government support
to the GB rail industry since the end of British Rail's era and
considers reasons for the increase. The main conclusions are:
- support to the passenger railway
has increased by about 50% (allowing for inflation and disregarding
privatisation receipts),while patronage has nearly doubled;
- the main reasons are the extra costs of leasing
and running more trains more frequently and—nearly as significant—of
paying Railtrack/Network Rail a return on its asset base, which
has grown from under £5bn at privatisation to over £40bn
now;
- total net profits of franchised passenger train
operators have roughly halved in the past three years;
- securing the efficiency target implicit in the
recent HLOS settlement will necessitate difficult decisions by
government as well as industry. The current disorder in the franchising
programme is deeply unhelpful.
A. How the numbers have changed
2. Table 1 below shows a variety of indicators including
total government cash to the industry over the past 23 years since
1989. All monetary totals are shown in cash terms and at current
(2011-12) prices. The figures for BR have been adjusted to exclude
receipts from the sale of Roscos and other BR businesses in the
period 1995 to 1997.
3. Broadly, this shows a pattern of subsidy in the
latter BR era through the early 1990s of £2.0 to £3.5
bn p.a. It is unsurprising that support fluctuated in the BR era,
not only because of the impact of economic cycles on revenue,
but because the availability of funds for capital investment (including
renewals) was variable and expenditure was controlled according
to the cash available. However, it is striking that the pre-privatisation
railway was shrinking in size (as measured by passenger-kms) while
at the same time increasing its subsidy requirement.TABLE
1
| ERA | YEAR
| PASSENGER-KM BILLIONS
| PASSENGER REVENUE AT 2011-12 PRICES £BN
| PASSENGER
COSTS £M AT 2011-12 PRICES £BN
| TOTAL INDUSTRY
CASH/SUBSIDY AT 2011-12 PRICES £BN
|
| | |
| | |
| BR | 89-90
| 33.5 | 3.69
| | 1,60 |
| BR | 90-91
| 33.7 | 3.69
| | 2,18 |
| BR | 91-92
| 32.1 | 3.58
| | 2,79 |
| BR | 92-93
| 32.0 | 3.54
| | 3,71 |
| BR | 93-94
| 30.6 | 3.50
| | 2,74 |
| Transition | 94-95
| 28.8 | 3.42
| | 3,55 |
| Transition | 95-96
| 29.7 | 3.64
| | 3,30 |
| Transition | 96-97
| 31.6 | 3.79
| 7.69 | 3,25
|
| Private Sector (Railtrack)
| 97-98 | 34.1
| 4.05 | 7.81
| 2,73 |
| Private Sector (Railtrack)
| 98-99 | 35.8
| 4.35 | 7.97
| 2,30 |
| Private Sector (Railtrack)
| 99-00 | 37.9
| 4.65 | 8.16
| 2,03 |
| Hatfield & aftermath
| 00-01 | 39.0
| 4.65 | 9.26
| 1,68 |
| Railtrack in Administration
| 01-02 | 38.6
| 4.73 | 10.51
| 2,51 |
| Railtrack in Administration
| 02-03 | 39.3
| 4.73 | 11.73
| 3,46 |
| Network Rail | 03-04
| 40.4 | 4.90
| 13.04 | 4,73
|
| NR CP 3 | 04-05
| 41.7 | 5.08
| 12.60 | 4,79
|
| NR CP 3 | 05-06
| 42.7 | 5.39
| 11.93 | 5,67
|
| NR CP 3 | 06-07
| 45.2 | 5.84
| 12.03 | 7,48
|
| NR CP 3 | 07-08
| 48.3 | 6.29
| 12.31 | 6,00
|
| NR CP 3 | 08-09
| 50.6 | 6.63
| 13.26 | 5,76
|
| NR CP 4 | 09-10
| 50.4 |
| | 5,09 |
| NR CP 4 | 10-11
| 53.3 |
| | 4,16 |
| NR CP 4 | 11-12
| 56.1 |
| | 3,90 |
NOTE: Data in this table come from the McNulty Report (updated
to current values) supplemented with some ORR official data. Revenue,
cost, and subsidy do not balance, firstly because the revenue
and cost data relate to the passenger business only and secondly
because of externalities - primarily NR borrowings.
4. After privatisation, subsidy fell marginally during the Railtrack
era, but rose back in the Administration era to similar levels
to BR, and then ascended to a peak of £7.5bn in the middle
of Control Period3. This big increase in subsidy financed the
renewals needed to return the infrastructure to acceptable quality.
A further cause was the loss of financial discipline while Railtrack
was in administration.. Since then, support has steadily reduced
to under £4bn.
5. Overall, it can be said that subsidy has risen since BR from
numbers around the £2.75bn mark to numbers around the £4bn
mark. We are thus looking to explain a real terms increase of
some £1.25bn.
B. Why the numbers have changed
6. Table 1 shows how substantially both revenue and costs have
increased: both have broadly doubled since privatisation. It might
have been expected that an industry with a high ratio of fixed
to variable costs which doubles its output would see costs rising
at a slower rate than revenue as economies of scale and efficiencies
kick in.
7. This has not been the case, and in explaining
why the net subsidy numbers have increased so much, it is necessary
to look at both revenue and costs. Key drivers have been as follows:-
8. Revenue. Revenue is a function of volume and pricing.
The growth has been overwhelmingly due to volume; since 96/97,
there has been only a 10% increase in real yield (i.e. real fares)
almost all concentrated in the 5 years from 2003 to 2008 when
regulated fares were RPI+1. (At other times, regulated fares have
been at in line with RPI or negative.) Thus growth in volume has
generated some £2.3bn, and growth in pricing some £0.3bn.
9. Operating Costs. McNulty showed that between 1996
and 2008 train operating (i.e. TOC own costs excluding track access
and ROSCO charges) increased from £2.6bn to £4.4bn,
i.e. by £1.7bn. This is broadly in line with revenue, i.e.
there has been no improvement from operating on a larger scale.
10. Rosco Charges. Since BRB days, the financial
structure has completely changed, and new capital investment in
rolling stock no longer drops through immediately to the cash
requirement. There has also been substantial expansion in the
size of the fleet to support growth, and a significant improvement
in the average age. McNulty estimates that rolling stock charges
per passenger-km have been pretty static since 1996 and assuming
this is true since 1989, this would explain an increase in costs
of some £0.5bn.
11. Infrastructure opex and maintenance. Now coming
down steadily, having peaked in 2003, following the substantial
increases following the demise of Railtrack. Overall it contributes
little to the explanation of the change.
12. Regulatory Asset Base (RAB). Since privatisation,
new infrastructure capital expenditure (including the substantial
quantity of enhancements) and renewals have been financed through
borrowing and has been added to the Regulatory Asset Base (RAB)
on which a regulated rate of return is allowed to enable Network
Rail to meet its borrowing costs. At the time of privatisation,
the RAB was very low (under £5bn), and has now grown to £42bn.
The allowed return on the RAB amounted (after technical adjustments)
to £1.5bn in 09/10 and is effectively a new item since BR
days, mostly reflecting the substantial expenditure on investments
(enhancements, and renewals) in recent years, all of which were
artificially low (or zero) at the end of the BR era. [119]
13. Train operator profits. (The annex shows the
operating profits earned by passenger train operators). Excluding
the (unsubsidised) open access operators but including the London
Overground concession, the net total of operating profits fell
from £188m in 2009 to £91m in 2011. This latest figure
is relatively small compared to the major items listed above and
some of it will be funding investment, for example in station
facilities.
| Table 2
| |
| £bn
|
| Revenue growth from volume
| -2.3 |
| Revenue growth from Pricing
| -0.3 |
| Increase in TOC costs largely in line with volume
| +1.7 |
| Changes in Rolling Stock costs
| +0.5 |
| Cost of providing a return on the NR RAB
| +1.5 |
| TOTAL NET CHANGE | +1.1
|
Table 2 shows that the key drivers have been the
significant change in volume which has affected both revenue and
TOC costs, and the impact of the burgeoning RAB which is itself
driven by the volume of infrastructure investment. In short the
issues are the rate of growth, and the costs of accommodating
that growth.
14. Thus Table 2 largely - though admittedly not
entirely - explains the rise of £1.25bn noted at the end
of paragraph 4.
C. Is the picture reasonable?
15. McNulty makes it very clear that the picture
is not reasonable. One would have expected unit
costs to have declined as volume increased. They have not, and
McNulty suggests some reasons for this such as increasing unit
costs of labour. The capital costs of providing for growth are
significant both in terms of infrastructure and rolling stock,
and once spent will push up operating costs for the future, through
the ROSCO and RAB mechanisms. McNulty points out that de facto
we have a policy for the railway sector of "predict and provide"
uniquely amongst the transport sectors, and he suggests that the
policy should instead be one of "predict, manage, and provide".
Had this policy been in force, it can be argued that the costs
of growth would have been partially mitigated through changes
to the balance of the investment programme, train utilisation,
and demand management.
D. What of the future?
16. Table 3 shows the support available for Control
Period 5 according to the Statements of Funds Available issued
by DfT and by the Scottish Government alongside the recent HLOS.
All these figures are in nominal (cash) terms.
| Table 3
| | | |
| YEAR | ENGLAND AND WALES
| SCOTLAND | TOTAL
|
| 14-15 | 3165
| 639 | 3804
|
| 15-16 | 3382
| 664 | 4046
|
| 16-17 | 3385
| 664 | 4049
|
| 17-18 | 3516
| 672 | 4188
|
| 18-19 | 3394
| 684 | 4078
|
17. Thus it can be seen that subsidy is expected to continue at
broadly its existing level of £4bn for the next expenditure
period despite real growth of 20% (as predicted in the Initial
Industry Plan). This implies (at least) three things.
18. First, the government's cash limit assumes that
the industry can reduce its annual costs by £3.5bn by 2019
(as compared to 2008/09). This is the most ambitious of the targets
in the McNulty report. Some of the savings are already in Network
Rail's plans, Most of the rest have to be secured by passenger
train operators and their suppliers (notably the Roscos) via the
next generation of franchises. But the problems with West Coast
will delay the reletting not just of that franchise but of some
or all of the other eight that expire over the next two years.
There is therefore a major question mark over the achievability
of TOC savings and hence over the realism of the HLOS targets.
19. Second, the looming financial pressures will
probably mean that growth will need to be steered towards times
and places where existing capacity (both rolling stock and infrastructure)
can absorb it , so that the costs of growth in future grow more
slowly than revenue. Slowing the rate of growth of Network Rail's
RAB (and its attendant financing costs) is likely to become increasingly
important,
20. Third, to the extent that in some places costs
of growth will necessarily be higher than incremental revenues
(services benefitting from the Northern Hub may well be a good
example), then costs elsewhere on the existing network will need
to be managed accordingly.
E. Conclusion
21. In real terms the passenger railway is costing
about 50% more than in the early 90s. Its size (as measured by
passenger kms) has nearly doubled. The substantial increase in
subsidy has occurred over a period when the strategic focus of
industry was largely on managing growth. Firstly, as McNulty has
shown, unit costs stayed flat or were allowed to grow when it
would have been expected that they would fall. Secondly, much
attention and cost has been put into investing to meet peak demand
at a time when policies of "predict and provide" were
being modified in other modes.
22. Through the RDG, and other mechanisms to follow
through the McNulty findings, the industry appears focused on
managing a growing railway against a broadly steady level of subsidy
and with regulated fares rising at no more than RPI plus 1%.
23. But, as Network Rail's growing RAB is almost
entirely debt financed, the costs of servicing this will remain
a challenge, and one which will become more acute as high levels
of RAB-funded investment continue.
Annex to Annex B: train operator
profits
| Table 4
| | Operating Profit for year (£m)
| Subsidy for financial Year (£m)
|
| Year end
| 2009 | 2010
| 2011 | 2009/10
| 2010/11 | 2011/12
|
| Arriva Trains Wales |
31 December | 13.8
| 15.3 | 20.5
| 128.6 | 129.8
| 136.8 |
| c2c Rail | 31 December
| 3.8 | 9.7
| 14.7 | -3.3
| -6.4 | -12.1
|
| Chiltern Railways | 31 December
| -4.3 | -16.4
| -57.1 | 8.8
| -16.7 | 6.5
|
| Cross Country | 31 December
| -8.4 | -12.9
| -30.0 | 65.5
| 31.4 | 6.7
|
| East Coast (Directly Operated Railways)
| 31 March |
| 1.3 | 4.6
| -46.1 | -170.7
| -187.7 |
| East Midlands Trains |
30 April | 3.4
| -27.8 | -34.0
| 10.0 | -22.3
| -40.4 |
| First Capital Connect |
31 March | 5.4
| -2.0 | 2.5
| -89.1 | -136.4
| -162.7 |
| First Great Western |
31 March | -12.8
| 9.4 | -52.3
| -2.9 | -103.7
| -110.1 |
| First Hull Trains (non-franchised)
| 31 March | 3.3
| -1.9 | 1.7
| * | *
| * |
| Grand Central (non-franchised)
| years to 31 March 2010, 9 months to 31 Dec 2011
| -3.9 | -6.2
| -8.4 | *
| * | *
|
| Heathrow Express (non-franchised)
| 31 December | 5.5
| 5.7 | 5.9
| * | *
| * |
| London Midland | 03 July
| -0.3 | -4.7
| -2.7 | 102.4
| 67.3 | 65.3
|
| London Overground | 31 March
| 3.8 | 0.8
| 7.5 | N/A
| 26.0 | 26.1
|
| Merseyrail | 08 January
| 12.5 | 13.3
| 14.9 | N/A
| 70.6 | 74.7
|
| National Express East Anglia
| 31 December | 19.9
| 19.3 | 29.6
| -97.4 | -108.9
| -72.6 |
| Northern Rail | 08 January
| 30.3 | 37.9
| 35.2 | 106.4
| 68.4 | 96.7
|
| First ScotRail | 31 March
| 22.5 | 20.3
| 15.6 | 271.0
| 290.0 | 305.0
|
| Southern | 03 July
| | 3.0
| 18.5 | 48.0
| -102.3 | -16.7
|
| Southeastern | 04 July
| 16.0 | 6.6
| 21.8 | 122.8
| 218.2 | 86.7
|
| South West Trains | 30 April
| 15.3 | 24.1
| 47.5 | -137.7
| -177.6 | -228.6
|
| Virgin Trains | 05 March
| 67.5 | 49.4
| 34.3 | 50.0
| -167.9 | -165.7
|
Negative Subsidy indicates premium paid to Government
* First Hull Trains, Grand Central & Heathrow Express are
open access, non-franchised operators, and do not receive subsidy
or pay premiums
Source: HC Library analysis of company annual
reports and Office of Rail Regulation publications
119 Network Rail is funded through a conventional regulatory
approach where renewals and enhancement expenditure is mostly
capitalised and added to the Regulatory Asset Base. This is paid
for through an amortisation allowance and an allowed return on
the RAB. About two thirds of the £42bn RAB - and of the allowed
return on the RAB - is attributable to investments and improvements,
the rest being of a technical regulatory nature. Back
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