Rail 2020 - Transport Committee Contents

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.


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




BR89-90 33.53.69 1,60
BR90-91 33.73.69 2,18
BR91-92 32.13.58 2,79
BR92-93 32.03.54 3,71
BR93-94 30.63.50 2,74
Transition94-95 28.83.42 3,55
Transition95-96 29.73.64 3,30
Transition96-97 31.63.79 7.693,25
Private Sector (Railtrack) 97-9834.1 4.057.81 2,73
Private Sector (Railtrack) 98-9935.8 4.357.97 2,30
Private Sector (Railtrack) 99-0037.9 4.658.16 2,03
Hatfield & aftermath 00-0139.0 4.659.26 1,68
Railtrack in Administration 01-0238.6 4.7310.51 2,51
Railtrack in Administration 02-0339.3 4.7311.73 3,46
Network Rail03-04 40.44.90 13.044,73
NR CP 304-05 41.75.08 12.604,79
NR CP 305-06 42.75.39 11.935,67
NR CP 306-07 45.25.84 12.037,48
NR CP 307-08 48.36.29 12.316,00
NR CP 308-09 50.66.63 13.265,76
NR CP 409-10 50.4 5,09
NR CP 410-11 53.3 4,16
NR CP 411-12 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
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

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
14-153165 6393804
15-163382 6644046
16-173385 6644049
17-183516 6724188
18-193394 6844078

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 20092010 20112009/10 2010/112011/12
Arriva Trains Wales 31 December13.8 15.320.5 128.6129.8 136.8
c2c Rail31 December 3.89.7 14.7-3.3 -6.4-12.1
Chiltern Railways31 December -4.3-16.4 -57.18.8 -16.76.5
Cross Country31 December -8.4-12.9 -30.065.5 31.46.7
East Coast (Directly Operated Railways) 31 March  1.34.6 -46.1-170.7 -187.7
East Midlands Trains 30 April3.4 -27.8-34.0 10.0-22.3 -40.4
First Capital Connect 31 March5.4 -2.02.5 -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 March3.3 -1.91.7 ** *
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 December5.5 5.75.9 ** *
London Midland03 July -0.3-4.7 -2.7102.4 67.365.3
London Overground31 March 3.80.8 7.5N/A 26.026.1
Merseyrail08 January 12.513.3 14.9N/A 70.674.7
National Express East Anglia 31 December19.9 19.329.6 -97.4-108.9 -72.6
Northern Rail08 January 30.337.9 35.2106.4 68.496.7
First ScotRail31 March 22.520.3 15.6271.0 290.0305.0
Southern03 July  3.0 18.548.0 -102.3-16.7
Southeastern04 July 16.06.6 21.8122.8 218.286.7
South West Trains30 April 15.324.1 47.5-137.7 -177.6-228.6
Virgin Trains05 March 67.549.4 34.350.0 -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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