High Speed Rail (Preparation) Bill

Written evidence from Wendover HS2 (HSR 05)

1. This submission is from Wendover HS2 action group (WHS2). This group has been working since April 2010 to oppose the route of the high speed line in the Chilterns AONB on environmental grounds, to examine the national business case and to seek local mitigation with the specific aim of a fully-bored Chiltern AONB tunnel.

2. This submission concerns the national financial consequences of the HS2 scheme. HS2 Ltd last provided an updated business case in August 2012. WHS2 has developed an interconnected financial model of the HS2 scheme based upon the business case numbers published by HS2 Ltd. This model, HS2-2037 V2.3, is available free of charge to MPs. It uses Microsoft Excel or similar spreadsheet programs running on standard PC’s.

3. The method used by HS2 Ltd to compile its business case relies upon manually linking disparate models of passenger demand, construction costs and social benefits. This makes rapid evaluation of possible scenarios impossible for policymakers. Because the linkage is done through Present Values, all time elements in the business case forecasts are hidden. It is therefore not easy to evaluate the potential financial impact in any future year.

4. The advantage of HS2-2037 is that different assumptions can be used with immediate indicative outputs. This enables rapid testing of assumptions about key variables like the economic growth to 2092, the level of passenger demand linked to economic growth, the impact of increased costs and the effects of debt, interest and real operating costs. HS2 Ltd assume that all costs remain at 2011 prices up to 2092 although social benefits are calculated at real GDP prices: for example, business passengers are assumed to become 350% richer whilst HS2 staff remain on 2011 wages.

5. It should be noted that the HS2 business model as of August 2012 is no longer "accurate". It was confirmed at the Public Accounts Committee on 1 July, 2013 that outdated standards for demand forecasting were used and will not be revised until November 2013. It is also known that the value of work on trains has been overstated by at least 50% according to internal DfT research. No new BCR has been provided, It seems to be 0.9-1.4.

6. A specific advantage of the HS2-2037 model is that it provides a realistic profit and loss statement for HS2 in any year of operation up to 2092. This is not available from the HS2 Ltd business case. In the summary of findings below, the year 2037 is used as this is the arbitrary peak passenger demand year selected by HS2 Ltd.

7. Passenger growth: the interacting effects of GDP growth, rail demand elasticity, and premium fares are key parameters. High demand is critical to HS2’s case so HS2 use an outdated long-distance passenger growth elasticity factor of about 2.9 compared to the current standard of 1.9. The HS2 forecast also assumes an average real GDP growth from 2013 to 2092 of 1.88% with no recessions. The HS2-2037 model allows users to make a simple adjustment to these parameters. For example, a demand factor of 1.6 with GDP growth of 1.5% reduces apparent demand by 37% implying a doubling of rail demand into London by 2069. Passenger numbers govern the social benefits of HS2 and its financial viability but do not affect the construction costs, hitting the BCR hard.

8. Premium fares: The model uses theoretical work by HS2 as a basis for exploring premium fare impact on HS2 revenues and demand. HS2 expect 30% business passengers; this seems to be an assumption rather than a verified forecast and may be significantly above West Coast line business use. If the number of business passengers was 20% and total demand was lower than expected a franchise operator would seek premium pricing (30% business, 20% leisure) to reduce the financial impact. This would further cut HS2 passenger numbers to 51.9% of HS2’s current forecast but would limit the loss in revenue to 23.4%. Of course, these are illustrative numbers but they illustrate the types of interconnected impacts that occur in the real world and require proper financial evaluation.

9. Construction costs: The Secretary of State announced a 56% rise in the underlying Stage One factor costs on 26 June with a reduction in the Stage One contingency at the 95% level giving a 31% increase overall. A 24% rise in Stage 2 factor costs and contingency was also announced. These are still at 2011 prices. No revision was yet made to rolling stock costs. The HS2-3037 model allows the use of real prices assuming that these increase in line with GDP. The model can also adjust to allow for more increases in cost. If the market price of HS2 rises in line with HS2’s GDP growth assumptions, the total cash cost could be £74.3 billion.

10. Interest charges: transport projects typically do not consider the cost of financing. However, Network Rail owns the rail network as an asset and is debt funded through a separate body. Network Rail pay a 3.5% interest charge plus a 0.8% government guarantee on its £33bn debt. The current position is that no decisions have been taken on how HS2 would be financed or run. The HS2-2037 model allows a Network Rail type scenario to be considered. In that case, the debt could rise to around £90 billion b y 2033. The annual interest charge plus the government guarantee could be about £4 billion. Even if this debt is "written off" it will still be embedded in the national accounts and any interest payable would still be charged to future taxpayers. It seems unlikely that HS2 could repay debt from its operating revenues and likely that it will need significant perpetual subsidy.

11. Operating costs: HS2 Ltd hopes that its operational costs can be curtailed. It uses constant 2011 prices in its evaluation; although unionised drivers are assumed to receive 1.5% pay rises. However, in the real economy, staff costs tend to track GDP. HS2 also assume that electricity, costing £472m a year in 2037 at 2011 prices, does not rise in price. Current government policy indicates that energy costs will increase. HS2 will require adequate grid base load generating capacity independent of renewable sources and uncosted. Any increase in line speed to 400 km/h will require disproportionately more energy. It therefore seems possible that HS2’s operational costs in 2037, in 2011 money, might be in excess of £1.6 billion a year rather than the £1 billion currently assumed.

12. Franchise costs and network contribution: the rail model implies a franchise operator with a guaranteed profit (revenue support). The HS2-2037 model allows franchise costs to be added. The profit margin is assumed to be based on the gross fare revenue. Given that HS2 hopes to carry at least 290,000 passengers of whom 270,000 would be to and from London, the gross revenue could be in excess of £4.4bn. However, HS2 may have removed about 190,000 passengers from the conventional network. A contribution of £2.9 bn to support underused conventional services is therefore assumed. At best, HS2 may carry about 5% of UK long-distance journeys in 2037, although this seems unlikely as the HS2 forecast is known to be an optimistic overestimate. However, HS2 directly serves only six major cities. Consequently, it will be important, but expensive, to maintain the extensive conventional rail network. This leaves net fares of about £1.4 billion on HS2’s assumptions directly paid into the HS2 fare box. Fares are over 40% higher in real terms than in 2011. Note that the HS2 Ltd journey projections appear to be on a network-wide basis with only a proportion of these travellers actually using the HS2 line.

13. Potential profit and loss account for 2037: the HS2 2037 model is a year by year cash flow-based model. As such, depending on the assumptions made, it projects a profit and loss statement and simple balance sheet for HS2 in each year. On assumptions made above, and these can be varied at will, HS2 could make a small operating profit on HS2’s August 2012 assumptions with high passenger numbers, no interest and fixed 2011 prices. On a more realistic scenario, Exhibit 1, the project could require a cash subsidy of at least £4.4 billion a year in addition to existing conventional rail network support. Given that rail network support is largely directed towards commuter services, as these are the bulk of rail journeys, it is highly probable that the national rail subsidy will rise dramatically. It should also be noted that to get the levels of demand suggested by HS2, the conventional rail network will have had its existing capacity significantly increased otherwise there will not be the massive numbers of passengers available to transfer to the new network. This requires further conventional network investment.

14. Exhibit 1: indicative HS2 financial statements for 2030 (Stage One) and 2037 (Full Y network).

15. Conclusion, using real-world cost and debt assumptions and more realistic passenger demand assumptions and fares, HS2 is a particularly risky project even without additional factor cost rises. It is likely to incur a significant debt and the cost of that debt has not been factored in to the business case. If passenger demand is not as high as HS2 Ltd forecasts, the result will be a largely-empty, expensive conventional network coupled with an underutilised and highly expensive, debt-ridden HS2 system. The French example shows how resources spent on high-speed rail cause underinvestment in conventional rail that has more value for regional economies. The HS2 business case is very strongly predicated on high and consistent economic growth and real salary rises for passengers worth 350% over a very long timescale. Whilst these are desirable outcomes, it is less clear why today’s taxpayers should bear the risk of a high-speed ride for very rich travellers in 2092.

July 2013

Prepared 10th July 2013