High Speed Rail (Preparation) Bill

Supplementary evidence from Dr Paul Hoad (HSR 28)

1. Introduction

1.1. This paper has been written by Dr Paul Hoad who has 16 years’ experience in Transport Modelling and Planning. Dr Hoad has worked on a wide range of transport projects, in the UK, East Asia and the Gulf, including the economic and financial assessment of transport schemes. This experience has included "hands on" computer modelling of schemes, the management of planning projects and the critical review of other consultants’ work

1.2. This evidence is provided to supplement an earlier submission by the author. However, this current evidence does not relate to the previous evidence but instead is aimed at providing additional information based upon recent calculations by the author (using information provided by HS2 Ltd) regarding the general viability of the proposed HS2 scheme.

2. Fare Sensitivity

2.1. The HS2 scheme as currently promoted by HS2 Ltd business case assumes that fares on the new railway will be equal to the fares charged on the competing "classic rail" network, so that there would be no "Premium Fares" on HS2. There has been criticism in the public domain that this is in fact an unrealistic assumption. This concern is echoed in the minutes of the HS2 Ltd Analytical Challenge Panel, for example item 2.6 of the Minutes for the meeting of 17th August 2010 [1] states:

"HS2’s current assumptions on rail fares were probably too simplistic. There was a significant discussion over the role and impacts of both premium fares and competition. This is an area for more work, although realistically it may not be achievable prior to a consultation (which was acknowledged to present a risk to HS2)."

2.2. The issue of Premium Fares is important as the justification for HS2 is not simply based upon the financial return from revenue on HS2 paying off the construction costs. Instead the overall economic return for HS2 is based upon the benefits which derive from three different sources:

· Additional Revenue;

· Journey Time Savings; and

· Wider Economic Impacts (job creation etc.).

2.3. Of these three elements, the revenue is actually the smallest component. As most passengers on HS2 will be simply transferring from the classic rail service, the amount of additional revenue will therefore be limited. On the other hand, given that the passengers transferring from classic rail are benefitting from a time saving, it would not be unexpected for these passengers to be charged a higher price for the service provided.

2.4. Despite this issue being flagged by the Analytical Challenge Panel three years ago, the HS2 project is still moving ahead with this simplistic approach, and no assessment of the viability of the scheme with Premium Fares has been carried out.

2.5. Fortunately however, the study has provided sufficient information for the economic impact of Premium Fares to be estimated. The report "High Speed 2 Support, Model Development report: A Report for HS2", dated February 2010, provides the results of testing that was carried out to look into the impact of Premium Fares on patronage (only). This was provided in the form of a number of tables setting out the effect on patronage for key movements (e.g. London-Birmingham, London-Manchester) of increasing the fare level on HS2 (by 10%, 20% and 30%). Separate tables were provided for Business and Leisure passengers. (NB Business and Leisure passengers make up about 99% of long distance rail passengers considered in the model.) The data from these tables is shown in Annex 1 (though in a slightly different format.)

2.6. From these tables it has therefore been possible to calculate an overall decrease (in percentage terms) in patronage for the HS2 system, which are given below. (For example, a 30% increase in fares on HS2 would lead to 26% less business travellers and 35% less leisure travellers with 33% less travellers overall due to the much larger number of leisure travellers.) As can be seen the model results show that the patronage on HS2 would be significantly affected by the introduction of Premium Fares.

Premium Uplift

0%

+10%

+20%

+30%

Business

0%

-4%

-21%

-26%

Leisure

0%

-11%

-21%

-35%

Combined

0%

-9%

-21%

-33%

2.7. It is possible to take these values further. The benefits of HS2 are calculated in a spreadsheet which brings together the different elements (costs and benefits) to give the overall Benefit to Cost Ratio (BCR). The factors calculated above can be used to adjust the benefits calculated for the published business case to give an estimate of the overall impact. For example, with a 30% increase in fare giving a 26% decrease in business passengers, then the Transport User Benefits of Business travellers can be assumed to have been reduced by the same amount (i.e. 26% decrease). Similarly the Wider Economic Impacts can be adjusted pro rata with the combined Leisure/Business patronage decrease.

2.8. A summary of the resultant calculations is given below, showing the Benefit Cost Ratio for both Phase 1 and the full "Y Network", as well as with or without the Wider Economic Impacts. (The full quantified Costs and Benefits are given in Annex 2.)

HS2 Business Case

Premium Fares

+10%

+20%

+30%

London - Birmingham

No WEIs

1.36

1.18

0.89

0.74

With WEIs

1.72

1.44

1.13

0.88

Full Y Network

No WEIs

1.87

1.58

1.16

0.95

With WEIs

2.47

2.03

1.54

1.18

2.9. As can be seen the viability of the project is very sensitive to the fare level. Increasing the fare reduces the patronage, thereby reducing the number of people gaining a time saving. Similarly with a higher fare there is improved connectivity is reduced thereby reducing the potential for creating jobs. Finally the total revenue drops with increased fare, the reduced numbers more than outweighing the extra value per passenger.

2.10. It is therefore clear from these figures that the issue of Premium Fares should be at the forefront of the analysis of HS2. Should HS2 ultimately be built, strict control would need to be kept of the fares charged, rather than left to commercial forces.

3. Discount Rate

3.1. In any financial or economic assessment covering more than one single year, it is important to take into account that the value of money in one year is different to that in another year, even if inflation is accounted for. For example, a pound today is worth more than a pound (adjusted for inflation) in five years’ time. This reflects for example the opportunity of investing the money now to get returns by the later date.

3.2. This issue is taken into account by use of the Discount Rate. This is the percentage value by which the value of money in one year is reduced to convert it into the value of the previous year (or increased to convert it to the value for the following year). The discount rate used for HS2 is 3.5% up to 2041, then 3% after 2041. So £1 in 2013 would be equivalent to £1.035 in 2014. Alternatively £1 in 2014 is equivalent to £0.96.6 in 2013.

3.3. The discount rate will have an important impact on the viability of transport projects because generally there are large costs early on (which are relatively unaffected by the discount effect) whereas the benefits are spread across 60 years which are more and more discounted as time goes on..

3.4. The discount rate used for transport schemes has not always been at this value. It has not been possible to find a record of historic discount rates, but I can recall using rates of 6% or even 8% in my career. The drop to 3.5% was brought in towards the start of last decade, during the period when the then Labour government was proposing major investments in public transport. The use of a reduced discount rate, together with extending the assessment period from 30 years to 60, generally gave an increased rate of return for government projects.

3.5. Around the time the discount rate was reduced, the UK economy was buoyant and the prospects were good for continued growth. Now however we are in definitely different financial circumstances where investment capital is short and economic growth is sluggish. It therefore seems reasonable to question whether the discount rate should continue as it is at present.

3.6. It is relatively easy to test the impact on the transport benefits from HS2 by varying the discount rate. The discount rate does not affect any of the modelling but is simply a factor applied in the final spreadsheet that draws model outputs together to calculate the overall costs and benefits. It has therefore been possible to carry out a test to see the effect of uplifting the discount rate by a given number of percentage points, and its impact on the final Benefit Cost Ratio.

3.7. The resultant BCR values are shown below:

HS2 Business Case

Discount Rate Uplift

+0.5%

+1.0%

+1.5%

+2.0%

London - Birmingham

No WEIs

1.36

0.98

0.75

0.59

0.47

With WEIs

1.72

1.29

1.02

0.84

0.72

Full Y Network

No WEIs

1.87

1.27

0.92

0.71

0.57

With WEIs

2.47

1.76

1.36

1.11

0.94

3.8. As can be seen, increasing the discount rate even by a half of a percentage point has a major detrimental effect on the viability of HS2. The BCR values, which are relatively low to begin with, move rapidly below the break even value of 1, as the discount rate is increased slightly.

3.9. It should be noted that the values for the Wider Economic Impacts should also be subject to adjustments due to changes in the discount rate. However at the present time it has not been possible for the author to understand how such an adjustment can be made. The above BCR values for the "With WEIs" cases therefore should be seen as being an overestimation of the return.

4. Summary

4.1. This paper has looked at two aspects that would affect the viability of the HS2 scheme, using data available from HS2 Ltd publications.

4.2. Having looked at the impact of Premium Fares, it is evident that increasing the fare level on HS2 higher than the competing "classic rail" would reduce the overall economic benefits and as a result would have a significant impact on the viability of the scheme.

4.3. Any revision to the current business plan should therefore be carried out only after a full economic assessment has been undertaken on the impact. Allowing fares to rise in accordance with market forces or in order to convert part of the benefit into money should therefore be avoided.

4.4. Having looked at the sensitivity of the scheme to the value of the discount rate assumed, it is clear that the calculated overall benefits are very sensitive to the discount value used, and that with only a modest rise in value (and still remaining below historic value) the HS2 scheme would become unviable.

4.5. Given the current economic climate where the government is particularly concerned about borrowing costs it would be appropriate for the government to review the current discount rate. Whilst the review of the discount rate would affect wider government spending not just HS2, it is important that a debate is had on the matter so that the full significance of such an ostensibly simple value is not overlooked.

July 2013

Annex 1:

HS2 Ltd Public Transport Patronage – Premium Fare Sensitivity Tests

Business Travellers: London-Birmingham

No HS2

HS2 Business Case

HS2 with Premium Fares

+10%

+10%

+10%

Classic Rail

785

0

0

1

9

Air

0

0

0

0

0

Highway

469

397

412

424

440

HS Rail

0

981

935

898

849

Total

1254

1378

1347

1323

1298

Business Travellers: London-Glasgow

No HS2

HS2 Business Case

HS2 with Premium Fares

+10%

+10%

+10%

Classic Rail

114

0

0

0

0

Air

776

571

589

664

679

Highway

2

2

2

2

2

HS Rail

0

411

384

272

249

Total

892

984

975

938

930

Business Travellers: London-Liverpool

No HS2

HS2 Business Case

HS2 with Premium Fares

+10%

+10%

+10%

Classic Rail

306

0

0

0

0

Air

41

15

16

25

27

Highway

0

0

0

0

0

HS Rail

0

467

454

383

371

Total

347

482

470

408

398

Business Travellers: London-Manchester

No HS2

HS2 Business Case

HS2 with Premium Fares

+10%

+10%

+10%

Classic Rail

804

0

0

0

4

Air

489

254

271

379

401

Highway

298

204

211

258

265

HS Rail

0

1479

1416

1075

1015

Total

1591

1937

1898

1712

1685

Source: Table 8.6, "High Speed 2 Support, Model Development report: A Report for HS2", February 2010

NB The data has been reformatted for clarity.

HS2 Ltd Public Transport Patronage – Premium Fare Sensitivity Tests

Leisure Travellers: London-Birmingham

No HS2

HS2 Business Case

HS2 with Premium Fares

+10%

+10%

+10%

Classic Rail

2546

0

47

403

889

Air

0

0

0

0

0

Highway

193

158

174

183

193

HS Rail

0

2887

2681

2230

1662

Total

2739

3045

2902

2816

2744

Leisure Travellers: London-Glasgow

No HS2

HS2 Business Case

HS2 with Premium Fares

+10%

+10%

+10%

Classic Rail

372

0

1

17

60

Air

418

125

178

200

223

Highway

3

2

2

3

3

HS Rail

0

899

772

709

621

Total

793

1026

953

929

907

Leisure Travellers: London-Liverpool

No HS2

HS2 Business Case

HS2 with Premium Fares

+10%

+10%

+10%

Classic Rail

949

0

2

39

127

Air

6

2

3

4

4

Highway

11

13

14

15

3

HS Rail

0

1256

1116

1040

916

Total

966

1271

1135

1098

1050

Leisure Travellers: London-Manchester

No HS2

HS2 Business Case

HS2 with Premium Fares

+10%

+10%

+10%

Classic Rail

2379

0

12

162

461

Air

155

56

93

108

124

Highway

73

48

59

63

66

HS Rail

0

3148

2752

2492

2093

Total

2607

3252

2916

2825

2744

Source: Table 8.7, "High Speed 2 Support, Model Development report: A Report for HS2", February 2010

NB The data has been reformatted for clarity.

Annex 2:

Quantified Costs and Benefits of HS2 and resulting BCR for HS2 – Premium Fare Sensitivity

HS2 Phase 1 (London-Birmingham): Quantified Costs and Benefits of HS2 and resulting BCR

Business Case

Premium Fares

+10%

+20%

+30%

Transport User Benefits (Business)

12,566

12,005

9,893

9,351

Transport User Benefits (Other)

7,198

6,434

5,687

4,651

Other quantifiable benefits (excl. Carbon)

593

541

468

400

Loss to Government of Indirect Taxes

-1,587

-1,447

-1,253

-1,071

Net Transport Benefits (PVB)

18,770

17,533

14,796

13,332

Wider Economic Impacts

4,849

4,849

4,849

4,849

Net Benefits including WEIs

23,619

21,533

18,642

15,932

Capital Costs

18,763

18,763

18,763

18,763

Operating Costs

8,180

8,180

8,180

8,180

Total Costs

26,942

26,942

26,942

26,942

Revenues

13,189

12,025

10,410

8,897

Net Costs to Government (PVC)

13,753

14,918

16,532

18,046

BCR without WEIs (ratio)

1.36

1.18

0.89

0.74

BCR with WEIs (ratio)

1.72

1.44

1.13

0.88

Values in £millions, 2011 Market prices, discounted to 2011.

HS2 Phase 2 (London-North): Quantified Costs and Benefits of HS2 and resulting BCR

Business Case

Premium Fares

+10%

+20%

+30%

Transport User Benefits (Business)

34,292

32,761

26,998

25,519

Transport User Benefits (Other)

16,742

14,966

13,228

10,818

Other quantifiable benefits (excl. Carbon)

1,046

954

826

706

Loss to Government of Indirect Taxes

-3,831

-3,493

-3,024

-2,584

Net Transport Benefits (PVB)

48,250

45,188

38,028

34,458

Wider Economic Impacts

15,377

15,377

15,377

15,377

Net Benefits including WEIs

63,627

58,008

50,221

42,918

Capital Costs

36,417

36,417

36,417

36,417

Operating Costs

22,256

22,256

22,256

22,256

Total Costs

58,672

58,672

58,672

58,672

Revenues

32,938

30,029

25,998

22,218

Net Costs to Government (PVC)

25,734

28,643

32,674

36,455

BCR without WEIs (ratio)

1.87

1.58

1.16

0.95

BCR with WEIs (ratio)

2.47

2.03

1.54

1.18

Values in £millions, 2011 Market prices, discounted to 2011.


[1] http://www.hs2.org.uk/sites/default/files/inserts/Analytical%20Challenge%20Panel%20170810.pdf

Prepared 18th July 2013