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INFORMED SOURCES May 2003

Network Rail costs rising

Forget talk of £6billion, Network Rail sees its operating expenditure rising to £6.45billion in 2005/06

We have to remember the golden rule of company rescues. In the first year you pile every contingency and downside you can into the business plan so that whatever happens the rescuers will, at least, be seen to have made some improvement. Oh yes, and if you are Network Rail you get your excuses in first.

And the Excuse of the Year 2003 is that traffic has grown since privatisation. Five times in the first 23 pages of the 55 Business plan summary we are told that passenger kilometers have risen by 30% since 1995/96. and there are sundry other references to growth.

This is terribly impressive until you take the long view. Then you see that passenger km fell by 15% in the five years before 1995/96, so that the network is only 15% higher than the previous peak demand when I don't remember things falling apart.

Scary numbers

Anyway, the meat of the Business Plan is in the numbers. In addition to the full analysis (Table 2) I have also prepared a simplifier showing the key figures plus the Regulator's Determination in his Periodic Review for the current Control Period (CP2) which ends on 31 March 2006 .

In the run up to publication of the Business Plan, the shorthand figure for Network Rail's annual spend was £6billion. But, as you can see rounding numbers in this case disguises the true cost.

If we assume that 2002/03 is diesel through the injector, the average requirement for the final three years of CP2 is £6.27billion. Worse, in his Periodic Review for CP2, the Rail Regulator foresaw efficiency savings coming in which would cut costs by £500million a year over the three years. Network Rail now expects costs to <ital>increase<ital> by just over £400million over the same period.

In all between now and 2006 Network Rail will need an extra £10billion just to cover Operation, Maintenance and Renewals (OMR). And remember Bowker's Law – that the railway's money comes only from the customer or the taxpayer.

Currently the railway's income over these three years will be around £26.5billion. Feeding Network Rail, our own Weapon of Money Destruction, means increasing funding by another 37%.

And that's before the limited number of enhancements are paid for– notably the £1billion Southern Region power upgrade. I couldn't help noticing that when the Chancellor made another £1.25 billion available to fight the Gulf War, he was effectively bombing Baghdad with 750V DC sub-stations.

Table 1

Industry constrained

While Network Rail's reasons for the state we are in may be a bit flimsy, the company Chairman Ian McAllister says that the rate of renewals has to be stepped up ‘to reduce or stop the decline'. The company adds that it has to achieve this with a ‘constrained supply market which was expected at privatization to have a considerably smaller work programme'.

Network Rail is clearly concerned that ‘there is a relatively small number of large service suppliers in the key niche markets of maintenance track renewals and signaling deign and equipment. Barriers to entry to this market are ‘high' and ‘despite substantial growth in activity levels only one supplier in maintenance and two significant suppliers in track renewals have entered the market since privatisation.

This shows that the decision to take back two more areas was indeed taken in the ruddy blush we all thought, since the ‘only one supplier' is Serco which has just been told it is losing its one contract.

Similarly, Network Rail believes that ‘if anything the signal engineering market has consolidated constraining activity in this area. This is weapons grade meretricious tosh. The only thing constraining activity in signaling has been Railtrack's changing policies and lack of orders.

For heaven's sake, we have three suppliers of Computer Based Interlockings new to the market in addition to the established duo of Westinghouse and Alstom (ne GEC).

And the volume of signaling renewals forecast is not going to keep even this ‘constrained' sector busy.

Savings?

What about cost savings? Under the Business Plan Network Rail is committed to reducing the costs of operations and maintenance by 20% over the three years to the end of the current control period in March 2006. This would be worth £500m a year.

Note that only applies to Operations and maintenance. Joint Chief Executive Iain Coucher told me that he hoped that a similar saving might be achieved from renewals. That seems a stiffish task, but 20% off the total OMR spend in 2005-06 would represent £1.3bn a year, knocking the total back to just over £5billion – but still £2billion more than the Periodic Review allowed.

That is a big gap and not surprisingly the Network Rail Board is fully up to speed on Tom Winsor's Appendix A proposals (Informed Sources April). Incidentally Tom Winsor should know that my analysis of Appendix A was described by a reader as ‘ a load of completely-over-the-top cheap sensationalism'. I assume that referred to the writer not Appendix A.

Chairman Ian McAllister told me ‘at the end of the day we have to run a safe railway that is as reliable as we can make it . To the extent that we don't have the level of funding to do what we want to do it makes a much higher degree of prioritisation [of maintenance] necessary which means in the longer term your asset will deteriorate and you get to a point where you have to ask “can I continue to operate this piece of track”'.

But such decisions are not ‘part of this plan going forward'. With Network Rail and ORR working together ‘on an iterative basis' on the Interim Review and using the same consultants the Company expects an agreed position to emerge. Then the Government will have to decide how to pay for it.

Hard options

As explained, last month, this ‘position' will set the agenda for the discussion in July, at which SRA and Government will have to decide how to bridge the yawning funding gap. This is likely to be a combination of the options in Appendix A, namely, do the work and borrow the extra, defer work until it costs less, cut back the network, either in length or capability, and, finally, ask the Treasury to pay any remaining overspend.

As the time for Richard Bowker to make his ‘case for rail' to the 2004 Comprehensive Spending Review (CSR) comes nearer, the task becomes more daunting. Asking for more money for a railway in retrenchment and performance at such low levels will be more of an apology than a case.

I still think that it is a CSR too soon. My strategy would be to tough out the next two years and go for the 2006 CSR when infrastructure costs should be coming under control, franchise replacement almost completed and performance improving. But, of course there is the slight inconvenience of an election in between which will be fought on the performance of the public services.

Meanwhile, we at least know the scale of the problem. Say £6.25billion a year to feed Network Rail, another £1billion for the ROSCOs, that leaves £1.5billion from current income and subsidy levels to run the passenger and freight operators. Does that suggest fares increases to you?

Continues.........

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