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Can privatisation lite be applied to the private sector ROSCOs?
My problem when it comes to the Rolling Stock Companies is that, unlike some contemporaries in the railway press,I don't really have a problem with the ROSCOs. Bye and large they have done what it said on the tin, plus a bit more, despite operating in a dysfunctional economic model of a privatised railway.
However, the ‘The future of rail' White Paper revealed that the Government certainly does have a problem with the ROSCOs. This is what it said on the subject of rolling stock.
ROLLING STOCKEach year the rail industry pays over £1 billion to the rolling stock operating companies to lease stock. The leases are commercial agreements between private companies. However, as the Government ultimately pays for much of this through its funding of the rail industry, it is important to ensure that they represent good value for the taxpayer. When the industry was privatised, it was envisaged that a competitive market for rolling stock would drive cost improvements. In addition, the returns earned from leasing existing rolling stock were based on an assumption that there was a high risk that the ROSCOs would find themselves with rolling stock they could not let once new stock came into use. However, this is another instance where assumptions made at the time of privatisation have not generally come to pass. There are also continuing concerns in the industry about how maintenance responsibility is allocated, given the evolution in the roles of the different parties in the industry since privatisation. Taken together, the Government believes that these observations suggest the markets in rolling stock financing and maintenance established at privatisation are not working in the way they were expected to, and that there is a case for looking to see how the operation of those markets can be improved. Government remains committed to ensuring that risks are held by the parties best placed to manage them and to securing best value for the taxpayer. To support this, the Government will develop a longer-term strategy for the rolling stock market, which will help the industry to plan ahead more effectively. "The future of rail" White Paper.
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We also know that the various Franchise owners have problems with the ROSCOs too and that this was reflected in their submissions to the Government's review of the railways. So what is the White Paper saying?
In the opening paragraph we have another example of that paradox - a fragmented railway shovelling around the taxpayers money between its various parts, each part claiming to be in the private sector and taking a profit. Currently, government support represents a scandalous 58% of the railway's total income, so concern for value for money is wholly legitimate.
Next, the assumption that a competitive market for rolling stock would drive costs improvements. This is not so straightforward as it seems.
Lease rentals on existing stock inherited from BR were totally artificial and based on indifference pricing. The concern was that if this stock was too cheap no one would buy new trains. Hence the rentals were set at a level which made Train Operating Companies indifferent as to whether they leased old or new kit.
But, in line with the view that BR was hopelessly inefficient, including British Rail Maintenance Ltd (BRML) – the workshops arm which was being split up for privatisation – the non-capital portion of the lease rentals included a Production Price Index–3% year-on-year cost reduction.
When it comes to new stock, my analysis (Informed Sources April 2003) showed that prices for post privatisation multiple units were in general lower than the later Networkers, but higher than the York built EMUs of the 1980s. So there have been some cost improvements.
Next, there is the issue of risk, ‘where assumptions made at the time of privatisation have not generally come to pass'. Well, as Chairman Mao replied when asked for his views on the French Revolution – ‘it is too soon to say'.
Until there were substantial quantities of new trains in fleet service, there could be no major risk of ex-BR stock standing idle. But for over a year the pressure has been rising.
Take the case of MerseyRail Electrics and their Class 507/508 fleet of electric multiple units. Angel is refurbishing the 59 units at a cost of £32 million, extending the lease by 10 years.
This will give Merseyside PTE time to develop and build the replacement fleet with level-floor access. All 80 stations on the Network are being made fully accessible.
However, Angel is convinced that if it had not signed up to the refurbishment, there was a genuine threat that its EMUs could be replaced with new trains sooner. Similarly with Chiltern, where the choice between new diesel multiple units and refurbishing the existing 165 fleet was certainly a material threat.
I assumed that in such deals, the cost of the refurbishment is covered through increased lease rentals. Apparently not. The owning ROSCO takes most of the hit, having calculated that an asset producing a lower rate of return for another 10 years is preferable to having the cost of the refurbishment in the bank and an expensive asset earning nothing.
And, as this column is wont to remark, it is worse than that. When you start stripping out for a major refurbishment you may find all sorts of nasties, ranging from corrosion to manufacturing defects. The ROSCO pays for these too.
What else is at risk? Porterbrook, famously, has 150 Mk 3 coaches released by the Virgin franchises with no immediate application. Potential markets explored include Channel Tunnel Rail Link Domestic Trains, the Greater Anglia franchise and spot hire for charter operators.
Lying idle modern stock needs to be kept heated if sub-systems are not to deteriorate. If a leasing company has airliners temporarily idle, they can be stored in the deserts of the American South West but Northern Europe 's climate provides ideal breeding conditions for the tinworm and its electrical relations
Finding a use for locomotive hauled coaches is complicated by the shortage of suitable diesel traction. Then, as with the IC125 fleet, there is the issue of classified repairs and refurbishment. If there isn't a long term application, then the owning bank's investment committee will not authorise the expenditure.
And, from the ROSCO view point, it is going to get worse. The Class 458 fleet comes off lease in February, with no obvious home to go to. The Midland Main Line Meridians are starting a cascade of Class 170s which will could Class 150s falling out of the bottom. There is talk of the Brighton line Route Utilisation Strategy binning Gatwick Express.
But the biggest hit of all could come when TransPennine Express re-equips with Class 185 Desiro DMUs, releasing over 100 Class 158s which are just coming up to mid-life.
So the risk is here, now, real and growing. The ROSCOs estimate the number of vehicles off lease in 2006 at between 500 and 600. And with the White Paper presaging regional authorities transferring funding from trains to buses finding new users for DMUs will be even more difficult than it is today.
DfT has been looking to see how the operation of the leasing and maintenance markets can be improved for some time. A review was commissioned from accountants Ernst & Young and the d raft findings were shown to the ROSCOs at a meeting with DfT on 28 July.
E&Y were critical of the ‘indifference pricing' model. This, of course, is nothing to do with the ROSCOs since the model was invented by the consultants working for the Treasury and the Department when it was ‘of' not ‘for' Transport.
Two specific criticisms were identified by E&Y. The lack of ‘transparency' in the financial terms, already mentioned, may prevent best value being achieved. They also picked up on-going criticism from the TOCs over the arrangements for carrying out heavy maintenance.
Maintenance has been a contentious issue for some time. The PPI-3% cost reduction has proved difficult to manage in an immature market where new owners were getting to grips with bringing BRML into the real world.
In his statement to the House introducing the White Paper Transport Secretary Alistair Darling was even more direct than the extract quoted from the White Paper. Referring to the fleets for which the original leases were set at privatisation, he said ‘the renewal of these leases in the same form would be poor value. So as passenger franchises are replaced, we will deal with these problems and drive a better deal for the public'
Tough talking? No, just more huffing and puffing.
Remember that Tom Winsor has ensured that the rights of public sector investors are protected – which includes current rolling stock leases, and that not many franchises will be coming up for renewal. As a result perhaps 10% of the UK fleet could be affected by the White Paper between now and 2010.
Note too, in the final statement in the box above, that Mr Darling is offering the ROSCOs the security they need to reduce residual risk. If you have a long term rolling stock strategy, as opposed to the bodge up rushed out by the SRA and excoriated in this column, then there is obviously less uncertainty and risk can be priced accordingly.
If you know, as much as anyone can trust the weasels at the DfT, that IC125 replacement is scheduled for 2015, then you can get authority from your owning bank's finance committee to spend serious money on a mid life refurbishment of the existing fleet. And in meetings with the DfT ROSCO representatives have explored the possibility of linking long term leases underwritten by Government to cuts in rentals reflecting the reduced risk.
However, with DfT Permanent Secretary David Rowlands known to believe that the existing leasing market is risk free, such a trade off might be difficult to negotiate. That is until the national media are invited to see the first Mk 3 under the cutting torch.
So am I being contrary in not having a problem with the ROSCOs? Well, they weren't an attractive business in the first place – with only the three MBOs and John Prideaux' Babcock and Brown/Nomura consortium bidding.
Now they have been sold on to the Banks they are still a risky business. Porterbrook has been up for sale for months and no one wants to buy. Even more to the point, the finance houses which came into the leasing market have all given up and walked away.
But are an expensive way for the state railway to acquire trains. The extra cost of the SWT Desiro fleet is about £1 per head for the population of Britain . However the ROSCOs have funded about 10% more vehicles than BR acquired in its last 10 years.
What about Section 54? When a ROSCO borrows to buy a train fleet it doesn't start making a return until halfway through the lease. SRA can use its Section 54 powers to guarantee leases beyond the end of a franchise, reducing rentals
For example, the lease rentals for the SWT Desiros were based on a 20 year franchise. When the franchise was shortened, Section 54 was used to underwrite a 20 year lease so that the rentals remained the same.
Overall, and because the ROSCOs have kept alive traction and rolling stock engineering expertise during the privatisation dark ages, I still reckon that they just about come out on the side of the angels. But there could be an alternative, which you read first in the Editor's review of the track machinery market last month.
Network Rail Chief Executive John Armitt explained, that when it came to acquiring heavy track plant, ‘we have a very low cost of capital because of our structure, so…it either us or a ROSCO'. And already it is being proposed that Network Rail should take over responsibility for procuring and funding new passenger stock, which could even be provided to the TOCs as part of their track access charges.
This would also simplify acceptance and compatibility issues, as exemplified by the South Region Power Supply Upgrade. And you read it here first