There was no politically easy option, but a novice minister chose retro
If anything confirmed the ‘blunt’ view of Keith Williams, Chairman of the Government’s Rail Review, that ‘franchising cannot continue the way it is today: it is no longer delivering clear benefits for either taxpayers or fare payers’, it was the award of the West Coast Partnership (WCP) to the FirstGroup/Trenitalia consortium on 19 August 2019.
That Mr Williams was rolled out to endorse the award as ‘a step forward that is firmly in line with the review, introducing benefits for passengers today and capable of incorporating the reforms needed for the future’, confirmed my view that we should moderate expectations for his much-touted review, the 31st such since 2006.
Indeed, it was noticeable how keen recently-appointed Transport Secretary Grant Shapps was to share the glory with Mr Williams. Here is the second paragraph of the award announcement: ‘Both the Transport Secretary Grant Shapps and Keith Williams, chair of the Rail Review, have heralded the Partnership as vital to deliver the swift introduction of significant benefits for passengers.
The new Partnership is also designed to fit with the direction of the Review and to facilitate the implementation of Williams’ recommendations in due course’.
SPOT THE DIFFERENCE
So, what is different about the WCP that Mr Williams finds so compelling? Well, according to DfT: ‘It reflects a significant move away from the previous flawed franchising system to tackle issues already highlighted by the Williams Review, with the use of a Forecast Revenue Mechanism (FRM) to avoid a repeat of the issues that affected the previous East Coast main line’.
As we know, what sank National Express East Coast and Virgin Trains East Coast were over-optimistic forecasts of revenue growth. As a result, when the money didn’t come rolling in from every side, the franchises ran at a loss. And when the parent company support was used up, both defaulted.
FRM is intended to limit the franchise operator’s exposure to such revenue risk. For each Franchisee Year in which FRM applies, DfT will review the franchisee’s actual FRM revenue in each reporting period against the bid Target Revenue. As soon as revenue strays outside plus or minus 3% of forecast revenue, DfT either caps 80% of the loss or collars 80% of the gain.
CAPPED AND COLLARED
Does this sound familiar to franchising veterans? Yes, it’s a more generous, less sophisticated version of the ‘Cap & Collar’ regime which applied before the Brown/Wilkinson reforms which followed the Inter-city West Coast replacement franchise procurement scandal of 2012. The box summarises the rules of Cap & Collar Mk 1, Table 2 provides practical examples.
BROMANCE AT FIRST SIGHT
‘Meeting Keith last week confirmed our shared determination to deliver a future that puts passengers at the heart of the railways, and get our trains to run on time.
‘That is why I have asked Keith to produce his recommendations for a White Paper, with fearless proposals that will deliver a railway system fit for the 21st century’. Grant Shapps, Transport Secretary, 14 August 2019
CAP & COLLAR
Revenue Share – If actual revenue outturns between 102% and 106% of target revenue, then 50% of the excess between 102% and 106% will be shared with DfT. If it out-turns above 106%, then 80% of the further excess will be shared with DfT.
Revenue Support – If actual revenue outturns between 98% and 94% of target revenue, then DfT will provide support equivalent to 50% of the shortfall between 98% and 94%. If it outturns below 94%, then DfT will provide support equivalent to 80% of the further shortfall.
Revenue support arrangements only apply after the first four years of the franchise.
As you can see, where under Cap & Collar the train operator remained responsible for 51.7% of the shortfall, with FRM, DfT’s share of the pain increases to 52.8%. Contrarily, when the good times roll and revenue share applies, DfT takes 59% of the gain.
There is one further, and very significant, difference. Cap & Collar became available only from the fifth year of the franchise.
FRM is instant gratification.
This was the crucial difference between default and survival for two franchises let in 2006-07. Both First Great Western and National Express East Coast had ambitious revenue growth targets which would be overtaken by the market crash of 2009. Both had Cap & Collar protection – but with a difference. DfT had made an error in the terms of the FGW franchise agreement.
First let DfT off the hook in exchange for Cap & Collar being available a year early. NatEx had to wait. First Great Western survives to this day; National Express is out of franchising. So when Grant Shapps proclaimed that the franchise ‘represents a decisive shift towards a new model for rail’, it was very much a case of the emperor’s old clothes.
In addition to FRM, there is also the Gross Domestic Product Adjustment (GDPA) which has been a feature of post-2012 replacement franchise agreements. Since ridership is linked to the economy, premium/ subsidy payments can be adjusted if the real world deviates from GDP forecasts DfT provides to bidders.
FirstGroup reckons that had FRM been available to its TransPennine Express and South Western Railway franchises, the current £200 million provision for onerous contracts could have been avoided.
There is an interesting hostage to fortune in the details of the rolling stock programme. According to the DfT press release, ‘23 brand new trains [will be] introduced by December 2022, replacing the unpopular diesel Voyagers and expanding the fleet’.
Yes, Voyagers are now officially ‘unpopular’, joining Pacers in DfT’s Bad Trains Guide. This should make planning a cascade interesting when negotiating the extended Direct Award for Cross Country: DfT person: ‘We thought you could have the ex-West Coast Voyagers to augment your fleet.’
Arriva person: ‘What? Even you admit they are unpopular. They would really hit our ridership and revenue.’ DfT person: ‘But Boris desperately needs to provide more capacity on your services to demonstrate that he’s not part of the metropolitan elite.’
Arriva person: ‘Oh, alright then, knock £500 million off the NPV of our premium profile and we’ll take them.’
Replacing the 20 unpopular Class 221 tilting diesel-electric multiple-unit Voyagers will be 13 five-car bi-mode DEMUs plus 10 five-car EMUs for the expanded Liverpool service.
These are all to enter service ‘from December 2022’. Meanwhile the Voyager fleet will be refreshed by December 2020, which suggests DfT thinks that someone will offer them / be ‘encouraged’ to provide a long-term new home. Credit where it is due: it is good to see firm dates being specified for the deliveries of these new trains. Put it in the book!
DfT claims that replacing the diesel-only fleet will reduce CO2 emissions by 61%. The faux precision is admirable, although it would be interesting to know whether the figure is rounded up from 60.873 or rounded down from 61.341. My initial reaction was that this was a bit optimistic. In fact, the new electric trains could easily exceed a saving of this magnitude.
In my old chum Roger Kemp’s seminal 2007 study on traction energy for RSSB, the Class 221s produced more CO2 per seat kilometre than any other train. This must make them even more unpopular.
Interestingly, given the current focus on decarbonising the railways, back in 2007, electricity generation produced 455 grams of CO2/kWh. At that time, this was forecast to fall to 320g/kWh by 2022.
Based on that 2022 forecast the Class 390, with regenerative braking, would ‘produce’ 14g of CO2 per seat kilometre compared with 35g/seat km for the Class 221. But when I checked the CO2 emissions for the current electricity generation mix, it was down to 180g CO2/kWh in 2018.
In other words, a 125mph Pendolino today is generating about a quarter of the CO2 per seat kilometre of a 125mph Voyager running to similar timings with the same operator. If you are taking decarbonisation really seriously, this makes even bi-modes hard to justify compared with full electrification.
Just to emphasise the point, Roger Kemp has kindly recalculated his CO2 per passenger kilometre chart on the assumption that the reliance on renewables continues with CO2/kWh falling to 160. This allows for average load factors, which obviously favours aircraft. Personally, I don’t go with load factors, since they obscure the potential for modal shift. Table 3 uses Mr Kemp’s basic data on CO2/seat km.
If I ruled the world it would be mandatory for the chart to be displayed before every presentation at conferences on decarbonising rail. If you are serious about climate change a rolling programme of electrification is the only rational policy.
And a point to note about bi-modes. While the little MTU Vee-12s in the Class 800 bi-mode generating units have lower overall emissions than their big brothers in the Class 43 IC125 power cars, in the case of CO2, when you burn a litre of diesel fuel you get 2.8kg of CO2.
There is good news for Alstom and Angel Trains in the announcement. A ‘major refurbishment’ of the Class 390 Pendolino fleet is proposed, costed at £117 million. To be completed by December 2022, this will include new standard class seats and additional luggage space, technology ‘to support the digital railway agenda’, improved passenger information systems (including reservation screens) and ‘enhanced toilet facilities’.
With High Speed 2 opening now confirmed to have moved at least three years to the right – as exclusively forecast by my colleague Dan Harvey in the August Modern Railways – the Class 390s could remain in service for a nominal 30-year book life. For Alstom, there is the prospect of a major refurbishment programme for the Widnes facility.
According to the latest Office of Rail and Road data, in 2017-18 Virgin West Coast had an annual revenue of £1.108 billion, paid a premium of £250 million and generated a total dividend for its owners, Virgin and Stagecoach, of £51 million. First Trenitalia quotes revenue for 2018-19 of £1.2 billion with the Net Present Value (NPV) of the premia over the first stage of their replacement franchise to 2026 of £1.6 billion.
Passenger revenues are expected to increase at a ‘mid-single digit Compound Annual Growth Rate’ (CAGR) over the first phase ‘from the additional capacity created and other initiatives’. First Trenitalia notes that this is lower than the historic growth rate of the franchise over the last 10 years.
Revenue for 2018-19 was up by around 9% year-on-year. Mid single-figure suggests around 5%. Directly funded investment in residual value assets by the consortium will be £11 million, while deductions from the premium will fund investment of £252 million. A further £453 million will be funded by rolling stock leasing companies for new and refurbished trains. Deducting the £117 million earmarked for the Class 390 refurbishment, this equates to £2.9 million per vehicle for the new Hitachi bi-modes and the assumed CAF Class 397 EMUs.
Overall, FirstGroup expects to earn a ‘robust margin’ towards the high end of the recent industry range during the first phase.
By chance, DfT included a baseline premium profile in the WCP invitation to tender.
I must emphasise that Table 4 and Figure 2 are DfT’s view of what the premium might be and could bear no resemblance to what First Trenitalia offered. However, since the NPV of the DfT figures comes to £1.595 billion I suspect it is not that far out.
Parent Company Support for Phase 1 provides a loan of up to £30 million, subordinated contingent loan facilities of £102 million, and a performance bond of £20 million. FirstGroup will be responsible for 70% or £106 million of this total contingent capital commitment of £152 million.
In Phase 2 – when the deal shifts to a management contract covering Inter-city West Coast and HS2 services – the total contingent commitment reduces to £65 million.
On the subject of pensions, First says that a ‘wide range of scenarios’ were modelled to assess the pension aspects of the bid, including the risk sharing mechanisms provided by DfT.
This was supported by advice from external specialists. First concludes that ‘in common with other rail franchises, no ongoing pension liabilities remain at the end of the franchise term’ and, in any case, will be transferred to the DfT ‘during the second phase of the contract’.
As we all knew, HS2 was already two years late but in the WCP announcement DfT still portrayed the franchise as running to 2026 plus provision for an extension for up to five years. This extension will be subject to an agreed revenue and selected cost-reset mechanism. The franchise will then end ‘at least six months’ before HS2 services are launched.
Now, the Cook report (p8) says that integration of HS2 services with the national network is now expected from December 2030 following a period of ‘captive’ operation restricted to HS2’. DfT must have known this, so why the mad rush to bind itself into a franchise at a time when maximum flexibility is going to be needed to cope with accelerating uncertainty?
True, FirstGroup has shown itself adept at dealing with chaos on the Great Western Route Modernisation, but that is more a reflection of GWR management than ownership.
And note that FirstGroup sought to placate its activist shareholder by emphasising that it was not going to bid for any more franchises after WCP.
DO OR DIE
As LNER has shown, when management can get on with running the railway, untrammelled by franchise agreements and premium profiles conceived in different circumstances, good things happen. Imagine the pressures on a franchised operator tied to a premium profile facing the event horizon that is the ECML 2021 timetable.
Perhaps, having been forced to bin the South Eastern franchise procurement, DfT was determined to get WCP away, do or die. And it seems they talked their new Secretary of State into believing it would be a good news story.
An expensive decision I fear, when there was no hurry to make a decision. Wait and see would have been the prudent approach, with the Operator of Last Resort (OLR) acting as caretaker. As for Keith Williams’ claim that this noughties-style retro-franchise aligns with his emerging proposals, this is either clearly nonsense or par for the course.