Press Release - Department of the Environment, Transport and
the Regions: The Channel Tunnel Rail Link
28 March 2001
Sir John Bourn, Head of the National Audit Office, told
Parliament today that although the Private Finance Initiative deal
for the construction of the Channel Tunnel Rail Link was in many
respects unique, the lessons to be learned from the project’s near
collapse are not. The report makes three key points.
- In negotiating with the private sector the Department of the
Environment, Transport and the Regions achieved its key objectives
through a restructured deal in 1998 that is in many respects more
robust, with a better allocation of risk, than the original deal
signed in 1996.
- However, the complex financial arrangements agreed during the
restructuring will require significant and long-term Government
support for the project.
- As there is room for debate on the economic case for the Link,
the justification for the project is heavily dependent on wider
policy benefits envisaged by the Government.
The report notes that, in difficult circumstances, a range of
complex issues had to be addressed and that the Department handled
the negotiations with LCR in a competent manner. It also sets out a
number of lessons for future Public Private Partnerships,
including:
Make sure that bidders for a PFI deal are not encouraged to be
over-optimistic
Poor performance by Eurostar (UK) Limited (the UK arm of the
international train service transferred to the private sector in
1996 as part of the PFI deal) weakened London & Continental
Railways (Eurostar UK’s owner and contractor for the construction
of the Link) to such an extent that its ability to fund
construction of the Link was destroyed and the entire project came
close to collapse. There have been recent examples (such as the
Millennium Dome and the Royal Armouries Museum) of high profile
projects whose business plans have depended on forecasts of usage
that turned out to be highly optimistic. As bidders’ forecasts in
1996 for the fledgling Eurostar UK business were in line with
previous estimates made by the Department and British Rail, the
Department did not have them independently reviewed.
If a deal goes wrong, private sector partners should bear their
share of the risk
The private sector is paid for taking risk. Responsibility
should therefore remain with the private sector should these risks
actually occur. In the restructured deal, LCR’s shareholders
retained an economic interest in the project while avoiding the
full financial consequences of its near collapse. On the other
hand, the taxpayer could be exposed to further financial risk of
£360 million on current forecasts if Eurostar UK revenues are badly
affected by poor passenger numbers. Departments should ensure that
over-optimism in bidding for contracts will lead to losses if
things go wrong.
Substantial risks arise if public sector assets are transferred
in advance
The risk of running a relatively new international train service
was bundled together with the risk that the private sector
contractor would be unable to raise sufficient finance to build the
Link. Significant public assets were transferred to the private
sector more than a year before the planned completion of the
external financing for the project. If a department proposes to
depart from the normal practice in Public Private Partnerships of
transferring assets only when all finance has been raised, then it
needs to think through its approach to managing the increased risks
involved.
The proportion of equity capital in a PFI project should
reflect the risks involved
Departments should ensure that the capital structure of a deal
is consistent with the risks involved in the project. If the
proportion of risk capital is too low, the project will not be
financially robust in the face of lower than expected revenues.
Moreover, having a relatively low investment at risk may provide
insufficient incentive for the private sector shareholders to
tackle business problems with determination. Either way, the impact
of proceeding with too little risk capital is likely to be a call
on the public sector for increased financial support, as happened
in this case. It follows that a department should take a close
interest in private sector proposals for the capital structure of
Public Private Partnerships.
The Department should monitor the expected benefits from the
Link
The Department calculated benefits of some £3,000 million from a
public sector subsidy of £2,000 million. Reworking the calculation,
adjusting some of the Department’s assumptions, the report shows
that the economic case for the Link is debatable and that the
justification for public sector support is heavily dependent on
wider policy benefits. If regeneration and passenger benefits are
not as high as expected, the Link is unlikely to be good value for
the taxpayer on economic grounds. It is essential therefore that
the Department should do what it can to ensure that such benefits
are realised.
Government guarantees of project debts are unlikely to be
costless
The Department retained the risk that future Eurostar UK
revenues would be insufficient to service £430 million of debt
taken on by LCR and attract further investment in the project. If
the market is unwilling to provide sufficient debt capital secured
on the project, that is a clear signal that the project risks go
beyond normal commercial risks. Such guarantees transfer project
risks to the department, which needs therefore to consider
thoroughly how to manage those risks.
If a project requires public funding, give careful
consideration to the most cost-effective route
LCR could not have raised all the finance it needed without
Government help. However, the use of bonds carrying a Government
guarantee rather than a voted loan from the Department to fund the
project, cost the taxpayer an additional £80 million. The use of
such bonds reflected the unique circumstances of this deal and
achieved the Government’s objectives for risk allocation and
accounting treatment in this Public Private Partnership.
Departments will need to consider this cost-benefit balance with
great care if similar situations arise in the future.
Sir John said today:
"It is apparent that, faced with a range of complex
issues, the Department handled negotiations with LCR in a competent
manner. The financing of the restructured project is fundamentally
different to that envisaged in 1996, and so is the distribution of
risks between the various parties now involved. There are a number
of important lessons here for future PPPs, along with some specific
points for the Department".
Notes for Editors
In February 1996 the Department of the Environment, Transport
and the Regions awarded London & Continental Railways the
Channel Tunnel Rail Link contract. LCR would finance, build and
operate the Link drawing revenue primarily from Eurostar UK while
the Department would provide LCR with subsidies of £2 billion
for the construction of the Link and its use by domestic train
services. However, LCR could not raise all the money it needed from
private investors and in January 1998 the company asked for an
additional £1.2 billion in public subsidy. Following
negotiations, the Deputy Prime Minister announced that the deal had
been restructured without a material increase in the level of
public subsidy.
The restructured deal retains the same route for the Link but
splits construction into two sections: Section 1, from the Channel
Tunnel to near Ebbsfleet on the outskirts of London, and Section 2
from near Ebbsfleet to St Pancras. Railtrack has been brought in
both to manage construction and, when it is completed, to purchase
Section 1. Construction of Section 1 began in October 1998 and is
on target for completion by 30 September 2003. Completion of the
entire Link is now scheduled for late 2006. The Department is
discussing the arrangements for Section 2 of the Link with LCR,
Railtrack and other parties with the intention of concluding a deal
very soon.
Press notices and reports are available from the date of
publication on the NAO website at http://www.nao.org.uk/ Hard
copies can be obtained from The Stationery Office on 0845 702
3474.
The Comptroller and Auditor General, Sir John Bourn, is the head
of the National Audit Office employing some 750 staff. He and the
NAO are totally independent of Government. He certifies the
accounts of all Government departments and a wide range of other
public sector bodies; and he has statutory authority to report to
Parliament on the economy, efficiency and effectiveness with which
departments and other bodies have used their resources.
Press Notice 24/01
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