Select Committee on Environment, Transport and Regional Affairs Appendices to the Minutes of Evidence


Memorandum by Tom Winsor, Rail Regulator (RI 21)

INTRODUCTION

  1.  This submission forms my written evidence in response to the letter from the Clerk of the Transport Sub-committee dated 19 May 2000. It addresses the record to date of the privatised Railtrack and it looks ahead to the work that my office and the Shadow Strategic Rail Authority are doing to create a new and more effective framework for the railway industry. Together we must ensure the delivery of a better railway which will meet the challenge of growth in rail use.

  2.  The letter from the Clerk did not explicitly mention safety. Although I am not the regulator of safety in the industry, I regard safety as a fundamental consideration for all who work in or regulate the railway. Thus, my office works closely with the Health and Safety Executive. We have co-operated on issues such as broken rails and the creation of Rail Safety Limited to replace Railtrack's Safety and Standards Directorate.

  3.  Since I took office my approach has been twofold:

    (a)  to ensure Railtrack delivers on its commitments in a competent and effective way, and to take action when it does not. My intention is not to penalise Railtrack but to ensure it performs better; and

    (b)  to set up a new financial and contractual framework for Railtrack to ensure it responds positively to the challenges ahead.

  4.  This document uses the same structure as the Clerk's letter:

    (a)  Railtrack's past performance and the likely impact of its plans for the future;

    (b)  the adequacy of the oversight exercised in the past by the Office of the Rail Regulator and how it intends to ensure that Railtrack in future honours its commitments; and

    (c)  the role of the Strategic Rail Authority and the franchise replacement programme.

RAILTRACK'S PAST PERFORMANCE AND THE LIKELY IMPACT OF ITS PLANS FOR THE FUTURE

Railtrack's performance to date

  5.  In January 1995, the then Rail Regulator, John Swift QC, set Railtrack's track access charges for the price control period 1995-2001. He allowed £8.6 billion for the maintenance and renewal of the infrastructure, plus £570 million over the control period to tackle a backlog of expenditure.

  6.  These charges were set before the privatisation of Railtrack (May 1996). At the time of flotation, Railtrack increased its estimate of the expenditure necessary for maintenance and renewal of the network by £1 billion.

  7.  In its most recent submission Railtrack says it has spent an average of £2.25 billion per annum on maintaining and renewing the network since privatisation. Thus its expenditure has significantly exceeded the amounts allowed for in the 1995 charging review (by £2.2 billion) and expected at the time of flotation (by £0.9 billion).

  8.  The charges set in 1995 were based on the amount of money the then Regulator considered necessary for maintenance and renewal of the network, and its timely renewal in the appropriate modern equivalent form. Beyond this, however, the Regulator did not specify outputs for the network in terms of performance or quality. My understanding is that this reflected the limited information available to him at the time. However, he did require Railtrack to publish key performance indicators on the capability and reliability of the network. In September 1998 he commissioned a report from Booz Allen and Hamilton on Railtrack's stewardship of the network and this was published in April 1999.

  9.  Between 1995-96 and 1996-97, Railtrack reduced total delays attributed to it (for all trains, passenger and freight) by just over a third (12.8 million minutes down to 8.5 million). Over the next two years this level was broadly held. In 1999-2000 there was again a significant improvement of just under 10 per cent (taking the improvement since 1996 to 40 per cent despite major traffic growth—see paragraph 13).

  10.  Track quality worsened in the years before privatisation and showed little sign of improvement before the then Regulator took action in 1998. In July 1998 Railtrack gave undertakings to my predecessor to ensure that by April 2000 the proportion of very good and satisfactory track would at least equal that existing in 1994. Over the same period the number of broken rails had been broadly level, but rose sharply in 1998-99. Railtrack has now contained the rise, but I am pressing them to achieve a material reduction as fast as possible.

  11.  Railtrack inherited a number of BR resignalling projects which typically involved large scale resignalling of entire control areas of the network. While continuing to implement some of these projects, Railtrack has adopted a targeted policy of replacing signal components on the basis of their condition. This strategy is intended to extend the life of the current system until radically different train control systems are adopted.

  12.  My advisors, Booz Allen and Hamilton, concluded that Railtrack had not put in place a database of reliable asset information to inform a long-term asset management strategy, and that remedying this should be a high priority for Railtrack.

  13.  Over the period 1995-2000, there was significant growth in the use of the network. From 1995-96 to 1999-2000 passenger train miles grew from 231.3 million to 256.0 million (a 10.7 per cent increase) and freight train miles from 24.5 million to 29.3 million (a 19.6 per cent increase). Railtrack also entered into a number of commitments to enhance the network, including:

    (a)  Thameslink 2000 agreement with the Franchising Director. In 1995, Railtrack agreed to expand the Thameslink network to link more stations north and south of London using the central London Thameslink route. The Franchising Director underwrote the access charges needed to pay for this. The commencement of the works is dependent on a successful application under the Transport and Works Act 1992 and construction of a new station at St Pancras as part of the Channel Tunnel Rail Link. The work is expected to be completed in 2007.

    (b)  West Coast Route Modernisation (WCRM). The arrangements for this upgrade were established in two stages. In 1996 the Franchising Director negotiated an upgrade agreement (known as "PUG 1") between Railtrack and InterCity West Coast Limited (then a subsidiary of the British Railways Board and therefore in public ownership). In 1997 the West Coast franchise was awarded to Virgin Rail Group Limited. Virgin immediately renegotiated the upgrade with Railtrack, leading to the signing of a new contract ("PUG 2") which replaced PUG 1. PUG 2 provides for the upgrade to be completed in two phases. Phase 1 contemplates trains running at 125 mph by May 2002. Phase 2 provides for 140 mph operation by May 2005. The PUG 2 contract was approved by the then Regulator in June 1998.

    (c)  Chiltern Line track doubling. In 1997, Railtrack agreed with Chiltern Railway Company Limited to double the track between Princes Risborough and Bicester North, thereby enabling more frequent services. The work was completed in July 1998.

    (d)  Tyne and Wear Metro Extension. In 1999, Railtrack agreed with the Tyne & Wear Passenger Transport Executive (Nexus) on work to extend the Metro to Sunderland. Work on this started in January 2000, and is due to be completed in January 2002.

  14.  In November 1999 I began enforcement action in relation to the WCRM because I considered that Railtrack was likely to breach its obligation under its network licence which requires it to enhance and develop its network, including the WCML, to certain standards. The enforcement action requires Railtrack to show clearly that it can deliver on its existing obligations to provide additional capacity for operators other than Virgin, and to complete and deliver reviews of capacity of the WCML to establish how it can be enhanced and developed.

  15.  In the course of the periodic review of Railtrack's access charges, I am assessing the extent to which these and other enhancements should be reflected in the Regulatory Asset Base (RAB).

  16.  In my view, the relatively small number of committed enhancements reflects weaknesses in the strategic framework for the industry, and in the clarity of the arrangements and the role of government. I plan to address these concerns with the Shadow Strategic Rail Authority (SSRA) (see paragraph 48 below).

Railtrack's plans for the future

  17.  Railtrack's 2000 Network Management Statement (NMS), published in March 2000, contains the company's plans to maintain and renew the network over the next two price control periods, and also a series of options to enhance the network. Publication of the NMS is a requirement of Railtrack's network licence. The form—but not the content—of the NMS is agreed with me and the statement must demonstrate compliance with Railtrack's network licence.

  18.  In the 2000 NMS Railtrack states that it will need to spend an average of £2.1 billion per annum over the next price control period (2001 to 2006) simply in order to maintain and renew the network. This is considerably higher than the average of £1.7 billion projected by Railtrack in the 1999 NMS. Railtrack says in the 2000 NMS that its plans for the next control period reflect increased maintenance and renewal to cope with the growth in traffic, improved track quality, annual reductions of 2.5 per cent in delays attributable to Railtrack and gradual improvement in the condition of stations.

  19.  I am considering, as part of my periodic review of access charges, the expenditure which I should allow to be recovered in access charges and the outputs it will deliver.

  20.  The 2000 NMS also sets out committed and optional network enhancements:

    (a)  The principal committed enhancements are those summarised in paragraph 13 above. Other schemes include the installation of the Train Protection Warning System on parts of the network, and the upgrade of stations to comply with the Disability Discrimination Act 1995. The upgrade of the WCML involves both renewal and enhancement work. I am considering revised estimates submitted by Railtrack for this work to establish the efficient level of costs, and the appropriate split between maintenance and renewal.

    (b)  Railtrack has also costed options (known as "incremental outputs") at the behest of the SSRA and train operators and other funding bodies. The SSRA may decide to purchase some of the incremental outputs through the access charges paid to Railtrack. I am therefore considering, as part of my periodic review of Railtrack's access charges, whether the costs estimated by Railtrack are the efficient costs. In addition, Railtrack has costed a series of options to deal with different scenarios for traffic growth on the rail network. I expect that train operators will consider a number of these as part of the franchise replacement programme.

  21.  The 2000 NMS also contains an analysis of the rail freight market and its economics, including current trends and the prospects for further growth under a variety of different economic and public policy assumptions. It shows that there has been a 41 per cent growth in rail freight between 1996 and 1999, from 32 to 43 billion gross tonne kilometres moved, and that it could further increase to between 56 and 140 billion gross tonne kilometres by 2010. The 2000 NMS contains a set of "options" for the development of key routes used by rail freight, including a proposal to develop a third Anglo-Scottish route, to meet the increased capacity requirements.

  22.  I am currently consulting a range of railway industry parties on the NMS before deciding whether it demonstrates compliance with Railtrack's network licence. I will update the Committee at the hearing on the current position.

THE ADEQUACY OF THE OVERSIGHT EXERCISED IN THE PAST BY THE OFFICE OF THE RAIL REGULATOR AND PLANS FOR FUTURE IMPROVEMENT IN THE REGULATORY FRAMEWORK

  23.  The Committee will be aware that the adequacy of ORR's regulation of Railtrack's maintenance and renewal of the rail network was the subject of a report by the Comptroller and Auditor General published on 12 April 2000. On 24 May 2000 I gave evidence to the Committee of Public Accounts in relation to those matters and the report of that Committee is awaited.

  24.  At the time of privatisation Railtrack's network licence (issued by the Secretary of State in March 1994) had no substantive obligations in respect of the maintenance and renewal of the rail network. Nor did the track access contracts with the train operators contain substantive obligations on these matters.

  25.  The then Regulator advised the Department of Transport in 1995 that Railtrack's network licence obligations should be strengthened before the company was privatised in 1996, but the Department indicated that it would not be prepared to support this. Following privatisation, in 1997 the then Regulator sought and obtained Railtrack's agreement to a new licence obligation in respect of the maintenance, renewal and enhancement of the network. In 1998 he concluded that Railtrack would be in breach of this obligation unless it took specific action.

  26.  Following publication in the 1998 NMS of targets for reducing train delays, which the then Regulator concluded were inadequate, Railtrack undertook to reduce delays to passenger and freight trains by 7.5 per cent by 31 March 1999. While Railtrack met the freight target, delays to passenger train movements were down by just 2.2 per cent. In the meantime, Railtrack set a target in the 1999 NMS for further reductions of 7.5 per cent. I told Railtrack last year that I considered that it was a reasonable requirement of train operators and funders that it both make up the 1998-99 shortfall and achieve its 7.5 per cent passenger train target by 31 March 2000 (a cumulative passenger train target of 12.7 per cent). When Railtrack refused to commit to this, I made an enforcement order requiring Railtrack to achieve the target, on pain of a penalty of £4 million for each percentage point by which it failed to meet the target. Final figures for the year to 31 March 2000 will not be available before mid-August 2000, but Railtrack estimates that reduced delays to passenger trains by about 10 per cent. This is substantially more that the 1999 NMS target which Railtrack had set for itself. I will review the final figures in the light of any further information submitted by Railtrack in accordance with the enforcement order. Railtrack has appealed against the order, in particular the level of penalty, and the matter is before the High Court.

  27.  Notwithstanding the above actions I accept the following points made in the Comptroller and Auditor General's report:

    (a)  the ORR should set out more clearly than before what they expect Railtrack to deliver as a result of maintenance and renewal;

    (b)  the ORR should secure a better picture of the condition of the network's assets;

    (c)  the key elements of the monitoring information that the ORR should receive from Railtrack should be independently verified to ensure that it is robust and commands public confidence; and

    (d)  the ORR should continue to develop appropriate targets and clearly predictable incentives for Railtrack to improve their performance on punctuality, cancellations and track conditions.

  28.  Between July 1999 and April 2000 I announced the steps I intend to take in these and other areas.

  29.  I consider that Railtrack's performance to date, the experience of the regulation of Railtrack and the points made by the Comptroller and Auditor General, highlight the need for fundamental improvements in Railtrack's regulatory framework. Specifically, I believe it is necessary to:

    (a)  provide much better definition and monitoring of what Railtrack is expected to achieve;

    (b)  improve Railtrack's accountability to the Regulator and to its customers;

    (c)  improve the incentives on Railtrack to deliver a better railway; and

    (d)  ensure transparency and stability in the regulatory framework.

  30.  I plan to implement these improvements in two ways. The first is by means of the periodic review of access charges (where I will be announcing draft conclusions in July 2000 and final conclusions in September 2000). The second is by making important changes to the licence and contractual framework.

Definition and monitoring

  31.  As part of the periodic review, I plan both to define what is expected of Railtrack to sustain the network over the next five years and how I will measure and monitor delivery. In my provisional conclusions (December 1999) I said I expected to see targets for performance and track quality, and a range of asset condition measures.

  32.  This will need to be accompanied by improved measurement and monitoring including:

    (a)  the creation of a proper asset database;

    (b)  a system of independent reporters, owing a duty of care to me, to report on the accuracy of information supplied to me, and on the adequacy of Railtrack's progress; and

    (c)  improvements in Railtrack's regulatory accounts and the ring-fencing of items not covered in charges.

  33.  I have published proposed modifications to Railtrack's network licence covering the second and third of these points. I will publish my proposed licence condition on the asset database shortly.

Accountability

  34.  Condition 7 of Railtrack's network licence, as amended in September 1997, requires Railtrack to maintain, renew and develop the network to meet the reasonable requirements of train operators and funders as to the capability and quality of the network, in a timely efficient and economic manner in accordance with best practice. Railtrack is required to do this to the greatest extent reasonably practicable, having regard to all relevant circumstances, including Railtrack's ability to finance its activities.

  35.  I consider this is a very strong obligation. The actions I took on performance targets and on West Coast Main Line route modernisation were carried out under Condition 7.

  36.  I also consider it is important to strengthen Railtrack's direct accountability to train operators through the access contracts under which operators use Railtrack's network. The Regulator has powers to issue model clauses for access agreements, and I am well into the process of issuing such standard clauses to clarify and strengthen Railtrack's accountability to train operators. This process has involved considerable discussion and consultation with train operators, funders and others. I believe it is very important to give train operators the means as well as the encouragement to use the powers in their access agreements to secure delivery of Railtrack's commitments.

  37.  The standard clauses for access contracts will provide for a clear and detailed specification of what Railtrack is required to deliver in terms of network capacity and capability. These specifications will be on an operator-by-operator basis and will be revised every year, so that both Railtrack and the train operator know what has to be done, by when, and what happens if something goes wrong. This is an improvement of the relationship between Railtrack and train operators and is much needed. The first generation of access contracts were seriously deficient in this (and other) respects.

  38.  In my view Railtrack has been rightly criticised for the way in which it deals with its dependent customers. These include train operators and funders, but also a wider group of stakeholders, such as rolling stock owners and manufacturers. I plan to propose a new licence condition requiring Railtrack to produce an effective code of practice governing its relationships with dependent train operators and funders. For the wider group of stakeholders, I believe that the actions I am proposing on the asset register, combined with customers having more effective contractual relationships with Railtrack, should create significant improvement, particularly for rolling stock acceptance.

  39.  In relation to rolling stock acceptance, the rules and the ways in which they have been applied in the past have attracted considerable criticism. Delays in the introduction of new rolling stock have been blamed on their complexity, difficulties in their interpretation and the ways in which they have been applied. There have also been severe criticisms of Railtrack's knowledge of the gauge of the railway, causing rolling stock manufacturers and other difficulties in relation to the design of new rolling stock. I am dealing with a complaint by two rolling stock manufacturers that in these respects Railtrack is in breach of its network licence. I expect to publish conclusions on that matter very shortly, and then to consult the industry on improvements to the system.

Incentives

  40.  In April 2000, as part of the periodic review I published my provisional conclusions on Railtrack's track access charges for the next price control period. The approach proposed included:

    (a)  ensuring that charges for additional services cover the cost of running those services;

    (b)  stronger and clearer incentives on Railtrack to improve performance across the range of its activities; and

    (c)  a volume incentive linking parts of Railtrack's income to growth in train miles on the network.

  41.  These proposals were designed better to align the incentives on Railtrack with the need to encourage the use and development of the network, and to improve services to passengers and freight customers. They would also reduce the cost of individual negotiation of charges. I am currently considering consultation responses to the provisional conclusions.

Transparency and stability

  42.  As noted above, a key challenge for Railtrack and the railway industry over the next few years is meeting the challenge of growth in rail traffic. If this investment is to be financed efficiently and delivered effectively there is a need for transparency and stability in the regulatory framework. I aim to provide that as part of the periodic review.

  43.  Thus I propose to set out clearly what will happen if, despite the new incentive structure, Railtrack fails, in a material way, to deliver on the expectations embodied in these changes. This could ultimately involve penalties and, where possible, I will set out the scale in advance. However, this will not always be possible and I have already published draft guidelines on the basis for establishing penalties which are sufficient to incentivise compliance without introducing unnecessary risks. One of the key requirements is for a common understanding of the allocation of risk at the outset (eg the way in which the RAB will be adjusted) so that investors can invest with confidence.

  44.  I consider that much more clarity is needed in the arrangements under which Railtrack invests in enhancing the network and how it can expect to be remunerated for that investment. I have already proposed some very significant steps on this as part of the periodic review and model clauses processes.

  45.  In addition, I have initiated a fundamental review of track access charges for freight services. Given the changes in the industry since privatisation and our improved understanding of Railtrack's costs, the review will be an important element in helping to encourage the future growth of rail freight.

  46.  I am reviewing the costs associated with the WCRM. On 20 June 2000 I published my views on the amounts which Railtrack will need for maintenance and renewal of the West Coast in the next control period. I will publish my conclusions on the costs of enhancements in July 2000.

  47.  I consider that the agenda set out above will create a much more robust framework for the regulation of Railtrack than has hitherto existed, and will address the points made by the Comptroller and Auditor General. The plans can be introduced under the existing legislative framework. However, although I began work on them as soon as I took office, several of the improvements which the NAO recommended cannot be implemented earlier than the effective date of the periodic review—1 April 2001. They will be implemented from that date. Others will be implemented before then, if possible.

  48.  In addition, under the Transport Bill currently before Parliament, further improvements to the framework are proposed:

    (a)  I am to have an explicit power to direct Railtrack to make improvements to the network and to amend access agreements to allow more extensive use of the network;

    (b)  Railtrack is effectively to have a right of appeal to the Competition Commission on matters of access charging. I believe this is important in creating consistency of treatment with other utilities, and in promoting transparency and stability; and

    (c)  existing constraints on my ability to deal in licences with matters covered by my jurisdiction concerning access are to be lifted.

  49.  I am also taking the steps necessary to secure controls on Railtrack's disposal of its assets (including land) if those assets are or can reasonably be expected to be needed for railway purposes in the future. Examples are land beside the railway which is needed for station car parks, enlarged stations, new sidings or passing loops, rail freight terminals the like. This will be by way of licence modification. I have gone out to consultation with a wide range of organisations—public and private—and have asked them to tell me about land in their areas which may be at risk.

THE ROLE OF THE STRATEGIC RAIL AUTHORITY

  50.  I welcome the proposal in the Transport Bill to create the Strategic Rail Authority to take over the functions of the Franchising Director and to provide strategic leadership to the industry.

  51.  My role and that of the SRA will be complementary. The SRA will be the key public sector funder of the railway, both in terms of paying subsidy for the operation of services, and in terms of financing investment. My role as independent regulator will be to ensure that the monopoly and dominant elements of the industry (including Railtrack) play their full part in improving the railway. The SRA's role is as a player; mine is as the referee.

  52.  The Transport Bill, if enacted, would change the framework under which I operate, and in particular would establish the SRA with a strategic role in relation to the funding of railway enhancement. It would also move certain consumer protection functions from my office to the SRA. This will simplify the existing overlapping responsibilities and is to be welcomed.

  53.  I consider that under this new framework it will be possible for the independent regulator and the SRA to work together constructively to generate improvement. In particular I believe that independent regulation remains necessary to secure private sector investment in the improvement of the railway because:

    (a)  it enables a balance to be achieved between responsiveness to events and stability in the overall framework which will be essential for the railway to progress. Too much responsiveness will make it difficult to finance investment; too much stability will lead to ossification; and

    (b)  it is a model widely understood by the capital markets from experience in other regulated industries.

  54.  I am already working closely with the SSRA. The Chairman of the SSRA and I both recognise the key need to ensure the network can accommodate growth. I welcome his proposals for longer-term franchises their holders will be in a better position to fund investment in the railway. Our offices are working closely together to facilitate this programme. My plans, set out above, to improve transparency and stability, entirely complement and will facilitate the franchise replacement programme.

  55.  Thus far the assumption has been that train operators and ultimately funders of the railway through access charges will pay for investment in the railway infrastructure, but financed and implemented by Railtrack. Given the scale of the investment programme that may be necessary to accommodate growth in usage, it has been suggested that Railtrack may not be able to finance or deliver the entire enhancement which is required, and that the franchise replacement programme will require changes in the assumptions about Railtrack's role.

  56.  I set out my provisional views on this point in the April 2000 periodic review document. The safety of those using or working on the railway must be a fundamental consideration, and I consider that both the integrity of the timetabling and day-to-day operation of the network must be retained. Provided these requirements can be met, I consider it possible for bodies other than Railtrack to take on the financing of or delivery of enhancements. Such an approach is likely to overcome any constraints on Railtrack's ability to do by itself what is needed; but it is also likely to put pressure on Railtrack to deliver more efficiently, more competitively and more effectively. This approach is more likely to be suitable for new connections, new or significantly upgraded lines or stations than for the existing network, but it is for the proponents to demonstrate the benefits.

June 2000


 
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