Examination of Witnesses (Questions 160
WEDNESDAY 21 NOVEMBER 2001
160. Would you answer Mr Grayling's first question
then; is it true that the Treasury came back, having seen the
original assessments, and asked for a reassessment?
(Mr Smith) No, the Treasury did not come back and
ask for a reassessment; we have to make certain assumptions about
the fact as to how much of the public purse would stand the cost
of investment in the early years.
161. But you must, surely, have had some governmental
context for doing that; it is inconceivable that there was no
dialogue taking place through the DTLR into the Treasury, in some
shape or form?
(Mr Smith) We certainly have regular contact with
the DTLR, and we have discussions with them.
162. So was there nothing to suggest that the
Treasury wanted you to push the expensive stuff into the later
years of the arrangements?
(Mr Smith) We have discussions with officials about
what we can and cannot do around this, and we have to draw conclusions,
in the end, about what the public purse will or will not do. It
would be very nice, from our point of view, to be able to spend
billions of pounds in the first five or six years of the PPP,
as long as we could also operate the railway at the same time.
Realistically, though, there has to be an amount that we judge
can go into investment in the underground network.
163. Let me ask you the question in a different
way then. If you take the total amount that is being spent on
a PPP exercise, and if it was entirely within London Underground's
discretion as to when that money was spent, would it be possible,
whilst operating the current network, for you to speed up the
(Mr Smith) To an extent, yes. The trail-off would
be, and you have raised the point yourself, just how much of the
network could reasonably be worked upon and closed down while
still not impairing the service too much.
164. But if you are saying the answer is to,
a certain extent, yes, by definition, therefore, some of the expenditure
must be being pushed to a later date than would otherwise be necessary?
(Mr Smith) Than would otherwise be ideal, certainly.
165. So the answer, in the first place, was,
yes, Mr Grayling was right.
(Mr Smith) Not exactly.
166. Given the process you have gone through
to reach the point you are at now, a number of statements have
been made by Government over the years as to when we can expect
improvements to take place; most recently, there was a long list
of examples of when new trains would be in place, when modernisation
would be in place. Is that timetable still good, or has it slipped?
(Mr Smith) That is the timetable to which we are working.
167. Is there any reason to believe that timetable
is under threat?
(Mr Smith) It will depend very much upon the bids
as they come in. If there are bids that would suggest that the
private sector want to front-load, to a degree which is intolerable,
the improvement in investment in the underground, then we would
have to look at that; so that would be considered as part of the
assessment of the value of the bids and whether they are going
to give us what we want.
168. Lastly, can I ask you, what has happened
with Railtrack clearly has a knock-on effect in terms of perceptions
of financing of private sector projects. Based on what you know
so far, is there any reason to believe that the returns that will
be demanded for financing for the bidding companies, and given
the fact that the bidding companies are clearly not raising the
money off their balance sheet, they are raising it through debt
finance, is there any reason to believe that the rates of return
that they will have to offer to the providers of that debt have
(Mr Smith) If I may, I will ask Mr Poulter to answer
that question, as he has been engaging with our bankers.
(Mr Poulter) I do not think there is any reason to
think that. Most of the money, as you say, will be provided in
the debt markets, and I see no sign that for well-structured Public
Private Partnerships or PFIs there will be an increase in the
cost of finance.
169. Is there a gap between, and I appreciate
this is commercially sensitive, in terms of actual figures, but
is there any gap, that you are aware of, still, between the demands
on the table, the cash on the table, from the private sector,
as part of this process, and what the Treasury ultimately says
it is willing to finance?
(Mr Smith) We will only know that when we have the
170. If the Infracos operate in an efficient
and economic manner, what is the rate of return that they are
expecting over the contract period?
(Mr Callaghan) The answer is, the returns to the shareholders
are in the mid teens, about 17 per cent would be right, possibly.
171. It has been suggested, as you probably
know, a report in the press, the returns could be as high as 35
per cent; do you dismiss that?
(Mr Callaghan) I am aware that they are reported,
but that is not a correct figure, no.
172. Mid teens. Could I ask about the Deloitte
and Touche report, because the National Audit Office report was
referred to earlier, and I think you said, or Mr Poulter said,
"Ah, but that was last year;" of course, this report
was July this year. And although the report does say that perhaps
they needed more time, and so on, to go into it, it does raise
some very interesting issues. You talked about the prices for
the first seven and a half year period being, I think the word
you used, firm, and then we heard what you said about the subsequent
22½ years; but in the Deloitte and Touche report it says
that you, that is, London Underground, have chosen not to use
the first seven and a half year period for value for money comparison,
because of the difficulties of validly comparing the net present
value of the bids and the public sector comparator at this point.
It goes on to say that, in their opinion, the draft public sector
comparator, which has been provided for the seven and a half year
period, shows the bids to be more expensive than the public sector
comparator, with the exception of one bid. What is your response
to that finding?
(Mr Poulter) Those comments are wrong. We have made
available, and it is published, a commentary on that report, which,
if the Committee has not seen, I would be happy to send to you.
173. So they are just plain wrong; you dismiss
(Mr Poulter) I do not dismiss them; we considered
them. I am just indicating to youthey are wrong.
174. They are just plain wrong. Well, if they
are wrong, what do you consider to be right, in this context,
in the context of this issue?
(Mr Poulter) The value for money comparison is made
over seven and a half years and over 30 years, and the conclusion
that London Underground reached on assessing the bids was that
there were enough good bids to proceed with on those bases.
175. Could I turn to another issue, from the
Deloitte and Touche report, which I thought was very interesting,
the suggestion in the report that there has been highly material
adjustments to the public sector comparator that are judgmental,
volatile or statistically simplistic. It gives a couple of examples,
that adjustments have been made to the base costs, and these adjustments
amount, in aggregate, to some £2.5 billion. Is that figure
(Mr Poulter) I cannot answer whether that figure is
correct. I will happily come back to you on it.
176. Perhaps I can go on to my next question,
you may have to get back to us then. It goes on to say, one of
the largest adjustments, amounting to £1.17 billion, related
to performance, and this represents an expected failure of London
Underground Limited, under the public sector comparator assumptions,
to meet the performance requirements of the projects. On what
sort of basis has that assumption been made; it is actually saying
that, by definition, the private sector is going to be more efficient
than London Underground?
(Mr Poulter) The factor which you are referring to,
Mr Stevenson, is the assessment of the possibility, or probability,
of the public sector not meeting performance requirements.
177. Which is it, Mr Poulter, possibility or
(Mr Poulter) There is no answer to that question.
It is a probability for which the percentage is has to be assessed.
And, if I may, the report that I referred to, and if the Committee
has not seen it we will provide it this evening, refers to all
these issues, and I believe responds fully to the comments which
you are quoting from.
178. Yes, I am grateful for that. But I would
still like to press, if I might, and understand a little clearer,
if I might, just what is the basis for this assumption, this probable
or possible assumption, you are not sure which, that the private
sector will perform, to the tune of nearly £2 billion, better
than the public sector; on what basis is that assumption made?
(Mr Poulter) The assumption is what will happen in
the public sector; what will happen in the private sector is shown
by what they commit to in their bids.
179. So, I think I am beginning to understand,
built into this base cost and comparator is an assumption that
London Underground will perform, without any question, will perform,
up to £2 billion less than the private sector?
(Mr Poulter) The assumption, for which a range of
figures are considered in the comparator, is that, as has been
shown on a large range of major projects, they will not always
be delivered fully and to time, and that that will affect performance.
1 Note by witness: I think Mr Stevenson was
referring to the figure of £2,519 million referred to in
paragraph 3.3.3 of the Deloitte & Touche report. This refers
correctly to an increase in the net present value of the PSC.
We commented on it in paragraph 15 of our report, Commentary
on Deloitte & Touche Report-A paper by PricewaterhouseCoopers
(Redacted version) 24 August 2001, and related points are
made in the paragraphs which follow. Back