Select Committee on Transport, Local Government and the Regions Minutes of Evidence

Examination of Witnesses (Questions 60 - 79)



  60. So it would not be appropriate for someone to use that report to say, "This shows PPP will give value for money over 30 years in real life"? I am not trying to denigrate the report.
  (Mr Blaiklock) I reserve judgment on this in that sense. One has to perhaps go back to the Terms of Reference which Ernst & Young were asked to work under in the first place. From their report, the actual technique which is being used, the mathematical technique for evaluating bids, is well understood, and in that sense, fine. But there are, as their report says, a number of subjective areas which I have a stronger view about as to whether they should or should not be included, and what weight you should give to them than perhaps Ernst & Young have reflected.

  61. So, in a sense, you are saying the report was not asked to deal with the question of, "Is this value for money over 30 years in real life?" They were asked to do something else, which they have done, a different question?
  (Mr Blaiklock) Yes, I think that is probably true.

Chris Grayling

  62. Can I just ask: we have seen since the announcement by the Secretary of State a couple of weeks ago that the Government is offering guarantees through London Underground to the banks of the finance that is being raised for the project. When you carried out your assessment of the financial details provided to you by London Underground, did you make any assumptions about the rate of return that would be required; about the necessity of providing guarantees in order to deliver a certain level of interest rate to the banks that finance this?
  (Mr Middleton) When we finished our report, the negotiations between London Underground and the banks on this and on the PPP bidders was not completed. We understand now that the underpinned amount, as referred to in the contracts, has been agreed between London Underground, the banks, and the bidders. The key issue in value for money terms in considering this issue is to consider the likelihood that the guarantee will be called ie, what is the likelihood of one of the Infracos defaulting, and London Underground having to step in and provide, I think it is 95 per cent guarantee to the funding banks.

  63. Which has just happened with Railtrack.
  (Mr Middleton) What we did in our analysis on this point was look at, effectively, the risk transfer proposals, the ability of the Infracos to absorb the risk which was being transferred to them, and you will see in our report the levels of contingencies etc which are built into the Infraco bids. Based on that analysis, we asked London Underground to carry out sensitivities, and they provided us with the sensitivities that were completed on behalf of the funders by the Infracos. They showed that under most scenarios, apart from the most extreme banking based case sensitivities, that the Infracos financially were robust and could handle those downside scenarios.

  64. The reason I ask the question is given what has happened to Railtrack, and, therefore, the uncertainties that must exist around infrastructure projects, particularly where there is uncertainty about the condition of the assets, given that that has happened, had the Government not been willing to offer guarantees to London Underground, and, through them, to the Infracos and to the banks about those debts, would there have been a significant material change in the financial position of the project that would have changed the conclusions that you reached?
  (Mr Middleton) It is an interesting question, but, to a large extent, it is a hypothetical question.

  65. It is not hypothetical in the sense that had the Government only been able to manage to demonstrate that the PPP option is a better option than the public sector comparator by providing guarantees to the private sector to do it?
  (Mr Middleton) No, I think that particular point, again, is beyond our brief.

  66. It might be specifically beyond the brief of your report, but in the work that you have done, you have made assumptions about the rate of return that will be required by the banks in order to provide finance for this project, in order to come up with the overall costings of the project, or, at the very least, you have looked at the figures London Underground has provided to you and evaluated that in the context of the arithmetic of the project. Have you looked at all at the sensitivities of that rate of return, and if the guarantees were not there, would that have materially affected the sums that you were doing?
  (Mr Middleton) This is a bit beyond our brief, but I will answer.


  67. We are not seeking to put you in a difficult position. Are you, in effect, saying, "We were not asked to do this, we did not make that evaluation because it was not part of our Terms of Reference"?
  (Mr Middleton) The assumption and the value for money analysis is that the project would be funded at the rates which were implicit within the PPP bids. It is not part of a normal value for money assessment to delve down into any individual component which makes up the overall price, because you could check any one of thousands of input figures and argue that a different result would be fair. We were not privy to the negotiations and discussions with the banks, so the importance of this guarantee and the level of this guarantee is very, very difficult for us to comment on.

Chris Grayling

  68. What would your view be, Mr Blaiklock?
  (Mr Blaiklock) Well, I think I, like you, have only read about this in the Financial Times, which perhaps reflects the rather secretive approach that has been made on a number of aspects of this PPP negotiation. I certainly have not seen the contracts, nor been really privy to the Terms and Conditions of the finance that has been proposed. On the other hand, it does reflect the fact that the Treasury are very much involved, and I share your frustration as a Committee that the Treasury have perhaps not been at some of the discussions you have had. However, this guarantee must have a cost to it, and to that extent, it should be included in the PPP value for money assessment. That is one of the costs which one could say have not been included. Not only that, but it must have an impact, I assume, on the PSBR, or possible impact, and that, in itself, has an impact on, "Is it state aid?", and then you move into territories like, "Will it have an impact on the European Union and Procurement rules?", et cetera, et cetera. It opens a Pandora's box, but unfortunately, at the moment, we cannot actually open the box to see what is inside it.

  69. Ernst & Young said in their report that any major enhancements to the network would give rise to the issue of the possibility of the Infracos taking advantage of what by then would be a monopoly position. Do you feel that that would have implications for the long term value for money of the project, and particularly, if it transpires that there are hidden costs in this, that, for example, the knowledge of the assets does not prove to be as great as it was otherwise, but nonetheless the Infracos are there and in position, and the only people that can really carry out additional work? Does all that have an implication of value for money?
  (Mr Middleton) Your question mirrors the question asked by your colleague in terms of the interim revue and relative negotiating positions. I think we have set out in our report that there is a logic, and there should be an expectation that the Infracos will have a reasonably strong position in negotiating these contracts, and that, not necessarily on the overall contracts, but in terms of the procurement of those individual pieces of work, then there is a probability that the value for money of those individual enhancements might be worse than if you were in a wholly open and competitive situation. But that is mitigated by the fact that there are rights to go out to open contract, and that there are a number of contractual protections built into the structure, so it is not an unfettered ability to do so.

  Chairman: I want to move on. Dr Pugh.

Dr Pugh

  70. Can I take you on to using different discount rates. Your analysis shows no difference in outcome, depending upon whether you use a discount rate of 3.5 or 6 per cent. The reason appears to be that you are taking something into account that is referred to in London Underground's final assessment as "The social opportunity cost of Exchequer funding". What exactly is that, and why is it fixed at 30 per cent?
  (Mr Middleton) This is a question which you really have to address to the Treasury. What London Underground did in their value for money assessment, they used the discount rates which are set out in the current and published Green Book on Project Appraisal, and also the 3.5 discount rate with the 30 per cent social opportunity cost adjustment, which is set out in the draft Green Book, which is not fully established as Government guidance. The technical details which sit behind that are extremely complex and really are one for the Treasury.

  71. Without accountants, do you think the figure of 30 per cent is at all realistic, when the Government can borrow 3.5?
  (Mr Middleton) We have no view on that.

  72. Do you recognise it puts a significant disadvantage on any public project because the money can always be spent elsewhere for any public project?
  (Mr Middleton) I think the key thing about the discount rate which is used in comparing either projects within the public sector or comparing the public sector against the private sector alternative is that the discount rate which is used is the same for the various options which you have before you, and is used in a consistent manner. The reason that we ran the 3.5 per cent discount rate as part of our report was to show that actually, in this case, the project was not that sensitive to varying discount rates. Depending on the shape of the cashflows you are dealing with, discounting can create different results, using different interest rates. All we sought to do in our report was demonstrate that in this case, the use of different discount rates, that the project was not that sensitive to it.

  73. Mr Blaiklock, it appears to me that it tilts against the PPP, essentially because you are taking into account the fact that the Government can spend the money somewhere else, and they always can, private money can go somewhere else. Can I ask you to comment on this? Is it a kind of fiddle, or is it a recognisable, decent accountany practice.
  (Mr Blaiklock) A fiddle is your word, but I have not seen it before, and I did not understand it either. It did seem to be an unfair imposition against the PSC (Public Sector Comparator) alternative, because if you use a lower discount rate, which actually more closely reflects the actual cost of capital, then the public sector comparator alternative does come out better than the PPP one on the basis of the data that I managed to glean from the report.

  74. So it has a decisively different result?
  (Mr Blaiklock) It improves the position. I think there is some argument as to whether one actually should be using 6 per cent on every occasion. HM Treasury has used 6 per cent for years and the world outside has changed. Another issue which I would raise is that by using real, as opposed to actual, figures, and including in your assumptions financial issues which they have, then you are starting to mix apples and oranges, and you have to be very careful. In a period of low inflation, the differences are not that great, but over 30 years, and if you look back over the last 30 years, and use this as the basis, or going forward 30 years, we are going to have higher inflation. When you start to do this kind of analysis in periods of higher inflation, you get some significant differences. I think one has to be quite careful about this issue, and I would always recommend that one does sensitivity analyses using different rates of discount in your evaluation and see whether that changes your priorities as to whom you award a contract, between A and B, by changing the discount rate. I think on this occasion it actually favours the public one.

Andrew Bennett

  75. You also said that the opportunity costs should come down, given the guarantees that the Government is actually giving; is that right?
  (Mr Blaiklock) Sorry, this is not a comment I made, I think.

  76. Do you feel, then, that the opportunity costs should be varied to take into account the greater commitment in view of, I think you used the words, "the possibility of State aid"? If that is being put forward, then the Government is actually committing some money to it, is it not?
  (Mr Blaiklock) If it is providing guarantees, yes it is.

  77. Yes, and therefore the opportunity costs change, do they not?
  (Mr Blaiklock) They would do, yes, but I am not an economist and I could not answer much more than that.

  78. Do you think that anybody could come up with an analysis like this and say, "No, it was not on"?
  (Mr Blaiklock) What is not on?

  79. That the Public Private Partnership was not on?
  (Mr Blaiklock) If you did this kind of analysis and you took everything into account, I know what kind of conclusion I would come up with.

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