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

Supplementary note from the Secretary of State for Transport, Local Government and the Regions


  At my appearance before the Transport Select Committee on Wednesday, 10 April, I agreed to provide the Committee with a written note setting out the reasons behind the offer of a grant to Network Rail to secure the benefits of an earlier exit of Railtrack Plc from administration than would otherwise be the case.

  I shall write in due course on the other Railway related matters promised during my evidence.

The grant offer

  The Department informed Network Rail, during the week before Network Rail made its bid to Railtrack Group Plc on 24 March, that it was potentially willing to offer a £300 million grant on the basis of Network Rail's proposal.

  The grant offer is conditional upon Network Rail securing an earlier exit from administration than would otherwise have been the case and reflects the benefits available from this earlier exit. The payment would not be available if Network Rail was unable to deliver an early exit.

  Financial support of a type similar to that negotiated by Network Rail could be available to other bidders. The Government and the SRA are willing to discuss proposals advanced by any serious bidder for Railtrack plc. The guidelines issued by myself on 31 October 2001 (Official Report, cols 669-671W) make clear that any proposal should address the basis, extent and nature of support that will be required from Government. Any support would be subject to negotiation and agreement. Contrary to the assertions made by the Shadow Secretary of State for Transport (Official Report, 25 March col 583), no other detailed proposals have been received.

The £300 million grant

  The grant payment reflects the available benefits from an earlier exit from administration than would otherwise be the case. The time difference is based on a comparison between the administrator's process for removing Railtrack from administration (the Schedule 7 transfer) and the process for the Network Rail bid (a share purchase) rather than on specific dates.

  A share purchase is expected to lead to an earlier exit from administration than would be possible under a schedule 7 process of at least six to nine months.

  The premium the Government is prepared to pay is not compensation to Railtrack shareholders. It reflects an assessment of the value to the Government, the taxpayer and rail users in terms of the benefits and savings that would result from an earlier exit from administration.

  Consequently, the grant payment to secure an earlier exit from administration can help to deliver offsetting savings in Government support requirements to Railtrack's successor over the medium and longer term compared to what would otherwise be the case.

  The £300 million amount represents a reasonable sum based upon a range of possible scenarios. It has been tested and agreed within Government and is consistent with advice on potential benefits provided by external advisers.

The benefits of an earlier exit

  The value of the payment reflects an estimate of the wider benefits to passengers and the general public based upon an earlier exit from administration. These economic benefits are obtained through:

    —  An earlier realisation of efficiency savings.

  Railtrack has made welcome progress during Administration under the guidance of John Armitt though, as to be expected, focus has been upon addressing immediate concerns. An early exit from Administration will help to focus the new management upon the challenging tasks ahead and to identify and implement efficiency improvements. Specifically, it allows an earlier introduction of a new improved incentive framework for management, where performance is aligned with key public interests such as track availability, punctuality and safety rather than profits. These incentives will draw out improved efficiency as the successor delivers better engineering performance.

  By way of illustration of the potential benefits, the Regulator had set Railtrack a profile of efficiency improvements in Control Period 2, beginning with net efficiency targets of 2 per cent in 2001-02 and 3 per cent in 2002-03. No progress towards these targets had been made by Railtrack, and the situation had probably worsened though appears to have stabilised during administration. If an earlier exit from administration could secure an earlier delivery of these first two targets alone it would save around £50 million for every £1 billion of expenditure than would otherwise be the case.

    —  Reduced performance penalties.

  Earlier improvements in the punctuality and reliability of services not only provide upfront benefits for rail users but would also be reflected in lower penalty payments. The current penalty payments reflect the societal costs of rail delays, costs which would be greatly reduced through improvements in network performance. Performance penalty payments are currently running at about £370 million per annum.

    —  Projects and schemes in the 10 Year Plan proceeding more quickly than may otherwise have been the case.

  Several investment schemes have continued to be developed while Railtrack plc is in Administration. However, it is clear that an early transfer to a successor that would improve its knowledge and management of its assets helps to provide greater certainty and confidence for taking forward further investment in SRA Strategic Plan projects than would otherwise be the case.

  In addition to the benefits mentioned above, additional benefits arise from the Network Rail bid through the earlier implementation of a Company Limited by Guarantee structure. Such a structure offers the following benefits in comparision to the Railtrack equity model:

    —  A greater alignment of the operations of the infrastructure manager with the wider public interest ie, no more "profit before safety".

    —  Decision making based on long-term analysis of whole-life asset costs not deferring much needed investment expenditure for short-term economic gain.

    —  A re-investment of surpluses earned on operations back into rail industry rather than shareholder dividends. Railtrack Group Plc paid £709 million in cash, or equivalent, dividends to its shareholders between May 1996 and October 2001.

    —  More efficient financing through a strong capital structure, offering a potentially lower cost of capital through a debt-financed company, rather than one having to pay higher returns to equity.

  By way of illustration of this last point, we can refer to the Rail Regulator's October 2000 Periodic Review. In determining the 8 per cent real cost of capital return for Control Period 2, the Regulator estimated that the real cost of debt for Railtrack Plc was of the range 4.5-4.75 per cent while the real cost of its equity was of the range 9.3-11.7 per cent. On this comparison, using the midpoint of both ranges, each £1 billion of finance raised though debt would be around £58 million cheaper in real cost of capital annual repayment terms than raising an equivalent £1 billion through equity.

Funding of the £300 million

  As I said in my evidence, the £300 million payment will not be a cost to the overall 10 Year Plan for Transport. The benefits from an earlier exit outlined above will deliver greater savings in future Government support levels than would otherwise be the case over the 10 Year Plan period.

Stephen Byers

30 April 2002

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