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Another new way to rebuild our railway

The Strategic Rail Authority has come up with a new way to help Railtrack finance its £26bn capital investment programme. But it could be at least two years until new projects get under way reports Andrew Bolton.

Earlier this month the Strategic Rail Authority (SRA) announced that it had come up with a new way of encouraging private investors to help Railtrack get its £26bn capital investment programme moving. The design, build, finance, transfer (DBFT) concept is a subtle but significant variation on design, build, finance, operate (DBFO) common to privately financed infrastructure projects.

Even before the Hatfield train crash last October, it was clear to the SRA that Railtrack would have problems meeting the spending targets imposed by its 10 year investment programme on its own. Now it seems that Railtrack will have its work cut out to finance even its ongoing commitment to operate, maintain and renew the national rail network.

Until Hatfield, the track operator, under then chief executive Gerald Corbett, was opposed to early SRA ideas to bring in privately financed consortia to design, build, finance and operate new infrastructure. But the disaster plunged Railtrack into a financial crisis.

Suddenly its core operation, maintenance and renewal (OMR) business was sucking money away from capital spending on new projects. Profits disappeared virtually overnight as the track operator ploughed hundreds of millions of pounds into replacing broken rails and compensating train operators whose trains were delayed as a result of emergency speed restrictions and track work.

As a result Railtrack, under new chief executive Steve Marshall, has been forced to accept that privately financed consortia must have a role in its capital programme.

'There is now a consensus that Railtrack - which must give priority to its core OMR business - does not have sufficient financial and management capability simultaneuosly to monopolise its second business (capital projects), ' says the SRA's Strategic Agenda, published earlier this month.

But the SRA has not had it all its own way. Over the last year or so, it realised that allowing other companies to operate sections of track would be impractical and that it would have to modify original proposals to introduce DBFO companies into the rail industry.

This was partly because of the increased risk of accidents resulting from a lack of communication between Railtrack and operators of individual sections of new track.

But other concerns had also surfaced. The SRA realised that it would be more expensive for private sector groups to carry maintenance risk on the individual sections of track. Railtrack is able to spread these same risks across the entire network. There were also problems of allowing different train operators access to routes which could be operated by several different organisations, including Railtrack.

These different factors led the SRA towards replacing the DBFO concept with a new and more appropriate DBFT.

The SRA has deliberately kept its options open over how the DBFT concept will be applied. In essence, it wants privately financed consortia to design, build and finance improvements to the network.

Who will own the new track after the construction work is finished is still open to question although it is clear that one way or another Railtrack will operate and maintain the whole network.

Opinion about how DBFT will work in practice varies among those most likely to get involved in financing new rail infrastructure. Some, like UBS Warburg head of transport Robert Jennings, believe that new Railtrack could buy new pieces of infrastructure as soon as they had gone through commissioning.

Jennings says that immediate transfer on completion would enable DBFT consortia to cash in their investments quickly, so they can recycle their money into new projects as the capital programme develops. 'The total investment is so huge that you won't want to tie up risk capital in the less risky activity of maintenance, ' he says.

He points out that rail projects will tie up an enormous amount of finance relative to other privately financed infrastructure.

'Rail is incredibly capital intensive, ' he says, pointing out that the Channel Tunnel Rail Link's costs run at up to £50M a kilometre. A kilometre of motorway is thought to cost around £3M to build.

Delaying spending on projects until after completion will also enable Railtrack to offload risks of cost and time overruns. This in turn will help it borrow money to pay for the new track at a lower rate of interest than if it had provided financing during the risky construction phase.

It is thought that this will enable Railtrack to save money even after paying off a DBFT consortium. With such a huge construction programme, even marginal differences in financing costs of individual projects soon add up.

David Metter, civil engineer and chief executive of infrastructure investment company Innisfree, sees the DBFT concept working differently. He says that a DBFT consortium could retain ownership of new infrastructure over a long term concession arrangement. It could then lease the track back to Railtrack over 20 to 30 years in return for a track access payment.

Under this arrangement the DBFT consortium could also pay Railtrack to operate and maintain new track but retain ownership, allowing it to repay finance raised over a longer period, at cheaper interest rates.

Metter also disputes the need to recycle investment cash, pointing out that there is no shortage of equity for well thought out, financially robust projects.

Precisely how the DBFT concept evolves will depend in part on the outcome of discussions under way between Railtrack, the SRA, the Rail Regulator and the Government over the track operator's precarious financial position. These discussions will determine Railtrack's own borrowing capabilities and should shed light on how much extra private finance will be needed to keep the 10 year investment programme on track.

But even when this has been resolved, more will have to be done before the first DBFT projects are let. Some infrastructure enhancement work is inextricably linked to the outcome of negotiations to renew the 18 train operating franchises. Who ends up with which franchise could determine what capital expenditure is needed. The SRA does not expect these negotiations to end until later this year at the earliest.

To add to the uncertainty the SRA is keeping its options open over how to use the £7bn Route Modernisation Fund created by the Government to pump prime rail improvement projects. 'The forms of support offered through the RMF will be tailored to the specific circumstances, ' says that SRA's Strategic Agenda.

The money could be allocated as grants or, more likely, as equity or loans.

At this stage it is unclear which projects will need RMF money and which can survive without it. The SRA says that 'the RMF will not compete with funds from the global capital markets'. Instead it is likely to be used to pump prime difficult to fund projects and help to lever in outside cash.

Even when these issues have been resolved, details of Railtrack's capital investment programme will still have to be worked out. With the exception of West Coast Main Line, Channel Tunnel Rail Link and Thameslink, Railtrack has few capital projects which are ready to go out to tender, even on a conventional procurement basis. As a result it is thought unlikely that the first DBFT projects will start before 2003.

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