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Private rail is back on the agenda

Privately financed rail infrastructure deals may be on the cards once again, as chancellor George Osborne seeks to reconcile budget cuts with a commitment to transport spending in next month’s Comprehensive Spending Review.

Efforts to get private finance into the rail infrastructure sector ran into the sand in the mid 2000s, but as Network Rail struggles to deliver its investment programme within budget, it looks as though the idea could resurface.

Network Rail’s problems were thrown into the spotlight in the summer when transport secretary Patrick McLoughlin ordered Network Rail to “pause” the Midland Mainline and Transpennine route electrification projects to allow it to focus on one, the electrification of the Great Western Line between London and Bristol.

Shenzhen metro

Shenzhen: Train and track operation is taking place under a PPP franchise

Last week, McLoughlin announced that the frozen projects could restart, following a review. Now there is a feeling that these will take increasingly scarce public funding away from other major projects, for example the Cambridge to Norwich section of the East-West Rail project which are in Network Rail’s spending programme. Perhaps these could qualify for private finance instead.

Attempts to harness private finance in rail foundered in the 2000s as Railtrack struggled to juggle its track operating function with ambitions to expand the rail network. High profile crashes at Hatfield and Potters Bar brought the company to its knees forcing it back into public ownership. This and financial difficulties with high-profile, high-capital cost, privately-financed rail projects like the Channel Tunnel Rail Link and the Channel Tunnel, soured investor appetite for such schemes.

Capital costs

High capital costs have been many a private rail project’s downfall, but more recently other countries, notably China and Australia, have been experimenting with a different type of public, private partnership – one that could perhaps be taken up by the UK’s Department for Transport. The difference with conventional private finance deals is that this time around, the construction element is removed from the private finance deal and paid for by the public sector client.

This significantly reduces the risk to investors, reducing the cost of finance, and leaving the private sector with the more manageable task of designing, manufacturing and installing signalling and operating systems and trains. It is then paid to keep track available and to keep trains running, and penalised if levels of service fall below agreed standards.

Beijing metro station

Beijing: PPP payments relate to standards of service

So what are the advantages of this new type of PPP deal? Hong Kong metro operaor MTR’s general manager, corporate finance and development Terry Wong has experience of working on the PPPs in Australia and China (see box). He explains that removing the civil engineering from the PPP deal takes a significant amount of risk out of the project. Removing construction from the PPP also brings down the financing cost. Wong says that contractors still tend to focus on the construction aspect of a project rather than taking a more holistic view of a project which also has to be operated and maintained while incorporating sophisticated signalling and telecoms systems. Keeping the construction work in the public sector also allows the transport authorities to exert more control over the project and ensure that future operation and maintenance requirements are accounted for during the construction phase.

Conversely, the private sector suppliers and operators like MTR have considerable expertise in the installation of signalling and telecoms systems and so are best able to carry the associated risks into a PPP concession.

Debt reduction

In Australia’s Sydney Metro North West example (see box), the removal of construction from the PPP deal has enabled the client, Transport New South Wales to reduce the amount of debt and associated financing costs. The concession length is also shorter as the finance can be paid off more quickly. A shorter concession also gives the public sector commissioning authority the flexibility to re-tender the infrastructure operating franchise sooner, keeping the pressure on the incumbent private sector consortium to maintain a high standard of performance. In the North West Rail Link example, the concession is only 15 years, instead of 25 to 30 years typical of many UK PPP deals.

In addition, Transport New South Wales has put its own project team, the contractor and the concession team in the same office, to ensure it can exert close control over those involved in all stages of the project from construction through to operation and maintenance.

 

MTR

Hong Kong metro operator MTR has developed experience of the new type of non-construction rail PPP deal over the last few years. In China it is part of joint ventures which hold PPP concessions for two metro lines in Beijing, one in Shenzhen and one in Hangzou.

These are major metro lines. One is Beijing metro line 4, which has been in operation since 2009, has 44 stations and carries an average of 1.18M passengers per week. In all it is responsible for operating 145km of track and 100 stations across the four franchises, handling passenger volumes averaging 2.28M per week.

Another is Beijing metro line 14, a £5bn project of which £1.6bn covers the concession for installing and operating trains and infrastructure. £500M of the concession finance is in the form of at-risk equity, put up by MTR and other concessionaire shareholders.

This year MTR was part of the consortium which signed a similar deal for the Sydney Metro North West in Australia. The deal again excludes the extensive civil engineering aspect of the project, one third of which is in tunnel with the rest on a viaduct.

MTR can be expected to keep a close eye on the UK’s attitude to privately financed rail work, as it sees opportunities on High Speed 2 (HS2), where the Chinese and Australian models could be applied to operations, signalling and telecoms. There is also a feeling that, as HS2 is such a large project, discrete elements like signalling or electrification could be split into individual PPP deals. If things move ahead, it is well placed to bid. Aside from its experience in China and Australia, it has successfully established itself in the UK as a train operator, holding the train operating franchises for London Overground and Crossrail.

China: Metro projects

To outsiders it may seem unusual that the all powerful Chinese public sector is seeking private finance and expertise for metro projects. Although some of the bank loans are coming from state owned Chinese banks, significantly privately owned, or stock market listed companies like MTR and private sector banks are also involved. They stand to lose their investments if costs overrun, if performance dips below agreed standards, penalties kick in as a result and the profitability of the concession suffers. And it seems that the Chinese authorities appreciate that the private sector has something to offer in terms of a strong service ethic.

“The Chinese government is looking for more expertise from private companies in terms of operational excellence and customer service excellence,” says MTR general manager, corporate finance and development Terry Wong.

Typically the PPP element of a project accounts for between 30% and 40% of the total cost, although the extent of the deal can vary. For example on the Shenzhen Line 1 project, the Chinese public sector financed construction of the 20.5km first phase of the project and then invited the private sector to build the 10km second phase and take over the operation of the whole line after phase two had been completed.

Australia: Sydney Metro North West

North West Rail Link

North West Rail Link: Construction precedes the start of the PPP operating concession

Australia’s A$8.3bn (£3.8bn) Sydney Metro North West project is a new 23km metro line between the suburbs of Cudgegong and Chatswood. When complete in 2019 it will run in a 15km twin bore tunnel and on a mixture of viaduct and embankment and through cuttings. The project has been split into three main packages. Two of them, the tunnels and viaducts, will be publicly funded and the third, the provision, installation and operation of electrical and mechanical equipment plus the delivery and operation of the rolling stock, will be done under a £1.4bn PPP concession. Payments will be made to the operator based on the availability of track and trains and other performance measures over 15 years. After that time the PPP will be rebid, giving Transport New South Wales the option to put the franchise out to further competition, further incentivising the concession company to maximise efficiency and service quality.

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