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INFORMED SOURCES October 2003

Interim Review highlights renewals cost explosion

Rail Regulator Tom Winsor 's Interim Review makes uncomfortable reading for the industry andGovernment

Before we start navigating our long and tortuous way through the detail in the third set of consultation documents issued by Rail Regulator Tom Winsor under his current Interim Review of Network Rail's track access charges, we ought to have a gross error check to make sure we are heading in the right direction. So here is the newly sexed-up chart of historic infrastructure maintenance and renewals spend under British Rail and Railtrack which first appeared in the August column.

If you can take your eyes off the WCD at the right, you will see that the dramatic dip in maintenance spend in BR's last two years has softened. Several readers pointed out that BR changed its accounting practices in 1992/93 when routine infrastructure renewals were no longer charged to revenue as part of maintenance. When the 1991/92 figures were restated on this basis track and signalling expenditure fell from £773.4 million to £568.5 million or roughly 25%.

So apologies to John Welsby for suggesting that he slashed maintenance and to engineering chums for implying that they would have let him. I have been able to restate 1992/93 on the previous basis but if any demon accountant in the readership needing some light relief would like to try and reconstruct BR's final year to maintain the series on a like for like basis it would be appreciated.

Anyway, back to the gross error check. What I have done is extend the chart to include maintenance and renewal expenditure between now and 2011/12 as described in Network Rail's Business Plan.

Maintenance expenditure is broadly in line with historical levels back to 1975. But renewals? Well, the figures are simply bonkers and the fact that Network Rail management can put them forward with a straight face is deeply worrying. Of course, you could argue, that it represents a bow wave of renewals created by decades of under-investment, but even Richard Bowker now agrees that BR handed over the infrastructure in decent condition.

Tsunami

But this is not a bow wave, it is veritable tsunami which threatens to sweep the railway away. My simplistic reaction when this chart appeared on my screen for the first time was that it does not allow for the Ford Factor for project cost inflation.

And if you divide these projected annual renewal expenditures by pi you get down to figures that are recognisable. And what the interim review is largely about is identifying the reasons behind this renewals cost explosion and making Network Rail do something about it. Tough on costs, tough on the causes of costs, to coin a soundbite.

Chart 2 illustrates why the Interim Review is necessary. As you can see, the last Periodic Review assumed that Operations Maintenance and Renewal (OMR) expenditure would fall by 20% over the five years of Control Period 2 (CP2), but Network Rail expects it to grow year on year, ending up at more than double the sum allowed. Table 1 breaks down this Chart in detail.

Chart 2 (off ORR web site)

Table 1: Network Rail's forecasts of increases in OM&R expenditure by type over the period 2001/02 - 2005/06 (£ million)

Source : Network Rail's March 2003 business plan.

Following publication of the Business Plan, further work by Network Rail resulted in an update published on June 30 in which the Company said that it was reducing its forecast expenditure by 3% in 2004/05 and 2005/06. Network Rail also reported that it was making progress towards identifying efficiency savings of 20% in the 2006/07 budget. But don't hold your breath because the company also warned that renewals might need to increase after 2006/07.

Chart 3 adds operational expenditure to the tsunami produce a total expenditure profile.

Chart 3

Unrealistic

It is obvious that either these figures are madness on wheels or the railway is unaffordable and gets closed down by the Treasury. The Rail Regulator's current Interim Review has to prove the former is true. Which is the job of his in-house Boiling Frogs Task Force and their team of consultants - LEK Consulting, Halcrow Group and Transport Technoliogy Centre Inc – henceforth LEK/Halcrow/TTCI

These consultants have now analysed the activities and units cost needed to deliver the original CP2 outputs at minimum whole life cost. And since this is mission-critical stuff, they decided to have three different approaches to the same answer

•  A bottom-up engineering appraisal of the scope for identifiable cost savings

•  Internal and external benchmarking

•  Top down analysis comparing Network Rail's forecast cost reductions with those achieved in other utilities.

As Tom Winsor explains, while none of the techniques gives a ‘perfect' answer in its own right, by assessing efficiency in a number of diverse ways he has got an ‘overall picture' of the situation. And, mirabile dictu, apart from international benchmarking, there is a strong correlation between the savings identified by the three approaches.

While this is an Interim Review, the Regulator intends his decision on TAC to apply to a new five year Control Period staring in April 2004. CP2 is dead, long live CP3, due to start in April 2004.

And based on the work to date, Mr Winsor believes that efficiency savings of 30% can be achieved by the end of CP3 . Experience from other regulated industries also suggests that substantial savings can be achieved quickly. So when the provisional conclusions are published in October we could see could see efficiency savings of 6-10% a year required in 2004/05 and 2005/06.

Bottom up

Within the consultants' triplicated analysis, the engine room is the bottom-up analysis of maintenance and renewal activity. Detailed analysis was possible only up to April 2006 and in many asset categories it was not possible to break down the proposed increases in expenditure. However, what ORR can do is compare Network Rail's projected track renewals with those assumed by Railtrack in the last Periodic Review (Table 2)

Table 2 Track renewal volumes for CP2 (2001/2006): comparison of actual volumes achieved to date with the periodic review figures and Network Rail's projected activity levels in the 2003 business plan

Note : All figures include West Coast route upgrade renewals.

Enter boiling frogs croaking. Received wisdom has been that the surge in renewals was a one-off function of the post-Hatfield panic, aimed at eliminating the ‘backlog' of work. Not so. As Table 3 shows Network Rail is planning to step up renewals to roughly double Railtrack's predictions for 206/7-2010/11.

Table 3: Comparison of Network Rail's business plan projections of track renewals activities in CP2 (2001 / 02 - 2005 / 06) with CP3 (2006 / 07 - 2010 / 11); and Network Rail's CP3 figures with Railtrack's figures from the periodic review

Note: West Coast route upgrade renewals are included in CP2 and CP3 figures.

Of course, it's not as simple as that. The forecast rising expenditure is a function of increasing volume at increasing unit costs. In other words, twice the work at twice the unit cost quadruples the bill.

Regulators also have long memories. Only three years ago Railtrack was forecasting that volumes of work would decrease over time. So Mr Winsor has ‘insisted' that Network Rail provides ‘detailed robust and compelling evidence' that the proposed increases in the amount of maintenance and renewal activity is justified.

He does not dismiss concerns about the age of key assets and their condition. But this ‘in itself', would not justify all the increased activity in the March 2003 business plan.

Detailed

LEK/Halcrow/TTCI examined the documentation for 789 track renewal jobs – 413 plain line plus 385 switch & crossings – across all seven Network Rail Regions. They inspected 372 sites.

This represented only 12% of the total number of jobs in the ‘work bank' over the three years 2003/04-2005/06, but equated to 22% of planned volumes and 34% of total cost. Similar examinations of Switch & Crossing renewals covered 32% of jobs, 35% by volume and 48% by cost respectively.

According to Tom Winsor , this degree of detailed examination is unprecedented in any regulatory review and he places ‘great weight' on the work.

Each job analysed by the consultants was categorised as either:

1) fully justified

2)Partially justified - but some reduction on the planned extent appears to be possible

3)Partially justified - but scope is not optimal

4) Not justified.

Table 4 shows the breakdown for plain track and Switch and crossing work.

Table 4 : Conclusion on overall justification for track renewals proposals

Source: L.E.K./Halcrow/TTCI

As an example questionable extent, ORR's consultants instance the inclusion of track between two fully justifiable lengths in renewals schemes. Similarly they note a requirement to renew S&C units with the new RT60 design. In one case this meant that the renewal of seven S&C units was extended to cover 22 units.

Examples of questionable scope include justifiable rail replacement being combined with the renewal of sleepers with life remaining. Similarly, where S&C renewal is driven by ballast or formation problems the entire layout may be renewed even if the rail and bearers are in good condition.

Continues.........

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