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An ORCATS raid by Grand Central is only one of GNER’s problems
When, on 23 March, the Office of Rail Regulation confirmed its provisional decision to award track access rights for three services each way a day between Sunderland and London to Grand Central Railway (GCR), there was much wailing and gnashing of teeth, not to mention the odd bit of misinformation and gratuitous retribution. That the continuation of Hull Trains’ existing temporary access right for a sixth daily service was also confirmed got lost in the sturm and drang.
At the same time, ORR asked Network Rail to determine ‘urgently’ whether there is additional capacity available between Peterborough and Doncaster to accommodate the six London-Leeds off-peak services proposed in the GNER franchise agreement, in addition to the newly approved open access paths. Another point of detail is that GNER already has one conditional path.
ORR said that if Network Rail can find more paths, without affecting other passenger and freight operators or overall performance, it would be minded to approve ‘some or all’ of the rights sought by GNER. The universal opinion among Informed Sources is that a competent timetabler unfettered by post-privatisation timidity and contractual correctness could do it tomorrow.
Naturally, GNER exploded. As you might expect, a train operator created by one of the swash buckling entrepreneurs beloved of Margaret Thatcher is all for competition, except where someone else is the predator.
GNER claimed that ORR's own study concluded that its six off-peak Leeds services had the best economic case of the three applications. Licking the hand that feeds it, the company added that ORR ‘has undermined the Government's franchising policy and has pre-judged the review of all services on the East Coast Main Line by Network Rail’.
Chief Executive Christopher Garnett was ‘at a loss to understand the basis on which this incredible decision has been made’ and believes that the ORR ‘has made a grave error of judgment’. In which case the proof of the outrage will be in the Judicial Review.
Christopher also claimed that ORR had moved the goalposts on ECML capacity problems. In the provisional decision ORR’s show stopper was capacity between Leeds and Doncaster; in its final decision capacity between Peterborough and Doncaster became an issue too. GNER claims that the original concerns, which were ‘based on an incomplete and out-of-date report’, could be solved with very minor changes to the timetable.
There was also a reprise of the issue discussed in last month’s column – the iniquity of open access operators paying only variable track access charges. Or as Christopher put it, the ORR decision has created ‘a recipe for chaos’, with franchise contracts, ‘devalued and undermined by predatory operators who do not have to pay either fixed charges for the privilege of accessing the railway or any premium to Government’.
‘The only way Grand Central can make money is by stopping at intermediate stations and taking revenue from franchised operators under an industry revenue allocation system, regardless of the quality of service they offer or how many passengers they attract’.
Christopher Garnett sees the bulk of GCR’s revenue coming through the ORCATS revenue allocation system courtesy the company’s stops at York. Informed Sources support this concern.
Historic experience shows that even a single train can generate significant ORCATS revenue. For example, when Anglia added an extra London-Norwich service in BR days it knocked around £750,000 of Great Eastern revenue.
But, and it is a big ‘but’, an ORCATS raid by GCR was a known risk in bidding for the InterCity East Coast (ICEC) franchise. According to Informed Sources the Strategic Rail Authority warned bidders that Hull Trains was seeking further rights on the ECML, boosted by 125mile/h running, and that GCR was also seeking paths. And when asked ‘what do we do about it?’ SRA wrote to all four bidders saying , ‘open access operators remain an industry risk allocated to franchisees’.
Complicating the issue is Christopher’s statement that SRA told Sea Containers to ‘Ignore any extra paths for open access operators’. This, I think, referred not to the ORCATS risk but to the availability of the off-peak Leeds paths.
Given the SRA letter, would-be franchisees had to take a punt on whether Hull Trains and GCR would get their paths. Two (unsuccessful) bids are reported to have included the caveat that premium profiles were conditional on the absence of further open access operators on the route. GNER and the fourth bidder accepted the risk.
Was that wise? With ORR already having granted Hull Trains an open access license for five paths, plus a conditional sixth path, precedent might have suggested that Grand Central’s application would be granted too, at least in part.
Clearly the likely profit from the ICEC franchise had to be balanced against the open access risk. And it was a risk outwith the control of either the SRA or the Department for Transport. The Office of Rail Regulation really is independent and if you don’t like a decision you go for judicial review.
How big was the risk? To produce a winning subsidy/premium profile bidders are, typically, assuming a return of 4% on sales and revenue growth around 8% - 8.7% in the case of GNER.
With such tight margins, loss of revenue due to external factors becomes more critical. Worse, franchise agreements bring in force majeure only after a loss of 2% of revenue, similarly with the cap and collar risk and reward sharing provision.
Like the other TOCs serving London, GNER saw revenue fall after the July 2005 bombings. In general, the traffic was back by the end of the year, but income does not recover to where it would have been without the interruption.
In other words, in addition to the direct losses in 2005, revenue growth from now on is now running late, having restarted from ridership figures and fares income as they stood before 7/7.
Assuming that GNER lost £10 million as a result of the bombing, I calculate that even before GCR starts taking its share of revenue under ORCATS, the GNER revenue line will be 2% lower than the franchise bid assumed. Cap and collar applies from year five of the franchise but even then the shortfall is shared 50/50 down to 94% below budget.
And that’s not all. ICEC bidders also had to forecast how the cost of Electric Current for Traction (EC4T) would change over the life of the franchise.
And they also had to take into account Network Rail’s ability to improve its performance on the ECML and how fast this would be achieved. Under Schedule 8 of track access agreements TOCs are compensated for poor performance, but, equally, the cash flows the other way if Network Rail gets its act together.
With the wires coming down regularly and temporary speed restrictions galore, Schedule 8 payments made a useful contribution to GNER revenue in the original franchise. Now GNER is making Schedule 8 payments – another drain on revenue.
Clearly, there is more to GNER’s reaction to the ORR decision than the GCR threat. The day after the ORR decision, GNER’s parent company Sea Containers announced that it was withdrawing from the ferry business at a cost of $415 million. A further charge of $85 million has been incurred by the company’s container operation.
On this news, the Sea Containers’ share price fell from $12 to close at $7.45, and was bumping along around $7 as this column went to press.
In these modern times I was able to listen to the Sea Containers’ press conference through a webcast. This included an assessment of the current state of the company and its businesses from Robert MacKenzie who took over as President and Chief Executive in January.
On GNER, Mr MacKenzie confirmed that the business had been adversely affected by the July 2005 London bombings. He also admitted that ‘some of the sales growth assumptions made at the time of the franchise bid now appear to be challenging to achieve’.
As for the ORR decision, this ‘could pose a significant threat to GNER’. Mackenzie promised that ‘GNER will vigorously pursue its legal options’ following publication of ORR’s formal decision on April 6.
Meanwhile GNER’s travails could prove a test case for DfT Rail. While Director General Mike Mitchell’s stroppy letter to ORR (last month’s column) echoed GNER’s outrage at the GCR decision, as we know, the risk is firmly with the operator.
Thus, as he surveys his truncated company, Mr MacKenzie faces some hard decisions on GNER which now represents a major part of the long term business,. And DfT Rail has made it clear that ‘we do not renegotiate franchises’.
It was ORR Chairman Chris Bolt who reminded me that successful franchise bidders are subject to the ‘winner’s curse’ of paying more than anyone else thought the business was worth. In Sea Container’s case, the size of the curse was increased by the knowledge that to lose would take the Group out of rail franchising.
Meanwhile, First Group has a manager surveying potential open access opportunities. This is concerned as much with future bids as current franchises where InterCity Cross Country is obviously vulnerable.
In the event of further developments on the GNER front, there will be an update in Informed Sources e-Preview, sent out to subscribers on the Monday of the week of publication. You can register through Alycidon Rail (www.alycidon.com)