Highway Robbery? A financial analysis of Design Build Finance and Operate in roads in the UK

1. Highway Robbery? A financial analysis of Design Build Finance and Operate in roads in the UK Jean Shaoul, Anne Stafford and Pam Stapleton University of Manchester

2. DBFO - the policy and the evidence • Background to the policy • Scale of DBFO • National Audit Office reports • Other literature • Credit ratings agencies • Financial analysis of Highways Agency and DBFO company accounts

3. DBFO - what it is • Some new build • Operation and maintenance of road for 30 years • Annual payments by government based on traffic volumes • Shadow tolls

4. DBFO - the rationale • Access to finance • Value for money- ambiguous concept - 3Es • Economy: greater private sector efficiency and risk transfer over life of project • VFM - comparison of discounted whole life financial flows - ex ante • Methodology and process critiqued in hospitals • Assumed to be unproblematic in roads • Little financial evaluation of roads

5. DBFO - scale • Little financial information • Inconsistent construction costs • Total capital cost of 14 schemes £1.3bn • 56% of total new construction • No estimate of annual payments • Business Cases and Contracts unavailable - commercial sensitivity • Highways Agency - description • After the first 8, only about 6 more • 25% of 10 year plan will be DBFO

6. Research literature • Little analytical v descriptive research • World Bank project literature • Walker and Con Walker - Australian evidence • Lack of financial information - commercial sensitivity • Snippets of information • Lack of transparency

7. NAO reports (i) • Cost of public < private finance before risk transfer • After RT, 2 out of 4 failed VFM test at 6% • Risk transfer crucial - methodology? • Only large construction projects were VFM • Uncertainties in quantifying Public Sector Comparator

8. NAO reports (ii) • Gov guarantees payments • Who is carrying the risk? • Shadow tolls create extra risks when traffic volumes rising • Own calculations showed that little difference between PSC and DBFO in some cases • Conclusions did not follow own evidence • >>> DBFO expensive

9. Other Evidence • Haynes and Roden - VFM in aggregate at 8%, not when disaggregated at 6% • NPC of £1,093m • But little re methodology, assumptions, etc

10. Credit ratings agencies’ reports • Financial information to the capital markets • Now required to assume more risk • “Significant government support” to offset “additional risk” • “Continue to offer a comparatively safe haven in times of economic downturn” • Main risk = construction risk, refinancing • Contracts complex, difficult to enforce, few penalties, eg January 2003

11. Highways Agency’s accounts (Table 2) • 8 DBFOs for period of study • Information is limited and opaque • Total construction cost £590m • Payments not shown for 3 years 1997-1999 • Changed from off to on balance sheet – risk? • About £210m p a - 3 elements to payments - not broken down by contract • Payments rising due to traffic and payment profile

12. Highways Agency’s accounts(Table 2) • In 3yrs 2000-2002, paid £618m • > £590m construction cost • Refutes the gov’s argument • £6bn cash cost over 30yrs • = NPC approx £2.2-2.5bn • Gov claimed NPC = £1.093bn • Costing more than expected?

13. Highways Agency’s accounts(Table 2) • Estimated finance/capital costs = £1.723bn • = 3 x construction costs and 1/3 total cash costs • Most risk is construction risk, estimated £100/400m risk = 25% premium - to build to time and budget • Gov guarantees payments- who is carrying the risk?

14. DBFO companies’ accounts (Table 4) • Shell company, complex web of subcontracting, 95/5 debt/equity • Disclose little financial information • Rising income • Income less than shown in HA accounts • Operating profit = 68% of income in 2002 AFTER subcontracting to sister companies • Tax payable rate of 8% - but deferred, so less • Treasury methodology (2003) assumes 22%

15. Cost of private finance • Cost of capital = £103m (surplus less tax) • Effective interest rate of 11% • Post tax return on capital of 29% • Risk premium = cost of private less public debt • > 6 percentage points • Approx £56m (>50% of £103m) = additional cost of private finance

16. DBFO companies • Profit on construction, subcontracting and financing • Refinancing • Sale of equity stakes • Yorkshire Link - interest free loan to parent company • Front loaded payment stream - surplus not ring fenced • Must pay maintenance costs in future

17. Financial implications • High cost, affordability and implications for service provision elsewhere • Extra public finance and investment eaten up by cost of private finance • Shadow tolls >> direct tolls? • Risk transfer limited and creates additional risks • VFM methodology? • Outcomes are inconsistent with the claims • DBFO in roads no more ‘successful’ than in hospitals • PFI poor VFM in practice?

18. Accountability • Little financial information available to public • More to capital markets • Commercial confidential - smokescreen to hide cost from public • Makes scrutiny, control and accountability all but impossible • Creates potential for future liabilities and calls on public finance • Gives increasing wealth and political power over direction of public policy to financial elite