Where next for Conservative

rail policy?

WESTBOURNE INTELLIGENCE

SPRING 2016

www.changeopinion.com

Conservative policy on rail is driven by the consequences of growth and how to fund it. The government is seeking to avoid ‘selling off’, ‘pricing out’ or ‘rationing’. There are no grand visions, radical ideologies or over-powering personalities. To achieve its goals, the government faces immediate challenges, principally on costs and funding to support growing demand.

Building railways is always expensive, wherever you are in the world. But there is evidence that costs are particularly high in Britain. After years in a special unaccountable status ‘off the government balance sheet’, Network Rail still struggles to manage costs. Providing solutions that drive down costs is a real opportunity for the private sector. Companies who can do it cheaper than Network Rail might win out.

The credit card is maxed out and major projects like HS2 put additional strain on transport finances. Network Rail cannot borrow in the way it did. Transport for London (TfL) has a tight capital settlement. The alternatives are not clear. PFI has a bad reputation and the M6 toll road has not been a great success. There is a feeling that in the future projects with no idea for funding will struggle, but those with solid funding mechanisms will be given the green-light. This is an important lesson for industry and local politicians.

In line with the general political direction of travel, the government is devolving power. In the future, there will be a profound shift to multiple sources of authority. Devolution will break the command structure based on the Department for Transport and Network Rail. With this fragmentation of control, it will be more confusing who to speak to. People will need to be much smarter about working with key stakeholders like the Treasury, TfL, Transport for the North, DfT and the City.

For the future of rail policy, it looks calm on the surface but there is a lot going on. The government is looking at how industry can handle passenger franchises that are so big that few companies can carry them. Policy is likely to be more positive about open access advocated by, amongst others, the Competition and Markets Authority (CMA) and the Centre for Policy Studies. Do not expect massive announcements, but keep track of the underlying changes. Office of Road and Rail (ORR) reform is also important. The government has sought to create a regulator that is instinctively interested in better ways of doing things.

INTRODUCTION

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Politicians are conscious that seven years of spending money on new plans has yielded few tangible results for voters and travellers to see and touch. However, the opening of Crossrail next year will be a chance for celebrating rail policy and the industry. It will be a moment to toast a quiet revolution in rail delivery – rising passenger satisfaction, increased fare revenue, and a future secured by long-term infrastructure investment plans for, amongst others, HS2, HS3 and Crossrail 3. Not everything is perfect. Local rail is still expensive and crowded, for instance. But the Conservative party may take the moment to communicate a fresh vision for rail that goes beyond cost and finance management.

Amidst the shifts towards devolution and calls for increased competition and private involvement, a successful policy vision would seek to move the debate away from one of inputs and structures to one of outcomes. This would see supply-side interventions measured against their effect on fares and satisfaction, social mobility and economic growth.

Hard working families instinctively understand that better rail links create opportunities for themselves and their children. In HS2 focus groups, parents would describe with passion the opportunities that better transport links would give to their children so they could attend better universities, find better jobs and retain links with their families and communities.

This paper unpicks the subtle story of how an essentially managerial Conservative rail policy is seeking to create a legacy of long-term rail investment. We also seek to identify the future direction of rail policy as it comes under intense pressure to devolve management of the rail system to the regions and employ digital solutions to open up greater capacity and competition for passengers.

The recent story of Conservative policy on rail begins with George Osborne, the Chancellor who is committed to rail investment and persuaded the party to bear with him, at least for the moment.

Investment in Britain’s rail systems aligns with his passion for infrastructure, his instinctive belief in ‘supply-side investment’ in the economy and his admiration for Japan’s bullet trains. Conveniently, it is also a driving force for greater regional devolution and balancing the economy including via his legacy ‘powerhouse’ project led by special adviser Neil O’Brien.

At the Chancellor’s direction, rail investment is used by Conservatives as a handy metaphor for the government’s ‘long term economic plan’. During the last election, the Conservative campaign machine used rail announcements to illustrate in local papers how a Conservative government would deliver a better life. Aided and abetted by Downing Street, candidates made bold promises to their electorate. These now need to met.

In Patrick McLoughlin, the party has found an experienced political player who can navigate the complexities and personalities of the hybrid delivery organisations. He is trusted by the Chancellor,

regarded as a straight-talking former-miner who can break bread with union officials, and also

a ‘normal’ person who can communicate confident professionalism and

emote compassion over sticky issues like rail-fare rises

and network failures.

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THE POLITICS OF RAIL ON THE CENTRE-RIGHT

Most Conservative backbenchers are ambivalent to the Chancellor’s passion for rail. They have more local concerns which are not addressed by the Chancellor’s grand projects. Those in secure Home Counties seats worry about poor, over-crowded services and those in South-West swing seats are concerned about connectivity. Now that Michael Portillo has left the green benches for the TV, there are relatively few train enthusiasts within the Parliamentary party.

If they give it any thought, many Conservatives are instinctively suspicious of the perceived faux-capitalism of the sector and the salaries of‘fat-cats’ running Network Rail. Many would like to breathe the air of enterprise and the free market into the dark corners of the rail industry, and have seen their concerns reflected in a small number of recent papers by centre-right think tanks. The Centre for Policy Studies and the Institute of Economic Affairs have both, for example, advocated fascinating but challenging ideas for more competition.

But the party is also aware that the public supports a nationally-led and publically-owned railway. It is also acutely aware of the power of the transport unions to bring the country to a halt and bring misery to voters. It is the government’s role to avoid worrying either the public or the unions, the Prime Minister believes.

The government also understands that, despite the revolutionary impact of the internet age in so many facets of life, there are no international case studies of developed countries successful turning legacy railways into profitably-run ‘digital transport networks’.

So, in the absence of a better plan, ministers are focused on making the current system work and highlighting achievements, without dangerously raising expectations.

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RECENT POLICY

Over 2016/17 the government plans to invest £29 billion in transport, including bringing forward a large chunk of the £46.7 billion planned capital expenditure by the DfT this Parliament. This is a significant rise on recent years, and a reverse in the decline in transport spending underway since 2011. 2011 was the year transport spending peaked following a steady rise over the previous decade from very low levels. According to the Conservative 2015 manifesto, this is the biggest investment in the railways since Victorian times, most extensive roads improvements since the 1970s, and a reversal of the ‘starvation’ of the sector under Labour.

On rail, the government has given the green light to Crossrail 2, with £80 million provided to support the development phase including a hybrid bill by the end of this Parliament. Another £80 million will be funded by Londoners. In the north, as part of a £300 million investment in connectivity in the region, the Chancellor has given the green light to the development of ‘High Speed 3’. Legislation for Phase 1 of HS2 is making its way through the House of Lords and HS2 Ltd expect to have Royal Assent by the end of the year.

The government is acutely aware that maintaining this increased spending will require reform and new thinking, especially since it is cutting the DfT’s operating budget by 37 per cent over this Parliament, curtailing Whitehall’s ability to manage projects from the centre. However, there are few in the party pushing ambitious proposals.

The spiralling costs at Network Rail and the ‘pausing’ of major electrification projects in June 2015 caused significant political angst for the newly elected Conservative Government, raising questions over the Chancellor’s flagship Northern Powerhouse policy drive. In the wake of the crisis, Nicola Shaw was commissioned to consider the future structuring and financing of Network Rail alongside the Competition and Markets Authority’s (CMA) work on passenger services.

Following the delivery of this advice, it remains unclear what the government will do next: whether it will seek to maintain the status quo with Network Rail running the entire network and franchises operating the vast majority of services; or if there will be a new role for concessions and private investment in infrastructure.

The fundamental question of how to provide greater competition and choice for passengers also remains unaddressed. Free market thinkers have largely failed to engage with the debate around open access operations. Perhaps that is unsurprising, as the issue is a complex thicket of regulation and vested interests, not least the potential threat it presents to DfT income from franchised operators.

If the government is to promote reform, the Transport Secretary and Chancellor will have to convince backbenchers that this will result in better services for their constituents, whilst also reassuring those in the sector that prefer the network to be managed as one.

Commission’s High Speed North report, this lack of connectivity hinders the wider productivity benefits that could be gained from creating more cohesive economies across the north.

This twin challenge raises a host of questions about what investment is needed to improve capacity and connectivity, who should decide what investment is needed and how potential improvements can be financed and funded.

One answer, currently on trial with the introduction of Transport for the North (TfN) and Midlands Connect, is to delegate difficult decisions within limited budget constraints, with regional transport bodies such as these taking on greater political risks in the future. It is too early to tell if this will be a success, but there are signs that these organisations are struggling to make an impact. The relationship between TfN, Network Rail and the ORR remains worryingly unclear. At this stage their roles are largely advisory. Any calls for a wider roll-out of the experiment will be come up against those sceptical of the devolution agenda, and against investing in anything other than overcrowded services in and out of London.

Delivering on plans

Across the government portfolio of major projects there has been a keen appetite to involve international experience and seek best practice in delivery. This paid dividends for Crossrail, HS1, London 2012 and Heathrow T5. All of them delivered ‘on time and on budget’, as witnessed in the Built in Britain BBC TV documentary by Evan Davis in 2012.

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POLICY CHALLENGES

Whilst the government is spending more on the future of the railways, there are three major challenges facing the sector which taxpayers’ money and maintaining the status quo alone will not solve.

Planning for future capacity and connectivity

Investment in capacity is failing to keep up with demand for existing services and further connectivity. Over the last 10 years, rail passenger journeys in the country have increased by 57 per cent with over 4.3 million rail journeys made each day.

It is hard to precisely define the causes of this dramatic shift in transport patterns. Several factors are at work. The growth of the economy, particularly in London. Immigration. Better service levels, marketing and ticketing. Congestion on the roads. Changing work patterns that require more long-distance travel. And, perhaps, changing attitudes to public transport, particularly amongst professional travellers. As a result, trains on many lines into London, as well as Manchester and Edinburgh, are over-crowded and over-priced.

Secondly, the government is concerned about connectivity. Parts of the country

suffer from poor intercity links, with commuters currently driving

or taking circuitous rail journeys. As affirmed

in the National Infrastructure

Satisfying customers

Finally, rail fares have increased by 54 per cent over the last ten years, more than double the rate of inflation, but the transport experience for many has not changed dramatically. For instance, over the same period, passenger satisfaction has increased by only 4 per cent. Travellers’ perceptions are often of overcrowding, poor customer service, patchy network performance, high fares and lack of wifi.

Rising ticket prices can be partly attributed to the cost of maintaining and investing in the railway, but the major factor has been Conservative policy to readdress the balance between the taxpayer and the fare payer.

The government has started to look at placing greater requirements on passenger satisfaction in its franchise specifications. The East Anglia franchise is the first ever franchise where the government will directly set challenging customer service targets. However, some fear that increasing Whitehall stipulations will ultimately stifle innovation and do nothing to create more competition between operators. Similarly, whilst TfL’s plans to take over poorly performing commuter services in South London have been overwhelmingly welcomed, the march of devolution raises questions over the compatibility of market competition and local control.

06

Network Rail has remained stubbornly immune to this modernisation in British project management. For many years it has used its fiscal status – it was technically ‘off the balance sheet’ – to resist government pressures to pull its socks up.

This resistance to modern project management disciplines creates additional problems when the government piles up capital and rolling stock investment. The results have been costly project overruns and delays on the network that have highlighted acute management weaknesses at Network Rail.

The November 2015 Hendy Review announced both an increase in the enhancements budget for Control Period Five (2014-19) and a reduction in what will actually be delivered in this programme. For instance, the scope has got embarrassingly smaller and the budget has got painfully bigger for the Great Western Main Line electrification. This was acutely embarrassing for the Prime Minister (who had promised transport enhancements to voters in the 2015 election), the Chancellor (who was an evangelist for investment) and the Transport Secretary (who carried the can).

Dame Collette Bowe, in her review for the Transport Secretary, concluded that poor project development has previously taken place during the early phases of major projects. She also asserted that cost estimation and risk functions were not adequately resourced, compounded by a worrying absence of a meaningful and effective assurance process.

It is difficult to say whether Network Rail has learnt its lesson.

and other UK players with long-term capital such as L&G have indicated their interest. However, representatives of the UK pensions industry have also commented that the concession model might be too expensive for them to operate and the risks too great.

On top of this, taxpayer funding will continue to play a major role. Whilst the business case for Crossrail 2 contains approximately 50 per cent locally-raised funding, the development opportunities around the portfolio of projects in less prosperous regions proposed by TfN for HS3 are unlikely to support such significant levels of local contribution.

Greater competition

It is also not obvious that the government wants a major shake-up, at least not with operators. For the Prime Minister and Chancellor, the franchise system is predictable. If maintenance and enhancements costs can be brought down by the private sector, then franchises should, theoretically, be able to make a profit on fares without additional taxpayer subsidy. They are also sceptical over whether it is worth expending political capital on seeking to increase competition between operators when, ultimately, politicians will continue to be held accountable by the travelling public.

Radical structural reform seems to be off the table for now. Maybe a reforming, post-referendum Cameron Government will launch a dizzying programme of modernisation that encompasses Network Rail, franchising and ‘digital railways’. In the absence of a radical vision from the centre, two incremental changes are more likely.

Private funding

Since the ‘pausing’ of electrification there appears to have been a pact reached for less Whitehall interference in Network Rail, and the consolidation of the role it has as System Operator, in return for the divestment or privatisation of certain assets.

In addition, with the government setting itself a 2020 target of £61bn in transport infrastructure spending, the option of infrastructure concessions are tempting. The private model that is being shown to work on the new Chiltern Railways’ line to Oxford remains an interesting example. However,

contrary to some expectations the Shaw Report did not advocate a radical influx

of private sector funding.

Private sector reaction has also been mixed.

International pension funds

07

WHAT ARE THE POLICY OPTIONS FOR THE CONSERVATIVE

GOVERNMENT?

Devolution

A circle that Conservative policy makers want to square is how to marry the current system with their vision for regional devolution, including the Northern Powerhouse and Midlands Engine. The goal of devolution, for the government, is for regions to become economically self-sufficient through taking greater responsibility for local decisions and local investment. For rail, this means local areas directing investment, and either part-funding it through local taxes or making their own deals with private investors.

Nicola Shaw, Mark Carne and Sir Peter Hendy have all advocated further regional devolution within Network Rail to bring the system operator closer to customers and better align it with emerging regional decision-makers. However, there is a big difference between this and genuine local control.

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Nonetheless, the CMA’s Competition in passenger rail services in Great Britain policy document in March 2016 outlined some interesting ideas for how greater competition could benefit rail passengers on Britain’s major intercity routes. The CMA made the case for open access train operators to be allowed to compete with franchised rail operators in a bid to improve passenger services. This would see customers on single routes having a greater choice, building on the model most significantly used on the East Coast Main Line, where Grand Central and Hull Trains compete with the Virgin Stagecoach franchise.

The CMA is not alone in this. The ORR responded to the CMA consultation by stating that it is in favour of greater competition.However, whilst such a move would seem to better align with the Conservative ethos on competition, not everyone is as keen.

As was recently reported, discussions between Virgin Trains and the DfT seemed to indicate that the growth of open access would have a significant impact on current franchise agreements and the premiums offered.

If the government is to succeed in delivering reform, it will need to reframe the debate away from nationalisation versus privatisation. In doing so it will have to navigate ever increasing demand, fares at record highs, public opinion strongly in favour of more government control and the drive towards devolution.

The leadership is making some ground here within its own party. Through the ‘rebalancing the economy’ agenda, many small ‘c’ Conservatives in favour of rail investment have found new ways of expressing its importance for unlocking economic growth in their local areas. Across East and West Anglia through to the South and South West of the country, as well as between Oxford, Milton Keynes and Cambridge, there are groups of Conservative MPs successfully campaigning for investment and making the case for how rail improvements will unlock private sector growth.

If the government is to harness this desire for greater local involvement in the network, it will have to navigate these schisms carefully.

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CONCLUSION

For backbenchers focused on constituency concerns, this devolution debate gives them more leverage to engage with Network Rail and the DfT.

However, there are challenges ahead. Outside of the cities, there is concern about the stipulations of the Treasury’s devolution deals. The government’s plans to invest further north are raising eyebrows from MPs outside the Northern Powerhouse. On top of this, the DfT and Network Rail are highly sceptical over the efficiency of allowing regions to pull a national network into separately managed pieces.

Above all, the leadership wants a railway which is only in the news for positive stories about investment and growth. That means a predictable system, increasingly user or investor-funded, and one which can respond to continued growth in demand without breaking the bank.

The search for the next phase of Conservative rail policy swings between two opposite poles of evolving the status quo to fit the devolved regions and embracing the opportunities presented by the ‘digital railway’ to open up greater competition for passengers.

Sitting temptingly in the middle of these options is the hypothesis advanced by Shaw for “time limited licences” for the private sector to operate, maintain and enhance regional chunks of the railway.

The debate over the future of the railways has only just begun. Industry and interested

stakeholders must continue to engage to ensure their voices are heard.

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• Lord Adonis, the formerly Labour and now independent Peer became the interim chairman of the National Infrastructure Commission last year.

• Former CBI Director General John Cridland, is now Chairman of Transport for the North.

• Sir Peter Hendy became Chairman of Network Rail last July, following 14 years as Commissioner of Transport for London.

• Chancellor George Osborne is the leading proponent of the Northern Powerhouse and transport mega-projects such as Crossrail 2, HS3 and the M62. He is also focused on finding alternative sources of funding for the railways, and persuading region’s across the country to accept devolution deals that include a greater say on regional transport.

• Deputy Director for Transport Regulation and Competition Dan Micklethwaite, and Head of Transport Strategy Sophie Bishop are increasingly important to engage with following the departure of infrastructure special adviser Jennifer Donnellan.

• Transport Select Committee member Iain Stewart MP (Milton Keynes South) is heavily involved in both local and national transport issues. Iain is currently driving the campaign to ensure delivery of the East West Rail project, and fellow Transport Committee member Martin Vickers MP (Cleethorpes) is calling for improved transport connectivity across the Pennines.

• Other backbenchers engaging in the debate include former Rail Minister Stephen Hammond MP, who remains a highly visible figure following his call for a Department for Infrastructure last year and the launch of his All-Party Parliamentary Group (APPG) on the Future of Transport.

• The Chair of the APPG for Rail in the North is Jason McCartney MP. He is a strong advocate of increased funding for the railways, having campaigned for the Northern Hub Rail investment and putting his full support behind HS2.

• Other active players in the south include Oliver Colvile, MP for Plymouth Sutton & Devonport and chair of the South West Rail APPG; Alan Haselhurst, MP for Saffron Walden and campaigner for investment in the West Anglia line; and Chloe Smith, MP for Norwich North and co-chair of the Great Eastern Main Line Taskforce.

PARLIAMENT

HM TREASURY

BEYONDCABINET

DFT

KEY PLAYERS

• Secretary of State for Transport, Patrick McLoughlin MP has been a steady hand at the DfT since his appointment in 2012.

• He is ably supported by special advisers Julian Glover and Simon Burton, who play an important role on various rail agendas, ranging from rail franchising to the Northern Powerhouse.

• Claire Perry MP generates fresh ideas and bangs the table for the consumer, whilst Robert Goodwill MP oversees HS2.

• Bernadette Kelley, Director General of the Rail Group at the top of DfT, oversees a powerful triumvirate of key officials - Brian Etheridge is Acting Director General Rail Executive running network services; Richard Carter leads on Rail Strategy and Security; and Peter Wilkinson oversees Passenger Services.

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PAUL CHAPMANAssociate Partner, Infrastructure and Citiest: 020 3397 0100e: paul.chapman@westbournecoms.com