financial considerations – a report for hs2
TRANSCRIPT
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Financial considerations a report for HS2
18 December 2009
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Ernst & Young i
The UK firm Ernst & Young LLP is a limited liability partnershipregistered in England and Wales with registered number OC300001and is a member firm of Ernst & Young Global Limited. A list ofmembers names is available for inspection at 1 More London Place,London SE1 2AF, the firms principal place of business andregistered office.
Ian Jordan
High Speed Two
55 Victoria Street
London
SW1H 0EU
18 December 2009
IA/MG/AB/GF
Direct Line: 0207 951 0742
e-mail: [email protected]
Dear Ian
Financial considerations a report for HS2
I am pleased to provide you with this report setting out a summary of the financial outputs relating to
the options for a potential High Speed Rail link from London to the West Midlands. This report
provides a summary of the financial cost of the project from a capital and revenue perspective based
upon our recommendations on the delivery and financing options for the project addressed in our
separate report titled Delivery considerations a report for HS2 dated 18 December 2009.
This report has been prepared in accordance with the terms and conditions of our existing contractwith High Speed Two in respect of the Provision of Financial Advice under the Buying Solutions Multi-
Disciplinary Consultancy Framework Agreement Code: RM353 (the Contract).
The attached document is a result of the analysis that we have undertaken to develop an
understanding of the funding requirements necessary for a High Speed Rail link between London and
Birmingham. This analysis has been developed following a review of the cost and revenue forecasts
prepared and presented by HS2 and its Technical Advisers. We have not reviewed the adequacy or
appropriateness of the figures provided. As a result, should the cost and revenue forecasts differ from
those estimated by HS2, the findings of this analysis may be materially different.
Our report may not have considered issues relevant to any third parties. Any use such third parties
may choose to make of our report is entirely at their own risk and we shall have no responsibility
whatsoever in relation to any such use.
Our work in connection with this assignment is of a different nature to that of an audit. Our report to
you is based on publicly available information and on discussions with you and your other advisers. We
have not sought to verify the accuracy of the data or the information and explanations provided. Our
work has been limited in scope and time and we stress that a more detailed analysis may reveal
additional considerations that this paper has not.
Should you have any questions please do not hesitate to contact me on 0207 951 1702.
mailto:[email protected]:[email protected] -
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Contents
1. Introduction & Background .................................................................................... 11.1 Phase I ............................................................................................................................................ 11.2 Phase II ........................................................................................................................................... 11.3 Report Structure ............................................................................................................................ 2
2. Financial Analysis ................................................................................................. 32.1 Infrastructure Costs ....................................................................................................................... 32.2 Infrastructure Revenues ................................................................................................................. 72.3 Franchise Financials ....................................................................................................................... 72.4 InfraCo Financial Forecast .............................................................................................................. 92.5 Government Premium Summary ..................................................................................................... 9
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1. Introduction & BackgroundIn January 2009, the Government created a new company, HS2 Limited, to comprise a non-executive Chairman, Sir David Rowlands, and a small number of full-time staff (mostly
seconded from the Department for Transport (DfT) and Network Rail) led by a Chief
Executive, Alison Munro.
Lord Adonis, the Secretary of State for Transport, asked HS2 to consider and provide advice
on options for an entirely new HSR line between London and the West Midlands by the end of
2009.
HS2 has commissioned Ernst & Young to provide support and advice on the delivery and
funding of a new HSR line. Development of HS2 to date has focused on the overall London to
Scotland HSR line feasibility and the development of whole life capital and operating cost
estimates for a number of route and structural options for the London to Birmingham route.
Ernst & Young was appointed to assist in evaluating the funding and delivery options
associated with the project. The evaluation was undertaken through two distinct phases.
1.1 Phase IThe objective of this phase was to enable HS2 to benefit from the experience of other
international HSR projects. This entailed:
Conducting research on international HSR projects and comparable UK infrastructure
projects, including an analysis of the projects delivery structures and sources of
funding adopted;
Assessing how the lessons learned from these projects contractual delivery structures,
risk allocation and sources of funding may be applicable to a new HSR line in the UK.
The Phase 1 report titled International case studies: lessons learned and recommendations
for HS2 is included as Annex 1.
1.2 Phase IIThe objective of this phase was to evaluate the financing and delivery considerations for a
potential new HSR line. This entailed:
Assessing the different operating and governance structures for a new HSR line;
Evaluating the contractual and delivery options for a new HSR line; and
Considering the financing issues that must be addressed in the delivery of a new HSR
line.
The findings of the Phase II analysis described above is included in a separate report entitled
High Speed Two Finance & Delivery Considerations Phase II Delivery Report dated 18
December 2009 (the Delivery report). This paper provides a summary of the financial
analysis undertaken in conjunction with the review of the delivery options.
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1.3 Report StructureSection 2 of this report summarises the financial analysis that we have performed and is
structure in the following sections:
2.1 Infrastructure Costs
2.2 Infrastructure Revenues
2.3 Franchise Financials
2.4 InfraCo Financial Forecast
2.5 Government Premium Summary.
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2. Financial Analysis2.1 Infrastructure Costs2.1.1 Infrastructure Capital Costs
The table below presents a summary of the capital costs for the High Speed Rail (HSR) link
from Euston to Birmingham.
Capital Item
(m real, base date September 2009)Risk Adjusted Capital Cost
Civils 3,615
Structures 5,154
Railway Systems 881
Control Systems 1,150
Stations 4,138
Depots 635
Mobilisation & Testing 938
Rolling Stock 2,835
Total 19,347
Table 1 : Capital Cost breakdown
This capital cost spend profile over the construction period is highlighted in Figure 1 below:
Figure 1: Capital Cost Spend Profile (including rolling stock)
The profile above includes the capital cost of the rolling stock at 2.8bn. As we have
highlighted within the Delivery report, we believe that the size of the rolling stock contract
and the bespoke nature of a large proportion of the trains may make financing through the
private sector using a conventional approach to train procurement challenging.
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500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
4,500
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
m
Construction Year
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Should a traditional approach to the procurement of rolling stock be used and a lease agreed,
the construction profile excluding the rolling stock capital cost would change, with substantial
ongoing annual lease payments required over 30 years instead. However, we have assumed
that for the central case, Rolling Stock is funded via Government Grant.
2.1.2 Infrastructure Operating CostsIn addition to the capital costs presented above, there will be a requirement to fund the
maintenance costs of the infrastructure once operational. We present below the annual
maintenance costs for the infrastructure.
Annual Cost (m real)
O&M Costs 45m
Station O&M 22m
Table 2 : Infrastructure Operating Costs
2.1.3 Infrastructure Renewals CostsOver the initial 30 year operating period it will also be necessary to renew elements of the
infrastructure. HS2 has estimated that the renewals requirement will be to:
Renew half of the control systems in operating year 14 and 15. This equates to 288m
per year for each of the two years (or one quarter of the initial capital cost of 1,150m
in each of two years);
Renew the remainder of the control systems in operating year 29 and 30. This equates
to a further 288m per year in each of these two years (a further quarter of the initial
capital cost of 1,150m in each of two additional years);
Fully replace the railway systems by the end of 30 years. This is estimated to take 4
years to complete starting in year 27. This equates to an annual renewal cost of 220m
(or one quarter of the initial capital cost of 881m in each of four years).
No renewals are forecast for civils, structures, stations and depots and the life of the rolling
stock is expected to exceed 30 years so a replacement will not be required within the initial
30 year operating period. In total over the first 30 year operating period, total renewals
spend is estimated to be just in excess of 2bn.
Figure 2 below provides a summary of the timing of the renewals spend over the first 30years of operations.
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Figure 2: Renewals profile over first 30 years of operations
In modelling this expenditure, in order to smooth the revenue impact of the cost, we have
spread the 2bn total over the 30 year period, similar to the approach adopted in standard
PPP contracts. This has lead to an annual revenue impact of approximately 68m.
2.1.4 Estimating Profit MarginsAnalysis undertaken by OXERA on behalf of the ORR during the CP4 determinations included
considering the margins made by companies undertaking a similar type of activity to Network
Rail (i.e., rail engineering). We have assumed that the InfraCo will seek a similar level ofreturn. The OXERA analysis was based upon a selection of companies undertaking rail
engineering activities, as well as United Utilities Operating Services, a company set up
specifically to take responsibility for the operation and maintenance of the entirety of Welsh
Waters assets. The results of the OXERA study are presented below.
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100.0
200.0
300.0
400.0
500.0
600.0
1 2 3 4 5 6 7 8 9 10 11 1 2 13 14 15 16 17 1 8 19 20 21 22 23 24 25 26 27 28 29 3 0
m
Operations year
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Table 4 : Estimated Franchise Profit excluding rolling stock lease charges & infrastructure access charges
NB: The High Speed operations start date is estimated to commence in January 2026 which would allow a 3 monthoperating period before the start of the first full operating year ending 31 March 2027. In order to present full yearmovements, this initial 3 month operating period has been excluded from the table.
The Net Revenue figures in Table 4 above is the revenue forecast to be received by the
franchise net of the revenue that the project will subtract from the conventional rail network.
The franchise figures above exclude rolling stock and track access charges at this stage and
highlight that, based upon the franchise cost and revenue estimates provided by HS2,
franchise operations will make an operating profit exceeding 180m in year 2027 increasing
to circa 422m by year 2033. Therefore, allowing for an operating profit in line with those
profits currently achieved across conventional rail franchises, the franchisee would be able to
pay a premium to Government of circa 152m in year 2027 increasing to 382m by year
2033. Under this scenario it would be possible for the franchisee to make Track Access
Charges in line with the minimum level of 150m per annum discussed in Section 2.2.
Table 5 below highlights the impact on profitability and the value of the premium that could
be repaid to Government should Rolling Stock be procured up front and TACs are set at the
minimum 150m required to cover infrastructure costs.
m real year ending 31March
2027 2028 2029 2030 2031 2032 2033
Net Revenue 565 604 643 682 723 764 806
Franchise Op Costs (204) (204) (204) (204) (204) (204) (204)HST Maintenance (180) (180) (180) (180) (180) (180) (180)
Infrastructure TAC's (150) (150) (150) (150) (150) (150) (150)
RosCo Charges - - - - - - -
Profit 31 69 108 148 189 230 272
Government Subsidy/(Premium)
(2) (39) (76) (114) (152) (192) (232)
Retained Profit 28 30 32 34 36 38 40
Retained Profit (%) 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0%
Table 5 : Franchise forecasts assuming no rolling stock lease costs and minimum infrastructure access charges
NB: The High Speed operations start date is estimated to commence in January 2026 which would allow a 3 monthoperating period before the start of the first full operating year ending 31 March 2027. In order to present full yearmovements, this initial 3 month operating period has been excluded from the table.
The analysis above highlights that, assuming TACs are set at the minimum level required, it is
possible that the franchise operator could make a premium payment to Government in the
range 2m in year 2027 increasing to over 230m in year 2033.
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2.4 InfraCo Financial ForecastBy bringing together the estimated income from track access charges and subtracting theestimate infrastructure costs, it is possible to estimate the operating profit range that theInfraCo may be able to achieve and the possible premium payments to Government. Table 6below highlights the estimated profit and premium payment to Government assuming 150mper annum TACs.
m real / yearending 31 March
2027 2028 2029 2030 2031 2032 2033
HST TAC's 150 150 150 150 150 150 150
O&M Costs (45) (45) (45) (45) (45) (45) (45)
Station Op Costs (22) (22) (22) (22) (22) (22) (22)Renewals Spend (68) (68) (68) (68) (68) (68) (68)
Profit 15 15 15 15 15 15 15
Premium to Govt (8) (8) (8) (8) (8) (8) (8)
Retained Profit 8 8 8 8 8 8 8
Retained Profit (%) 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0%
Table 6 : InfraCo Profit estimate including infrastructure access charges at minimum TAC level
NB: The High Speed operations start date is estimated to commence in January 2026 which would allow a 3 monthoperating period before the start of the first full operating year ending 31 March 2027. In order to present full yearmovements, this initial 3 month operating period has been excluded from the table.
We have estimated the premium that Government could receive under a regulated capped
return model assuming a real (revenue) profit margin of 5% per annum being approximately
8m per annum. Track Access Charges of circa 150m are necessary to meet the forecast
operation, maintenance and renewals cost of the line once operational. NB: These costs
exclude any element of capital cost.
2.5 Government Premium SummaryIn summary, under the assumptions adopted for this analysis, the level of TACs will determine
how much premium the Government receives from the franchise operator and from the
InfraCo: the lower the track access charges, the higher the premium that the franchise
operator generates compared to the InfraCo and vice versa. The total premium to
Government is only marginally impacted by the level of TACs. The differences that arise are
the result of the increased premium that the InfraCo is allowed to receive as TACs increase as
profit is a function of revenue. There would be no difference to the premium to Government if
the profit margin was linked to costs but that would not create an incentive on the InfraCo to
increase capacity and usage of the HSR line. Table 7 below summarises the premium
payments to Government from the two sources.
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m real / yearending 31 March
2027 2028 2029 2030 2031 2032 2033
Premium fromfranchise
2 39 76 114 152 192 232
Premium fromInfraCo
8 8 8 8 8 8 8
Total Premium 10 47 84 122 160 200 240
Table 7 : Total premium to Government
NB: The High Speed operations start date is estimated to commence in January 2026 which would allow a 3 monthoperating period before the start of the first full operating year ending 31 March 2027. In order to present full yearmovements, this initial 3 month operating period has been excluded from the table.
Profile of Government Support
Figure 3 below provides a summary of the profile of Government spend and income assumingminimum TACs of 150m are set. The profile of the cash flows shows that HS2 will generate
a premium to Government from 2027.
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Figure 3: Government funding profile during construction and operations
2.5.1 NPV of Government SupportTable 8 below provides a summary of the net present value to Government discounted at
3.5% real.
Total NPV
3.50%
Income from Franchise 5,903 2,433
Income from InfraCo 231 102
Support to Franchise (8) (6)
Support to InfraCo - -
Support for Capital Cost (19,347) (16,679)
Net Government Position (13,222) (14,150)
Table 8 : NPV of Government Support over 40 years
NB: The support to the franchise forecast above is estimated to be required during the first 3 months of operationscommencing January 2026 whilst passenger revenues are still low and subject to future growth. Thereafter revenuegrowth is estimated to be sufficient to cover operating costs.
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