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

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

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

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

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

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

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

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

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

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

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 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

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

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?

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%

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

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

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?

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