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Contractors braced for Network Rail revolution

The government-backed operator awaits the Shaw Report as rumours swirl of a major break-up or even full privatisation. As the rail industry holds its breath, what could the future look like for contractors?

The past two years have represented arguably the most challenging period for Network Rail since its inception.

Now, High Speed 1 chief executive Nicola Shaw’s review of the organisation is set to guide the sector out of its darkest time since the Grayrigg derailment in 2007.

On that overcast February day, a faulty set of points caused a death and nearly 90 injuries in Cumbria.

Network Rail has focused hard on improving its safety practices since then – it boasts of having the best record in Europe - so the current problem for the state-backed operator and maintainer of 32,000 km of track is not one of fatalities, but of finance.

Ever since the organisation moved from being essentially autonomous to reclassified onto the nation’s books in September 2014 (see timeline) it has been in trouble.

Financial friction

Following the move to the public balance sheet, made at the behest of the Office for National Statistics to meet European accounting rules, ministers have discovered just how vast Network Rail’s debt burden had become.

It is expected to reach £42bn this month and top £50bn by 2020, all of which has been dumped on to the Treasury’s liabilities because of the accounting change.

Last year, Network Rail chairman Richard Parry-Jones was replaced by Transport for London commissioner Sir Peter Hendy, the electrification of the TransPennine and Midland Main Line routes were “paused” over cost concerns, and the entirety of its current five-year £38.5bn spending programme was rejigged, partly over soaring construction inflation.

Sir Peter Hendy chairman Network Rail

Sir Peter Hendy chairman Network Rail

Sir Peter Hendy replaced Richard Parry-Jones as NR chairman last year

These problems emerged at a time when there are more passengers on the rail network than at any time since the 1920s, with that number set to double in the next 25 years.

While there have been other high-profile reviews, notably Sir Peter’s moves to put the upgrade programme on a more realistic footing, Ms Shaw’s will be the most crucial.

The High Speed 1 chief executive, whose love of trains developed as a child when her stockbroker father commuted from Oxted in Kent to London Bridge, is assessing the future structure of Network Rail, with the industry feverishly speculating about the possible conclusions she has reached.

“I’m not even sure where Nicola is going to end up on this and anybody who says differently is lying”

Senior rail adviser

This review is due to be published next week and there is speculation Ms Shaw will recommend selling several major lines – and perhaps larger networks – to pension, insurance and sovereign wealth funds on long concessions.

They would then hold responsiblity for the upgrades in this devolved structure, with services being bought in from Network Rail and the wider construction industry.

Ms Shaw, it is thought, could be sympathetic to lengthy concessions given her experience at HS1, the country’s only privately run railway, with Canadian pension funds spending £2.1bn to run the St Pancras-Kent line in 2010 for a period of 30 years.

However, equity stakes in Network Rail could also be sold to investors in an effort to bring greater commercial discipline to the wider organisation.

Separately, Network Rail has hired bankers at Citigroup to look into selling concessions to developers and shopping mall giants to manage some of the 18 major stations they currently run, or at least the lucrative retail outlets inside them.

It is not clear which ones could be sold, but this glamorous portfolio includes London Charing Cross, Bristol Temple Meads, Manchester Piccadilly and Birmingham New Street.

Birmingham New Street at dusk

Birmingham New Street at dusk

Birmingham New Street is among the stations that could be managed privately

Network Rail also announced on Friday that it had hired KPMG to advise on the sale of electrical power assets.

For contractors, all this means their client, which rose from the ashes of the failed Railtrack, itself privatised in 2002, will be completely transformed.

‘Hiatus of investment’

The result could be a period of great uncertainty for contractors. As one senior rail adviser warns Construction News, a full-scale break-up could cause a “hiatus in investment” that would hit rail contractors’ pockets while the government decides on and carries out the reformulation of Network Rail.

The adviser, who has worked closely with Ms Shaw, says Network Rail’s future will be “very heavily Treasury-steered”, an inevitable upshot from chancellor George Osborne’s shock at seeing all that debt suddenly appear on his books.

But the source points out there are “different factions and different debates” not only between the Treasury, the Department for Transport, Network Rail and industry experts, but even with the Treasury itself.

“While creation of a concession will raise capital proceeds, significant work will be required to demonstrate that this model is feasible”

Network Rail submission to the Shaw Report

The source adds: “I’m not even sure where Nicola is going to end up on this and anybody who says differently is lying.” Another source who is close to Ms Shaw confirms she is “playing her cards close to her chest”.

Network Rail wants what an official there describes as “the best of both worlds”. Executives are keen to devolve the organisation into eight semi-autonomous regional subsidiaries along its major routes, while maintaining safety standards and timetable planning from a national centre.

The source insists it is “unlikely” that these routes would be fully privatised because “the risks associated with infrastructure approaching 200 years old would not be attractive to private firms”.

An example is the recent storm damage in Dover and the Lamington Viaduct on the West Coast Main Line, which, along with other weather-related repairs, will cost about £150m to put right.

Smaller concessions?

HS1 is much better suited for sale, given it is just eight-and-a-half years old and has been designed to modern, resilient standards, such as tunnel embankments, and built with fresh materials.

It is thought more likely that smaller concessions could be granted to consortiums to carry out all upgrades and renewals over a fixed period, with the potential for certain big projects to bespecifically managed by contractors.

In its submission to the Shaw review, Network Rail also states: “Introducing capital at a route or sub-route level, via some form of concession could be a… deliverable proposition.

“Some of the train operating companies wouldn’t like this, because they won’t be able to blame all their problems on Network Rail anymore”

Senior industry source

“This could enable a more ‘active investor’ approach, attracting private capital and expertise to finance railway growth and specific schemes (for example electrification or digital signalling), with companies or other entities accepting greater risk for potentially greater returns.”

Network Rail also says it will develop the concept of longer-term concessions, lasting as long as 30 to 50 years, but warned: “While creation of a concession through the sale of a discrete part of the infrastructure will raise capital proceeds, significant work will be required to demonstrate that this model is feasible.

“It also appears unlikely that the sale proceeds will reduce government debt unless there is a full transfer of risk to the third party who also has sufficient financial capacity to withstand potential large losses… It will take a number of years to establish whether a concession is delivering benefits to the rail industry.”

For now, Network Rail only wants one concession to be created so as to trial the idea, while a senior industry figure adds that such a bold move could only realistically take place “step by step”.

He adds: “You start small time, awarding one or two concessions to test the market and then you move forward on a piecemeal basis.

“That said, some of the train operating companies wouldn’t like this, because they won’t be able to blame all their problems on Network Rail anymore.”

Network Rail New tracks in Abbey Wood

Network Rail New tracks in Abbey Wood

One proposal is to split maintenance with project management

A rail industry chairman agrees, arguing he was “surprised” by talk of privatisation, given it is “very difficult to do that model” on what is still essentially a monopoly, while taking into account that the privately owned Railtrack collapsed.

Network Rail also takes every opportunity it can to remind ministers and officials that its “inheritance… was a poor one”, with “decades of underinvestment” and dreadful train punctuality.

Balfour Beatty’s submission states it has “no ideological preference for private, public or hybrid finance”, but believes concessions of 25 to 40 years that include improving infrastructure are worth considering.

This would provide the stability the construction industry requires, while also offering the concession operator the incentive to invest and have enough time to reap the financial returns when the railways have improved.

“The Railtrack model of contracting out this core day-to-day responsibility… spectacularly failed, as corners were cut”

Network Rail source

The contractor says Network Rail was “often” guilty of “over-optimism on costs and timescales at the beginning of projects, inadequate early planning, and changes in scope during development and delivery which adds costs and leads to delays”.

However, it argues that any break-up along regional lines should only be introduced if there remains an overarching body to keep an eye on safety and nationally important infrastructure.

For example, any projects valued at more than £50m could be considered “nationally important” and therefore approved and monitored by a central body.

Maintenance vs management

A senior rail executive who has overseen large-scale construction projects thinks what would be best for the building industry would be for Network Rail to split everyday maintenance with project management, such as electrification.

It would, the source says, be more straightforward to introduce private money into specific projects. Investing in individual projects is considered safer due to easier-to-identify returns and less risk of shocks, such as floods. A separate project is also easier to ringfence financially and literally in terms of security.

A Network Rail source points out that “the Railtrack model of contracting out this core day-to-day responsibility” of maintenance “spectacularly failed, as corners were cut”, which he alleges resulted in the multi-fatality accidents at Hatfield in 2000 and Potters Bar two years later.

As a result, maintenance responsibility was stripped from the private sector and taken in-house by Network Rail in 2004.

On a more positive note, the idea of the major stations being passed on to developers would slim down Network Rail and let it concentrate more fully on its core maintenance work.

To make money, those developers would have to invest in the stations in moves that would, for example, lead to higher rents from retailers, while also resulting in more work for contractors and their subbies.

While there is a real fear that any restructuring could delay work, there has to be some optimism that a reformed Network Rail, whatever shape it takes, could unlock hundreds of millions of pounds of private investment and sharpen up the way work is undertaken on the railways.

It is to be hoped that the reason why Ms Shaw is holding her cards so close to her chest is that she is concealing all the aces.

Timeline: Network Rail’s rocky road

December 2013: The ONS announces its intention to reclassify Network Rail to the public sector because of new EU accounting rules
April 2014: CP5 gets under way after being agreed with the Office of Rail Regulation, with £38.5bn to be invested over five years on around 5,000 projects
September 2014: Network Rail is reclassified, bringing more than £30bn of debt onto the government’s balance sheet – expected to hit more than £50bn by 2020
December 2014: More than 115,000 rail passengers are affected as engineering overruns hit King’s Cross and Paddington
January 2015: Network Rail’s reputation takes another hit with heavy delays at London Bridge station
March 2015: It emerges that the government is undertaking a “high-level board effectiveness review” of Network Rail, which could result in the imposition of a special director on the board who would report directly to transport secretary Patrick McLoughlin
May 2015: The Independent reveals that the private sector could end up managing 18 of the country’s busiest stations; nine months later, Citigroup is hired to look into selling concessions to developers
June 2015: Mr McLoughlin announces the “pausing” of two electrification projects, the exit of Network Rail chairman Sir Richard Parry-Jones, and the appointment of former Eurostar boss Richard Brown as special director
August 2015: The ORR fines Network Rail £2m for missed punctuality targets
September 2015: Work on the TransPennine and Midland Main Line electrifications is “unpaused”, but completion dates are delayed by several years
November 2015: New chairman Sir Peter Hendy announces his “re-plan” of Network Rail’s upgrade programme, while a separate review by Dame Colette Bowe cites a range of reasons for cost hikes and delays, recommending a review of the ORR’s role and responsibilities
December 2015: Storms in the North of England put even greater strain on Network Rail engineers, with the West Coast Main Line among those affected
March 2016: Nicola Shaw to release her report into Network Rail.


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