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In danger of being mistaken

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On the same day that transport secretary Patrick McLoughlin announced the ‘big electrification pause’, the government also released the MPA project assessment review reports of the HS2 scheme from 2011 and 2012.

[HS2: Major Projects Authority project assessment review reports, gov.uk, 25 Jun 2015]

In March 2015 the Supreme Court handed down its judgement in the Evans case, which limited considerably the circumstances in which the FOI veto can be exercised. The government had previously used the veto to withhold a MPA report on the HS2 project. That decision was judicially reviewed.

[Extract from 2012 MPA report]

At the time of the Secretary of State’s announcement in 10 January 2012 the estimate of capital costs for phase 1 was £16,280 million (in Q2 2011 prices), comprising:

a point estimate of costs of £9,674 million

and

a combined contingency and optimism bias of £6,606 million (or 64%)

and

within this was an assumption that costs would be brought in at £500 million less than benchmark industry norms (i.e. there was a half billion cost saving challenge).

At that time the confidence level that the project would be brought in within that overall cost envelope (and assuming the £500 million cost saving was realised) was P50 (i.e. 50%). Since then HS2 have taken on their development partner CH2M Hill who have undertaken a high level (still desk top) baselining exercise. The result of this was to increase the point estimate of costs by £315 million to £9,989 million (50% of which is attributable to the need for a more appropriate rate for station inflation and the rest to revisions to pricing of roads, property, and the relocation of a station). In addition, as a result of work done by IUK and others the baselining exercise identified that within the £9,989m HS2 Ltd had assumed efficiencies savings of approximately £1.5bn (15%) over UK norms, in line with Government targets. HS2 cost challenge has been increased from £500 million to £1.5bn (assuming that costs can be brought in 15% under industry norms).

HS2’s revised estimate has kept the overall envelope at £16,28 billion. As a result of the increase in the point estimate the amount of contingency in the overall £16.28bn estimate has reduced from £6,606m (68%) to £6.289m (63%).

The DfT guidance relating to contingency and optimism bias suggests that to have P80 confidence in an estimate, for a project at this stage of development, a contingency of 57% is required. Therefore, although the contingency has reduced it remains above the P80 level. It should be understood that if the assumption that efficiency savings are achieved is removed then the confidence level in the estimate reduces to circa P50.

It should be noted that the estimates in January and today are still only high level (as is expected at this stage of the programme) based on a concept design and benchmark costs.

Further we are not convinced that there is a clear understanding as between HS2/DfT on the one hand and HMT on the other as to the interpretation of these figures and confidence levels in them. […]

We have seen every indication that HS2 are committed to achieving these cost savings. They have set up a committee to take forward 6 work streams designed to drive out these efficiencies. The details of the savings are not yet developed and they represent a significant challenge for the project. Since achievement of these savings will require some real movement to current market norms, it will be necessary for other parts of Government and Industry to throw their weight behind this initiative for it to succeed. HS2/DfT do not believe they can achieve it on their own.

Recommendation: DfT consider the governance and resourcing of their cost challenge and consider, with their stakeholders, a strategy to ensure the cost challenge is shared across wider Government. Overall we conclude that HS2 have conducted a reasonable costing exercise for a project at this stage in its development. The unusual feature of these figures however is the £1.5 billion cost challenge and when this is factored into account the confidence levels of staying within the overall cost envelope are significantly reduced. Obviously further more detailed work will be done as the design and solution are further developed and this will need ongoing scrutiny.

7.8 Programme Estimate

Our greater concern lies in what has been left out of the above estimate. The £16,280 million figure is in danger of being mistaken for the expected cost of Phase 1 – whereas it is only a partial estimate made in 2011 prices with significant exclusions. Excluded from this figure are a number of items including:

Escalation/inflation costs (figures are at Q2 2011 prices)

Rolling stock costs (estimated at approximately £3 billion for phase 1 – and a further 5 for phase 2)

DfT sponsor costs (and their advisers)

TOC operator costs

VAT

Stamp duty on land purchase

Exceptional hardship scheme (blight) costs

Costs of over-site development

Project costs accrued prior to 10 January 2012.

Effectively, the £16.28 billion figure appears to be the estimated costs prepared by HS2 for their part of the project. Grafted onto this needs to come the other costs, prepared by DfT, for the project as a whole, in order to give a complete picture. A detailed “whole of project” cash budget needs to be in circulation, which can then serve as the basis on which affordability discussions can take place. Without it there is a risk that the affordability risk, and the issue of where responsibility for this lies, is not properly addressed.

There is also a risk that public perception of the project will be that it will cost less than is actually expected – which may cause handling issues later in the project life. Parliament will also wish to know if it is affordable. We understand that in the preparation of the Business Case and calculation of the BCR some of the excluded costs above (such as rolling stock) have been estimated and included, but there appears to be no overall current estimate in circulation.

As for capital costs for the whole Y network (phase 1 and 2), we believe that further significant work on this has not been done since last time and the estimated capital cost of this is largely unchanged at £32,670 million (at Q2 2011 prices) including a 66% optimism bias.

Recommendation: that a comprehensive budget for phase 1 of the project be drawn up, including all items currently excluded.

7.9 Budget and Costs for this spending review

There is an overall budget for this project for this spending review of £931,686,000 (RDEL and CDEL for DfT and HS2). This appears to be adequate with no overspends expected. There has been an underspend of £70 million last year on the HS2 budget. The main area of underspend was consultant/contractor spending – and this may be evidence of some slippage in the mobilisation phase of the project. It is not clear if this may put pressure on the budget in future years but this has not been flagged as an expected problem.

7.10 Affordability

Without a comprehensive budget in circulation it is difficult to have fully meaningful discussions on affordability. The Department believes however that the costs of this project are so large, and over such a long period, that it will not be able to afford it alongside all its other likely spending commitments. Accordingly we understand that, prior to the Secretary of State’s announcement in January, high level political commitment was obtained to take the project forward. Quite what this will mean, in terms of any governmental funding/support for the project outside the Department’s own budget and over future periods, is unclear. Engagement on this between the Department and HM Treasury is not easy, and there is some thought that the next spending round may provide the forum for making progress on this. The timing of this is not yet announced –but may be next year. This may not be complete by the time the Bill is presented to Parliament.

There is an assumption that the whole project will be public sector funded (though this is not to rule out possible private sector funding of some aspects in the future – e.g. around station development and, possibly, rolling stock).

The Bill is scheduled to be laid before Parliament in October 2013, and we suggest that some position/understanding and some public statement will be needed for this time – dealing with affordability and how it will be paid for. It is acknowledged however that for a project of this scale and complexity it will not be feasible to have bottomed out this issue at this time, but we believe that by the time of second reading of the hybrid bill it is important that some conclusion has been reached as to the affordability of the project and this will require some level of understanding as to who will pay. We believe however that it is important that some plan or approach is needed for this; without this, this may become a risk without an owner, and it may not be properly managed.

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Written by beleben

June 26, 2015 at 9:12 am

Posted in HS2

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