Looking above the bottom line

When the Command Paper setting out the Government’s plans to accelerate the delivery of the section of HS2 Phase 2 from Fradley, north of Birmingham, to Crewe – coined “Phase 2a” – was published towards the end of last year the opportunity was taken to recalculate the overall project costs on the basis of 2015 prices, rather than those in force in 2011, the year that has been used up to then. According to the Command Paper, the total budget for Phase 1, Phase 2a and the remainder of Phase 2 has increased to £55.7 billion, on this basis. However, the Command paper also claims that “the [real] cost of HS2 has not changed since the 2013 spending review”, attributing the new higher budget figure to “the prices [having] been uprated to take account of inflation” (see footnote 1).

The 2011 present value budget figure for Phase 1 plus the whole of Phase 2 had previously been advised as £50.1 billion (see footnote 2), so the raw figure has increased by a little over eleven per cent. The Bank of England’s Inflation Calculator tool yields ten per cent as the rise in the retail prices index (RPI) between 2011 and 2015, and the Government claims that “construction inflation since 2011 has been higher than background inflation and may continue” (see footnote 3), so the assertion that an eleven per cent hike in the budget is due solely to inflation appears plausible.

Indeed, had it not been for the intervention of Stop HS2’s Joe Rukin, I may well have been willing to swallow this particular example of HS2 spin. Joe had the presence of mind to employ freedom of information legislation to obtain a breakdown, by phase, of the total figure (see footnote 4) and posted this information in a blog on the Stop HS2 website. This breakdown reveals a more complex picture than the simple inflation hike portrayed by the Government.

At this point, a small detour is called for, I feel. HS2 budgets are based upon a “point estimate” of the build cost. I have been unable to find a satisfactory explanation of what this estimate represents, but it does appear clear that nobody thinks that HS2 can actually be built for the point estimate present value cost. Potentially more realistic budgetary figures have been derived by adding a contingency to the point estimate; the levels of this contingency have been set so that the “with contingency” figure represents a P95 confidence level (see footnote 5).

The information that Joe Rukin has obtained in response to his FOI request provides the point estimate figures, referred to as the “without contingency” costs, and the P95, or “with contingency”, costs, as present values in 2015, separately for Phase 1, Phase 2 (including the accelerated Phase 2a) and rolling stock. Whilst Joe has presented a first-class analysis of these broken-down costs in his blog, I cannot forgo adding my own twopenn’orth, even at the risk of belabouring the point.

The point estimate for Phase 1 has increased from £15.65bn to £18.0bn, representing a percentage increase of fifteen. However, a direct comparison of these two figures is not really valid, since the scope of Phase 1 has changed. As I complained in my blog Just tell us the basis of your calculation (posted 9 Apr 2014), the man tasked with reducing the cost of HS2, Sir David Higgins, could, apparently, only think of removing the HS2-HS1 link from the project scope, but failed to advise us of the resulting reduced Phase 1 point estimate. Since then the recommendations of the Commons HS2 Select Committee have increased the scope of Phase 1, most notably by additional tunnelling under the Chilterns. The result of these scope changes is that it is impossible to form a view about whether the point estimate increase that has been advised is actually a zero amount in real terms, unless the Government also advise the overall cost increase due to scope additions and the overall cost decrease resulting from scope reductions.

The contingency that has been applied for Phase 1 has been increased from £5.75bn (representing 36.7% of the point estimate) to £6.3bn (35% of the point estimate). So, whilst this is an increase in money terms, it actually represents a reduction of about £200m in real terms, which is, I suppose, small beer in the HS2 budget, but the onus is surely on the Government to explain why the contingency percentage has changed.

The point estimate for Phase 2 has been increased from £12.5bn to £17.4bn, an inflation busting thirty-nine per cent. Some of this increase must be conceded to the additional cost of accelerating Phase 2a, but Government figures put this increment at an insignificant £25m (see footnote 6). This whacking increase in the base cost of Phase 2 gives some credence to the rumours that have been rife that coal mining and salt extraction activities along the route of Phase 2 have created huge engineering problems in achieving the almost billiard table flat trackbed that ultra high speed operation requires, necessitating expensive solutions. The increase clearly demands an explanation from the Government, rather than hiding it within a blanket project cost increase that mirrors inflation.

The contingency applied to the Phase 2 total included in the 2011 present value figures was £8.7bn, representing a 69.6% hike in the point estimate. This margin is considerably higher than the contingency employed for Phase 1, reflecting the greater uncertainty in Phase 2 costing due to the relative low-level engineering work that had been undertaken for Phase 2 at the time. The 2015 Phase 2 total reduces the contingency to forty per cent, still higher, but not much, than the contingency used for Phase 1. This may represent a perfectly reasonable reflection of the improved level of knowledge that has been obtained about the engineering requirements of Phase 2. However, it also has the convenient impact of keeping the increase in the P95 cost for Phase 2 from the 2011 present value estimate at around fifteen per cent, in the right ball park for the Government to claim that the increase is in line with inflation. Notwithstanding, the Government has a duty, surely, to explain these changes in approach.

The point estimate for the costs of purchasing rolling stock has come down from £5.6bn to £5.4bn, representing about a fifteen per cent decrease in real terms. Whilst it is perfectly defensible to claim such a reduction in the light of gaining a better understanding of the likely costs, informed no doubt by ongoing negotiations with potential train suppliers, it is, I feel, a move that merits public justification. Similarly to be explained is the reduction of the contingency that has been applied from 34% to 30%.

Both the Transport Secretary and the Transport Minister in the Lords chose only to echo the presentation of project cost in Cm 9157 when reporting to their respective Houses of Parliament, and so both only revealed the bottom-line figure of £55.7bn, allowing them to make the claim that the budget increase was in line with inflation (see footnote 7). I trust that you will agree, based upon the detail that I have set out in this blog, that both Ministers thereby failed to provide those responsible for deciding the future of the HS2 project with sufficient detail for them to be appropriately informed. In particular, the news that there has been a big hike in the point estimate cost for Phase 2 could be crucial information for those called upon to decide if HS2 should be extended north of Crewe and reflect on what this means to the viability of the project as a whole.

The Government swan is trying to maintain the semblance of calm and is assuring us that all is well with HS2 costs. However, below the waterline, it appears that the swan’s legs are paddling like the clappers: press reports (see footnote 8) that the Cabinet Secretary, Sir Jeremy Heywood, is undertaking a review of HS2 costs have been confirmed by Government sources, but the significance has been brushed aside as “standard practice”. Nevertheless, I am sure that the implication of a nigh on forty per cent increase in the base cost for Phase 2 will not escape Sir Jeremy’s attention, however much the spin doctors at the Department for Transport want to keep it from us.

Footnotes:

  1. See paragraph 7.5 of Cm 9157, High Speed Two: East and West The next steps to Crewe and beyond, Department for Transport (DfT), November 2015.
  2. See paragraph 7.2.5 of the October 2013 DfT document, The Strategic Case for HS2. The budgets are advised separately for Phase 1 (£21.4bn), Phase 2 (£21.2bn) and rolling stock (£7.5bn), totalling £50.1bn.
  3. See paragraph 5.3 of the November 2015 DfT document HS2 Phase 2a Strategic Outline Business Case. I have not been able to source a figure for the rise in the Construction Prices Index. Responsibility for this index was under the remit of the, now defunct, Department for Business, Innovation and Skills, but was inherited by the Office for National Statistics in March 2015 and I have failed to locate a consistent set of data for the index over the period 2011 to 2015.
  4. FOI15-1444.
  5. The P95 budget figure is the present value cost that gives a 95 per cent degree of confidence that the project can be delivered at, or below, budget.
  6. See paragraph 5.2 of HS2 Phase 2a Strategic Outline Business Case. However, it is also worth noting, as Joe points out in his blog, that paragraph 2.21 of the DfT December 2015 document HS2 Phase 2a Strategic Outline Business Case Financial Case advises that the cost of a new hub station at Crewe has not been included in the Phase 2 budget.
  7. For the report to the House of Commons by the Rt Hon Patrick McLoughlin MP, Secretary of State for Transport, to the House of Commons see Column 25 of the House of Commons Official Report for Monday 30thNovember 2015. For the equivalent report to the House of Lords, by the Parliamentary Under Secretary of State for Transport Lord Ahmad of Wimbledon, see Column 362 of the House of Lords Official Report for Thursday 14th April 2016.
  8. See, for example, this article in The Guardian.

 

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