THE SKYE BRIDGE
1. The Skye Bridge is one of the earliest examples of an infrastructure project carried out under the Private Finance Initiative (PFI). The Scottish Office Development Department (the Department) signed the contracts for the bridge in December 1991. Under the deal the private sector designed, raised capital for and built the bridge, and they opened the bridge to users in 1995.
2. The cost of the bridge to users will take the form of tolls which they will pay until the total revenue collected reaches some £24 million. In addition, the Department spent £15 million, of which £12 million went on approach roads and other costs, such as design modifications and £3 million on negotiating the deal. See the Table.
Expenditure on the Skye Bridge project by the Department and users
|Payments to Skye Bridge Limited||
|Toll payments by users to be received by Skye Bridge Limited over the lifetime of the concession, together with payments agreed in December 1997 by the Department to subsidise tolls for regular users||24||1|
|Payments by the Department to or on behalf of Skye Bridge Limited for constructing the approach roads, and compensation for the cost of design changes and delay following a public inquiry||12||1|
|Other direct project expenditure by
Including advisers' fees, survey work, land purchase and staff costs
|Total payments by users and the Department||39||1|
|Indirect public expenditure reflecting loss of ferry revenue by Caledonian MacBrayne||£1 million a year|
Source: National Audit Office
Note 1: These figures are expressed in constant 1991 prices discounted at 6% a year to 1991 base year. This is how toll revenues are measured within the Skye concession contract and allows the figures to be compared on a common basis
3. In December 1997, to assist regular users such as local residents, the Department amended their agreement with the operator to allow the introduction of new lower discounted tolls from January 1998 for those who purchase books of toll tickets in advance. As a result, the Department are likely to make further payments of some £3 million to the operator over the remaining life of the concession which will substitute for higher tolls which these users would otherwise have paid. The precise amount to be paid will depend on the number of users of the bridge but, as these new payments will count against the £24 million target revenue for the operator, they will not increase the total expenditure on the bridge project.
4. In addition to this expenditure the Department are also forgoing the income previously generated for the public sector by the ferry service which the bridge replaced (about £1 million a year).
5. On the basis of a report by the Comptroller and Auditor General the Committee took evidence from the Department on how far they had achieved their objectives, on the costs of the bridge, on the value for money, and on the limited extent of the competition achieved for the project. In doing so, we had regard to the fact that the Skye Bridge contract was agreed in 1991, before some of the guidance on privately financed projects which now exists had been developed.
6. Our examination of this case provides many important lessons for departments and other public bodies implementing future PFI projects.
7. Overall our main conclusions in this case are:
(i) A better comparison of alternative options was needed
In negotiating the deal with the only acceptable bidder to emerge from the competition, the Department did not make a systematic comparison of the costs and benefits of the proposed deal with alternative options (such as continuing with the ferry service). This was a serious omission in their evaluation of the project which leaves a question mark over its value for money. We note the Department's undertaking to consider making such comparisons in future projects. We expect them to do so.
(ii) Toll payers' interests were insufficiently protected
For many users the bridge is now the only practicable means of reaching Skye: the operators are in effect monopoly providers of an essential public service. We are not satisfied that the Department paid sufficiently close attention to the need to protect the toll payers from having to pay tolls for longer than necessary.
(iii) The financial terms of the deal were not fully satisfactory
We are not satisfied that the costs of the bridge, which are being met over time by toll payers and by the taxpayer, are reasonable. In particular, we are concerned that the terms on which the bridge has been provided, including the real rate of return to equity investors of 18.4 per cent a year, were not determined competitively. As the financial market for PFI deals develops, we look to Departments and their advisers to seek ways of securing improved terms in such contracts.
8. Our further detailed conclusions and recommendations are as follows:
On the achievement of the Department's objectives
(i) The Department achieved their primary objective, the provision of a privately financed tolled crossing to Skye. Compared with the former ferry service this has brought a number of benefits to people travelling to and from Skye, including shorter journey times and a more reliable service in bad weather. The Department did not fully achieve their other objectives in relation to the level of tolls, the duration of the concession or the design of the bridge. Our reservations on these are set out below (paragraph 26).
(ii) The Department expect traffic to continue to grow at a rate that will allow the bridge to become toll free within 14 and 17 years from opening, with tolls kept below the level of the former ferry fares. But we note that the contract does not guarantee either that the bridge will be toll-free within the Department's 20 year target period, or that tolls will remain lower than their target level (paragraph 27).
(iii) Following the Government's decision to set lower tolls for regular users of the bridge, the Department's further payments to the operator of some £3 million over the remaining life of the concession will count towards the £24 million target revenue for the operator. While the new payments do not increase the total revenue the operator will receive, they may increase the operator's profits from the project. This is because, given the target toll revenue, the operator's profits depend on the length of the concession: the shorter the concession, the shorter the period for which the operator must bear the operating costs of the bridge, and hence the higher the profits (paragraph 28).
(iv) We would have expected the Department to have negotiated a revised agreement for tolls which minimised their own extra costs and which was financially neutral for the operator. But there is no assurance that this will be the case. Because the new lower tolls are likely to generate extra traffic, over and above the levels there would have been under the original toll regime, the operator is likely to reach the £24 million target revenue sooner than previously expected. And because the new agreement does not take full account of this likely earlier flow of revenue, this means that the operator's profits are likely to be higher than previously expected (paragraph 29).
(v) The principal test of the Department's objective to ensure a satisfactory design of the crossing was the outcome of the public inquiry which in 1992 examined the proposals put forward by the operator and the objections that had been made to them. The Department were not wholly successful here, since the design did not attract unanimous support, and while the report of the public inquiry endorsed the design this was subject to a number of modifications which were carried out largely at the expense of the Department (paragraph 30).
On the costs of the bridge
(vi) The £39 million cost of the bridge falls directly both on the toll payers and on the taxpayer. Together they will pay the amount the winning private sector bidder estimated as necessary to cover the cost of construction, the cost of operating the bridge over the lifetime of the concession, and the cost of financing the concession. It follows that to minimise the costs to toll payers and to the taxpayer, it would have been necessary for the Department to have persuaded the winning bidder to accept the lowest estimates of likely costs (paragraph 54).
(vii) In the event the estimated costs rose rather than fell during a period of exclusive negotiations with the winning bidder. The Department accepted the bidder's argument that traffic flows might not increase over the concession period in line with the Department's own expectations. The effect of this and other concessions made during exclusive negotiations is that the target toll revenue figure rose to £24 million from £22 million increasing the burden on toll payers by some £2 million. It also means that the operator will get the benefit of this additional income if, as now seems likely, their own more pessimistic traffic forecasts are exceeded (paragraph 55).
(viii) This upward pressure on the costs of the bridge arose because the Department were negotiating this aspect with a single bidder as a result of financing difficulties encountered by that bidder. The Department did not detect the risk of such difficulties before entering into exclusive negotiations because they relied on an assurance from the Bank of America, who were the financial adviser to the bidder, that the proposed method of finance was achievable. In the event it was not and we criticise the Department for relying on an assurance, which provided no real security (paragraph 56).
(ix) Following objections to the preferred design on environmental and aesthetic grounds, the Department agreed with the operator to pay an additional £4 million in real terms to cover costs arising from the delay caused by the need for a public inquiry and from the recommended changes which resulted. The Department were unable to persuade the private sector to accept the risk of such additional costs. We note that subsequent Treasury guidance is that such risks should be retained in the public sector as being best able to handle them. This guidance casts doubt on the practicality of awarding contracts for privately financed projects before statutory planning procedures have been concluded (paragraph 57).
(x) The Department believe they would have encountered the same level of construction costs had they promoted the bridge at a public inquiry before, not after, proceeding with a competition. But if the competition had followed the public inquiry then the additional costs would have been subject to competitive pressure. We note the Department's assurance that lessons have been learned from this project, though they have not said what these are (paragraph 58).
(xi) The Department consider that the financing terms on which the bridge has been provided are not out of line with other private sector projects concluded at the time. But neither the real rate of return to equity investors of 18.4 per cent a year nor the terms of the index-linked bonds which formed the next tier of financing were determined competitively. The terms of neither of these forms of finance were readily capable of being benchmarked against the market. There was, moreover, clear evidence of market imperfections, such as the fact that at the time of the deal there was only one potential provider of the index-linked bonds. This calls into question the validity of such benchmarking as may have been possible (paragraph 59).
(xii) The experience of privatisation has shown that Departments are able to learn from experience and put pressure on the market to deliver increasingly good value for money in successive deals. We therefore look to Departments and their financial advisers to secure improved terms, as the financial market for PFI deals develops (paragraph 60).
(xiii) In those cases in which negotiation cannot be avoided, Departments should protect themselves from making unnecessary concessions to the bidder by developing a clear negotiating limit and by taking steps to avoid unwelcome surprises, for example by seeking independent confirmation of the likely viability of bidders' financing proposals (paragraph 61).
On the limited extent of competition for the project
(xiv) Departments must try to secure effective competition as the basis for any commercial deal, whether for privately financed projects, public private partnerships or for other types of procurement. Shortlisting too few bidders or failing to maintain competitive tension throughout negotiations, as in this case, will increase the risk of poor value for money. But there is a danger too that the high cost of tendering for private finance projects may discourage bidders if too many are shortlisted, and this may also weaken competition (paragraph 69).
(xv) For this reason Departments must consider carefully the balance between having too few and having too many bidders, and how this is likely to affect value for money. Departments must also try to minimise the cost of tendering in order to maximise the number of potential final bidders. It will be very important to keep these aspects in view as experience of projects grows (paragraph 70).
(xvi) The Department decided not to apply competition for the appointment of their advisers. This was contrary to good practice, unfair and imprudent. Competition would have been no barrier for getting the best people for the job. Indeed it would have reinforced the selection of the most suitable advisers. And the way in which they were appointed makes us all the more concerned that the Department failed to set budgets for their advisers. As our predecessors' reports have noted, this is an elementary element of sound financial control. Departments must ensure that they carefully assess at the outset their likely costs in managing private finance deals, and set budgets and manage and monitor costs accordingly (paragraph 71).
On value for money
(xvii) The Department decided against calculating a public sector comparator for this project on the grounds that such a comparison would have been false and misleading since they had no intention of funding the Skye Bridge except as a privately financed project. But it is highly unsatisfactory that a Department can seek to avoid having to carry out a thorough comparative evaluation of a proposed project merely by asserting that public finance would not be available for a conventional solution (paragraph 78).
(xviii) The Department took a narrow view of the amount of taxpayer's money in the project, looking only at their direct contribution to the project. But the project involved the public sector forgoing the income from the former ferry service, which was generating profits at a rate of £ 1 million in its last year of operation, to the benefit of the taxpayer. We expect Departments to consider the full implications of projects for the taxpayer, including not just direct expenditure but also indirect costs, such as income forgone. We also expect Departments to seek good value for those users, whether or not taxpayers, who will be required to pay for monopoly services (paragraph 79).
(xix) Because every decision to proceed with a privately financed project must involve rejecting some alternative, systematic comparisons are the key to prudent decision-making in this area. We criticise the Department for not having carried out such a comparison. We note their assurance that, in similar circumstances, they would now look carefully at preparing a comparator (paragraph 80).
(xx) In the absence of such a comparison, and given that competitive tension did not apply in the final stages of the negotiation of this deal, a question mark must remain over the extent of value for money obtained by the taxpayer and the toll payer from this project (paragraph 81).
1 C&AG's Report (HC 5 of Session 1997-98) para 1 Back
2 Evidence, Appendix 3, p26 Back
3 C&AG's Report paras 4, 5 and Figure 2 Back
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