The Cost of Rail Privatisation

by Pete Whitelegg

With the election of Margaret Thatcher in 1979 most of the state-owned industries were privatised including many of the businesses operating within the umbrella of British Railways. Sealink Ferries and British Transport Hotels were sold by 1984. Travellers Fare catering by 1988 and British Rail Engineering (train building) by 1989. But it was not until the publication of the Railways act of 1993 that John Major’s government began the process of fully breaking up what had been British Rail since its nationalisation in 1948.

Under this system the regulatory functions were passed to the Office of Rail Regulator. Ownership of the rail infrastructure, tracks, and stations etc, was transferred to Railtrack. Maintenance of these assets was passed over to 13 companies across the network. The rollingstock was passed over to 3 rolling stock companies (ROSCOs) who would lease the trains to the train operating companies (TOCs) who would be awarded contracts by the Office of Passenger Rail Franchising; the contracts would last between 5 and 7 years.

One of the principles underpinning rail privatisation was the expectation that the railways could be run more efficiently in the private sector because of the profit motive. This view rested on the assumption that there were considerable savings to be made through running the services more efficiently. Competition and profit were to be the driving forces of this new era in rail travel. However, the new operators soon realised that BR had already accomplished much of what could be done to improve the efficiency of the system and competition between rail services was almost negligible.

Another core aspect of rail privatisation was to remove the financial risk of rail operation from the taxpayer and place it firmly within the orbit of the franchised rail companies. It was envisaged that over time the franchised rail companies would cease to require the support of government funding because of the greater efficiency of the private sector and their ability to cut costs. 

What has been clear from the outset is that much of the investment since privatisation in improving the functioning of the rail network has not come from the private companies. Instead, it has come from central government or the devolved authorities. It has been this investment that has driven the increase in passenger numbers. These have been major investments in network speed improvements, electrification and in cab signalling and many others. 

The railways have never managed to operate without significant government subsidy. In recent years, particularly since 2016, operator expenditure has increased faster than income, as cost inflation continued, and passenger numbers began to stagnate, falling significantly below the expectations of operators when they bid for the franchises. This has drastically affected the profitability of operators and the cost for government. This has led to some of the franchises, like Virgin and Stagecoach handing the keys back to government, and one, Northern, failing altogether.

Even prior to the emergency measures brought in due to covid the private rail companies were lobbying for a change to a management fee system of rail funding as a way of addressing the falling rate of profit.

When covid hit, this is precisely what happened. The government stepped in and implemented a series of emergency funding agreements that transformed the way in which the rail industry is funded.

Immediately after the Government announced the UK was going into lockdown it announced that there would be Emergency Measures Agreements (EMAs) for the railways. Initially these were to last six months. The government would take on all the revenues risk from plummeting passenger fares and would cover all industry costs, while at the same time guaranteeing the rail companies’ profits through a management fee. Department for Transport data shows that between March 2020 and September 2020 this amounted to £98 million with around half of that going overseas.

After September 2020, EMAs were replaced with Emergency Recovery Management Agreements (ERMAs). These were to run for 18 months and again they would be based on a management fee with a performance component. Over the 18 months of the ERMAs the TOCs were likely to make in the region of £231 million. 

The ERMAs were, as expected, replaced on a permanent basis by management contracts. The RMT estimates that by 2027, the TOCs are likely to have extracted another £626 million in profits and dividends. That would mean, by 2027 the TOCs would have taken around £955 million in dividends since the start of the pandemic.

Not only are the rail companies now guaranteed profits by the management contracts they also take none of the risk. Recently we have seen rail companies reduce services contrary to the performance criteria contained within the contracts. Yet there have been no deductions by the government because of the reduction in service levels. 

In 2004, in the wake of the disastrous accidents that accompanied the privatisation of rail infrastructure, Network brought its rail maintenance back in house. This produced savings of between £100 million and £264 million every year due to the reduced overheads from commercial profits, removal of duplication of systems to manage staff and programmes and economies of scale.

However, much of the renewals work continues to be outsourced. This decision was criticised in 2004 by the Transport Select Committee which said that “Taking more work “in house” would be an opportunity to reduce the number of company” interfaces” and contracts which burden the industry. This criticism could also be levelled at the rail companies. Each rail company has a significant bureaucracy dedicated to delay attribution and managing staff across a myriad of different staff agencies and maintenance contracts. This is a significant cost to the industry.

Grant Shapps, the previous Transport Secretary, made it clear that the industry as a whole needed to reduce its costs post pandemic. It was pointed out to the Secretary of State that one area could see significant reductions in costs was that of rolling stock. From 2016 to 2020 rolling stock costs increased by around 91%. 

At the outset of privatisation rolling stock was split into 3 companies. These three companies were supposed to compete in providing the private rail companies with trains. However, because of the differing needs of the rail companies they required different types of rolling stock. So instead of competition between these companies each company tended to specialise in certain types of rolling stock for use on particular routes. Over time this has resulted in each company specialising in certain types of rolling stock severely reducing any form of competition between them. 

The three main companies, who between them own 88% of Britain’s trains, make an average of £220 million in pre-tax profits every year. In the pandemic year of 2020 these companies paid out £949 million in dividends, with Angel trains paying some £822 million in dividends to its Jersey based parent company. Most of this money will flow overseas through low tax areas such as Luxembourg and Jersey.

When asked whether the government had considered capping any of the payments to these companies, the government reply was “there has been no assessment made as these are legally binding contracts between the train operator and the rolling stock company”.

The changes implemented because of the failure of the privatisation model have been a missed opportunity, clearly not one that was ever going to be picked up by this present government. The current system now guarantees the private sector continued and significant profit while taking no risks. For the rest of us who use the rail system, all we have to look forward to are increased fares and the managed decline of our rail system.

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