微密圈

News that the government is considering restarting the regular use of private finance to pay for public infrastructure has got some in the sector excited about the possibility of private capital funding a significant pipeline of work.

But the truth is that, while PFI was cancelled, private finance has never wholly gone away. The regulated asset base (RAB) model, under which investment is secured against a private revenue stream in a market underpinned by statutory regulation, still successfully funds water and energy sector investment in the UK.

The RAB model was also behind major projects such as the successful 拢4.5bn Thames Tideway scheme. And, right now, the government has committed that two of the biggest and most controversial projects in the country are to be funded privately: the 拢10bn Lower Thames Crossing, and the huge Euston station redevelopment.

However, beyond the fact that the government has said it wants to use private capital on these schemes, relatively little is known about what is being proposed 鈥� despite the fact that these projects could set the agenda in terms of funding models for the years ahead.

The two projects, which are at very different stages and face wildly differing challenges, together say a great deal about both the benefits and the challenges of reintroducing private finance models into the UK construction market.

Well developed

The Lower Thames Crossing (LTC), a proposed 15-mile road crossing under the Thames between Thurrock and north Kent, is the further advanced of the two schemes. The project received planning consent under the Nationally Significant Infrastructure Projects regime in March, and already has contractors Balfour Beatty and Skanska engaged to build the roads north and south of the tunnel respectively.

According to a by National Highways (NH), the government鈥檚 trunk road agency, to the planning inspector that approved the scheme, there are three funding options on the table for the scheme. Firstly, full public funding; secondly, a part public-funded, part PFI model, where the government builds the riskier tunnel elements and private capital is used for the roads; and thirdly, an RAB model where a single provider would build the whole thing, and operate the existing Dartford crossing to boot.

While the Treasury said any funding decision was subject to the outcome of next month鈥檚 spending review, several commentators who have spoken to  微密圈 said the RAB model is the clear favourite. The most obvious reason for this is made plain in submitted to the LTC planning inquiry: cost.

An assessment by NH submitted to the inquiry found that the part-PFI option was a full 拢1bn more expensive in capital terms than a public build programme, at 拢10.2bn. In contrast, the RAB option came out just 拢200m more expensive than full public funding, due to the costs of setting up the regulator, at 拢9.4bn.

This option would also see the public sector reduce its capital spend to just 拢1.9bn of enabling works 鈥� less than a quarter of the 拢8bn otherwise being asked of it. The PFI option, on the other hand, is not only more expensive overall, but also requires the public sector to stump up more than half of the up-front build cost, at 拢4.7bn.

The higher price given to the PFI option makes sense to many in the market, given that many increasingly see PFI as unsuited for very large, bespoke or one-off projects with significant risks. This is in part because the special purpose vehicles in charge of PFIs have generally relied on fixed-price construction contracts backed by heavy penalties.

Dr Alex Budzier, a former McKinsey consultant, now fellow in management practice at the Sa茂d Business School, University of Oxford, says: 鈥淭here is very little appetite for classic PFI on that kind of scale. The costs would be quite high because of the risks.鈥�

NH鈥檚 assessment found that the majority (拢650m) of the additional costs of the PFI route were due to 鈥渢aking construction risk under a fixed-price contract鈥�.

Meliha Duymaz, chief financial officer at Skanska UK, said contractors had 鈥渟hifted鈥� their risk attitudes since the early days of PFI, meaning that they will take on 鈥渙nly those risks they can best manage effectively, contrasting with earlier PFI models where risk transfer was less nuanced鈥�.

She added that 鈥渇ew bidders will entertain inflation risk now鈥�, and that the experience of Carillion鈥檚 downfall, which was hastened if not caused by large loss-making PFI hospital contracts, showed how damaging punitive contract conditions could be.

RAB-ing the headlines

The RAB model also has the advantage of allowing the government to move the borrowing for the project off the public sector balance sheet. Investment under a Regulated Asset Base model works where there is the potential for a revenue stream 鈥� road tolls in this case 鈥� to pay back capital investment over time.

Borrowing costs are then reduced by the presence of an independent regulator responsible for setting a fair operating environment, meaning the commercial risk in the project is vastly reduced, allowing long term institutional investors to step in.

Because the tolls are paid privately and the money raised privately, the scheme is much more likely to pass the accountancy test of being genuinely off the government books. PFI projects, on the other hand, while originally regarded as off-balance sheet, have more recently been classified as on the balance sheet 鈥� thereby impacting the government鈥檚 self-imposed spending limits.

James Stewart, chair of consultant Agilia Infrastructure Partners, says: 鈥淭he reality is that the question of whether projects are on or off-balance sheet seems to be a very big consideration. Being off-balance sheet is a big driver.

鈥淭his moves you from thinking about using private finance for social infrastructure projects, to a RAB-type model where there鈥檚 a private revenue stream.鈥�

Mace executive chairman Mark Reynolds, who has been working with the government to find funding solutions for both the Lower Thames Crossing and Euston projects, says: 鈥淭he Treasury鈥檚 problem goes right back to what鈥檚 on balance sheet and what鈥檚 off balance sheet. That鈥檚 always in the back of the Treasury鈥檚 mind.鈥�

>> See also PFI: Do the numbers add up?

>> See also Is PFI about to stage a comeback?

Lastly, where PFI projects can be tough to renegotiate when priorities change, the RAB model is set up to allow for that.

So, if the RAB model seems a clear winner for the Lower Thames Crossing project, it does not mean the financing will be entirely straightforward. Director at Navigate advisory, Beth West, formerly CEO of East-West Rail and commercial director at HS2, says the project in principle is 鈥渁n easy one鈥� because of the expected toll. 鈥淚t鈥檚 a well-trodden path that鈥檚 been done successfully all over the world.鈥�

The difficulty of it comes in its size. 鈥淚t should be in the range of what鈥檚 achievable, but it鈥檚 a massive project,鈥� she says. 鈥淭he question is whether it can be financed at that scale.鈥�

This is particularly an issue given the state of the market for toll road operators who would most likely be the only firms big enough to bid for the whole concession. Oxford University鈥檚 Budzier says firms such as Egis and Ferrovial have been hit hard by drops in traffic levels post covid-19. 鈥淎t 拢10bn it鈥檚 possible that not a single firm could carry it,鈥� he says.

Mace鈥檚 Reynolds says this is why contractors were clear that, even under the RAB model, the government still needed to spend 拢1.9bn on enabling works to 鈥渄e-risk鈥� the project. 鈥淭hey鈥檝e done the planning, difficult remediation, enabling works, utility diversions 鈥� all the difficult things that slow jobs down before the funding comes in have been covered by the government. Then you get a cleaner funding mechanism going forward.鈥�

Delays at Euston

Any challenges, however, are as nothing compared to the situation at Euston.

When former prime minister Rishi Sunak cancelled the HS2 project beyond Birmingham in October 2023, Downing Street also briefed newspapers that the line鈥檚 connection to Euston would only go ahead if the station could be privately funded. Mace had previously been appointed main contractor to build the earlier 11-platform Euston station design, and Mark Reynolds says conversations about options for private finance started immediately.

However, he says that the discussions took a different tenor to those about the Lower Thames Crossing. 鈥淥n one project you鈥檙e pushing at an open door. The other is more of a head scratch.鈥�

The Euston station project is complicated by the range of objectives involved, with HS2 prioritising the delivery of a modern, future-proofed station, Network Rail needing to rebuild its own ageing mainline station at the same time, Transport for London requiring an upgraded Tube station, and the local authority, Camden, hoping to use the scheme as a basis for the economic and social regeneration of the area. And Lendlease, now working in partnership with the Crown Estate, will be looking to get a return from the redevelopment of the office blocks that it owns adjacent to the station.

Original plans for an 11-platform station, on which the costs had risen to 拢4.8bn 鈥� 拢2.2bn over budget 鈥� have now been scrapped in favour of a stripped-down six-platform scheme, for which no costs have been put in the public domain. Asked about the project by MPs on the public accounts committee (PAC) in December, Department for Transport officials said the government, which has said it will set up a development corporation to drive the project, was looking to fund the project with a mixture of four funding sources.

These are: private finance, development receipts from development around the station, tax increment financing and residual public funding.

Chair of the PAC Sir Geoffrey Clifton Browne said in the session he understood that the private sector was being expected to raise 拢6bn for the whole project, a figure he described as a 鈥渧ery tough target鈥�.

Alan Over, director general of the Major Rail Projects Group, replied that, while he did not know if as much as 拢6bn would be needed, he maintained that 鈥渨e have done some early market testing, and we think that that [financing] is viable.鈥�

Alex Budzier thinks that, in principle, this idea has legs. 鈥淭he government has committed to pay for the tunnels to Euston, so this takes the risk out.鈥� he says. 鈥淭here鈥檚 potentially a great opportunity to unlock benefits through regeneration, with something like a Docklands Development Corporation that can capture the uplift in value.鈥�

Struggling

However, industry sources suggest that the Treasury has not settled on a finance model after asking the DfT for options in January, with the industry keen that the government spends more public money up-front, as with the Lower Thames Crossing, to de-risk the station scheme and make it investable.

But, even if that is done, there are doubts over the revenue stream against which finance could be raised, given that raising money against train access charges 鈥� fees paid by train operators for the use of stations 鈥� could send the scheme back on the public sector balance sheet.

In the latest HS2 update to parliament, transport secretary Heidi Alexander would only say that the government will 鈥渟et out our approach on Euston in due course鈥�.

One senior industry source says: 鈥淭hey are really struggling with how to fund Euston. It鈥檚 a combination of things: what happens with the development, because that鈥檚 definitely not enough [money]; what happens around the train access charge, because then it goes back on to balance sheet; and how does a RAB model work just on a station?鈥�

In comparison to the Lower Thames Crossing, Navigate Advisory鈥檚 West says that Euston is 鈥渁 really tricky one鈥�. There are also questions over the tax increment financing portion of the funding package.

鈥淚 would love to see Euston done, but I struggle to see how they鈥檙e going to make it work,鈥� West says. 

Mark Reynolds is likewise desperate for the project to work 鈥� understandably as Mace remains with Dragados the joint main contractor 鈥� but knows it is a challenge. 鈥淚t is probably the most complex funding project out of the whole infrastructure portfolio,鈥� he says. 鈥淚f you can crack it on that, you can crack it on anything.鈥�