3.6 It is too early to assess progress towards cost reduction over 2011-12 to 2014-15, although in some areas there is evidence of progress. For example, early progress reports from Crossrail Limited showed that the expected level of savings will be delivered. The Department believes that the majority of savings from the cost reduction measures it is directly responsible for implementing are on track so far. However, the assurance is limited for the reasons in paragraph 3.3 and the risks set out below, and does not cover cost reduction measures by local authorities or Transport for London. We have not validated this assessment, as most of the critical milestones lie ahead.
3.7 In managing within spending plans, the Department has to manage a number of risks, including:
• fluctuations in income (for example volatile rail revenues, see Figure 9);
• increases or decreases in cost, such as overruns or underspends on individual budget lines;
• increases in inflation; and
• a range of other potential spending pressures, for example, unexpected depreciation costs associated with high speed rail or any deterioration in the national road network associated with reductions in road maintenance.
3.8 Inflation is running higher than forecast and in May, the Department modeled the impact of the financial risk associated with some higher inflation scenarios and estimated that it could be between £104 million and £557 million by 2014-15. Were these inflation scenarios to occur, the Department could face a 1-4 per cent pressure to its 2014-15 budget, although the overall pressure on budgets will also depend on other upside or downside risks. The Department's exposure to inflation risk is greatest in relation to the Network Rail grant, which is currently index-linked. As part of its corporate planning process, the Department is seeking to manage financial risk. It has asked budget holders to assess the impact of inflation as well as any other pressures and opportunities, over the remainder of the spending review period so that budgets can be reviewed and, if necessary, further savings can be identified.
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Figure 9 Risks to passenger rail franchise budgets
In the past, the Department has had difficulty in accurately forecasting its income and spending on passenger rail franchises where it is exposed to unpredictability in rail revenues. In 2010-11, the Department's total support to passenger rail services was £511 million lower than forecast. The Department used a proportion of this, together with savings from other areas of spend, to finance improvements to the rail network and a number of other areas, for instance supporting local authorities in improving their winter resilience. This spending was not part of the Department's plans at the start of 2010-11, and was to a large extent determined by the Department's ability to spend additional resources late in the financial year. It is not clear that these areas would have been the priorities for additional spending if the funds had been allocated as part of a more comprehensive resource allocation process.
The challenge this creates for good budgetary management is also demonstrated by the fact the Department incurred an excess vote in 2010-11, meaning it exceeded a budget limit set by Parliament. The main reason for the excess was that the Department previously monitored its overall budget for the operation of rail services on a net rather than gross basis: the Department had not realised that increased income it received from some Train Operating Companies during 2010-11 meant that it had breached its Parliamentary income limit and should have been surrendered to the Treasury. As a result, the Department did not obtain the necessary authorisation from Parliament to spend the extra income received. The Department's 2010-11 annual accounts and Comptroller and Auditor General's report on these accounts provide more details. The Department has recognised that it needs to improve its management of the rail budget.
The Department announced its intention to raise the rate at which regulated rail fares can increase from 1 per cent above the Retail Price Index to 3 per cent during the spending review period. The Department has also budgeted to save £80 million in 2014-15 from its new approach to rail franchise contracts. As part of these plans, the Department wants to reallocate, between itself and Train Operating Companies the financial impact of variations in economic growth. This is intended to reduce volatility resulting from unexpected changes in economic conditions and will be phased in over several years as rail franchises come up for renewal.
In the meantime, all the budgeted savings in this area are dependent on accurate forecasting as well as successful commercial negotiations with Train Operating Companies. The Department's own assessments show that that there are significant risks to its budgets.
Sources: National Audit Office review of departmental documents and the Department's Annual Report and Accounts 2010-11
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3.9 In some areas, including road and rail, financial risks automatically affect the Department's budget. For spending devolved to Transport for London and local authorities, these bodies have autonomy over their budgets and normally bear financial risks themselves. However, the risk and the costs may ultimately be borne by the Department, as shown in our previous report on The failure of Metronet (Figure 10 overleaf) and in its provision of £200 million additional funding across all local authorities in 2010-11, after the unusually severe winter.
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Figure 10 Risks to the Department through Transport for London
In our 2009 report, The failure of Metronet, we reported that the Department's exposure to risk resulted in it having to pay £1.7 billion to London Underground when Metronet went into administration. The Department had ultimate responsibility for protecting the interests of the taxpayer and was exposed to policy and financial risk. However, the Department had few formal levers to manage risks as it was constrained by devolved oversight arrangements and was not itself a party to the contracts. Instead, it relied on other parties whose ability to identify risks was hampered by the poor quality of information available from Metronet. The fact that these other parties did not mitigate the risks effectively exposed the Department to major residual risks which it had few formal levers to manage.
The legacy of the failure of Metronet affects the Department's budgets during the spending review. The Department's settlement includes a separate grant of £960 million over the four-year period to replace funding that would otherwise have been raised by the former Metronet companies through borrowing.
Sources: National Audit Office report, The failure of Metronet (2009) and review of the Department's spending review settlement
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3.10 The Department has limited flexibility to respond to pressures that go beyond individual budget lines:
• In the past, the combination of volatile rail revenues and constraints in altering previous spending commitments have meant in-year changes to other parts of the Department's budget, notably the Highways Agency. In future, there will be less flexibility to manage shortfalls or underspend in this way. The road building budget is much reduced and £237 million of the efficiency savings required by the Highways Agency are based on better contracting, of which a key part is certainty of funding.
• Accelerating spending plans or delaying projects to balance budgets can be difficult because of the lead times and statutory approvals required to plan transport projects.
• The Department can carry forward unused budgets from the previous year, up to a limit specified by the Treasury, around £200 million per year and for a specified purpose. However, the limitations placed upon this roll-forward are such that projects that slip behind schedule must effectively 'catch up' within one year, or lose budget.
The Department finished the spending review with a small contingency budget, averaging £218 million, just 2 per cent of its budgets over 2011-12 to 2014-15. The Department has not yet identified what its response would be to a serious budget shortfall or surplus but told us it has recently begun developing detailed contingency plans.