Price

6  LUL and London Regional Transport (collectively "London Underground") established a competitive framework and secured a competitive process leading to the selection of preferred bidders in May and September of 2001. To secure such competition in the face of the very high bidding costs and political risks to the project, London Underground took the unusual but not unprecedented step of agreeing to reimburse bidding costs.

7  Although bidders were asked to price their delivery against an output-based specification, they were not asked and could not have offered firm prices beyond the first 7½ years of the deals. This was because there was limited information available about the condition of some of LUL's assets, and no-one had experience of pricing against output specifications for such a large and extended programme of work. In addition LUL wished to retain flexibility to re-specify its output requirements on a periodic basis. As a result, bidders and finance providers offered conditional or estimated prices over 30 years, unavoidably adding to the qualitative element of the assessment of the bids. The parties will, however, be able to refer to the Arbiter, for review of whether adjusted prices are economic and efficient and provide for the agreed return on equity.

8  During negotiations with short-listed bidders, it became evident that more work would be required to deliver the outputs and the terms of the deals changed significantly. The prices quoted all rose, adding £590 million to the 30 year cost of the deals. In addition the Department for Transport (the Department) and London Underground accepted the case, which some lenders had been making throughout, for an increase from 90 per cent or less to 95 per cent or more in the amount lenders to the PPPs would get back in the event of termination. The Department attributes this, in large part, to market perceptions of political risk.

9  In December 2000, we reported on the public sector comparator exercise then being used as part of the assessment of the value for money of the bids. London Underground acknowledged that its public sector comparators were always subject, as we had shown, to a high degree of inherent uncertainty and therefore gave only limited assurance about the reasonableness of the prices quoted by the bidders. When, some 12 months later, the Board of London Regional Transport took the decision to proceed with the PPPs, public sector comparator figures were available to them alongside, as we had recommended, considerable analysis of the wider benefits and risks associated with the deals.

10  The bidders' prices reflected not just their estimated costs of delivering the upgraded Tube system but also their financing costs. There is a risk of loss of the PPP investment, conditional on persistent uneconomic and inefficient behaviour, but the PPP otherwise differs in scale and type of risk from PFI deals. A comparison of financing costs with PFI deals is not straightforward, and is seen as inappropriate by the Department, but shows:

a  Private sector shareholders, who have put up altogether some £725 million risk capital in the PPPs, stand to receive nominal returns of 18-20 per cent a year. As the first deal of its kind, London Underground considered that such a rate of return was proportionate to the risks being borne. It is about one third higher than on recent PFI deals if the infrastructure businesses can deliver the bid levels of performance. Likely real rates of return at the benchmark levels set by the performance regime would be lower - in a range from 10-17 per cent.

b  Lenders, who are committed to advance at least £3,800 million to the private sector companies, have limited downside risk (because in the event of termination they stand to get back 95 per cent of what they have lent) but are charging rates of interest in line with an independent credit rating of the companies as "low investment grade". Direct government borrowing of such a base case amount, had it been available, would have cost some £450 million less. The Department considers this is a reasonable cost to pay for the risk sharing settled on and for scrutiny of the deal and Infraco performance by lenders.

c  In the Tube Lines PPP, at least £600 million of the original bank financing was due to be refinanced at an early stage by issuing bonds. Refinancing of the larger sum of about £1,800 million was completed in May 2004 and resulted in a net disclosed gain of £84 million. Tube Lines told us that the initial 60 per cent share for the public sector rises, over time, to 70 per cent, leaving 30 per cent for the consortia shareholders.