7 The debt used to finance construction of the Link, the operation of Section 1 and the current Eurostar UK losses is a combination of:
■ Government Guaranteed Bonds;
■ Commercial bonds and bank debt secured against LCR's revenue from track access charges and from Government payments for domestic access to Section 1, both sources of revenues having been guaranteed by the Government; and
■ Bank debt secured against unconditional payments of seven of the eight parts of the Government's grant for the construction of Section 2.
Our adviser, RBC Capital Markets, considers that LCR's dealings with the capital markets were handled well, given the way the project developed before and since 1998.
8 Construction of Section 1 of the Link has proceeded well. Despite the occurrence of a number of adverse events, the section opened on time in September 2003 at a cash outturn cost slightly below the target set in 1998. Since opening, the operational performance of Section 1 has exceeded expectations.
9 Although Section 2 is over 80 per cent complete in cost terms, its construction has entered its most challenging phase. Considerable work remains at St Pancras, where construction activities, including refurbishment of the existing station, are complicated by restricted access, heritage considerations and the proximity of the live railway. Section 2 has, to date, met all its construction milestones on a programme which concludes with the completion of the infrastructure in the spring of 2007.
10 Prior to the start of major construction activities for Section 2, LCR arranged a risk transfer agreement, known as the Cost Overrun Protection Programme. Under the programme, LCR paid £87 million to Bechtel and a group of insurers to bear £315 million of the first £600 million of any cost overruns including a contractually determined and capped risk for inflation. The Department considered the programme expensive, but approved it as the best value for money obtainable given the Department's desire to proceed with the project, as set out above, because the programme:
■ reinforced a perception that the Government would not bail out the whole project;
■ placed additional incentives on Bechtel to keep the cost of construction within a target;
■ transferred some overrun risk at a time when the Department and the Treasury were concerned about escalating estimates for the costs of running the London Underground Public Private Partnerships and upgrading the east and west coast mainlines; and
■ was substantially cheaper than the estimated cost of the improvements that Railtrack Group demanded to its terms if it were to exercise its option to purchase Section 2 and thereby take all associated construction risk. The cost of these improvements would ultimately have been met through increases in public sector support.
11 The Department and LCR expect that the final cost of Section 2 will exceed the target cost. LCR attributes most of the increase to railway-related inflation and considers that the overrun will be a few percentage points once inflation is removed. Generally, costs have increased faster than the assumed inflation rate (three per cent per annum) used in calculating the target. For the taxpayer, the cost overrun on Section 2 that is not absorbed by the Cost Overrun Protection Programme would, under current arrangements, ultimately flow through to the Department's future loans to LCR.