Transport Secretary publishes his Higher Level Output Specification (HLOS) for Network Rail and the regulator consults on improving Network Rail's renewals efficiency.

This is the seventh article in our PR18 series, reporting on key developments in the Office of Rail and Road (ORR)'s periodic review of Network Rail.  It focuses on the HLOS and accompanying Guidance to the ORR from the DfT and a consultation from the ORR on improving Network Rail's renewals efficiency, which will inform government decisions about future funding.

HLOS and SOFA

The HLOS sets out what the Transport Secretary wants to be achieved by railway activities during the next 5 year review period, or Control Period (CP6, 1 April 2019 to 31 March 2024). It is also supposed to provide a Statement of Funds Available (SOFA) for meeting those outputs, but this will not be finalised until 13 October, for reasons explained below.

This HLOS focuses on operations, maintenance and renewal of the existing railway and does not commit to infrastructure enhancements. These will be dealt with separately.

Underpinning the HLOS is the need for the rail industry, and Network Rail specifically, to make significant progress in improving its efficiency. In particular, the Transport Secretary expects "an ambitious implementation of route devolution to ensure competitive tension and improved understanding of costs through better benchmarking." He is not setting top-down performance targets but wants Network Rail, through its Routes, to set appropriate targets for each part of the network, working with train operators and user representatives. The ORR should develop regulatory Route-level performance targets to reflect this.

There is a need for increased volumes of renewals compared to CP5, but the Transport Secretary is concerned about the affordability of the initial cost estimates which do not contain an allowance for efficiencies. The ORR is therefore commissioning an independent reporter to look at operations, maintenance and renewals and the associated financial risks, as well as consulting on how best to improve Network Rail's renewals efficiency.

Once the Transport Secretary is satisfied about Network Rail's efficiency and delivery capability, he will make a final SOFA announcement by 13 October 2017.  At this stage, however, it is clear that:

• Network Rail will not be getting any further loan during CP6 from Government or other sources. Government funding to the railway industry will continue to be directed either to support franchised passenger service operators or as a direct grant to Network Rail. Government will however ensure that Network Rail gets adequate funding, outwith the SOFA, to meet its obligations to its bondholders.
• The rail industry should apply for other non-rail specific sources of public funding and seek to maximise possible third party contributions, including from land use planning.

DfT Guidance to ORR

Some key points from the Guidance (which replaces the last Guidance from 2012) are:

• Train service punctuality and reliability is of paramount importance and the ORR are to set "challenging, yet realistic" performance targets;
• The ORR is to support industry efforts to simplify and modernise ticketing and to improve accessibility and passenger communication;
• The ORR is to support an ambitious approach to reforming the railway, including route-based regulation and better joining up of track and train through deeper collective working between Network Rail's routes and train operating companies. This should include better alignment of Network Rail's regulatory incentives under route scorecards with the contractual incentives faced by franchisees;
• The ORR should rigorously challenge Network Rail's cost effectiveness and hold it to account, including through the use of reputational incentives;
• The regulatory framework should create certainty for the supply chain and investors, including facilitating a greater level of private investments and ensuring the supply chain has good visibility of Network Rail's project pipelines; and
• Franchising benefits passengers but open access is appropriate in certain circumstances, provided all open access operators make a fair contribution to costs. The ORR should continue with its proposals to reform track access charges (see our previous update, PR18 Charges and Incentives Consultation Conclusions, for details of this).

ORR consultation on renewals efficiency

Network Rail has become less efficient in its work to renew the rail network and the ORR is consulting to see what Network Rail, ORR and the wider industry need to do differently to improve renewals efficiency in CP6. The consultation looks at what went wrong in CP5 to cause the inefficiencies, how Network Rail's planning improved, and what the ORR will do differently in CP6 to monitor efficiency better. Responses are due in by 13 September 2017.

The ORR thinks that renewals efficiency declined over CP5 due to a combination of factors including:

• a slow start to CP5 due to increased activity at the end of CP4, at the expense of some early development work on CP5 renewals;
• Network Rail was too slow to address the rising costs of renewals, as it was focused on delivering enhancements and on its transition into public ownership;
• reduced access time to carry out the works, i.e. how effectively Network Rail managed possessions;
• reclassification of Network Rail into the public sector and the introduction of fixed borrowing limits, meaning it had to keep re-planning renewals to keep spending within the limits, leading to a downward spiral of deferred work and higher costs for the work done; and
• devolution to routes initially led to unaffordable increases in the scope of work in some areas: Network Rail may not have had sufficiently robust governance to be able to understand and manage the impact of individual decisions on the affordability and efficiency of the renewals portfolio as a whole.

Having said that, Network Rail's planning did improve over CP5 (the reliability of its assets improved by 16% in the last three years).

Network Rail is due to publish its strategic business plans on 8 December 2017, setting out what efficiency improvements it thinks it can deliver in CP6. The ORR is changing its approach to how it assesses these plans and how it incentivises Network Rail to deliver efficiencies. Key to this is having more direct comparisons between each route, based on the scorecards. There will be more on this in another consultation, due imminently, on the overall framework for regulating Network Rail.

We will continue to monitor, and report on, key developments in PR18.