However, this current topic is definitely unsuited to any of those media. Roger Ford, who’s probably the best railway journalist working in the UK at the moment (sorry Nick!) writes a great technical column in Modern Railways magazine, and sends out a monthly email based on his work for the mag. But although he’s a brilliant rail industry writer, he’s not a great finance industry writer. And so he’s fallen for an insiduous and silly myth spread by the Telegraph’s Alistair Osborne in this piece.

The last UK government put out a tender for 1,200 new train carriages to be built for the Thameslink project, which links southeast London and its commuter belt with north London and its commuter belt via upgraded lines running from London Bridge to St Pancras via Farringdon. The tender didn’t specify any British-built content for the trains, and was won by Siemens with trains that will be built in Germany rather than Bombardier with trains that would’ve been built in Derby. Siemens bid cheaper than Bombardier, and the government wasn’t allowed to take British jobs into account because a specification of British jobs wasn’t part of the invitation to tender.

This created anger, especially as Bombardier used the announcement as a catalyst to announce that it’d sack two thirds of its contract staff and 25% of its permanent staff in UK train-building, because it doesn’t have any UK train orders after it’s finished building new London Underground trains. Europhobics used it as an opportunity to attack the EU’s anti-corruption rules; more sensible people used it as an opportunity to attack the previous government for failing to specify British jobs (as would’ve been allowed by EU rules) in its invitation to tender.

Which is fair comment. A related question, though, is why – as the biggest supplier of trains to the UK railway network over the last five years – is why Bombardier couldn’t outbid Siemens to the contract. Osborne’s claim was that this was a reflection on Bombardier’s credit rating relative to Siemens. Siemens’s debt is rated at A+ by Standard & Poor’s, compared with Bombardier’s BB+ rating, and the contract was to provide the trains on a leasing basis rather than to buy them outright. He says that because it costs Bombardier more to borrow (credit ratings are basically like individual credit scores, so A+ means you get a cheaper loan than BB+), it would’ve cost Bombardier 1.5% more than Siemens per year in interest costs to supply the trains than Siemens, so no bloody wonder Siemens won.

However, this is rubbish. Neither Bombardier nor Siemens bid on their own. Bombardier teamed up with Deutsche Bank, services outsourcing company Serco, PFI investment company Amber Infrastructure and SMBC Leasing for its bid. Siemens teamed up with PFI investment company InnisFree and private equity company 3i Infrastructure. In neither case would the train manufacturer have put up the money for the trains – in Bombardier’s case it would have been SMBC (which has an A+ rating, befitting its position as one of Japan’s least bankrupt banks), and Siemens’s case, it would have been its own corporate finance division (A+) plus 3i Infrastructure (BBB+). For the Bombardier consortium, the money would have been borrowed against SMBC’s account; for the Siemens consortium, it would have been borrowed against Siemens’s account – they would both have had an A+ credit rating.

So, in other words, the Bombardier consortium and the 3i consortium would have had the same financing costs. The only difference is that, had the bid been successful, Siemens’s credit rating and ownership of a finance company would have allowed it to take a higher proportion of the profits. The difference between Bombardier and Siemens based on credit rating is that Bombardier wouldn’t have been able to take an additional slice of the profits based on the financing part of the project, and therefore had to bring in an external partner for the financing. But that’s about how the profits from winning the bid are shared, not about the cost of delivering the trains.

The same EU rules that ban the government from choosing Bombardier because it’s designed and built in Derby also ban the bid from being awarded on a cross-subsidy basis from companies’ finance arms compared to their building arms. In other words, Siemens’s assessment of the cost of building the trains had to be on the same basis as Bombardier’s, and it wasn’t allowed to pretend that the trains were cheaper and offset that money on the basis of any financing that its finance company did. So there’s no sane reason why this should have made the Bombardier consortium’s bid more expensive than the Siemens bid.

In short, either Siemens overbid (presumably because it was desperate to keep a foothold in UK rail, having lost most major recent contracts to Bombardier), or Bombardier underbid (either because it thought the government would somehow dodge the EU rules and pick the British-based trains, or because it couldn’t really be bothered and was looking for an excuse to cut Derby anyway). The financing problem is not important.

1) Which single airport (domestic or international) is the most popular passenger destination for people flying out of Boston Logan Airport?

2) Where was Air Berlin headquartered for the first 12 years of its existence?

3) Out of the top 40 international destination airports flown from the US, which five have the highest percentage of passengers flying there on US airlines? (ie as close as possible to “100% of people who fly there use Delta, United, AA, Southwest, etc”)?

4) Out of the top 40 international destination airports flown from the US, which five have the lowest percentage of passengers flying there on US airlines (ie as close as possible to “100% of people who fly there use Aeroflot / Zimbabwe Airlines”)?

5) From which airport in the EU can you catch a direct, non-stop flight to Australia?

RR engines do not like oil in the wrong places because it may stop the air-cooled turbine blades being cooled
All RR “B” checks are supposed to include a look for oil in the wrong places
Qantas seem less good at finding it than Singapore Airlines or Lufthansa
There is a problem with wear on some A380 engine components which is why the need for checks was highlighted in August
Qantas are more likely to have a problem because they operate their A380’s with higher thrust ratings than SQ or LH
The Trent 900 is the first RR engine to introduce contra-rotation, where one of its three shafts runs in the opposite direction to the other two
That massively increases the entertainment value of, say, bits of one broken turbine meeting a turbine rotating in the opposite direction
Since Qantas engineers have now looked at all their T900 engines jointly with RR engineers they have found two more with oil where oil shouldn’t be
Which begs the question why they didn’t find it before…

His words, not mine. Although, much as I respect Ben Sandilands, this is the most convincing analysis I’ve read. Apart from the misuse of “begs the question”, which is unforgiveable.

During the Korean War, Congress enacted an excess profits tax meant to keep military contractors from, well, profiteering. In its infinite wisdom, Congress defined excess profits as anything above what a company had been making during the peacetime years 1946-1949.

Boeing was mostly a military contractor in those days (Lockheed and Douglas dominated the passenger-plane business), and had made hardly any money at all from 1946 to 1949. So pretty much any profits it earned during the Korean conflict were by definition excess, and its effective tax rate in 1951 was going to be 82%…

It being 1951, Boeing instead sucked it up and let the tax incentives inadvertently devised by Congress steer it toward a bold and fateful decision. CEO Bill Allen decided, and was able to persuade Boeing’s board, to plow all those profits and more into developing what became the 707, a company-defining and world-changing innovation.

(I’ve deleted some of his sarcastic commentary about how a government enacting a similar measure today would be described, so that mine sounds cleverer.)

However, the funding shortfall threatening the public-private partnership (PPP) to build 78 new Waratah suburban trains for Sydney CityRail services is an exception. The NSW government did a good job in managing risks for this deal, and it’s at risk of having to stump up extra taxpayer’s cash for reasons nobody can blame it for not foreseeing.

On the plus side, even if the government does have to step in, it’s unlikely the NSW taxpayer will lose much. The biggest loser is likely to be Downer, the train’s builder, which is exactly where the blame should lie. Unfortunately for the NSW government, the deal is arcane enough that the press and the opposition can easily claim otherwise.

Why is PPP a good idea?

PPPs have become popular worldwide as a way of funding new rail rolling stock programmes because of the transfer of risk they involve. Under traditional contracts, a government agency buys some trains from a private contractor, who builds them and hands them over to the agency when they’re built, with the agency paying to maintain them until they’re no longer economic to repair. Under a PPP, the agency agrees with a private contractor that the contractor will provide it with working trains for a fixed time period, with repair and maintenance work carried out by the contractor.

The advantage of a traditional deal is that it’s straightforward. The disadvantage is that it sets up a terrible incentive structure. The manufacturer’s best option is to promise the lowest possible upfront cost, then deliver as many trains as possible as soon as possible, even if they won’t reliably last for their design life, so they can win the contract and get paid. The government’s best option is to take the lowest bid and accept as many trains as soon as possible, even if they won’t reliably last for their design life. So both sides have a good motive to agree to underspecified trains that will cost more in the long term. Not just in actual maintenance money but also in disruption, which is the absolute killer: a half-hour delay to a morning commuter train carrying 800 passengers costs the NSW economy over $10,000 in lost work hours.

The last trains procured in NSW under a traditional contract were the Tangara sets in the late 1980s and early 1990s. They’ve suffered from reliability problems throughout their working life, partly because the manufacturer built them down to the minimum spec, and partly because RailCorp specified cheaper components in the design than the manufacturer recommended. The first trains procured under a PPP, on the other hand, are the Millennium trains. Now, these also arrived late and suffered from initial reliability problems – but crucially, the manufacturer paid for the delays, and now that the trains are in reliable service, the manufacturer will pay for all future maintenance to keep them running.

The PPP approach for train procurement has also worked in Melbourne, as well as in countless successful projects in Europe, North America and Asia.

So what’s gone wrong on the Waratah project, then?

Well, first of all, as with almost every new rolling stock project in the world ever, the engineering side of the project is running late. Integrating multinational suppliers’ work has taken longer than expected, and the trains have encountered unexpected problems when they’re actually run on RailCorp’s rails. This is the consortium’s fault for not managing the project well enough, and for not pricing risks and delays into the original contract.

So Reliance Rail – the legal entity that’s providing the trains to RailCorp – is liable for a sizeable compensation bill that will wipe out its profit (Reliance’s main shareholder, Downer EDI, has already written off its entire equity investment in the consortium). This is exactly the point of doing a PPP – the private sector partner is paying for its failures, and the NSW taxpayer isn’t. Hurrah! And this would have been the end of the story, but for some complicated financial engineering…

Reliance is a company created solely to buy Waratahs from Downer EDI, and provide them to RailCorp with Waratahs. When the project was launched in 2006, Reliance raised a total of $274m from its shareholders (Downer, AMP, and, erm, RBS and Babcock & Brown), and $1.9bn in AAA-rated bonds. It also got its bankers (NAB, Westpac, Sumitomo and Mizuho) to pledge another $357m in debt financing that would be drawn after 2012 if required – effectively, an overdraft facility to cover the possibility of overruns.

From the point of view of everyone involved at the time, this was a fine deal. Reliance had enough cash to pay Downer to actually build the trains, and a guarantee of getting its hands on extra cash from the banks if its funding obligations ran ahead of delivery-based payments from the NSW government. NSW could see that Reliance had easily enough funding to deliver the trains and compensate for overruns. The bondholders had super-safe AAA bonds. And the banks’ overdrafts would have been on the same investor-friendly terms as the bondholders.

Unfortunately, the deal also involved one of the more surreal bits of the pre-GFC financial system. Reliance paid two large insurance companies – XL (now Syncora) and FDIC – to insure its debt. In other words, if Reliance were to go bust – say, because it spent all its capital and was completely unable to deliver any trains, or because NSW underwent a Communist revolution and refused to honour any private sector contracts – then XL and FDIC would make sure Reliance’s bondholders and bankers were repaid. This guarantee is how Reliance managed to get its bonds rated as AAA (‘almost totally safe’) despite being exposed to some operational risk.

You might be wondering why it was cost-effective for insurance companies to take on financial risks by insuring loans, rather than simply getting banks and bondholders to accept slightly riskier terms in exchange for higher interest payments. At the time, it was universally accepted that the logic was simply based on different risk appetites for different types of investor, with enormously clever computer models backing this up.

As it turned out, the actual reason was that the insurance companies had massively cocked up – they hugely underestimated the chances of defaults on the private-sector loans they made (mostly in US real estate. Yes, subprime mortgages again). And when the real estate companies whose bonds they were guaranteeing went bust, the insurance companies took the hit. So Syncora and FDIC are now both in serious financial trouble, and may become insolvent.

Who loses, and what can we do about it?

The insurance crisis doesn’t matter from the point of view of Reliance’s bonds: they’ve been sold, and the insurers’ failure is the bondholders’ problem. The same is true with the shareholders’ money. Reliance has $2.2bn in real money, and it will cover the vast majority of the project’s cost.

But it does matter for the overdraft: the bankers say that without the AAA rating that the insurance would have provided, their agreement to provide the extra $357m is null and void. So there is a danger that in the final stages of the roll-out, before the company starts receiving regular payments from RailCorp, it will run out of cash. This is what’s driving front-page headlines about ‘rail crisis goes off track’.

It’s the job of the opposition and the press to talk this up into a major disaster, with “$2.6 billion project in jeopardy and NSW taxpayer on the hook” headlines. But in truth, it isn’t a major disaster at all.

The insurers aren’t bust yet, and may not actually go bust at all – in which case, the banks will have to provide the overdraft. Even if they don’t, the bondholders will lose far more money if the contract collapses than if they agree to let the provider of the completion funding take precedence over their bonds (in other words, ensuring that if the company did go bust, the $357m would be paid before any of the bondholders are paid). So there’s a strong incentive for everyone in the private sector to work things out.

But let’s assume the worst financial scenario happens, and the NSW government ends up deciding to guarantee the $357m itself rather than see the introduction of the trains delayed until everyone’s sued everyone else to death. Reliance would pay the government back with interest over the life of the contract. The only risk to the NSW taxpayer would be if the project went so badly wrong that even with the $357m overdraft, the company was unable to bring the trains into service. This doesn’t look likely, considering the level of delays and the reported engineering quality of the trains so far.

A government bailout defeats some of the point of a PPP, in that NSW now has a financial interest in ensuring Reliance can pay its debts. But on the other hand, the private sector has already lost $274m (the value of shareholder equity in Reliance, which has been wiped out), and would lose still more if the final project went so wrong that the company did collapse (the $1.8bn in bonds). Even if NSW does end up having to underwrite some of the debt, this will still be a better deal for taxpayers than a traditional purchasing model.

For one: speed cameras are, entirely, a voluntary tax on idiots. Most non-urban speed limits are far lower than the safe speed for the average vehicle on the road in question driven by the average driver; that’s a given. But if you know a road has speed cameras on it, and you don’t drive within the speed limit as a result, you either don’t care about not being fined, or are too inept to drive within the parameters laid down by the law. And if you don’t know a road well enough to know whether it has speed cameras, then you don’t know whether it’ll suddenly turn into something where the speed limit is actually the maximum safe speed.

But for two: the people who hate speed cameras and the way that they impede their slightly-faster progress to wherever they’re going (not the ones who actually get caught, but the ones who do know the road, drive slower-than-required, and wish they didn’t have to) have a reasonable utility argument: why should fairly nebulous claims about accident reduction – and all claims about speed reduction leading to accident reduction in non-urban areas without a pedestrian presence are fairly nebulous – take precedence over people’s time? After all, part of the economic case for high-speed rail consists of the time savings involved – surely we should take them into account here as well?

In short: of course the Tory-led government is going to cut speed cameras, because its support base consists of Tories and Clarksons whose primary concern is “getting there quickly”. Meanwhile, since the last government’s support base consisted of urbanites and people who wanted to raise more tax money from society’s moral dregs, of course they were going to support speed cameras.

If the anti-clampdown is focused on motorways and A-roads, then the real-world effect will be negligible, except that the tax burden will be shifted slightly from Mr Toads to bus-using Sparts. If it also includes mixed-use urban single-carriageways, then kids will die. Hopefully, the impact will be the former – in which case, all we can say is “party rewards its supporters at its opponents’ financial expense; world neutral”.

(note: *safety*-neutral. Obviously, shifting the tax burden from Mr Toads to bus-using Sparts will also tend to shift it from rich to poor. File under “well, yeah, check out the blue rosettes”).

Once you’re in the air, the best alliance currently going is OneWorld, which features most of the world’s most likeable airlines, plus America’s least awful major one.

BA are the BBC of airlines; I’ve posted before about why I like them. In short, old-school Britishness is a good counterpart to the unpleasantness and sheer weirdness of long-haul flying.

AA aren’t as awful and generally customer-averse as the other US airlines (although they’re not good, reflecting the general impossibility of finding an airline to fly on in the US that is good. I haven’t had the chance to try Virgin America [**]. They may be an exception).

Cathay Pacific and Qantas are desperate to outperform BA for obvious, post-colonial reasons. And they do, a bit: Qantas has newer planes, because Australia is richer than the UK, and Cathay has prettier stewardesses. But the general experience across the three airlines is pretty similar.

Then here’s Iberia, who aren’t as bad as you’d expect: they’re the least worst airline with serious numbers of flights from Europe to South America, which is Useful.

Unfortunately, as I’ve posted before, British Airways spent most of the 2000s being run by an idiot. So when BA and airport operator BAA built their new terminal at Heathrow, which is OneWorld’s most important hub, they only made it big enough to accommodate BA flights – not to accommodate all OneWorld flights.

Terminal 5 is one of the best airport experiences in the world. It is architecturally stunning, it is massively useable; overall, it’s really not a bad place to pass a few hours. Or even a week. But flying into Heathrow on a OneWorld partner flight and out on a BA flight is a massive pain in the arse, and involves losing the far-from-lovely Terminal 3, and Heathrow’s terrible internal transport links.

Given that everyone’s endgame at the time T5 was being planned – even Rod Eddington’s – was to run OneWorld as an integrated airline, this is the most insanely stupid thing ever.

It means that for any long-haul journeys that don’t start or end in London, you’d do better to buy a Star Alliance ticket rather than a OneWorld ticket. And because BA and Qantas have integrated their UK-Australia routes and there’s no room to bring Qantas over, all BA flights to Singapore and Australia (so not important destinations or anything) also leave from Terminal 3, so again you’d be daft to use them or to try and transfer onto them.

The Star Alliance partners (the big ones are Lufthansa, United, Singapore and Air India) mostly aren’t as good as the OneWorld airlines, apart from Singapore, who are better. But they’ll have a single, integrated terminal at Heathrow that’s just as good as Terminal 5, as well as good hubs in Frankfurt and Singapore. So they’ll kick OneWorld’s arse on Europe-Asia/Pacific and Europe-US flights, despite offering mostly-German levels of customer service once you’re onboard.

This is what is known as “the kind of obviously stupid, even at the time, short-termist idiocy that could only be implemented by the management of a quoted UK company”.

[*] Obligatory footnote: if Jim Bliss is right about the scale of the impending oil crash, then none of the above applies. On the plus side, Terminal 5 will then easily be big enough to accommodate what’s left of OneWorld…

[**] It’ll be interesting to see what happens to Virgin alliance-wise and as ownership rules change. In theory, Virgin Atlantic, Virgin Blue/V Australia and Virgin America could be a decent global airline in their own right for primary routes, in the same way that at least one of the Middle Eastern carriers will survive. The problem here is that Star’s Singapore Airlines owns 49% of Virgin Atlantic. Integrating Virgin Atlantic into Star would kill it as a brand, and would leave the Aussie and US businesses as basically domestic/local carriers, which would be a terrible shame. But Richard Branson doesn’t have the cash to buy the stake back, and I can’t think of anyone else who’d be willing to fund the deal. For a start, the last company to back Branson on a major airline investment lost over a billion dollars and then quit passenger aviation for good….

The business model is unsustainable – but that’s the management’s fault, not the unions’

BA’s model before the global financial crisis was to charge a fortune for excellent service in Club World and First, while matching its competitors’ prices and service levels in World Traveller. Together with BA’s massive global coverage and its excellent connections between the financial boom centres of London, New York and Singapore, this business model allowed BA to attract a lot of passengers and make a lot of money.

This was lucky, as BA’s cost base is and remains far higher than that of its competitors. Not on planes, or marketing, or even management – but on staffing. At the time, the money that bankers were willing to pay to fly to Singapore in a bed whilst being served champers by reassuringly camp gentlemen was so vast that BA could get away with paying long-serving cabin staff double the national median wage.

However, this wasn’t a sustainable business model unless you believed the boom times would never end. BA should have taken advantage of the good times to stuff its current crews’ mouths with gold (pay rises, massive early retirement packages, one-off bonuses), in exchange for permission to hire new recruits under less generous contracts so that the long-term cost base was more sensible. Virgin Atlantic pays new recruits gbp15,000 ranging up to about gbp30,000 for senior crew, and anyone who’s flown on Virgin will confirm that this is enough to attract motivated people who provide excellent customer service.

Unfortunately, BA’s CEO for most of the boom – Rod Eddington – had approximately no aptitude for long-term strategic thinking, so kept with the status quo for an easy life (my assessment of his aptitude is supported by his report on UK transport policy two years ago, which managed to miss out high-speed rail completely. I’ve only just discovered via Google that he’s done much the same half-arsed job in Melbourne). Willie Walsh has a better track record, but by the time he’d taken over and settled in, the recession was already imminent. Now, BA has to cut costs for long-term survival, but doesn’t have the money to bribe its staff to accept the cuts.

The unions are in a far stronger position than most commentators realise

BA’s enterprise value – the amount that its assets plus goodwill are worth, before taking into account its financial liabilities – is something like GBP7bn. The reason its market cap is only GBP3bn is because it also has a GBP4bn pension deficit. In other words, money that BA owes to its workers and former workers accounts for more than half of the company’s total value.

This has two policy implications.

One is that Red Tory Philip Blond’s suggestion that the government should mutualise BA isn’t quite as insane as it looks – more than half the company is already owned by the workers, and if things were to get worse then the pension fund has priority over the shareholders as a creditor. A deal like the one the US government brokered for GM, leaving the workers as majority shareholders, isn’t totally implausible.

The other consequence of this ownership pattern is something which should make BA shareholders rather nervous.

If the industrial action were to turn into a major, long-term dispute that drove down passenger numbers and revenues to such a severe extent that BA had to go into administration, then the pension fund would have priority over BA’s assets (including not only its physical assets, but also its brands, goodwill, systems, etc). It’d be hard work to rebuild BA as a global brand after that kind of collapse, but it wouldn’t be impossible – particularly with worker ownership ending the company’s labour crisis overnight. The shareholders, however, would lose everything.

So while the “nobody backs down” outcome isn’t good for either side (as the workers lose salary in the short term, and in the long term their pensions end up secured on a much less valuable asset), it’s a lot more optimal for the workers than it is for the shareholders. This makes negotiations, erm, challenging.

Conclusions? None really, except that I wouldn’t want Willie Walsh’s job, and Rod Eddington shouldn’t be put in charge of the strategic direction of a whelk stall (although he’s probably competent to administer one day-to-day).

**********

Update: another conclusion is that if you blame the strikes on Gordon Brown’s ‘weakness’, you’re so utterly clueless that you shouldn’t even be allowed to assist Rod Eddington at his whelk stall…

Update 2: Jim notes that BA’s business model is also unsustainable in the sense that the oil’s going to run out. This is true, and worth a read (I’m not yet totally sold on Jim’s view on precisely when the oil’s going to run out, but that’s mostly based on sheer incredulity that if the oil’s really going to start running seriously short by 2015, governments and large companies haven’t done more to mitigate that. The GFC highlights that this may be over-trusting of me…).

Under devolution, it is for the Mayor and TfL to deliver the Tube upgrades within their generous budget – not for me to bail them out if they fail to do so.

If Boris wants me to take charge of TfL then he should say, and I would start with more sensible priorities like not cancelling the Western congestion charge zone and not replacing a modern bus fleet needlessly – both of which are costing Londoners hundreds of millions of pounds which could be spent on upgrading the Tube.

At some point, I’m going to post on why Tube PPP was a Good Thing (at least, given 2000s capital market conditions – it’s possible that credit availability over the next 10 years will mean that PPP/PFI is no longer as good an idea as it was during the Blair years). It boils down to “the government is committed to paying the money whether it wants to or not, rather than buggering about with the budget year-on-year as happened from 1945-1997″.

(yes, this kind of long-term commitment sacrifices democratic decisionmaking in favour of efficiency. As regular readers will hopefully have picked up, this blog has no moral attachment to the concept of democracy, or “rule by a mob of ignorant idiots”; the only reason I’m not actively opposed to it is the empirical one that other means of governance generally seem to turn out even worse.)

FD035 – Fatigue and Defensive Driving RUH
You are driving an older relative for an appointment and are running late. They ask you to go faster to get there on time. You should –
a) Choose a safe speed and say you will not go any faster
b) Take the advice of a more experience driver and go faster where you can.
c) Drop them off at the train station.

According to the Bumper Book of Common Sense, a) is the only permissible answer.

This is bad and wrong. When some silly old sod is hassling a kid (since 95%+ of Australians learn to drive in their teens) to drive dangerously, “here’s the train station, now piss off” is clearly the most appropriate response…