CoverStory
Broken models
What lessons could AAT members learn from the finance failures of HS2?
What lessons could AAT members learn from the finance failures of HS2? By Lawrie Holmes
While the political decision to axe the northern leg of Europe’s biggest infrastructure project has come under the spotlight, observers have raised concerns about how HS2 was modelled and financially managed from the start.
The scale of HS2 is vast, but AAT members may be surprised to learn the project was beset by issues that are probably familiar to them. Optimistic forecasts, scope changes and poor management and controls all played their part.
Mistake: project benefits were oversold
The Department of Transport’s (DfT’s) October 2013 report The strategic case for HS2 provides clues to the challenges that followed, says Roger Vickerman, emeritus professor of European economics at the University of Kent. Although the DfT report, which promised to open up “new markets, new job opportunities, and new opportunities for growth” offered no numbers to support those claims, adviser KPMG found total annual productivity impacts for the UK would be around £15bn.
In its report out the previous month, the Big Four firm said £13bn would come each year from rail connectivity to businesses, £1bn from rail connectivity to labour and £0.2bn from car connectivity to labour and businesses. KPMG, which declined to talk on the issue for this article, says its data and assumptions dated from 2010 when it published High Speed Rail in Britain: Consequences for employment and economic growth.
In DfT’s HS2 cost-benefit analysis in January 2012, it calculated net benefits of the London to West Midlands line generating net benefits of £22.2bn compared revenues of £13.9bn and net cost of £13.5bn and the Y Network (from Birmingham connecting Manchester and other cities in the north) delivering net benefits in the range of £47.2 to £59.3bn compared to revenues of between £31.8bn and £34bn and costs of between £26.3bn and £24.1bn. Jacco Thijssen, professor of mathematical finance at the University of York, says: “It is not clear at all where these figures came from.”
Mistake: people-pleasing by project lead
Thijssen says the cost-benefit ratio undertaken by DfT was characterised by a failure to take into account how sensitive construction delays and scope changes can be to the modelling. Many AAT members will know that optimism bias in scenarios such as this can be dangerous and result in overly rosy forecasts and expectations. When those figures are accepted, they can quickly be outstripped by reality.
“As soon as there’s a construction delay, you have two effects. On the one hand, you incur your construction costs for longer, so you expect costs go up. At the same time, you’re delaying the point where the revenues are starting.
“The problem with the construction delay is that it lowers the numerator of this cost benefit ratio, and also the denominator, and they both work in the wrong direction,” says Prof Thijssen.
The problem with the construction delay is that it lowers the numerator of this cost benefit ratio, and also the denominator, and they both work in the wrong direction"
Jacco Thijssen, professor of mathematical finance at the University of York
Mistake: project-sign off trumped viability
“Calculation of the benefits was generously interpreted,” says Len Shackleton, professor of economics at the University of Buckingham. “A lot of cost-benefit analysis was subverted when looking for evidence to support the scheme, which got a lot of ministerial push behind it,” he says.
Prof Vickerman says that HS2 costs rose sharply when the 400kmh maximum train speed, which he insists was unnecessary because of limited time savings, created huge costs from tunnelling and other expensive engineering.
“We always make things more expensive by giving in to various lobbies. The amount of tunnelling that’s being involved is excessive compared to France and Spain because of the density of population is very different in the UK, so it’s bound to be more expensive.”
Prof Vickerman says the costs were challenged in reports by the National Audit Office (NAO).
“They are critical because of a lack of genuine oversight into what the project was trying to achieve,” he says.
AAT members who have worked on large projects will know that scope changes such as those that occurred on HS2 can prove fatal for a project, as they lead to huge additional expense and can drastically affect delivery dates.
An NAO report last March said the budget set for developing the HS2 terminus at London’s Euston station had risen from £2.6bn in April 2020 to £4.4bn two months later. Among its findings, the NAO said the budget for Euston station “was fixed too early and too low for what was intended”.
Key gaps in the finance team
If that were not enough, HS2 Ltd was beset by a lack of oversight and direction from the top. It failed to appoint a chair despite having had more than a year to do so.
HS2 Ltd was without a finance director for a lengthy period, later addressed by the appointment in June of Keith Smithson, former European CFO of Barclays.
Senior personnel changes, particularly lengthy vacancies, can negatively affect controls and allow financial issues, such as growing costs, to develop unaddressed.
In his explanation of the decision to scrap HS2’s Birmingham to Manchester section, prime minister Rishi Sunak said “the facts had changed”, but experts assessing the HS2 plan paint a picture of a lack of robust modelling and accountability, that had to be tinkered with in the face of continual challenge. In essence, the facts were changing all along.
Ultimately, as any AAT member who has worked on a major project knows, no project can sustain that level of change and uncertainty and be successful.
Cost benefit
Benefit-cost ratio (£bn, 2011 price base, 60 year appraisal period)
