On the right road

1 September 2012 The government is asking some big questions on road investment. Paul Jarvis considers whether the Mersey Gateway might provide some of the best answers
A new road connection between two towns south-east of Liverpool may not immediately grab the imagination.

But factor in the construction of a new bridge across the Mersey Estuary, at an estimated cost of just under £600m, the tolling of that bridge and the existing crossing, and the presence of two million people living within 30 minutes’ travel time, and it is little wonder the scheme features on the government’s list of priority projects.

It is not just the numbers, though. At the heart of the Mersey Gateway lies a tension that is being replicated across the UK: how do you build new road infrastructure at a time when finance is almost impossible to get hold of? And how do you get the private sector interested in this market when, around the world, tolling schemes are falling over because of a lack of motorists willing to pay for the privilege?

If the team at Mersey Gateway can answer these questions, the project could become an exemplar for the rest of the country as the government looks to redefine its role in funding Britain’s roads. The Treasury and Department for Transport’s joint report into how the private sector could be more effectively leveraged in road building and maintenance is due on the prime minister’s desk this autumn and the Mersey Gateway project could inform that report.

One of the most keenly anticipated aspects of the project will be the preferred funding solution. At a time when bank debt is off the menu – at least to fund the entire project – finding a successful alternative will be welcomed by the whole industry.

“There are three general approaches that different people are looking at,” says Richard Threlfall, UK head of infrastructure at KPMG, which is advising Halton Borough Council on the project. First, there are the sort of approaches that have long been touted as a way to bring pension funds into the infrastructure market, relying on short-term debt that is flipped into a long-term financing arrangement once construction is complete.

“The question on these is who takes the refinancing risk,” Threlfall says. Then there are those ideas – also touted as a route to institutional investment – that involve mezzanine debt. This could well involve the much-touted Hadrian’s Wall Capital approach, which recently closed its first fund and is looking hungrily for investment opportunities.

“And there’s the approach looking at the potential for public borrowing credit,” Threlfall continues. “For example US-style municipal borrowing, which relies on the public authority getting a credit rating and being able to use that to attract investment through the capital markets.”

With the project yet to choose a preferred bidder, it remains some time before the favoured solution is chosen, and it may even be possible for more than one approach to be used.

“We want to encourage bidders to be innovative about the forms of finance they use,” adds Mark Swindell, founding partner of Rock Infrastructure and the project’s commercial director.

History boys
The Mersey Gateway has had a long gestation period. The existing Jubilee Bridge serving the area reached its capacity long ago, resulting in queues during rush hour and beyond.

“Existing Mersey crossings are pretty limited and the government has been pressed by the local authorities for some time to provide a new crossing,” says Steve Nicholson, project director at Halton Borough Council. “So the business case has always been very strong.”

Having originally secured PFI credits back in 2006, the scheme was put on hold by the coalition government four years later. The project was then approved in the 2010 spending review. In October last year, it was decided the government would provide over £150m in grants to the deal to ensure tolls would not be dictated by the cost of the project.

And in July, the project was touted as a possible beneficiary of the government’s guarantees initiative, whereby the state will underwrite private investment in significant infrastructure projects. Nicholson admits this is “encouraging”, but the project will go to the market first to discover what the appetite is before thinking about applying to the initiative.

“We need evidence about the current state of the market first,” he says. “But we know we have that safety net there now.”

Where demand risk sits may well have a bearing on the need for that safety net. “When we started, it was a concession project,” says Swindell, a former DLA Piper lawyer. “We decided to change it to a design-build-finance-operate contract because we didn’t believe we would get a funder to back the long-term demand risk.”

Nicholson points out that when the private sector takes the demand risk, “it results in some serious contingencies being built in. It means aproject’s commercial viability is tested on some pretty unlikely scenarios.”

The council’s approach significantly de-risks the project from the private sector’s point of view, but it also gives the authority much greater control over the level of toll being levied. “It was conceived as socially regulated tolling – we couldn’t accept market-driven tolls, the area is just not compatible with that,” says Nicholson.

“We had a benchmark for this from the nearby Mersey Tunnels, which have been operating tolls for 50 years.”

Having taken the demand risk out of the project, though, the Mersey Gateway team were left with the question of how to incentivise private sector performance over the life of the contract. The answer was the creation of a second, concurrent contract creating a Demand Management Participation Authority (DMPA), involving both Halton and the private contractor. This organisation will include the marketing, toll-setting and collation expertise of the private bidder, says Swindell. Under this contract, the private sector will be responsible not only for the availability of the new road, but also that of the existing Jubilee Bridge – which will also be tolled.

And further, the contractor’s performance will be measured on journey times. Rather than installing traditional toll plazas, the bridges will use the latest technology to capture vehicle data, both ensuring tolls can be charged without impacting the driving experience, and enabling the authority to monitor how quickly vehicles are getting across.

It is this innovation that seems to most excite those working on the project. “We go to the ultimate output, because the availability payment is based on time,” says Swindell. “If traffic is flowing at more than 40mph then the private provider gets paid, but if not it will get paid less.”

“The cunning thing about this contract is that we’re concentrating the demand risk question in the equity, by separating it from the contract, and isolating the debt from exposure to the demand risk,” adds Threlfall.

New horizons
Such an innovative approach is certainly something that could be developed more widely by the government. It might even be possible to imagine the Highways Agency paying the private sector on the basis of how fast traffic is flowing on its major routes, thus potentially providing the impetus to tackle pinch-points around the country.

Despite the experience of the nearby M6 toll, where traffic volumes have steadily declined as motorists refuse to pay the extra rather than queue on an existing route, Nicholson suggests such an approach could be used to build relief roads on some of the worst stretches.

“High-value trips will be willing to pay the tolls,” he says. “For example, one of our biggest supporters is [haulage giant Eddie] Stobart. Transport will see the economic benefit of reliability.”

Others are not convinced, though, and suggest the only way the tolling regime being planned in Halton could be replicated away from crossings would be through tolling the entire major road network.

“In my opinion, there is an inevitability that we will see road pricing across the country in the future,” says one expert. “A lot of the government’s policy plans don’t make sense without it.”

Indeed, the fact the Mersey project has been allowed to toll the existing bridge has been a vital concession from the transport department, ensuring that a free alternative route is not realistically available.

Earlier this year, Prime Minister David Cameron insisted tolls would not be applied to existing roads. But ministers have already announced proposals to toll part of the existing A14 to fund improvement work. Scott Wilson, associate director at consultancy LeighFisher, suggests the government’s policy has been extended to include an existing road when a new road has been built parallel to it.

“The proposal looks innovative,” he continues, “but the key will be how attractive the new parallel local roads will be compared to the tolled existing route for through traffic.”

But Wilson remains unsure whether the Mersey example is exportable to great swathes of other projects across the country. “Looking at the projects that have been deferred by the Highways Agency because of a lack of funding, I struggle to find any that fit the definition of being a bypass of pinch-points that could be easily tolled, beyond the A14 and Dartford Crossing.”

Small changes, big potential

Beyond the big changes being developed as the Mersey Gateway is progressed, the scheme is also coming up with smaller innovations that may prove just as important to future deals.

“We are well aware of [Cabinet minister] Francis Maude’s direction of not using Competitive Dialogue if you can help it,” says Swindell. “We have had to use it because this project has so many innovative elements. But we have been careful to make it as fast and cheap as possible.” He points to the number of dialogue sessions being carried out by the team: five instead of the more usual 10. Nicholson, too, is keen to stress the pared down nature of the bidding process, with the authority immediately choosing a shortlist of three bidders rather than the usual five or more.

“We had many more than three consortia applying to be prequalified,” he says. Another key aspect to the prolonged success of the project will be the DMPA itself, which will see the Mersey Gateway Crossing Board established to be the counterparty to the PPP contract.

“The infrastructure is being accompanied by structural change,” says Nicholson. “It’s also helping the market to be able to look and see a counterparty on the public side.”

Whether it is the funding mechanism, the financing solution, or something else, it seems inevitable that the Mersey Gateway will play an important role in the review of road financing being undertaken by the Department for Transport and Treasury.

“The government is getting infrastructure for 25% of its full cost thanks to the tolls,” Nicholson continues. “It means its roads strategy will go a lot further. Projects like this, which mean the government gets more for less, will be inevitable.

“Whether it is a template for the future, time will tell, but it will certainly provide plenty of direction.”

This page was last updated on:
7 November 2012.

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