Assessment of UK rail Infrastructure Owner's management of inflation risk
The Problem: Historic RPI inflation leading to swings in expenditure
The Infrastructure Owner's expenditure is c.£6bn p.a., c.£4bn of which is funded through its network grant from the Government.
All income and expenditure has historically been inflated by RPI which has meant substantial swings in expenditure. The budgetary uncertainty that the Treasury funds can be up to £300m p.a.
Our Approach: Quantification of inflation risk
In order to constrain the financial uncertainty related to the network grant, the Regulator commissioned a study to assess the management of input price and general inflation.
The study was intended to inform the debate between the Regulator and Infrastructure Owner on the final determination for CP5 funding (c.£42bn over 5 years).
Our work covered:
- A review of the procured cost base, involving analysis of over 60 contracts
- An assessment of the value of trade offs (with unions) made in the employed cost base
- An assessment of the inflation protection used in property income
- Benchmarking commercial risk structures with other infrastructure owners
- Business modelling covering the quantification of inflation risk
The Result: Recommendations for inflation management
In the final report submitted to the UK Rail Regulator we:
- Quantified the materiality of inflation. Cumulative inflation over the control period was 16% of expenditure, this compares with efficiencies of 23% over the same period
- Identified procurement categories where inflation risk was inappropriately managed, and therefore where the buyer was leaving money on the table
- Developed a 15 principle inflation management framework. Benchmarking revealed other industries where infrastructure owners were using a variety of measures to curtail inflation
- Identified pragmatic recommendations for the Infrastructure Owner to improve its management of inflation. Over 20 ideas were proposed that covered cultural and behavioural change, input price modelling, improved internal processes and the introduction of new skill sets
Our report has recently been published by the Office of Rail Regulation and can be found on their website. [Download]