Metronet puts its future on the line

It is the industry’s answer to Paul McCartney and Heather Mills. Almost. Not a week goes by without dirt being flung very publicly between Metronet, the PPP tube consortium, and London Underground.

This week, things got even messier. As Atkins, which has a 20% stake in Metronet, revealed its £121m loss on the contract, Metronet called in an independent arbiter to conduct an extraordinary review to try to recover about £2bn of cost overruns.

It has requested that the arbiter, Chris Bolt, award it £400m over the next 12 months through the infrastructure service charge that London Underground pays it every four weeks. Metronet says it needs that money to free up its cash flow and deliver its contractual obligations.

That demonstrates the severity of the situation. If it doesn’t get the emergency funding, the chances of it going bust are higher; London Underground has already made contingency plans to take over some maintenance work if that happened.

Metronet is claiming that it has overspent by £992m on its deep tube line contract, which covers the Bakerloo, Central, Victoria, and Waterloo & City lines. It will also claim a £1bn overspend on its the sub–surface lines, comprising the Metropolitan, District, Circle, Hammersmith & City and East London branches. This will be considered in a second review, to be held in August. Contrast that with Tube Lines, the PPP responsible for the other third of the underground, which in the same week announced that it had won two awards for innovation, and you might ask: why is it going so wrong for Metronet?

Crumbling assets

The signs were ominous from the beginning. Keith Clarke (pictured left), the chief executive of Atkins since 2003, has described the contract as the most complex he has ever seen. Those who have seen it say that it runs into tens of thousands of pages, split over a number of documents, and that scale greatly increases the scope for disputes.

Metronet is adamant that it inherited assets that were in a poorer state than Tube Lines, which is responsible for the Jubilee, Piccadilly, and Northern lines. The Jubilee line, for example, was newly extended and upgraded before Tube Lines got hold of it.

Paul Emberley, director of communications at Metronet, said: “In many cases our assets were in a much more degraded state than Tube Lines’. Many were 150 years old.”

It is true that Metronet is responsible for the oldest part on the network. It is also true that some of the trains and signalling systems were 40 years old. But at the same time, Tube Lines has got to deal with the Northern line, considered to be the most difficult to upgrade because it is one of the oldest, is extremely deep, complex, and carries more passengers than any other single line – an average of 750,000 a day.

Changing track

One of the major distinctions between Metronet’s contract and Tube Lines’ is that at the outset, in 2003, the former opted to use a tied supply chain comprising four of its five shareholders for the stations upgrade programme. Tube Lines on the other hand outsourced the work from the beginning. Admitting in February this year that it should have gone down the same road, Metronet announced that it would adapt the same model from then on.

Unsurprisingly Metronet is keen to disassociate itself from the past. “In the first couple of years our management processes simply weren’t good enough. The way that our tied supply chain was organised was not working effectively and that’s why we’ve changed to outsourcing,” says Emberley.

So far it has appointed other contractors on six station upgrades, including Taylor Woodrow at Baker Street and Costain at Embankment. This is the plan for all the remaining station upgrades where Metronet shareholders haven’t already started on site (a total of 89 stations).

Is Metronet the right vehicle? Possibly not. Are Balfour Beatty and Atkins the right companies to do the work? Probably yes

A senior city source

London Underground is reserving judgment. “There is no evidence that it is having any impact yet,” a spokesperson says. “Giving the work to a supply chain which was also the shareholders certainly didn’t work. Metronet has been unable to put pressure on its shareholders.”

The scope of work

Emberley is quick to point out that there were complicating factors. He says that the early upgrades, for example at King’s Cross and Oxford Circus, were larger than anything Tube Lines had to deal with. Metronet has also complained that the client has increased the scope of work that it wants on the station upgrades, including the repainting of recently painted walls and the refurbishment of back office space in stations.

It is London Underground’s increase in the scope of work that has triggered the extraordinary review. It is not a fixed price contract, says Metronet, so any extra work needs to be paid for.

Graham Pimlott, the chairman of Metronet, is straightforward on this: “Where we have made mistakes our shareholders have borne the cost. However, the PPP terms are clear – where additional spending is required to meet London Underground’s demands, then we are entitled to be paid.

“We have advised London Underground that their insistence on the high specification for the stations upgrade programme is rendering the programme unaffordable and will result in a great deal of overspend.”

According to Emberley, whereas Tube Lines agreed to get on with the increased scope, Metronet first wanted to agree on the extra work that was to be undertaken.

These factors combined to present Metronet with a larger capital expenditure burden than Tube Lines, although Tube Lines again had an advantage by being based on an operations expenditure model. This meant that a lot of its risk was transferred to the contractors it had outsourced work to.

Metronet is of course keen to stress that it has had some success. It is only the programme of station upgrades that is now behind schedule, and it is predicting that it will finish six months ahead of its February 2009 deadline on the District line fleet.

So, what now?

In public Atkins and Balfour Beatty, its consortium partner that is also taking a £100m exceptional charge over Metronet, have responded with dignity in the face of a constant barrage of criticism from their client. However, privately, disquiet is growing among senior executives, aware that, as quoted companies, their shareholders and the City are getting anxious.

As Howard Seymour, an analyst at Bridgewell Securities says, neither company is contractually required to put in more equity. The issue is, would Metronet go bust if they don’t? Seymour says the Metronet contract is one of the biggest ever examples of risk transfer. “It is a genuine PFI. They are taking the risk on a hugely complex project.”

But London Underground is also caught between a rock and a hard place. It has taken a combative approach to Metronet, but despite all the problems, it is difficult to see which companies would be better suited to the job. As one senior City source says: “Is Metronet the right vehicle? Possibly not. Are Balfour Beatty and Atkins the right companies to do the work? Probably yes.”

It is likely to be at least a year before we know whether irreconcilable differences lead to a permanent split, or whether Metronet can remember what it first saw in London Underground and give it another go.