A bridge too far? London's massive transport gamble

Commuters travelling on London's buses, trains and Tubes looked especially glum last week. Not only was it the first week back to work for millions after the festive break, but they'd just been stung by transport fare rises of up to 40 per cent.

The increases are part of what is a potentially huge gamble by the London Mayor, Ken Livingstone. And an analysis of how his Transport for London (TfL) body is financed reveals that the odds could be stacked against him.

Mr Livingstone wants to kick off what will be an unprecedented level of spending on London transport to reverse decades of under-investment. Over the next five years he plans to spend £10bn on a variety of high-profile schemes (see the box below).

This programme will be principally funded by debt and government grants. But under a series of complex financial arrangements, these vast sums of money will only become available if public transport fares go up.

This carries an obvious political risk. Last week's inflation-busting increases won't be the first. A TfL spokesman admits: "There will be probably be above-inflation rises next year and possibly the year after."

With mayoral elections in 2008, and with some members of the TfL board privately expressing concern over what one source describes as "the Stalinist way in which transport decisions are made", the fare policy is not one for the faint-hearted politician. As well as the political danger, there is evidence that the way the transport policies are being funded carries a great deal of financial risk. Even the smallest failure could see schemes axed.

According to TfL accounts, fare revenues from its main operating subsidiary, Transport Trading Limited, totalled £1.8bn last year. This year's fare hike will raise £125m, according to TfL.

So why are the fare rises so critical to Mr Livingstone's plans?

One reason is that the Mayor's budgets are finely balanced. Every pound of future income has already been accounted for, either in keeping existing transport schemes ticking over or for investment in new projects.

A TfL spokesman says that its investment plan is deliberately "over-programmed", which means that if there were a budget shortfall then some projects would be ditched.

Robert Robinson, an analyst at credit rating agency Standard & Poor's, says: "If TfL didn't raise fares then it would have to cut its cloth accordingly. TfL would have to scale back on what it is proposing."

If this happened then Mr Livingstone might lose face with the voters, but it could also damage TfL's standing in the Square Mile.

Over the next five years, TfL is planning to raise up to £2.9bn through the bond market. Last month it issued its first bond, valued at £200m. This went well, with the bond receiving a AA credit rating - the third-highest grade - and the issue was oversubscribed. On the back of this success, TfL is expected to issue a second £200m bond in March.

But the City is taking a lot on trust. "The current TfL board does not have a track record. The only thing we can really assess it on is the current five-year business plan," says Nicolas Painvin, an analyst at Fitch, a rival credit rating agency. One slip in delivering the plan and this could affect TfL's ability to raise more debt on its current terms. "It is important that the plan is implemented for the sake of the [TfL's bond] rating," adds Mr Painvin.

TfL's financial house of cards doesn't stop here. In July, Mr Livingstone pulled off what was widely regarded as a political masterstroke by persuading the Treasury to commit itself to paying TfL a grant for an unprecedented five years. To secure the £12.3bn, it is understood that the Mayor agreed to certain financial commitments, such as raising fares.

While the agreement from the Treasury is not legally binding, it is nevertheless essential to securing City backing for the bonds.

Tony Travers, director of the Greater London Group at the London School of Economics, says: "Take a look at TfL's bond document which was sent to the City. At one point TfL warns that it can't guarantee that the Government will keep paying it the grant. So Ken and his American lieutenant, Bob Kiley, are in effect warning the Government: 'If you don't pay up then you will have to face the City.' This is quite shrewd."

Nevertheless, Mr Travers describes Mr Livingstone's policies as "totally upside down" because the transport improvements are based on fare rises. "If you live in London and don't own a car then you face the biggest increase in transport costs," he says.

Let's assume that Mr Livingstone manages to jack up fares in the next two years, that the Government coughs up the grant and that the City remains onside. Even then there is another danger lurking in the Mayor's transport plan - project failure.

Big infrastructure schemes in London have a habit of going wrong. The £3.4bn Jubilee Line extension went over budget and at one point was two years behind schedule before the Government hired US construction firm Bechtel to bang heads together. More recently, the Millennium footbridge over the Thames condemned itself to being known as the "wobbly bridge" after its gyrations forced its closure for nearly two years.

The biggest project in TfL's five-year programme is the extension to the East London Line. Because this doesn't require any tunnelling , engineering experts do not anticipate any major difficulties. However, a project delay or modest cost overrun could bust the Mayor's budget.

There are new potential sources of revenue available to Mr Livingstone. He is considering increasing the daily congestion charge this summer from £5 to £8, which would boost TfL's income from the system. This totalled £78m in its first year.

But there are concerns over Mr Livingstone's plans to extend the zone west to encompass the affluent areas of Chelsea and Kensington, possibly in 2007. Under the proposals, residents in these locations would receive a 90 per cent charge discount for living within the zone. It is for this reason that Tony Grayling, an associate director at the Institute for Public Policy Research, the left-leaning think-tank, believes the financial gain from extending the zone would be limited: some people who pay full price for driving in central London now would only pay 10 per cent after the change. "It will use up lots of energy with limited gain in terms of traffic reduction and new capital," he says.

Wind forward to 2007 and consider the joint effects of the congestion charge extension and another transport fare rise: a wealthy Chelsea resident would pay less to drive to central London by car while someone in Peckham would pay more to travel by bus.

Mr Grayling warns that on top of the social consequences there is an economic danger in the Mayor's higher fares strategy. "Evidence suggests that a 10 per cent public transport rise might result in a fall of 4 per cent in usage. This could rise to 8 to 9 per cent in the long term. You don't get very far by increasing fares."

Mr Livingstone has won praise as a politician who is not afraid to make tough decisions and take risks. London is undoubtedly crying out for new transport infrastructure, especially in the east. But by relying on levering billions of pounds on the back of rises in public transport fares, the Mayor may be taking a gamble too far.

SEVEN STEPS: KEN LIVINGSTONE'S DREAM SCHEMES TO GET LONDON MOVING

East London Line extension

This is the biggest single transport infrastructure project in the Mayor's five-year plan, costing TfL £896m. Under the initiative, the line will be extended north to Dalston and south to Crystal Palace and West Croydon. The scheme is due to be completed by June 2010 and features in Britain's bid to host the 2012 Olympics .

Crossrail

A Bill for the long-delayed £12bn east-west London rail project should finally be laid before Parliament at the end of February or early March. But this does not guarantee that it will be built by the Government's self-imposed 2013-14 deadline. It is still unclear how the project will be funded and, while the Treasury is expected to underwrite the costs, TfL will have to dip into its pocket. Because Crossrail won't be built until the next decade, only £45m is allocated in TfL's five-year spending plans for the scheme.

Thames Gateway Bridge

A proposed east London road bridge connecting Beckton on the north bank to Thamesmead on the south, the £455m Private Finance Initiative scheme has won support from Newham and Greenwich councils. Subject to approval from the Deputy Prime Minister, John Prescott, the three-year project to construct the crossing could start in 2009. TfL will pay £72m, the Government £200m and the remainder will be paid through £1 and £2 road tolls to cross the bridge.

Extension to the congestion zone

The controversial scheme will see the charging zone extended into west London's affluent Chelsea and Kensington, as well as parts of Hammersmith. Budgeted at £275m, the scheme has been attacked by the residents of the affected London boroughs. The scheme could be introduced in February 2007, if the Mayor gives the final go-ahead. But he has warned that Capita, the company that installed the original charging system in London, won't necessarily be handed the contract.

London Underground improvements

More than half, or £5.5bn, of TfL's five-year transport budget will go down the Tube. Much of the work - such as track replacement, improvements to trains and new signals - will be carried out through the contractors operating the London Underground Public-Private Partnerships. But TfL will also invest money directly and through newly established Private Finance Initiative contracts for specific works, such as increasing the capacity at London Underground stations.

DLR railway extension and upgrade

The Docklands Light Railway will be extended to Woolwich Arsenal by 2008, adding to the extra links to City Airport and North Woolwich due to be completed at the end of this year. Last month, project management company Amec and Royal Bank of Scotland were selected as preferred bidders for the contracts. With planned upgrade work, TfL will spend £344m on the DLR over five years.

West London tram

A 20km route linking Shepherd's Bush to Uxbridge, the scheme was excluded from the Mayor's five-year plan though lack of funds. But TfL hopes to resurrect the idea in the next decade.