House of Commons - Trade and Industry

Select Committee on Trade and Industry Ninth Report

III PUBLIC PRIVATE PARTNERSHIP

15. The decision of Ministers in 1998 to review the status of BNFL, with a view to introducing a public private partnership (PPP), seems to have been prompted primarily by the perception that the integration of the Magnox generation business into BNFL, the hasty acquisition in June 1998 of Westinghouse's nuclear business,[14] and the winning by BNFL's US subsidiary BNFL Inc of two major US nuclear waste clean-up contracts, had so changed the nature of the company as to require a fundamental review of its future status. The Secretary of State told us on 4 November 1998 that BNFL was undergoing "a very significant change" as a result of the Westinghouse acquisition and the integration of Magnox.[15] The summary made public in July 1999 of the report from KPMG on options for the future structure of BNFL records —

It was not therefore a perception of incompetence or underperformance by BNFL which originally prompted a review of its status and structure, but of rapid growth in the company demanding a fresh look .

KPMG review

16. The then Secretary of State told us in November 1998 that nothing was ruled out in the KPMG study, including privatisation. A written answer of 11 November 1998 referred to "an initial review of the options for BNFL's future structure including, but not restricted to, some form of Public Private Partnership, having regard to the Government's objectives ......".[17] These objectives covered safety and environmental impact; efficient management of liabilities; efficient management of company and employee involvement: maximising the value of the business; and full value for the taxpayer in any "full or partial sale of assets".[18] While the terms of reference of the KPMG review did not restrict consideration of options to a PPP, it is apparent that it was understood from the start that this was indeed the intended outcome. The first study was entitled "BNFL-Public Private Partnership Options" . The terms of reference of the KPMG study as recorded in the published summary of its report in July 1999 were "to carry out a review of the various options for BNFL's future structure and to see how greater private sector disciplines might be introduced into the company." The report noted -

There is no sign from the published summary of the review that any option other than a minority shareholding was given any detailed consideration.

17. The first report, completed in December 1998, evaluated four groups of PPP options, in addition to the status quo option — an enhanced status quo option through much greater use of joint ventures; an option of sale of all or part of the equity in BNFL; an equity sale option excluding liabilities; and a partial sale (of THORP and/or US operations).

The report effectively dismissed the status quo option: "some improvements could be made to the accountability and incentive framework but the most difficult area is that of improving ownership pressures on BNFL."
The enhanced status quo option was unsurprisingly judged to be better than nothing, but the report suggested that joint ventures "would be unlikely to be beneficial in the existing businesses."
The report noted that, as a result of the "lack of interest among financial investors" and the difficulty in identifying appropriate potential trade investors, an Initial Public Offering (IPO) was the only equity sale option. The report stated that an equity sale was feasible and offered the "most comprehensive opportunity for the introduction of private sector disciplines and freedoms."
The options of sales excluding liabilities and a partial sale were examined but found wanting as a result of operational and regulatory difficulties in splitting the Sellafield site, and the fact that the objective of introducing private sector disciplines into all of BNFL would not be met.

18. The second report, commissioned in February 1999, addressed three questions all predicated on a minority sale of some sort, all essentially tactical — whether greater value would be achieved by selling BNFL as a whole or split up: whether to pursue a fast track (pre-General Election) or slow track sale; and on a work programme "to prepare for a PPP leading to the possible sale of up to 49% of its equity some time after mid-2000." From the summary of the KPMG reports, it was clear that

an Initial Public Offering (IPO) was the only feasible route for equity sales, given the reported "lack of interest among financial investors" and difficulty in identifying appropriate potential trade investors for even part of the business;
sale as a whole, including liabilities, was preferable to a division or partial sale;
a fast track PPP would have a greater impact on performance than a delayed PPP.

19. In his written answer of 13 July 1999 the Secretary of State stated --

In oral evidence on 3 April 2000 the Minister of Energy told us that the " PPP grew out of that original KPMG analysis of the business.."[21] From the published summary of KPMG's work, it is by no means self-evident that the injection of private sector capital through a PPP is the best way of injecting private sector disciplines. No alternative means of introducing private sector disciplines seems to have been considered. It seems to have been assumed from the start that only "ownership disciplines" could produce the required improvement in performance.

Privatisation

20. Given the repeated reference to private sector ownership disciplines, some analysis might also have been thought required of the extent to which the majority ownership remaining with the Government might blunt the impact of ownership discipline. So far as can be gathered from the published summary, the KPMG options review did not consider the merits of a full privatisation of BNFL in achieving the Government's stated objectives. It merely noted the statutory constraint on sale of over 49% of the equity. The reasonable assumption was made by KPMG that "constraints in the legislative timetable" ruled this out before a General Election. The review did examine the potential effects on the price to be achieved in a majority as opposed to a minority sale, and found no evidence to suggest that there would be a premium attaching to a majority share sale. KPMG was asked to look at the value for money to be achieved by a partial as opposed to a full privatisation, but not at the operational merits of the two options.

21. We have found no particular enthusiasm for full privatisation of BNFL. We have also found general confidence that a PPP along the lines envisaged would be as likely to deliver the anticipated benefits as a full privatisation. The Chief Executive of British Energy, for example, told us —

"I have absolutely no doubt that the pressures and requirements of private sector shareholding, whether they are 49 per cent, 51 per cent or 100 per cent are likely to make a company operate more efficiently."[

The Minister told us —

Even if there were the legislative time available and the Government were not opposed to the idea, a number of factors militate against full privatisation —

customer confidence: the Chairman of BNFL suggested that "it will encourage some customers to know that there is a government shareholding":[24] this applies particularly to some overseas customers;
the nature of some of BNFL's business, notably its custody of stockpiles of plutonium and other highly dangerous substances, and its relationship with other Government agencies, in particular the Ministry of Defence;
the potential profit to the Treasury: having invested in BNFL over the years, the Government and taxpayers are entitled to enjoy a share of its success, in terms of dividend and share value;
the workforce: the PPP is likely to be more welcome to the workforce than full privatisation, as we have learned from informal meetings with workforce representatives.

For these and other reasons, we see no purpose at this stage in detailed examination of the merits of full privatisation. The arguments for and against privatisation, including a trade sale, should have been plainly set out in some readily accessible form, and tested by thorough analysis. We recommend that Ministers take advantage of the opportunity offered by the debate which we propose to set out the arguments surrounding full privatisation.

Case for PPP

22. Some of the advantages which have been presented to us as likely to flow from a PPP should be attainable by other means.

BNFL has long had senior managers from the private sector. The previous Chief Executive had spent a career in the chemicals business: the retiring Finance Director was at Hanson plc: and the retiring Human Resources Director came from Volvo. The new Chairman and Chief Executive both come from long careers in the private sector.

Top managers are already paid commercial salaries: the Finance Director received £271,000 in 1998-99 and the Chief Executive £312,000. The six Executive Directors received total bonuses in 1998-99 of £205,000.[25]
There is no evident shortage of capital to finance acquisitions or investments, judging from the company's purchases of Westinghouse in 1998 and ABB nuclear business earlier this year.
As a plc for almost 30 years, it has had an obligation to publish full audited annual accounts; and its directors have had fiduciary duties to the company.

23. There are, however, good reasons to believe that a PPP will reinforce the disciplines imposed by plc status, and bring further advantage —

a "sophisticated shareholder environment capable of appraising and challenging the business"[26] should provide greater efficiency in making major capital investment and other major decisions;
the need to satisfy external shareholders imposes a necessary discipline of achieving targets and objectives set in a reliable and consistent way;
access to financial markets will be easier;[27]
the introduction of a partnership scheme involving employee shares or options, which BNFL and the Government wish to introduce, is more readily organised within a framework of other private shareholdings;[28]
it may prove easier to recruit and reward appropriate managers below Board level; external shareholders are more demanding as regards transparency;
the customer focus which has not in the past been a strong feature of BNFL[29] is more likely to be achieved through the insistence of external shareholders.

Delay in introduction

24. When the process of moving towards a PPP began some two years ago, the prospects for BNFL looked reasonably bright. BNFL was winning major contracts in the USA. We were briefed on BNFL's prospects in Japan in March 1998 in the course of our visit there. Although there was never a precise timetable for a PPP,[30] the July 1999 statement suggested that it was hoped to complete it by early 2002, and possibly sooner. Two years on, things look very different. In May 1998 the German Government suspended transport of used fuel to the UK and France. In the autumn of 1998, a new German Government came to power with a programme of phasing out nuclear power and ending reprocessing of its wastes: a policy to which it tried and failed to give effect in early 1999. In Japan, the existing sub-current of popular anti-nuclear sentiment became a flood after the incident at Tokaimura. The July 1999 shipments of Mox fuel to Japan, under armed guard, attracted unfavourable attention. In September 1999 it became public knowledge that there had been falsification of Mox fuel quality control records. Contrary to assurances originally given that the batches already delivered to Japan were not affected, in December 1999 it was revealed that they were indeed affected. The Japanese authorities now seek return of the Mox elements delivered. The German Government has declared a temporary ban on Mox fuel imports. In the USA the Department of Energy is reported to be reviewing BNFL's contracts and in particular to be unhappy at the estimate presented for the costs of the clean-up of the Hanford site in Washington State. In February 2000 the NII published critical reports on safety management at Sellafield and on the falsification of data on Mox fuel. In the same month the Chief Executive resigned. In April 2000 the company underwent another management shake-up.

25. The Secretary of State told us in February 2000 that the events of recent weeks -

On 29 March, however, five days before her appearance to give oral evidence to us, the Minister for Energy announced that it was now apparent that there could in the present circumstances be no PPP before the autumn of 2002 at the earliest.[32] There is no chance of BNFL reaching its performance targets before then. The prospects of the company around the world are so uncertain that the price likely to be achieved for any shares offered would be unduly low. We welcome the decision to delay the introduction of a PPP; it would plainly be unrealistic to proceed at the pace originally envisaged.

26. The delay means a delay in the advantages which a PPP is expected to bring. It places the onus on Ministers to ensure that the management they have now put into the company performs, so far as possible, as if there were private sector ownership disciplines. For the next three years it will be a prime task for the Government as the existing shareholder to ensure that BNFL improves its performance.

Preparation for PPP

27. The process of preparation for a PPP has already had a number of useful effects, which are all the more important now that the PPP is to be delayed. The past two years, which have been unusually troubled ones for BNFL, have provided an opportunity for Government to gain a clearer picture of the challenges facing the company. As part of the process of preparation for a PPP, external professional advisers have shone light into dark corners and raised awkward questions; challenging targets have been set and their attainment monitored; and BNFL's web of relationships with private and public sector customers has had to be thoroughly examined and tidied up. A number of personnel isues have finally been addressed.

Advisers

28. BNFL have had the services of Freshfields as its solicitors, Ernst & Young as its auditors and Rothschilds as its financial advisers. Ministers have had only a handful of officials. We have had the impression that BNFL has been allowed to go its own way for too long, constrained more by regulators and pressure groups than by supervision exercised by Ministers; and that it is only as they come to sell part of the company that a full understanding of its operations is being gained.

29. A raft of advisers has now been appointed to provide advice on a PPP.[33]

On 10 September 1999 Credit Suisse First Boston (CSFB) were appointed as Financial Advisers and Global Co-ordinator.
On 25 October 1999 Slaughter and May were appointed as legal advisers.
On 3 November 1999 HSBC were appointed as an independent adviser in areas where it might be thought that CFSB's dual role in the event of a flotation might lead to a conflict of interest.
On 4 November 1999 Arthur Andersen were appointed as Joint Reporting Accountants to identify any financial or performance issues requiring resolution prior to PPP. Arthur Andersen are also building a "financial model" of BNFL's business.
On 25 February 2000 Deloitte and Touche were appointed as Accountancy Advisers to provide independent advice to the Government on accountancy issues.
In March 2000 Clark Lane and Peacock were appointed to provide actuarial advice given "the high importance of ensuring proper financial provision for BNFL's extensive nuclear and non-nuclear liabilities."

Estimates of expenditure on fees in the Departmental Report refer to net expenditure of £7.5 m in 1999-2000 and £14.9 m in 2000-01.[34] These figures seem to be based on the timetable now abandoned. Fees so far paid total around £3.5 million.[35] On 3 April the Minister told us that there had been a number of reports to her and offered to examine if it were possible to share with us some of these reports.[36] On 16 May we were told that there was as yet no material suitable for presentation to the Committee, but that future reports would be reviewed on a case-by-case basis with a view to making these available wherever possible. We expect the Minister to keep us informed of the contents of reports from advisers.

Targets

30. In announcing his decision in July 1999 that a PPP would be a good idea in principle, the Secretary of State announced that he had set BNFL a number of specific performance targets, intended to ensure that the taxpayer would get "proper value for money, reflecting the company's commercial performance." Potential investors would want reassurance that the company's performance was improving over a range of areas. The July Written Answer stated that each target was backed by an understanding between the Department and the company of how it will be measured, "the precise details of which must, for obvious reasons, remain confidential". They form a "balanced scorecard" of stretching targets. The Government will look to introduce a PPP into BNFL before the end of the current Parliament, subject to BNFL's overall progress towards achieving these targets. The PPP will not be introduced if BNFL's overall progress towards achieving the targets is deemed insufficient; failure to meet some targets may however be accepted.

31. The targets cover six general areas —

safety, health and environmental (SH&E) performance, based on an index

skill enhancement and productivity

profitability

increased contribution to profits from US business

reduced costs

improved liabilities management.[37]

BNFL reports progress on meeting the specific targets every three months. It is not in every case clear by when each target is to be met. The SH&E Index is meant to show "continuous improvement". There is no apparent timetable within which the proportion of BNFL profits from its US business is to reach 15 per cent. In other cases, specific timed targets have been set, and provided to us in confidence, of Group profit before tax, and sales per unit of workforce cost. The 25 per cent cost reduction target, which BNFL set itself in 1997, was to have been met by March 2001.

32. BNFL and DTI agree that the targets will not be met this year. The Chairman of BNFL told us —

"We have had a poor year and we will be lucky to achieve any of the six key targets this year .........".[38]

The one exception is the SH&E Index, subject to finalisation of data on sickness absence.[39] The new contract with BNFL employees agreed in November 1999 should eventually produce productivity gains but has short-term costs.[40] The 18% interim costs reduction target is therefore unlikely to be met. From details we sought of cost reduction targets and achievements since the 1996/97 baseline, it is apparent that substantial cost savings are still required from several business areas.[41] The target of 15 per cent US proportion of profit will not be met. Poor Magnox plant performance and "lower gains to financial investments" will reduce forecast 1999-2000 profit. Productivity is behind target due to lower output. The liabilities management target will be missed; prospects will become clearer following completion of the regular review of liabilities.[42]

33. The targets are a useful measure of progress, and would be so even if there were no proposal for a PPP. They may need revision in the light of the new Corporate Plan due in July 2000, as BNFL suggested. The Minister accepted that they would need revisiting if they were completely "unrealistic": but warned that "it is not my instinct to seek to have a lightening of the load of targets."[43] Targets should be stringent but achievable, and linked to the company's own objectives. We recommend revision of the targets already set and the introduction of fresh targets directed to the performance of all the constituent parts of BNFL's business with clear timescales for achievement.

Tidying up

34. Evidence to us emphasised the amount of work under way in tidying up loose ends in preparation for a PPP . The future financing arrangements for dealing with pre-1971 liabilities on BNFL sites, hitherto reimbursed at cost with fixed overheads, and the forward estimates made of annual expenditure on these are being put on a more solid foundation for the future, so that UKAEA and MoD do not experience the unexpected calls on resources experienced in recent years.[44] UKAEA has been asked by DTI to negotiate with BNFL to convert existing arrangements on such liabilities into legally binding contracts.[45] The arrangement whereby UKAEA has assumed responsibility for BNFL Magnox liabilities on its sites in return for BNFL decommissioning at its expense the Windscale AGR may also merit placing on a firmer contractual basis.[46] We also raised in evidence the provision of pensions management services, which UKAEA provide for BNFL, and the costs to BNFL of the services of the UKAEA Constabulary.[47] Preparations for the PPP have turned up a number of contractual uncertainties and loose arrangements from the early days of BNFL which require resolution before embarking on a PPP.

35. The process of preparation for a PPP has already in the short term brought some of the benefits which it is anticipated will arise in the longer term from the introduction of a PPP. We must, however, record our concern that it seems to be only now that Ministers should be exercising their rights and obligations to have a thorough understanding of BNFL, having owned the company for almost 30 years.

Conclusions

36. In broad terms, we endorse the proposal for a PPP as set out by the Secretary of State in July 1999 as the best available means of introducing commercial disciplines into BNFL, noting that it is an extension of a policy formulated on BNFL's formation 30 years ago. The PPP cannot and must not be expected to solve all of BNFL's problems. No more must the delay in its introduction be used by Ministers as a reason for delaying some vital policy decisions which are required. For the next three financial years the Government is likely to remain the sole shareholder. The analysis of BNFL on which the PPP proposal is based takes as a starting point the regrettable absence of ownership pressures on BNFL. DTI Ministers must devote some effort over the next three years to improving their performance as shareholders.

14 Ev, p 100 Back

15 HC 1138, Qq 113ff Back

16 Ev, p 107, 2.1 Back

17 HC Deb, 1 Nov 98, col 222w Back

18 Ev, p 107, 2.2 Back

19 Ev, p 106, 1.1 Back

20 HC Deb, 13 July 99, cols 158-161w Back

21 Q 326 Back

22 Q 108 Back

23 Q 330 Back