Spending cuts I’d like to see – No 3

As part of his pre budget softening up exercise, Bill English has already announced that ‘lower value spending’ will be identified to free up cash for higher priority activities. This is a clear priority for his third budget. It should be possible to test this statement from the Finance Minister to determine the validity of it. One such way is to examine a key policy plank of this government, the Roads of National Significance (RONS). Also under scrutiny is the almost 11 billion dollars earmarked for the projects. So how do these projects and attached funding stack up as high value spending?

Some of the roading projects, using present criteria (we will return to that later), seem to come out well. The Victoria Park Tunnel has a Benefit-Cost Ratio (BCR) averaging around 4.25. That is, for every dollar invested society will see a benefit of $4.25. I used the term BCR ‘average’ to reflect that estimated BCRs will vary. On this project various BCRs exist ranging between the NZTAs estimated 3.2 and the very high 5.3 estimate of Australian consultants SAHA. In order to try and represent matters reasonably conservatively the BCR was therefore averaged using both the NZTA and SAHA. Another Auckland project, the Western Ring Route, averages a BCR of 2.3 based on an NZTA estimate BCR of 2.1 and SAHA 2.5. An argument could be mounted therefore that both these roads represent higher value spending. They both have a multiple return for each dollar invested.

Some of the other RONS however make for more interesting analysis. The Puhoi-Wellsford ‘holiday highway’ has a SAHA estimated BCR of 0.4. The NZTA estimates a slightly higher figure of 0.8. An average of the two results in a BCR of 0.6, returning 60 cents in benefits for every dollar invested. The cost to tax payers of the project is $1.65 billion for an estimated $990 million return. Another big ticket item, the Waikato Expressway, fairs little better. It has an averaged BCR of 0.8 using the 0.5 BCR SAHA estimate and the 1.1 estimated BCR from the NZTA. For every dollar invested there is an estimated 80 cent return, around $2 billion invested for $1.6 billion returned. A third, but cheaper, Levin-Wellington Highway project also averages a 0.8 BCR, a 0.6 estimate from SAHA and 1 from NZTA. There is a $550 million price tag which yields a $440 million return.

So to recap these figures, around $4.2 billion invested – that’s $1.65 billion for Puhoi, $2 billion for Waikato and $550 million for Levin – for around $3 billion return – $990 million, $1.6 billion and $440 million respectively. It seems difficult for the Government to explain these projects as ‘high value spending’, the test Bill English has set for his budget. Would you expect your bank to market itself as a ‘high value’ financial service if it returned to you 75 cents for every $1 you deposited? Such a poor return brings to mind names like South Canterbury Finance, Hanover, Blue Chip or Nathans. Some of the BCRs on these government projects look more like Bridge Corp ratios than Benefit Cost ratios.

In light of these seemingly poor figures it is worth reviewing what other transport projects are under discussion as a point of comparison with these Bridgecorp RONS. One high profile project is the Auckland rail loop. This has a build cost somewhere around $2 billion and a BCR ranging from 1.1 to 2.4 for an average of 1.75. For every dollar invested in this project $1.75 dollars of benefit flow back, $2 billion in for $3.5 billion out. Higher figures are reported, however, consistent with the BCRs for the RONS quoted above, a reasonably conservative approach to estimates is adopted here. Another rail project currently under review is a daily Hamilton-Auckland passenger train service. Operating costs on this service lie somewhere around $2 million per year with a BCR ranging from 1.5 to 2.5 for an average of 2. For $2 million invested net benefits of $4 million flow out. On these figures for both rail projects, statements from Bill English about reprioritising low value spending to higher priority projects, would seemingly dictate a large slice of RONS funding being diverted to rail.

I mentioned at the outset that some of the road projects stack up using present methodology. This is present modeling premised on (more or less) historical factors that yield sufficient returns to justify the spending. Clearly on the figures already presented that scenario does not extend to all the roads, even on present/historical patterns of transport. The case for these RONS gets a whole lot bleaker if the ongoing security of cheap oil is considered, the possibility of peak oil and an oil price spike occurring in the next few years. A 2010 report from the Parliamentary library stated that “Organisations including the International Energy Agency and the US military have warned that another supply crunch is likely to occur soon after 2012 due to rising demand and insufficient production capacity”.

The Government is aware of a possible coming oil price spike. Bill English has been questioned in parliament on this matter. His considered response was that the market will sort things out. We have already experienced the market and high oil prices interacting. The result, the global economic meltdown in 2008, was not promising. There is evidence to suggest that the precursor to the meltdown, the sub-prime crisis, resulted from high oil prices. Increasingly constrained household budgets could not cope with higher oil prices. Faced with spending more of their income on energy, home owners started having problems paying their mortgages, to the point of defaulting. That was the oil price part of the equation. The problem was not confined to the sub-prime housing market. Instead it quickly polluted the wider financial sector and soon after the entire global economy. Inventive methods of financing credit and debt along with slavish adherence to the neo-liberal narrative of deregulation and free market created the ideal conditions to spread the contaminant far and wide. This is the most recent experience we have had of an oil price spike and ‘the market’.

Last year David Bennett, Government colleague of English and Chair of the Transport Select Committee, laid out how this market led approach and the RONS may come together. Last year he was questioned about the lacking of government funding for a rail service between Hamilton and Auckland during a session on student radio. MP Bennett asked why a commuter would prefer making the trip on a ‘dirty polluting’ diesel train when by 2020 they could drive their ‘clean green’ electric car to Pukekohe on the new Hamilton-Auckland highway and catch an electric train to central Auckland. There are a number of contentious points to the statement from Mr Bennett including time frame, the potential for a rail service to start now versus 2020 for the RON completion, and the comparative pollution of a diesel train versus petrol & diesel vehicles making the same trip.

The most interesting factor in his statement, for the topic at hand, is however the forecast of being able to drive an electric car to Auckland come 2020. In 2005 the Ministry of Economic Development did some forecasting of what would be achievable under a sustainable energy strategy by the year 2050. The MED modeling assumes electric vehicle sales reach five per cent (5%) of market share in 2020, followed by a period of rapid growth that reaches a plateau of 60 per cent by 2040”. If market share for electric vehicles reaches 5% in 2020 the reality is that vast majority of drivers will continue to use petrol and diesel powered vehicles. A very real danger to realising this 5% figure is the continual economic drag of recession. Since 2008 the ongoing recession has caused the age of the national fleet to rise by more than a year. The current age of our vehicle fleet is now over 13, and growing, as Kiwis attempt to get more use from their current vehicles. The longer recession continues, the less likely that we will be fulfilling MP Bennett’s vision. The final kicker here is that an oil price spike and recession will likely go hand in hand.

Back in 2009 Dennis Tegg not only warned about the possibility of an oil price spike but also questioned what the Government was doing to prepare for it. “New Zealand has begun to tentatively prepare for climate change. We have comprehensive risk management plans for highly unlikely events like terrorism attacks, tsunamis, or bio-security breaches. Which is what government is for. So how come our Government neglects to make comprehensive plans for the highly likely threat of oil depletion and upwardly spiraling oil prices? Do we quickly implement wide-ranging liquid fuel conservation measures, and divert spending on new roads to public transport? Or do we continue the current myopic “business as usual – cheap oil forever” scenario?”

Reasonable questions. Twenty months ago, when Tegg wrote his piece, the prospect of an oil price spike was maybe 3 to 5 years into the future and seemingly too far ahead for this Government to plan for. The future has seemingly arrived a little earlier than anticipated. For budget 2011 and our immediate transport option in the face of high fuel costs, the question for Bill English and his government is, will the reality match the rhetoric? Is anyone holding their breath on this one?

– George.com

Running total:

$100,000 pa for scandal manager

$1,000,000,000 pa for polluter subsidies

$420,000,000 pa for motorways no-one will use

Total: $1,420,100,000 pa