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Appendix N United Kingdom (Scotland) Case Study

N1. Ferry Legislation and Licensing

Subsidised ferry services, routes and carrying statistics

N1.1 There are three main types of ferry operator serving domestic Scottish routes. By far the largest, in terms of both cost and routes are those services subsidised by the Scottish Executive. Some services are also supported by local authorities with other services provided on a commercial basis by the private sector.

N1.2 The Scottish Executive, subsidises two bundles of services: from the Scottish mainland to the Orkney and Shetland Islands (Northern Isles), and 28 services in the Clyde and to the Hebrides (Clyde and Hebrides).

N1.3 The Northern Isles services currently provide for subsidised carriage of passengers and vehicles with 2 or 3 return sailings per day between Scrabster and Stromness and a daily passenger and vehicle service between Aberdeen and Lerwick (with some sailings calling at Kirkwall). NorthLink also operates 2 freight vessels between Aberdeen and Lerwick (again with some calls at Kirkwall).

N1.4 Local authorities, such as Highland Council, Argyll and Bute Council, Comhairle nan Eilean Siar, Orkney and Shetland also subsidise some ferry services within their areas.

N1.5 In addition, there are a few non-subsidised commercial operators providing some passenger, vehicle, and freight transport to and from some of the islands to the mainland and between islands. However, this provision is insufficient to meet the needs of the local communities.

Operators

N1.6 All of the ferry routes in Scotland are operated by domestic companies.

Caledonian MacBrayne
N1.7 Caledonian MacBrayne (CalMac), which currently operates the services in the Clyde and Hebrides under an Undertaking with the Scottish Executive, is a private company whose sole shareholder is the Scottish Ministers. It was nationalised in 1948 and began to receive subsidy in the early 1960s.

NorthLink
N1.8 NorthLink Orkney and Shetland Ferries Ltd. (NorthLink), started operating the Northern Isles lifeline services on 1 October 2002. They are subsidised for carrying passengers and accompanied cars to and from the islands.

N1.9 NorthLink is jointly owned by CalMac and the Royal Bank of Scotland.

P&O Scottish Ferries
N1.10 P&O Scottish Ferries Ltd had provided the lifeline ferry service for passengers and accompanied cars to the Northern Isles for many years, until their last contract terminated on 30 September 2002.

Other Private Operators
N1.11 A few private operators operate passenger and freight services to and from the Scottish mainland and islands without subsidy.

N1.12 Western Ferries operates commercial vehicle and passenger services between Gourock and Dunoon, accounting for around 80% of the vehicle market share. The company has served the route for 30 years and provides a 365-day-a-year shuttle service across the Clyde River between Hunters Quay in Dunoon and McInroy's Point in Gourock.

Legislation

Cabotage
N1.13 There is no restriction on cabotage in the UK.

N1.14 There is no crew nationality requirement except for "strategic" ship types, of which the master must be of British, Commonwealth, EEA or NATO nationality.

N1.15 While the central and local governments provide subsidies to operators providing lifeline services, there is no restriction or limitations on other operators serving the same routes.

Licensing
N1.16 The Maritime and Coastguard Agency ( MCA) is the UK Department for Transport agency that is responsible for implementing the Government's maritime safety policy. It also operates the UK Shipping Register, which certifies vessels operating in UK waters.

Safety
N1.17 The MCA is responsible for enforcing safety regulations with regard to passenger vessels.

N1.18 All subsidised operators have to comply with the relevant statutory requirements pertinent to vessel, crew, passenger and operational safety, and freight transport on all their ships at all times. These include the Animal Act of 1981, the Welfare of Animals (Transport) Order 1997 as amended, the Environmental Protection Act 1990 and the Health and Safety at Work Act 1974.

Ports
N1.19 The majority of Scottish ports are trust ports, with the rest being owned by local authorities or private companies.

N1.20 Harbours are required to charge users equally. However, bulk discounts are available to users who contribute to high volumes of port activities.

N1.21 In the Northern Isles, the majority of ports are owned by Harbour Trusts.

N1.22 In the Clyde and Hebrides, around half of the ports on the network are owned by CalMac, with the rest split between Harbour Trusts and local authorities. CalMac's harbours will stay in public ownership if the CalMac services go out to tender. It is proposed that they would be taken over by the publicly owned company VesCo.

N2. Lifeline Services

History of Lifeline Services

N2.1 P & O provided services to the Northern Isles before the 1980's. In the 1980's, the routes became more expensive to operate and the UK Government stepped in to set minimum service requirements on the routes in return for subsidy.

N2.2 Similarly, the Clyde and Hebrides services had also been commercial until the 1960's, when adverse economic conditions made it no longer viable for the then privately owned Caledonian MacBrayne to maintain the same level of service to the islands.

Basis for Subsidies

N2.3 The 2003 Partnership Agreement commits the Scottish Executive to promoting public transport and to continue to support and invest in lifeline ferry links. The Scottish Ministers believe that lifeline transport links are necessary for the social and economic well-being of the islands and remote communities concerned.

N2.4 The Clyde and Hebrides and Northern Isles services are considered lifeline services,.

N2.5 The Scottish Executive decides on the routes, timetables, etc. of the lifeline services.

N3. Subsidised Services: Operation

N3.1 The lifeline services are for passenger, vehicle, and/or freight transport between the Scottish mainland and the islands.

Operators

Northern Isles
N3.2 P & O held the franchise to the routes in the 1980s and 1990s.

N3.3 NorthLink won the most recent (1998) tender exercise for the current five-year contract (lasting until 2007). It took over the services in October 2002. The operator has since found itself in financial difficulty. One reason for these difficulties has been the loss of market share to non-subsidised freight operators who are not subject to any obligations.

N3.4 As a result, the Scottish Executive has decided to re-tender the Northern Isles services ahead of schedule.

Clyde and Hebrides
N3.5 The state-owned Caledonian MacBrayne has been subsidised under the Highlands and Islands Shipping Services Act 1960.

N3.6 There is no formal contract. Instead, CalMac operates under an open-ended "Undertaking" with the Scottish Executive. The most recent undertaking was in 1995.

Vessels

Northern Isles
N3.7 Three of the vessels used on the routes are owned by Lombard (a Royal Bank of Scotland company). The vessels will be made available for leasing to the next operator. Bidders will be required to lease these vessels if they are successful in their bid for the tender. During the year there are peak times when extra capacity is required ( i.e. livestock) and arrangements must be put in place for additional vessels.

Clyde and Hebrides
N3.8 The Clyde and Hebrides services require special vessels that are built specifically for the geography and weather conditions of the network and the requirements of the services ( e.g. to transport dangerous goods, passengers, cars etc). The fleet is currently owned by CalMac.

N3.9 If tendering goes ahead the Scottish Executive plans to set up a company, VesCo, which will own the current CalMac fleet. The successful bidder for the services will be bound to lease its vessels from VesCo. In line with EU requirements leasing charges will be at market rates.

N3.10 The tender proposal, however, allows scope for operators to introduce their own vessel solutions although such proposals would be considered by the Scottish Executive on a case-by-case basis. Operators will only be able to bring their own vessels if they have taken all VesCo vessels

Services

N3.11 With the exception of the Gourock-Dunoon service (where only the passenger element is subsidised), the subsidised services are for foot passengers, vehicles, and freight in the Clyde and Hebrides.

N3.12 Currently in the Northern Isles, subsidies are available for passengers and vehicles only. The Scottish Executive plans to include the transport of livestock and freight in the re-tendered Northern Isles contract.

N3.13 The routes are grouped, tendered and operated as bundled services. In the Clyde and Hebrides, the Gourock-Dunoon route will be tendered separately, whereas the rest of the routes are treated as one bundle to maximise on economies of scale and flexibility.

Contract Requirements

N3.14 Service levels and frequencies are specified in the tender.

N3.15 Subsidies are reimbursed on a monthly basis. Any performance issues, remuneration adjustments, etc., are subject to negotiation between the operator and the Scottish Executive.

N3.16 Tables N1 and N2 summarise the services, contract terms, and carrying statistics for the lifeline ferry services.

Table N1 Northern Isles Lifeline Ferry Services: Contract

Source: Scottish Government website

Table N2 The Clyde and Hebrides Life Ferry Services: Contract

Source: CalMac Annual Report 2003.

Fares

N3.17 Fare levels for passenger and vehicle transport (and freight, where applicable) are determined by the Scottish Executive and specified in the contract.

N3.18 CalMac's current fare structure is based on the C-fares system introduced in 1994. This system aims to link fares to the costs incurred by the company on a route-by-route basis (as opposed to distance-based). The current fare structure will be protected in the contract with annual fare increases limited to CPI.

N3.19 Fares on the Northern Isles services are subject to a maximal increase tied to the Retail Price Index ( RPI). Any additional adjustments would require authorisation by the Executive following negotiation.

N3.20 Fare restrictions are not applicable to services above and beyond the minimum levels.

N4. Subsidised Services: Financial and Commercial Support

Subsidies

N4.1 The services in the Northern Isles and the Clyde and Hebrides are subsidised directly by the Scottish Executive.

N4.2 Subsidies are granted based on the level of services provided, irrespective of demand. Discounts are available to island residents and freight volume discounts are available.

N4.3 Subsidies are paid to the Northern Isles operator on a monthly basis, and this will be the same for the future operator of the Clyde and Hebrides services. CalMac draws down subsidy as it requires it - on average about four times a year.

Remuneration

N4.4 The Northern Isles service subsidies are granted based on services operated, irrespective of the passenger and freight load on the services (net cost contracts). Bidders specify the remuneration amount in their bid. Grant assistance available to the successful tenderer will be a grant towards the running costs of operating the service, supplementing the successful tenderers' revenues as derived from its fares and any other income. Maximum fare charges are determined by the Executive and will be applied throughout the contract period, plus an allowance for inflation as made annually by the Executive.

N4.5 In the Clyde and Hebrides network, around two-thirds of the total revenue comes from fares. The remaining one-third comes from central government reimbursement of operating costs.

N4.6 There is flexibility built into the contract which allows for changes to the subsidy as a result of cost fluctuations, etc.

N4.7 The current Northern Isles contract provides for a financial penalty in the event of non-performance by the operator.

Infrastructure Investments

N4.8 The Executive is committed to maintaining lifeline ferry routes and to ensuring that all harbours serving these routes are fit for purpose and capable of providing safe berthing of the vessels serving these routes.

N4.9 The Executive runs a Piers and Harbours grant scheme which supports lifeline services.

N5. Subsidised Services: The Contract

Structure of Contract

N5.1 Instead of a contract, CalMac operates under an open-ended "Undertaking" with the Scottish Executive. The most recent undertaking was in 1995.

N5.2 The proposed contractual arrangement for the new CalMac tender in the Clyde and Hebrides is summarised as follows:

Table N3 Proposed Structure for the Clyde and Hebrides PSO

Source: Scottish Executive website: http://www.scotland.gov.uk/consultations/transport/chfd-00.asp

Bundling of Services

N5.3 The Scottish Executive bundles the services for the following reasons:

• allows operators to achieve economies of scale;
• facilitates provision of relief vessels;
• facilitates safety management;
• supports integrated transport aims; and
• ensures that there is a service on all routes.

Contract Duration

N5.4 The contract awarded to NorthLink was for five years (2002- 2007). However, the re-tendered contract will be for six years. This is in line with the revised EU guidance ⁸.

N5.5 CalMac's undertaking has historically been open-ended. The new contract will be for 6 years.

Contract Monitoring

N5.6 The Scottish Executive is responsible for monitoring the operators' performance to ensure that they carry out their contract obligations.

Risks

N5.7 The Scottish Executive perceives creaming behaviour in the market to constitute one of the greatest risks for ferry operators bidding for the subsidised contracts.

N5.8 On the other hand, protecting the operators through escalation clauses (to allow for factor price changes) puts the financial risk burden on the Scottish Executive.

Revenue/ Competition Risks
N5.9 The Northern Isles Lifeline ferry services will be the only lifeline ferry services between the Northern Isles and the Scottish mainland to be operating as a result of a public service contract.

N5.10 The presence of "creaming" behaviour by non-subsidised operators in the Northern Isles freight market has potentially contributed to the financial difficulty of NorthLink. The Executive intend to include freight services within the next contract.

N5.11 Many of the islands are served by air transport. Competition with air transport is not a material risk, as they cannot carry vehicles and freight, and therefore serve a different market.

Cost Risks
N5.12 Bidders specify a remuneration amount at the time of tender. This amount should take into account their revenues and costs forecasts. The operator bears the risks should they incorrectly project their revenue and cost streams over the contract period.

N5.13 Escalation clauses in the contract allow for changes in factor prices for providing the services, such as fluctuations in fuel costs. The Scottish Executive bears the risks of significant cost fluctuations.

N5.14 In addition, fares are allowed to increase according to the Consumer Price Index.

Other Risks
N5.15 Inclement weather conditions can affect the operation of the ferry services. Operators are not penalised for relief events.

N5.16 By having VesCo owning and leasing CalMac's existing fleet, the Scottish Executive can ensure the safety, reliability and effective utilisation of the vessels.

N5.17 The proposed risk allocation structure for the Clyde and Hebrides services is summarised as follows:

Table N4 Proposed Risk Allocation for the Clyde and Hebrides PSO

N6. Subsidised Services: The Tendering Process

Invitation

N6.1 The last tendering process for the Northern Isles services started in October 1998, with three companies asked to submit bids following the Pre-Qualification Stage. In line with EU rules the bidder with the requirement for the lowest financial compensation, NorthLink, won ⁹.

N6.2 The current and next Northern Isles contract were advertised in the Official Journal of the European Commission.

Competition

N6.3 The tendering of the Northern Isles services generated substantial interest. The incumbent operator, P & O Scottish Ferries, lost the franchise to NorthLink.

Award

N6.4 The bids are screened in a step-wise process. Initially (Pre Qualification Questionnaire ( PQQ) stage), the history and experience of the operators is evaluated.

N6.5 At the second stage bidders who passed the PQQ stage are invited to submit technical proposals for providing the services. These proposals are evaluated against the service specification which sets out the minimum standards.

N6.6 Those bidders who pass the Technical Stage are then invited to submit costed bids. The contract is awarded, in line with EU rules, to the bidder who requires the lowest financial compensation.

N6.7 The Executive has discussed the proposals for tendering with the European Commission.

N7. EU Maritime Cabotage Rules

N7.1 The European Commission wrote to the UK government in June 1999 asking about the Scottish Executive's subsidy arrangements with Caledonian MacBrayne and drawing the Government's attention to the 1992 Maritime Cabotage Regulation. The Executive has since been in discussion with the Commission about bringing the Clyde & Hebrides services into line with EU rules and had begun to prepare for tendering. However, during a Parliamentary debate on ferry services on 8 December 2004, the Scottish Parliament expressed concerns about the Scottish Executive's proposals for tendering the Clyde and Hebrides ferry services. At the time of writing the Scottish executive were reviewing those proposals..

N7.2 The current Northern Isles contract with NorthLink was tendered in line with EU rules as is the new contract which is currently being tendered.

Sources

Scottish Executive websites:
http://www.scotland.gov.uk/library5/finance/db0506-10.asp
http://www.scotland.gov.uk/about/FCSD/MCG-NW/00018138/Lifelineferries.aspx

Caledonian MacBrayne:
http://www.calmac.co.uk

NorthLink Ferries:
http://www.northlinkferries.co.uk

Phone interview with Department of Enterprise, Transport and Lifelong Learning Development, Scottish Executive. 17 Dec 2004.

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