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UK Rural Broadband The Oxera Report and BT's missing £1 billion
1:09pm - 25/05/2015

The Oxera report on the UK’s broadband state aid measure was published on May 19th.  Due in January,  it was hoped it would build upon the work of the National Audit Office (NAO) and the Public Accounts Committee,  where we learned in January 2015 BT had inflated its 2012 cost models by 38%.   We also learned the total average cost per cabinet and fibre path was less than £25,000 before BT’s capital contribution on the first 8,500 cabinets installed.  This contrasts with subsidies of more than £40,000 implicit within the £1.2bn phase 1 BDUK contracts.  This was good progress and showed the importance of public scrutiny and how the NAO could aid government departments in mitigating ex-privatised utilities abusing their dominant position.  The Oxera report might shed light on the status of BT’s offer to match public subsidies with £1bn of its own capital promised very publicly and repeated in Parliament.

 

The Oxera report is a pre-cursor to EU re-issuing the state aid notification in July 2015 to approve continuance of the state aid scheme so BT can be paid subsidies through to 2018.

 

Oxera does not mention BT’s offer of £1bn matched funding. It does not mention any amounts paid by BT so far but does make a reference to BT’s matched investment being less than expected. But critically we get a hint in clause 3.83 on the bottom of page 44.

 

The Oxera report provides one new crucial fact but fudges many others.  The fudges include Oxera reporting on the £780m central government funding,  not the total public subsidies  of  £1.7bn.  The impact of the latter is to understate what Oxera describe as BT bids for cabinets.  They reference a number of  circa £32k each.  Using the £780m rather the £1.7bn  implies some level of alignment within the realms of a working contingency but this is misleading.  This oversight should be corrected and the report re-published with the full amounts,  but this rather large oversight can be forgiven if the new piece of information they provide can be acted upon.

 

The key new learning,  building upon the NAO work which focused on the excess modelled costs,  is found in clause 3.83, page 44 of the report.  It informs us that BT makes no capital contribution to the project until three years after each contract signature. The  BT offer of £1bn matched funding to Parliament has been reduced to  no more than an uncertain reconciliation process three years after the contract begins.  BT is free to re-balance costs, self-certify its own capital and add back any un-allowed costs presented and rejected for payment previously.  This new information explains why so many rural communities are being excluded from the planning process.

 

This means the BT promised capital contribution cannot be used in planning the fibre rollout.  The whole Broadband project in its initial stages is 100% state funded with assets gifted to BT.  This is at the odds with the principal of gap funding.  How can this be compatible with the principals of state aid where the subsidy should be the minimum needed and does not substitute for private investment? 

 

It is important to note that the nature of the capital subsidy is controversial,  as the upgrades are largely improvements in BT’s passive infrastructure in the form of ducts, sub-ducts, fibre, the cabinets, re-arranging copper.  The nature of the work is best considered as an allocation of BT’s existing resources to work on one section of the network while delaying other work.  It is important to note that BT’s commercial investment in fibre access came from within existing capital envelopes,  thus any state aid would act as a direct substitute for BT’s own resources,  should BT’s contribution not be forthcoming when the work is occurring.  In these circumstances it is quite easy to be in breach of the principals of state aid.

 

The Oxera report makes a virtue of the protections that the state cannot pay more than 100% of the capital cost.  This is certainly better than paying standard unit costs unrelated which are unrelated to the underlying costs as evidenced in some of the early contracts,  but the switch to actual costs ignores the gap funding principle and forgets BT assurance to Parliament of £1bn of matched funding.  The latter was never real but the principle of BT paying a fair proportion of the capital costs is captured in the intervention rates which suggests BT should be paying about 30% of the capital costs.  Can or should these payments be brought forward?

 

Should the EU Commission ignore or try a fix?

 

The focus for the last 2.5 years  has been on putting the BT abuses aside and getting on with the job of installing some 200 street cabinets  offering improved connectivity to some 40,000 premises a week, should customers want to order an upgrade.  Just as the NAO and BDUK have progressed the verification of actual costs,  it seems appropriate that the EU Competition Commission could amend the state aid measure to enforce the concept of gap funding and thus extracting from BT the monies promised.  But what form would this take?  One example is outlined below.

 

The USA FCC rural broadband scheme has this notion that the operator pays the first $70 cost per premise passed for rural broadband projects.  

 

For the UK a couple of things need to happen.

 

We need to stop believing BT spent anything like the £2.5bn capital they claim to have spent on the commercial rollout of circa 50,000 VDSL cabinets passing 19m premises.  The NAO efforts to help BDUK to get to actual costs suggest BT costs on the access network of cabinets,  fibre, handover points is not more than £20k a cabinet and fibre path.  This would put BT’s  commercial investment in the access network at a total of £1bn.  BT may have spent some more on Next Generation Access  for content distribution platforms, wholesale billing and provisioning systems but upgrading the exchange side of the network with optical fibre paths has been quicker and cheaper than imagined.   For simplicity this is about £50 per premise passed and so BT should not be expected to invest more per premise to upgrade premises in economically more challenging areas.

 

Thus,  any state aid measure should translate into an unambiguous BT contribution of c £50 pounds per premise passed.  For the first BDUK  funded 12,500 cabinets passing 2.5m premises to April  it would mean BT  paying £10,000 per cabinet,  while the state pays  the remaining £14,000  each.  This allows a greater amount to be achieved with subsidies rising as the geographies become more difficult to serve and cabinets serving fewer people.  Currently, the state pays everything and hopes to collect some money at the end.  This is likely to occur at the expense of those the programme was originally intended to meet.

 

For the 5m premises in the BDUK  scheme this is about £250m contribution from BT rather than the £1bn promised to Parliament,  but it is a real contribution as opposed to hot air.  It is consistent with sums mentioned in the first NAO report in September 2013.  It is also consistent with modelling work done to support similar subsidy schemes in the US.

 

The UK rural economy is now reliant on EU Competition Commission spotting clause 3.88 of this report and insisting upon the necessary changes.  If it does,  it finishes what will be three years of work.  This was begun by the Public Accounts Committee and the National Audit Office supporting BDUK’s  efforts to force through actual costs rather than tolerating standard unit charges unrelated to the underlying cost.  The latter are  evident in reports to North Yorkshire County Council where a charge of £179 per premise passed was reported.  The amendment to the state aid measure should convert the £1bn promised to the UK Parliament and to the UK Government into something directly tangible and usable.  £250m is much less than the £1bn promised, but it would be real and it would get spent where it was intended to be spent.

Finally,  if the cheapness is understood,  then UK policy makers would not hesitate in calling for a more ambitious connectivity plan for all UK businesses.  It would also allow the £1.7bn subsidies to be spent where intended with BT the asset owner making a fair and just contribution.  As we speak such a contribution is not secure and thus many villages and hamlets are being excluded from the opportunity of getting an upgrade.

To recap,  the combined efforts of the NAO and the BDUK value for money team was to secure actual cost data from BT,  so the state pays no more than 100% of BT’s capital costs.  This is a bigger achievement than one might first consider,  as it reduced average per premise payments from a possible  £200 per premise passed  (£1.2bn contracted /6m premises ) to  what should be a working total average  cost of £125 for the first 2.5 million homes.  The next step is to extract from BT a fair capital contribution which would be for indicative purposes would be £50 a premise for the estimated 6m premises in the programme.  No capital contribution has been paid yet and it is unlikely anything will be paid unless the EU Competition Commission act or the UK Parliament demands BT keeps its promises to Parliament by demanding specific changes to its undertakings.

We will know by July,  but there is nothing in BT’s annual accounts to suggest it will make any capital contribution to the 44 rural UK phase 1 projects. 
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