The Sustainable Distribution Fund for investments in England

This document sets out the Government's plans for the allocation of financial support for the promotion of sustainable distribution of goods.

1. Introduction

1.1 'The Future of Transport', published in July 2004, reaffirmed the Government's policy for promoting the sustainable distribution of goods. A key element of this policy was to move towards arrangements for allocating financial support according to the outcomes achieved.

1.2 In recent years the Government has funded programmes whose objective is to minimise the impact of freight on the environment, safety and other transport users. The two main programmes are rail and water freight grants, which aim to transfer freight traffic from the roads to these modes. In the last few years we have also run programmes to promote more efficient road haulage.

1.3 These programmes have separate budgets and are administered separately. But they all have the same objective. The aim is to buy the benefits of reduced pollution and congestion and better safety rather than to promote certain modes of transport.

1.4 The Government believes it is right to assess these investments according to the outcomes, so that funding can be directed where it secures the best value for money. This means bringing the different programmes with their budgets together into a single pot and prioritising expenditure on a value for money basis.

1.5 This document sets out our plans to move towards this new approach. In summary,we will:

• bring together funding for water freight grants and road haulage schemes into a single pot from April 2005;
• from April 2007 bring rail freight grants into the single pot;
• prioritise schemes that offer the best value for money in terms of their impact on the environment, safety and congestion.

1.6. The new single pot will be known as the sustainable distribution fund. The pot will not replace the existing individual grant opportunities, but constitutes a new method to allocate the total existing budget between them.

1.7 This document describes (Sections 2, 3 and 4) the various support programmes that are currently in place and sets out some adjustments we plan to make. It then describes the mechanisms we are introducing for selecting and prioritising schemes (Section 5) and the funding allocated (section 6).

2. Rail Freight Grants

Freight Facilities Grant (FFG)

2.1 Freight Facilities Grant (FFG) was introduced in 1974. Its purpose was to promote the transfer of goods from road to rail by providing financial support for the purchase of new assets or the replacement of existing assets necessary for the carriage of rail freight. These might include internal rail sidings, handling equipment, wagons and locomotives, containers, swapbodies, storage facilities / warehousing, rail terminal access roads and other infrastructure.

2.2 Grant can be provided where it can be shown that traffic will not transfer to rail without financial assistance, and is limited to what is necessary to bridge the viability gap. Grant is also limited to the assessed value of the environmental, safety and decongestion benefits.

2.3 Design and construction costs associated exclusively with the rail freight facilities are also likely to be eligible and, in some cases, FFG can be paid towards leased capital assets such as rail wagons. FFG for rail is currently suspended and is unlikely to be reopened before 2007.

Revenue Support Grants

2.4 More recently rail freight grants have been extended to include revenue support for specific freight flows. This was initially provided through Track Access Grant (TAG), which was set up in 1996 to help freight train operators meet the charges paid to Railtrack (now Network Rail) for access to their network.

2.5 TAG has since been supplemented by Company Neutral Revenue Support grant (CNRS) which is aimed specifically at intermodal container traffic. The aim of these programmes is similar to that of FFG, ie to help fund the difference in cost between rail and road where the environmental and other benefits justify such support.

2.6 For CNRS, the SRA (who manage the scheme) has developed set rates for flows between different regions of the UK. For TAG, grant is based on competitive quotes for road haulage and estimates of actual rail costs.

Grant Principles

2.7 For all three grant schemes, the net benefits, calculated on the basis of the traffic, which is to be transferred to rail from road, or retained on rail rather than reverting to road, represents a ceiling for potential grant. In the case of TAG, the level of access charges further limits the extent of public support, as does the level of capital expenditure in the case of FFG. Grants up to 100% of access charges are not uncommon while for FFG grants are typically offered at a lower percentage of capital costs.

2.8 Actual grant offers are determined on the basis of an assessment of financial need using a discounted cash flow analysis over the appropriate project life. These are based on a comparison of the total costs of moving the goods by rail including relevant track access charges, capital and operating costs, with the equivalent costs by road. For CNRS, these factors are taken into account in the SRA's published rates. In some circumstances, where the applicant does not control the road option, e.g. in the case of a multi-user freight terminal, financial need is assessed through a combination of cost and market revenue information. In all cases, an acceptable rate of return for the proposal is allowed.

2.9 There are a number of circumstances in which grant cannot be given under any scheme:

• when the freight facilities or services can be commercially justified without grant and would proceed anyway (i.e. commercial schemes where financial need is not demonstrated);
• when rail construction contracts have already been let (e.g. where prior investment commitments mean that public money is not required to secure the traffic on rail);
• where there are insufficient environmental benefits from a switch from road to rail;
• where road transport is not possible either physically or because of legal restrictions, including planning conditions (i.e. there is no road alternative and therefore in practice no environmental benefit).

2.10 The SRA currently administer and fund CNRS in England, Scotland and Wales, TAG in England and Wales, and FFG in England only. (The Scottish Executive administer and fund FFG and TAG in Scotland and the Welsh Assembly Government are responsible for FFGs in Wales.) The SRA's freight grant functions will revert to the Department for Transport following implementation of the changes set out in the recent Railways White Paper and passage of the Railways Bill.

3. Water Freight Grants

3.1 Freight Facilities Grant was introduced for inland waterways schemes in 1981 as an extension of the railways scheme. The purpose was, as for the rail scheme, to encourage the transfer of freight traffic off roads and on to a mode of transport that entailed fewer adverse effects on society. The grants meet part of the capital costs of providing inland waterway freight facilities.

3..2 Administration of the rail and water schemes was separated with the establishment of the Strategic Rail Authority, with responsibility for water grants remaining with The Department for Transport. Where there are coastal shipping grant schemes relating to Wales these are administered by The Department for Transport and funded from its budget. Inland Water FFGs are the responsibility of the WAG.

3.3 In 2001 the water freight grant regime was extended to include investments relating to coastal shipping. Following recommendations from the Freight Study Group the Government proposed extending the scheme further to cover not just capital investment in facilities, but time-limited operating grant. This proposal received state aid clearance from the European Commission in April 2004 but the scheme has not yet started.

3.4 There is well established guidance setting out the basis on which grants are provided. This has been revised and updated and is being made available on the Department for Transport's website.

3.5 The key changes from the previous version are as follows.

• New sections covering the new operating grant scheme. The requirements here are in line with the conditions set by the European Commission in approving the scheme. It should be noted that it is unlikely that funding will be available to support operating grant applications before 2006-07.
• A stronger emphasis on open access for facilities. The Government is keen to ensure that, where practicable, open access is provided to facilities funded through water freight grants. The European Commission has also addressed this point in clearing the coastal grant scheme. It is recognised that there are practical limitations, eg a conveyor being used to load food products destined for the food chain onto a vessel could not be used for waste. But it should be possible to allow other users to have access to, for instance, wharves in many cases.
• Special procedures will apply for applications relating to the purchase, refurbishment or adaptation of vessels for use on inland waterways. All freight grants carry with them the risk of distortion of competition, but this is particularly so in the case of grants for mobile assets. The water freight budget is not intended to fund a comprehensive vessel replacement programme, nor can it do so, so there is always a risk that a grant for one vessel will disadvantage other operators. However, there may be cases where investment in a vessel is the only way to secure the transfer of traffic away from road. We are therefore putting in place processes to help ensure that, for relevant applications, vessel investment is indeed the only realistic approach to securing the benefits in question, and that competition concerns are minimised. This issue does not arise in respect of coastal shipping grants as EU state aid clearance for our coastal scheme was given on the understanding that there would be no grants for vessels in sea-going operations.

Changes to reflect the move to the new arrangements set out in this document.

4. Road Haulage Schemes

4.1 The road haulage industry is highly competitive and generally offers an excellent service to British industry and consumers. The Government does not wish to create a framework for regular subsidies to the industry as this would risk distorting competition. It would also be likely to infringe EU state aid rules.

4.2 Nevertheless there are cases where some limited Government intervention may be a sensible way of encouraging more sustainable operating practices. In recent years the Government has run a number of programmes, notably through the Road Haulage Modernisation Fund, to promote safer and more fuel efficient driving, and operating practices that reduce vehicle mileage and pollution. These programmes, which entail supporting the cost of advice or training, have been built around best practice developed through the Department's research programmes.

4.3 Operators who take advantage of these schemes can make cost savings in the medium term, yet we have found that the schemes need a kick-start to encourage take-up. In considering further funding for such projects the Government will apply the following principles:

• Funding should be given only where best practice would bring benefits in terms of the environment, safety or congestion, and only where best practice would not be adopted without that funding
• Projects should be designed with the aim of embedding best practice in the industry so that continued funding is not required
• The risk of distortion of competition should be minimised. Projects must be consistent with EU state aid rules, notified where necessary, and tendered competitively where necessary.

4.4 Responsibility for funding and running road haulage schemes is devolved, so the proposals in this document relate to England only.

4.5 The Government welcomes suggestions from the industry for new projects, though the expectation is that they will be run centrally as now, with the Department taking the lead in specifying and letting contracts.

5. Prioritising Investments

What Schemes will be Available?

5.1 The new arrangements do not affect the menu of schemes on offer. In principle projects under any of the schemes described in earlier chapters may be funded from the sustainable distribution fund when it becomes fully operational in 2007-08. However the SRA is separately reviewing some of the rail grants and changes may be proposed as a result of this review. In some cases, continuation of schemes will depend on renewal of EU state aid clearance, and the possibility remains open of modifying schemes, for instance developing a CNRS-type scheme for both rail and water.

Measuring Benefits

5.2 For the last few years the two modal shift grant programmes (rail and water) have been run separately, largely on a first-come, first-served basis. The key criteria applying to the programmes have been that:

• the grant should be the minimum necessary to ensure transfer of traffic from road; and
• the grant should be capped at the level of the net benefits assessed for the scheme.

Efforts have also been made to limit capital grants to no more than 50% of capital costs.

5.3 Under the current arrangements the minimum benefit to cost ratio for any scheme should be 1:1, though for some applications it is considerably higher.

5.4 Benefits from freight grant schemes are assessed by calculating lorry miles saved and giving a weighting according to the types of road from which traffic is removed ("Sensitive Lorry Miles" - SLMs). The SLM methodology has recently been refined and the values are explained in the appendix to this document.

5.5 The Department believes this methodology has served us well and intends to continue using it. The SRA has recently developed some new SLM values, and the Department will apply these from now for water freight grant assessment.

5.6 In cases where there are significant benefits or disbenefits that fall outside the methodology, the Department will seek to take account of these in assessing value for money. The Department may also revise the methodology from time to time as necessary to take on board emerging evidence and other developments.

5.7 The SLM methodology is clearly not so well adapted to evaluating the sorts of road haulage schemes we have been funding through the road haulage modernisation fund. There are two issues raised by these schemes.

• How can we monetise the value of projected benefits that range across environmental, safety and congestion benefits? Our proposal is to use the best evidence and data we have. In the case of safety there are reasonably well-established figures for the value of preventing accidents and casualties. For some pollutants the consensus is still building but we will use the best figures available. The aim will be to produce an assessment of benefits that is as far as possible comparable with figures generated through the SLM methodology.
• How can benefits be valued when there may be considerable uncertainty about whether they will be realised? This will have to be a judgement. We may know the benefits of best practice, but the actual benefits will depend on the willingness of the industry to apply it. The Department will make the best assessment possible of the benefits that are likely to be realized, drawing on past experience if possible (see under "Monitoring and Evaluation" below).

5.8 Across all schemes we will work to improve our assessment of net benefits and aim to include all relevant factors. For instance we envisage that we will need to review fully the grant rates to take account of the introduction of lorry road user charging.

Prioritising Funding

5.9 The Government needs to ensure best value for the taxpayer's money in running the sustainable distribution fund. Our objective is to maximise the net benefit achieved per pound of grant and fund the schemes that represent the best value for money.

5.10 One way to do this would be to operate a challenge fund whereby applications for funding for a given year are received in advance and ranked by vfm criteria. Although this would facilitate both the direct comparability of schemes which are bidding for funds, and the process of prioritising subject to a given budget constraint, there are practical difficulties. First, it risks being over-bureaucratic. Second, capital grant applications in particular do not fit neatly into an annual cycle; good proposals can emerge and be implemented mid-year, and some entail expenditure across several years.

5.11 Our approach will entail two elements. First we intend to apply a minimum benefit to cost ratio of generally 1.5:1 to all grants made after April 2005. For the grants programmes this will be based on the SLM measure so will reflect the impact on the environment, safety and congestion, though, as stated above, there will be flexibility to take account of other relevant factors that fall outside the calculation.

5.12 Second, we plan to give priority to the best vfm schemes. This will apply for the water/road pot from April 2005, and for all grants from April 2007. (Prioritisation already applies to rail schemes.) It is not possible to be prescriptive about how this will operate as it depends on demand for grants and the relative vfm of grant applications in the pipeline. But the assumption should be that applications with benefit to cost ratios near to the floor 1.5:1 level may be displaced by applications that are more favourable in vfm terms. Similarly applications with very attractive vfm levels will have a greater chance of being awarded funding.

5.13 Applicants will clearly want to know what chances of success their applications have. They should discuss with the freight grants unit, who will be able to provide an indication of the level of demand, and the sort of vfm levels that might be required to "make the cut" at that particular time.

5.14 We are aware that these processes will not always lead to a neat cut-off, and it is possible that in some circumstances (eg where a scheme is changed or withdrawn during the process) there may be cases where grants are made with slightly lower vfm than grants turned down.

5.15 Applications that would account for a large proportion of available funding in any one year may have to be viewed less favourably because they reduce flexibility. Experience suggests that where such schemes are accepted in principle, any delay means that a large sum of funding has to be frozen and it is not available for other schemes. This can lead to the budget being underspent.

5.16 We will probably wish to retain some type of bidding process for revenue grants, and we may conclude that a full bidding process is the sensible way forward.

Aggregate Levy Sustainability Fund (ALSF)

5.17 The Aggregates Levy reduces demand for primary aggregates by increasing their cost and makes the use of recycled and secondary materials more viable; but it does not tackle the environmental impacts directly. The ALSF uses revenue from the Aggregates Levy to address those environmental impacts. Roughly £300m per year is raised by the Aggregates Levy and £35m per year is channeled into the Fund in the UK (£29.3m in England).

5.18 The Fund is spent through various agencies, and The Departmant for Transport has been allocated some ALSF funding for the period up to end March 2007 to use to mitigate the environmental impacts of the transport of aggregates."

5.19 Some freight grants, for both rail and water, are already associated with the movement of domestic aggregates, and some of our road haulage schemes help operators carrying aggregates to improve their practices.

5.20 The Department proposes that ALSF schemes should be administered alongside the sustainable distribution fund, though be administered separately from it to ensure transparency.

5.21 There is a tension between simplicity of arrangements and demonstrating that ALSF funding is additional to the current grant regime. Some aggregates projects have been funded through both rail and water grants, though this has been lumpy.

5.22 We intend to apply the following arrangements.

• About 12% of water grant funding over the last few years has gone to projects that would be eligible for ALSF support.
• Over the next two years, where aggregates-related schemes offer competitive levels of value for money and are pursued, we make available about 12% of the pot, thus ensuring similar levels of funding to recent years. Any other aggregates-related schemes will be funded from the ALSF. In other words, the first eligible aggregates-related schemes will be funded from the water freight grants budget before turning to the ALSF.
• Where schemes are not pursued from the main pot because of lower vfm levels, these will be funded from the ALSF provided they meet minimum (1.5:1) vfm levels and other relevant criteria. This will be additional funding because they would not otherwise have been supported.
• For rail, around 20% of existing TAG obligations relate to the movement of aggregates. Discussions are ongoing to determine whether the ALSF could be used to provide additional funding for TAG. If this proves to be possible, then over the next two years a similar arrangement will be adopted to that proposed above for water grants i.e. applications relating to relevant aggregates movements that could not be supported from the main budget for rail freight grants would then be considered for funding from the ALSF.

Arrangements will be reviewed prior to the start of 2007-08, alongside the wider review of the ALSF.

5.23 The same assessment methodology will be applied too, though the Department would be ready to consider on a case by case basis other relevant benefits, for instance where the avoidance of primary aggregate extraction is associated with a scheme.

Devolved Administrations

5.24 This document primarily describes arrangements for funding in England, though it does affect arrangements for devolved administrations, as described below:

Scotland

5.25 The Scottish Executive is responsible for running its own capital and operating grants programmes for water and rail (apart from CNRS which is currently operated by the SRA in Scotland). There are already arrangements to deal with cross-border schemes which lead to lorry mile savings in both England and Scotland. It is anticipated that these arrangements will remain in place, with the English element of the grant being assessed in line with the principles laid out above.

Wales

5.26 The WAG will continue to fund rail and inland water FFG schemes. CNRS and TAG grants relating to Wales will continue to be administered as now for the next two years, unaffected by the transfer of SRA functions into the Department for Transport. The arrangements will be reviewed prior to the beginning of 2007-08 in the light of decisions on the future of CNRS. But if the schemes are renewed it is anticipated that Welsh schemes will continue to compete for funding alongside English schemes on a vfm basis.

5.27 By agreement between the WAG and The Department for Transport, coastal-related FFGs are administered by The Department. The same will apply to any operating grant applications affecting Wales. Again, Welsh schemes will compete for funding on a vfm basis alongside English schemes.

Northern Ireland

5.28 The Department for Transport operates the coastal grant and operating grant schemes in respect of applications affecting Northern Ireland. There is no significant freight traffic on rail or inland waterways in Northern Ireland.

Monitoring and Evaluation

5.29 It is important that grant funded schemes are monitored to ensure they deliver the benefits that the taxpayer is buying, and to help inform future decisions on the design and conduct of schemes. Arrangements are largely in place to ensure this happens.

5.30 In the case of some schemes such as CNRS, the grant is paid as the benefits are delivered. For freight facilities grant schemes the usual arrangement is for verified returns to be provided confirming that the goods in question have indeed been moved by rail or water. Where there are shortfalls, the grant commitment period can be extended or, if appropriate, grant can be clawed back.

5.31 The road haulage schemes we have operated to date have also included a monitoring component.

5.32 We plan to evaluate the new arrangements after their first full year of operation in 2007-08. We will want to know whether they have provided better value for money in contributing to safety, environment and congestion-related objectives compared with previous arrangements.

Transparency

5.33 While the Department and SRA have published some details of grants, these have often been aggregated. The Department intends in future to make more information public earlier in the process.

5.34 From next April the Department intends to start making available on its websites brief details of grant applications where it is minded to make an offer including the amount of grant offered, what it is funding, the public benefits it will deliver and the vfm assessment. The Department will not publish the grant percentage at this stage, but will do so once investments have been made. The Department and SRA intend to discuss some of the issues arising with the industry before proceeding, in recognition of commercial confidentiality concerns.

6. A Budget for the Sustainable Distribution Fund

6.1 The Government proposes a phased introduction of the sustainable distribution fund, with the new arrangements coming into full effect in 2007-08.

6.2 Owing to funding constraints within the SRA, FFG and TAG have been suspended to new applications since January 2003 - although all existing contractual commitments have been honoured. TAG has since been reopened for new applications, but funding is currently dependent on the SRA's regular rebudgeting processes.

6.3 The Government will provide over £20m in CNRS grant for committed schemes in each of the next two years. However, funding for new applications is currently extremely curtailed.

6.4 In addition to its support for CNRS, the Government will be making available £10.6 Million in 2005-06 and £12.6 million in 2006-07 for the new sustainable distribution fund. In the first two years this will be reserved mainly for water freight grants and road haulage schemes, though as a transitional measure we will make available up to £2 million of this in each of the next two years for the best performing Track Access Grant and CNRS applications.

6.5 No funding has been identified for rail freight facilities grants in England for at least the next two years.

6.6 An indicative budget of £22.6 million has been set for the Fund for 2007-08. The size of the sustainable distribution fund for 2007-08 and beyond will be revisited as part of the 2006 Spending Review process.

6.7 The table below gives an indication of how the pot might be divided.

£m	05-06	06-07	07-08
Rail	2.0	2.0	22.6 (provisional figure - to be revisited in 2006 Spending Review)
Water	7.1	9.1
Road	1.5	1.5
Total Sus Dis Fund	10.6	12.6
Committed SRA spend	23.9	22.5

6.8 It should be noted that the totals shown above include both capital and resource funding. The resource elements of the budget are £3.6m and £5.6m respectively for 2005-06 and 2006-07. For next year this means that the resource element will be almost entirely used by road and rail schemes so it will not be possible to offer water operating grant. For the following year (06-07) there should be some £2 million available for water operating grant.

6.9 There will be some £3-4 million from the ALSF available for sustainable distribution support in each of the next two years. Following a review, a decision will be taken in late 2006 as to whether it should be renewed from April 2007.

Appendix

Economic Justification for Rail and Water Freight Grants

Freight movements form an indispensable part of our economy and generate significant benefits. These benefits are in the most part fully captured through market prices and the behaviour of firms and consumers. Many of the costs of freight movements, however, such as air pollution, noise, accidents and congestion, would not be fully factored into firms and consumers' decisions without Government intervention. Ideally, the most efficient means of doing this would be to levy a tax or a charge at point of use that mimics these costs - the "polluter pays" principle.

In the absence of a road user charging system that reflects internal and external costs, providing support to a less environmentally damaging means of freight transport, such as rail, can achieve a reduction in the social cost of all freight movements.

These arguments are incorporated within the freight grant system. The relative environmental benefits of rail/water as against road that the flow is assumed to deliver are calculated utilising the Sensitive Lorry Miles (SLMs) values. SLMs are designed to capture the net noise, safety and congestion effects in monetary terms of removing a lorry from the road network: they are expressed in terms of pounds per lorry mile removed. Research undertaken by SRA, The Departmant for Transport, Defra and others underpins a proportion of these values. Inevitably there is an element of judgement and these values include an "unquantified" element. Table 1 (a downloadable document) below presents the SLM values in terms of quantified and unquantified benefits.