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A leading Welsh economist says the Welsh Government should back the Circuit of Wales project because it could help kick start a revival in the Valleys economy.

Prof Brian Morgan of Cardiff Metropolitan University has written a report looking at the economic impact of the race track project proposed for Ebbw Vale.

The scheme, put forward by the Heads of the Valleys Development Company, has proved controversial because of the company's demand that its investment be underwritten with a £210m loan guarantee from the Welsh Government. Ministers are due to announce whether they will give that guarantee in June.

Prof Morgan says the project should be supported, because:

it might have potential to help kick start a process of regeneration in the northern Valleys;

construction could begin as early as this summer and be finished by the time the Brexit negotiations are finished;

it could create nearly 3,000 jobs during construction and a further 3,000 long term;

it could boost the attractiveness of the area for tourism;

major investment projects normally require some level of government support;

even if the initial business plan fails, it will create a legacy scheme that could continue to support jobs into the future.

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Prof Morgan's analysis

If any part of Wales was to be targeted for a transformational investment project then the area surrounding the northern Valleys would probably be top of the list.

It has suffered significantly from deindustrialisation and the decline of the coal industry and this has been exacerbated over many years by chronic under-investment in infrastructure.

Consequently, the area has relatively high levels of unemployment and poor employment opportunities. There is a shortage of high quality commercial and industrial property available for new businesses, along with a lack of investor-ready industrial sites.

poll loading Should the Welsh Government underwrite the Circuit of Wales project? 0+ VOTES SO FAR Yes No Don't know

These economic problems have been with us for decades. Indeed as long ago as 1936, Edward VIII when visiting the area said: “Something should be done to get [local people] working again.”

And sadly this is still the case. Something is needed to create a step change in economic development in the Valleys and the time has passed for tinkering around the edges (which is a good description of recent attempts to regenerate this area). Something transformational is required to kick start the growth process and reduce the prosperity gap with the rest of the UK. Something is needed now to reverse the decline in employment opportunities and introduce new investment.

The Valleys Task Force has been created by the Welsh Government to develop an economic regeneration strategy for the Valleys. It is due to report its initial findings and recommendations in July.

It must be acknowledged from the outset that the CoW is not a panacea for the area’s economic problems. It might have considerable potential to help kick start a process of regeneration but it is not in itself going to transform an area where economic opportunities remain scarce.

Reversing this cycle of decline will take a coordinated and interventionist approach to economic regeneration over the next decade or longer. But the CoW might play an important part in the process.

One of the key points in favour of the CoW project is that it is ready to roll - it is ‘shovel ready’ and there could be diggers in the ground this summer, constructing the circuit.

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In addition the project is also timely in the sense that the construction phase would coincide with the Brexit process which, because of the increased uncertainty involved, is holding back other private sector projects. But investment is needed now and the Circuit could be up and running by the time that Article 50 negotiations are completed.

It is worth emphasising that the CoW investment was first proposed in 2010 and the project is still awaiting a decision from the Welsh Government.

However, if a timely decision is made by the Welsh Government on the loan guarantee, then in two years’ time Phase 1 of the project could be almost complete, creating over 500 full-time equivalent jobs (equivalent to nearly 3,000 jobs on site during the two-year construction period).

Also by 2020, after the construction phase is complete, there could be in place the basis for an international racing circuit attracting over 100,000 spectators and boosting the tourist product along the Heads of the Valleys road. Alongside this investment other businesses could be planning to relocate or expand in the area, and, in addition, the extreme sports partnership could be up and running, with further impacts on tourism and jobs.

What is holding the project back?

The financial package to deliver the investment has not yet been finalised. Much has been made of the offer by the Welsh Government to provide a loan guarantee that would underwrite the capital investment needed to bring the project to fruition. It has been claimed that this guarantee is very risky and does not offer value for money.

The CoW is a risky, private sector led project but the Welsh Government guarantee has to be seen in the context of a policy intervention that is in line with existing regional economic development practice.

For example, although a Welsh Government guarantee of around £200m amounts to a lot of money, it has to be accepted that some form of grant aid is often required to underpin commercial investment in the so-called Objective One areas of Wales – the relatively poorest communities that have been eligible for the highest level of state aid for decades.

Over the years, various forms of public sector financial support for investment have been introduced. In the days of the WDA, the main form of support for private sector investment in the Valleys was provided in the form of property development grant (PDG).

This meant that up to 25%, and sometimes more, of the capital cost of a project was eligible for grant aid as long as it was located in the most deprived parts of Wales. The £400m investment that underpins the CoW project would certainly have been eligible for PDG – it would also have been eligible for support from EU regional development funds.

However, instead of PDG, the Welsh Government offered an alternative route – apparently because of the restrictions and uncertainties surrounding EU state aid rules. Instead of grant aid the Welsh Government offered to underwrite the CoW investment in the form of a 100% loan guarantee for which it will receive an annual credit guarantee fee.

In the long negotiations that followed the original decision to provide the loan guarantee, this surety has been reduced to 48% of the total capital cost in order to meet the stated metrics of compliance with state aid: ie off balance sheet treatment and appropriate sharing of risk with the private sector.

It is worth pointing out that the difference in cost between providing an up-front grant through PDG or alternatively underwriting 48% of the capital investment with a loan guarantee over a longer period is not significant – indeed PDG would probably be more expensive - and we are effectively comparing one form of grant aid to another.

The essential point is that some form of public support is inevitably required to bring forward private sector investment in the more depressed areas of the economy.

What are the risks involved?

The CoW investors agree that the project has to be classed as a higher risk investment. After all, the CoW is a very large, long-term development project that will require a number of important factors to be put in place in order for the investment to be successful. For example:

it will need to be tightly project managed from the start to ensure that the construction phase is completed on time and, hopefully, comes in under budget;

it will need to be expertly marketed and linked in to other events in Wales to maximise spectator numbers and ensure the maximum impact on tourism;

it will need to develop good strategic partnerships with other private investors in order for the full commercial benefits to be reaped in terms of ancillary investments from other parts of the automotive sector.

Howver, although the financial outcome is uncertain (as is the case with most demand led investments) the loan guarantee will only be drawn down once the facility is built and then only where the company experiences severe and sustained downside performance.

In this scenario, other private sector investors, (who will have already invested significant funds), will have lost all or part of their investment. So the largest share of the risks involved in the project is being borne – as it should be – by the private sector. Also, private sector institutions have assessed the risks and are still prepared to invest.

But an important point to note is that, with the guarantee in place, the racing circuit will definitely be built and the infrastructure will be put in place to run Moto GP, automotive, cultural and action oriented events. According to the financial model, the project has enough working capital to ramp up spectator numbers at the main events for the first three years of operation.

So, whatever happens in terms of the financial outcome of the project, in five years’ time there will be a legacy in the form of a state-of-the-art racing circuit that can host various events, ancillary buildings that can be used for a number of commercial activities and top class facilities that can be used for testing vehicles.

What if actual spectator numbers are low?

If the projected spectator numbers and other predicted revenue streams are lower than expected then a financial restructuring of the company may be needed in five years’ time. How much of a financial restructuring will be required in the event of low spectator numbers will depend on how far short the actual numbers turn out to be.

A relatively small shortfall might only require some fairly minor adjustments to the financial model. However, a large shortfall in numbers might require a completely new financial model and even a new set of investors to take over the project.

This has happened in other large infrastructure projects like the Channel Tunnel – the original investors lost most of their investment but Le Shuttle eventually turned out to be very successful.

As long as the scheme gets built to a quality level that allows the Circuit to host a series of international motorsport events, then the eventual owners only have to cover their running costs to make the Circuit viable and financially sustainable.

If the Welsh Government’s loan guarantee is activated, what will be the long-term benefits to Wales?

This will depend crucially on how much of the original development objectives have been realised by the time any proposed restructuring takes place. For example:

how many jobs will have been created in building the Circuit and running it for three years or more;

what is the potential at this stage for the scheme to attract further investments and complete the original business plan in terms of industrial and commercial buildings and hotels?

will the circuit still have the potential to become the UK’s premier destination for motorsport?

will the extreme sports partnership and facility be successful and sustainable in the longer term?

This highlights the risks involved, but the analysis in our report suggests that the economic impact from building and running the Circuit in the first few years of operation will be significantly positive in terms of both jobs and GVA.

poll loading Will the Circuit of Wales ever be built? 0+ VOTES SO FAR Yes No

The main measure for employment opportunities are the number of full time equivalent jobs (FTEs) created, measured over 10 years. We have estimated that in Phase One of the project there would be around 3,000 jobs created over the period to 2020 – this is equivalent to over 500 FTE jobs, ie long-term jobs.

But most of the long-term jobs will be created in Phase 2 of the project, by which time the operations side of the project should be fully up and running. In this second phase an additional number of jobs will be created – some part-time, some full-time - amounting to a further 3,000 jobs.

Converting these employment numbers to long-term jobs, we estimate that 1,600 FTE jobs could be created through both onsite and offsite activities in Phase 2 of the project.

However, the economic impact of Phase 2 will depend crucially on whether the three commercial zones that will underpin the operational phase of the project are built and successfully operated. So in the best case scenario the CoW project, once it becomes operational, has the potential to create over 2,000 FTE jobs over the eight-year development phase on which we have focused in measuring its total economic impact.

The other main measure of economic impact is the expenditure profile of the investment and the consequent uplift in gross value added (GVA) for the regional economy. Phase 1 will involve expenditure of over £400m but when leakages from the economy are taken into account (particularly when constructing a specialised race track where few local companies will have the expertise to become directly involved) we have estimated a net expenditure of around £218m in Phase 1.

The Circuit of Wales in numbers £210m Loan guarantee from Welsh Government 3,000 Construction jobs 3,000 Long-term jobs

Similarly in Phase 2, although leakages in the operational phase will be less than in construction, we estimate the net expenditure at around £470m from a gross expenditure of £700m. Once taxation effects and non-value elements are removed this leads to total GVA impact over Phase 1 and Phase 2 of around £450m once multiplier effects are taken into account from both onsite activities and off site activities. This represents a significant, positive impact on the local economy.

However, although the uplift in both GVA and in employment opportunities are significant they are far from automatic. Phase 2 of the project in particular will require a number of strategic investments to be made by third parties which are not guaranteed.

Consequently, it is worth stressing that at the end of the development period, the project may be underpinned by a completely different financial model to the one with which it began and there may even be new investors and owners involved.

But, on our understanding of both the financial model and the planned expenditure profile, in eight years’ time one thing is certain: if the loan guarantee is put in place, there will be a state-of-the-art racing circuit built on the site, a number of high quality buildings will have been erected and a lot of hard work will have been expended in trying to make the Circuit the UK’s premier destination for motorsport.

To get this far the CoW project has had to overcome considerable obstacles including getting consent for deregistering common land. If it succeeds, the CoW is likely to become a major tourist destination – not only for motorsports and related events but also for extreme sports enthusiasts. It could also have a positive impact on other events-led activities such as food and music visitor days.

It could also increase the visitor economy of Wales, adding additional spend and stay to those who have decided to visit Wales as an activity break destination. Indeed, the opportunities are endless, but getting there will be very challenging – it is, after all, operating in a highly competitive sector with a new and largely untried product. Our balanced conclusion is that the CoW has the potential to make a significant positive contribution to both the local economy and to the Welsh hospitality product.

Conclusion

poll loading Can the Circuit of Wales be a success? 0+ VOTES SO FAR Yes No

It must be emphasised that the risks involved in developing the CoW are not insignificant. However, they are calculated risks. In terms of benefits, the Circuit will help regenerate a part of the northern Valleys that is in most need of regeneration. It will create a significant uplift in GVA and an important expansion in employment prospects in an area where unemployment remains well above the UK average.

On our calculus of the economic benefits versus the financial costs, the increase in the number of jobs, the expansion in GVA and the enhancement of the tourist product in this deprived area are likely, on balance, to outweigh the risks involved.

Post Brexit, lifting Wales off the bottom of the UK prosperity league table will require a much higher rate of both private and public investment. Wales, especially the poorer areas, needs ambitious long-term projects on the scale of the successful Cardiff Bay development and, currently, the Valleys Task Force is investigating how investments on this scale can be stimulated. The CoW could play a prominent role in this investment strategy.

However, to be successful CoW will need to be well planned and professionally organised if it is to meet the challenge of managing the financial risks confronting the project. If it succeeds in overcoming these obstacles then the Circuit could better position Wales in the British and international motorsport industry and the project could underpin a longer term and sustainable strategy to develop jobs in tourism, hospitality and automotive engineering in the Valleys.

And the evidence from the USA and Europe is that whilst the risks associated with motorsport circuits can be significant, especially in the earlier years as spectator numbers are being ramped up, they can develop into durable and positive assets that can ride out storms and maintain investor confidence.

For example, Carolina Motorsports Park opened in 1999 and has continued to expand facilities and services. On weekdays it is used for race team practice, car manufacturing testing, TV show and commercial filming as well as law enforcement training.

Weekends are busy with auto and motorcycle races, track time events and driver training. In 2014 it was put on the market as a going concern. Further examples are outlined in the report.

So the underlying business model for the CoW has been tested in other parts of the world and found to be feasible. The conclusion of our report is that there is a distinct possibility that with judicial management of the construction project, a good marketing strategy for the events and an ability to leverage in the investment needed for Phase 2, that the CoW can deliver long-term and sustainable benefits to the Welsh economy.

Brian Morgan is Professor of Entrepreneurship at Cardiff Metropolitan University