Part 4: Tender process to choose a construction partner

Inquiry into the Mangawhai community wastewater scheme.

By early 2001, the Council had appointed Beca to manage the overall project on its behalf and was committed to exploring the possibility of a PPP. The next step was for Beca to help KDC go to the market to see who might be interested in tendering to build and operate the scheme. This is a major step in any PPP.

In this Part, we discuss:

  • the preparatory work that was done in early 2001 before approaching the market;
  • the April 2001 call for Expressions of Interest (EOI) from potential providers and the assessment of responses;
  • the RFP process that began in November 2001;
  • the September 2002 decision to negotiate with Simon Engineering as the preferred provider;
  • preliminary work on funding the construction; and
  • our comments on the overall tender process.

In summary, we conclude that:

  • The basic process and steps that KDC took to tender for a provider were reasonable and appropriate.
  • The substance of the work regularly fell short of what was needed for a PPP project of this nature. For example, there was no clear documentation in KDC's files to demonstrate that the PPP would be more cost-effective than traditional procurement.
  • There is a risk that the way the work was carried out increased the price of the scheme and might have made a PPP look more attractive.
  • Record-keeping and documentation of decisions were poor. The Council did not pay enough attention to proper process and appropriate lines of accountability when it made decisions.

Our assessment is that KDC was out of its depth in embarking on a PPP and relied heavily on its project managers for guidance.

Preparatory work before going to the market

Good practice steps before tendering a public private partnership

When deciding to use a PPP to construct and operate infrastructure, it is good practice for a public entity to assess the bids from the private sector entities against an estimated cost for the public entity to design, construct, and operate the infrastructure itself. Partnerships Victoria provides guidance on how to establish what it calls a "public sector comparator", which is essentially an estimate of what it would cost the public entity to carry out the project using traditional procurement methods. Public entities use the public sector comparator as a benchmark for deciding whether using a PPP would offer better value for money.

Compiling a public sector comparator using the Partnerships Victoria model is complex. There are several components:

  • a raw public sector comparator, which is an estimate of the base cost if the public entity were to build and own the asset using traditional methods and should include all the capital and operating costs of building, owning, and operating the asset and of providing the service;
  • an adjustment for competitive neutrality, which is a financial calculation to take account of any inherent price advantages that public sector entities have (such as a different tax treatment) that would be in the raw public sector comparator;
  • a price for retained risk, which is an estimate of the value of the risks of the project that the public entity is to retain; and
  • a price for transferred risk, which is an estimate of the value of the risks of the project that are to be transferred to the private sector partner.

These last two components reflect that the allocation of risks between the private sector partner and public entity is critical for the costs of a PPP. The theory behind risk allocation in a PPP is that the party best able to bear and manage a risk should be allocated that risk. If risks are inappropriately allocated to the private sector partner, the public entity will end up paying a premium for the private sector partner to carry those risks.

One of the advantages of compiling a public sector comparator is that it requires the public entity to determine what the risks of the project are, assess the likelihood of their occurrence, and place a value on the costs of the risk if it were to occur. This process should help the public entity identify which party is best placed to manage that risk and, therefore, where it should be allocated.

Under the public sector comparator, the assessment is of cost over the entire operating life of the project. To do this, a net present costs conversion is applied – that is, the future costs are converted to present-day costs using a discount rate. The Partnerships Victoria guidance on public sector comparators states that "The discount rate reflects government's time value of money plus a premium for the systematic risk inherent in the project." In Victoria, advice about what discount rate to use was provided by the Department of Treasury and Finance.

The benchmark

There was no copy of a public sector comparator for the project in KDC's files. In KDC's files, we found a Benchmark Design Report (discussed further below) and a document titled Risk Inputs and headed "Risk summary for total project. Risk allocation between retained and transferred based on design/construct approach as per documents". The Risk Inputs document includes a table setting out several risks, providing an assessment of the likelihood of their occurrence, and placing a value on the cost of the occurrence of the risk. The table also set out an analysis of which risks KDC would bear under a design/construct approach and a BOOT approach.

Beca prepared the Benchmark Design Report and provided estimated capital and operating costs for a wastewater scheme if KDC were to construct it. The Benchmark Design Report states:

The benchmark is intended to reflect a scheme that would likely have been provided had the project been delivered by traditional means (design/tender/construct). It is to be used to compare both technically and cost wise with offers made for a BOOT, DBO or similar risk transfer schemes.

The scheme set out in the Benchmark Design Report consisted of:

  • conventional gravity reticulation to a treatment plant in a rural area south of the Harbour;
  • treatment by aerated lagoon and aerated sludge lagoons with UV disinfection; and
  • effluent disposal by rapid infiltration to the coastal sand dunes.

The estimated cost for the reticulation part of the scheme was based on the estimated population in 2015. The report identified that parts of the reticulation network would need to be upgraded in 2015 to cope with the increased population. The report included an estimate of the costs for this. The report also identified the areas that were to be serviced and noted that, if other areas were to be serviced, the estimates would need to be adjusted. The design capacity for the reticulation system was based on an estimated weekend population of 12,800. The design capacity for the wastewater treatment plan was based on a "typical summer population" of 9200 in 2027.

The report set out that the estimated capital cost for the scheme was $18 million, made up of:

  • sewer reticulation: $11.4 million
  • 2015 sewer reticulation: $3.1 million
  • treatment plant and disposal: $3.5 million.

The report also broke down the construction cost this way:

  • Cost for present population $11.5 million
  • Provision now for future population $3.4 million
  • Future extension $3.1 million.

It also estimated the annual operating cost would be $290,000 in 2002 and $375,000 in 2027.

The Benchmark Design Report was not a complete public sector comparator, and Beca told us that it formed only part of a comparator. This was because it did not include any information about retained risks or transferred risks, nor any adjustments for competitive neutrality. The information from the Risk Inputs document, together with the Benchmark Design Report, could have formed the basis of a public sector comparator.

EPS told us that the Benchmark Design Report and Risk Inputs document were both used as inputs into the "benchmark" (that is, a public sector comparator). It told us that the benchmark was prepared and sent to the Council's solicitors, Brookfields, before the tenders were received.

KDC's files did not show whether councillors were shown the Benchmark Design Report, the Risk Inputs document, or the benchmark.

The PSC minutes for the meeting in October 2001 record that EPS told the PSC that the benchmark was completed. However, later minutes of the PSC suggest that this was not the case. The March 2002 PSC minutes record that:

[the] financial model to be used for the establishment of the benchmark and comparative quantitative evaluation of proposals has been completed and presented to J McKerchar and J Lok. The model will be populated with commercial and technical benchmark information and locked away with Councils solicitors prior to bids being opened. Target Date for this Thursday 28 March 2002.

The April 2002 PSC minutes record that the benchmark had been sent to KDC's solicitors. We asked KDC's solicitors for a copy of that document, but they were unable to locate it in their files.

The PSC minutes do not record that the PSC saw the benchmark or had any role in approving it. Nor is there any record in the Council's minutes of it being provided with the benchmark or being asked to approve it. We discuss further below how the benchmark was used in the evaluation of the tenders.

How the Council allocated risk

The Council held a workshop in February 2001 to discuss risk management, including the allocation of risks between KDC and a private sector partner. It appears that the results of this process were reflected in the Request for Expressions of Interest for the Mangawhai Infrastructure Project document KDC issued in April 2001. We were able to locate only draft copies of this document in KDC's files, not a final copy, so we were unable to confirm that this information about risk allocation was in the final document KDC issued.

In the later RFP for the wastewater project issued in November 2001, the allocation of specific risks was shown in a table. The only risks allocated to KDC were:

  • construction cost over-runs caused by KDC;
  • pursuit of legal remedies in the case of illegal discharges and connections;
  • any issues with availability of KDC's sites; and
  • managing the customer interface, including billing and accounts.

KDC and the private sector partner would also share a small number of other risks. These included some risks associated with KDC's sites, such as contamination and archaeological risks, and the community liaison risk.

The RFP document required the tenderers to prepare tenders based on this allocation of risks, which would be included in the Project Deed – the final contract between the successful tenderer and KDC. The table listing the risks and their allocation contained in the RFP clearly showed that KDC was allocating as much risk as possible to the private sector partner (in this instance, called the Promoter).

We asked one of our engineers to review the allocation of risks and provide us with his comments on the appropriateness of the allocation (see Appendix 3). He concluded that the risk allocation would have resulted in a significantly higher bid price. Some of the allocated risks had significant uncertainty, and the tenderers would have priced their bids to protect their commercial position as a result.

Our comments on the preparatory work

The initial decisions the Council made on allocating risks between KDC and the private sector partner were significant for the cost and efficiency of the project. We reviewed the initial allocation of risks with help from our engineer (see Appendix 3). Our overall conclusion is that the Council shifted too many risks to the private sector partner that it would have been better placed to manage. Tenderers would have priced these risks into their bids, and so it is likely that, from the start, the prices were higher than they might otherwise have been.

We were unable to evaluate a core part of the preparatory work for the tender process – that is, the use of the public sector comparator. This means that we were unable to conclude whether it provided a robust basis to determine whether it would be more cost-effective to use a PPP compared to KDC carrying out the project.

Expressions of Interest process

After the February 2001 Risk Management Workshop, a tender process was begun, starting with calling for EOIs for the wastewater project. The EOI document was advertised in April 2001. As already noted, KDC was unable to find a copy of the EOI document that was finally issued. However, we saw draft versions of the EOI document that included information about the project scope, the tender process and timing, risk allocation, and the evaluation criteria.

The draft EOI document set out that there would be a three-stage process to select the preferred bidder. There was to be an initial short-listing of bidders. An RFP and draft contract documents would then be issued to the short-listed bidders for them to develop detailed proposals. These proposals would be evaluated, a final preferred bidder selected, and a contract negotiated with that party.

EPS prepared the draft EOI documents. The PSC minutes for March 2001 record that "Comments on the draft Request for Expressions of Interest been received and input from the workshops had been added. Further minor comments were provided. The document is now ready for issue." The minutes do not record who the comments were from. We were unable to tell from KDC's files who approved the final EOI documents for release or what that document contained. Beca told us that the documents for the tender process were submitted to the Chief Executive and that he either acted under his delegated authority or sought approval from the Council.

The draft EOI documents provided that the EOIs would be evaluated on the basis of the bidder's ability to:

(a) develop and manage best practice wastewater and stormwater infrastructure;

(b) develop environmentally sensitive infrastructure projects and maintain high levels of community service and involvement;

(c) provide a competitive and commercially acceptable proposal; and

(d) maintain consistency of approach from Expression of Interest to contract finalisation.

The draft EOI documents also set out that the bidder's capabilities in other areas would be assessed. These capabilities included the bidder's financial viability, commercial concepts, innovation, technical concepts, and management skills.

It appears that EPS developed a process for selecting the preferred bidder. This process was set out in a document dated 25 June 2001. This included the process to be used during the EOI phase. We were unable to tell who approved this process. There is no record in the Council's minutes of the Council or the PSC receiving this paper. The PSC was provided with information about the evaluation process in May 2001. Again, Beca told us that all the documents for the tender process were submitted to the Chief Executive.

The process set out in the EPS paper included the appointment of a Core Assessment Team to evaluate the tenders and then to make a recommendation to the PSC about the tenderers. The PSC's minutes for May 2001 record that the PSC was advised that KDC's asset manager, two EPS employees, and one Beca employee would evaluate the EOIs.

EOIs were required to be submitted by 28 June 2001. KDC received seven EOIs, five from New Zealand companies/consortia and two from Australia. They were:

  • NorthPower;
  • Duffill Watts and King;
  • Fletcher Construction;
  • Earthcare NZ Consortium;
  • Works Infrastructure;
  • EarthTech Engineering (a subsidiary of Tyco); and
  • Simon Engineering (Australia) Pty Ltd (Simon Engineering).

The seven parties that had expressed interest gave presentations to the Core Assessment Team on 31 July and 1 August 2001. Other KDC staff, including the Chief Executive and some councillors, attended the presentations. The PSC report in August 2001 to the Council, recommending which parties be selected as tenderers to go through to the RFP process, noted that the Core Assessment Team had assessed the submissions and presentations of all the parties. There were no documents in KDC's files about how the Core Assessment Team carried out this evaluation, including whether the EOIs were evaluated against the evaluation criteria that had been established earlier.

The Core Assessment Team recommended to the PSC which companies should proceed to the RFP stage. The Committee agreed and recommended that three companies be short-listed to proceed to the RFP stage: NorthPower, EarthTech, and Simon Engineering. The Council confirmed the recommendation on 22 August 2001.

Our comments on the Expressions of Interest process

On its face, the EOI process appears to have been relatively straightforward. However, our ability to assess it fully was again hampered by the limited documentation in KDC's files.

We are also concerned at the apparent lack of clarity in this phase of work about who was to sign-off documents and who was responsible for particular decisions. We have not been able to establish who saw the EOI documents or who approved them. Again, this suggests that KDC's approach to management and decision-making was too loose for a public entity carrying out a project of this size.

Request for Proposals

Issuing the Request for Proposals

EPS prepared the documents for the RFP, which was issued on 23 November 2001. The PSC minutes for November 2001 record that EPS provided the draft RFP, Project Deed, and schedules to KDC's Chief Executive for review. However, we found no evidence to suggest that these documents or a summary of them were seen or approved by either the Council or the PSC.

A community forum was held on 24 November 2001 so that the community could meet the three bidders in the RFP process. About 150 people attended and presented verbal and written submissions. At the request of the MRRA, a special meeting was also held between the MRRA and the bidders on 10 January 2002.

The original deadline for submissions was 22 February 2002. This was extended to 3 April after two of the bidders asked for an extension of time. Meeting notes show that the PSC discussed this issue, but it is not clear whether the PSC approved the extension or whether the decision to extend had already been made. All three bidders submitted their proposals on 3 April.

The evaluation process

In December 2001, the PSC had discussed at its meeting a proposed process for evaluating the tenders. The project managers were asked to prepare recommendations for the process for its next meeting. In February 2002, the PSC discussed the proposed tender evaluation process further. In March 2002, EPS provided further information about the evaluation process to the PSC, and the minutes for March 2002 record that the PSC agreed with what had been proposed. Although the minutes record that information about the broad structure for evaluating the tenders was provided, they do not set out what the evaluation criteria were to be. No copies of the information provided to the PSC were in KDC's files, so we could not establish exactly what the PSC agreed to.

The March 2002 Council minutes record that the Council received a report from the Chief Executive and that the Council adopted the evaluation process recommended in his report. No copy of his report was in KDC's files, so we could not be certain what process the Council agreed to adopt. However, in a monthly report from Beca to the Council, there was high-level information about the tender evaluation process. The report attached a paper setting out more detailed information about the evaluation process for the Council's information. KDC's former Chief Executive told us that he believed that his report would have attached the Beca report to it.

The Core Assessment Team was to conduct the evaluation process, which the Evaluation Overview Team would oversee. The Evaluation Overview Team was made up of councillors, an iwi representative, and two members of the Community Liaison Group. The Core Assessment Team was to make the final recommendation on the preferred proponent to the PSC. Subject to the PSC's approval, the Chief Executive would make the recommendation to the Council.

Beca told us that the evaluation process the Council approved was followed when the bids were evaluated. However, there were only limited records of the evaluation process in KDC's files.

The three tenderers included sites for disposing of the treated effluent. The former Chief Executive told us that none of the sites proposed were suitable to the Council for a variety of reasons.

EPS prepared a report in August 2002 with a recommendation to award preferred proponent status to Simon Engineering. We were unable to determine from the files why the tender evaluation process took over four months.

Our comments on the Request for Proposals

The information we have been able to find suggests that a reasonable evaluation process was developed and followed. However, we cannot be certain, because we have not been able to locate the substantive documents.

Again, we are concerned that the approval and decision-making process appears to have been relatively informal and that the overall RFP process was barely documented. We regard this as inadequate in a public sector context, where accountability for the use of public funds and how decisions are being taken should be basic.

Simon Engineering selected for negotiation

The RFP document set out the evaluation criteria to be used by the Core Assessment Team. They included legal and commercial matters, financial matters, and technical and operational matters. The tenders were also to be compared against the benchmark developed by EPS.

The Core Assessment Team met with the Evaluation Overview Team and the PSC on three occasions while developing its recommendation. Beca and EPS prepared a report for the Council, Recommendation to award preferred proponent status, in August 2002. This report set out how the tenders were evaluated and provided an overview of the three tenders. It included a document that compared the major items between the three tenders. The proposed capital cost, operating cost, and toll stream (that is, payments to be made by KDC to the successful tenderer during the project to cover capital costs, and operating and maintenance costs) were also compared against a benchmark figure.

The report also assessed whether the project complied with section 122C of the Local Government Act 1974 (see paragraph 5.13). It concluded that the project did comply.

The report stated that all three proposals were technically sound. Simon Engineering offered the best option for disposing of the treated effluent. It also offered the lowest price, bettered the benchmark figure, and demonstrated the best commercial terms for the lowest price. Simon Engineering's proposal included ABN Amro (using New Zealand private investors) as the financier. Simon Engineering's proposal offered a fixed capital cost of $13.5 million as a guaranteed maximum price, with savings below this being shared 50:50 with KDC. Simon Engineering's proposal involved disposing of the treated effluent to a Carter Holt Harvey forest south of Mangawhai. The report stated that the Core Assessment Team recommended awarding Simon Engineering preferred proponent status, which meant that contract negotiations could begin.

The document comparing the three tenders refers to a benchmark with a net present value of $25.2 million. This appears to be made up of a capital costs benchmark of $24.4 million and annual operating costs at the beginning of the project of $400,000. The RFP was for both wastewater and stormwater systems, and the evaluation does not break down the benchmark figure into costs for both systems.

None of these figures correlate with the figures provided in the Benchmark Design Report for wastewater or stormwater prepared by Beca or in the Risk Inputs document. The comparison of major items document does not provide any information about how the net present value calculation was arrived at – in particular, it does not specify what discount rate was used.

Although we were unable to determine how the benchmark figures used to evaluate tenders were derived or what they included, EPS told us that the Benchmark Design Report and the Risk Inputs document were inputs into the benchmark. EPS also told us that the tenders were assessed against the benchmark. It also told us that a common discount rate was applied to the benchmark and the tenders, although not what that rate was.

Because we were unable to obtain a copy of the benchmark, we were unable to assess properly how the Core Assessment Team concluded that Simon Engineering's proposal was going to be cheaper during the wastewater scheme's operation, compared to KDC building and operating the scheme itself.

Simon Engineering proposed to dispose of the effluent from the wastewater scheme to land leased by Carter Holt Harvey at Te Arai Point. This land was in the Rodney Council district and would require consent from Rodney District Council and Auckland Regional Council. The recommendation for preferred proponent report notes that it had the best disposal option of the three tenderers.

Determining the location of disposal of treated wastewater is one of the main decisions for a wastewater scheme. The location of disposal will determine the method of disposal, the standards the wastewater needs to be treated to, and therefore the design of the wastewater treatment plant. This means that location can have a significant effect on the overall costs of a wastewater scheme. Until the location is decided, the potential costs of the scheme remain uncertain. If the Council did not agree with the disposal site and required Simon Engineering to find another site, there was a real risk that the cost would increase and that it might be higher than that included in the other tenders.

The Core Assessment Team briefed the Council at a workshop held on 14 August 2002. In addition, a public meeting was held on 17 August 2002 to provide information to the community on the recommendation, before the Council made its final decision on the preferred proponent.

The Council agreed with the recommendation from the PSC that Simon Engineering be offered preferred proponent status to enable negotiations to take place before a final recommendation was taken to the Council. The Council noted that preferred proponent status did not mean that Simon Engineering had been awarded the contract. Simon Engineering was formally notified on 10 September 2002 that it had been awarded preferred proponent status.

Our comments on the selection process

Again, the overall process for evaluating the tenders and selecting a preferred proponent was reasonable. KDC took the right steps with its Core Assessment Team, comparative work, oversight arrangements, and briefings to the Council and community.

However, we have many questions about the detail of the evaluation work that was done and how it related to the benchmark material put together in the preparatory phase. We could not see how the two were related because the benchmark itself was not in KDC files. We have already noted our concerns about whether the preparatory work created a risk that the price would be higher than necessary. In our view, these risks might have been increased by the way the evaluation was carried out. For example, we have not been able to establish what discount rate was used for the discount costs conversion in the comparison. This is an important element, because the PPP will look more attractive if too high a rate is used.

Also, the Council did not appear to understand that going to the next stage of the tender process with an unsuitable disposal site was risky. At a minimum, it meant that the Council had no certainty about the costs of the scheme or whether they bettered the benchmark.

Preliminary work on funding the construction

The RFP provided that the BOOT scheme would last 25 years. That meant that Simon Engineering would build the wastewater scheme and then operate and maintain it during that 25-year period. KDC would pay annual payments to Simon Engineering during that period. The payments, referred to as the toll payments, would cover the capital costs of construction, as well as the finance and operating and maintenance costs for the scheme.

EPS, with assistance from PwC (Australia), using information from Simon Engineering about the toll payments to be made during the 25 years, then developed an initial model of one-off charges and annual charges that ratepayers would pay to KDC to match the toll payments to be paid to Simon Engineering. The report to the Council recommending Simon Engineering stated that:

An initial model reflects that the following charge structure could fund the Mangawhai EcoCare project:

Wastewater Charges $800 + GST
One Off Service Provision Charge
  • Current Sections
$1,000 + GST
  • Future Sections
$6,000 + GST

The report does not specify what the legal basis for these charges was – that is, whether they were to be rates and, if so, what type. The first charge in the table was an annual payment, and the charges below were one-off charges. It was proposed that the charges would increase over 25 years in line with inflation. The report also noted that feedback from the community had been that the one-off service provision charge could be set at $10,000 to $12,000 for future section owners. This would have the effect of reducing the annual charge.

The report also suggested that KDC might "… wish to fund part of the initial capital cost utilising lower interest rates than those available in the Simon proposal." The Council's decision on 28 August 2002 to award preferred proponent status to Simon Engineering was made subject to Simon Engineering "acknowledging the ability for KDC to consider the provision of some equity or funding".

Our comments on the early funding work

It was important for the Council to focus on how it would pay for the scheme from the start. These early calculations show that it recognised this as an issue. However, this initial thinking was relatively sketchy. We note, in particular, that there was no analysis at this stage about how the proposals would fit with the legal rules governing the types of rates or charges that the Council could impose.

Our overall comments on the tender process

In our view, the basic process and steps that the Council took to tender for a provider were reasonable and appropriate. It put effort into preparation, an EOI, and then a full RFP process to evaluate proposals provided by three short-listed bidders.

We were unable to assess how robust the public sector comparator was, including how it related to the documents that were inputs for it. Therefore, we were unable to assess whether the conclusion that the PPP was a more cost-effective way for delivering the project was correct. We note that, even if the public sector comparator was robust, once the Council had decided it did not want to go ahead with any of the disposal sites put forward by the tenderers, there was little point evaluating the tenders (with the unacceptable disposal sites) against the public sector comparator. This was because the cost of a proposal with an acceptable disposal site was likely to be different.

By deciding to carry on with the process, the Council created a significant risk. It did not know how much the scheme with an acceptable disposal site would cost to construct or whether it would be cheaper for it to use a PPP rather than other forms of project delivery.

The Council should have paid more attention to proper process and accountability when it made decisions, by being clear about who was responsible for which decisions and making sure that decisions and the reasons for them were adequately documented. Even when using a contracted project manager, the Council still needed to know and to be able to explain what was being done on its behalf. A public entity cannot contract out its accountability obligations.

Our overall assessment is that the Council had weak governance of this stage of the project. There was a lack of clarity about who within KDC was to have oversight and ownership of the project. The Council accepted the information presented by the project managers that the PPP would be more cost-effective, without anyone in KDC really understanding the basis of that information or testing it. In effect, the Council relied on its project managers to have answered this issue correctly.

At this stage, there is also no evidence that the Council focused on the overall cost of the scheme. The tender price and the benchmark price were significantly higher than the figure included in the Preferred Options report in April 1999, some four years earlier.

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