Part 15: How construction was to be managed
15.1
In Section B, we discussed what happened between 2003 and 2007, when the Council dealt with several difficulties in getting the wastewater project under way. In this Section, we look at the construction and implementation phase of the project. Later Parts in this Section discuss:
- events during the construction process;
- funding and financing changes;
- the process of KDC taking ownership of the scheme;
- how the scheme is operating now; and
- our overall comments on events during the construction phase.
15.2
In this Part, we cover how the construction process was to be managed. We discuss:
- the basic commitments in the 2007 project documents;
- the arrangements for overseeing the construction work; and
- our overall comments
15.3
In summary, we found no evidence that KDC monitored how the tools in the contract to manage its risks were being used while the project proceeded. KDC does not appear to have:
- received the information it needed to assure itself that the design was appropriate for its needs before construction began (so it could not be certain that what was to be built and paid for was suitable); or
- received the monthly monitoring reports from the Project Director in EPS (so it had no way of monitoring the progress of construction or of understanding whether modifications would lead to additional financing costs).
15.4
As we set out in the next Part, the contract documents did not cover all the works to be carried out. This had financial consequences for KDC.
The basic commitments in the 2007 project documents
15.5
The 2007 Project Deed and Tripartite Deed included a construction timetable. They provided for EarthTech to carry out the works and for MDHL to make progress payments for the works. MDHL then took ownership of the works as they were constructed. Interest accrued on the payments made by MDHL. The accrued interest, the various fees ABN Amro charged, and the actual construction costs all formed part of the purchase price that KDC was to pay to MDHL once construction was complete.
15.6
If KDC made changes that meant that works were not completed to the construction timetable – for example, by modifying the works to be carried out or by changing the dates for commercial acceptance – and MDHL incurred any costs as a result, these costs would be added to the purchase price, as well as additional interest costs. There were therefore potential cost consequences if KDC agreed to change the scope of the works in any significant way.
How the guaranteed maximum price worked
15.7
The contract included a guaranteed maximum price for the works set out in the Project Deed and a provision for sharing the benefits of any savings. That is, the works set out in the Project Deed were to be carried out for a fixed cost. If the costs came in below that price, KDC had to pay EarthTech half the value of the difference between the guaranteed maximum price and the actual costs paid. If the actual costs exceeded the guaranteed maximum price, EarthTech was responsible for the additional amount.
15.8
To make up the guaranteed maximum price, the cost for each part of the work was set using either a fixed or a variable amount. For example, the cost for the geotechnical investigation of the storage site was a fixed amount. The cost for the reticulation pumps was a variable amount. This was to be made up of EarthTech's fee, the base cost of the pumps, and a contingency amount. EarthTech had to tender the variable components. EarthTech told us that it always obtained a minimum of three quotations from local or national subcontractors for the full range of works. Incorporated into the amount paid to EarthTech was a design fee, management fee, and margin. EarthTech also assumed a range of risks for the scheme's performance.
15.9
During construction, EarthTech was required to regularly compile a document setting out the actual costs it had incurred. We did not find a copy of any such document in KDC's files. However, monthly reports that EarthTech provided to the Project Director included this information.
15.10
The Project Deed also required the guaranteed maximum price to be revised and updated to record any adjustments resulting from modifications. Again, we did not find any copy of such a document in KDC's files. However, the monthly reports that EarthTech provided to the Project Director included this information.
The works that were not included in the Project Deed
15.11
Although the Council agreed to change the scope of the works to be carried out in October 2006, those decisions were not fully reflected in the amended Project Deed that was signed in 2007. For example:
- The Council agreed to include the costs of connecting properties to the sewer network, but these works were not included in the 2007 Project Deed.
- Because of the resource consent process, it had been agreed to move the wastewater treatment plant and to seal Thelma Road. The Council knew this before it signed the Project Deed in December 2007. However, the Project Deed did not include any provision for these works.
15.12
This meant that the costs agreed to in the Project Deed and covered by the guaranteed maximum price did not cover all the works that were to be carried out. It also meant that the timetable for construction, including the dates for commercial acceptance, would need to change. As a result, KDC was likely to incur additional financing costs. We did not find any evidence that this was explained to the Council.
Our comments
15.13
In our view, the amended contract documents should have covered all the works that KDC intended to carry out as part of the project. This would mean that KDC could be certain about the cost of the project. It would also mean that KDC would be unlikely to incur additional financing costs because the dates for completing works needed to change. In the documents we reviewed, we could find no explanation of why the contract documents were signed even though they did not include the full scope of the works to be carried out.
15.14
The Council's approach of dealing with changes in the project's scope while the works progressed carried risks. In our view, if the Council wished to take this approach, it needed to closely monitor the additional costs to ensure that the project remained affordable. As we discuss later, there is no evidence that this occurred, and the modifications KDC made had a significant effect on the cost of the project. Ongoing changes to the requirements also undermine the benefits of a PPP approach, as already discussed.
15.15
There was no information in KDC's files to show how the final figure for the guaranteed maximum price was arrived at. It appears that the contract overheads and profit margin were agreed before the works were priced, because the guaranteed maximum price includes figures for EarthTech's fee. However, there is no other supporting information.
15.16
Ensuring that the guaranteed maximum price is not set too high is usually done either by determining the amount it would cost KDC to design and construct the scheme or by getting an independent audit of the estimated actual costs before finalising the price. A probity auditor is often also used. Beca told us that KDC did not estimate the cost of designing and building the scheme, nor did it engage an independent auditor. Beca told us that:
EarthTech did however procure a significant value of works through competitive subcontract tendering. This process was transparent and provided an assurance that Council was getting competitive pricing. Competitive subcontract tendering is a cornerstone of pricing a contract that is not to exceed a Maximum Price.
Arrangements for oversight of the construction work
15.17
As we set out earlier in the report, the protections against construction risk that had been in the BOOT approach were reduced somewhat under the DBFO approach. The key mechanisms in the Project Deed to protect against construction risk during construction were:
- endorsement of the design reports;
- endorsement of various other plans (as set out above);
- monitoring of monthly progress reporting from EarthTech;
- technical audits; and
- the technical acceptance and commercial acceptance process.
15.18
In addition to these tools, which could be used during construction, other mechanisms in the contract would provide incentives for EarthTech to build a scheme that would operate appropriately. These included:
- warranties and indemnities provided by EarthTech;
- the ability to reduce the monthly operating payments if the performance standards set in the Project Deed were not met; and
- the requirement for asset condition reports and maintenance to bring the scheme up to standard.
15.19
The combination of the tools in the Project Deed to manage construction risk should have caused EarthTech to build a scheme that operated appropriately. The tools we have set out in paragraph 15.23 could be used only after construction had been completed, while the tools set out in paragraph 15.22 could be used only during construction. To protect itself, KDC needed to make sure that it took advantage of the tools that were available to manage the construction process. This would mean that it would not need to use the tools that were available during the operating period and afterwards.
15.20
We reviewed how KDC used the tools that were available to it to manage construction risk during the construction phase. We note that, unlike a traditional design/construct contract, KDC had no direct oversight of construction.
Final design report
15.21
The Project Deed required EarthTech to submit a final design report to the Project Director (at EPS) for endorsement, two months before construction started. The Project Director and EarthTech had to agree on the drawings and specifications included in the final design report.
15.22
Our ability to assess this stage of the work on the project was hampered by our not being able to review EPS' files. However, we have assessed how well KDC managed its role during this stage of the work by reviewing the information in its files, the information in Beca's files, and the information EarthTech provided to us about what it submitted to EPS.
15.23
EarthTech told us that it prepared the design report and provided it to the Project Director. As an example, EarthTech provided us with a copy of the specification of the reticulation system and transfer main.
15.24
EPS told us that the Project Director provided copies of the endorsed designs to KDC. However, as we have set out above, there were no copies of these in KDC's files.
15.25
KDC was unable to produce any information from its files to show that it knew whether the Project Director had endorsed the final design report nor any copies of the final design report.
15.26
As we set out earlier in the report, Beca and EarthTech staff reviewed the design in 2005. However, by 2007, the design had changed. KDC had no information to assure itself that people with appropriate specialist expertise, such as a wastewater engineer, had reviewed the later design report before it was finalised. Nor did it have any information that would show that it had been satisfied that the Project Director had used appropriate processes to check that the specified design standards and requirements of the resource consents were met.
15.27
Beca told us that it carried out a design review and provided a report on this to the Project Director. We found in KDC's files a copy of a design review report carried out by a Beca Director in July 2009. We discuss this further in Part 18. There was no evidence in KDC's files that a design review was carried out before construction started.
15.28
EarthTech also told us that final design reports for the treatment plant and the strategic design for the reticulation were prepared and provided to the Project Director during the design and construction activities. As examples, they provided us with copies of three design features reports for the reticulation system.
Works programmes and other plans
15.29
The Project Deed also required EarthTech to submit a works programme to the Project Director showing the order that works were to be carried out in. This was to ensure that the commercial acceptance dates would be met, which carried financial consequences for KDC. EarthTech was also required to update this works programme regularly. EarthTech told us that it updated the works programme regularly and provided this to EPS monthly. EPS told us that the Project Director provided copies of these to KDC. However, we found no copies of these in KDC's files. We found no information in KDC's files to suggest that it reviewed the information in these documents to monitor its financial risks.
15.30
EarthTech was also required to submit various other documents to the Project Director for endorsement, including an Operation and Maintenance Manual, a Quality Assurance Program, an Environmental Management Plan, and a Health and Safety Plan. Although we found copies of some draft documents in KDC's files, there was no information in KDC's files about whether the Project Director finalised or endorsed these documents. However, EPS told us that the Project Director provided all documents required under the contract to KDC.
15.31
EarthTech told us that it prepared these documents and provided them to the Project Director. It gave us copies of examples of these types of documents, including a Project Management Plan, an Occupational Health and Safety Management Plan, a Project Communication Plan, a Waste Disposal Management Plan, and an Environmental Management Plan. It also told us that the Project Director prepared and approved the Operation and Maintenance Manual before the scheme achieved commercial acceptance.
15.32
The Project Deed also required EarthTech to provide an environmental report on the land where the wastewater treatment plant was to be built by 7 January 2008, before works on the site began. EarthTech told us that an environmental report was prepared for the wastewater treatment plant site. It was part of the material submitted to the NRC as part of the resource consent application process. EarthTech was also required to provide an environmental report before works began on any other land KDC owned that was to be used for the scheme. There was no copy of any such report in KDC's files.
15.33
EarthTech was also required to give the Project Director monthly development reports. These were to set out several matters, including progress against the works programme. There were no copies of any of these reports in KDC's files. EarthTech told us that it prepared a project report each month during construction. This included a section on the programme (timetable), discussion about the programme, a cost report, and requirements of the integrated management system and project management plan. It provided us with a copy of a monthly report as an example.
Our comments
15.34
One of the main tools to manage construction risk that KDC had was the requirement that the Project Director endorse the design reports before construction started. From what EarthTech told us, we are satisfied that the design reports were created and sent to the Project Director. Because we had no access to EPS' files, we were unable to determine what the Project Director did with these documents. There is no record of whether KDC saw those documents or checked that they had been completed.
15.35
In our view, the endorsement of the design was one of the main tools that KDC had to enable it to gain assurance that what was to be built was appropriate for its needs. Because KDC took ownership of the scheme immediately after construction, and because the operating period was relatively short compared to the life of the scheme, KDC needed to be certain that what was to be built was fit for its purposes and that appropriate quality checks were being completed. In our view, KDC should have assured itself that these critical documents were being submitted and approved as part of its monitoring of the overall project.
15.36
KDC also needed to keep copies of the documentation on the scheme's design in its files. It needs this information to be able to monitor the operating contract. As the owner of the assets, it will also need them when it becomes responsible for operating the scheme at the end of the current contract.
15.37
From what EarthTech has told us and the documents it provided, we are satisfied that it prepared monthly works programme reports and provided them to the Project Director. EPS also told us that it provided copies of these documents to KDC. In our view, KDC also needed to ensure that it received and kept copies of these documents. The Council needed to understand whether the project was running to time and whether additional financing or other costs would be incurred, so that it could monitor its own risks and assess the performance of its project managers.
15.38
With a works programme, KDC could determine whether EarthTech's performance caused delays. If so, it could appropriately pass on any additional costs incurred because of those delays to EarthTech. Without a works programmes, and with the numerous modifications KDC made, it would have been almost impossible for KDC to tell whether EarthTech caused delays.
15.39
We were surprised that these documents were not in KDC's files, because the broad purpose of documents such as the design reports and other plans specified in the contract, as well as the sign-off requirements, is to assure KDC that the project is being managed appropriately. We do not know how KDC could be confident that the project was being managed appropriately if it was not provided with copies of the documents.
Our overall comments
15.40
In our view, there were numerous problems with the contract documents that KDC signed. The documents should have covered all the works KDC intended to carry out as part of the project. There were risks with using the modifications process to deal with any changes to the scope of works, and some of these risks came to fruition. The fact that the documents did not cover all the works KDC had agreed to suggests that the Council had a very poor understanding of what it was agreeing to.
15.41
The contract provided KDC with some tools to enable it to manage construction risk, some of which were available during construction. In our view, KDC needed to ensure that it received information from its project managers about how it was using the tools to assure itself that the design of the scheme was fit for purpose and that construction was being appropriately managed.
15.42
From what we have been able to determine, it does not appear that a wastewater engineer reviewed the final design report before construction began. The Council does not appear to have been told that the final design report had been endorsed by the Project Director or the basis on which the endorsement had been made. Therefore, the Council could not be certain before construction began that the scheme it was paying for would be suitable for its needs.
15.43
Although EarthTech provided monthly reporting to the Project Director, and the Project Director told us that he provided this information to KDC, KDC does not appear to have used the information. There is no information in KDC's files to suggest that it used the information to monitor the progress of construction or to understand whether modifications would lead to additional financing costs.
15.44
In our view, at this stage of the project, KDC needed to be more closely involved with the project and ensure that it used the tools it had under the contract fully and appropriately.