Part 3: Difficulties getting the wastewater project under way (2003 to 2007)

Changing to a different kind of project

3.1
In September 2002, the Council had selected a preferred provider, Simon Engineering (Australia) Pty Ltd (Simon Engineering), and was ready to begin negotiating the final contract. All of the work to this point had been based on a proposed BOOT (Build, Own, Operate, Transfer) scheme, under which:

• The private sector partner would build the infrastructure at its own cost.
• The partner would then own and operate the wastewater scheme for 25 years.
• KDC would pay toll payments to the partner once the scheme was operating.
• At the end of the 25 years, ownership would transfer to KDC with no further payment.

3.2
With the enactment of the Local Government Act 2002, KDC could no longer use a BOOT scheme and needed to change the way it was to deliver the wastewater scheme. We looked at how the Council made the decision to change to a DBFO (Design, Build, Finance, Operate) type of PPP and what that meant for its negotiations with Simon Engineering and the proposed contract.

3.3
The enactment of the Local Government Act 2002 should have prompted a more fundamental reconsideration of how the project was being approached. That is, the Council should have asked, for example, whether a PPP was still the best option, what models were now available and their relative merits, and what options were available for funding the purchase. Instead, the Council very quickly decided it could carry on with the current parties, after negotiating some adjustments to the contracting terms. In our view, this decision was based on inadequate information and analysis.

Funding the wastewater project

3.4
With the change from a BOOT to a DBFO, KDC now had to find a new way of funding the project. Although the private sector partner would still fund the construction costs for the first five years, KDC had to fund it after that. KDC's Treasury Management Policy meant that it could not simply borrow the money. In the first half of 2003, KDC brought together several different mechanisms to fund the project. It summarised the expected costs and funding mechanisms in the Statement of Proposal that was released for community consultation in July 2003.

3.5
We looked at the work that KDC did on the funding mechanisms that it proposed to use to fund the project, including development contributions and a subsidy from the Ministry of Health. We also looked at the work KDC carried out on its borrowing and financing policies between 2003 and 2007.

3.6
We found that:

• There was no evidence that the Council did any systematic planning or budgeting for the funding of the project as a whole.
• The Council's changes to its Treasury Management Policy in 2006 meant that it effectively no longer had any borrowing limits for the wastewater project.
• The Council failed to get legal and treasury advice about the change to its Treasury Management Policy.
• The tools that the Council wanted to use to fund the scheme were operating under new legislative requirements. The Council needed to understand what those requirements were and how they affected its ability to use those funding tools. As funding from those tools was critical to the ongoing affordability of the scheme, the Council needed to ensure that the details of the tools it proposed to use were lawful at an early stage. It did not do this.

Changing the contractor

3.7
In late 2002, the Council selected Simon Engineering as the preferred proponent and began negotiations. In early 2003, it decided to continue those negotiations on a modified basis. In early 2005, the parent company of Simon Engineering went into voluntary administration. The Council withdrew from negotiating with Simon Engineering and engaged with the two bidders that had participated in the earlier tender. One bidder was not interested, so KDC decided to contract with the other bidder, EarthTech.

3.8
We found that:

• KDC did not have good records of the information it relied on when making decisions about the project. The information that we were able to locate was inadequate in some cases. If this was the only information the Council relied on, then, in our view, the Council would not have been able to properly assess what it was being asked to make decisions on.
• KDC's advisers and the Chief Executive understood that there were risks in negotiating with Simon Engineering. It is not clear that the advisers and Chief Executive communicated those risks to the Council.
• The Council's decision to negotiate with EarthTech and NorthPower, once Simon Engineering went into administration, was not robust.
• The Council had no information to enable it to determine whether the contract with EarthTech was more cost-effective than KDC building and operating the scheme itself. Nor could it determine whether the price was competitive.
• The Council signed the contract without resolving the disposal site issue.
• The Council failed to get independent legal or financial advice about the contracts with EarthTech.

Finding a disposal site for the effluent

3.9
In August 2005, the Council decided to sign the contract documents and commit itself to the arrangement with EarthTech and ABN Amro. However, it did so with a major issue still unresolved. There was no certainty about how or where the effluent would be disposed of. From the initial community consultation in 1999, the Council had a clear position that disposal should be to land, not water. However, none of the sites that had been considered so far were acceptable.

3.10
We reviewed the work KDC did to secure a disposal site and identified the consequences of that decision.

3.11
We found that:

• When the Council signed the contract documents in 2005, the disposal site had not been identified. This created a significant risk for the project and left KDC in a weak bargaining position when purchasing a site.
• The costs for disposal were estimated in the contract signed in 2005 as being $361,000, but ended up costing an estimated $14 million.
• The Council should have resolved the disposal site issue before it signed the contractual documents in 2005.

Increasing the scope of the wastewater project

3.12
In February 2006, KDC adopted a Statement of Proposal to consult the community on the wastewater scheme. This set out the estimated capital costs of the project, $35.6 million, and KDC's preferred funding of the scheme using a mix of rates and development contributions. Later in 2006, the Council decided to purchase land for the disposal site (a farm). Because of the costs of the additional infrastructure required for the disposal site, and the costs of purchasing the farm, the estimated capital costs of the scheme increased. The Council needed to consider how it was going to fund these increased costs. In October 2006, Beca estimated the costs of the additional infrastructure and the purchase of the farm to be $11.1 million (excluding financing costs associated with purchasing the farm).

3.13
We looked at the work KDC did on the assumptions about population growth. These assumptions were used as the basis for the contract with EarthTech and to determine the level of rates and development contributions included in the Statement of Proposal. We also considered the Council's decision in October 2006 to change the growth assumptions for the scheme and increase the scope of the scheme.

3.14
We concluded that:

• The Statement of Proposal put out for consultation in February 2006 estimated the capital costs at $35.6 million, but by October 2006 these had increased to $57.7 million.
• As the estimated capital costs increased, the Council sought to keep the scheme affordable by increasing the number of ratepayers paying for it.
• The data about growth assumptions supporting the increase in the number of ratepayers paying for the scheme was not robust.
• There was no evidence that the Council considered the risk that growth might be slower than its projections. It had no plans to manage that risk if it eventuated.
• It was not appropriate for the Council to put out a Statement of Proposal for consultation in February 2006 and then make significant changes to the scope of the works and cost of the project by October of that year.
• The Council's focus on the costs to the ratepayer meant that it failed to appreciate the significant increase in the capital costs of the project and the effect on its overall affordability for KDC and the community.

3.15
We have not commented on whether the decision not to consult with the community on the increase in the scope of the project complies with the Local Government Act 2002, because this matter is before the High Court.

Other changes to the wastewater project

3.16
As well as the major changes and challenges that the Council had to deal with between 2003 and 2007, there were many other changes during this period. KDC needed to give effect to its earlier decision to increase the scope of the scheme. This meant that it needed to amend the contracts it had agreed with EarthTech and ABN Amro. We looked at the reasons that the contracts were amended and the changes that were made. We also looked at the oversight that Council had of this process. The contracts that had been signed in October 2005 included financing costs that would need to be paid by KDC if construction was delayed. The delays in getting started meant that KDC was continuing to incur these costs.

3.17
KDC also decided to extend the project management contract with the Beca consortium. When it signed the amended project documents, KDC also decided that it would use swaps to hedge its interest rate risk during construction.

3.18
We concluded that:

• It was sensible for the Council to extend the Beca consortium's contract for project management, but it was done in a piecemeal way. The Council did not appear to have estimated or budgeted for the costs of the project management services.
• The financing and contractual arrangements were complex, and it appears that the Council and its advisers did not understand them well. The delays to getting started cost the Council an estimated $450,000 in financing costs.
• The Chief Executive and EPS decided to use swaps to hedge KDC's interest rate risks. However, they did so in breach of KDC's Treasury Management Policy, and it is not clear that the Council approved the decision to use swaps.
• The Council did not get independent legal advice about the new contractual documents or independent financial advice about the financing arrangement.
• It appears that, by this stage of the project, the Council was no longer in control of the project or its costs.
• KDC's record-keeping was poor.

How the community was kept informed

3.19
From 2003 to 2007, KDC and its contractors were communicating regularly with Mangawhai and Kaipara ratepayers about what was happening. We looked at the formal consultation that KDC carried out in this period, as well as KDC's communication with the community on important decisions during this period.

3.20
We concluded that:

• Until mid-2006, KDC kept the community informed on the project and put a lot of effort into this.
• After then, its communication was much poorer, and it failed to communicate important decisions that affected the overall cost of the project, such as the purchase of the farm and the increase in the scope of the works.

3.21
We have not commented on whether KDC's consultation with the community complies with the Local Government Act 2002, as this matter is currently before the High Court.

Our overall comments on how the Council dealt with difficulties

3.22
Between 2003 and 2007, the weaknesses in the way the project had been set up started to show. We consider that the Council would have been able to deal with these events better if it had had a stronger system for maintaining overall control of the project. Instead, what we have detailed is a series of disjointed decisions on issues when they arose, with no particular regard for the overall aim and affordability of the project.

3.23
In our view, the Council had become committed to the project in its current form and was not able to stand back and reassess it appropriately when problems arose. We saw no evidence of a willingness or ability to contemplate writing off what had been done to date or backtracking a step or two. Instead, there was a determination to press on and find solutions to whatever problems presented themselves. Several problems that were encountered should have caused the Council to stand back and reconsider whether its approach remained appropriate.

3.24
We are concerned that the Council lost control of the size and cost of the project. It is not satisfactory that we could not find clear and consistent figures for the project's costs and funding.

3.25
More generally, our concern about the quality of KDC's record-keeping and its informal approach to decision-making increases as the years progress. We have commented in several places on the poor quality of KDC's decision-making processes. For example, we found when considering the work to find a disposal site, that:

• The records are partial at best. For example, the written records do not show whether the Council was given information about the limited capacity of the site.
• Decisions seem to have been taken informally (for example, we do not know what formal authority the Chief Executive had to make the initial offer to purchase).
• KDC did not obtain a valuation for the farm until the bank required it to.
• We did not see evidence of appropriate work to consider funding and borrowing options, and the value for money of the proposed financing arrangements.

3.26
By the time construction was ready to begin in late 2007, the Council had lost control of the project – what was being built, what it would cost, how many properties it would service, how it would be funded, and what the legal responsibilities of each of the parties were.

3.27
The Council initially failed to understand what it needed to do to manage the project and the limits of the project management services the Beca consortium would provide. The Council appears to have mistakenly assumed that the project managers would provide it with assurance that what was to be constructed would be cost-effective and appropriate for its purposes and that the financing arrangements would be appropriate and competitive.

3.28
The limited project management services provided none of these things, and the Council needed to manage these issues itself. The Council did not have enough information to make the decisions it was being asked to make, so it relied heavily on the project managers' advice.

3.29
The Council's focus on the affordability to ratepayers rather than the overall project costs meant that it failed to appreciate the significance of the increase in capital costs and to assess whether that was appropriate.