Decision on request to inquire into purchases of rolling stock by KiwiRail

In August 2012, the Auditor-General received a request from Clare Curran MP to inquire into four purchases of railway rolling stock by KiwiRail in recent years. In all four cases, rolling stock was purchased from China Northern Locomotive and Rolling Stock Industry Corporation (CNR). Correspondence from Ms Curran in November and December 2012 raised further concerns about the value for money of these purchases and the effect of the purchases on the future of KiwiRail’s workshops in Hillside, Dunedin.

To assess whether the questions raised by Ms Curran warranted a full inquiry, we met with some relevant staff and obtained background information from KiwiRail on each purchase. The work involved in large purchases of this kind can extend over several years; we have therefore reviewed a substantial amount of documentation dating back to 2005. Because of the passage of time and the change in ownership of the company in 2008, we were careful to take the time to locate and access the relevant records and people who had been involved. Given the highly technical nature of the purchasing process, we used specialist assistance to complete our assessment.

As a result of this assessment work, we have decided that there is no need for the Auditor-General to inquire further or more formally into these purchases by KiwiRail. The detailed reasons are set out below.

June 2009 purchase of 20 DL locomotives

Between 2005 and 2008 Toll Holdings Ltd, the private sector railway operator, had been exploring the market for new locomotives. When the company moved into public sector ownership in July 2008 and was renamed KiwiRail, submissions and indicative pricing were already being evaluated. We have considered the steps taken by KiwiRail from that point on against normal public sector procurement standards.

The KiwiRail board considered papers on the proposed purchase in September and December 2008. The papers provide information on the criteria used to assess the potential suppliers and a summary of the evaluation of the options. CNR was ranked first in the overall evaluation and Hillside workshops ranked sixth. The Hillside proposal was assessed as uneconomic due to its longer delivery time and higher cost structure.

The board agreed to negotiate with CNR as the preferred supplier for the locomotives. In June 2009 KiwiRail and CNR entered into a contract for the supply of 20 locomotives. Six locomotives were delivered in November 2010 and 14 in June 2011.

We have concluded that the decision to select CNR as a supplier was made for normal business and commercial reasons after a competitive market process. We did not identify any unfairness in the way the proposal from Hillside workshops was treated.

December 2010 purchase of 300 container flat top wagons

In June 2010 KiwiRail prepared an internal paper proposing the purchase of 300 container flat top (CFT) wagons. The chief executive approved the proposal and KiwiRail issued a request for proposal (RFP) to the market on the Government Electronic Tendering Service (GETS) in October 2010. KiwiRail received nine tenders, including a tender from Hillside, and evaluated them according to assessment guidelines prepared in advance.

The evaluation ranked CNR first overall. Hillside was ranked third. Based on this evaluation, a paper to the board in December 2010 recommended the purchase of 300 wagons from CNR. The paper noted that the Hillside tender was the third most expensive, could not meet the delivery schedule, and would require KiwiRail to carry all performance, warranty and cost risk itself. KiwiRail entered into a contract with CNR for the supply of 300 wagons on 23 December 2010.

A specific question was raised with us about how freight costs were treated. We noted that the wording in the RFP was ambiguous on this point. KiwiRail confirmed that the prices used to evaluate the CNR tender included the costs to bring the wagons to New Zealand and that the contract was for the delivered price.

We have concluded that the decision to select CNR as the supplier was made for normal business and commercial reasons. We did not identify any material departure from good practice process or any unfairness in the way the Hillside tender was treated.

February 2011 proposals to negotiate to purchase additional wagons and locomotives

In February 2011, papers to the KiwiRail board proposed negotiating directly with CNR to purchase an additional 200 CFT wagons and 20 more locomotives.

In both cases the papers recommended direct negotiation with CNR alone, on the basis that they had recently tested the market, standardisation of supply was important, and early supplies from CNR had been acceptable.

The papers considered the possibility of supply from Hillside. In relation to the wagons, the advice was that Hillside’s capability to manufacture some or all of them had been tested again and CNR was again shown to be significantly cheaper and faster. Hillside was already behind time on a separate wagon order. In relation to the locomotives it was noted that Hillside had not manufactured locomotives for some years.

On 31 March 2011 KiwiRail executed a variation to the December 2010 wagon contract to increase the order from 300 to 500 wagons. The price was slightly higher because the cost of materials had increased. KiwiRail entered in a further contract with CNR for 20 more locomotives in June 2011.

Although an open market process is the standard approach for commercial purchases of this size, there are situations where a direct approach to a supplier is reasonable. The papers to the KiwiRail board addressed why a direct approach was considered appropriate in these cases. We think this was reasonable advice.

The significance of the defects that were later found

Concern was expressed to us that the various defects that have been found with the goods supplied by CNR call into question the value for money of the original contracts.

KiwiRail has advised us that:

• it is not unusual to encounter some defects in the course of completing this type of contract;
• comprehensive testing had to wait until wagons and locomotives arrived in New Zealand because of rail gauge differences in China;
• the relevant contracts included provisions to manage these risks including performance bonds, warranties, and liquidated damages; and
• CNR has met all the costs to remedy the defects.

We note that it is possible that any defects already apparent by February 2011 might have been relevant to the decisions made to negotiate additional purchases. We have not attempted to review the technical advice provided by KiwiRail staff that quality at that time was acceptable. To do so would require specialist and technical expertise. In any event, we have seen nothing to suggest that the defects that have been encountered and fixed by CNR affect the original decision that CNR provided the best value for money. The problems have been addressed through the contractual mechanisms designed to manage such issues.

Conclusion

We have carried out enough preliminary work to be satisfied that there is nothing to suggest that decisions to purchase locomotives and wagons from CNR were made for anything other than normal business and commercial reasons. The processes followed by KiwiRail appear reasonable, the relevant evaluations have been carried out properly, and we have seen no evidence to suggest improper influence over these decisions.

We have therefore concluded that further investigation, in the form of a full inquiry, is not warranted.

We acknowledge the co-operation we have received from KiwiRail during our assessment work.  We will not be making further public comment.