East West Link Project

Tabled: 9 December 2015

2 Project costs

At a glance

Background

The East West Link (EWL) project was one of the largest transport infrastructure projects ever proposed in Australia. It was to be delivered in two stages. Prior to the November 2014 state election, work had commenced on Stage 1, the eastern section, with limited progress on Stage 2, the western section. Following the November 2014 state election, after significant costs had been incurred, the new government terminated the project.

Conclusion

The EWL project was terminated in June 2015 with more than $1.1 billion paid, or expected to be paid, by the state for little tangible benefit. This cost will be partially offset by future proceeds from the sale of properties acquired for the project. The Department of Treasury & Finance estimates that these properties can be resold for around $320 million.

Findings

  • The arrangements in place to track costs for Stage 1 were mostly comprehensive and robust.
  • Monitoring of expenditure against the approved project budget was undertaken and regularly reported for Stage 1 to the EWL steering committee. However, despite only minimal costs being incurred on Stage 2, there was no whole-of‑project monitoring and reporting on costs.

Recommendation

That the Department of Treasury & Finance provides guidance to support whole-of-project cost tracking and reporting against budget for major projects that involve multiple stages managed by different agencies.

2.1 Introduction

In May 2013, the state announced its intention to proceed with Stage 1 of the East West Link (EWL) project at an estimated capital cost of $6 to $8 billion. Following a competitive tender process the state appointed a consortium—East West Connect (EWC)—to finance, design, construct, operate and maintain Stage 1.

In May 2014, the state announced its commitment to deliver Stage 2 at an estimated capital cost of $8 to $10 billion with initial works commencing in 2015.

In June 2014, the Commonwealth Government committed funding of $3 billion for the EWL project—$1.5 billion each for Stages 1 and 2. It paid the state $1.5 billion in June 2014 comprising $500 million for Stage 1 works and $1 billion for Stage 2 works.

Following the 2014 state election, the new government instructed EWC to suspend works on Stage 1 and commenced negotiating a termination settlement, which was finalised on 15 June 2015.

This Part of the report examines the financial implications of the project, considering both the termination and the outcome had the project progressed to completion. It also considers the management and reporting of costs by the key entities involved.

2.2 Conclusion

The estimated total project cost of Stages 1 and 2 of EWL, had it proceeded to completion, was in excess of $22.8 billion in nominal terms over the life of the project. This funding was to be met primarily through imposing tolls on users of the road, with $3 billion provided by the Commonwealth Government, and the Victorian Government meeting the remaining costs, including taking on the risk that toll revenue might be lower than expected.

The EWL project was terminated in June 2015 with more than $1.1 billion paid, or expected to be paid, by the state. This cost will be partially offset by future proceeds from the sale of properties acquired for the project. The Department of Treasury & Finance (DTF) estimates that these properties can be resold for around $320 million.

This significant expenditure will yield little tangible benefit. Pre-construction activities including design and geotechnical work and elements of the complementary projects may provide some value in the future.

2.3 Actual and expected project costs

The EWL project was terminated in June 2015 at an expected total cost to the state in excess of $1.1 billion. This includes expenditure on the planning, development, procurement and termination of the project.

2.3.1 Costs incurred on the eastern section

Figure 2A shows the total costs for the state associated with Stage 1 including actual costs incurred up to 30 June 2015, and costs expected to be incurred after 30 June 2015 relating to the final settlement of outstanding costs on the project.

Figure 2A Stage 1 total costs

Item

Costs ($ '000)

Actual project expenditure at 30 June 2015

Business case development

26 045.5

Property acquisition costs

276 915.0

Complementary projects

5 668.8

Other state costs

124 784.8

Termination payments made to EWC

424 093.8

Cost of advice on termination

3 176.2

Total costs to 30 June 2015

860 684.1

Expected future costs

Settlement of interest rate swap on EWC loan facility

217 889.7

Settlement of outstanding property acquisitions and legal cases

75 378.6

Completion of complementary projects

4 003.6

Total estimated future costs

297 271.9

Summary of actual and expected costs by project phase

Planning, developing and establishing the EWL project(a)

503 123.9

Terminating the EWL project(b)

645 159.7

Other costs: complementary projects

9 672.4

Total costs

1 157 956.0

(a) The total costs for planning, developing and establishing the project includes costs for business case development, property acquisition, and other state costs including procurement and contract establishment.

(b) The total costs for terminating the project includes termination payments to EWC, the expected future cost of settling the interest rate swap and the costs of advice on termination.

Source: Victorian Auditor-General's Office.

Figure 2A includes around $350 million in costs relating to property acquisitions. These properties have been offered back to their original owners and a sales strategy is currently being developed for the remaining properties. DTF estimates that these properties can be resold for around $320 million.

The costs of the project will also be offset by rental revenue on acquired properties and any proceeds from the sale of assets acquired from EWC as part of the termination settlement.

Interest rate swaps

The termination settlement involved the state assuming the interest rate swap established by EWC for its loan facility. The state will realise a loss when it finalises this swap.

An interest rate swap is a financial instrument in which two parties agree to 'exchange' interest rate cash flows or the amount of interest they pay, which effectively results in the parties paying—or receiving—a different interest rate to the rates in their agreements with their financiers. Interest rate swaps assist entities to manage their cash-flow requirements and interest rate risk exposure.

As part of the financing arrangements, EWC entered into an interest rate swap with five of the major financiers providing the loan facility—two major Australian banks and three international banks.

The swap arrangement allowed EWC to effectively pay a fixed instead of a variable interest rate during the construction period. This is a standard component of public private partnership (PPP) financing arrangements as it provides the state with some certainty of the future payments that will be required once the PPP enters the operational period.

The value of the interest rate swap at 30 June 2015 was $217.9 million. The state will be required to pay the value of the interest rate swap when the arrangement is closed. The amount will depend on interest rates at that time.

2.3.2 Costs incurred on the western section

Stage 2 was still in early planning and development and therefore the procurement method had not been determined by the time the project was terminated. Total costs incurred on the western section to 30 June 2015 were $15.2 million, comprising:

  • costs incurred by the Department of Economic Development, Jobs, Transport & Resources (DEDJTR) in completing the detailed planning work and the interim business case
  • costs relating to a package of early works completed by VicRoads, which were passed on to DEDJTR.

2.4 Project costs if it proceeded

The estimated total project cost of EWL had it proceeded to completion was in excess of $22.8 billion in nominal terms over the life of the project. This estimate is detailed in Figure 2B and is based on approved business cases and budgets and the financial modelling for the PPP.

Figure 2B

Total estimated cost in nominal terms($ billion)

Item

Budget (nominal)

Stage 1

 

PPP(a)

10.697

Other state costs

2.095

Total Stage 1 expenditure

12.792

Stage 2(b)

10.000

Total project expenditure

22.792

(a) The Present Value equivalent for this amount is $4.3 billion discounted to 30 June 2013.

(b) The total estimated cost for Stage 2 did not include costs for operation and maintenance during its operating phase.

Source: Victorian Auditor-General's Office.

The project was to be funded by the Commonwealth Government, state government and by road users through tolling arrangements.

2.4.1 Eastern section

Project cost and funding

Figure 2C shows the total budget for Stage 1 of the EWL project, based on the outcomes of the tender process that appointed EWC.

Figure 2C

Total budgeted eastern section costs ($ billion)

Item

Budget

Costs related to PPP agreement with EWC(a)

Design and construction

4.336

Operations and maintenance

3.279

Financing costs

3.082

Total PPP costs

10.696

Other state costs

Business case development

0.027

Property acquisition

0.515

Complementary projects

0.400

Pre-agreed modifications

0.169

Other design and construction period costs

0.559

Risk and contingency

0.382

Operations and maintenance period costs

0.043

Total other state costs

2.095

Total

12.791

(a) As at financial close, October 2014.

Source: Cabinet submission, financial model for the PPP and Victorian Auditor-General's Office.

Figure 2D shows how the funding for Stage 1 was structured.

Figure 2D

East West Link funding structure for Stage 1

Figure 2D shows how the funding for Stage 1 was structured.

Source: Victorian Auditor-General's Office.

Toll revenue

The majority of the costs of Stage 1 of EWL were to be met by tolls on users of the road. Under the PPP terms, the government would collect and retain toll revenue. Actual toll revenue collected would not affect the payments to the road operator. This was different to the models previously used for Victorian tolled road infrastructure—i.e. CityLink and EastLink—where the private road operators charge and collect tolls directly, and therefore bear the risk that revenue will be lower than expected. In the event that EWL traffic volumes were lower than expected, the state would have been required to fund any shortfall, but the state would have benefited from higher than forecast traffic volumes.

Commonwealth Government funding

On 28 June 2014, the government entered into a memorandum of understanding (MoU) with the Commonwealth Government under the National Partnership Agreement on Land Transport Infrastructure Projects. Under the MoU, the Commonwealth committed $1.5 billion funding for Stage 1, of which $500 million was received by the state in 2013–14. The early receipt of funds allowed for interest to be earned on the contribution, which could then be applied as a further offset against the state costs.

State government funding

As part of the business case, it was identified that for very large projects—those with a capital cost in excess of $2 billion—a funding contribution from the state may be required to address issues associated with the size of the debt funding required and available funding from debt markets. As a result, in October 2013, the government approved contributions to be made to the selected PPP partner for Stage 1:

  • $2 billion to be made available during construction—$1.5 billion of which was to be funded from the Commonwealth Government funding contribution plus $0.5billion from the state
  • $1 billion to be made available two years after construction was complete, fully funded by the state.

2.4.2 Western section

The 2014–15 State Budget included an initial capital budget for Stage 2 of the project of $10 billion. This included $4 million of funding in 2013–14 and $100 million in 2014–15 to finalise the business case and commence planning work.

The MoU with the Commonwealth Government also included $1.5 billion in funding for Stage 2, $1 billion of which was received in 2013–14.

The initial package of works for Stage 2—the upgrade of Paramount Road and Ashley and Dempster Streets—was to commence construction by the end of 2015 to meet the Commonwealth Government's funding conditions.

2.5 Monitoring of project costs

The arrangements in place for agencies to track EWL costs were mostly comprehensive and robust. However, there was no regular monitoring and reporting of costs against budget at the whole-of-project level.

2.5.1 Eastern section

As part of the project governance arrangements, the then Department of Transport, Planning and Local Infrastructure (DTPLI) established the EWL steering committee whose responsibilities included endorsing all recommendations to the Minister for Roads and to Cabinet, including those in regards to whole-of-project scope and budget management.

The steering committee's meeting agendas and minutes indicate that regular reports were provided by the key operational entities for the project—the Linking Melbourne Authority (LMA), DTPLI, DTF and VicRoads. LMA tracked its own expenditure against the approved project budget together with costs for which other departments and agencies sought reimbursement. LMA reported this information to the EWL steering committee.

The regular reports from departments and agencies were generally noted in the steering committee meetings. However, there was little documentation of discussions that may have occurred and questions that may have been asked. The steering committee only considered Stage 1 and not Stage 2.

2.5.2 Western section

For Stage 2, DEDJTR established a project code in its finance system against which project costs were charged. There was no evidence of regular monitoring and reporting of costs against budget for Stage 2 or at the whole-of-project level.

2.5.3 Departments and agencies

Figure 2E summarises the responsibilities of departments and agencies and to what extent project costs were tracked.

Figure 2E

Agency responsibilities and cost tracking

Agency

Role

Costs tracked

LMA

Lead development of the business case and project manager of Stage 1.

All costs were tracked and recorded.

DEDJTR

Lead department for the project. Stage 2 development was managed by an administrative office within the department.

Staffing costs were not tracked. Other costs were recorded and tracked for Stages 1 and 2.

VicRoads

Contributor to development, as well as project manager for a number of separate components.

All costs were tracked and recorded, however, not all were passed on to LMA.

DTF

Involved in reviewing the business case and the structuring of the PPP arrangement. After suspension of the project, involved in assessing solutions for the financing arrangements.

Staffing costs were not tracked. External costs during the PPP procurement process were the only costs passed on to LMA.

Department of Premier & Cabinet

Represented on the steering committee prior to termination. Responsible for managing termination negotiations with EWC.

Staffing costs were not tracked. External costs during the termination were tracked.

Department of Environment, Land, Water & Planning

Provision of advice and performance of statutory functions in relation to the statutory planning assessment and approvals processes.

Staffing costs were not tracked. Planning functions were transferred from DEDJTR—formerly DTPLI—as a result of machinery‑of‑government changes. Relevant financial information resided in DEDJTR systems and it provided information on external costs.

Victorian Government Solicitor's Office

Provision of legal advice relating to the project, including in relation to court action.

Operates on a fee-for-service model, with all costs passed on to the relevant agency.

Planning Panels Victoria

Provision of administrative support to the Assessment Committee appointed under the Major Transport Projects Facilitation Act 2009.

Operates on a full cost recovery basis, with all costs passed on to LMA.

Environment Protection Authority

Assessment of the Comprehensive Impact Statement and works approval application, including making a submission to the Assessment Committee.

Costs were not tracked, however, the Environment Protection Authority was able to provide a reasonable estimate of the costs they incurred.

Treasury Corporation of Victoria

Interest rate benchmarking services at financial close of the PPP and involvement in assessing and managing solutions for the financing arrangements.

Work conducted prior to termination was under a fee-for-service arrangement. Costs after project termination were not tracked, however, TCV was able to provide a reasonable estimate.

Source: Victorian Auditor-General's Office.

Some departments did not capture the staff costs attributable to the EWL project. For example DTF, Department of Premier & Cabinet, and DEDJTR staff do not complete timesheets, and therefore internal staff costs were not captured and included as part of the project cost. These departments only passed on costs associated with external consultants to LMA.

Recommendation

  1. That the Department of Treasury & Finance provides guidance to support whole-of-project cost tracking and reporting against budget for major projects that involve multiple stages managed by different agencies.

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