Guest Post by David Vardy and Ron Penney
Breaking news from the CBC casts new light on Muskrat Falls!
On January 30, 2017 Uncle Gnarley posted on the falsification of estimates, drawing upon allegations made by a Nalcor engineer, who said that
I could not put up with falsifying information anymore.To begin with, the original cost of $6.2 billion on which the project was approved was a complete falsification. The estimate was deliberately kept low — below $7 billion, so as to appear favourable relative to the cost of thermal power generation.
The likely costs were known about three years ago, but Nalcor Management kept it a secret, steadfastly denying that there were major schedule delays and cost overruns, until it was no longer possible to hide the true status with the election of a new Provincial Government.
|David A. Vardy|
Yesterday, on May 10, 2017, the CBC released its story on the Morning Show, preserving the anonymity of Uncle Gnarley’s informant, but confirming the essence of the story. The falsification of the project estimates allowed the proponents to claim a large preference, based on cumulative present worth analysis, for the Muskrat Falls project, a preference which we now know to be fabricated. Confirmation of these allegations, through the due diligence of CBC’s Morning Show, highlights the importance of a comprehensive and forensic audit by the Auditor General.
The CBC quotes the anonymous engineer as follows: "The risks were vastly understated and the contingencies absurdly low."
The engineer — whose identity CBC News has agreed to protect, because he is not authorized to speak publicly about his work on the project — believes that "the purpose of this estimate was not to generate an estimate for project implementation, but secure project sanction."
This forensic audit is beyond the normal scope of audit work performed by the AG. It will require additional personnel familiar with industrial construction, having knowledge of workforce costs and productivity, the costs of materials, logistics, and quality control related to the construction. The AG will need to put in place a professional team which can assess the extent to which variances from Nalcor’s cost estimates are due to: poor management, falsified estimates, unqualified contractors, poor workforce productivity, or inadequate material cost estimates.
Will the audit be broad or narrow?
The question is how broad the AG’s review will be. Will it be a comprehensive review of the project? Will it examine the factors which led to the sanctioning of the project or will it be confined to the examination of individual contracts? Will the audit rely totally upon Nalcor for data, as was the case with the Ernst and Young interim report of April 8, 2016? Will it examine the decision making process and the division of decision-making responsibilities among three key groups, namely Nalcor management, Nalcor’s consultants and Nalcor’s Board of Directors?
We know virtually nothing about the Auditor General’s review, about the audit plan and its coverage and timing. The Premier has indicated that government will not consider a public inquiry into the Muskrat Falls project until the AG’s review has been completed. This suggests that the review will be comprehensive in scope.
The undersigned have written to the AG and requested a copy of the audit plan. In our letter we suggest that six underlying principles be accepted as thefoundation for the audit. These are as follows:
3. Minimizing cost
4. Verification of data
5. Inclusion of project management, governance and oversight, and
6. Quality control
The AG report should be more than an academic exercise or a post mortem review of the project. It should instead become a living, breathing part of the management and governance of the project. It can perform such a role if the audit will enable Nalcor to learn from its mistakes and make course corrections, relying upon the audit as a management tool.
With more than three years remaining before full power is achieved there is every reason to believe that the AG can play a vital role not only in informing the shareholders of the progress and success of the project but also in the navigation of its future course over the next few years. If the audit is conducted in a phased process, with robust reporting on a phased basis, then the results can be a vital tool for management decisions to improve the quality of future decisions on this project.
Probity is a key concern when so little information is disclosed and Nalcor is exempted from the Public Tendering Act. In our letter to the AG we have suggested that a review of hiring practices be conducted and that the award and management of Nalcor’s contracts be scrutinized with care. The accusations that cost estimates have been falsified need to be investigated with the most robust forensic audit techniques as recommended by the engineer, who was interviewed by both Anthony Germain of the CBC and Uncle Gnarley.
The audit should assess the quality of the original cost estimates, particularly the DG2 and DG3 estimates, and the adequacy of the allowances for cost escalation and for contingencies? Why did it take so long for more realistic cost estimates to be released to the public? Clearly, we relied upon contrived cost estimates up to the time of the new estimates released by the new Nalcor CEO in June of 2016.
3. Minimizing cost
Our letter to the AG recommends that he examine the structure of Nalcor’s contracts to ensure that there are incentives to minimize rather than maximize costs? Ernst and Young (section 5.8 of their April 2016 interim report) pointed out a major discrepancy in the incentive structure relating to Astaldi as disclosed by Nalcor’s CEO at the 2015 AGM, compared with the incentives which EY found in the actual contractual arrangements with Astaldi, which suggested “that the payment mechanism is based on person-years expended rather than m³ of concrete poured. Former CEO Ed Martin told David Vardy at the 2015 AGM that payments were based on the amount of concrete poured. The contract was a “cost plus” arrangement and not the purported fixed price or lump sum contract.
Our letter also recommends that the AG direct particular attention to the Astaldi contract, which has grown from $1.1 billion to $1.830 billion, with little explanation of the reasons for the escalation?
Clearly the AG must undertake an intensive review of the award and management of all major contracts to ensure that they are designed to minimize cost and to protect the ratepayer.
There have been reports suggesting that Nalcor contracts had loop-holes "you could drive a truck through". One report is that Astaldi was claiming extra for weather delays to the work. Weather related risks are normally assigned to the construction contractor. Additionally, there have been reports that Nalcor, at least during the early days of the project, was very lenient in adjudicating contractor's claims. Therefore the AG should investigate:
a. The adequacy of the contract documents especially in the matter of sharing risks.
b. Nalcor's contract management experience and practice and whether it is capable of
dealing with a mega project of this scale.
4. Verification of Data
The Independent Engineer and the Oversight Committee have relied on data supplied by Nalcor. Similarly the Ernst and Young interim report relied fully on data supplied by Nalcor. Our suggestion is that the AG should verify data directly with contractors and subcontractors, without being reliant solely on Nalcor.
5. Inclusion of Management, Governance and Oversight
Governance and project management should be included in the audit, recognizing that the Ernst and Young review (section 1.7) “did not include a formal review of the Project governance arrangements”. The AG should assess the governance structure within Nalcor and its capacity to manage a project of this magnitude and scope? He should also review the decision of the new CEO to continue with the same management team, with modest realignment, as well as his decision to maintain Nalcor’s lead role in project management.
6. Quality control
Quality control should be included, recognizing that there are numerous examples of lack of quality control relating to “popped” transmission wire strands, leaking coffer dams and collapsing formwork at the powerhouse to suggest that quality control may be an issue.
The proposed audit plan should be made public as soon as possible so the public can be aware of its scope and make comments before it is finalized. The credibility of the audit will depend upon the qualifications and experience of the team as well as the quality of the audit plan itself.
In our letter we asked how a strong audit team can be assembled, one with the capacity to review a major hydroelectric project of this magnitude? Will the AG be seeking outside audit expertise?
If the AG adopts these six principles there is some hope that finally the public will know where we stand on the cost and schedule of this project.
However it has to be noted that this audit will not provide the cost benefit analysis for which we have been calling over the past year. Such an analysis would have allowed government to stop the project if it confirmed that the cost of finishing the project far exceeds the cost of stopping it, taking into account only future costs and ignoring sunk costs which are irrelevant. Both Nalcor and government have refused to undertake this analysis.
Nor will the audit disclose whether the project was a wise decision. For such an analysis we need nothing less than a full public inquiry, a Royal Commission to determine how we as a province made such a monumental error in public policy.
David Vardy and Ron Penney