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.
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| 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?
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| Ron Penney |
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:
1. Timeliness
2. Probity
3. Minimizing cost
4. Verification of data
5. Inclusion of project management,
governance and oversight, and
6. Quality control
1. Timeliness
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.
2. Probity
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.
Conclusion
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