SNC LAVALIN: THE MUSKRAT FALLS EXPERIENCE
SNC Lavalin’s role in the Muskrat Falls project has figured prominently in recent hearings of the Muskrat Falls Inquiry. On Friday the Inquiry heard from Nalcor’s senior procurement officer on the project’s management practices, including those which led to the selection of SNC Lavalin (SLI) as EPCM contractor in 2011 and to their removal from this role in 2013.
The New York Times had this to say on the biggest scandal facing Prime Minister Justin Trudeau:
“The case revolves around accusations that SNC-Lavalin, a multinational engineering company based in Quebec, paid 47.7 million Canadian dollars in bribes to officials in Libya to win contracts there, and defrauded the Libyan government and its agencies of 129.8 million Canadian dollars.
“The prime minister and his aides have been accused of pressuring his justice minister at the time, Jody Wilson-Raybould, to drop the criminal inquiry against the company because a conviction could potentially cost thousands of jobs in Canada, and diminish his Liberal Party’s political fortunes.”
While SNC Lavalin’s (SLI) quest for absolution has landed Justin Trudeau and his Liberal government in hot water it is timely to ask how the company has conducted itself in our province. SLI had been selected as the main project manager responsible for Engineering, Procurement, Construction and Management (EPCM) on the Muskrat Falls project. The contract was awarded by Nalcor in February of 2011 through a competitive selection process.
EPCM contract awarded to SLI
Grant Thornton, the forensic auditor for the Muskrat Falls Inquiry (MFI) describes how SLI were awarded the contract based on their knowledge of hydroelectric development and their “world-class engineering, procurement and construction management experience”. In March of 2013 Nalcor rescinded this decision and moved toward an “integrated management team,” reducing the role of SNC Lavalin to engineering design, with Nalcor taking on the responsibility for management, construction and procurement.
The December 2018 project report from Nalcor reveals that 43 million person hours have been expended to date. The DG2 estimate of 2010 was 15 million person hours and this was increased at the time of sanction in the DG3 estimate of 2012 estimate to 20 million person hours. It is clear that when the project is finished the number of person years will be more than three times the DG2 estimate. Nalcor’s “basis of estimate” document reveals that 2.7 million person hours had been projected for EPCM services at DG3.
In their phase two forensic audit for the Muskrat Falls Inquiry Grant Thornton describe the problems which Nalcor experienced with SNC Lavalin.
“Nalcor has indicated that they experienced performance issues with SNC shortly after the contract was awarded, including turnover of key project resources, the failure to complete key project deliverables, lack of adequate systems and tools, and significant organization and alignment gaps.”
Nalcor cited lack of resources as well as high turnover. Nalcor was concerned with the high level of turnover of SLI staff who were told they had to work out of St. John’s to comply with local benefits policy put in place by the province. Many were not happy to leave Montreal to work in Newfoundland and Labrador. Some did not have the relevant experience. Their computer systems were not compatible with those of Nalcor. SLI claim that some of the people they wanted to hire were not acceptable to Nalcor.
GT report that “SNC failed to complete a significant number of Decision Gate 3 Deliverables by the contractual date (December 12 2011).” Nalcor had prepared a report on what was needed to get the project back on track, with key deliverables needed to maintain the schedule. There were problems with the lack of collaboration between Nalcor and SLI. Nalcor hired Deloitte to undertake team training to improve the effectiveness of the relationship. At the end of the day this did not succeed and Nalcor decided to reduce the role of SLI, thereby replacing the EPCM model with an “integrated project management” approach.
In his testimony before the Inquiry on March 1, 2019, Pat Hussey, Supply Chain Manager with Nalcor, described the selection process which led up to the engagement of SLI as EPCM contractor. Toward the end of the process Hussey said it was a choice between Hatch and SLI. In their evaluation Nalcor officials compared their bids and were surprised with how SLI fees were lower than those submitted by Hatch. Hussey said it looked as if SLI were “buying the job” by bidding too low, because their fees, based on the hourly rate times the estimated person hours, were coming in well below Hatch. SLI put in a low hourly markup rate as well as a low estimate of person hours..
Grant Thornton’s forensic audit reports that the EPCM and Owner’s Cost were $712 million at DG3 and this rose by March 2018 to $1,118 million.
At the end of the day the contract was awarded to SLI, who had estimated 2.5 million person hours. Because the contract was “reimbursable” they were able to increase the number of person hours from 2.5 million to 5.5 million after the contract was awarded. It is not clear as to whether this increase was a contributing factor in the decision to jettison SLI.
“Cost plus” vs Reimbursable Cost
Many will remember the construction scandals of the Smallwood era, before public tendering became a legal requirement. Contractors who were highly esteemed by Smallwood and his colleagues were awarded “cost plus” contracts which enabled these contractors to give generous financial support to the governing party. Is not a “reimbursable” contract tantamount to “cost plus”? If SLI was able to submit a bid which could subsequently be altered by increasing the number of person hours then one has to question the whole process for awarding contracts. In the case of SLI their contract with Nalcor was subsequently changed and their role was diminished. We look forward to learning how many person hours were charged by SLI and how the resources allocated for EPCM and Owner’s cost were affected.
Cost Overruns for three major projects
The testimony of Pat Hussey is very revealing. It raises a number of questions about the flexibility of contractors to change the terms of their contract through “change orders” which significantly transform the scope of work. The forensic audit by GT describes major changes made in the three of the major projects, namely Astaldi (power house and spillway), Valard (transmission lines on Island and in Labrador) and the EPCM contract (initially awarded to SLI). These three projects account for 45% of the $10,117 million direct project cost in the latest direct cost estimate. The overruns on these three projects account for 61% of all overruns.
Astaldi contract for power house and spillway
The Astaldi contract went from $752 million to $1959 million (March 2018) and Astaldi has now been replaced.
In their report of April 8, 2016 EY commented on the “reimbursement” of labour costs in the Astaldi contract
“The contract structure was designed to realize possible savings in construction labour productivity and also to protect Nalcor from any labour cost overruns that might be experienced by the contractor. It was intended that this would be achieved by including in the contract a maximum value for labour that Nalcor would have to pay to the contractor. However, the payment mechanism is based on person-hours expended rather than m3 of concrete poured. This mechanism did not capture the potential for poor contract management of labour and the consequent decoupling of labour paid for from work completed (measured by m3 of concrete poured). As at December 2015, the proportion of contract value paid to the contractor is significantly greater than the proportion of the concrete that has been placed.”
Did Astaldi also “buy the job” by submitting a low bid and use it to secure the contract, knowing they could renegotiate it later.
Valard contract for Labrador Island Link
Grant Thornton report that the contract with Valard went from $735 million to $1523 million. The contract was sole sourced to Valard.
Why was Valard awarded the contract for the entire Labrador Island Link (LIL) when that same company was busily engaged in building the line from Churchill Falls to Muskrat Falls, a contract which they won in a competition among eight bidders? Nalcor’s original plan was to break the LIL into four smaller contracts but that plan was thrown out and Valard was given the entire LIL, without public tendering or a new call for proposals! How does this comport with best practice in project management?
Grant Thornton has taken a “gentle” approach in their evaluation of Nalcor’s performance. One has to question whether this treatment is justified by the facts, particularly when it comes to “reimbursement” of costs, which opens the door to the sins of “cost plus”. GT is more critical when it comes to Astaldi. Apart from their handling of Astaldi GT is less critical. GT uncritically describes Nalcor’s role in cost overruns on page 70 of their phase 2 forensic audit when they say that
“their conduct in retaining and subsequently dealing with contractors did not contribute to project cost increases and project delays?”
Is this judgement of Nalcor’s behaviour justified when they allowed major EPCM cost escalation through reimbursement? In dealing with a company whose international dealings have placed its survival in jeopardy did Nalcor exercise the kind of oversight and cost control needed? Why was Valard exempted from competitive bidding and yet allowed significant cost overruns through change orders? Why was Astaldi’s bid accepted and subsequently renegotiated to a value above the higher bidders?
GT gives Nalcor a clean bill of health except for their management of Astaldi. Pat Hussey lays the blame at the door of SLI. What is clear is that there is much more to hear before anybody rushes to judgement. Was SLI treated too harshly by Nalcor or did they exploit Nalcor’s weaknesses when they took us back to the “cost plus” practices of a bygone era? Has the state of public administration and public probity advanced beyond that same bygone era of our history?
Early cost overruns did not prompt reassessment
GT does take strong issue with the fact that prior to financial close bids were exceeding DG3 estimates by 25% and yet these warning signs were ignored.
“bids were received from contractors whom ultimately were hired which collectively exceeded the DG3 budget by approximately $600 million, a twenty five percent (25%) overage. The amount of this overage exceeded the DG3 tactical contingency amount ($368 million) by over $230 million. Hence, prior to financial close, Nalcor should have been aware that the contingency amount included in DG3 budget was insufficient. Furthermore, Nalcor should have known that by April 2013 when the CH0007 bids were received (four months after sanctioning) that the DG3 contingency amount was exhausted.”
GT point out that these large overruns should have triggered a reassessment of the wisdom of continuing before the province took on the risks of a completion guarantee which would compel it to complete the project regardless of final cost.
√ Prior to financial close, Nalcor should have been aware that the contingency included in the DG3 budget was insufficient.
√ At the time of financial close, the project schedule was delayed by six months, demonstrating that the 97% chance of schedule slippage determined at sanctioning was in fact materializing.
√ Nalcor had the ability to stop the project prior to execution of the FLG and financial close without funding the remaining costs to complete.
√ Once the FLG was executed, Nalcor/GNL were committed to funding the project at their costs regardless of if the project was stopped or not. Under the FLG, Canada had the right to complete the project with Nalcor/GNL funding it.
√ Nalcor should have been aware that the contingency they selected for the LCP (less than 7%) was less than the low end of the range of what the IE typically sees at comparable DG3 stage gates.
There is no evidence that these overruns prompted Nalcor to reassess the project! Nor is there evidence that Nalcor advised the province of the large overruns or that the province reached out to Nalcor to determine if overruns were taking place. This reflects an egregious failing of oversight!
Why not finalize all major bids before financial close?
All of this begs the question as to why Nalcor and government did not insist that all major components be invited, assessed and finalized prior to sanction and released only after financial close. This question was raised by Muskrat Falls Concerned Citizens’ Coalition (MFCCC) counsel Geoff Budden during cross-examination of Pat Hussey. Budden referred to an exhibit P-02095 which refers on slide 33 to development of “contract strategies & contract plans with schedule to accommodate financial close requirements (Financial Close may require most contracts to be complete by project sanction).”
This suggests that as early as 2008 Nalcor had in mind the concept of using the outcome of a real bidding process to raise the confidence level of the cost estimates. Indeed it is worthy of note that the “Limited Notice to Proceed” (LNP) issued to Astaldi took place on the date of Financial Close, namely November 29, 2013. Clearly the strategy of having contracts in place and ready to go at the time of sanction or financial close was not an alien concept. Sadly it did not prevent the unfortunate saga which led to the removal of Astaldi from the site in the fall of 2018 and which included various amendments and change orders from the contract/LNP of November 29, 2013.
Nalcor was exempted from having to comply with the legislated rules which bind all other Crown agencies and departments. Government’s public tendering policies are far from perfect but they do impose a measure of disciple and certainty. Will the Commissioner pass judgement on the wisdom of giving a provincial crown corporation this kind of extraordinary discretion to dispense with public tendering. Were the sweeping powers and extraordinary authority conferred by statute upon Nalcor Energy appropriate? Were appropriate oversight measures put in place to protect the public interest for this enormous project?