Interislander: How Labour's Compromise Over iReX Ferry Project Led To $100m 'Cost Burn'

Tuesday, 16 July 2024, 3:59 pm
Article: RNZ

Russell Palmer, Digital Political Journalist

Analysis - "We intend to put the government on notice," KiwiRail's then-chair wrote to ministers, just 16 days out from last year's election.

It was the second frustrated letter David McLean had sent the government in four days, after being provided with only a portion of the roughly $1.2 billion KiwiRail had said was needed to continue with the ferry replacement project.

"The project as amended to fit the insufficient funding envelope will result in an incomplete and less than satisfactory solution, and we will be seeking a pathway to fund the de-scoped assets through a second stage of funding."

The funding decision had left KiwiRail short of the money to urgently sign contracts for the increasingly expensive and urgent port upgrades. It also could not confidently exit the ship-building contract it had already signed with the government's support.

With an election looming, the iReX project also could not simply pause and start up again, with contractors engaged in work or held on standby for particular parts of the port build.

While the full price tag would have been a hard pill to swallow for a government fighting constant criticism over the cost of living, the choice to demand KiwiRail continue the same project with too little resources arguably made a bad situation worse.

Less than a week after the new coalition was unveiled, KiwiRail complained in a letter to incoming ministers about this "prolonged period of infrastructure indecision to deal with the cost of the terminals".

The new government in December decided to cancel the extra funding, throwing the entire iReX project back to the drawing board.

Labour has consistently said the ferry link between the North and South Islands is a crucial one - but when in power, senior ministers refused to provide the money KiwiRail said was necessary to achieve the goals the government was still saying it wanted to achieve.

RNZ is looking back at the handling of the 'iReX' Interislander replacement project, closely examining 44 documents that reveal the advice and information provided and how it led to decisions across multiple governments - culminating in the project's cancellation.

'Limited options' with contracts needed within days

KiwiRail had been recommending an increase of $1.2b since February.

The shareholding ministers Grant Robertson (Finance), David Parker (Transport) and Duncan Webb (State-Owned Enterprises) informed KiwiRail of the government's in-principle decision to provide an extra $750 million on 19 September.

Chair David McLean responded five days later, on a Sunday, noting the funding was $200m less than "the minimum needed" and $550m less than the total - and was a contingency fund that could not be immediately relied on.

"We have limited options to proceed with Project iReX without a minimum of $950 million of additional funding," McLean wrote.

"We are at risk of losing programme-critical equipment such as barges within days, as equipment suppliers have other demands for these and require confidence to commit this to KiwiRail.

"We must decide soon on whether to proceed with Project iReX or pause and initiate a fundamental review. We will need to announce our decision as it affects investment partners, and listed companies including contractors and Hyundai Mipo Dockyard."

He said KiwiRail understood its obligation to show a sense of social responsibility, but "we also cannot enter or remain as a party to existing contracts to proceed with an investment that is at risk of exceeding the funding available".

"If the outcome sought from government is a resilient Cook Strait connection, then we recommend the $2.6 billion total programme be funded."

'Descoped' option pursued, then abandoned as unviable

McLean sent another email four days later, on Thursday 28 September.

"We have previously communicated the need for decisions to be taken now. Contractors require certainty so that equipment for the critical path can be allocated to iReX, such as barges, and contracts need to be entered in order for work to proceed in line with the critical path," he wrote.

"Consistent with your expectation for a staged delivery programme, the Board has instructed management to advise on the deliverability and risks of de-scoping and deferring elements of the terminals infrastructure."

Such a "descoped" option would affect all the rail-related assets at the Wellington terminal, and half the rail assets at the Picton terminal. Wharves, seawalls and connections like vehicle bridges would be retained.

It would also have meant ferry passengers would need to board a bus which would then be driven onto the deck, then exit the bus, to board the ferry.

McLean noted KiwiRail had presented this option as early as June, but said it would likely fall short of the iReX project goals.

"This option was presented to your officials in June 2023. We advised then that the option is not workable to achieve the detailed business case outcomes expected by us and by you."

In early October, the company said it believed the descoped works could be delivered within the funding available, but by November - after two months of exploring its options - concluded it was simply not viable.

Labour: 'We are not in a position to make a decision'

KiwiRail's deputy chair Sue McCormack also wrote to the ministers the day before the election saying the government "has the right to be a party to a decision to pause the Project but this is not practical given the General Election".

She warned that "a pause in the project now would effectively constitute a stop". Restarting the project for replacing the ferries was estimated to take "18 months to a year".

"A pause would also materially increase the cost to complete if the government and Board decides to proceed with a de-scoped Project, so we are seeking to balance these issues."

Robertson's response 10 days after the election was brief and to the point, washing his hands of responsibility.

"I understand KiwiRail's desire to preserve as many project options as possible. However, you will appreciate that the government is now operating in a caretaker capacity and as such we are not in a position to make a decision on KiwiRail's request," he said.

"KiwiRail will be required to wait until the new government has been formed, and new Ministers have been sworn in, before further engagement on Project iReX will be possible. In the interim, KiwiRail should look to preserve optionality, including through the use of cash available at a company level as necessary."

In a later briefing to the new ministers, KiwiRail complained of the delays in decision-making, and the large expense involved with keeping all options on the table for a future decision to be made.

"Following a prolonged period of infrastructure indecision to deal with the cost of the terminals, Project iReX is close to stopping," one briefing warned.

Another, provided on the same day, said "Project iReX has experienced months of lost time as main works contracts were expected to be entered in June 2023. This cost of this delay is estimated at $100m.

"This delay in signing up contractors to a firm price - we are still operating on time and materials cost-plus arrangements which gives us the flexibility to demobilise - means that the cost burn is large."

'Untenable risk': Dispute over access to additional funding

The documents also show KiwiRail was unable to make use of the money for completing the scaled-down works on the terminals.

"We also need a decision from you [the ministers] to revoke two conditions imposed in your letter," McLean wrote on 28 September, "These funding conditions in your letter do not provide certainty, which places untenable risk on directors and the company."

The approach of trying to limit the use of the $750m contingency funding, and the ministers' suggestion KiwiRail could borrow more - were each a "material constraint", he said, and the money needed to be provided as a grant or equity drawdown as "a requirement for directors to proceed".

Roberton responded that Cabinet was "not able to take any further decisions on Project iReX at this time", saying KiwiRail could try re-negotiating its ship-building contract, and reiterating his view the $750m was "the final Crown funding contribution".

"Given the fiscal context, it is critical that Crown funding represents value for money relative to all other calls on the Crown's funds."

But KiwiRail still could not access the funds, and sought legal advice on how to do so.

"Your letter refers to a total funding request of $145 million. In fact, that amount is made up of two components: a previously approved equity appropriation with [redacted] and the balance from the previously approved as Tagged Contingency," McLean wrote on 26 October.

"At this time, our legal and other advice is that directors can rely on the already appropriated $88.6 million. What we need is confirmation that we are able to draw down on the already-appropriated $88.6 million* as soon as possible.

"We accept the balance of the funding request, which was approved as Tagged Contingency, is in a different category. However, accessing the [redacted] under the approved appropriation will, together with our free cash, enable the project to continue through until January 2024."

Robertson went to the Treasury, which advised the ministers that "on the basis that Ministers' primary objective is to preserve project optionality ... we recommend that Ministers sign the share subscription agreement".

KiwiRail had considered, at the Labour ministers' urging, getting the private market to involved to help with funding, but said this was unlikely to work.

"Private investors would require a return on their investment, adding further risk to proceeding with the project because KiwiRail is at the limit of its lending headroom already," McLean said.

* Italics emphasis is consistent with the original document

Ships delayed with contract variation

KiwiRail had also been approached by the ship-builders, HMD, with a request to delay the ship construction to arrive in 2026 - and eagerly agreed, as this would more closely match the terminal construction timeframes.

The ships had been set to arrive in August 2025 and May 2026, but delivery was deferred to February 2026 and September 2026.

The company did not at first inform ministers of this development. In his 24 September letter, McLean bristled at the suggestion ministers should have signed off on the renegotiation.

"Your letter expressed disappointment at how challenging this process has been, and surprise that the terms of delivery dates in the vessel purchase contract were renegotiated at a time when the future funding of this project was under active consideration by the government," he wrote.

"The ferry purchase contract amendment secures a six-month postponement to delivery dates at no cost to Kiwirail. This was necessary because the delays in securing funding have impacted the critical path and mean the landslide infrastructure would not be ready before the ships arrive. This outcome mitigates risk and responds to your decision timeframes, which in the circumstances should not be a matter of concern."

It should be noted Treasury informed shareholding ministers and then-prime minister Chris Hipkins of the amended contract five days KiwiRail was approached about it by HMD.

McCormack's letter also highlighted that HMD was "asking that we now execute the ships' contract variation as this matter has been pending for some weeks and they need to be able to plan and work with contractors and suppliers towards delivery within the new date timeframes," suggested it did in fact require sign-off at a ministerial level.

Concerns raised about ports' reaction

McCormack also repeated a warning that the ports in both Wellington and Picton would be frustrated at the government's indecision.

A portion of the funding for the iReX project's port upgrades had been expected to come from the ports themselves, which are both owned by local councils.

Labour ministers - at officials' urging - had requested KiwiRail to try to seek more funding from the ports, but the company considered it unlikely, particularly in Picton where the port's council owner had only agreed after extensive community consultation.

"Commercial engagement with other parties, particularly the two port companies will commence urgently," McCormack wrote on 13 October.

"We anticipate that some parties may express strong dissatisfaction with the need to reduce the Project's scope."

That followed McLean's warnings in late September, which came alongside the concerns about accessing the funding.

"We will communicate our status to Ports and contractors that 'KiwiRail remains in discussion with shareholders about options to address the cost increase, and while we cannot enter further contracts at this time, we have reason to believe the Project may proceed and we will ask for their continued patience.' We will seek to engage them on the feasibility of the proposed option.

"If we are asked about this by media, we will issue a statement acknowledging the discussions are ongoing."

'Focus was on ... optionality' - Labour

The rest is history. The new government came in and promptly scrapped the extra funding, leading KiwiRail to say it was backing out of the ship contract.

Labour's Transport spokesperson Tangi Utikere now says the government of the time was focused on keeping options open for the next government.

"There is no doubt that there needs to be portside developments, but the scale upon which KiwiRail was suggesting was not something that the government was prepared, as I understand it, to accept on face value," he said.

"Some of the costs that were cited at the time, the government of the day felt as though that was not acceptable. And so that's why there is effectively a bit of exchange between the two.

"The focus was on making sure that whatever decisions were taken ... would give optionality to the government, whoever the government might be, post the election so that decisions could be made."

He acknowledged the $100m cost of that approach.

"Sure, sure, well, I think what's really important is that, you know, ministers were continuing to scrutinise KiwiRail and there were still questions around what KiwiRail was ... putting in front of the government of the day.

"I think it's fair to say that the money had to be committed at the time to ensure that options were preserved."

When asked if ministers simply had not believed KiwiRail when it said the minimum needed was $950m, he said there was "still some work to go in terms of landing what that portside development in a finalised fashion would actually look like and what it would actually cost".

"This was pattern of ongoing conversation .... they were not conversations that I understand that were actually complete at the point of the election."

He said it was now over to the new government, that the uncertainty posed by the current situation was "completely unacceptable", and the cancellation of the project without finding a replacement was "really disappointing".

On Wednesday, RNZ will delve into National's decision-making when it came to government, and explore the advice the new government was relying on.

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