PENLINK FINAL S 122C REPORT

The CSL ("Cranleigh's") report and the subsidy issue

The draft S 122C PENLINK report reached the conclusion [ref; page 16 of Section 1 Summary of Findings] that:

            "Though no complete data has been provided of the RDC 'doing it' option, it seems that the view that the RDC could not 'do it themselves' is not the full picture...For if the revenues from tolls more than offset the costs of servicing PenLink debt and other operating costs then the RDC 'could do it'. "

After discussions with the Chief Executive - the "CEO" and Councillors this view was accepted.  As a result of these discussions, which were conducted at a PENLINK Workshop held on the 8 October 2001, Councillors agreed to obtain further information and determine what the result would be if the RDC was to do it themselves - termed the "RDC/DIY" or just the "DIY" option.

To assist in the measurement of the "DIY" option, the author prepared a document, [ref: "Specifications of the Rodney District Council Public Sector Comparator"] the "Specifications" document. These specifications detailed the information necessary to satisfy the S 122C investigation requirements.

The document was forwarded to the Council's CEO who then set out the terms of reference of this exercise and commissioned the firms of Capital Strategy Ltd and Cranleigh Strategic Ltd, (CSL) to complete the task.

The firms reported their findings on 5 November 2001 [ref;  CSLs report titled "Weiti Toll Road Option"] and presented these to a meeting of Councillors held on that date.

The turn of events concerned with "the CSL initiative" requires a commentary, as there were a number of issues that arose which proved to be unsatisfactory.

The terms of reference produced by the CEO did not completely follow the suggestions of the "Specifications" document. As a consequence the CSL report did not fully include findings of significance to the case. The discussions at a later workshop of the report's findings not surprisingly left a number of Councillors in doubt on some matters.

This section of the report attempts to set the record straight on the issues involved, it highlights the information missing from the CSL report, information that should have been more fully considered by the decision-makers.

It is first necessary to clear up the confusion that arose as to the purpose of the "Public Sector comparator" exercise. [ref;  Specifications for the PSC October 2001]  The principal purpose of the exercise was not, as a number of Councillors appeared to believe, to assess the "DIY" option in expectation that the RDC would in fact do it themselves.

The purpose of the exercise was to provide Councillors with a basis for comparison, a "benchmark" by which they could compare the quality of the BOOT bids, that is by providing a basis for comparison of the bids with a hypothetical (or conjectural) "RDC/DIY" option.

This distinction on the face of it might seem pedantic. Far from it. Councillors must be aware of what an "RDC/DIY" option would involve in monetary terms. They will then be fully aware of the value of the rights they are proposing to cede to the private bidders under the proposed BOOT scheme.

As was perhaps inevitable, given the ambiguity surrounding the purpose of a "DIY" financial modeling, much discussion at the workshop concerned the views of those who for their own valid reasons were opposed to the RDC considering an actual completion of the project by the Council rather than the posited conjectural "DIY" solution.

Because of the uncertainties as to the purpose of the exercise the meeting of Councillors did not achieve a properly moderated result. What is more important, due to the nature of the report they did not have the opportunity to assess the important information that is now produced.

The following analysis makes the relevant comparisons and shows that the DIY option produces results that are significantly superior to those that KPMG, the Council's financial advisors had earlier considered were likely to be offered by the private funders. Without knowledge of these comparisons the Council risks achieving less than the "best deal' possible. The private bids can only be fully and properly evaluated having been benchmarked against a DIY alternative.  This was the objective in specifying the development of the Public Sector comparator model.

As stated earlier in this report the impact of receipt by the Council of subsidies or grants for PENLINK alters the analysis of the project in favour of a "DIY" option.  But the matter of receipt of Transfund and/or other agencies subsidies or grants and as stated in the CSL report remains uncertain.

The following observations regarding the CSL analysis are in part based on the assumption that the full Transfund subsidy would be received if the Council used its "DIY" option.  Whilst this is, as already has been conceded, a matter of some uncertainty, for the purposes of the comparator exercise, and consistent with its desired specifications as suggested by the writer the effects of a subsidy need to be factored in.  CSL failed to fully model the impact of subsidy receipts.

The comparisons (largely due to the influence of subsidy receipts) are startling. Based on Council's figures, a "DIY" option compared with a projected equivalent private funders bid would shorten the tolling period associated with a private funder by about sixteen years!  This is a very significant matter that was not given sufficient airing when the CSL report was prepared.

To keep the matters relating to the CSL report and subsidies simple, the details of the "Specifications" document and of the CSL report are only selectively quoted, more detail of their contents is contained in the appendices to this report.

The "Specifications" for the comparator exercise when comparing the "DIY" option with PENLINK as proposed, included the statement  [ref;  page 1 Specifications for a PSC] that :

            "one most important component of the model will be the inclusion of receipts of subsidies which would accrue to the RDC, but as advised these would not be offered to a private contractor".

For whatever reason, either the exercise of CSL's judgment or due to their limited terms of reference, the main and prominent findings of the CSL report did not include the effects of the receipt of subsidies.

As a result, the intended S 122C analysis contained in the "Specifications" document was not performed.  The full notional impact of the receipt of the Transfund subsidy of $24 M, the accepted detail of which was taken from and was referred to in the draft report [ref; for example page 12 Section 7 of the draft report] was not tested or reported by CSL.

CSL reported in the following terms within their Executive Summary [ref;  pages 3 of the CSL report]:

            " The DIY offers a projected pre-tax positive Internal Rate of Return ('IRR') of 8.8% and would result in a toll of $1.75 being applied for a period of 22 years"

An IRR of 8.8%, CSL considered might not meet RDC's capital expenditure criteria, that is, it made the benefits of the DIY appear marginal.

But this finding did not make any allowance for inclusion of the receipt of subsidies. Even so it should be noted that without the inclusion of subsidies the tolling period of the DIY option is shorter (by say ten years, 32 less 22 years) than is likely from private funding.

Later analysis of this section of this report demonstrates how a notional inclusion of the full subsidy would materially alter CSL's principal finding.

CSL did do some calculations involving inclusion of "a subsidy" of $10 M, although after exhaustive enquiries by the writer of the reports author it is uncertain why this particular figure was chosen. At page 14 of their report they stated in terms which can only be described as remarkable understatement that:

            " The possibility of subsidy funding will have a material effect. We have considered the possibility of the receipt of the sum of $10 million from a funding source and this significantly reduces the length of the toll period and improves RDC's balance sheet financing requirement". (emphasis added).

NOTE:  It might be speculated that the $10 M figure is an estimate of an amount possibly partially made up from receipts of grants including an amount received from Infrastructure Auckland.  There is a good chance of receiving some grant(s) of this kind but these have yet to be applied for.

The above extract was taken from the body of the CSL report. CSL's principal findings, contained in their executive summary which was widely circulated as a Council agenda paper were made without reference to or inclusion of the effects of subsidy receipts. Their report did not fully provide information on their effect. Their report, whilst on the one hand admitting to the possibility of subsidy receipts, (above) and stating that they would have a material effect failed to give any prominence to or measure the (full $24 M) effects of these.

CSL's exclusion of the effect of subsidies appears to be based on their belief, as stated at page 14 of their report that:

            "there is a high degree of uncertainty as to whether or not the RDC would receive subsidy funding for the DIY option".

The question of this "uncertainty" and its "high degree" is covered later in this section. Covered also is the need, in spite of any uncertainty because of the very material size of the subsidy monies involved, to actively pursue the matter of RDC"s entitlement to PENLINK subsidies.

CSL's analysis as pointed out was incomplete for the DIY option. Much of the prior work conducted for the draft S 122C report and the DIY case factored in the receipt of subsidies.  In addition, for matters involving uncertainty it is not sufficient for the conduct of a full and complete analysis to merely take one position without demonstrating the effects of the other(s). This will result in a clouding of the issues and in the worst case a bias to the findings.

Consequently, CSL's principal findings have not told the full story. The somewhat marginal results attributed to the DIY option as reported, for example an IRR of 8.8% as will be shown, would be very different if subsidies had been included.

Arising from the CSL reporting, from a Councillor (decision-maker's) perspective, the important point to bear in mind is that their report, which has had the effect of marginalising the DIY option is that the CSL positions were reached without factoring in the effect of very significant subsidies, uncertain or not.

What would be the results if the full total for subsidies had been included in their calculations?

As part of the field work conducted to produce the draft S 122C report, modeling was conducted, [ref;  Internal Memorandum Kevin Ramsay, RDC's Finance Manager to John Brown dated 14 May 2001].

This study was conducted to ascertain the financial effects of "the RDC going it alone" (DIY) for the PENLINK project. The "Ramsey" analysis, whilst it might vary in some minor matters from that conducted by CSL is so starkly different from CSL's findings that such variations within Ramsey's model as might exist, would not invalidate or materially alter its conclusions. The model was constructed from data provided by Mr. Brown, the PENLINK project leader.

Again keeping the detail to a minimum and put very simply this analysis showed:

The "RDC/DIY" option, without subsidies showed a positive Net Present Value (NPV) of  $29.8 M.  In other words the surpluses over a 31 year tolling period would be this total. Whoever built or operated the PENLINK facility could expect to enjoy a surplus of about this magnitude though naturally the party involved would also carry the risks of operational revenue shortfalls as well.

The RDC however, if entitled to and in receipt of a subsidy for the project would enjoy a surplus of over $50 M, for with the full subsidy included the project's NPV increases to
$51.4 M.

The tolling period for the facility, roughly equivalent to the period of "payback", that is the time it would to take to pay off the bridge and cease tolls, if managed under the "RDC/DIY" option would shorten to about sixteen years, a period itself some sixteen years shorter than if the PENLINK proposed BOOT-type funding went ahead.

CAVEAT: As described in the Introduction to this report no further corroboration/audit of this data has been conducted.  The data is taken unaltered from the draft report whose particulars were accepted as valid, that is following their corroboration and they were substantiated by RDC Management at the time.

These are very material facts relating to the subsidy matter which are also highlighted elsewhere in this report.  It should be clear from this analysis that the matter of subsidies is a major, though not the only determinant of achieving the "best deal". Receipt of a subsidy is by no means assured but a clear understanding of the reasons for this is essential to this case.

To state that, merely because the receipt of subsidies and or grants is not assured that their effect should be ignored, is unacceptable. The view is unacceptable because, given the right circumstances and by taking the appropriate actions the subsidy and or grants for PENLINK could either in total or in part be secured.

The current circumstances for claiming a Transfund subsidy were recorded in the CSL report [ref;  page 14] and are these:

            The current Transfund evaluation criteria is now 4.0:1, this changed from 3.5:1 in July 2001"

The evaluation criteria, often termed the benefit to cost ratio alters periodically and largely reflects the availability of roading funding. The movement to a 4.0:1 ratio indicates a greater scarcity of funding now than when the draft S 122C report was prepared.

The draft report [ref;  Section 1 Summary of Findings page 12] recorded the fact that:

"$24 M would be paid by Transfund as their share of the costs of the Weiti crossing and related roadworks. It should be noted that the Crossing and other works meets Transfund's subsidy benefit/cost ratio"

The eligibility of roading projects for subsidies is subject to variation. The PENLINK project having been clearly eligible prior to July of 2001 is now borderline but its circumstances can still alter again in future. For example the traffic volume counts on Whangaparaoa Road could over time increase to a point where the project once again moves into the eligibility range.

It would seem unlikely though not impossible if roading funding is not increased that the opposite would occur, that is that the project would not attract subsidy particularly given the continuing population growth being experienced on the Peninsula.  But in spite of this, if the PENLINK benefit to cost ratio was to make PENLINK remain ineligible for subsidies, then this may be a good reason to seriously question the need for the facility at all!  After all, a ratio of this nature does carry with it some assurance that a project is worthy of proceeding with.

The Transfund benefit to cost cut-off could rise or fall due to funding variations. The fluctuations of funding are not readily predictable but the influences upon them can be identified and some idea given of the chances of an improvement of the situation.

Transfund's financial capability to provide roading subsidies is dependent upon the transfer payments they derive from road user charges, excise duties and motor vehicle registration fees. [ref;  Funding for Land Transport System]  Over the last five years the nationwide benefit/cost ratio has measured on average 3.6:1.  Alterations to Transfunds mandate, added sources of roading funding (from increases in the petrol tax) and a new funding regime are all mooted within imminent policy announcements and are discussed elsewhere in this report.

The circumstances of subsidy eligibility for PENLINK are therefore uncertain but it is suggested not sufficiently uncertain as to exclude them from consideration within financial and other analysis.

Having been eligible "last year" it would not take major movements of the (existing, let alone future) measurement criterion in the short to medium term to again achieve eligibility.

In spite of the loss of subsidy monies some allowance might be made in effect a premium added to PENLINK's benefits by proponents of the project for building PENLINK "now" rather than waiting for a subsidy at some future indefinite time - when the project became eligible. This may be understandable given the support that appears to be present for getting the project completed.  Elected members need however to carefully weigh the merits of the bridges possible earlier completion against the loss of the subsidy, that would as a consequence be foregone.