On 12 May 2017, in accordance with Section 38C(2) of the Public Finance and Audit Act 1983, the Audit Office provided the final report for this audit to the heads of the five audited agencies, their responsible Ministers and the NSW Treasurer.

I note that on 18 May 2017, Portfolio Committee No.2 – Health and Community Services Inquiry into Road Tolling received evidence regarding the potential for a financial contribution from Roads and Maritime Services if a certain percentage of heavy vehicles continue to use Pennant Hills Road.

Subsequently, the issue of compensation payments to the NorthConnex operators has been the subject of public interest.

As part of my audit, I examined how the assessment of the NorthConnex funding model ensured value for money for NSW taxpayers. My report notes the published contract summary for NorthConnex states that:

• Roads and Maritime Services will implement regulatory measures with respect to heavy vehicles travelling on Pennant Hills Road
• there are specific conditions where Roads and Maritime Services must provide compensation to the proponents if an agreed percentage of certain heavy vehicles continue to use Pennant Hills Road.

I consider the matters of public interest referred to above were adequately addressed on 22 May 2017 at the public hearing for the Inquiry into Road Tolling. The transcript from this hearing is available on the NSW Parliament website.

Margaret Crawford
Auditor-General of NSW
June 2017

NorthConnex is a nine-kilometre tolled motorway tunnel between the M1 Pacific motorway at Wahroonga and the M2 Hills motorway at West Pennant Hills. Major construction work commenced in February 2015 and the tunnel is expected to open to traffic in late 2019.

In March 2012, the M7 shareholders (also referred to as the proponents) submitted an unsolicited proposal for NorthConnex to the NSW Government. The proponents, led by Transurban, include the Queensland Investment Corporation and the Canada Pension Plan Investment Board.

A steering committee, with representatives from the Department of Premier and Cabinet, NSW Treasury, Infrastructure NSW, Transport for NSW and Roads and Maritime Services, as well as an independent member, assessed the proposal in accordance with the ‘Unsolicited Proposals - Guide for Submission and Assessment’ (the Unsolicited Proposals Guide). The

Unsolicited Proposals Guide sets out a three-stage assessment process:

1. Initial Submission and Strategic Assessment — A comprehensive initial assessment to identify any potential benefit to the NSW Government of further consideration and development with the proponent
2. Detailed proposal — The NSW Government and proponent work collaboratively to develop and assess a detailed proposal
3. Negotiation of final binding offer — Outstanding issues are finalised with a view to entering a binding agreement should the NSW Government accept the final offer.

As this was a Public Private Partnership (PPP) proposal, the steering committee also assessed the proposal against the National and NSW PPP Guidelines.

This audit assessed whether the process used to determine the NorthConnex funding model adequately considered value for money for taxpayers and road users. In making this assessment, we answered the following questions:

1. How did the assessment of the NorthConnex funding model ensure value for money for NSW taxpayers?
2. Did the assessment adequately consider the overall impact of tolling arrangements to road users and the community?

More details on the audit scope and focus are in Appendix three.

Assessment processes complied with established guidelines

The steering committee, chaired by the Department of Premier and Cabinet, was responsible for assessing and evaluating the proposal, managing communications with the proponents, and advising the NSW Government.

The unsolicited proposal assessment process involved considerable multi-agency stakeholder involvement and input. The steering committee met monthly throughout the proposal assessment and evaluation process. The committee established an assessment panel and technical, commercial and representative teams.

In accordance with stage 2 of the Unsolicited Proposals Guide, the documentation we reviewed indicated a high level of collaboration between relevant NSW Government agencies and the proponents under the guidance of the steering committee.

In line with the requirements of the Unsolicited Proposals Guide, the steering committee considered value for money as a key assessment criterion. We found that the steering committee used multiple processes to assess the NorthConnex proposal which adequately considered value for money for taxpayers and road users within the NSW Government’s stated policy objectives. These processes included:

• assessing the NorthConnex proposal against the costs and benefits of the NSW Government fully funding the project (referred to as the public sector comparator)
• developing a business case which demonstrated a positive cost benefit ratio (noting that a business case is not a requirement of the Unsolicited Proposals Guide)
• adding a competitive tender process for the design and construction components
• using independent cost estimation and traffic modelling
• introducing a cap on the NSW Government’s contribution.

The steering committee also ensured that the proposal had received planning approval and that it met other government requirements, such as completing a public interest evaluation report which is required by the NSW PPP Guidelines.

The steering committee prepared governance plans which addressed probity requirements, and the probity advisor for the proposal completed probity reports for stages 2 and 3. An issue related to the incomplete documentation for the management of a declared potential conflict of interest is described later in this report.

The NorthConnex proposal met a compelling need for the NSW Government, that RMS had identified many years before the unsolicited proposal was received. However, previous assessments demonstrated that the NSW Government was unable to independently fund the project.

Two key assurance steps were not completed in a timely manner

The decision to proceed from detailed proposal (stage 2) to negotiating the final binding offer (stage 3) was not informed by a business case gateway review or stage 2 probity report. The steering committee completed these key assurance steps after the NSW Government announced the decision to proceed to stage 3.

While there is no specific guidance in the Unsolicited Proposals Guide or the NSW PPP guidelines on when a business case gateway review should be completed, our view is that a business case gateway review would be more effective at providing risk assurance if it were completed during stage 2 and before commencement of the procurement phase in stage 3. An expert panel reviewed the draft business case in February 2014, after stage 2 was completed in May 2013. As a result, the gateway review did not inform the development of the project cost or scope, as the commercial terms had been negotiated as part of stage 2.

The probity advisor reviewed probity related content in the stage 2 assessment report in May 2013. Although the probity advisor confirmed that there were no unresolved probity concerns/issues and that a draft probity report had been prepared, the stage 2 probity report was not finalised until November 2013, six months after the NSW Government announced that it had reached an in-principle agreement with the proponents and completed the stage 2 assessment process in May 2013.

The Department of Premier and Cabinet has provided a draft update to the Unsolicited Proposals Guide. We note that this draft provides clarity on when these assurance steps should be completed for future unsolicited proposals.

Record keeping did not fully comply with legislation or the governance plan

Government agencies are required to keep documentation in accordance with the State Records Act 1998 and the NSW Government Standard on Records Management. By their nature, unsolicited proposals lack transparency and the benefit of competition in the procurement process. This makes it more critical for NSW Government participants involved in the assessment of unsolicited proposals to keep complete and accurate records of their activities and decisions.

In addition, the governance plans for stages 2 and 3 state ‘Records of the proposal and evaluation process must be maintained in order to allow for independent audit and review. The maintenance of appropriate records increases the accountability and transparency of the process’.

Agencies were unable to provide key documentation requested as part of the audit. With the exception of the steering committee, record keeping for groups such as the assessment panel, the technical team, commercial team and representative team did not meet the standards for government record keeping. This was due to a lack of clarity regarding the roles and responsibilities for record keeping, including what should have been recorded during the assessment of the NorthConnex proposal and who was responsible for doing this.

The management of a potential conflict of interest was not fully documented

The governance plans for NorthConnex state that ‘All participants in the assessment process (including advisors) must have no conflicts of interest, which would, or may appear to, adversely affect the impartiality of the process. Project team members are responsible for bringing any actual or potential conflict of interest to the attention of the steering committee Chair or Probity Adviser’.

In July 2012, one of the government representatives declared a potential conflict of interest to the steering committee after discussions with the probity advisor in May 2012. This person was involved in all three stages of the assessment process.

The steering committee noted the declaration, and directed the probity advisor and person declaring the interest to ‘work on a plan to manage any future conflict of interest and present it to a future meeting’. There is evidence that a management plan was developed and the Department of Premier and Cabinet advised us that this plan was adopted by the steering committee. This was not captured in the steering committee meeting minutes.

The stage 2 assessment panel report confirmed that ‘the probity advisor has not reported any unresolved concerns/issues’. The probity reports, which were prepared at key points in the assessment process, did not document that the potential conflict of interest had been declared or that a mitigation strategy had been implemented.

We acknowledge that the government representative acted appropriately in declaring the potential conflict of interest. The chair of the steering committee and the probity advisor were responsible for ensuring impartiality in the assessment process.

Transurban initially submitted that the proponents could finance, design, construct and operate two motorways to complete the links in the Sydney motorway network. It also proposed changes to tolling concessions to support these initiatives. The initial NorthConnex proposal used the preferred route identified in an independent review conducted in 2004 (and confirmed in 2007) as the basis for the project and provided an initial cost estimate based on this route.

During stage 2 of the assessment process, the commercial team sought to establish a set of commercial terms which met the requirements of the Unsolicited Proposals Guide, in addition to directions from the steering committee. The negotiation and agreement of the commercial terms required an initial project cost figure to inform assessment of the proposed tolling concessions.

A multi-agency technical team assessed the cost of the proposal. Project costing during the strategic and planning stages of infrastructure development relies on contingency figures to estimate the cost for the project. The technical team's assessment was consistent with the Department of Infrastructure and Transport's ‘Best Practice Cost Estimation for Publicly Funded Road and Rail Construction 2011’.

The extent of assessment was consistent with the rigor that would be expected for a project that was at the business case stage of development

There were multiple reviews of cost estimates for the NorthConnex proposal as the assessment progressed. During stage 1, cost review focussed on assessing the initial proposal. During stage 2, Roads and Maritime Services engaged an independent costing expert to assist the technical team to review the proposal and develop an independent cost estimate for the project.

The cost estimates for the project decreased over time as the contingency requirement reduced. This is consistent with the Department of Infrastructure and Transport's ‘Best Practice Cost Estimation for Publicly Funded Road and Rail Construction 2011’.

The steering committee considered whether the cost target, which was used as the basis for the design and construction tender, was likely to be achievable and provide scope for competition in relation to innovation and design.

Traffic modelling involves the use of real world data and computer simulations to predict the number of vehicles that will use roads. For large infrastructure projects like NorthConnex, traffic modelling plays an important role in determining the potential benefits and costs of a project (in terms of modelling reduced road congestion and estimating travel time savings). Traffic modelling also underpins commercial negotiations relating to tolling concessions, such as the length of an agreement (in years) and the amount of a toll.

Roads and Maritime Services released traffic modelling guidelines in February 2013. The guidelines aim to develop consistency in traffic modelling practice and promote high quality model outputs that will lead to better project design.

The use of independent traffic modelling represented the best available assessment, given the complexities of the network being modelled and the available traffic data

During the assessment of NorthConnex, Roads and Maritime Services engaged an independent traffic modelling consultant to assess the traffic impacts of NorthConnex and validate the forecast provided by the proponents. The assessment included providing forecasts for the 2021 and 2031 traffic volumes for NorthConnex and the M7 corridor.

The assessment used a specific model, initially developed for the WestConnex project, and the use of this model was consistent with Roads and Maritime Services' practice at the time. The results of the independent assessment were also used to validate the proponents' modelling and to provide confidence to the NSW Government.

The NSW Government managed the risk of underestimating traffic volumes by including a revenue sharing arrangement

As part of their initial proposal, the proponents accepted traffic risk for NorthConnex. This meant that should the predicted traffic volumes not eventuate, the NSW Government would not have to provide any financial reimbursement or subsidy to make up for lower than expected toll revenue.

During the negotiations for the proposal, the risk of underestimating the traffic volumes was managed by including a revenue sharing arrangement. If NorthConnex traffic volumes are higher than expected, the proponents share the additional revenue with the NSW Government. This mitigates the risk of the private sector making super profits from the infrastructure investment.

Traffic modelling identified the impact of truck diversion from the M7 as having a significant potential impact on the funding model for the NorthConnex proposal  

As part of the NorthConnex funding arrangement, tolls for heavy commercial vehicles (trucks over 12.5 metres in length and 2.8 metres high) will increase significantly on the M7. Heavy commercial vehicles used to pay the same toll as cars. Under the terms of the NorthConnex agreement, they will now pay three times the car toll. This change has been gradually phased in through quarterly incremental increases starting in January 2015.

The traffic modelling for NorthConnex identified that this increase would result in some heavy commercial vehicles diverting from the M7. The additional tolls for heavy commercial vehicles on the M7 contribute 27 per cent of the funding requirement for NorthConnex (compared with 27.3 per cent for tolls on NorthConnex and 27.4 per cent for NSW and Australian Government contributions). There was a limited sensitivity analysis conducted on the impact of the potential diversion.

The unsolicited proposal assessment process provided the decision-making framework for NorthConnex. The steering committee and assessment panel applied relevant government policies and guidelines, including the NSW PPP Guidelines.

The process used to determine the NSW Government's contribution was in line with NSW Government requirements. There was consideration of value for money and value to government, with the application of a ‘cap’ for the NSW Government's contribution early in the process.

The public sector comparator confirmed that the NSW Government could not afford to deliver the project by itself

The public sector comparator is an estimate of the cost that the NSW Government would pay were it to deliver a project or service by itself. The public sector comparator assumes that a state owned corporation would deliver the project and would earn a commercial rate of return on revenues derived from user charges.
The commercial team developed the public sector comparator for NorthConnex in stage 2, consistent with the NSW PPP Guidelines. 

The public sector comparator indicated that a state owned corporation could only support a capital investment of around $600 million in net present value terms. This would result in a funding shortfall of $1.7 billion. The steering committee concluded that traditional delivery and funding of the NorthConnex project was not affordable or viable from the NSW Government’s perspective, given the budget position and commitment to other infrastructure projects.

Competitive tendering for the design and construction component added value

In May 2013, the NSW Government announced that it had reached an in-principle agreement with the proponents and agreed to proceed to stage 3 of the unsolicited proposal proces (submission of a final binding offer) on the basis that a competitive design and construction tender be conducted.

The inclusion of a competitive tender at this stage of the proposal helped drive value and allowed the market to share innovative ideas, which ultimately helped improve the scope, including increased tunnel height.

Transurban (on behalf of the proponents) ran the tender process which encouraged innovation in design. Roads and Maritime Services provided the output specification requirements for the motorway.

The decision to proceed from stage 2 to stage 3 was not informed by a Business Case Gateway Review or completed stage 2 Probity Report. The steering committee completed these key assurance steps after the NSW Government announced the decision to proceed to stage 3.  

The Department of Premier and Cabinet has provided a draft update to the Unsolicited Proposals Guide. We note that this draft provides clarity on when these assurance steps should be completed for future unsolicited proposals.

The business case expert review (or gateway review) report did not inform the stage 2 assessment

The stage 2 assessment involves the proponents working with the NSW Government to develop a detailed proposal, which is then presented for Cabinet's consideration. If the detailed proposal is successful at this stage, the proposal moves to stage 3, and the NSW Government and proponents develop a final binding offer.

For an infrastructure project like NorthConnex, the detailed proposal is equivalent to a business case. Like comparable projects, NorthConnex did undergo an expert review panel (also known as a 'gateway review').

In February 2014, the expert panel reviewed the draft business case. This was after stage 2 was completed in May 2013. The gateway review did not inform the development of the project cost or scope, as the commercial terms had been negotiated as part of stage 2.

While there is no specific guidance in the Unsolicited Proposals Guide or the NSW PPP guidelines on when a business case gateway review should be completed, our view is that a business case gateway review would be more effective at providing risk assurance if it were completed during stage 2 and before commencement of the procurement phase in stage 3.

The stage 2 probity report did not inform the stage 2 assessment

According to the Unsolicited Proposals Guide, the role of a probity advisor is to monitor and report on the application of the Independent Commission Against Corruption's probity fundamentals during the assessment process. Probity fundamentals include maintaining impartiality, accountability and transparency, confidentiality, managing conflicts of interest and obtaining value for money.

The probity advisor reviewed the probity related content in the stage 2 assessment report in May 2013. Although the probity advisor confirmed that there were no unresolved probity concerns/issues and that a draft probity report had been prepared, the stage 2 probity report was not finalised until November 2013, six months after the NSW Government announced that it had reached an in-principle agreement with the proponents and completed the stage 2 assessment process in May 2013.

While there is no specific guidance in the Unsolicited Proposals Guide or the NSW PPP Guidelines on when a probity report should be completed, our view is that the probity report should have been completed earlier to inform the decision to proceed to stage 3.

By their nature, unsolicited proposals lack transparency and the benefit of competition in the procurement process. This makes it more critical for NSW Government participants involved in the assessment of unsolicited proposals to keep complete and accurate records of their activities and decisions.  

We found that record keeping for the NorthConnex proposal did not fully meet the requirements of the State Records Act 1998, the NSW Government Standard on Records Management and the proposal specific governance plans.  

The governance plans for stages 2 and 3 state:

Records of the proposal and evaluation process must be maintained in order to allow for independent audit and review. The maintenance of appropriate records increases the accountability and transparency of the process.

The governance plan specifies that the Proposal Manager (Department of Premier and Cabinet) was responsible for record keeping for the steering committee. However, the stage 2 governance plan did not specify who was responsible for maintaining records for other groups associated with the proposal, such as the assessment panel and the commercial, representative and technical teams. The stage 3 governance plan did specify that the chairs and team leaders of the project teams associated with the proposal development were responsible for ensuring appropriate records were maintained for their respective committees and project teams.

However, we were unable to obtain minutes or agendas for these groups. In our previous audit on unsolicited proposals, this documentation was available. There were inadequate records kept of all NSW Government representative meetings with the proponents, despite this being a requirement of the Stage 2 Governance Plan. Additionally, some status reports from these groups were not tabled or adequately captured in the minutes of the steering committee meetings.

The management of a potential conflict of interest was not fully documented

The governance plans for NorthConnex state that ‘All participants in the assessment process (including advisors) must have no conflicts of interest, which would, or may appear to, adversely affect the impartiality of the process. Project team members are responsible for bringing any actual or potential conflict of interest to the attention of the steering committee Chair or Probity Adviser’.

In July 2012, one of the government representatives declared a potential conflict of interest to the steering committee after discussions with the probity advisor in May 2012. This person was involved in all three stages of the assessment process.  

The steering committee noted the declaration, and directed the probity advisor and person declaring the interest to ‘work on a plan to manage any future conflict of interest and present it to a future meeting’. There is evidence that a management plan was developed and the Department of Premier and Cabinet advised us that this plan was adopted by the steering committee. This was not captured in the steering committee meeting minutes. However, there is some evidence that shows the management plan was implemented.  

The stage 2 assessment panel report confirmed that ‘the probity advisor has not reported any unresolved concerns/issues’. The probity reports, which were prepared at key points in the assessment process, did not document that the potential conflict of interest had been declared or that a mitigation strategy had been implemented.  

We acknowledge that the government representative acted appropriately in declaring the potential conflict of interest. The chair of the steering committee and the probity advisor were responsible for ensuring impartiality in the assessment process.  

The primary service delivery objectives of NorthConnex are to complete a missing link in Sydney’s motorway network, reduce the number of heavy vehicles using Pennant Hills Road and to ease congestion for Sydney motorists. The tolling arrangements were designed to pay for the cost of the infrastructure and divert heavy commercial vehicles from using Pennant Hills Road.  

During the assessment of the NorthConnex proposal, the steering committee considered tolling arrangements.

The tolling arrangements are consistent with the Long-Term Transport Master Plan

The Long-Term Transport Master Plan (2012) described the NSW Government’s intention to explore new methods of funding road infrastructure, such as changes to road pricing. Of particular relevance is the intent to use innovative financing and funding approaches to expand the motorway network. The NorthConnex funding model is consistent with the following principles described in the Long-Term Transport Master Plan:

• NSW will seek more direct charging of heavy vehicles for the roads they use, with these revenues being reinvested in transport.
• direct charging, or road pricing, is a way to raise revenue for new infrastructure and or lessening congestion
• toll revenues will be directly allocated to fund public transport and complete missing motorway links.

Public interest evaluation report considered issues related to equity

The steering committee completed a public interest evaluation during stages 2 and 3 in accordance with the NSW PPP Guidelines. The evaluation addressed eight criteria including meeting NSW Government objectives, public access and community consultation.  

The evaluation concluded that the proposed level of user charge and the contribution from the taxpayer are reasonable considering the benefits that will eventuate from this infrastructure.

The evaluation considered whether there were adequate arrangements to ensure that the public, including disadvantaged groups, can access and use the government service and related infrastructure. The evaluation report states that:

The proposal will be designed, constructed and operated to provide a service to all motorists subject to the payment of a toll. The public, including disadvantaged groups will have equal rights to use the completed project. The proposal will not change access to existing private or public facilities or infrastructure.

The assessment of NorthConnex complied with government policies which consider the impact of infrastructure

During the assessment of NorthConnex, the steering committee and Roads and Maritime Services completed relevant processes to assess the impact of infrastructure in line with government policy. These included:

• unsolicited proposal assessment reports
• the business case and subsequent expert panel review
• public interest evaluation report
• environmental impact statement.

Traffic modelling was undertaken to consider the impact of tolling arrangements across the motorway network

Roads and Maritime Services undertook network wide traffic modelling, using an independent consultant, to ascertain the impact of tolling changes across the motorway network and adjacent roads.  

The most significant finding from the traffic modelling was the potential for heavy commercial vehicles to divert from the M7 because of the increase in the heavy commercial vehicle toll multiplier. The modelling attempted to estimate the traffic impact on some roads surrounding the M7 which might experience greater heavy commercial vehicle use. The most recent traffic data show that the increase in the truck toll multiplier has not had as much of a diversionary impact as the modelling predicted.

There was consideration of the cumulative impact of tolling changes on motorists across the life of the agreement

Throughout the assessment of the NorthConnex proposal, the assessment panel and steering committee evaluated the impact of tolling changes across the different toll roads through to 2048, the final year of the agreement with the proponents.