Infrastructure: an increasingly risky business

Hitting the headlines

The issue of inappropriate risk transfer, which has been simmering behind closed doors, has now boiled over and become far more visible as disputes have hit the headlines.

The construction of the Sydney Light Rail – a complex project that involved shutting down George Street in the heart of Sydney’s busy retail and office precinct – is one high-profile project that has made the news.

The dispute between the New South Wales (NSW) government and the ACCIONA-led ALTRAC consortium arose from the additional costs incurred by the consortium for relocating utilities during the construction phase. In June 2018, following months of delays and no doubt significant legal fees for all parties, the state government paid ALTRAC AU$ 576 million (US$370 million) in an out-of-court settlement'Sydney light rail cost blows out to at least $2.7b after settlement'.

In another high-profile case, the stock market was shocked when Lend Lease announced an AU$350m write-down in 2019''All options on the table': Lendlease shares dive as it takes $350m hit on engineering business'. The most significant losses appear to have stemmed from several road projects in its engineering division, including the NorthConnex project, a nine-kilometre, 90-metre-deep tunnel, linking two motorways in Northern Sydney.

The size and unexpected nature of the write-down contributed to a significant hit to the company’s market valuation, wiping off more than AU$2 billion. In the same year Lend Lease took a strategic decision to stop building tunnels, railroads and other large infrastructure by selling Lend Lease Engineering to ACCIONA for AU$180 million in December 2019.'Lendlease to divest Engineering business'

Finally, over 18 months after the Light Rail settlement in Sydney, a high-profile legal stand-off broke out in Melbourne between contractors, proponents of the AU$6.7 billion West Gate Tunnel toll road project, and the state government. Australia’s two largest builders, CPB Contractors and John Holland, are refusing to foot the bill for the disposal of huge volumes of contaminated soil that will be produced if and when boring machines tunnel under the Western suburbs of Melbourne (currently they are sat idle).

The reality is that these disputes are just the tip of the iceberg with many more being played out behind closed doors between project owners, contractors, engineers and associated sub-contractors.

Furthermore, as the industry grapples to respond to the current coronavirus pandemic and social distancing protocols, it is likely that there will be many new disputes arising as parties try to protect their commercial position.

Negative effects: a growing understanding

In the same month as the Light Rail project dispute was settled, the NSW Government’s Construction Leadership Group (CLG) issued the NSW Government Action Plan: a ten point commitment to the construction sector guidance document to establish a more collaborative relationship with contractors. The first point states that government should “procure and manage projects in a more collaborative way” and “move away from a reliance on fixed-price, lump-sum procurement methods.”'NSW government action plan: A ten point commitment to the construction sector'

Infrastructure NSW chief executive at the time, Jim Betts, acknowledged in an interview with the Financial Review, that there had been a “macho” view that governments should push the maximum level of commercial risk onto the private sector, even when they were unable to predict or manage the risks involved.

He went on to say: “adopting more collaborative methods of contracting saves costs but it also enables us to acknowledge that some things are unpredictable and that we actually need to work together to reduce risks rather than simply arguing about how we allocate them between us.”'NSW has dropped 'macho' approach to projects, says Infrastructure NSW chief'

The Economic Benefits of Better Procurement,'Economic benefits of better procurement practices' a Deloitte Access Economics report commissioned by Consult Australia, sheds further light. It found that firms often respond to onerous risk by either pricing it into their bid, or deciding not to bid on a particular project, which in turn drives up price by reducing competitive pressure. The report also estimated that savings of about 5.4 per cent could be made through better risk sharing and other improved practices. When translated to the current Victorian (AU$80bn) and New South Wales (AU$87bn) infrastructure pipelines, it could represent a potential saving of over AU$8bn through better procurement; that’s enough to pay for another Sydney Metro Northwest.

According to Nicola Grayson, Consult Australia’s Chief Executive, professional services have several common complaints when it comes to onerous risk allocation.

“Onerous contracting is more likely to lead to disputation, as well as lengthier negotiations in the initial phase,” she says. “Should a risk be realised, and liability eventuate, an onerous contract means there will be less incentive for the parties to settle instead of pursuing costly litigation. Combine these adversarial contracts with the increasing size and complexity of the current pipeline of projects and you have a recipe for small delays or disputes to turn into multi-million-dollar legal battles.”

Furthermore, research from legal firm Allens, in its Securing The Missing Benefits of Australia's Infrastructure Boom report, reveals an industry feeling the strain of project complexity. Prominent concerns raised in the survey and market research include:

● 77% of senior industry leaders are more concerned with the risks facing the sector than they were five years ago 
● 90% of the future projects in the pipeline are in transport
● Senior industry leaders say tunnels are nine times more likely than social infrastructure to cause delays or cost blowouts. 

The review from Allens looks at specific infrastructure project risks and proposes a range of measures to secure the future benefits of these projects. Partner David Donnelly, who is also the firm’s Sector Leader of Infrastructure and Transport, explains how the industry is concerned that the benefits of the infrastructure boom may not be fully realised, calling into question the significant investments made by governments.

“The sector faces a conundrum: there is an infrastructure deficit but there are fundamental issues creating risk in supply chain and these underlying risks threaten the economic and social benefits of the projects,” he says.

With thanks to contributors: David Donnelly, Partner, Allens; Nicola Grayson, Chief Executive, Consult Australia; and Scott Langdon, Partner, KordaMentha.