East West needs to be Victoria’s last project debacle

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East West needs to be Victoria’s last project debacle Malcolm Maiden

Victorian Premier Daniel Andrews with Treasurer Tim Pallas announce the state government will pay $339 million to East West Connect – the group contracted to build the East West Link. Photo: Josh Robenstone

Credit and blame are fairly evenly shared in the East West Link tollway contract dispute that Victorian Premier Daniel Andrews announced on Wednesday had been provisionally settled after months of tense negotiation.

Let’s allocate the blame first.

Labor lit the fuse ahead of last November’s election, by expanding its opposition to the project to include a commitment to kill it off.

It did so without knowing what the legal and financial consequences were, and its warning that Labor would kill the project if elected raised sovereign risk –the risk that the Victorian government would be regarded as untrustworthy in its dealings with the private sector.

The Napthine government and the East West Connect consortium led by Lend Lease also contributed to the debacle, however, by pushing ahead with a project that was set to return only 45¢ in the dollar, using Infrastructure Australia’s cost-benefit methodology.

They pushed the project to its financial close ahead of the election, triggering the first big debt drawdown by the consortium, and they agreed on a side letter to the contract stating that compensation payments set out in the contract would flow if the tollway project was halted, or derailed by a legal challenge. East West was locked in the face of Labor’s warnings, and the side letter was written because of them.

Now let’s spread some praise. After the Andrews government was elected, it and the consortium quickly and sensibly agreed to try to negotiate a commercial resolution.

The talks were difficult, and complicated by the fact that the financial close had triggered an initial $400 million-plus drawdown of project debt by the consortium, from banks including CBA and Westpac.

That drawdown created a contingent liability for the government, because the tollway needed government support and money to survive: The Napthine government estimated that the spend would be $6.8 billion, more than half of it on operational payments. Andrews claimed on on Wednesday that the real bill would have been $10.7 billion.

The aim of commercial negotiations is to find a deal that both sides can live with, and the provisional settlement announced on Wednesday fits, by overriding an algorithm in the contract that could have resulted in the consortium being paid about $1.2 billion on the cancellation of the project.

Subject to audit the consortium will instead keep $339 million from the first drawdown – almost certainly more money that it spent on the project itself, but the amount it had accessed under the terms of its contract before the project was suspended.

An East West project company that has already paid loan establishment fees totalling $81 million for a $3 billion loan facility from the project’s lenders will meanwhile be purchased by the government for $1.

About $110 million of drawn but unused East West funding will be loaded back into the $3 billion facility, and the government will negotiate with the banks to use the establishment fee already paid in a “repurposed” loan that will finance its own infrastructure projects.

Pain for the government comes from the fact that it inherits ownership of the East West lending company, and will eventually be required to repay the $339 million the consortium partners are keeping.

Killing the project also strands money the government under its previous leadership spent on developing the East West tollway project. Opposition Leader Matthew Guy put those costs at between $400 million and $500 million on Wednesday, although most of it was spent on land that obviously has a value.

All in all, it looks to be a fair resolution of a mess that Labor, the Coalition and the consortium all helped create. The consortium did not press its claim for compensation above and beyond the amounts it had already accessed in accordance with its contract, and the government did not resort to legislation that could have resulted in it paying less than it has agreed to, or even nothing. The threat of legislation underpinned the final offer the government put to the consortium just after Easter.

As for sovereign risk, the agreement if confirmed will limit it, but not erase it. East West was not a brilliant project, but the difficult fact remains that in opposition Labor threatened to kill off a a major government contract, and that in government it did so, even after the previous government raised the financial risk.

It can use the agreement with the Lend Lease consortium to argue that East West was a one-off situation. Most companies that deal with the state government will agree. After this, Victoria is on probation, however: another project derailment by an incoming government or even the threat of one would seriously dent Victoria’s reputation as a safe and profitable place to invest.