KiwiRail is in the middle of replacing its ferries with two bigger rail-enabled ones. Image / KiwiRail
Last year KiwiRail was celebrating a $551 million contract being signed off for its two new Interislander mega-ferries, but briefings and letters reveal how close the deal was to unravelling.
The saga, which at one point escalated to being a $1.76 billion project, ended with a stern letter from a "disappointed" Grant Robertson.
KiwiRail's existing Interislander fleet of three ferries is ageing, more prone to unexpected breakdowns, and systems onboard are becoming obsolete.
The Kaiarahi ferry was "catastrophically" damaged and in need of European specialist assistance when its gearbox failed in August. It's expected to be out of action until mid-this year.
KiwiRail is in the process of replacing these ferries with two bigger rail-enabled ones to make the supply chain across the Cook Strait more resilient.
They can carry twice as many passengers and significantly more freight to meet expected growth over the next 30 years.
In Budget 2019 Kiwirail got $35 million to undertake detailed design work for the ferry project, called iReX (Inter-Island Resilient Connection).
Then, in Budget 2020, a further $400 million was dished out to fund the ferries themselves. At that time it was expected KiwiRail would debt-fund the remaining $700 million.
But KiwiRail then went on to submit a 2021 budget bid seeking more money. This time the state owned enterprise wanted an additional $565 million.
Advice, briefings, letters, and a Cabinet paper, which have been proactively released and made public, reveal the to-ing and fro-ing that ensued.
Treasury and Ministry of Transport officials were not happy with KiwiRail's latest budget bid.
Costs for the overall programme had ballooned from $775 million in November 2018 to $1.76 billion in March 2021. Portside costs alone had almost quadrupled to more than $1 billion.
Officials raised concerns about the increasing scale and cost of the project, including that its latest business case was still in draft form and yet to be finalised by KiwiRail's board.
Meanwhile, an Ernst and Young review of KiwiRail's capital structure had recommended a debt ceiling of $320 million, hampering its ability to debt fund remaining costs as planned.
Officials recommended deferring the budget bid and ministers agreed.
The decision was not without risk. KiwiRail warned that without the $565 million, the arrival of the new fleet would be delayed and the Interislander service would be compromised.
That's because there was a critical milestone at stake. KiwiRail had signed a letter of intent with Hyundai Mipo Dockyard in South Korea for the two new ferries.
The letter was due to expire on June 30, just a few months away.
If it expired without a formal contract being signed, the terms and price could be renegotiated. This would open up KiwiRail to another cost escalation, especially considering the increasing price of steel.
KiwiRail's view considered any contract to be dependant on funding certainty from the Crown.
Minister for State Owned Enterprises David Clark wrote to the chairman of KiwiRail's board on April 8 advising the project continued to be of concern to ministers.
"We would like to reinforce the need for more transparent information around the proposed project, options available regarding scope and funding, and reassurances around the management of risks."
Clark asked KiwiRail to prioritise finalising the business case, assess the feasibility of two medium size ferries, and advise what work was planned to test KiwiRail's ability to take on more debt.
KiwiRail deputy chairwoman Sue McCormack and chief executive Greg Miller responded to Clark's letter later that month on April 20.
They said the final detailed business case was scheduled to be signed off by the board in June and would be formally presented to ministers and officials shortly after.
The pair expected the business case would confirm the decision to procure two large rail-enabled ferries as the best option.
"This is because the infrastructure requirements (e.g. wharves, linkspans, seawalls) are, ultimately, similar irrespective of the size of the ferries but the projected revenues decrease in proportion to ship capacity."
By May, the month before the letter of intent with the shipyard was due to expire, Treasury and Ministry of Transport officials were recommending a revised plan.
Essentially, Cabinet would give three ministers the authority to draw down money from a contingency fund for the ferry project if and when required. The exact amount proposed for the fund is redacted in the documents.
This was so the money could be provided in time for the June 30 deadline.
It wasn't going to be possible for officials to assess the business case (which was still yet to be finalised), provide advice, and for Cabinet to approve more funding all in less than a month.
Instead, the Finance, Transport, and State Owned Enterprises ministers would have delegated authority to provide further funding if they were satisfied with the final business case and found the risks and trade offs to be acceptable.
By this time, the cost of the project had changed again because KiwiRail had progressed the design of the port infrastructure including revisiting contingencies. The expected cost was now estimated to be $1.45 billion instead of $1.76 billion.
Between these refinements, KiwiRail being able to take on a little bit more debt, investments by the Picton and Wellington port companies, the funding gap had narrowed to $257 million.
KiwiRail proposed this figure could be made up of $125 million in new Crown equity and $132m in repurposed insurance proceeds from the Kaikōura Earthquake.
The Main North Line railway was heavily damaged in the earthquake and the Crown provided $285 million to reinstate it. This was done on the basis that any insurance proceeds received by KiwiRail would be returned to the Crown - it's this money KiwiRail suggested repurposing.
The detailed business case for the ferries was finally delivered on June 3. Its executive summary said KiwiRail had revisited and retested its preliminary decision on fleet size and configuration.
"It has confirmed that two large, rail-enabled ships is the correct choice.
"This selection is now reinforced by the global increase in steel prices. Sharply increasing steel prices mean today's price for two medium ships would in fact be higher than that of the two larger ships which has been locked-in with KiwiRail's preferred shipyard."
The clock was ticking.
Finance Minister Grant Robertson delivered the verdict in a letter sent to McCormack later that month.
He told her significant risks remained with the project and "elements of the business
case fall short of expectations".
But ministers were conscious of the pressing need to replace the aging fleet, as well as the letter of intent's looming deadline of June 30.
Robertson acknowledged the business case's clear preference for the options of two large rail-enabled ferries.
He asked KiwiRail to address shortcoming in the business case, work with officials to review project governance arrangements, and ensure the total capital cost did not exceed $1.45 billion.
Robertson advised Cabinet had agreed to establish a contingency fund that covered the amount of KiwiRail's shortfall, but it was too early to commit to actually funding the $257 million gap.
This was partly due to the fact the funding shortfall wasn't expected to occur until some time later.
The expectation remained for KiwiRail to find a way to fund the shortfall off its balance sheet, Robertson said.
He said no to the idea of repurposing the Kaikōura Earthquake insurance money and that it should be returned to the Crown as intended.
"We are aware of the significant work that has gone into this project, and the challenges of working with so many stakeholders", Robertson wrote.
"However, we are disappointed that Ministers were given such a short timeframe between the receipt of the final detailed business case and the requirement to approve a Major Transaction based on that information."
On July 1 KiwiRail issued a press release saying it had signed a now binding contract with Hyundai Mipo Dockyard for the state-of-the-art ferries.
KiwiRail acting chief executive David Gordon told the Herald KiwiRail was satisfied with the outcome of a contingency fund.
He was confident the project could be delivered for $1.45 billion.
"We've been working hard to ensure that we can deliver the project as promised."
Gordon said contingencies were typically accessed after other funds were used, so the fund had not been drawn upon at this stage.
"We demonstrated the value of this investment and received the confidence of the Government as shareholder. KiwiRail was delighted to enter the ship build contract and we know our customers look forward to the new ferries arriving in 2025 and 2026."
Clark said ministers were satisfied with KiwiRail's transparency and timely reporting on the project.
"Officials from the Treasury and the Ministry of Transport are now observers on the Project Governance Board, providing timely visibility of information on project progress."
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