Value for Money Examination 04;    Gas Interconnector Project   Summary


Background

Ireland's reserves of natural gas, extracted from two sub-sea fields off the south coast, are being progressively depleted. It is estimated that, at current rates of extraction, remaining reserves will be insufficient to supply peak demand by the winter of 1996.

The Government decided in December 1991 that Bord Gais Eireann (BGE) should undertake construction of an undersea pipeline connecting the Irish and UK natural gas grids (the interconnector). The capital cost was then estimated at ?238m, with a further provision against contingencies of ?33m, and the project was scheduled for completion on 1 October 1993. (Paragraphs 214 to 218)

The funding for the project was to be provided by BGE from retained earnings and borrowings. The EU agreed to provide grant assistance of 35 per cent of the capital cost under its REGEN initiative for the energy sector. (Paragraphs 2.16 and 217)

This review focused on the procedures employed in the planning and execution of the project with particular reference to the role of the Department of Transport, Energy and Communications (the Department) in ensuring that mechanisms were in place to provide for its cost effective completion. (Paragraphs 1.14 to 1.16)

Project Appraisal

Appraisal was carried out in two stages. The Department and BGE prepared a feasibility study which examined the economics of the main supply options after Kinsale/Ballycotton gas is exhausted. Subsequently, an independent economic analysis of the interconnector project was conducted by consultants engaged at the request of the EU.

The appraisal concluded that the only real alternative to the gas interconnector project was the importation of LNC but this was ruled out on grounds of cost and security of supply. In these circumstances, it was recommended that the gas interconnector project should proceed and this was duly approved by the Government. (Paragraphs 3.3 to 3.8 and 3.15)

Economic Returns

The proposal seeking Government approval for construction of the interconnector presented estimates of economic returns for the project based on the assumptions that  bulk importation of gas would commence in 1994 and that capital costs of the project would be around ?200m (1990 prices). However, the proposal also recognised that, due to changes in circumstances, bulk importation of gas would not commence until the winter of 1996 and that the capital costs of the project would be around ?240m in 1991 prices. (Paragraph 3.16)

Neither the feasibility study nor the consultants included a provision for the costs up to the year 2000 of ongoing development and up-grading of the natural gas infrastructure. These are estimated at around ?160m (1994 prices) for the period 1993 to 1998 alone. (Paragraphs 3.17 to 3.20)

A more complete appraisal at the time of Government approval of the project, taking account of the higher capital cost, the effect of deferred importation of gas and the costs of extending and upgrading the grid, would have estimated the return to the national economy to be of the order of 11 per cent a year over a 25 year period and the return to BGE to be in the range 2.7 to 5.7 per cent a year (before EU assistance). When EU funding is taken into account, the estimated return to BGE is increased by about 2 per cent a year. (Paragraphs 3.21 to 3.24)

Accordingly, the project would have a positive return to the national economy and EU funding would contribute to its viability from the viewpoint of BGE.

Project Timing

A key decision which had to be made concerned the timing of the project. Increases in UK gas prices in 1991 caused the Department to review the economics of the project. Although in pure economic terms there was a good case for postponing the project for one or two years, the Department concluded that when everything was taken into account, the balance of advantage lay with conunencing construction of the pipeline in 1993 and delaying importation of gas until winter 1996. The principal factor underlying the Department's decision was that REGEN funding would be available for the project if it went ahead in 1993 - the project would be very difficult for BGE to finance at a later stage without REGEN or other grant assistance. Furthermore, the Department was advised that construction costs were likely to be higher in 1994 and 1995. (Paragraphs 3.9 to 3.13)

Project Monitoring

The project was managed by a project management team. Progress on the project was monitored by a project task force which provided co-ordination between BGE, the Department and the project management team and by a Monitoring Committee set up under EU funding rules. This approach was appropriate to a project of this size and complexity. (Para graphs 3.27 to 3.33)

Project Outturn

The current scheduled completion date for the interconnector is December 1995.

The estimated final cost of the project is ?249m - about 4.6 per cent over budget. At this cost, it represents a good performance bearing in mind the scale and complexity of the project and the fact that some additional work had to be undertaken over and above that envisaged. (Paragraph 3.38)

Within the overall expenditure on the project, there were cost overruns on elements of the project, including the construction of the gas compressor station in Scotland and the gas pressure reduction station in Ireland. These overruns were the result of delays due to replacement of project contractors from the Kentz Group of companies because of its financial difficulties, additional work and faults in the compressor station in Scotland. (Paragraphs 3.42 and 3.45)

BGE estimates that the net increase in costs of construction and overheads for the pressure stations due to the change in contractors and some additional work will be of the order of ?10m. Extra interest charges of ?2.6m will also accrue. (Paragraphs 3.40 and 3.41)

Project Administration

Project administration and design costs are now expected to be ?27.5m - an overrun of ?8.5m (about 45 per cent). Remuneration of the project management team was originally set on a reimburseable fee basis but was capped at ?18.6m in January 1993. This arrangement was altered in September 1994 from a fixed fee to a reimburseable fee basis with the approval of the Board of BGE to reflect the extra work arising from the change of contractor on major elements of the project. (Paragraphs 3.47 to 3.49)

Evaluation

18 While some preliminary work has been done by the Department on evaluating the economic impact of the project, its long term achievement is dependent on successful commissioning and its future operation to design standards. The contribution of the project in terms of its economic, security and environmental objectives should be monitored and evaluated following commissioning, taking into account the changes that have occurred in the energy sector since the adoption of those objectives. (Paragraphs 3.60 to 3.69)