Cablegate: Canal Bidding Process Delayed Again

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PP RUEHWEB

DE RUEHZP #0820/01 2982337
ZNY CCCCC ZZH
P 242337Z OCT 08
FM AMEMBASSY PANAMA
TO RUEHC/SECSTATE WASHDC PRIORITY 2603
INFO RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY
RULSDMK/DEPT OF TRANSPORTATION WASHDC PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RUEKJCS/OSD WASHDC PRIORITY

C O N F I D E N T I A L PANAMA 000820

SIPDIS

DEPT OF COMMERCE - MATTHEW GAISFORD
DEPT OF TREASURY - SARA SENICH

E.O. 12958: DECL: 10/22/2018
TAGS: ECON EINV ETRD MARR PM EWWT
SUBJECT: CANAL BIDDING PROCESS DELAYED AGAIN

REF: A. 2007 PANAMA 1899
B. 2008 PANAMA 0320
C. 2008 PANAMA 0732

Classified By: Ambassador Stephenson for reasons 1.4 (b) and (d).

1. (U) This cable contains sensitive proprietary business
information concerning on-going negotiations. Please
handle accordingly.

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Summary
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2. (C) The Panama Canal Authority (ACP) announced on October
24 that the deadline for submission of bids on the contract
for the third set of locks, centerpiece of the overall $5.25
billion Panama Canal expansion, will be extended from
December 10, 2008 to March 3, 2009. This third delay marks
turbulence in the bidding process for this mega-project and
allows the ACP to reconsider the key issue of the balance of
risk between the ACP and the consortia. Furthermore, the
bidding consortia claim that the net effect of the Panama
Canal Authority's (ACP) 18 amendments to the original request
for proposal added complexity to an already complex project.
Despite the bidding complications, there is no indication of
a decrease in the level of transparency and fairness in the
process. While the Panama Canal Authority (ACP) enjoys a
record of efficiently, safely, and profitably operating the
canal and overseeing incremental improvements, constructing a
project of this scope and complexity demands a different
skill set and effective ACP cooperation with its project
management advisor. Regarding funding for the expansion, the
Government of Panama trumpeted its success in securing a $2.3
billion financing package despite construction cost estimates
that exceed original projections.

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Expanding a Canal is Hard
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3. (C) Jhan Schmitz of the American firm CH2MHill, the
Project Management Advisor to the ACP, stated on September 8,
"Nobody has done this (the Canal Expansion Project) before,
but all the pieces have been done before." He noted that the
coordination of all the contractors and the scale of the
$3.35 billion project combined with the seven year
construction timeline will be challenging. Although rolling
gates have been constructed before, the scale is
unprecedented. The design calls for 4,000 ton, 50 foot
thick, 60 foot high rolling gates with a lifespan of 100
years that must move across 200 feet of water in ten minutes
or less. The complexity of the expansion combined with the
fact that the ACP has never managed a multi-billion dollar
project has created delays in the bidding process due to
numerous amendments. While the ACP does not have experience
in mega-projects, the Panamanian people and world-wide
maritime transport industry recognize that the ACP
transparently and successfully operates the Canal and
implements incremental infrastructure improvements to the
Canal - see ref C.

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Issues of Risk
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4. (C) The ACP will likely institute changes to its
"draconian" "liquidated damages" clause, according to
President of Bechtel Civil, Michael Adams on October 5. This
view was confirmed in an October 20 conversation between
Administrator Aleman and the Ambassador when the Minister
stated the ACP will review the full status of the bidding
process to encourage participation of all consortia and to
examine flexibility on the bidding deadline, the budget, and
issues of risk. For the third set of locks contract, the
original bidding documents placed every possible risk
(financial and technical) onto the consortia. Subsequent
amendments shifted some of the risk burden from the consortia
to the ACP, such as price escalation clauses for some
construction commodities. However, the possible deal killer
for the bidders remains liquidated damages - a specified
amount of damages by a contractor for non-performance. For
example, the rolling gates must close in 10 minutes. The
liquidated damages clause, if enforced, would cost the
winning consortium hundreds of millions of dollars if the
gates close a just few seconds over 10 minutes. Usually,
liquidated damages clauses apportion damages according to the
severity of non-performance. There is no incentive if the
gate is faster than the requirement. Adams stated the ACP is
creating an adversarial relationship and is fostering the
conditions for future litigation.

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ACP Appears to Listen to Advisor's Advice
-----------------------------------------

5. (C) The ACP and its project management advisor (CH2MHill)
are struggling over the control of the contracting process.
The fierce independence and control of details that have made
the ACP an effective manager of the Canal are impeding the
management of the bidding process, according to CH2MHill,
which cautions that the project cannot continue to a
successful completion on its current course. It appears that
the ACP is listening.

6. (C) In its most recent round of talks on October 9,
CH2MHill representatives Joe Cazares, Canal Construction
Advisor, and Michael Kennedy, President of Transportation
Business Group report that CH2MHill issued an "early warning
notice" as specified in the contract between CH2MHill. In
order to correct the process, CH2MHill outlined options for
CH2MHill to gain control of the contracting process. Kennedy
told the Ambassador on October 16 that CH2MHill would not
walk away from the project, because that is "not who we are."

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Bidding Process - 18 Amendments and Counting
--------------------------------------------

7. (C) The original specifications for the contract for the
third set of locks, the primary contract of the expansion,
were publicly released on December 21, 2007. To date, the
ACP amended the document 18 times, which is higher than the
normal two or three modifications for a project of this
complexity, according to Schmitz. The amendments resulted
from the ACP and the four prequalified consortia refining the
original specifications. On the one hand, ACP Administrator
Aleman asserts the refining process provides "value
engineering" - cooperatively designing plans with bidders
(which shifts extra costs to the bidders). ACP Administrator
Aleman in several meetings has stated that the process will
reduce the likelihood of future litigation, improve the
design, and achieve the best price for the ACP. While
meeting with Aleman on August 27, a delegation of U.S. Army
Corps of Engineers (USACE) personnel lauded the ACP's value
engineering process as having the potential to be a model for
extremely large USACE projects in which there are only a few
bidders in order to reduce the likelihood of legal disputes.
On the other hand, the ACP's failure to incorporate "tracked
changes" in over a thousand pages of specifications in each
of the 18 amendments has created confusion, uncertainty, and
deadline delays (from August 22 to October 8 to December 10
and now to March 3). Due to the delay, all four consortia
are spending a million dollars per month, according to
Bechtel (one of the four prequalified consortia - see ref B
for information on the four prequalified consortia) and
CH2MHill Representatives.

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Bidders' Dilemma - Lowball, Value, or Punt
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8. (C) Adams of Bechtel outlined three possible bidding
strategies for Bechtel and the other consortia for the locks
contact which the ACP publicly expects to be $3.35 billion or
less: bid lowball, bid value, or punt.

-- Lowball Bid: Bechtel assumes that governments (the ACP is
quasi-statal) are only able to accept the lowest bid due to
political reasons; therefore, Bechtel must be the lowest
bidder in order to win, regardless of their technical design.
Bechtel anticipates that the "lowball strategy," which would
entail bidding low enough to win this highly prestigious
contract yet not high enough to cover contingencies (much
less profits) could lead to crippling losses. However, Adams
believes that the two weakest consortia, Sacyr led Spanish
consortium (which is reportedly close to bankruptcy) and the
French-led consortium, might lowball the bid with the
intention of securing the contract and attempt to renegotiate
the price during construction. Bechtel has been worried
about this concern since April - see ref B.

-- Value Bid: Bechtel bids what they believe is the proper
cost of the contract to construct the third set of locks
which is in the $4-8 billion range depending on which Bechtel
official provides the number. Adams noted that traditionally
Bechtel's services are more expensive than its competitors,
but that Bechtel finishes all of their projects and has high
quality engineering.

-- Punt: Bechtel decides that bidding on the locks contract
creates too much risk for the company and bids $10 billion
dollars. By putting in such a high bid, Bechtel would not
expect to win the contract, but exchange ownership of
Bechtel's engineering plans for a several million dollar
stipend from the ACP and the right to walk away without any
legal obligations.

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Financing
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9. (C) President Torrijos secured $2.3 billion in financing
for the already initiated $5.25 billion overall Canal
expansion (construction of the locks and related dredging and
excavation projects); the ACP plans to fund the remaining
cost out of its operating budget. During a October 14 press
conference, Torrijos announced that five governmental
financial institutions offered loans with a 20 year term with
a 10-year grace period and an average annual interest rate of
5.49%. The lenders and amounts committed are: Japan Bank for
International Cooperation, $800 million; European Investment
Bank, $500 million; Inter-American Development Bank (IDB),
$400 million; Andean Development Corporation, $300 million;
and International Finance Corporations, $300 million.
Minister of Canal Affairs Dani Kuzniecky was pleased that the
cost of financing fell below ACP projections and that these
lenders remained committed to the ACP despite the on-going
financial crisis. We understand that First Vice-President
and Foreign Minister Samuel Lewis Navarro told EEB A/S
Sullivan that President Torrijos wants to announce the
consolidation of financing for the Canal expansion at the
December 9-10 Pathways to Prosperity Ministerial.

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Price
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10. (C) The $5.25 billion cost estimate for the Canal
expansion was established by the ACP in 2005 when commodity
prices, financial environment, and world economy were more
favorable than they are at present. An IDB independent
consultant estimated the total cost to be $5.9 billion and
Bechtel representatives believe the price could be $5.9 to
$9.9 billion dollars if all risk in the locks contract is
placed upon the consortia. The IDB analysis of alternative
scenarios for the IDB Loan Proposal states that under the
worst case scenarios the ACP has a strong capacity to repay
the outstanding debt due to its strong balance sheet.

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Comment
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11. (C) Post believes the bidding extension provides time for
the ACP, the Project Management Advisor CH2MHill, and the
consortia to iron out the fundamental issues outlined above.
The Panamanians realized that a project of this scope,
complexity, and duration requires flexibility, even if that
flexibility entails finishing the expansion beyond the summer
2014 deadline. It is noteworthy to mention that the
announcement of the winner now likely will occur after the
May 3 elections.
STEPHENSON

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