Lowball Bid Comes Back to Haunt Panama Canal Expansion

A bitter dispute between the Panama Canal and a Spanish-led consortium of construction companies over the spiraling cost of expanding one of the world's busiest waterways was years in the making.

The two sides are at odds over who should pay for $1.6 billion in cost overruns to build a third set of locks for the canal, the main part of the expansion of the 50-mile (80 km) cargo route that connects the Atlantic and Pacific oceans.

The impasse over the 100-year-old waterway could delay construction, which aims to double the canal's shipping capacity and bring in billions of dollars in new revenue for Panama.

Reuters interviews with people involved in the 2009 bidding for the contract, local officials and leaked diplomatic cables reveal their concerns that the Grupo Unidos por El Canal (GUPC) consortium would not be able to finish the job with a bid that was $1 billion lower than its nearest rival.

The GUPC, led by Spanish company Sacyr, said the overruns were caused by problems including flawed geological studies carried out by the Panama Canal Authority (PCA), a semi-independent government entity that has managed the waterway since the United States transferred ownership to Panama in 1999.

But the PCA has rejected the GUPC's assertions.

A top Panamanian official close to the bidding process, who spoke on condition of anonymity due to the sensitive nature of the matter, said within months of the project being awarded, Sacyr executives were saying the work would not stay on budget.

"The PCA knew some years ago that Sacyr authorities were saying that openly, but felt they were protected by the contract," the official told Reuters.

A second Panamanian official, also speaking on condition of anonymity, said even before the deal was signed, discussions with consortium officials showed they believed they would be able to negotiate a higher cost at a later stage.

"But they found in Quijano a brick wall," the official said, referring to the head of the PCA, Jorge Quijano.

Large infrastructure projects often run over budget, and GUPC officials have said overruns are an occupational hazard.

But Sacyr denies it ever planned to ask for more money and says flawed data from the geological studies of the canal pushed up costs, because it meant that local basalt excavated for the work was not right for the concrete mix it planned to use.

"It was not a deliberately underbid offer," the company's chairman Manuel Manrique told reporters this month. "Sacyr has successfully carried out a great number of projects ... and we are still winning and carrying out projects."

The PCA has dismissed that basalt claim, and points out that its contract offered no assurances over the rock.

"The employer in no way guarantees that such (material) is adequate, or meets the requirements for the contractor's proposed design, or is suitable for the works," says the contract, which is publicly available on the PCA's site.

COSTLY DISPUTE

The dispute could prove costly for both sides.

Expansion was originally due to be finished in 2014 to coincide with the canal's centenary celebrations, but that deadline was pushed back to the middle of next year.

If work is delayed, Panama could lose out on millions of dollars in projected revenue from toll charges.

For Sacyr, which has 48 percent of the consortium, the work brings in a quarter of its international revenue. Like most Spanish builders, the company relies heavily on foreign orders to offset a sharp economic downturn at home.

Winning the bid gave the company a major lift.

At the end of 2008, Sacyr was grappling with falling core earnings, punished by weak construction and property markets as Spain's economy swung from boom to bust. The company was swamped with 14.5 billion euros ($19.7 billion) of debt, around seven times its market value. Sacyr's shares had lost nearly 90 percent of their value from the 2006 all-time peak.

In July 2009, GUPC clinched the contract for the locks with an offer worth $3.12 billion - significantly below the $3.48 billion target reference issued by the PCA for the process.

That was $1 billion below the second lowest offer tendered by a group fronted by U.S. engineering company Bechtel.

Both Bechtel and another consortium led by Spanish company ACS, whose bid was worth $6 billion, quickly sent letters to the PCA complaining the GUPC proposal did not meet the bid requirements and had inherent structural risks.

But neither losing bidder formally challenged the process, and Canal Administrator Quijano told Reuters those structural concerns had since been resolved.

Jorge Sanchiz, a Panamanian engineer with experience in canal work, said both the PCA and the consortium were to blame: one for underestimating the costs, the other for allowing it.

"They only way (the consortium) was going to be able to cover this was asking the Canal Authority to meet the overruns," said Sanchiz, who forecast before the PCA made its choice in 2009 that the winner would run substantially over budget.

The overall expansion of the canal was initially forecast to cost $5.25 billion in total. But the overruns now being claimed by the consortium are pushing it close to $7 billion.

"COST OVERRUNS COMMON"

A senior figure within the GUPC said the PCA was being unrealistic if it thought the project would not cost more than originally projected by the consortium.

"To think that a five-year project with the complexity and size of this one won't have overruns is absurd," the official said, asking not to be identified. "In a lot of projects the deviations were much bigger than in this one."

One of the biggest academic studies on the issue in recent years was a 2003 investigation at Aalborg University in Denmark which looked at 258 transport infrastructure works worldwide and found they had an 86 percent chance of incurring cost overruns.

On average, the costs were 28 percent higher than forecast, the study said - but below the 50 percent jump on the GUPC bid.

Sacyr's main partner is Italy's Salini Impregilo, which has a similar share in the project. The GUPC also includes Jan De Nul from Belgium and Panama's Constructora Urbana (CUSA).

A day after the PCA published its evaluation of the bids, the U.S. embassy, which had backed the Bechtel-led consortium, described the GUPC proposal as a "bargain basement bid," according to cables published by WikiLeaks.

"It is widely expected that during construction, Sacyr will attempt to renegotiate the price," the cable said.

Less than six months later, the U.S. embassy cabled Washington that Panamanian vice president Juan Carlos Varela had expressed grave misgivings about the winning offer.

"When one of the bidders makes a bid that is a billion dollars below the next competitor, then something is seriously wrong," the cable quoted him as saying at the end of 2009.

Alberto Aleman, who headed the PCA from 1999 to 2012, said all the competitors had faced the same rules and that the Sacyr-led group had offered both the best design and the best price.

"Bechtel's offer had a different design in which the gates were 50 percent bigger, using much more concrete," he said.

But costs were always likely to be an issue, he admitted.

"We knew before we put this together that any project of this complexity would have claims. No matter who would win."

The dispute has not surprised industry experts in Spain.

The practice of making low offers for a contract, then negotiating costs later has been a popular strategy for Spanish construction firms for years, industry officials told Reuters.

Companies put in low bids in the hope of booking extra pay-outs on modifications and extensions as revenue, they said.

"We've all done that at some time or another, making low bids was a typical Spanish tactic," said one official, speaking on condition of anonymity.

The Spanish government passed a law in 2011 aimed at preventing the practice of underbidding, and said at the time that 98 percent of public contracts signed in the previous 15 years had ended up with cost overruns.

The PCA said this month it could take over the project from early February if GUPC made good on its threat to suspend work unless the authority footed the bill for the cost overruns.

The dispute over costs looks likely to be settled by arbitration panels agreed in the contract, but a question remains over whether the GUPC will finish the project.

The first Panamanian official said he expected the expansion to be taken out of the GUPC's hands. The consortium's suspension was due to take effect Monday, but GUPC said work would continue for now while it remains in talks with the canal authority.

However the row plays out, the expansion looks unlikely to suffer the fate of the 19th century scheme to build a canal through Panama led by Frenchman Ferdinand de Lesseps.

Starting work in 1880, it collapsed after the loss of thousands of lives and millions of dollars, allowing the United States to step in and take control of the canal project in 1903.

Panama's President Ricardo Martinelli said the expansion of the waterway could not be stopped.

"The Canal will be finished regardless of what's said, come rain, wind or hail," he said.

By Lomi Kriel and Sonya Dowsett (C) Reuters 2014.