Construction contingencies in infrastructure

23 February 2016 

Frank Peacock-Brennan and Simon Longstaffe review the contingency assessment for Phase Two of HS2, connecting Manchester and Leeds into the UK’s high-speed rail network

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One of the many discussions with stakeholders at HS2 is: “What is the right level of contingency to be included within investment appraisals?” Any such estimate recognises the uncertainty and risk that is inherent at any particular stage of a project, and provides a level of confidence that this will not be exceeded.

The source of this uncertainty and risk typically occurs in five categories: programme; quality and safety; procurement and contracts; people and behaviours; and external influences. As an organisation, HS2 Ltd recognises the financial benefits of effective management of these factors, and is committed to adopting a disciplined and rigorous approach to drive new standards of best practice for the industry.

To reflect the different stages of development of the scheme, two techniques are used to calculate a contingency allowance for Phase One and Phase Two – quantitative risk analysis (QRA) and optimism bias (OB).

HS2 Ltd has developed the application of Treasury OB guidelines to reflect the magnitude of the project. The method deployed calculates a contingency sum on an asset-by-asset basis that recognises the complexity, uniqueness and innovation incumbent in the early route design solutions. The method aims to avoid overinflating contingency sums at early stages in the development of a project, while being cognisant of the need to determine an appropriate provision within investment appraisals.

Modelling risk

HS2’s risk exposure for Phase One is represented through a series of risk registers. These have been typically developed through a series of interviews, workshops and reviews, and list the threats and opportunities, with a cost impact should they occur, the likelihood of occurrence and a mitigation plan to avoid or reduce the impact and/or likelihood.

A cost QRA model is created through a stochastic method. This makes a distinction between threats and opportunities that may or may not occur, and tolerance ranges associated with the status of the price estimation and design development. Both threats and tolerances represent uncertainty to the base cost estimate, but are best modelled separately.

HS2’s risk exposure for Phase Two is calculated through the use of OB. This is an appropriate measure due to the infancy of scheme development. HS2 is working diligently to increase its knowledge base and level of information regarding route characteristics, which is enabling the development of a QRA for this phase.

The application of OB is intended to counter a demonstrated, systematic, tendency for project appraisers to be overly optimistic. The Green Book supplementary guidance on optimism bias suggests that the upper bound on optimism represents a “starting point”, and the contributory factors to the OB uplift are then assessed in terms of whether they are mitigated.

Assessment strategy

HS2 is unique in size, scale and complexity, and it became clear that the way we applied OB needed to go beyond Treasury and Department for Transport (DfT) guidance for public departments, while maintaining a method that recognised the recommended approach.

Unsurprisingly, a great deal of analysis has been undertaken, such as treating the scheme as a railway in line with DfT guidance. This is something we have always debated – that it is not a railway until latter stages of the programme where we construct and commission railway systems.

The method developed delivered a comprehensive review of OB calculation to ensure contingency assessments are specific to the Phase Two scheme. Treasury guidelines are applied in different ways to enable comparison of contingency sums, and application of informed professional acumen.

It is helpful to outline some terminology from the Treasury guidance.

There are four project types deemed applicable to HS2:

• non-standard civil engineering project: involves the construction of facilities, in addition to buildings, requiring special design considerations due to space constraints or unusual output specifications e.g. innovative rail
• standard civil engineering project: involves the construction of facilities, in addition to buildings, not requiring special design considerations
• non-standard building project: involves the construction of buildings requiring special design considerations due to space constraints, complicated site characteristics, specialist innovative buildings or unusual output specifications
• standard building project: involves the construction of buildings not requiring special design considerations.

In addition, HS2 has defined a set of criteria that makes a project non-standard or standard. It believes that the key to appropriate categorisation is the conditions used to establish the project type. The guidance falls short of providing definitions. To remove ambiguity and ensure a consistent and transparent application across the scheme, HS2 set the following criterion – if an asset satisfies any one of these conditions, it is deemed to be non-standard:

• innovative: use of new construction methods previously not tried and tested.
• unique: one-of-a-kind construction solution that is not comparable to other solutions in any aspect of its design.
• complexity: the solution is of a complicated nature given its intricacy or complexity, determined by the construction method itself or the environment in which it is constructed.

Methodology

The underlying principle for HS2’s approach is to calculate a contingency provision that protects the public purse from the inherent risks of delivering major infrastructure, while avoiding unnecessary diversion of public funds from other key public expenditure and investments through overinflation of contingency.

HS2 has designed a balanced approach to assessment for Phase Two of the programme, which is now in the early stages of project development. It has done so by deploying a three-step method for evaluating contingency provision that uses OB guidelines as a basis.

• Step one: application of Treasury guidance generically across all route sections, elements and assets using the upper bound percentages for each project type as defined in Treasury and DfT guidance; this approach took no account of specific factors, and as a benchmark, categorises all civil elements as standard civil and all building elements as standard building (see Table 1).
• Step two: building on the Treasury and DfT guidance when trying to derive an appropriate contingency provision. Application of OB under a single project type, or a combined assessment based on dominant characteristics that drive asingle categorisation, is seen as inappropriate because the HS2 programme contains projects valued in the hundreds of millions, or exceeding £1bn. HS2 analyses OB application on an asset-by-asset basis to determine a reflective assessment of which project type is appropriate for each, based on known specific conditions. This approach enables targeted application of OB against those assets with the greatest level of complexity, innovation or uniqueness in their design or site conditions, to derive a contingency provision applicable to the construction or physical design characteristics of an individual asset. In HS2’s case, an individual asset construction cost estimate can be equal or greater than the total project costs used to inform the Treasury’s upper bound OB percentages. As such, HS2 Ltd has elected to assess the impact of a project-specific project type assessment, while still applying the upper bound OB percentages from the Green Book supplementary guidance. It is at step three that we look at how the organisation is mitigating contributory factors that underpin the Treasury’s percentages.
• Step three: Here, our methodology looks to build on our learning from Phase One of the programme where we have achieved a more advanced stage of development, and deposited a hybrid bill in Parliament.We are critically appraising our processes for Phase Two periodically, and testing how we are mitigating the contributory factors that underpin the Treasury’s upper bound OB percentages.
  To date, we have undertaken the early rounds of this process, and have applied mitigation factors in accordance with the Treasury guidance. Peer review from a range of disciplines contributed to the development of the scheme, and Table 2 summarises the impact of this process on reducing the upper bound percentages.

Table 1: Upper bound OB percentages (Treasury supplementary Green Book guidance)

DfT WebTAG guidance development stage (NR GRIP Stage):	Non-standard civil: OB (% of present value capex)	Standard civil: OB (% of present value capex)	Non-standard building: OB (% of present value capex)	Standard building: OB (% of present value capex)
Stage 1: output definition	66%	44%	51%	24%

Table 2: Impact of mitigation assessments for each contributory factor and resultant OB percentages

Project type	Upper bound OB for capital expenditure (Green Book guidance)	HS2 Phase Two mitigation factor assessment (% of upper bounds)	Resultant OB for HS2 Phase Two
Non-standard civil	66%	81%	53%
Standard civil	44%	89%	39%
Non-standard building	51%	86%	44%
Standard building	24%	86%	21%

Analysis

In addition to the project-specific application of OB, and the benefits derived in calculating contingency levels appropriate for the scheme, our methodology also delivers some key metrics and management information.

An analysis by value of the asset project type assessment, demonstrates that the most common asset we are building is standard civil engineering (see Table 3).

Table 3: Characteristics of HS2 Phase Two split by OB project type

Asset type	% of total estimate
Non-standard civil	23%
Standard civil	67%
Non-standard building	0%
Standard building	3%
Indirect costs	7%
TOTAL of investment cost components by value (%)	100%

This identifies that, of the thousands of assets along the linear route for Phase Two, the majority of construction required is for standard civil engineering assets such as bridges, cuttings and embankments.

HS2 Ltd’s methodology enables us to assess and review transparently the impact of following the methodology described (see Figure 1):

• result zero: before applying the HS2 methodology outlined, we captured the impact of treating all investment components as non-standard civil in line with DfT guidance for high-speed rail b result one: the impact of applying the Green Book upper bound OB percentages using a generic assessment of project type as ‘standard’ for buildings and civil works (step one)
• result two: the impact of applying the Phase Two specific project type assessment while still using Green Book upper bound OB percentages (step two)
• result three: the result of applying the mitigated OB percentages established by HS2 (step three) along with Phase Two’s asset-by-asset assessment of project type (step two).

Figure 1: Phase Two OB assessment impact on provision in Phase Two contingency provision

Optimising Treasury OB guidance and developed methodology at HS2 enables a project heat map to be prepared, pinpointing where the perceived complexities lie in early project design and which areas drive the contingency provision (see Figure 2).

Figure 2: Phase Two assets heat map

This information is enabling HS2 to provide a basis for targeted risk maturity development.

A lasting legacy

Alongside the OB methodology, HS2 has been developing an anticipated final cost (AFC) model, which includes scope, uncertainty and risk. To achieve this, we are modelling identified risks using a QRA, and the uncertainties are being assessed on a sub-elemental level for the eastern and western routes.

A series of scope, cost and risk workshops has enabled a multidisciplinary contribution and a joined-up approach to risk capture. This process has ensured alignment between cost estimating assumptions and contingency provision, both in the assessment of OB and comparative QRA.

The AFC model is also founded on an asset-by-asset categorisation for risks, where applicable. This is enabling us to compare contingency provision generated by our OB methodology at a granular level, even at the early stages of development prior to full risk maturity.

Applying OB aims to counter a tendency for project appraisers to be overly optimistic

We initially use this capability to improve confidence in the Phase Two contingency provision and adjust OB provisions where we have additional information. Also, by developing the maturity of our risk management early, we can move away from OB when the appropriate stage of development is reached.

The joined-up approach will enable HS2 Ltd to track contingency from early provisions through to project close, when we hope to hold informative data on risk drawdowns and against which risks contingency provisions were expended. This is a key legacy we hope to achieve and one where we feel the industry needs to improve on more generally, particularly in major public sector major projects. Delivering on this will help better inform our future contingency provisions within HS2 and future government projects, and should ensure equilibrium between protecting government from cost overrun and overcommitting finite funds to contingency pots.

Frank Peacock-Brennan is Interim Strategy, Analysis and Planning Lead – NHS England Commercial Group

Simon Longstaffe is Head of Estimating and Cost Management at HS2

Further information