Background

1. The States, Territories and the Commonwealth Governments spend around $350 million annually on the production and supply of blood and blood products for the Australian community. Commonwealth expenditure on plasma products under the Plasma Fractionation Agreement (PFA) between the Commonwealth Government and CSL Limited (CSL) represents more than one-third of the total annual expenditure on the sector by Australian Governments with expenditure under the PFA amounting to $124.1 million in 2001–02.

2. The material nature of this expenditure, together with the importance of plasma products to the care of Australian citizens with serious health problems, makes the ongoing procurement of plasma products an important public issue. Until 1 July 2003, the PFA was the largest single commercial contract managed by the Department of Health and Ageing (Health)¹. When the contract was signed, in December 1993, it was estimated that total Commonwealth expenditure over the 10.5 years of the initial term of the PFA would be around $1 billion (in nominal terms). Actual expenditure by the Commonwealth under the contract over the first eight and a half years of the PFA (that is to 30 June 2002) totalled some $800 million.

3. Under the PFA, the Commonwealth was provided with an extension option that was a unilateral right to extend the agreement, under its existing terms and conditions ‘to 30 June 2009, or such later date as the Commonwealth may decide', so long as it exercised the option and notified CSL of its decision to do so by 23 June 2002. Such a decision by the Commonwealth was in the sole discretion of the Commonwealth. Thus, CSL could not have refused to accept the extension had the Commonwealth chosen to exercise the option, nor could it have required the Commonwealth to exercise it. The PFA, had it been extended, would have become an enforceable contract upon notification to CSL of the Commonwealth's decision to exercise the option.

4. The PFA, and the plasma products supplied under it, is only one component of the wider Australian blood banking and plasma product sector. However, the context in which the PFA operates is important to any consideration of future arrangements for the supply of plasma products in Australia. In May 1999, the then Minister for Health and Aged Care announced the establishment of a review of the Australian blood banking and plasma product sector (the Blood Review). The review was to cover blood collection and banking activities as well as the processing and distribution of blood and blood products.

5. The Blood Review recommended fundamental reform of the blood sector both in terms of how it should be funded by the Commonwealth, State and Territory Governments and in terms of how it should be administered in future. Two of the Blood Review's terms of reference had particular reference to the Commonwealth's consideration as to whether or not to exercise its option to unilaterally extend the PFA after the Contract's expiry on 30 June 2004.

6. The then Minister's press release announcing the Blood Review indicated that it was expected to run for about a year. Accordingly, the Review Committee was originally expected to report to the Minister in mid 2000. However, in light of the scale and complexity of the task, the Committee's report was not finalised until March 2001. The Blood Review recommended that, rather than extending the current agreement, the Commonwealth should enter into a second shorter¬term PFA with CSL at the expiry of the present Agreement to ensure that Australia's future needs for plasma products are met.²

Health's role

7. Until 1 July 2003, responsibility for the management of the PFA was located within the Blood and Organ Donation Taskforce (BODT) in the Acute Care Division of Health. The Department formed a high level Steering Committee for the Future of Plasma Fractionation and Diagnostic Products Arrangements in December 2001 that determined Health's advice to the Government on the PFA extension option. The BODT provided a secretariat to the Steering Committee.

8. During the Steering Committee's deliberations on the PFA extension option, the BODT advised the Committee that, in recommending the establishment of a new, shorter-term agreement between the Commonwealth and CSL, the Blood Review did not consider in detail the option to extend the PFA.³ Health advised ANAO in response to the section 19 proposed audit report that:

At no time did the Departmental Steering Committee accept the view in the paper, or take a decision to that effect. Therefore, this comment does not represent the view of the Departmental Steering Committee. The Department is of the opinion that the ANAO has taken this comment out of context, and that the ANAO's conclusion is not supported by the evidence.

9. ANAO notes that no reference is made in the minutes of the 18 April 2002 Steering Committee meeting that the Committee did not accept the BODT's view that the Blood Review did not consider in detail the option to extend the
PFA.⁴

10. In total, the Steering Committee met four times between 14 December 2001 and 18 April 2002 before reaching a decision on its recommendation regarding the extension option contained in the PFA. At the fourth Steering Committee meeting on 18 April 2002, two months before the option expired, the Committee reached the decision that it should recommend to the Government that the option to extend the PFA not be exercised, given that the Committee had concluded that the disadvantages of extending the current PFA outweighed the advantages.⁵ The Steering Committee's recommendation and other advice on this matter were forwarded to the Minister for Health and Ageing on 11 June 2002 and 20 June 2002. The Minister accepted the Department's recommendation and chose not to exercise the option on 21 June 2002.

Audit scope

11. The Joint Committee of Public Accounts and Audit (JCPAA) of the Parliament conducted an inquiry into Audit Report No.24 1999–2000, Commonwealth Management and Regulation of Plasma Fractionation. The audit report, tabled in December 1999, examined Health's management of the PFA and regulation of plasma fractionation. In light of the JCPAA's findings in relation to its inquiry into the audit report, the Committee's Report No.378 included a recommendation that ANAO undertake a timely performance audit of Health's handling of the PFA extension review.

12. ANAO's response to the JCPAA recommendation was to include a proposed audit of the PFA extension review in its 2001–02 Audit Work Program. The audit commenced in late June 2002 following the expiry, on 23 June 2002, of the Commonwealth's unilateral option to extend the PFA. The scope of the audit was limited to the planning and conduct of the PFA extension option review. The objective of the audit was to review the efficiency and effectiveness of Health's planning and conduct of this review, in accordance with the JCPAA's recommendation.

13. In June 2002, Health proposed to ANAO that the audit scope should also include the Department's subsequent work on securing a supply of plasma and related products beyond 30 June 2004. Health advised ANAO that the Department's reasoning was that the full implications of the planning and conduct of the extension review cannot be properly assessed until this subsequent work is completed in 2004.

14. ANAO noted that, as Health did not expect the process for securing plasma and related products beyond the expiry of the PFA to be completed until mid¬2004, any audit of the complete process would not be able to be completed until early 2005. Accordingly, rather than delay reporting to the Parliament, and in accordance with the JCPAA's request for a timely audit of the PFA extension review, ANAO proceeded with the requested limited scope audit. The audit builds upon previous performance audits undertaken in this area by ANAO.⁶

15. Health's views and opinions on a number of matters raised in this audit report differ from those of the ANAO. ANAO sought to resolve these issues by issuing four issues papers to Health in December 2002. Following Health's response to these papers in March 2003, ANAO issued a consolidated discussion paper to the Department later that month and a further discussion paper was issued in May 2003.

16. Health's April 2003 comments on the first discussion paper required ANAO to take legal advice on issues raised by Health relating to section 37 of the Auditor-General Act 1997 (the Act).

17. Subsection 37(1) of the Act provides that the Auditor-General must not include particular information in a public report if the Auditor-General is of the opinion that disclosure would be contrary to the public interest for any of the reasons set out in subsection 37(2) of the Act. In May 2003, ANAO issued a further discussion paper to Health, which had been revised in light of the Department's comments and ANAO's legal advice. This paper was also provided to the Departments of Finance and Administration (Finance) and the Prime Minister and Cabinet (PM&C).

Key Findings

Timeliness of the process

18. Audit Report No.24 1999–2000, tabled in December 1999, noted the importance of the Commonwealth being well prepared for taking a decision on the PFA extension option. The report recommended that Health commence early planning for the expiry of the initial term of the PFA contract to ensure that the Commonwealth could advise CSL of its preferred position by the required date.

19. In the event, the Steering Committee process for determining Health's recommendation to the Government on the PFA extension option commenced in December 2001, some six months before the expiry of the option. ANAO found that, on Friday 21 June 2002, the last working day before the expiry of the option on 23 June 2002, the Minister accepted Health's recommendation not to exercise the PFA extension option. On the same day, the Department notified CSL in writing of the Commonwealth's decision.

Value for money

20. ANAO would have expected that some substantive risk analysis, including the availability and costs of alternative options for the future provision of plasma products after the expiry of the PFA, would have been explored by Health in advance of making a decision on the PFA extension option. This would be necessary in order to make an informed judgement about the value of exercising the option. However, this did not occur.

21. In this regard, ANAO notes that, when Health briefed Finance in June 2002 on the recommendation not to exercise the option, Finance indicated concern about the breadth of the risk analysis undertaken by Health, particularly in relation to costs. Finance advised that it would want to see an economic analysis of the savings that Health envisaged would be made under a new PFA before supporting the advice not to exercise the extension option, despite the difficulties of the current PFA.

22. The advice provided to Health's Steering Committee regarding the relative value for money of the PFA extension option was formulated on the basis of limited analysis of the current contract and preliminary testing of the operation of the contract in response to the likely effects of a number of possible changes to the product mix over the term of the possible PFA extension. The Committee concluded that it had sufficient information before it, through the processes it had undertaken, to make the decision in regard to the PFA extension option. However, in the ANAO's view, Health's Steering Committee would have benefited from more substantive information on the costs and benefits of the option.

23. Under the PFA, payments to CSL are based on a fixed price for each unit of product. However, there are two prices set for each product. The higher price is paid by the Commonwealth on a threshold level for each product that is broadly in line with CSL's production levels at the time the PFA was signed in late 1993. The second tier price, which is significantly lower than the first tier price, is paid on all production above the threshold level and aims to recover variable costs.⁷ By 2001–02, nearly 25 per cent of the total payments under the PFA were for products at the lower tier-two price, representing a more than four-fold increase as compared to 1995–96 expenditure.

24. The Steering Committee received legal advice on 18 April 2002, which it relied on in deciding to recommend that the PFA extension option not be exercised. A key part of the legal advice was the proposition that, even if the Commonwealth were to source a significantly greater proportion of its requirements outside of the PFA, the revenue received by CSL must be no less than the revenue received for the previous financial year, as indexed under the contract (that is, CSL's revenue would not decline even if it manufactured less product under the PFA). The record of the Steering Committee's decision identified this as one of the three main disadvantages of the current PFA.

25. ANAO received legal advice that it is not clear that Health's interpretation of the PFA's terms, such that CSL's revenue is not able to fall from that of the previous year, is a correct interpretation of the operation of the PFA.⁸ Subsequently, Health obtained advice from the Chief General Counsel at the Australian Government Solicitor (AGS) that conflicted with the earlier advice obtained by ANAO. Consequently, ANAO can only note the differences in legal opinions. However, the legal advice obtained by Health from AGS did conclude that Health's own legal adviser's general statement as to guaranteed revenue overstated the position as to guaranteed revenue because it did not spell out that, in AGS' view, this only happens ‘when a certain series of events occurs.'

26. CSL's revenue under the PFA has risen in each year of the contract to date. ANAO notes that there have already been occasions when Health has notified CSL that it required less than the specified minimum volume of a particular product for a year. ANAO understands that CSL has yet to seek to use the provisions of the PFA to seek an adjustment to the price of such a product.

27. ANAO found a lack of detailed work undertaken during the Steering Committee process to clarify the contract's terms including analysis of potential for benefits to the Commonwealth from continuation of the existing terms of the two-tier pricing system for plasma products that applies under the PFA.

Consultation

28. At no time,prior to recommending to its Minister that the PFA extension option not be exercised, did Health consult with CSL about the PFA extension option. ANAO notes that, when major contracts incorporate an option to extend the contract, it would be unusual for the parties not to consult in attempting to inform themselves about the pros and cons of exercising that option, prior to its expiry.

29. The ANAO considers that effective communication between the parties is a prerequisite to good contract management both for ongoing operations and for strategic purposes. The absence of dialogue in relation to the strategic management of an important Commonwealth contract is, in ANAO's experience, also unusual, particularly given Health's advice to ANAO that the cost involved for the supply of plasma products in the five years following the expiry of the PFA could be some hundreds of millions of dollars.

Advice to Government

30. Following consultations with PM&C, Health provided a brief to the Minister for Health and Ageing on 11 June 2002, advising that the Steering Committee recommended that the PFA extension option should not be exercised and that the Minister write to the Prime Minister recommending that he agree to the Government not exercising the option.

31. Health met with officers from PM&C on 12 June 2002. At the meeting, Health provided a briefing on the background to the recommendation not to extend the PFA. The Department also provided the reasons it considered that the risks it would not succeed in negotiating a new agreement were of an acceptable level. Following the meeting, the PM&C officers indicated that they would be talking to Finance before completing a briefing for the Prime Minister on the Minister for Health and Ageing's letter and suggested Health should also contact Finance ahead of this to provide the necessary background and information. Health subsequently arranged a meeting with officers from Finance and Treasury on 14 June 2002.

32. At the meeting on 14 June 2002, amongst other matters, officers from Finance questioned the timeframe available for the decision on the option, noting that there was little time available for detailed consultation with departments and their Ministers. The Finance officers also indicated concern about the breadth of the risk analysis undertaken by Health, particularly in relation to costs.
33. In the week that the PFA option expired, Health responded to Finance's questions indicating that estimates of the financial impacts of all elements of the proposed new arrangements, including the assumptions underpinning them could not be provided because Health was not proposing new arrangements at this point. Health advised it was just providing advice to Government on whether or not the Commonwealth should exercise the option to extend the current agreement.

34. The Minister for Health and Ageing wrote to the Prime Minister on 16 June 2002 seeking his agreement to the Government not exercising the PFA extension option. Following oral advice from PM&C, on 20 June 2002, that the Minister for Health and Ageing had full authority to make the decision in relation to the PFA extension option, Health provided another brief to its Minister late on that day advising her of this and requesting her to make the decision. On 21 June 2002, the Minister accepted the Department's recommendation that the PFA extension option not be exercised.

Procedural ambiguity

35. Health advised ANAO, in February 2003, that its internal legal advice was that Regulations 8 to 13 of the Financial Management and Accountability Regulations 1997 (FMA Regulations), dealing with the specific decision making requirements for approving and entering into commitments to spend public money, did not apply to the decision not to extend the PFA. ANAO has again received conflicting legal advice on this issue. ANAO considers that the opportunity to exercise an option in a contract creates economic benefits and costs. Clearly, if in exercising, or not exercising, the option the spending of more public money is involved, then the Commonwealth financial management framework applies. ANAO considers that it is undesirable that there be ambiguity around the procedures to be applied by Commonwealth agencies when deciding whether or not such an option should be exercised.

36. Health's February 2003 internal legal advice also stated ‘the [Commonwealth Procurement Guidelines (CPGs)] do not contain any requirements or principles which apply specifically to a decision on whether or not to exercise an option under a contract.' ANAO agrees that the CPGs do not currently specifically contain any guidance for agencies on options nor do they provide any specific advice as to whether the CPGs apply in circumstances where agencies decide not to exercise an option. ANAO considers that there would be merit in Finance, as the responsible agency, reviewing the CPGs to determine how to specifically address this issue.

Overall conclusion

37. The request of the JCPAA was for a timely performance audit of Health's handling of the PFA extension review. This was the focus of the audit. ANAO considers that insufficient information was available to Health's Steering Committee to allow it to form an objective view on the financial merit of the advice it provided to the Minister on the value of the PFA extension option. ANAO makes no judgement about whether or not the decision not to extend the current agreement was a correct decision.

38. Health advised ANAO, in July 2003, that the Department did not agree with this conclusion and stated:

The Department notes that, in ANAO's opinion, the Steering Committee had insufficient information to form an objective view of the value of the extension option. The Department disagrees with this finding. The finding is based on the ANAO's conclusions about the legal advice on the revenue maintenance provisions of the PFA and the fact that the Steering Committee did not formally assess the future costs and benefits of the two-tier pricing arrangements that would have persisted had the contract been extended.

In relation to the first point, and in response to the audit, the Department obtained advice from the Chief General Counsel at the Australian Government Solicitor (AGS) that substantially confirmed the advice received by the Steering Committee. The Department considers that it had been prudent in seeking the legal advice, and also considers that the AGS advice supports the basis for the Steering Committee's consideration of the value for money issues.

In relation to the second point, the Department considers that the basis for the ANAO's conclusion relates to a perception that the Department did not fully appreciate the future financial value of the two-tier pricing arrangement. The Department's view is that the most important analysis required in relation to the two-tier pricing arrangements was whether the benefits would continue if the extension option were taken up. Having undertaken this analysis, the Department concluded that, based on its assessment of future product requirements, the arrangements might be of limited financial value.

The Steering Committee identified that a major challenge for the future was to deal with the increasing demand for substitutes for some plasma products and with potential over-supply of some products. In particular, there was a likelihood that beyond June 2004, synthetic products would increasingly replace plasma-derived coagulation products. Under the two-tier pricing arrangements, any fall in demand increases average prices and if demand fell below the minimum volume, the current PFA provides for the possibility of a compensating price adjustment.

The Steering Committee concluded that the benefits of the two-tier pricing arrangements would be more than offset by these two countervailing factors. This was the crucial analysis required at the time.

39. ANAO notes that, in the Steering Committee's 1 May 2002 record of its decision on the option, there is no explicit consideration of the value of the two-tier pricing regime. As discussed in para 23 above, by 2001–02, the proportion of total payments under the PFA for products at the lower tier-two price had increased by more than four-fold as compared to 1995–96 expenditure. The Steering Committee concluded that the current pricing arrangements were unlikely to be the most advantageous available to the Commonwealth (see para 3.19). The main analysis underpinning this conclusion appears to have been a scenario analysis undertaken on 16 April 2002 by the Steering Committee's advisers together with the BODT. This scenario analysis did not include any data on the costs of alternative options. As mentioned in para 32, at a meeting with Health on 14 June 2002, Finance officers indicated concern about the breadth of the risk analysis undertaken by Health, particularly in relation to costs (also see paras 4.42 to 4.45).

40. Notwithstanding Health's comments outlined above, ANAO concludes that there were five key areas where improvements could have been made in Health's handling of the PFA extension option review as follows:

• Despite early warning by ANAO in December 1999, and coverage of this issue by the JCPAA during 2000, the Steering Committee process for this complex issue was not commenced until December 2001, some six months before the expiry of the extension option.
•  There was a lack of appreciation by the Department of the nature of the analysis required to underpin adequate advice to the Government on whether or not to exercise the option.
• The Steering Committee determined that it did not have to establish the best value for money approach for the future supply of plasma products before making its recommendation as to whether or not to exercise the extension option.
• In reaching its conclusions about extending the PFA, at no time did the Department consult with CSL.
• The process to advise the Government on Health's recommendation not to exercise the option was undertaken very late, restricting the opportunity for adequate consultation with senior Ministers and detaled consideration of the Department's advice.

Agency responses

41. Health's full response to the section 19 proposed audit report can be found at Appendix 1. Health advised ANAO that the following was its summary response:

The Department's response is framed in the context of the overall policy and procurement environment in which the PFA extension decision was taken. In summary, the Department considers that it:

• adopted a timely and effective approach to the PFA extension review, including consideration of value for money issues;
• fully appreciated the nature of the analysis required to underpin advice to Government;
• provided advice to the Minister based on sound analyses of the information available, in particular the findings of the comprehensive National Blood Review; and
• met its obligations under the PFA in terms of timing of the decision and advice to CSL.

The audit was conducted at a point that meant that it reflected only a part of the whole policy and procurement process relating to future arrangements for the supply of plasma products. There are still policy matters relating to the future arrangements that are to be decided.

The Departments views and opinion on a number of matters raised in the report differ from those of the ANAO.

42. PM&C provided correspondence, jointly signed by Health, advising of further information identified in the Departments, since the issuing of the section 19 proposed report in June 2003. On the basis of this information, the Departments requested some amendments to the section of the report that discusses interaction between the two agencies on 7 June 2002 (see para 4.38). PM&C also advised ANAO that the Department did not have any further comments on the conclusions reached in the audit.

43. Finance advised ANAO that it was ‘satisfied that the proposed report accurately reflects the nature, content and extent of the interaction between Finance and other agencies including Health, PM&C and the ANAO on this issue.'

44. The focus of the audit, in accordance with the JCPAA recommendation, was Health's planning and conduct of the PFA extension option review. In this circumstance, the audit was chiefly concerned with specific past events. However, during the course of the audit, Health brought to ANAO's attention its view that the FMA Regulations and the CPGs do not apply to a decision not to exercise a contractual option. ANAO and Finance, the agency with policy responsibility for the FMA legislation and the CPGs, do not agree with Health's view.

45. However, given that there may be uncertainty about this issue, ANAO made one recommendation in the audit report suggesting that Finance enhance the guidance provided in the CPGs by including specific advice to agencies on the procedures to be applied to evaluating options in materially important procurement contracts. Finance agreed with the recommendation and has advised ANAO that it will investigate the inclusion of the consideration of options within the whole-of-life assessment of value for money when next updating the CPGs. In the interim, Finance will consider distributing guidance in a Commonwealth Procurement Circular on the consideration of options in materially significant contracts.

Footnotes

1 On 1 July 2003, the new National Blood Authority (a Commonwealth statutory authority jointly funded by the State, Territory and Commonwealth Governments) took over responsibility for the management of the PFA.

2 Review of the Australian Blood Banking and Plasma Product Sector, March 2001, p. 89 and p. 91.

3 Paragraphs 4.3 to 4.5 of the agenda paper prepared by the BODT for Item 2 of the Steering Committee's agenda for its 18 April 2002 meeting.

4 The BODT's advice was included in Agenda Paper 2 prepared by the BODT for the Steering Committee's fourth meeting on 18 April 2002 and this paper recommended that the PFA extension option not be exercised. The ANAO notes that the BODT prepared the material in question in response to a direction of the Steering Committee contained in the minutes of its third meeting, on 15 March 2002. The Steering Committee's minutes for the 15 March 2003 meeting contained the following direction that: ‘ …..a paper be prepared exploring the question of whether or not to extend the current [PFA] beyond 30 June 2004. The paper is to (i) examine the material prepared for the Review of the Australian Blood Banking and Plasma Products Sector (the Blood Review) and report on the extent to which the above question was addressed and the adequacy of the evidence on which it was based; ... '

5 Record of Decision of the Steering Committee for the Future of Plasma Fractionation and Diagnostic Products Arrangements, 1 May 2002.\

6 In addition to Audit Report No.24 1999–2000, Management and Regulation of Plasma Fractionation, ANAO undertook an earlier audit, Audit Report No.14 1995–96, Sale of CSL, Commonwealth Blood Product Funding and Regulation.

7 See CSL Limited Prospectus, April 1994 p. 84 and Review of the Australian Blood Banking and Plasma Product Sector, March 2001, p. 88.

8 ANAO's legal advice was that:

• Paragraph 11 of Schedule B (paragraph B11), which prima facie has the effect of providing continuity of revenue for CSL Ltd in the PFA in the absence of agreement by the parties to the contrary, is inconsistent with a principal clause of the contract, clause 3.2.6. It is our view that paragraph B11 and the clause probably cannot be construed in a manner to make them consistent, because they require opposite results.
• Where there is a conflict between a clause and a term in a Schedule, then the clause prevails (clause 1.2.9).
   
• Subject to a qualification concerning the intention of the parties, which may have to be explored further, we do not think that the inconsistency can be remedied by omitting a word or words from the PFA. As a result, clause 22.2 would have the effect of severing paragraph B11 from the PFA.