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Audit Finds Fault with KentuckyWired Internet Project

Ballooning project costs and delays were called into question by state Auditor Mike Harmon in a critical report issued Sept. 27.

(TNS) — A complex, ambitious project that was initially supposed to deliver high-speed Internet access to all 120 Kentucky counties by this year was badly structured and has been plagued by delays and construction cost overruns nearing $100 million, according to a special examination released Sept.27 by state Auditor Mike Harmon.

The KentuckyWired system now isn’t projected to be done until 2020 and will cost taxpayers almost $1.5 billion over its 30-year life, according to the critical 125-page audit.

The state would have paid much of that amount for Internet service to government buildings even without the project, but faces significant additional costs because of its problems.

If all goes as planned from now on, KentuckyWired is expected to come in $96.7 million over the original estimated construction price, a cost overrun of at least 35 percent, the audit said.

The audit said Kentucky taxpayers and state legislators were told when the project started that they would be responsible only for $30 million approved by state lawmakers in 2014, and that most of the money would come from private investment.

However, the funding for the $324 million project primarily came through state-backed bonds.

“What we now find is that, between what has paid out thus far, what has been bonded and what we have been obligated to by former leaders, taxpayers are responsible for 93 percent of the total cost for KentuckyWired,” said Harmon, a Republican.

The initial proposal from private vendors on the project was more favorable to Kentucky, but officials in the administration of former Gov. Steve Beshear approved changes that shifted significant amounts of risk to the state, the audit said.

KentuckyWired was announced in 2013 by Beshear, a Democrat, and U.S. Rep. Hal Rogers, R-Somerset, as a public-private partnership in an effort to improve Internet service, which lags in many rural areas of the state.

The project is designed to provide an access point in each county for high-speed Internet. It would not deliver service to individual homes and businesses, which would be the job of other providers who could hook into the network.

Supporters say the network would make it easier for providers to spend money installing “last mile” service to homes and businesses.

Better Internet service could boost economic development, education and health care, supporters of KentuckyWired have said.

“It’s an investment in job creation,” said Harlan County Judge-Executive Dan Mosley. “It’s going to have a significant economic impact.”

Mosley, a Democrat, noted that hundreds of people in Eastern Kentucky have gotten jobs through a work-from home program that requires good Internet service, but that others can’t qualify because of poor service.

Most of the initial cost for the network was fronted by private investors, led by Australian firm Macquarie Capital, to design, build, operate and maintain the network, though the debt is backed by the state.

Kentucky would sell excess capacity on the network. The state projects the network will generate $1.9 billion over its 30-year life, with $1.3 billion of that going to Kentucky, the audit said.

However, auditors found “scant support” for those projections, and the state will have to pay a good chunk of whatever it makes to the Center for Rural Development in Somerset, the report said.

In another sore spot, the state has already started making “availability payments” to contractors for the network, even though it’s not yet up and running and so can’t produce any revenue for the state to offset the payments.

The Kentucky Communications Network Authority, which oversees the project, said in a statement that it started working to fix several of the issues identified in the report, including by hiring more employees to boost oversight and monitoring.

“KCNA appreciates the Auditor’s work, and we will continue our efforts to correct the problems and delays that were present from the KentuckyWired project’s inception in 2015,” the agency said.

The authority is working to resolve bills the state owes contractors because of delays in the project. Legislators this year authorized a settlement of $88 million to cover those claims, plus the power to borrow another $22 million to cover future claims.

The audit questioned that settlement, though KCNA head Phillip K. Brown said in a response that contractors first demanded $159 million.

The settlement, which has not been finalized, not only would reduce that amount and keep the project on track, but also reduce the state’s financial risk, Brown said in the response.

Beshear said in response to the audit that the broadband project started with bipartisan support and still has that.

“Kentucky Wired is a transformational project that will allow someone in far Eastern or Western Kentucky to work in a good job for a company anywhere in the world,” he said.

Republican Gov. Matt Bevin did not respond to a request for comment, but has said he supports the project.

Harmon said at a news conference Thursday in his Frankfort office that about 700 miles of the planned 3,400 miles of fiber optic cable in the project have been installed but none is functioning.

The network is to be finished in rings, with Northern Kentucky and Eastern Kentucky ready in July 2020 and the others all done by October 2020.

Harmon said state officials were warned several times about potential problems with the project when they were setting it up in 2014 and 2015, but disregarded the concerns.

He said no one has been able to explain why the decision was made to proceed.

Harmon’s review found:

  • Significant changes were made that placed the burden on taxpayers during a “lengthy and unorthodox procurement process” between late 2014 and late 2015.
The initial proposal made to the state included private funding and greater responsibility on the private sector.

However, in late 2015, Beshear Administration officials signed agreements that upped the risk to the state and committed taxpayers to essentially all project costs, the audit said.

There may have been some anticipated savings in switching to tax-exempt financing, but it also removed incentive for contractors to get the job done on time, the audit said.

In one example of how the risks shifted, the state’s initial request for proposals on the network required private contractors to work out agreements to attach KentuckyWired’s fiber-optic line to utility poles owned by other companies, such as AT&T and Windstream.

The final deal saddled the state with that job, however, the audit said.

It turned out to be much harder to work out those agreements than officials first anticipated, creating delays that drove up the state’s costs.

  • The state Department of Education cautioned that one key source of revenue for the project — payments for Internet service from state elementary and high schools — would not be available, but state officials still kept the revenue as part of the package.
AT&T, which has a contract through 2023 to provide K-12 Internet service, protested and the state has had to make up for the difference with other money.

  • The state is increasingly relying on speculative wholesale revenues from the network to fund the project. Revenue models call for steadily increasing rates to be charged for use of the network.
  • Increased monitoring and analysis are needed to reduce costs if the project continues and to avoid repeating the same mistakes on future projects.
Harmon said his office will continue to examine the time frame between when the proposal request for the project was issued in 2014 and when the project agreements were signed in September 2015.

Harmon said his office will use all available means, including issuing subpoenas if necessary, to try to figure out why state officials signed off on the deal despite warnings of potential problems.

“There are questions that remain as to why the terms were changed from the original proposal that placed little burden on taxpayers to what was signed the following year that put the responsibility of almost $1.5 billion on the commonwealth,” said Harmon.

The office also will refer the audit to the Executive Branch Ethics Commission, which can discipline state employees. The commission can hold former state government workers accountable.

“Given that we have switched from a $30 million state obligation to a $1.5 billion state obligation with no General Assembly approval, with merely the simpleness of a signing of a contract, we believe that’s important to be looked into,” Harmon said.

He said he did not know why the switch was made. “On the surface, it looks as if this was rushed.”

The examination found no evidence of any criminal misconduct, he said.

Some Republican legislators have said the project should be discontinued, but the audit said it would cost the state an estimated $261 million to back out of the project under one scenario.

That doesn’t count $230 million the state has already spent, nor does it include other potential costs from litigation or potential damage to the state’s credit rating that could push up borrowing costs.

Project supporters have said it would make no sense to stop the project, leaving the state with no broadband network despite hundreds of millions in spending.

The legislature’s Program Review and Investigations Committee is reviewing the project’s contract.

©2018 the Lexington Herald-Leader (Lexington, Ky.) Distributed by Tribune Content Agency, LLC.