DR. D.N.S.KUMAR

Project Risk Management

WHAT IS RISK ?

Something THAT MAY HAPPEN and if it does, will HAVE ADVERSE impact on a project

Risk Vs Uncertainty

Risk - when the decision maker knows the probability of each and every state of nature and thus each and every outcome. An expected value of each alternative action can be determined

Uncertainty - when a decision maker has information that is not complete and therefore cannot determine the expected value of each alternative

Types of Project Risks

Approaches to Risk Analysis

Approaches that consider the stand-alone risk of project (sensitivity-analysis, scenario analysis, break-even analysis, Hiller mode, simulation analysis, and decision tree analysis).

Approaches that consider the contextual risk of a project (corporate risk analysis and market risk analysis).

Corporate Risk Analysis

A projects corporate risks is its contribution to the overall risk of the firm. Put differently, it is reflects the impact of the project on the risk profile of the firm’s total cash flows. On a stand-alone basis a project may be very risky but if its returns are not highly correlated- or, even better, negatively correlated-with the returns on the other projects of the firm, its corporate risk tends to be low.

Sources of Risk

Size of the investment

Reinvestment of cash flows

Variability of cash flows

Life of the project

Risk Analysis

Principal contribution of risk analysis is to focus the attention on understanding the nature and extent of the uncertainty associated with some variables used in a decision making process

Usually understood to use financial measures in determining the desirability of an investment project

Pre Construction Risks

Construction Contract Penalties

Arbitration Process

Technology Risk

Market Demand Risk

Structural Risk

Opening of a Project Risk

During Construction

Construction Delay

Cost overrun

Zoning and Regulatory Risk

Permitting Risk

Environmental Risk

Title Risk

Contractor Risk

During Construction….contd.,

Design and Engineering Risk Materials Risk Labor Risk Natural Hazard Risk Political Risk LitigationsWorkmanship Risk

Post Construction

Management Experience Economic Conditions Demand GapCatastrophic Events Concession Risks O&M Risk Flow of Funds

MANAGEMENT / MITIGATION OF RISK INVOLVES

Risk identification in the selected domain of interestAllocation of risk to various competent partiesRisk quantificationRisk monitoringResponse and controlComprehensive contractual frameworkAdequate insurance coverageKeeping risk within acceptable limits

RISK CATEGORIES

Risk Category Significant Risks Phase of Predominance

Statutory and Regulatory Risks

Right to collect, retain and appropriate user charge

Right to fix the user charges Obtaining approvals and

clearances from authorities Land acquisition/right of way

Project Development period

Design & Development Risk

Design defect Construction difficulties

Project development/ construction period

Completion Risk Cost overrun Time overrun Fund Mobilisation Institutional Arrangement

Construction period

Performance and Operation Risk

Failure to meet performance criteria

Operating cost overrun

Operation period

Revenue Risk Changes in user charge Changes in chargeable volume

Operation period

Contd..

Risk Category Significant Risks Phase of Predominance

Finance Risk Interest rates Change in tax regime Forex rate fluctuation

Operation period

Force Majeure Risk Acts of God (non political event) viz. flood, earthquake etc.

Political event, viz. changes in law, breach or cancellation of contract

Throughout the project period

Social Risk Resettlement and Rehabilitation

Project development/ construction period

Environmental Risk Environmental incidents Construction and Operation period

Insurable Risk Casualty

Third Party Liability

Workmen’s compensation

Through the period from project development, completion and operation period

RISK CATEGORIES

RISK ANALYSIS

RISK MANAGEMENT / MITIGATION

MANAGEMENT / MITIGATION PLANRisk Category / Description

Risk Mitigation Instrument / Allocation

Failure to obtain Approvals and Clearances from the concerned Authorities

CA necessitates prior clearance from the GOI/GOWB, failure of which will result in termination of agreement and financial losses to be borne by the Authority

Instrument:- Concession Agreement (CA)

Allocation:- The Authority

Delays in Land Acquisition and Right of Way

Allotment of physically encumbrance-free land achieved through prior Social Assessment studies by identifying the project affected land and adequate cost estimates.

Instrument:- Concession Agreement, Lease Deed

Allocation:- The Concessionaire

Delay in Project Development activities

The onus of expeditious completion of the project falls on the Concessionaire

Instrument:- Concession Agreement

Allocation:- The Concessionaire

Time over-runs due to Contractor’s default

Being an equity partner, the onus of early completion of the project lies on the Concessionaire.

Levy of penalty and liquidated damages in case of default

Instrument:- Construction Contract

Allocation – The Concessionaire

Contd…

Management / Mitigation PlanRisk Category /

Description Risk Mitigation Instrument/

AllocationCost overruns Carry out detailed engineering

surveys & investigations during Project Development Phase

Extension in the Concession period till the desired rate of return is achieved

Instrument:-Concession Agreement

Allocation:-the Concessionaire Contractor

Non realisation of Operation Revenue because of lower offtake, user charge leakage and avoidance

Accurate demand projections in Project Report

Proper monitoring and reporting mechanism as well as independent audits of user charge operations

Instrument:-Concession Agreement

Allocation:- the Concessionaire, O&M Contractor

Force Majeure Political / Termination Risk

Adequate compensation in case of imposition of new laws and tax structure, withdrawal of tax holidays or restrictions on Forex transfer

Reimbursement of outstanding dues to the project lenders and a pre-agreed return to the equity investors in case of termination because of policy change by the government

Instrument:-Concession Agreement

Allocation:-The Concessionaire

Contd…

Management / Mitigation Plan (Contd…)

Risk Category / Description

Risk Mitigation Instrument/ Allocation

Financial Risk due to drastic change in the interest and tax rates

Project to be financed through an optimal mix of fixed rate and floating rate instruments

Instrument:- Lender’s Agreement

Allocation:- The Concessionaire

Financial Risk – Exchange rate risk

Financing arrangement to be made to swap the Forex debt for equivalent Rupee debt when exposed to the risk of currency devaluation

Instrument:- Financing Agreements

Allocation:- The Concessionaire

Financial Risk – Inflation Risk

Provision for inflation adjustment of costs in CA. The Concessionaire would bear the inflation risk accordingly

Instrument:- Concession Agreement

Allocation:- the Concessionaire

The attractiveness of a PPP project depends on the risk perception of the private sector

Risks may be analysed and mitigated using available technological, human and organizational resources

If risks can be reasonably allocated and an effective management and mitigation plan built into the agreements, then private sector participation in infrastructure projects can be ensured.