MARIM Understanding Project Risks and How You Manage Them ...
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RISK-MITIGATION STRATEGIES
IN MEGA PROJECT: Learning
From Past Experience
Ghazali Ab Rahman
School of Economic, Finance & Banking
Department of Banking & Risk Management
Universiti Utara Malaysia
Understanding Project Risks
and How You Manage Them
MARINE Seminar, 13 May 2015
MARIM
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1. The Big Picture.
2. Corporate Vs. Project Finance
3. History of Project Finance.
4. Major Risks.
5. Risk Management Strategies.
6. Lessons for the way forward.
CONTENTS
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We leadTHE BIG
PICTURE
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Region Project
Count
Investment
(Billion USD)
Latin America and the
Caribbean1,586 672.5
East Asia and Pacific 1,564 336.7
South Asia 771 320.7
Europe and Central Asia 742 289.1
Sub-Saharan Africa 436 121.1
Middle East and North Africa 139 85.9
1.826 Trillion
PPP 1995 - 2011
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We leadTHE BIG
PICTURE
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Sector Project
Count
Investment
(Billion USD)
Energy 2,283 630,414
Transport 1,371 310,002
Telecom 822 820,622
Water and sewerage 762 65,164
1.826 Trillion
PPP 1995 - 2011
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CORPORATE FINANCE VS.
PROJECT FINANCE
Two ways to
finance a
corporate
project1
Using a Project
Finance Concept
Using Corporate
Finance concept
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Corporate Finance
Project Finance
Corporate
Project
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Corporate Finance Toshiba borrows money
to construct a project
(constructing an Art
Science Factory)
BANK
LOAN
REPAYMENT
The whole Balance Sheet of Toshiba
Is pledged to the bank.
CORPORATE FINANCE VS.
PROJECT FINANCE
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2
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Debt/T Capital from 1,799 companies:
Mean 33.1%
Median 30.5%
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Project Finance
In case project fails, sponsors only lose their 30% shares.
Their Balance Sheets escape creditors’ claims.
CORPORATE FINANCE VS.
PROJECT FINANCE
PROJECT
VEHICLE (PV)
- As borrower
- As implementer
- As operator
- Repay from CF
- Recover from assets
(as security)
BANKS
Syndicate
Multilateral,
Bilateral,
other lenders
70%
Set-up & hold 30% Share Capital in PV
Loan
s
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Debt/T Capital from 1,050
companies:
Mean 70%
Median 70%
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Full Spec.
CORPORATE FINANCE VS.
PROJECT FINANCE
PROJECT
VEHICLE (PV)
- As borrower
- As implementer
- As operator
- Repay from CF
& assets
SPONSOR A SPONSOR B SPONSOR C
BANKS
Syndicate
d
Multilateral,Bilateral,
other lenders
70%
Set-up & hold 30% Share Capital in PV
Host Government
EPC Contractor
O&MContractor
Off-Taker
Loan
s
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We leadHISTORY OF PROJECT FINANCE
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1299:Devon Silver Mines (English Crown).
1500’s:Dutch East-Indian Co. &British East-Indian Co.
1860’s:Suez Canal.
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CORPORATE FINANCE VS.
PROJECT FINANCE
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CORPORATE FINANCE VS.
PROJECT FINANCE
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CORPORATE FINANCE VS.
PROJECT FINANCE
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We leadMAJOR
RISKS
This
discussion
focuses on
the first
three risks
Corporate
Project
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Mitigating Strategies
Use PF structure (see slide 8). US$3.7b Chad-Cameroon Pipeline. CLICK
Minimize financial commitment– High-
Leverage with Limited-recourse or
non-recourse. CLICK
INSOLVENCY
RISKS
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Mitigating Strategies
Choose well-rated co-sponsors with
adequate expertise.
Use proven technology. US$5.5b Iridium failed due to unproven
technology.
Commit Host Government –
Implementation Agreement (IA). €934m Poland’s A2 Motorway. CLICK
INSOLVENCY
RISKS
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Mitigating Strategies…….
Get the off-taker to buy the project: US$13b Airbus A380 – multi-government off-
takers.
£9.5bn Euro Tunnel & US$2.3 billion Disneyland
Paris ‘failed’ mainly due to no off-takers.
Use Hell-or-High-Water Clause. Party must do what has been agreed with no
contractual defense.
Take appropriate insurance.
INSOLVENCY
RISKS
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Mitigating Strategies
Engage sponsors with high political
cloud. IFC loans in Chad-Cameroon Pipeline & in
USD$2b Mozal Project. Giant companies from USA, Europe, Japan, etc.
Leverage on technology to avoid
CEND Mozal Project, Chad-Cameroon & US$2.4b
Pertozuata in Venuzuela.
POLITICAL RISKS
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Mitigating Strategies……
‘Internationalize’ the project. Mozal Project:
POLITICAL RISKS
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Input From
Power & Management S. Africa
Alumina Australia
Petroleum, liquefied pitch, etc. Abroad
Technology France
Financing UK, Japan, US
Purchasers of end products Overseas
Sale proceeds & Debt Reserve Ac Trustee A/C overseas.
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Mitigating Strategies…….
Involve Multilateral & Bilateral Org. World Bank’s Environmental Analysis in
Chad-Cameroon Pipeline & Petrozuata.
IFC for Project Evaluation.
ECA (USA & French) - Chad-Cameroon Pipeline,
Mozal Project & Petrozuata.
POLITICAL RISKS
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Mitigating Strategies…….
Firm control over outputs Airbus A380 – JV bet, UK, France Germany &
Spain to beat Boeing and impede US threat.
Petrozuata – Process outputs in Louisiana, USA.
Use sponsor’s own laws, US laws or international laws.
UK Law in Poland A2 Motorway. US Law in Chad-Cameroon, Mozal &
Petrozuata.
POLITICAL RISKS
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Mitigating Strategies…….
Use Hell-or-High-Water Clause
Implementation Agreement: Not to change law, tax rate, etc.
Take Political-Risk Insurance: CEND. Force majeure.
Terrorism-Risk Insurance.
Currency-devaluation Risk Insurance.
POLITICAL RISKS
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Mitigating Strategies…….
Accurate evaluation of CF: Use sophisticated models – Monte Carlo,
Probability Analysis, Possibility Analysis, etc.
Well-crafted & extensive Financial Model
Conservative pricing:
US$10 per barrel in Chad-Cameroon Pipeline.
US$11 per barrel in Petrozuata.
RETURN RISKS
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Mitigating Strategies ……
Liquidated damage: Turnkey Contract on EPC Contractor.
Guarantees – Tender, Performance, etc.
Control over Cash Flow CF Waterfall. CLICK
High Debt Service Ratio (DSR) CLICK
Reserve Account to meet payment obligations.
Maintenance Reserve Account.
RETURN RISKS
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Mitigating Strategies ……
Minimize cost of borrowing:
Engage high-rated sponsors.
Use appropriate hedging tools.
Include ‘ITF’s financing’ to signal strength.
Use contracts to protect revenue: Supply-or-Pay Contract – on suppliers
Take-and-Pay Contract – Plus Highway
Hell-or-High-Water Clause
RETURN RISKS
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Mitigating Strategies ……
Use contracts to control behavior: Agency problem over Cash Flow.
Use Guarantee to enhance return: Partial Credit Guarantee – covers private lenders
against all risks, allows to extend maturities and
improve commercial terms.
Partial Risks Guarantee – protect lenders when
government fails to perform contractual
obligations.
RETURN RISKS
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Mitigating Strategies ……
Use suitable organization Build-Own-Operate (BOO) – Oil.
Build-Transfer (BT) – Risky project.
Build-Operate-Transfer (BOT) – Highway. Build-Develop-Operate-Transfer (BDOT) -
Highway.
RETURN RISKS
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Mitigating Strategies ……
Use hedging tools: Mozal
Price of Power & Alumuna tied up to London Metal
Exchange price (when output price falls, costs of input
also falls/sufficiently hedged).
Other Mega Projects Interest-rate risks -Interest-rate swap, interest-rate
forward, future, option, etc.
Currency risks – currency swap, futures or option.
Exchange-rate risks – FX forward, swap and option.
Price risks – commodity forward, future or option
contract.
RETURN RISKS
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The Way Forward to Managing Risks
SOME LESSONS
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1 • Lots of creativity & innovation.
2• Use ‘Negotiation’ as powerful
weapon for risk management.
3• Allocate risks to parties best
able to manage risks.
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Thank you for your attention!
THAT’S ALL….
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