Risk Management in PPP Projects

Mormugao, 21st September, 2007

Agenda
Overview of Risks in PPP Contracts Types of risk Mitigation strategies Case Studies Mumbai Pune Express way Mundra Port Mumbai Metro Conclusions

Sources of Risk
Government Legal & Regulatory Framework Developers Contracts Construction O&M Demand Target Market

Risks in a typical PPP project

Risks in PPP Projects

Regulatory Political Commercial Operational & Maintenance Financial Risk

RISKS RISKS
Force Majeure Risk Market Risk Cost Overrun Risk Land Acquisition Risk Technology Risk Construction Risk

Risk Categories, Phase of Dominance and Allocation

Risk Categories
Land acquisition Delays in project development - Design risk - Planning risk Project completion risk Project cost risk/Cost over-runs Technology risk Regulatory & administrative risk Commercial risk Operations & maintenance risk Financial risk - Interest rate risk - Foreign exchange exposure risk - Tax rate change risk - Inflation risk Termination risk Insolvency and outside creditor risk Force Majeure Environmental risk Political & social risk - Events of wars - Nationalization or revocation - Social risk

Phase of dominance
Project Development Project Development Construction Period Construction Period Construction/Operations Period Operations Period Operations Period Operations Period

Allocation of risk
Institution/Private party Private party Private party Private party Private party Institution/Private party Private party Private party

Operations Period

Private party

Operations Period Throughout Project Cycle Throughout Project Cycle Construction/Operations Period Throughout Project Cycle

Private party Private party Institution/Private party Institution/Private party Institution/Private party

Risk Mitigation Steps

Identify Risk Determine Severity of Risk Allocate Risk Mitigate the Risk Price the Risk

Identifying the events or Actions which Effects the Viability of the Project

In Case the Event occur the effect of the same on the cost / time of the project

Identifying and allocating the risk to the party who can manage it best

Steps / actions which can be taking to reduce the chances of the event occurring

Cost of addressing the risk have to be determined

Management of Risks
What ? Time and Cost Overruns or shortfall in performance parameter of the competed project Why? High capital intensity and a relatively long construction period How to Mitigate? Engineering, procurement, and construction contracts to an experienced and reputed firm Provisions for liquidated damages in the contract(s)

Construction Risk

Management of Risks
What ? Technical performance of the project during its operational phase can fall below the levels projected by investors Why? Technology is untried or is changing rapidly or inability of the operator to manage such big and complex project i.e. Metro How to Mitigate? Entrusting operation to experienced operations and maintenance contractors Provisions for liquidated damages in the contact(s) Insurance against Force Majeure risks
Operations Risk

Management of Risks
What ? Possibility that market conditions assumed in determining the viability of the project are not realized. Non fulfillment of demand projections is an obvious example Why? Uncertainty in the forecast of the demand projections How to Mitigate? Investors enter into a contract with the monopoly purchaser to guarantee a minimum level of purchase.

Market/Demand Risk

Management of Risks
What ? Interest rates can vary during the life of the project (construction and payback period) Why? High capital intensity (large impact) and long payback periods (Risk spread over a long time). Interest cost is a large component of the total project cost How to Mitigate? Pass it on to consumers, as, for example, in arrangements in which the impact of interest rate variations on unit costs are treated as a pass-through into the tariff Using hedging instruments

Interest Rate Risk

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Management of Risks
What ? Risk of not being paid for services delivered Why? Financial condition of public sector utilities in developing countries is often very weak. These utilities are often the monopoly / large buyer for example power and water How to Mitigate? Long term solution is to improve the financial condition of the utilities by improvement in efficiencies or privatization Short term, guarantee and counter guarantee by state and central government Set up an escrow arrangement

Payment Risk

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Management of Risks
What ? Any disruption in construction or operation of a project due to regulatory changes Why? Infrastructure projects have to interface with various regulatory authorities throughout the life of the project, making them especially vulnerable to regulatory action How to Mitigate? By establishing strong and independent regulatory authorities that operate with maximum transparency of procedures within a legal framework that provides investors with credible recourse against arbitrary action

Regulatory Risk

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Management of Risks
What ? Any disruption in construction or operation of a project due to political decisions Why? Infrastructure projects have high visibility, and there is always a strong ele-ment of public interest. This makes them vul-nerable to political action that can interrupt or upset settled commercial terms; in extreme cases it can even lead to cancellation of licenses or nationalization. How to Mitigate? Partially mitigated through political risk insurance offered by multilateral organizations, such as the Multilateral Investment Guarantee Agency, or bilateral investment protection agreements.
Political Risk
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Typical Risk Allocation in India

Risk Participants Equity Holders, Developer Lenders Government EPC Contractor Role
Promoter

Construction Risk
No

Operation Risk
Yes

Revenue Risk
Yes

Market Risk
Yes

Interest Rate Risk

Yes

Regulatory Risk
Yes

Lender Awarding Agency SubContractor

No No Yes

No No No

No No No

No No No

Yes No No

No Yes No

Developer carries all type of risk in India unlike UK and other Latin American Countries where government guarantee minimum revenue and share the same also in case that exceeds threshold limit

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Management of Risks
Type of Project Road Port Airport Power Construction Risk High High High Medium Operation Risk Low Medium High Low Market Risk Project Specific Medium High Low Interest Rate Risk Project Specific Project Specific Project Specific Project Specific Payment Risk Medium Low Low High Regulatory Risk Medium Low Medium High

Market Risk versus Payment Risk

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Agenda
Overview of Risks in PPP Contracts Types of risk Mitigation strategies Case Studies Mumbai Pune Express way Mundra Port Mumbai Metro Conclusions

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Mumbai Pune Expressway

Total Project Cost Rs 2136 crores Initial estimate Rs 1600 crores Time taken 3 years Physical land acquired 1030 ha Contractors appointed: IJM / SCL Joint Venture Hindustan Construction Co. Mumbai Larsen and Toubro Ltd. Mumbai V.M. Jog Engineering Ltd. Pune Konkan Railway Corporation Ltd Operation & Maintenance: Ideal Road Builders (IRB)

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Mumbai Pune Expressway

Risk Allocation

Risks borne by MSRDC

Land acquisition Specific project clearances Political Non-insurable Force Majeure Water & Power Availability at source Project completion

Risks borne by Private party

Design Construction Operation & Maintenance Project cost Financing Revenue Technology Insurable Force Majeure

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Mumbai Pune Expressway

Risk mitigation by MSRDC Different consultants appointed for the purpose of detailed engineering and for construction supervision of works Land acquisition and clearances for tree felling, forest clearing etc. obtained beforehand Environmental impact assessment carried out by external agencies Strong political will Providing power through 8 MSEB substations Removing/diverting utility service lines (power, telephone, water & sewer) coming in alignment Risk mitigation by Private party

Pre-approved designs for the respective road segments Financial SOPs from GoM (Tax, imports etc.) Contractual and legal shield Employing state-of-the-art technology for carrying out the construction work Subcontractors working under tight clauses Absorption of certain cost escalations by MSRDC

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Mumbai Pune Expressway

Total Project cost Rs 2151 crores Multi-terminal greenfield port developed through PPP by the state of Gujarat Commenced operations in 1999

Traffic is at 8 MMTA Was one of the first ports to secure rail connectivity by putting up the investment for it through PPP (Rs 136 crores)

Private party Gujarat Adani Port Ltd. (GAPL) and P&O J

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Mumbai Pune Expressway

Risk Allocation

Risks borne by GoG/GMB

Revenue Regulatory & administrative Political & social Creditor Environmental

Risks borne by Private party

Design & Construction Operation & Maintenance Subcontractor Financing Revenue Financial Technology Environmental Connectivity Rail, Road
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Mumbai Pune Expressway

Risk mitigation by GoG/GMB Risk mitigation by Private party

Traffic risk sharing Required clearances obtained beforehand Transparent and clear-cut BOOT policy in place Sustained political support to the non-major port development cause Various bodies constituted for reviewing and monitoring the PPP process

30 years Concession agreement with GMB Future development rights and sub-concession contracts Tariff set by P&O (independent of TAMP) Developed own rail connectivity Heavy machinery & equipments taken on lease basis GAPL sold stake to P&O ports

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Mumbai Metro
Total Project cost Rs 2356 crores First phase 2006-11 Commencement of Operations 2009-10 Mass transit corridor from Andheri to Ghatkopar First MRTS project in India being implemented on Public Private Partnership (PPP) format DMRC (Delhi Metro Rail Corporation) prepared the master plan for Mumbai metro Private party Reliance Energy Ltd

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Mumbai Metro
Risk Allocation

Risks borne by MMRDA

Land acquisition Force Majeure Environmental Political & social

Risks borne by Private party

Design & Construction Operation & Maintenance Subcontractor Financing Revenue Financial Technology Project completion Environmental
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Mumbai Metro
Risk mitigation by MMRDA Risk mitigation by Private party

Detailed feasibility study carried out by TEWET in association with DE-Consult & TCS, during 1997-2000 Plan updated by MMRDA in 2004 Clearances obtained beforehand Deep political backing by GoM

35 years Concession agreement with MMRDA Contractual & legal shield Capital contribution of Rs 650 crores with a 70:30 debt-equity ratio Independent parties assigned the review and monitoring job Technical consultants appointed for planning & reviewing the engineering & construction phase Insurance coverage for certain Force Majeure
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Agenda
Overview of Risks in PPP Contracts Types of risk Mitigation strategies Case Studies Mumbai Pune Express way Mundra Port Mumbai Metro Conclusions

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Conclusions
PPP Projects are complex projects that require effective attention to risk and their mitigation Risks are inherently related to returns and the service/expertise which yields those returns This gives a good perspective on who is best placed to bear the risk Objectives of the government in taking up a ppp project is essential to decide who bears a particular risk PPPs in Western India Very active as compared to other parts of the country and ever increasing activity Activity is mainly confined to transportation sector However some landmark projects have failed because risks were not properly identified

Some General Principles in Risk Management Thoroughness in identification of risks Lessons from similar projects Should be borne by party best placed to bear it Quantification of financial impact to the extent possible Thoroughness of documentation J

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Thank You!

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