Risk Management - Port Project

Chapter 4 cont...

4.6 Risk Management

Private financing of Port projects hereto has been very rare as it is full of risk and requires a lot to be done to promote better risk and requires a lot to be done to promote better risk sharing, accountability, monitoring and management. In some sectors like Power and Telecommunication, the scope is much more compared to that of Port and Roads.

A typical Port project runs through three phases:

• Engineering and Construction Phase
• Start-up Phase
• Operations Phase

In the first phase of Engineering and Construction, the amount of risk begins to increase sharply as funds are advanced to purchase equipments and materials. Interest charges on loans also start to accumulate.

The Start-up phase is associated with cost and time overruns. Successful commercial operation culminates in finally proving the correctness of the feasibility report. The risk is at its maximum in the Start-up phase.

A successful Operating phase brings down the risk as repayments start and liability gets reduced gradually. Analyzing the various type of risks in a Port project, we have the following:

(1) CREDIT RISK: Proper financial appraisal with sensitivity analysis to indicate extent of cushion is important. Though debt equity ratio of 4:1 is permitted, it is advisable to have equity involvement of all connected parties so that debt equity level of 1:1 is maintained. To minimize the credit risk, worst case scenarios must be considered and contingency plans prepared accordingly.
(2) SUPPLY RISK: There is a high degree of risk in projects with respect to uninterrupted supply of key inputs and against price escalation. A long term ‘supply or pay’ contract or ‘put or pay’ contract would assure regular supply of the inputs. Such long term supply contracts can also be made transferable so that it can act as a security document to the leading institution, besides minimizing the supply risk.
(3) MARKET RISK: Financial success of a project depends upon the existence of a market for the product and anticipated cash flows. Long-term buying contracts in the form of ‘take or pay’ contracts or ‘take and pay’ contracts are useful. In ‘take or pay’ contracts, the obligation of the purchaser to pay is unconditional, even if the product, commodity or service is not delivered. In a ‘take and pay’ contract, the obligation of the purchaser to take the product only if it is delivered. Take or pay contracts are tantamount to guarantees of a stream of revenue if drafted carefully. In a road project, we have a tolling agreement or what is called a ‘through put’ agreement wherein a minimum pay contract, an all events tariff or a deficiency agreement is used.
(4) RISK OF SUITABILITY OF CONTRACTOR AND OPERATOR: The contractor must possess technical expertise and financial strength. Ideally it should be a company, which has undertaken similar projects in the past. A lender must have a say in choice of suitable contractor. Similarly, the operator must have the technical and financial expertise to operate the project as per the financial feasibility of the project.
(5) CURRENCY AND FOREIGN EXCHANGE RISK: As Port projects require huge funding, there is a strong need for seeking cheap foreign currency borrowings. But with devaluation, the repayment burden becomes very costly unless the project has some foreign exchange revenue as a natural hedge. Hence foreign currency borrowing can be resorted to in a port project where future revenue in foreign exchange is possible.
(6) RISK OF COST OVERRUN: Cost overrun is quite possible in such projects. Unless this is tied up from the beginning, it puts the entire project in jeopardy and the responsibility for completion with additional finance comes upon the lender. This aspect has to be covered by various methods such as,
(a) Assurance of putting in additional capital if need be by the sponsor. The lender should satisfy himself about the capability of the sponsor to this effect.
(b) The lender should also be prepared for a standby credit facility in such eventuality.
(c) Cost overrun can also be guarded against by entering into fixed-price contracts or turn-key contracts from the suppliers.
(d) Maintaining an ESCROW account for the funds required for completion, so that the funds are utilized for the specific purpose of completing the project and not otherwise.
(7) ENVIRONMENTAL RISK: Infrastructure projects can affect the environment through,

• Deforestation and felling of trees
• Atmospheric pollution by emission
• Site contamination
• Resettlement of inhabitants at the site

(7) POLITICAL RISK: Inadequate clarity of government policies and selection of entrepreneur are the major political risks.

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