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Cairo University

Faculty of Engineering

Department of Construction Management

Paper Titled:

Risk Management for PPP Highway

Infrastructure Projects: An Investors Review

By: Mahmoud Ali Elhisnawi

Supervised by:

Dr.

2012

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Introduction:

Public private partnerships (PPP) are, in general, agreements between two

parties, the public and the private sector, for delivery of services which were

traditionally provided by the public sector. These partnerships serve as a model for

overcoming budgetary shortfalls, i.e. for filling the gap between services required by

the society and available funds for delivery of those services [1].

Transport is one of major sectors in which the implementation of these types

of agreements has become a common approach in resolving the infrastructure

issues Revenue generating projects like toll roads were usually funded by the

public sector, while the private sector was involved mainly in several phases of

project’s life like construction of the highway section or scheduled

maintenance work. However, PPP agreements enable the private sector to

participate in the project delivery through several crucial phases like design,

building, finance, and operation or build-operate-transfer (BOT) scheme which

is one of common PPP models. For providing these services, the private sector

is usually entitled to collect tolls from users, although the public sector may

provide an annual payment directly to the private sector proportional to the

highway traffic volumes [2].

Considering long term obligations between contract parties, which are

for highway PPP projects, i.e. concessions, usually 25 to 30 years, and complex

nature of this type of projects with number of associated risks, there is a need

for contractual flexibility which will provide a right for a change in investment

decision depending on the project’s future performance. Application of real

options theory in road PPP projects enables this kind of flexibility thus increasing the

project value, and better share between parties of project’s risks.

In this paper, focus is on risk management for PPP Highway Infrastructure

Projects from investors prospective. It also, presents a process model for risk

management including identification, assessment, allocation, monitoring and control

of risks over the whole lifecycle.

Goals and Objectives:

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1. To identify the risks occurred through the partnership of Public – Private

Sectors work.

2. To identify the types of risks.

3. To propose the optimal solutions might help the decision makers involved

in the partnership to avoid the risks.

The PPP Concepts:

Governments in most developing countries face the challenge to meet the

growing demand for new and better infrastructure services. As available funding from

the traditional sources and capacity in the public sector to implement many projects at

one time remain limited, governments have found that partnership with the private

sector is an attractive alternative to increase and improve the supply of infrastructure

services. The partners in a PPP, usually through a legally binding contract or some

other mechanism, agree to share responsibilities related to implementation and/or

operation and management of an infrastructure project. This collaboration or

partnership is built on the expertise of each partner that meets clearly defined public

needs through the appropriate allocation of [5].:

Resources

Risks

Responsibilities, and

Rewards

The term of Public-Private Partnerships (PPPs) has been interpreted widely in

the literature to encompass any arrangement between the government and private

sector to deliver services to the public. Although there is no unified definition of

PPPs, all definitions have common features or characteristics [1], such as the potential

for synergy, the development and delivery of a strategy or a set of projects or

operations, and the social partnership [4]. In this study, PPPs refer to a complex long-

term contractual arrangement involving the provision of services that require the

construction of infrastructure assets (Anonymous, 2004). The PPP has also defined as

a long-term contractual arrangement between the public and private sector where

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mutual benefits are sought and where the private sector provides operating services

and/or puts private finance at risk [6].

What advantages PPPs may provide?

Governments worldwide have increasingly turned to the private sector to

provide infrastructure services in energy and power, communication, transport and

water sectors that were once delivered by the public sector. There are several reasons

for the growing collaboration with the private sector in developing and providing

infrastructure services, which include:

• Increased efficiency in project delivery, and operation and management;

• Availability of additional resources to meet the growing needs of investment

in the sector; and

• Access to advanced technology (both hardware and software).

How a PPP project is different from a conventional project?

There are significant differences between a conventional construction procurement

project and a PPP project that need to be clearly understood. The main differences

include:

• PPP projects are different from conventional construction projects in terms

of project development, implementation, and management. The

administrative and approval processes in the case of PPP projects are also

different.

• A PPP project is viable essentially when a robust business model can be

developed.

• The focus of a PPP project should not be on delivering a particular class/type

of assets but on delivering specified services at defined quantity and levels.

• The risk allocation between the partners is at the heart of any PPP contract

design and is more complex than that of a conventional construction

project. Both partners should clearly understand the various risks involved

and agree to an allocation of risks between them.

• A PPP contract generally has a much longer tenure than a construction

contract. Managing the relationship between the private company and the

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implementing agency over the contract tenure is vital for the success of a

PPP project.

Models of PPP :

A wide spectrum of PPP models has emerged. These models vary mainly by:

• Ownership of capital assets;

• Responsibility for investment;

• Assumption of risks; and

• Duration of contract.

The PPP models can be classified into five broad categories in order of

generally (but not always) increased involvement and assumption of risks

by the private sector. The five broad categories are:

• Supply and management contracts

• Turnkey contracts

• Afterimage/Lease

• Concessions

• Private Finance Initiative (PFI) and Private ownership.

The basic features of these five categories of PPP models are shown in figure (1).

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Fig.(1): Basic Feature of PPP Models [3]

RISK CATEGORIES

Identifying and sharing risk in PPP projects are essential for the success of the

partnership and project. Risk is something that creates or suggests a hazard, which

might include delays in construction schedule and cost overruns. A significant feature

of the PPP approach is that while the allocation of risk is to the partner (private or

public) most able to manage that risk, however no party is immune from risks

entirely. Understanding and addressing the risks of a PPP project early on is essential

for the success of the partnership both (Public and Private sector) in PPP Project.

Here some of the risks involved and actions that can be taken to mitigate them.

Investors would desire to invest in a project only if the risks in the project are less

than the reward which the project fetches.

PPP projects carry several risks that are unique to this type of delivery system

in addition to the risks associated with more traditional assignments. Some of the risks

in PPP are [7]:

1. Market and revenue risks.

2. Design risks

3. Construction risks

4. Operating risks

5. Financial risks

6. Political risks

7. Legal risks

8. Environment risks

9. Force Majeure risks.

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These above risks were categorized in following figure (2):

Fig. (2): Risks in PPP Projects

Source: designed by the Author

1. Market and Revenue risks:

Revenue risk is the uncertainty in relation to the revenue that a project would

actually generate. The market and revenue risks that a PPP project may face can be

grouped into the three broad areas discussed below.

Force

Majeure

risks

Environment

risks

Legal risks

Political risks

Financial risks

Operating risks

Construction

risks

Design risks

Market and

revenue risks

Risks

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i. Insufficient Income from Fares or Tolls:

In the case of a PPP project operating under a government concession, it

would be expected that the concession company would request a cash

compensation from the government for a deficiency in income from fares or tolls,

request authority to increase tolls or fares, or extend the concession period. Here

it is necessary to identify its risks clearly with respect to cash flow or its returns,

as they may be affected by an extended concession period.

ii. Insufficient Income from Other Operations:

In this risk, similar opportunities exist for requesting the government to

provide cash compensation for deficiencies and/or extending the concession

period. In addition, the concession company would have opportunities to increase

rents or pursue different business strategies, including alternate uses of major

portions of the concession facility.

iii. Insufficient Traffic:

It is important for the PPP contractor to obtain a commitment from the

government, to the extent possible, with respect to anticipated traffic levels and to

negotiate a sufficient compensation arrangement for deficiencies. In the event

that the government has not offered to provide such additional compensation,

needs review its role carefully as it relates to traffic and earnings forecasts for a

PPP project.

2. Design Risks:

This risk relates to any defect in the design of the infrastructure facility or the

design requirements stipulated for the project. This is an inherent risk in the project as

it is very difficult to conclusively ascertain that damage to the facility is actually

caused due to the defect in the design parameters or the very design itself. Generally it

is the design contractor who is responsible for the design aspects of the project. In the

event of the design parameters being stipulated by the grantor of the concession or

license, the risk would be within the control of the grantor.

3. Construction Risks:

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The construction risks are essentially a bundle of various individual risk

factors that adversely affect the construction of a project within the time frame and

costs projected and at the standards specified for the facility. Construction risks are

associated with PPP projects, more traditional construction projects and the simpler

forms of design/build projects. They include:

i. Land Expropriation.

These risks may flow to both the government and concession company.

Available actions include claims under expropriation legislation or claims by the

concession company of liquidated damages from the contractor.

ii. Cost Overruns and Time and Quality:

These risks affect the concession company directly. The available actions

are to either claim liquidated damages from the contractor or draw down standby

finance from the project lenders. (A major issue is that design requirements in

PPP projects are different than those for a traditional owner.)

iii. Cost and Scope of Identified but Unspecified Work and Variations:

These risks flow directly to the contractor and the concession company

and represent a potential area of future disputes.

iv. Increased Financing Costs:

This risk flows directly to the concession company, which may attempt to

mitigate the risk either by a new injection of equity or subordinated debt from the

sponsors. Alternatively, the concession company may draw down standby finance

from project lenders.

v. Contractor Default:

This is a risk to the concession company, which may claim liquidated

damages from the contractor or make a claim against the contractor’s

performance bond and bonding company.

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vi. Default by Concession Company:

This is the flip side of the prior risk. This risk is to the contractor, with

the primary mitigating measure being claim of liquidated damages from the

concession company.

vii. Environmental Damage:

This risk accrues to the concession company primarily and may result

in claims on insurers or the party causing the damage.

viii. Force Majeure Event:

This risk accrues to the concession company primarily and would

result typically in a claim to the project insurers.

4. Operating Risks:

Some of the risks that we may face in a PPP project apply also when we are

providing operations and maintenance (O&M) -type services. Except for termination

of the concession by the concession company, these risks flow directly to the

concession company. Some of the risks and actions available to the concession

company include:

a. Performance risk: The completed facility cannot be effectively operated or

maintained to produce the expected capacity, output or efficiency.

b. Operation cost overrun: The operating costs exceed the original estimates

c. Operating Contractor Default: The concession company may terminate the

operations and maintenance contract and appoint a new O&M contractor

d. Force Majeure or Environmental Damage: In this type of event, the

concession company would most likely place a claim with its insurers because

risks of this type would be normally insurable.

e. Default: The default may be caused by the actions of a third party, in which

case the concession company could make claims of damages against that

party.

f.

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5. Financial Risks:

a. Exchange rate risk:

Relates to the possibility that changes in foreign exchange rates alter the

exchange value of cash flows from the project. Prices and user fees charged to

local users or customers will most likely be paid for in local currency, while the

loan facilities and sometimes also equipment or fuel costs may be denominated in

foreign currency. This risk may be considerable, since exchange rates are

particularly unstable in many developing countries or countries whose economies

are in transition. In addition to exchange rate fluctuations, the project company

may face the risk that foreign exchange control or lowering reserves of foreign

exchange may limit the availability in the local market of foreign currency

needed by the project company to service its debt or repay the original

investment.

b. Interest rate risk:

Force the project to bear additional financing costs. This risk may be

significant in infrastructure projects given the usually large sums borrowed and

the long duration of projects, with some loans extending over a period of several

years. Loans are often given at a fixed rate of interest (for example, fixed-rate

bonds) to reduce the interest rate risk. In addition, the finance package may

include hedging facilities against interest rate risks, for example, by way of

interest rate swaps or interest rate caps.

6. Political Risks:

The project company and the lenders face the risk that the project

execution may be negatively affected by acts of the contracting authority

(Government), another agency of the Government or the host country’s legislature.

Such risks are often referred to as political risks

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Nationalization of project

Changes in law

Development approvals

Adverse government action or inaction

Payment failure by government

Increases in taxes

Political force majeure (including changes in government)

Termination of concession by government (or unplanned competition).

7. Legal Risks:

Some of the legal risks that a PPP project can face are related to:

Title/lease of property

Ownership of assets

Corporate and security structure

Financial failure or insolvency of concession company

Breach of financing documents

Enforceability of security.

8. Environment Risk:

These are risks relating to occurrence of environmental incidents during the

course of implementation of the project. These risks are generally within the control

of the construction, and the operation and maintenance consortium. This risk has

increased due to the presence of strict legal liability in relation to such environmental

incidents, which can result not only in adverse affects on the financials of a project

but may also cause a closure of any work or operations of and in relation to the

facility.

9. Force Majeure Risks:

These risks are regarding the events that are outside the control of any party and

cannot be reasonably prevented by the concerned party. These risks generally arise

due to causes extraneous to the project. The defining of force majeure events, these

include:

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Natural force majeure events

Direct political force majeure events

Indirect political force majeure events

a. Natural force majeure events: It comprise of all events that can be attributed to

natural conditions or acts of God such as earthquakes, floods, cyclones and

typhoons. These risks should be shared equally among the parties.

b. Direct political force majeure events: They are events attributable to political

events that are specific to the project itself such as exploration, nationalization.

c. Indirect political force majeure events: They are events that have their origins

in political events but are not project specific such as war, riots etc.

However, the mechanism of managing and mitigating such risks cannot be

categorically stated as they vary with each project and the circumstances surrounding

each project.

PEST framework of risk factors could play an important role for developing

risk management strategies. To develop a risk framework (PEST) by categorizing PPP

risk factors into four groups: Political, Economic, Socio-Cultural and Technical

The risks can be properly allocated by preplanning and sharing resources

between the parties involved. The public agencies primarily assumes risk during the

project scope and definition and are primarily responsible for activities associated

with environmental clearance, right of way acquisition, conceptual engineering,

forecasting demand and revenue, financial feasibility analysis, agency permitting,

political and stakeholder commitment and any necessary enabling legislation.

Li et al. (2005) has conducted a survey on risk allocation FROM Investor's

View showed that the political risks should be retained by the public partner and most

of the project-specific risks should be allocated to the private partner. The risk factors

such as force majeure and changes in law should be shared by both parties. The risk

allocation strongly depends on specific project circumstances like the level of the

public support, project approval and permit, the contract variation and the lack of

experience with PPP. A standard model of risk allocation is not possible, because

projects differ widely [3].

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Table (1) shows the risk factors categorized in the PEST framework. This

table also shows which party (public, private or both) bears the risks. For example,

direct political risk is categorized under Political (P) risks which the public sector is

mostly responsible for. Most of the technical risks related to project management lie

in the contractor's part, hence the private party bears these technical risks. This may

vary according to project type and size. For example, in the 772 Malaysian Highway

Project, the construction risk was shared due the complexity and geotechnical risk of

the project. Both the public and private parties bear the risks categorized under the

socio-cultural, for example risk factors such as moral hazard, environmental and

environmental justice. This will allow the different parties to know where most of the

risks lie, and which party the risks are associated with.

Table (1): Categorization of risks under PEST along with party

bearing the risk [8]

PEST RISK PUBLIC PRIVATE SHARED

Po

liti

ca

l R

isks

(P)

Direct political X

Political Decision making X

Competing facilities X

Regulatory Protectionism X X

Legislation change X

Eco

no

mic

Ris

ks

(E)

Pre-investment X

Tolls Revenue X

Financial X

Cost overrun X

So

cio

-Cu

ltu

ral R

isks

(S)

Public opinion X

Environmental X

Moral Hazard X

Partnering X

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Environmental Justice X T

ech

nic

al

Ris

ks

(T)

Project management X

Construction X

Design and latent defect X

Environmental X

Technology X

Force majeure X

Physical X

As the PEST framework suggests, the risk factors as shown in Table (1), can

also be categorized according to which phase the risk lies in. The four phases of

construction are Planning, Pre-construction, Construction and Operation and

Maintenance [9]. Table (2) shows the categorization of risk factors into phases of

construction where the risk is most likely to occur. The Planning phase is the first

stage of construction project which includes the identification of the location and pre-

design of the building or facility. In this stage, the project details are not yet defined

and environmental reviews are incomplete. The public support and funding is also not

committed in this stage. The risks include uncertain political and public support and

competing interests and competing projects. The Pre-construction phase involves

defining project goals (project scope, cost and schedule well defined), environmental

reviews, initial approvals such as those of construction approvals, including permits

and agreements. The issues include the land uses risks, changes in design

requirements, environmental issues that could build up during the project, funding

uncertainty, market conditions and permit requirements. The Construction phase starts

when the design is complete along with the funding and policy. There could be issues

of contractor performance, construction quality, technological advancement, final

permitting, and changes in design and unanticipated site/working conditions. Once all

construction is complete, the operation and maintenance phase of a construction

project begins. This is a stage where there could be risk of whether the toll revenues

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will be enough to recover the cost of the highway project or not and risk of

environmental issues lie.

Table (2): Risk factors from PEST framework into different phases of construction

Planning Pre-Construction Construction

Operation &

Maintenance

Political Risks

Direct Political

Political Decision Making

Protectionisms

Legislation Change

Regulatory

Competing Facilities

Economic Risks

Pre-Investment

Tolls Revenue

Financial

Cost Overrun

Socio-cultural

Risks

Public Opinion

Land Uses

Moral Hazard Environmental

Partnering

Environmental Justice

Technical Risks

Project Management

Construction

Design and Latent Effect

Technology

Force Majeure

Physical

Table (2) shown the Risk factors from PEST framework into different phases

of construction. The PEST framework also proposes that the risk factors can show

risk dependencies within the category. The state diagram has been implemented to

show the dependencies of each risk factor within the category. State diagrams are

used to describe the behavior of a system [10]. State diagrams describe all of the

possible states of an object as events occur. State diagrams are mostly used in

computer science to describe behavior of systems.

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CONCLUSIONS

The primary motivation for using PPP is due to the failing of the traditional

approach to adequately fund transportation project delivery. One of the major benefits

of using PPP projects is that the risks involved can be managed by allocating expected

risks to the party who is best able to manage them. The risks identified during the PPP

highway construction projects are categorized in PEST framework based on Political,

Economic, Socio-cultural and Technical risks. The PEST framework categorizes the

different risk factors according to parties responsible for risk management; different

phases of construction: planning, pre-construction, construction, or operation and

maintenance or; project types: greenfield or brownfield; and according to risk

dependencies: independent, contingent or mutually exclusive. By illustrating risks

according to types of projects, phases of construction and risk dependencies gives

visual understanding of risk distribution for contingency planning. The risk

categorization can help practitioners on evaluating risks as a category and devise

common risk mitigation strategies adding value to risk analysis.

The analytical tools such as influence diagram and state diagram further expands in

analyzing the risks identified by visual representation. The PEST framework when

analyzed based on these tools helps identify the risks impact and dependencies. This

categorization of risk factors can also help identify the parties involved (public or

private) that assume the most risk based on different phases of highway construction

and the type of risk involved within it.

Due to the lack of substantial project quantitative data, this paper is limited to

assumption of possible risks and its dependencies during a PPP project. Mixed

methods of data collections including surveys can be used to quantify the risk factors

and determine the probabilities of risk occurrence. Further studies could also include

the risk analysis of the data that are outcome of the risk factors which have been

categorized in the four groups in this research.

References:

1. Nevena Vajdić. (2011), " Risk Management in Public – Private Partnership

Road Projects using the Real Options Theory", International Symposium

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Engineering Management And Competitiveness, June 24-25, 2011, Zrenjanin,

Serbia.

2. Mustafa.A. Benhkoma & Mahmoud Elhisnawi, "The Contractual

Arrangements in Construction Projects and the new trends towards the

execution of the project using B.O.T", Tripoli: Dar Elfusiafasa, 2011.

3. Li, B., Akintoye, A., and Cliff, A. (2001). “Value for money and Risk

Allocation Models in Construction Public Private Partnerships Projects.

4. http://www.pppcouncil.ca/aboutPPP_definition.asp). Accessed: 2012.04.13.

5. McQuaid, R.W., 2000, The theory of partnership: Why have partnerships. In:

Public private partnerships: theory and practice in international perspective,

edited by Osborne, S., (New York; London: Routledge), 9-35.

6. Garvin, M. J. and Bosso, D. J. (2008). “Assessing the Effectiveness of

Infrastructure Public-Private Partnership Programs and Projects”, forthcoming

in Public Works Management & Policy.