R.

Kannan
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MODULE - 2
RISK EVALUATION IN PROJECTS
Structuring cannot be made with weak counter parties
High risk projects are those with earnings volatility
and not necessary low return projects
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Oman India Fertiliser Project (OIFR)
Promoters IFFCO
KRIBHCO
Scope Production of ammonia, urea
Oman Government to supply gas at 1/5
th

of the Indian price
Products to be imported by IFFCO &
KRIBHCO
Problem Urea prices are volatile and range from
$80 to $200/tonne.
The breakeven price is $120/tonne
How to protect lenders?
Oman-India Fertiliser Company S.A.O.C.
(Project Company)
Closed joint stock company
Ministry of Chemical & Fertilisers
Government of I ndia
Urea Offtake Agreement
Ministry of Oil & Gas
Sultanate of Oman
IFFCO
69% GOI owned
Gas Supply Agreement Excess Ammonia Offtake
Agreement
Personnel Supply Agreement
Turnkey EPC Contract Technical Services
Agreement
EPC Joint Venture Company
(EPC Contractor)
IFFCO
69% GOI
KRIBHCO
67% GOI
IFFCO
69% GOI
KRIBHCO
67% GOI
Snamprogetti
SpA, I taly
Technip-Coflexip
France
50% 50%
Oman India Fertiliser Project Structure
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KRIBHCO/
IFFCO
OIFP
OMAN
Government
DSRA
DSRA
Receivables
Sale of Urea
Excess/Shortfall
Over $120/T
Shortfall/Excess
Over $120 / T
Operating expenses
Lenders liabilities
Oman Govt. dues
Dues of KRIBHCO/IFFCO
DSRA = $40 million (max.)
Risks - Price
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Financing of Blue Sky Project
Project: Upgrading refineries of Petromina for production of
unleaded gasoline for domestic market to reduce
pollution
Structure: Offshore trustee borrowing structure
Sponsors: Petromina, Indonesia
Project Cost: $280 million
Project Debt: $200 million
Lead Arrangers: Mitsui & Co ($120 million from JBIC)
EPC Contractor: Toyo Engg.
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Financing of Blue Sky Project
Features: Mitsui offtakes certain products (not
gasoline) from Petrominas existing five refineries,
and pays the proceeds in $ to an Offshore Trust
established by JP Morgan and Petromina. The debt is
repaid through a priority waterfall mechanism. The
Offshore Trust is in New York.
Construction Risk: Absent as debt service is not
related to completion of the project. Not serviced
through sale of products from the project.
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Agreements
1. Loan Agreements between the
Lenders and the Trustee
Loan provided to offshore trust
established by JP Morgan and
Petromina at New York. This
receives sales proceeds from
Mitsui & Co and used to repay
debt.
2. Product sales and purchase
agreement between Petromina
and Mitsui
Petromina to supply certain
products from its existing
refineries to Mitsui. Mitsui pay
the proceeds in $ into the trust
3. Trust agreement between
Petromina and Trustee
Appointment of a Trustee in
New York who enters into a loan
agreement with lenders and
avails of the loan
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Agreements
4. Operators Agreement between
Petromina and lenders
a) Cash shortfall undertaking
by Petromina
b) Undertaking to enter into
various agreements
5. EPC Contract Agreement to supply machinery
and technology
Risk Mitigated Political risk, Exchange risk, Construction Risk
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Risk Mitigation
1. Trustee borrowing structure
2. Five refineries located at different locations
3. Debt repayment even before operating
expenditure/capital expenditure
4. Presence of JBIC
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PERTAMINA



5 Refineries
including Cilacap
and Balongan
1. Cilacap Refinery
2. Balongan Refinery
Plant Construction
EPC
Mitsui Trustee
Excess Cash
Sale Proceeds of
LSWR/Decant Oil
Long term Offtake
Of LSWR/Decant Oil
Special Purpose Vehicle
(established by Mitsui)
Commercial Banks
JBIC
Repayment Loan
Repayment Loan
Payment
of EPC
Cost
Lenders
Risks: Political
Exchange
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Project Financing Phu My3 company in Vietnam
Project: Power plant of 715MW
Sponsors: British Petroleum
Sembcorp Utilities
Kyushu Electric Power
Nissho Iwai
Features: Build Operate Transfer (BOT)
Concession 23 years
Gas supply agreement with Petro Vietnam (PV)
Power Purchase agreement with Electricity of
Vietnam (EVN)
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Features: Currency conversion / transfer agreement with
Vietcom Bank (Bank for Foreign Trade in
Vietnam)
Applicable law Singapore / rules of International
law for all agreements
EPC Contract / O&M contract with Siemens
Cost: $412M
Debt / Equity: 3 : 1
Debt Providers: ADB - $40M, JBIC - $99M, Bonds - $170M
Project Financing Phu My3 company in Vietnam
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Power Purchase Agreement (PPA)
Capacity charges to cover fixed charges plus equity
return
Variable cost covered by energy charges
Gas cost plus penal charges under gas supply
agreement due to offtaker
Capacity Utilisation 88%
Linking of power tariff to gas price
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Government Guarantees and Undertakings Agreement:
Government Guarantees
Full repayment of debt if contract is terminated by
Government / default or breach by Government / Force
Majeure
Government if needed will substitute the project company
if agreement is breached
Guarantees for performance of EVNs PV
Continuity of local taxation to be applicable for project
Currency conversion and remittance
Assurance on nationalisation / expropriation
Exemptions from certain Vietnamese laws and
compensation for law change
Risks - Price
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Financing of a new stadium for St.Louis cardinals
Promotors Cardinal base ball club
Advisers Bank of America Securities sports finance
Amount - $200.5 million private placement bond debt
Features - 20 year financing
cost $ 330 million
$130 million from St.Louis country / city of St.Louis
Construction of a Major League Baseball
(MOB) stadium
Financing aided by monetizing Contractually
Obligated Income (COI) (i.e) naming rights, luxury
suites, sponsorships, multi year contracts, club
seat premiums.
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Traditional Securitisation
Sponsor
SPV
Investors
Generates and sells receivables
Purchase proceeds Sale of receivables
Loan / purchase proceeds Transfer of interest in receivables
This keeps sponsors financial transaction away from the deal through a dummy SPV
though sponsor company originates receivables by performing contracts
Isolate receivables from the bankruptcy / credit risk of the sponsor
But if sponsor who is also an executor becomes bankrupt COI would be affected
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Structure 2
Investors SPV
Lessor
St.Louis Cardinals
LLC
Loan proceeds
Security Interest
License to play Base ball
Ground
Lease
Owns exclusive rights on
dedicated property and generates
contracts / receivables and COI
1. Acts as servicing and marketing
agent for SPV
2. Agrees to play at the stadium
Dedicated property means those that originate COI
rights to naming, conduct activities, license luxury suites
And club seats, sponsorship rights.
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In case St.Louis cardinals LLC fail, SPV can always look for
another party to take over the role. St.Louis cardinals is only a
service provider.
But in the original securitisation, since sponsors originates
receivables, the failure of sponsor would end the transaction.
Another alternative is a owners trust (any sports franchise
owner) taking the ground on lease and sub-lease it to SPV
with all rights. SPV transfers its interest dedicated property
through owners trust to investors and loans provided to
owners trust.
In this case debt could be less as sponsors equity would be
there.
Risk - Promoter
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Oil / Gas Monetisation Structure
DSRA
FD/Investment
T&R A/C Gujarat Gas
SPV/GSPC
Operator
Bank
Interest Income
Top up
of DSRA
Shortfall
Receivables
Sale of Oil /
Gas
Sale of receivables
Advance purchase
consideration
Debt service Capex
Opex
GSPCs A/C
Risk Bankruptcy risk
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Shipyard Finance
Shipyard Bank
Platform hire
company
Sponsor
Oil production
company
Loans / Guarantees
Platform
credit sale
Guarantee fee / principal /
interest / assignment of oil
revenues
Equity
Profit
Hire payments
assignment of
revenues
Platform hire
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Captive Leasing Company
Manufacturer Captive lessor Lessee
Bank
Asset sale
Cash 100%
Lease agreement
Assets
Loan
Assignment
of lease
proceeds
Deposit
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Financing of Iduapriem Gold Mines in Australia
Minproc Engineers, Australia
Feasibility study
Iduapriem
IFC
Senior debt/non recourse
Subordinated debt
Standby facility
Banks
Hedging 1/3
of production
of Gold
Equity 20%
Construction
contract
Sponsors
80%
$60.4 million
$8.4 million
$38.4 million
$17 million
$5 million
$30
million
(Syndicated by IFC)
1. IFC is a equity investor, standby debt facility provider, senior debt lender and mezzanine lender.
2. The subordinate debt had royalty linked to Gold prices above $350 / ounce raising to 8% when
Gold in US $450 / ounce.
3. 50% of excess cash flow above $20 million / annum. Mandatory prepayment in inverse order of
maturity
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Gold Warrants
Banks
Guarantee
Loan
Placer Pacific
Placer (Barbados) Misima Mines P Ltd
Political risk
Guarantee
EDC, Canada,
EFIC, Australia
Standby Gold loan Equity
Misima Mine
20% Government
5 year gold
warrants
Redemption
80%
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Structure of Power Projects
Promoter
Company
Equipment
Supplier
Equity
Lenders
Fuel
Supplier
Contractor
Fuel
EPC
Contract
Electricity
Board
PPA
Trust & Retention A/c
Debt Reserve
Loan Repayment
+ Interest
Guarantees from
State/Cent. govts
Overflow
Revenues
Excess
Profits
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Gas Monetisation
Trust RIL
T&R A/c
IOC/GAIL
FDs/Investments
Liquidity A/c
Investors
Operator
RILs A/c
Pledge
Interest
Income
Shortfall
Undertaking to
pay capex/opex
Supply of
Oil & Gas
Debt
Service
Sale of
receivables
Receivables
Overflow
Opex/capex (in
the event of
default by RIL)
Topping up
of shortfall
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Pipeline Financing Structure
Refinery
Pipeline
Company
Off-Taker FIs & Banks
Strategic
Investor
EPC
Contractor
Pipeline
Sponsor
Product
purchase
Equity
Equity
contract
Use of pay
contract
Joint Venture
Agreement
Equity
Loans
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Project Risks
Risks
1. Project Completion
Risk
Impact: Cost / time overrun increases interest during construction, loss
of revenues, and penalties to input supplier / off taker. Project
becomes non-viable. The largest items of project cost are the EPC
(Equipment) and Finance charges. The lenders are most
vulnerable if overrun occurs.
Mitigation:
1. Ensuring the promoter is resourceful / experienced in the relevant
field / ability to raise equity. The project size should be in line
with his resources.
2. Selecting an experienced and financially resourceful EPC
contractor.
3. Ensuring that the financial tie up is complete.
4. Confirmation that the project has obtained all regulatory
approvals.
5. Appointment and review of the project by a lenders engineer.
6. Having LSTK / EPC type of contracts (i.e.) Fixed Price Contracts,
with performance bonds and liquidated damages.
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7. Tying up infrastructure; Grid connection for power
evacuation, road connection to ports, receiving
terminals for pipelines; Relocation
8. Ensuring completion of land acquisition / Right of
way for pipeline
9. Having sufficient contingent debt and equity in
escrew account
10. Equity stake from contractor
11. Sponsor support completion guarantee / limited
overrun finance guarantee. The guarantee can be
upto a date, has a ceiling amount or stops attaining
satisfactory D/E or DSCR ratios.
12. Predisbursement conditions
Promotors contribution to be brought upfront
Finance tie up
Government clearances
13. Undertakings
- Contingent equity in escrew account
- Completion guarantee
- Standby credit guarantee
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13. Adequate contingency provision in the project cost
Unforeseen
Items likely to have been left out
Items where full data is not available
Price escalation
14. Loss of profit insurance
15. Arms length contractual agreement with promotors. If
sponsors have contractual relations their payments are
subordinated to lenders dues (input supply)
16. Sponsors guarantee for interest payment, dividend
plough back and cash shortfall.
17. Delay in start up insurance
18. Strong concession / Government support agreement in the
infrastructure projects
19. Comfort letters stating
Awareness / consent
Policy
Practice
Recognisation of liability / compliance
Cases: Synthetics and Chemicals, Rama Newsprint,
Essar Oil, Spic Petro, Nagarjuna Oil
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Risks
2. Market Risks Quantity Risk; lower demand/larger supply leading to
lower capacity utilisation
Price risk; lower product prices affect profitability
Causes of Market Risk:
a) Low width of the customer base and options for customers
(Explosives Coal; Electrical Equipment State
Electricity Board) and customer dedicated pipelines
b) Entry barriers (Refineries Distribution of products)
c) Inadequate promotion of new products
d) Lack of understanding of the user environment
(Polyester fibre, Potato chips)
e) Competing facilities/nature of the competitors (Bombay-
Pune Highway) (Reliance Polyester, Grasim Viscose
Fibre, Essel Collapsible Tubes)
Project Risks
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Risks
2. Market Risks f) Low value addition
g) Narrow product range/ single product
h) Poor financial position of product offtakers
i) Substitutes (Polymers)
j) Sponsor/company entering a field where their
qualities and success requirements do not match
k) By product disposal Environmental issues
l) Lack of application development for new products
m) Unwillingness to pay for services in the infrastructure
projects
n) Too localised market (housing, retail)
o) In case of Ports, tollways, lack of access roads
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Risks
2. Market Risks
Mitigation:
a) The only dependable mitigation for market risk is to ensure
international competitiveness Interfirm comparison
Leaders (low cost producers, brand leaders) never lose. Tisco,
Nalco, Hindalco, Hero Honda, Bajaj Auto, Grasim
b) A detailed study of the above issues and profitability of the units
operating in the industry
c) Higher value addition
d) Strong binding contracts for offtake and price
e) Equity stake from offtaker/input supplier (cost structure will be
known to them a risk)
f) Study of financials of the offtaker letter of credit and escrew
mechanism.
g) Cycle analysis
h) Special studies Traffic studies Toll road, Jipp curve
Telecom (GNP -vs- Access lines / 100 people)
i) Viability funding by Government in infrastructure projects
Airbus/Boeing, Euro tunnel, Polyester, Noida Toll Bridge, Bandra-Worli Link, Airports.
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Risks
2. Market Risks Contracts:
a) Take or Pay agreements (Power)
Commitment to offtake products of quantity within a
band
With banking
b) Throughput agreements (pipelines)
c) Minimum quantity offtake per month (LNG, Gas)
No banking
d) Market preference contract
Sponsor/company to sell the specified product first
Offtaker gives preference to the company when
everything is same
e) Requirement contract (cogeneration)
Compulsory delivery and purchase (no banking)
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Risks
2. Market Risks Contracts:
f) Tolling contracts (Power)
Offtaker supplies inputs and conversion charges and
offtakes output
g) Advanced sales contract (Oil production)
Procurement of advances against future sales
Securitisation of future sales proceeds.
h) Production payments
Escrewing a part of the sale proceeds for debt service
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Risks
2. Market Risks Contracts:
i) Power Purchase Agreement (special case of take or
pay agreement)
Capacity charge Rs./MVA/Month
Energy charges Rs./Kwh
Operation and Maintenance charges
Return on networth
(Minimum = Debt service + return)
j) Buy back contracts (Minerals)
Sponsor to buyback the product if unsold
k) Long term sales agreement quantity of offtake
guaranteed but not price
l) Shadow toll agreement
In all these contracts, quality of the offtaker / counter
party is important. It needs to have escrew account
and waterfall mechanisms
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Contract Price Structures
Escalation based on index (consumer price index)
Cost based cost pass-through (Fertilizer, Power) (Opex +
Debt Service + Return)
Publically available prices
Benchmarked prices (LNG to crude)
Comparison of alternative options (pipelines to rail, road,
shipping)
Floor, Cap, Collar systems of prices
Cashflow based prices (sponsor is the offtaker)
Fixed prices (decline in real prices)
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Contract Price Structures
Fixed price plus a partial linking to indices ($75 plus
53% CPI escalation or 70% GNP growth)
Put/call options
Linking product price/tariff to debt service
a) CPI based interest and tariff (Bonds)
b) Commodity loans
Equity stake by offtaker/Input supplier (cost structure
will be known to them - a risk)
Cycle analysis
Contract for differences: offtaker agrees for a fixed price
and swaps into a spot price
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Price and demand information
Chemsystems - Petrochemicals
Ferticon - Fertilisers
Steel world - Steel
Petroleum refiner - Crude oil / petroleum products
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Risks
4. Promotors
Risk
Impact: Improper implementation leading to cost and time overrun.
Mitigation:
1. A detailed study of
compatibility of the promotor with the project (cultural fit)
Relevance of the past experience of the promoter
Relationship of promotor and the project (Is he a contractor
Euro tunnel)
Resources available with the promoter vis a vis the projects
size and its requirement of funds
In case of joint ventures, does the joint venture agreement
sets out obligations/rights of the partners and the role of
lenders in case there are disputes. Prohibition of amending
the JV agreement without lenders permission
Provision for contingent equity /debt through bank
guarantees
Ability to implement and operate large projects
Ability to raise equity / debt
Project Risks
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2. Analysis of past results of companies
associated with promotor to study
His financial policies
Quality of accounting
Approach towards financial risk (conservative/
aggressive)
3. Provision in the joint venture for dispute
resolution through buy/sell and lenders
intervention
4. Reference to bankers, customers and suppliers
5. Concurrent auditors for monitoring use of
funds where reports are not conclusive.
6. Ascertaining sources of promotors
contribution
7. Pledge of shares
8. Ascertain details of other projects of promotors
9. Deferment of promotors dues / clawback
Project Risks
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9. Comfort letters from sponsors
Maintenance of ownership
Keep the company in sound financial position
Providing management support
10. Ensure promotors also earn adequately.
Otherwise they will earn through purchases /
sales
Project Risks
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Project Risks
% inflation
Revenues 100 100 100
Expenditure 60 60 60
40 40 40
Repayment 10 10 10
Interest 5 4 3
Net Cash flow 25 26 27
a) Inflation Risk:
5. Financial Risks:
Normally inflation benefits the company / projects if fixed rate loans
are taken unless the product is subject to price control as petroleum
products, drugs and utilities
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Project Risks
10% inflation
Revenues 100 110 121
Expenditure 60 66 73
40 44 48
Repayment 10 10 10
Interest 5 4 3
Net Cash flow 25 30 35
But if debt servicing is in a currency different from revenues, problem
could occur as rapid inflation and devaluation normally go together
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b) Interest Rate Risk: Increase in cost of project;
Volatility in interest leading to loss of viability
Mitigation:
(a) Interest rate swaps: Project company which has
an obligation to pay interest at a floating rate
agrees to pay the Swap Provider (Bank) the
difference between the floating rate and the
preagreed upon fixed rate. If floating rate is
lower, company will pay Swap Provider (SP) and
SP will pay company if it is otherwise
(b) Consumer price index based interest
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Principal 100 100 100
Prime Lending Rate (PLR) 8 9 10
Swap Fixed Rate 10.5 10.5 10.5
PLR Interest at PLR + 2% 10 11 12
Interest Fixed Rate 10.5 10.5 10.5
Floating Rate 10 11 12
Difference (0.5) 0.5 1.5
Receivable / (Payable to Swap
provider)
(0.5) 0.5 1.5
Thus the project company has turned its floating interest
loan to fixed interest at 10.5% per annum
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Features of Swap
a) Average swap rate is a weighted average rate for a series
of swaps covering each repayment. Hence varying
principal amounts are taken into account
b) Basis of fixed rate Government bond rates for the
relevant period
c) Swap market premiums reflect supply and demand in the
swap market / fixed rate corporate bond market
d) Credit risk of the company =
credit margins X % of principal at risk
e) The swap agreement is usually between the company and
one of the consortium lending bankers called fronting
bank as otherwise swap roll over in case of delay in
draw/repayment creates problem

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Features of Swap
f) The fronting bank enters into back to back arrangements
with other swap providers if so desired by company
g) Syndicate of lenders counter-guarantee fronting bank.
Swap Breakage due to default and swap breakage cost
Default in second year by which time fixed rate declines from 10.5% to
9.5%. Bankers enter into a new swap at fixed interest of 9.5%
Principal 100 100 100
Prime Lending Rate (PLR) 8 9 10
Swap Fixed Rate - Original 10.5 10.5 10.5
Swap Fixed Rate Revised 10.5 9.5 9.5
Floating Rate 10 11 12
Interest (Amount)
- Fixed Rate (original) 10.5 10.5 10.5
- Fixed Rate (revised) 10.5 9.5 9.5
- Floating Rate 10 11 12
Difference +ve or (-ve) for swap
- Original 0.5 (0.5) (1.5)
- Revised 0.5 (1.5) (2.5)
NPV of loss (at 10.5% discount) - 3.8
Thus the swap provider looses due to swap breaking if fixed interest goes down.
This is called breakage cost which is 3.8%
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Fixed Interest rate
No interest rate risk but to avoid duration
mismatch on long term loans, bankers usually
provide only floating rare loans.

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c) Exchange Rate Risk: Gap in financial plan. Mismatch
between revenues and expenses leading to loss of viability
(1) Implications if the financing and outlay are in different currencies.
- Change in project cost leading to financing gap
Financing Expenditure Rate Rs./$
Original $100/Rs.4300 4300 43
Revised $100/4100 4300 41
Gap 200
- Change in debt repayment capacity if revenues and
financing are in different currencies. Variation in the
quantum of debt relative to cash flow
(2) Mismatch due to revenues, operating costs and debt being in
different currencies.
Loans
Sale Proceeds
Equipment cost
Repayment/interest
Input cost
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Mitigation:
Use of hedging of principal through currency swaps possible but it is
difficult for long term project loans due to credit risk. Breaking of swaps
is costly
To protect against project cost increase, as far as possible, the currency of
equipment purchase (EPC) and financing currency kept same. Risk passed
onto EPC contractor
To protect against exchange risk in operations, effort to be made to make
the debt servicing equivalent to net foreign exchange earning
Indigenization of components (Auto)
Offshore account subject to RBI regulation
Exchange risk on debt servicing passed on to offtaker provided he is
capable of taking it.
Normally the risk of devaluation is counteracted by inflation benefits. But
timing is the key and some temporary protection is required.
Natural hedge : toll road financing in local currency
: oil production through dollar financing
Pass through tariffs for both capacity and operating charges; check local
affordability
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Risks
d. Funds shortage for project
completion/ servicing loan
in the initial years
(Financial Risk)
a) Provide for cash loss in the initial years in the
project cost itself comparison with similar
projects
b) In case of high business risks, reduce
leverage.
c) Provide for contingent debt/equity.
d) Ascertaining details of funds requirement of
other ongoing projects of promotors
e) 100% tying of funds including promotors
contribution before disbursement
f) Repayment matching cash flows (ballooning
schedules)
Project Risks
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Risks
6. Technology Risk Low capacity utilisation and higher consumption of inputs
leading to the lack of viability. It is important in sectors
like telecom. Quality in mineral projects and short
effective life in software.
a) Ensure a strong project implementation team
b) Involve the lenders Engineer in the project right from
the initial stage
c) Involvement of a local engineering company from the
initial stage
d) Spelling out a detailed vendor development programme.
e) Analysis of experience of other companies which have
utilised a similar technology
f) Application Development
g) Strong contracts with warranties
h) Payment in terms of royalty rather than downpayment
Project Risks
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Risks
6. Technology Risk
i) Lenders engineer to report on competence of EPC
contractor / technology supplier
j) Size of EPC contractor vis--vis the proposed project (max
10%)
k) Credit worthiness of EPC contractor
l) Report of lenders engineer on provenness, obsolescence of
technology, competitiveness of other technologies
m) Experienced O&M operator
n) Equity investment by technology supplier EPC contractor
o) Business interruption insurance
p) High performance bonds, penalties for non performance/
buyout structures
q) A study on the history of technology and time taken for
stabilisation in that industry indicates life of technology
r) For infrastructure projects, strong operation and
maintenance agreement with maintenance bonds.
Project Risks
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Technology Risk

Technology from individuals
Unproven Technology
Changes in Technology
Liquidation of collaborator
Unsuitable raw materials
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Risks
7. Operating risk
i) Cost risk
- Increasing consumption of inputs enhances cost of
production and affects viability
- The only reliable mitigation is ensuring international
competitiveness. Leaders never fail (TISCO, Reliance,
Grasim) as prices fluctuate
- Effective contracts
a) Cost pass through
b) Escalation based offtake contracts
c) Cost guarantee (consumption of inputs, and
operation and maintenance)
d) Subordination of costs like royalty and input costs if
supplied by promotors. The amount payable to
sponsors for land etc. is deferred till positive cash
flow.
Project Risks
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Risks
7. Operating risk
e) Analysis of cost curve. A company with low operating cost
and higher fixed cost is viable with elongated repayment
schedule. Cost curve is production quantity versus cost of
production

- Cash flow controls
- Assignment of contracts
- DSRA / liquidity A/C
- Pledge of shares
- Default triggers
Project Risks
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Risks
7. Operating risk
ii) Management risk
Construction: Driver, time/budget and critical path experience
Operations: Relationship, hands on management, flexible,
focussed and mature person
Project Risks
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Risks
8. Non-availability of
critical inputs and
price volatility
Higher cost of raw materials/other inputs leading to viability issues.
Each industry has certain critical input factors. Power-fuel; oil
exploration reserves of oil and also production decline over
years. Water supply water, mining reserves
Mitigation:
a) Widening the range of suppliers
b) Arresting price volatility through long term supply agreements
c) Integrate manufacture of critical components in the manufacture /
Indigenisation of components (auto)
d) Ascertain the relationship of the prices of input and product
e) Entering into a Put or Pay agreement the input supplier agrees to
supply the fixed quantity of input or pay an amount equal to cash
value of extra cost incurred in purchasing the input over the
contracted cost. These contracts are to be assigned to lenders.
f) Indexed prices
Project Risks
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Risks
8. Non-availability of
critical inputs and
price volatility
g) If promotors are contractors for offtake / input supply
subordination of payment
h) Pass through to off taker (Power, Fertilizers)
i) Hedging
j) Detailed study of reserve risk in oil / minerals / coal
including access to alternate reserves
Finance only proven reserves
Leave a tail of 25% which is difficult or costlier NPV tail
to extract.
k) Special studies on wind for wind farm and water supply for
hydroelectric project
l) Assessing credit worthiness of the supplier, experience,
ability
m) Building up adequate storage arrangements for inputs at site
n) Monitoring supply arrangements such as rail, road etc.
Project Risks
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Risks
8. Non-availability of
critical inputs and
price volatility
o) Many a time, input suppliers are required to provide
collateral/contingent equity as a back up of contract
p) The cost of production of the input supplier is also critical.
A provision to purchase from alternate sources upto a
certain quantity in case it is cheaper is desirable.
q) Banking provisions in the contract
r) Tolling contract
s) Special studies through experts
i) Oil production reserve estimation; production rates and
profile; production costs; oil quality and associated gas over
years;
ii) Mining quality of product
iii) Cost curve analysis (cost versus production) for fuel inputs
iv) Variable production link repayment to production $3 /
barrel.

Project Risks
Example: LNG Contracts, fuel supply agreements, Ancillary
supply contract
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Risks
9. Regulatory Risk Increased cost, stoppage of production, control on sales
price, change in tax / environment laws / informal
price ceiling (petro products), revocation of
concession agreements
a) Study of price control policy (drugs, sugar) to
understand implication
b) Avoid heavily subsided operations (naphtha based
fertliser/power units)
c) Credit policy in case of agriculture dependent
industries
d) Understanding the state government policies with
respect of labour/closing unviable operations
e) Ensuring that the unit is internationally competitive
so that it can resort to exports in case of problems.
Project Risks
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Risks
9. Regulatory Risk f) Understanding local government willingness to reform
g) Ensuring that creditors rights are enforceable in a
court of law
h) Involving multilateral agencies in the consortium
i) Ensuring availability of land / right of way
j) Exchange controls for foreign currency loans,
maintenance of foreign accounts and holding foreign
currencies.
k) Investment permits by foreigners and dividend
repatriation
l) Import of inputs / export of outputs
m) Construction / operation permits
n) Work permits for foreigners
Project Risks
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Risks
9. Regulatory Risk o) Provision of infrastructure
p) Provision of tax concessions
q) Exclusivity (airport / road)
r) Strong concession agreement for infrastructure
projects
s) Completion guarantee of sponsors
In large infrastructure projects, it is better to have a
Government Support Agreement with the State
Governments / Central Governments on these issues.
t) Emissions / water pollution
u) Catastrophe (Bhopal, Chernobyl)
v) Lawsuits, agitations, blackmail


Project Risks
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Risks

10. Environment
and social risk
a) Lenders engineer to give a report on environmental compliance
including decontamination costs, transportation of toxic
materials, regulatory, permit and licensing issues
b) The risk to be partly passed to EPC contractor
c) Through Environment impact assessment study
d) Resettlement and Rehabilitation Plan and plan monitoring
e) Public Consultation / compensation / information
f) A sound environment Management Plan
g) Involving multilateral agencies in financing
h) Government support under concession agreement
i) Study of adequacy of local standards.
j) Study of world bank handbook (guidelines)
Project Risks
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Risks
10. Environment
and social risk
k) Appointment of an experienced operation & maintenance
contractor (NGO liaison and Government management)
l) Plan for emergency response
m) Reprocessing of waste (fly ash, slag cements)
n) Trading in environmental credits purchase a heavy
polluter in the zone and shut it down / or clean up to
keep/reduce pollution levels in the zone (sulphur,
greenhouse gas)
o) Second hand plants
p) Infrastructure O&M agreements to have environment
warranties
q) Legal opinion on whether all environmental clearances
have been obtained
Project Risks
1. Hydropower projects
2. CFCS
3. SIV
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Risks
11. Infrastructure risks
(Availability of
power, water,
communication and
transportation)

Delays in completion of the project and results in overrun
Mitigation
a) Monitoring of the arrangements of the offtaker for
lifting of products such as grid connection for power,
terminals for pipeline
b) Access routes for pots and airports
c) Railway siding for coal / inputs etc.
d) Effluent disposal
e) Drainage
f) Right of way for pipelines, road projects
g) Centralised facilities
h) Transportation (examples crude in Rajasthan)
i) Strong concession agreement / Government support
agreement in infrastructure projects
Project Risks
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Risks
12. Legal / Documentation
Risks
Legal council to check:
a) Whether date of commencement is same in all
documents (EPC, Loan agreement, offtake
agreement)
b) Matching of dates of input supply and offtake
agreements
c) Whether penalties payable to offtaker for poor
performance is fully passed on to offtaker
d) Input (fuel) price formula in final supply
agreement and offtake agreement
e) Force majeure definition
f) Date of completion / loan payments
g) Legal procedures for taking and enforcement of
security / contracts
h) Obtaining / renewal of permits / licenses
Project Risks
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Project Risks
13) Political risk
Currency inconvertibility
Expropriation
War and insurrection
Termination
Environmental laws
Landowners activities
NGO action
Legal / bureaucratic approach
The country unwilling or not able to service loan due to political, social and
economic factors in cross border lending
Cancellation of concessions, licences, permits, tariffs, quotas, price control
Mitigation
Involve multilateral agencies in funding
Insurance from Exims
Assurance from Central Bank regarding availability of hard currency
Review of the legal and regulatory regime
Insurable
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Project Risks
14) Counter party risk
Strength / reliability of offtakers / swap providers,
contractors, lenders, insurers
Mitigation
Check the financial strength and past experience
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Risk systems
a) Project completion risk
b) Market risks
c) Inflation risk
d) Interest rate risk
e) Exchange rate risk
f) Funds shortage for completion of project risk
g) Technology risk
h) Operating cost risk
i) Operating management risk
j) Supply of input risk
k) Regulatory risk
l) Environment and social risk
m) Infrastructure risk
n) Legal / documentation risk
o) Force majeure risk
Financial Risks
Operating Risks
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Profitability
Item Risk systems
A. Output (Quantity) b, l, o, j
B. Price of product b, e
C. Revenue A x B
D. Less: Cash costs e, g, h, i, j, l, m
Overhead c, k, n
E. Net operating cash flow C D
F. Interest e, d
G. Income tax k, o
H. Net cash profit (E F G)
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Cash flow / Balance sheet items
I. Equity a, f
J. Project loan a, c, d, e
K. Working capital b, h
L. Capex a, c, e, f, g, d
M. Principal repayments e, o
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Power a) Poor financial position of offtaker Electricity Board
b) Fuel cost and heat rate; Degradation of heat rate overtime
c) Lack of reforms
d) Base load, peak load
e) Availability of natural gas
Toll roads a) Traffic risk (diversion %), traffic mix
b) Risk due to linkage with real estate (Bangalore/Mysore highway,
Mahankali flyover)
Resources (Oil, gas, mining)
Estimation of reserves / decline over years
Price risk
Rehabilitation / social risk
Telecommunication a) Foreign exchange risk
b) Regulation (ownership, services, tariff)
c) Market risk / customer retention
d) Technology obsolence risk
Sector Specific Risks
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Ports / Airports /
Stadium
- Concession conditions
- Market risk (competition from existing)
- Infrastructure (Access risk)
- Concession income risk
Water - Regulatory risk on user charges
- Cost of water procurement
- Seasonality
Refineries - Marketing outlets (Entry barriers)
- Access to pipelines
- Exchange rate risk
Chemicals - Environmental risk
- Technology risk
- By product disposal
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Steel - Price risk
- Availability of high quality raw material
Cement - Local demand risk
- Availability of limestone
Pipelines - Confirmed usage, tariff
- Right of way
General - Take the experience of last 10 similar projects; If you
havent done a similar, what is special about this project
- How this application travelled from sponsor to your desk
- Is this the first project of sponsor
- Look at management and cash flow