Non Commercial OR Policy Risk consist of …

Non Commercial OR Policy Risk consist of …
1. Project
a. Specific Policy risks arising from expropriation
b. Changes in the regulatory regime
c. The failure of the government or its public enterprises to meet
contractual obligations
2. Political from events such as war or civil disturbance
Staged Approach to Risk

Most projects consists of three main phases
1 Development Risk – Very High
Only equity capital from the main sponsor is generally used
2 Construction &
start up
Risk – high
Large volumes of finances are required
Typically in a mixture of equity, senior debt, subordinated debt
& guarantees
3 Operation Risk – Generally lower
It may be possible to refinance senior bank debt in the capital
markets with cheaper less restrictive bonds
 Importance of construction risk…

In the construction phase, the major risk is that construction will not be
complete on time or will not meet the specifications set for the project.

Long delays in construction may raise costs of a project significantly &
erode it financial viability.

A project may fail to reach completion for any of a number of reasons
ranging from…
Technical design flows Financial problems
Difficulties with sponsor management Changes in government regulation

Project companies hedge construction risk primarily by using…
1. Fixed price
2. Certain date construction contracts – including turnkey contracts
3. With built I provisions for liquidated damages if the contractor fails to
perform
4. Bonuses for better than expected performance
5. Business start up & other kinds of standard insurance
6. Include a construction contingency in the total cost of the project
7. Build in some excess capacity to allow for technical failures that may
prevent the project from reaching the required capacity.

Typically, creditors & investors are interested in both the physical &
financial aspects of project completion.
 Project completion & financial completion

Project completion is defined as the project’s ability to sustain production
at a certain capacity for a specified period of time.

It may be one month or one quarter of the operating year.

Financial completion is defined as the project’s ability to produce below
a certain unit cost for a specified period of time.
 Cost Overruns

The most common threat to physical completion is cost overruns.

If costs significantly exceed the initial financing plan, they will affect the
project’s financial rate of return & if they cannot be financed, may even
lead those involved abandon the project.
Market risk & its mitigation
 Off take agreement

An off take agreement obliges the off taker to purchase all part of the
product’s output.

Few examples…
o Agreement to buy up to a certain amount per year at the prevailing
market price
o Buy enough to ensure debt payment
o Buy enough to provide foreign exchange for debt services or to reduce
foreign exchange risk

Some instruments of mitigating market risk are…
1. Power purchase agreement (PPA)
2. Call and put options
3. Forward sales & purchase contracts
 Power Purchase Agreement (PPA)

A Power purchase agreement is a form of off take agreement commonly
used in power projects in emerging markets.

A PPA specifies the power purchasing price or the method of arriving at it.
 Call & Put Options

A Put option gives a project company the option to sell its output at a
fixed price at some point in the future.

A call option would allow the project company to buy its input at a fixed
price in the future.
 Forward sales & purchase contracts

Forward sales & purchase contracts provide another means of hedging
product price risk.

A project may wish to enter into a forward purchase contracts to stabilize
the price of a key raw material.
Other Risks & their Mitigation

Mitigation of some other forms of risks…
1. Management, Technical or maintenance risk
2. Economic risks
3. Environment risks
4. Political risks.