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Assignment:
The following information has been provided on a project opportunity. Your company has a standard risk
assessment model (see the framework shown in tabular format below) and it wishes to use this so that a
preliminary decision can be made on whether to increase the resource provided for the project and proceed with
more detailed preparation. When there is no information provided on the given risk factor for the project, it is
customary to assume the maximum risk. Complete the risk assessment and report your total risk score range (e.g.,
130-155). Identify risk factors that can be mitigated to some extent by negotiating different terms and conditions
with the client so as to bring down the overall risk score. Evaluate your new overall risk score range. (Hint: Use
excel spread sheet to calculate the risk score and also state the assumptions under each risk factor for taking that
risk score).
The project
The project is a new 70 MW hydro-electric power station in Central Vietnam. The company has
been asked to bid for the engineering, procurement and construction management of the
mechanical and electrical engineering (M&E) works, with a contract value of approximately US$45
M. The project calls for the commissioning of two turbines, one to be completed in two years and
t h e other following 3 to 6 months later. The owner has requested that a 100% financing
proposal is required, i.e., the contractor will need to find a bank o r export credit agency or finance it
in some other manner during construction. The bid will be fixed price.
The form of contract will be the client's own conditions and the governing law of the contract
will be the laws of Vietnam, al t ho ug h the contract language will be E n g l i s h and payment will
b e in US dollars. Advance payments of 10% are available for both equipment and construction
management although the follow-up payments are upon receipt of major equipment and on a
monthly measure basis for construction management work.
The contract documents call for the following: $500,000 bid bond, Performance security of 10% of
contract price, recognition of the usual force-majeure situations, a defects liability period of 12 months
from handover although it will be specifically 6000 hours use for the actual turbines. There are no
retention clauses specified although liquidated damages for delay can be up to 10% of contract value and
for performance can be up to 2.5% of turbine cost.
The company would like to work with a consortium which is led by a large Japanese company. The
Japanese are known to the company but they have no previous experience of working together.
Case Study
Public–Private Partnership Risk Factors in Emerging
Countries: BOOT Illustrative Case Study
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Karim S. Rebeiz, Ph.D., M.ASCE1
Abstract: A public–private partnership (PPP) is an agreement between a host government and a private entity in which the private sector
supplies infrastructure assets and services that are traditionally provided by the government. The popularity of PPP projects has been steadily
on the rise over the past few years. This upward trend is in large part driven by governmental fiscal austerity, particularly in the aftermath of a
prolonged global economic recession. The perceived attractiveness of PPP projects is particularly acute in emerging countries because of
population growth and increased urbanization. PPP projects are usually highly complex in nature. They require large capital expenditure, they
have long durations, and they usually utilize sophisticated technology. For a construction firm willing to expand its services internationally, a
PPP project represents a unique opportunity to leverage its core competency and achieve competitive advantage in both domestic and foreign
markets. Risk, however, increases with foreign penetration because of unfamiliarity with the geography, the supply chain, the local codes, and
the business practices. Using an illustrative case study of a build-own-operate-transfer (BOOT) thermal power plant project, this paper addresses the salient risk factors facing the construction firm undertaking a PPP in an emerging country. DOI: 10.1061/(ASCE)ME.1943-5479
.0000079. © 2012 American Society of Civil Engineers.
CE Database subject headings: Partnerships; Private sector; Build/Operate/Transfer; Infrastructure; Risk management; Power plants;
International factors; Developing countries; Case studies.
Author keywords: Public–private partnership; Build-own-operate-transfer (BOOT); Infrastructure; Risk; Power plant; Emerging market;
International construction.
Introduction
During the past decade, the financial market has endured prolonged
periods of recession (Reinhart and Rogoff 2009). The repercussions
of the recession have reverberated worldwide because of the globalization of businesses and the integration of financial markets.
The emerging countries have experienced decreased gross domestic
product (GDP) growth as a result of the deteriorated economic situation (Griffith-Jones and Ocampo 2009). A widely used strategy
to reinvigorate the economy and boost aggregate demand is to
invest in core infrastructure projects that include thermal power
plants, toll roads, airports, waste water treatment plants, pipelines,
and mines (Elwell 2010). The development of the infrastructure
has been given more importance in emerging counties because of
population growth and increased urbanization of the society (Iimi
2005). In addition, a well-functioning infrastructure has a positive
effect on public safety and the quality of life. It also promotes the
efficient and cost-effective flow of resources within and across
geographical borders (Munnell 1992; Aschauer 1989a).
In effect, economic research has shown that infrastructure development contributes to the productivity and economic expansion of
the private sector, even after accounting for a possible crowding-out
effect (Aschauer 1989b). In other words, the public investment
would eventually generate a higher return of investment for the private sector. Another stream of research has indicated that public
1
Associate Professor, American Univ. of Beirut, Suliman S. Olayan
School of Business, Beirut, Lebanon. E-mail: kr03@aub.edu.lb
Note. This manuscript was submitted on April 4, 2011; approved on
June 27, 2011; published online on June 29, 2011. Discussion period open
until March 1, 2013; separate discussions must be submitted for individual
papers. This paper is part of the Journal of Management in Engineering,
Vol. 28, No. 4, October 1, 2012. © ASCE, ISSN 0742-597X/2012/4-421428/$25.00.
investments would reduce the cost of production in the manufacturing industry (Nadiri and Mamuneas 1994; Morrison and
Schwartz 1996; Moreno et al. 2002).
Historically, the financing of energy infrastructure projects
(primarily power generation plants and energy transmission systems) has been the sole responsibility of the government. The
government secures financing either directly from fiscal budgets or
by issuing revenue bonds. The government then bids the project,
supervises the construction activities, operates the project, and
collects the cash flow resulting from the operational activities
through revenues and/or taxes. One part of the cash flow is used
to reimburse the debt (such as coupon payments), whereas the
remaining fund is used to balance the budget. The government
retains control and ownership of the project from its inception to
its completion. The government financing scheme is illustrated in
Fig. 1.
In the aftermath of a global recession, many government agencies in emerging countries may lack the resources and expertise to
undertake development projects requiring significant capital outlay.
An astute solution for infrastructure development projects is for the
government to form a partnership with the private sector. Such an
initiative is referred to as public–private partnership (PPP). There
are different forms of PPP depending on the extent of private
involvement in public projects. The private-sector participation
in public projects varies in a continuum from limited control to
full control of the assets and services. The various PPP models
for infrastructure projects are shown in Fig. 2:
• Procurement agreement: The government outsources procurement activities to the private sector. However, the overall management control of the infrastructure remains under the
jurisdiction of the government.
• Management agreement: This arrangement is similar to the previously discussed procurement arrangement. The difference is
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The capital expenditures for PPP energy projects in India,
Russian Federation, Brazil, and China are available in the Global
Market Information Database (GMID) from the Euromonitor
Database. The four aforementioned countries have been at the forefront of promoting PPP energy projects. In particular, India and the
Russian Federation are emerging as leaders of PPP energy projects
in terms of absolute expenditure and growth.
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Nature of BOOT Construction Projects
Fig. 1. Traditional government financing scheme of public infrastructure projects
Fig. 2. PPP models for public infrastructure projects
that the government relinquishes some aspect of control and
operation of the asset to the private sector.
• Lease agreement: The private sponsor leases or rents the infrastructure from the government for a specified time period. The
private sector has the right to cash flow, resulting from the
operation of the infrastructure.
• Concession agreement: The government gives the private sector
the right to finance, build, and operate an infrastructure project.
The private sector has the right to cash flow for operating the
infrastructure over the concession period. At the expiration of
the concession period, the private sponsor transfers the control
and assets’ ownership back to the government. At that point, the
government could either decide to operate the plant itself or put
the operation up for another round of bidding. Popular forms
of concession agreements include build-own-operate-transfer
(BOOT) and build-lease-transfer (BLT).
• Divesture: The government fully transfers the ownership and
control of the assets to the private sector. A build-own-operate
(BOO) falls under this category as it permits the private sponsor
to retain ownership of the project indefinitely with no obligations to return it to the government.
A construction project could be viewed as a temporary and dynamic network made of many independent groups, including multiple layers of consultants, contractors, and suppliers. The work is
initiated by the owner/promoter who develops the project scope,
defines the project parameters, and devises a plan to secure key
resources. The work is then allocated through contractual agreements to the key production players who, in turn, subcontract parts
of the work to other parties. The contractual agreements delimitate
the rights and obligations for performance of the various parties to
the project. The network eventually disintegrates and ceases to exist
at the completion of the construction project.
The product development process in construction is typically
characterized by fragmentation of resources and discontinuation
of expertise. The output of a typical construction endeavor is a
unique project, using a customized design and produced in situ
under highly variable and uncontrollable environmental conditions
(such as uncooperative weather). As a way of comparison, the output in a manufacturing environment is often in the form of mass
or continuous production of a large number of similar products
(i.e., standardized products). The production is performed under
steady state and under controlled conditions. As such, the risk
factors in construction are often higher than in other production
environments. As noted in some studies, the key success factors
in construction greatly depend on the ability to proactively and
efficiently manage the risk factors (Chapman and Ward 2004;
Loosemore and Teo 2000).
Specifically, the initiation process of a BOOT project in the context of a PPP is typically as follows: The host government identifies
a need for the infrastructure project. An expression of interests
is requested by the host government to interested private parties.
The private parties submit their credentials that encompass both
financial capacity and technical expertise. A short list of 10 to
15 firms is typically retained for further consideration. Eventually,
the concession agreement is awarded to one private sponsor. The
private sponsor manages the PPP project from its inception to its
completion.
The BOOT concession agreement is the one binding the private
sponsor to the host government. It stipulates the important terms
for constructing and operating the infrastructure energy project.
It specifies the concession period, the rights and responsibilities
of each party during the concession period, and the tariff that will
be collected by the private sponsor during the operation phase. The
quality of assets and the performance standards at the end of the
concession period are also important stipulations in the concession
agreement.
The private sponsor is either a private organization (such as a
construction/engineering firm) or a consortium of private firms
(such as construction/engineering firms, equipment manufacturers,
investors, and venture capitalists) that coalesce for the specific
purpose of financing, constructing, and operating the project.
The reason why various private firms may join forces is to combine resources and expertise. This joint effort also allows the
achievement of economies of scale and the diversification of risks.
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The organizational type of the private sector could take the form of
a corporation, a joint venture, a partnership, a limited partnership.
or other organizational forms.
The private sponsor forms a project company (PC) to construct
and operate the project. The PC is in charge of the engineering,
procurement, construction, and operation phase. It secures the
key resources and it selects the consultants, the prime contractors,
and the operators of the project. The PC has the right to cash flow
for operating the infrastructure over the concession period. The host
government reviews and approves the design. It also takes part in
the approval of the performance tests to ensure proper compliance
with the specifications of the concession specifications. In addition,
it facilitates the necessary approvals and other authorizations for
constructing and operating the facility. The government plays an
active role in quality control and assurance in its capacity as the
steward of public interest. The public is the final user of the project.
The government also has a claim on the ownership of the infrastructure assets at the term of the concession period.
The success of the BOOT depends on the extent by which the
goals of the private sponsor are congruent with those of the host
government. As shown in Fig. 3, each party has its own set of motives. The private sponsor needs to earn profit, control the activities
under its jurisdiction with minimal political interference, and
collect its tariff (payment processing) during the operation phase.
The host government needs to minimize the life cycle cost of
the project, ensure quality standards, and ensure minimum performance standards. The incentive scheme of the concession agreement should address all the previously discussed aspects, and
should emphasize the common interests between the public and
private sectors, namely the timely completion of the project, the
performance of the project, the coordination and integration of
various operating activities, and transparent transactions.
riskier than projects with relatively little investment outlay and
fewer participants to the construction process. There are more
uncertain variables in high magnitude projects that could adversely
affect the cost, quality, and duration of the project than in low
magnitude projects. A second risk factor is related to the duration
of the project: Projects with long durations are inherently riskier
than projects with short durations. The variables occurring in the
long-term horizon are less defined and more uncertain than variables occurring in the short-term horizon. A third risk is related
to the financial structure of the project: Projects with high debtto-equity ratio are financially riskier than projects with low
debt-to-equity ratio. The earnings of projects with high leverage
are more volatile than those with low debt-to-equity ratio. Highly
leveraged projects/firms are less able to meet their obligations to
the creditors than low leveraged ones, thus pushing the project
closer to potential bankruptcy. The financial risk increases with
the debt-to-equity ratio, the intensity and schedule of the debt,
and the duration of the project. A fourth risk is related to the type
of construction: Complex and highly customized projects using
untested technologies are riskier than standardized projects with
well-established technical and regulatory precedents.
The exogenous risk factors are those related to the external variables belonging to the macro-environment in which the project operates, including the political and geographical environment. For
example, projects located in areas in which the macro-environmental
is rapidly changing (e.g., price increases, social trends, demographics, technological innovations, regulatory changes) are facing
more uncertainties than projects located in relatively stable macroenvironments with slow-moving changes. The risk of construction
projects further increases with foreign penetration (Gunhan and
Arditi 2005). The country (sovereign) risk factor is substantial, notwithstanding the unfamiliarity of the sponsors with the geography,
the local codes, the business practices, and other idiosyncratic
cultural and operational issues.
Risk Factors of BOOT Projects
A BOOT project is recognized as one of the riskiest project delivery
schemes (Dey and Ogunlana 2004). The risk management of
BOOT projects starts with the identification of the risk factors
resulting from the inherent characteristics of the project itself and
the risk factors resulting from exogenous factors in the external
environment. An implementation plan is then put in place to avoid
the risk, mitigate the risk, diversify the risk, or allocate the risk to
the party best able to assume it.
The inherent risk factors of BOOT projects are those that are
related to the characteristics of the project itself. One risk is related
to the cost magnitude of the project: Projects that require relatively
large capital expenditure and large number of participants are
Fig. 3. Public and private sector motives in a BOOT project
Illustrative Case Study
The demand for electricity has been on the rise in an emerging
country. In an effort to sustain the projected demand, the
government has decided to initiate a PPP for the construction of a
state-of-the-art 850 MW combined-cycle thermal power plant using
natural gas as its fuel source. The cost of the project is estimated
to be $900 mils. The government has decided to commission the
project to the private sector using a BOOT approach. The concession period is 25 years.
A private sponsor has been awarded the BOOT concession.
The sponsor is a consortium of international engineering and construction firms. The consortium also includes the manufacturers
that supply boilers, turbines, generators, and other heavy equipment. The private sponsor, represented by PC, has the right to cash
flow for operating the infrastructure over the concession period.
At the expiration of the concession period, the PC transfers the control and asset ownership back to the government according to the
terms of the concession agreement. At that point, the government
could either decide to operate the plant itself or put the operation for
another round of bidding.
Before starting a bidding process, the sponsors have to develop a
risk management strategy. One important endeavor in this regard is
the categorization of the project risk into different groups depending on the level of control and anticipation of the uncertainties:
• Uncontrollable risks: Such risks belong to the macroenvironment, like force majeure, politics, geology, economical
issues, restrictive laws and regulations, and other external
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variables. The uncontrollable risk could be shared, diversified,
or avoided through some sort of an insurance mechanism.
For example, commodity prices and foreign currencies could be
hedged against price increases through the use of financial
derivative instruments.
• Controllable but undefined risks: Such risks are controllable, yet
the extent of their occurrences is not known in advance. An example is a potential labor problem or the use of new technologies.
• Assumed risks: Such risks are assumed because of the actions of
a third-party. Examples include poor design, poor workmanship,
poor coordination, right-of-way problems, or other assumed
responsibilities for third-party inadequate actions. This risk is
mitigated through a vigilant screening process of production
players.
• Controllable inherent risks: Such risks are inherent to the project,
yet controllable in advance. Examples include supply shortage,
poor material delivery, and productivity problems. The controllable risks are allocated to the parties that are best able to
handle them because of their unique expertise or resources.
The project would be subdivided into separate major work packages that are awarded to different prime contractors (assuming the
PC has in-house construction management expertise). The prime
contractors might be responsible for one or more of the following
activities: the engineering, procurement, construction, installation,
and testing of their assigned work packages. The selection and coordination of the prime contractors is the responsibility of the PC.
The prime contractors would have to provide the bid, payment, and
performance bonds (or other equivalent forms of guarantees such as
letters of credit) to ensure the proper execution of the project. Such
bonds indicate that the contractor has undergone a rigorous prequalification by the surety company and is capable of fulfilling the
obligations of the contract. The reputation and stature of the surety
company is a valuable piece of information in assessing the
adequacy of the bonds and the pre-screening process.
The next step for the PC is to share the risk with the various
prime contractors. Some important issues to consider in this regard
are as follows:
• Which party is best able to conduct a feasibility study?
• Which party is best able to plan, organize, lead, and control
the preconstruction work, including the bidding process and
contract administration?
• Which party is best able to secure financing for the project?
• Which party is best able to design the project?
• Which party is best able to provide post-design constructability reviews and value engineering?
• Which party is best able to secure procurements and key
resources?
• Which party is best able to utilize efficient and effective
construction methods and techniques?
• Which party is best able to control the project in terms of
productivity, safety, and quality?
• Which party is best able to coordinate the field work, handle
administration procedures, and provide overall customer
service?
• Which party is best able to operate and manage the completed
project?
• Which party is best able to handle jurisdictional disputes and
local problems?
• Which party is best able to handle labor relations, including
subcontractors’ claims?
• Which parties are best able to streamline their activities and
achieve project synergy?
The previously noted strategy requires a thorough identification
of the risk factors during the construction phase and during the
Fig. 4. Cost–influence curve of a typical BOOT project
operation phase. As shown in Fig. 4, the ability to influence the
final project cost and to ensure its final success is very effective
at the beginning of the process and it diminishes significantly as
the project progresses through time. Once the design is completed
and the project is awarded for construction, than the ability to
influence the final project cost is greatly reduced.
Inherent Project Risks
Cost Escalation Risk
There are many controllable or uncontrollable variables that could
increase construction costs such as poor productivity, force majeure, and high supply cost. The risk related to cost is addressed
through the type of pricing contract agreed between the PC and
the prime contractors and/or the subcontractors hereafter referred
to as contractor for simplicity). Each work package contracted to
a prime contractor would have a different pricing strategy. The two
broad contract pricing mechanisms, namely fixed price and costplus pricing arrangements, depend on a number of factors, most
notably information at contract award, project control expertise,
and risk allocation (Fig. 5).
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Fig. 5. Contract pricing strategies
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Fixed Price: Under a pure fixed-price (or lump sum) agreement,
the contractor agrees to carry out all aspects of the work, including
risk of construction, in exchange for a fixed sum of money. Under
this scheme, it is particularly important for the PC to provide the
contractor with a complete set of instructions, including desired
scope and overall schedule, to minimize subsequent expensive
change orders. Once the fixed-price contract is awarded, the PC
relinquishes project management control to the contractor. Nonetheless, it is in the interest of the PC to oversee the operations without infringing on the ability of the contractor to perform day-to-day
operations. A unit-price contract is an example of a flexible fixedprice contract as it accommodates variations in the quantity of work
during construction. Other flexibility features are typically utilized
by incorporating standard change condition clauses in the contract.
Cost-Plus: A cost-plus contract is used in case the scope of the
project is poorly defined, or in case significant changes to the work
are anticipated during construction, or in case concurrent design
and engineering needs to be undertaken to shorten project duration.
Under this scheme, the contractor is reimbursed for the cost of
construction plus a fee (either fixed or variable). The determination
of the appropriate fee is a matter of negotiation between the PC
and the contractor depending on the size of the work package, its
nature, duration, complexity, sophistication, and other risk factors.
A guaranteed maximum price could also be specified to minimize
cost uncertainty. By assuming the cost responsibility, the PC
becomes de facto the project manager. The PC also assumes a risk
manager role as the cost-plus contract transfers all economic risk
from the contractor to the PC.
Special Provisions: A combination of different pricing approaches could be devised to meet the specific needs of the work
package. For instance, a convertible contract could be used in
some special cases. It starts as a reimbursable cost and progressively converts to a fixed-price contract as engineering proceeds
and the scope becomes more defined in nature. However, the
PC relinquishes bargaining power in such a case because of the
absence of market competition.
Construction Delay
Construction delay is another major risk that could affect project
success because time is of the essence in a power plant project, notwithstanding possible penalty clauses in the concession agreement.
The causes of the delay include unfamiliarity with the technology,
labor unrest, design implementation problems, change order disputes, and inability to receive supply on time. There are two categories of clauses that could be used to manage the risk of delay, namely
the no-damage clauses and the liquidated damage clauses.
The no-damage clause stipulates that the contractor is entitled
to time extension but no monetary damages in the event of delay.
Such clauses are the result of delays caused by third parties (such as
another prime contractor), by disrupted or accelerated work, by
failure to coordinate or properly schedule work, and by design
errors. However, there are four exceptions to the no-damage clause
in which contractors are entitled to monetary damages because of
delays, e.g., the delay was not contemplated or anticipated by the
parties to the contract.
A typical liquidated damage provides that the contractor will
pay the PC a stipulated sum of money for each day of delay beyond
the agreed completion date. Such clauses are intended to compensate the PC for actual loss, but they are not designed to punish
or penalize the contractor for the failure to achieve the contract
schedule. In most jurisdictions, the inclusion of a liquidated damage clause precludes the PC of recovering actual damages, although
actual damages may exceed stipulated liquidated damages.
Subsurface Risks
A large project like a thermal power plant involves a lot of excavation and earthwork. The unforeseen subsurface conditions are
risk factors that should be taken into account in the contract documents. As a general rule, the contractor bears the risk of unforeseen
subsurface conditions unless evidence shows that the information
provided by the PC is imperfect, incomplete, or it would be impossible for the contractor to have discovered the error through a reasonable site investigation. The PC may elect to combine subsurface
information, along with exculpatory language (disclaimers) with
the deletion of the changed condition clause. Such contractual
languages are not advisable because they increase the adversarial
relationship between the PC and the contractor. In addition, they are
not always effective in many jurisdictions because of the unjust
enrichment doctrine that prevents a party from unjustly benefitting
at the expense of another party.
Exogenous Project Risks
Foreign Exchange Trade
Preconstruction
The bidding documents are often denominated in foreign currency,
as is often the case in international markets. If the project is accepted, then the PC is exposed to foreign currency appreciation
vis-à-vis the domestic currency. During the construction duration,
the exchange rate could easily snowball and, as such, could potentially result in catastrophic consequences. One possible hedging
strategy is to purchase call options in the foreign currency with
different maturities depending on the procurement schedules.
A call option provides the purchaser with the right (but not the obligation) to purchase an asset (a commodity or a foreign currency)
at a certain price agreed (called the exercise price) for a certain time
period regardless of future price fluctuations. There are two possible outcomes under this hedging strategy (Fig. 6):
• If the bid is accepted, the PC would exercise the calls at maturity
to purchase foreign currencies in case the currency spot price
rises above the exercise price. Accordingly, the PC is protected
against foreign currency appreciations. The call options are not
exercised in case the foreign currency spot price remains below
the exercise price.
• If the bid is rejected, the PC would exercise the options at maturity if the foreign currency spot appreciates above the exercise
Fig. 6. Hedging strategy with call options on foreign currency during
bidding stage
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price. The PC would then immediately sell the foreign currency
in the spot market. The gain that is received from exercising the
calls may partially or fully offset the premium (price) for the options. If the foreign currency spot rate depreciates below the
exercise price, then the PC will obviously not exercise the calls
at maturity. The loss is limited to the premium (price) paid for the
options (i.e., it is similar to purchasing an insurance premium).
During Construction
The PC is also subjected to foreign currency fluctuations during
construction. It is therefore incumbent on the PC to hedge against
the price increase of foreign procurements. As an example, steel is
to be purchased from a foreign supplier over a multiple-year period.
The PC has signed a contract with the supplier, thus fixing the price
of the steel in advance. In effect, the company has protected itself
against the commodity price fluctuations. Nonetheless, the PC is
still not protected against the foreign currency appreciation
vis-à-vis the domestic currency. An example of a hedging strategy
consists of purchasing a forward contract on the foreign currency.
A forward contract allows the PC to buy the foreign currency at a
future date for a specific price agreed in advance regardless of
future spot price fluctuations. The difference between a forward
contract and an option is that the former carries with it an obligation
(and no corresponding premium), whereas the latter carries with
it a right (and a corresponding premium). As shown in Fig. 7, the
purchase of the forward contract removes the foreign currency risk
because any loss incurred in the actual transaction is offset by the
gain incurred in the forward contract, and vice versa. In other
words, a forward contract effectively decouples the financial risk
from the business risk.
During Operations
The net revenue of the project (the selling of the electrical power) is
often denominated in foreign currency. The PC is therefore exposed
to exchange rate risk as the foreign currency may significantly
depreciate vis-à-vis the domestic currency of the PC, thus significantly lowering the revenue of the project. An example of a hedging
strategy to protect against this risk is to engage in a currency
swap transaction. Under this scheme, the PC agrees to transfer the
cash flows of the revenues (denominated in foreign currency) to
the counterparty in the over-the-counter (OTC) financial market.
In turn, the counterparty provides the PC with an equivalent cash
flow denominated in domestic currency. The net present values of
both cash flows (principals and interests) are equivalent at the time
of the swap agreement. Under such an agreement, the PC is no
longer exposed to foreign currency fluctuations as the net cash
outflow is ultimately denominated in domestic currency.
Political Risk
The project may be subjected to unwarranted government intervention. For instance, the government may unilaterally decide to
nationalize or expropriate some or all of the project (either partially
or fully). The extent of political risk and governmental interference
is influenced by the prevailing political regimes and the economical
importance of the project to the local economy. The public is also a
highly influential stakeholder. The public resentment for the project
is usually high if the sponsor is a foreign entity and if the project is
located in an urban setting with no perceived value-added benefit.
The public resistance to the project may slow down construction
and may even result in the abandonment of the project. Conversely,
public resentment is reduced if the project provides value in terms
of output (e.g., improved quality of life) and social issues (e.g., increased work opportunities for the local population). The hiring of
local contractors is advantageous from the standpoint that they are
more accepted by the community, and they are more familiar and
responsive to the specific political and business environment within
the country.
Operational Risk
The project faces performance risk during the operation phase.
The thermal power plant may not generate power at the expected
performance standards because of technological malfunctioning,
including latent defects. The utilization of known and well-tested
technologies minimizes the occurrence of such risk. The contractor
should provide the PC with warranties for proper performance for
an adequate time period after the project completion. The PC faces
market risk or fluctuation in the price and quantity of the power
demand from the marketplace (this risk is often referred to as offtake risk). In a typical scenario, the demand for energy output is
expected to increase with projected growth in GDP. If the expected
GDP growth is less than expected, then the revenue of the project
would be lower. The PC also faces supply risk in terms of shortage
and price increase. A long-term agreement with the government
(a power purchase agreement and a gas supply agreement) will help
minimize the market risk. In such circumstances, the government
assumes the economic risk of supply, demand, and price fluctuations. Nonetheless, the PC still faces default risk as the government
may not honor its contractual agreement. The risk is magnified in a
foreign environment because of the possible ineptness of some foreign jurisdictions to enforce contracts and agreements, particularly
when it involves government agencies.
Risk Factors of Emerging Markets
Shortage of Skills
Fig. 7. Hedging strategy with forward contracts on foreign currency
during construction
A thermal power plant is highly sophisticated and complex, and
therefore requires a special set of skills to operate the technology.
The main risk factor facing the PC is the potential lack of human
resource skills in emerging countries. A PPP project undertaken
in a foreign environment is often exposed to safety problems
associated with strife, war, and terrorism. This safety risk factor
further exacerbates the shortage of talent risk of emerging countries. Accordingly, a formal training and development (T&D) program should be established during the construction phase and
operation phases of the project. To be meaningful, T&D should
not be a one-time occurrence, but rather an ongoing process that
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Fig. 8. Training and development ongoing needs analysis for the
BOOT project
involves organizational analysis, task analysis, and person analysis (Fig. 8).
• Project analysis: The PC needs to first assess whether T&D is
necessary for the project, whether it is cost effective, whether it
has the resources to conduct T&D, and whether T&D should be
conducted in-house or outsourced to a separate entity.
• Task analysis: In case T&D is needed and affordable, the next
step consists of identifying the important jobs for which T&D is
needed. Each job is then subdivided into different tasks that are
scrutinized in terms of knowledge (facts or procedures), skills
(competency in performing a task), abilities (physical and mental capacities to perform a task), and other conditions (such as
working conditions) to successfully complete the job.
• Person analysis: The final step entails identifying the employees
who are most suited for the T&D program. The objective is
to close the gap between actual skills and needed skills. The
T&D programs should concentrate on hard skills (e.g., scheduling, equipment operations) and soft skills (e.g., coaching, empowering, team building, cultural sensitivity). Three important
characteristics are important in this regard: (1) Professional
maturity: The employee should have the aptitude to acquire new
skills; (2) Personal maturity: The employee should have the
motivation and the willingness to learn new skills (i.e., personal
maturity); (3) Social maturity: The employee should have the
capacity and the opportunity to put the new skills into use
through social support.
The types of T&D that could be offered are as follows:
• Basic skills training: This type of training is common and fairly
standard across organizations. It focuses on technical skills to
improve functional competency in a specialized area. Ability
to use specialized expertise in solving complex problems
through design/analysis, estimating, scheduling, budgeting, and
others. Because of the highly dynamic nature of the marketplace, the training program should focus on the development of
flexible skills with depth and breadth. A flexible workforce also
produces a reduction in the bureaucratic layer as fewer supervisors are needed.
• Interpersonal and diversity training: This training provides the
skills necessary to interact with people of different cultures and
to operate effectively in a team environment. The construction
professionals should be able to communicate effectively with
people of different cultures and maneuver with ease in a multicultural team environment. It is indeed not sufficient for an
engineer to possess technical knowledge about foreign codes
and specifications. The employee should also possess “cultural
intelligence,” meaning an awareness and appreciation of various
customs and habits, and a diverse portfolio of behaviors.
• Management development: This development initiative helps
sharpen one’s ability to plan, organize, delegate, inspire, and
identify problems by clearly delimitating between symptoms
and root causes. An integral part of the development process
is to provide the skills necessary to make decisions using a
systematic process and analytical reasoning.
• Leadership development: The construction project needs to
develop effective leaders who can orchestrate positive and
significant changes. Such leaders should be able to devise a
meaningful vision, stimulate commitment from the followers,
and achieve superior organizational results.
The successful implementation of a formal T&D program
requires the following:
• The establishment of a competent T&D team consisting of
subject-matter experts: The function of the team is to decide
on training themes, learning goals, delivery modes, training
evaluations, and roadmaps for future improvements.
• The appointment of a knowledgeable person who drives the T&D
process, namely a T&D champion. The champion gives the T&D
program an enthusiastic and credible support in the forms of
resources and tangible support. The T&D champion also seeks
psychological supports from top leadership. In fact, leadership
should be intimately involved in the T&D program through time
commitment to the training endeavor (e.g., teaching, coaching,
mentoring). In addition, leadership should empower the employees and provide them with the opportunities to practice their
newly acquired skills through enriched job experiences.
Corruption Risk
Thermal power plants, by their very nature, are particularly prone to
corrupt practices such as change order manipulations, unbalanced
bids, bid shopping, reverse auctions, over billing, payment games,
falsified claims, and other unwarranted practices. There are three
levels of cost associated with corruption.
• The lowest level (level 1) consists of direct and indirect
costs (including fines and penalties) resulting from unethical
practices.
• The intermediate level (level 2) consists of monitoring costs,
auditing, and remedial actions to prevent future mishaps.
• The highest level (level 3) entails the erosion of trust and loyalty,
and the ensuing loss of confidence and morale. Level 3 is by far
the most damaging cost because reputation is the most valuable
asset of the organization. In effect, it takes a long time for the
organization to build its brand equity, but it only takes a fraction
of that time to lose the confidence of the marketplace with
sometimes irreversible consequences.
The management of corruption should start at the earliest time
possible and should encompass all construction players including
the owner’s representative, the procurement manager, government
officials, trade contractors, consultants, and many other stakeholders. The PC should take a leadership role in forming an ethics committee at the earliest stage of the process. The ethics committee
should include representatives from the major stakeholders. The first
function of the ethics committee is to write a code of ethics and
to devise an anti-corruption management program to ensure the
effective implementation of the code of ethics. The anti-corruption
management program includes awareness building, whistle-blowing
procedures, training and development initiatives, anonymous assistance, and other issues aimed at mitigating corruption practices.
Another important role of the ethics committee is to ensure that
all contractual agreements with suppliers, contractors, consultants,
government agencies, and others contain anti-corruption warranties.
A provision should also be made to incorporate anti-corruption
clauses in all subcontracting and third-party contracts. Clear accountabilities in case of violations should be clearly articulated in the
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contract documents; otherwise, the anti-corruption clauses may not
be enforced by the concerned parties. The contractual safeguards are
supplemented by integrity pacts in which all parties ascertain that
they will act with integrity in relation to that project.
The ethics committee should also appoint an independent assessor to monitor the project from its inception to its completion. The
assessor should have access to all relevant information and records
of the parties involved in the construction endeavor, particularly
those pertaining to officers’ expenses and use of corporate assets.
The independent assessor should first review the firm’s ethical
standards and procedures, including scope, procurements, human
resource practices, environmental compliances, and conflicts of
interest. The assessor should engage in due diligence in screening
business partners and ensure that the project operates in a corruptionfree environment. The assessor should maintain an arm’s-length
relationship with the various construction parties to ensure impartiality and complete independence. The assessor should be skilled
at recognizing moral dilemmas (i.e., having a keen sense of moral awareness) and at delimiting between what is right and what
is wrong (i.e., having a sound moral judgment).
(MIGA), and the International Center for the Settlement of Investment Disputes (ICSID). The roles of these institutions are as
follows:
• The IBRD extends loans and technical assistance to middleincome countries.
• The IDA provides grants and low-interest loans to low-income
countries.
• The IFC promotes private-sector investment by supporting
high-risk sectors and high-risk countries.
• The MIGA offers political risk insurance to investors and
lenders working in developing countries.
• The ICSID settles potential legal disputes between foreign
investors and the host government.
Such a wide ranging involvement from the World Bank Group
would decrease the actual and perceived macro-environmental risk
factors of PPP projects. In turn, it would increase the pool of
potentially interested and qualified foreign construction firms
and investors, which is an important consideration for the ultimate
success of PPP projects.
References
Conclusions
A PPP provides the opportunity for a construction firm to team up
with other international private sponsors for the design, construction,
and operation of an infrastructure project. This form of project delivery method enables the construction firm to take advantage of its
core competency, to customize its services, and to export its capabilities. It also improves the competitive standing of the construction
firm because domestic work volumes may not be large enough
to fully accommodate economies of scale and learning/experience
curve effects. In addition, it allows the construction firm to take advantage of lower labor cost and to diversify the risk across different
markets rather than being entirely dependent on its own domestic
economy. The hallmark of superior management depends on the
crafting of a proactive risk management plan, followed by a vigilant
implementation process. In emerging markets, the construction
firm should not only manage project and country risk factors, but
also the risks related to corruption practices and potential shortages
of human talent. In fact, PPP projects are most effective in country
environments that foster transparent, expeditious, and reliable
transactions with minimum political interferences.
As a final note, the World Bank could provide valuable assistance to emerging countries in planning and executing PPP
projects. This assistance could take the form of a country assistance
strategy (CAS), a strategic document prepared by the World Bank
in consultation with the host government. The CAS intends to identify relevant infrastructure projects that fulfill the specific developmental needs of the country. The World Bank could also provide
technical and financial assistance for PPP projects, including
the preparation of bidding documents. The World Bank Group
constitutes five basic institutions, namely the International Bank
for Reconstruction and Development (IBRD), the International
Development Association (IDA), the International Finance
Corporation (IFC), the Multilateral Investment Guarantee Agency
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Moreno, R., López-Bazo, E., and Artís, M. (2002). “Public infrastructure
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Morrison, C. J., and Schwartz, A. E. (1996). “State infrastructure
and productive performance.” Am. Econ. Rev., 86(5), 1095–1111.
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Risk Management in International
Construction Projects
What is Risk?
Two types:
1) pure risk when there is the possibility of financial
loss but no possibility of financial gain, and
2) speculative risk that involves the possibility of both
gains and losses.
Known
Risk
Known-Unknown
Unknown-Unknown
Risk Management
A systematic approach to control the level of risk to
mitigate its effects.
Risk
RiskIdentification
Identification
Risk
Estimation
RiskAnalysis
Estimation
Risk
Evaluation
RiskResponse
Evaluation
Types of Risks in International
Construction
Country Level Risks
Market Level Risks
Project Level Risks
Types of Risks in International
Construction
Total Risks
Country Level
Market Level
Country Level
✓ Approval and Permit
✓ Change in Law
✓ Justice enforcement
✓ Govt. Influence on Disputes
✓ Corruption
✓ Expropriation
Project Level
✓ Quota allocation
✓ Political Instability
✓ Government Policies
✓ Cultural Differences
✓ Environmental Protection
✓ Public Image
✓ Force majeure
Types of Risks in International
Construction
Total Risks
Country Level
Market Level
Market Level
✓ Human Resource
✓ Local Partner’s
Creditworthiness
✓ Corporate Fraud
✓ Termination of Joint Venture
✓ Foreign Exchange &
Convertibility
Project Level
✓ Inflation and Interest Rates
✓ Market Demand
✓ Competition
Types of Risks in International
Construction
Total Risks
Country Level
Market Level
Project Level
✓ Cost Overrun
✓ Improper Design
✓ Low Construction
Productivity
✓ Site Safety
✓ Improper Quality Control
Project Level
✓ Improper Project
Management
✓ Intellectual Property
Protection
Risk Analysis
Estimating the potential impacts of risk to decide what risks to
retain and what risks to transfer to other parties
Cost of Risk
=
Likelihood
X
Consequence
Risk Response
Risk Response Methods
Elimination
Transfer
Retention
Reduction
Risk Elimination Practices
✓ Tendering a very high bid
✓ Placing conditions on the bid
✓ Pre-contract negotiations as to which party takes certain risks
✓ Not biding on the high risk portion of the contract
Risk Response
Risk Response Methods
Elimination
Transfer
Retention
Reduction
Risk Transfer
✓ Two basic forms.
✓ (a) The activity responsible for the risk may be transferred, i.e.
hire a subcontractor to work on a hazardous process
✓ (b) The activity may be retained, but the financial risk
transferred, i.e. methods such as insurance.
Risk Response
Risk Response Methods
Elimination
Transfer
Retention
Reduction
Risk Retention
✓ Handling risks by the company who is undertaking the project.
✓ Two retention methods, active and passive.
✓ Active retention is a deliberate management strategy after a
conscious evaluation of the possible losses and costs of
alternative ways of handling risks.
✓ Passive retention occurs through negligence, ignorance or
absence of decision.
Risk Response
Risk Response Methods
Elimination
Transfer
Retention
Reduction
Risk Reduction
✓ Continuous effort
✓ Improving housekeeping, maintenance, first aid procedures and
security.
✓ Education and training within every department
Risk Response- Country Level
✓ Approval and Permit
✓
Establish JV with renowned local
partners
✓ Govt. Influence on Disputes
✓
✓
Obtain support from World Bank, IMF,
ADB against misuse of power
✓
Direct business contact; no broker
✓ Expropriation
Rely on international consortium/
insurance policies
Prepare/submit all necessary reports on
time
✓ Political Instability
✓
Political risk insurance
✓
Termination/delay clause in contract
✓ Government Policies
Establish JV with renowned local
partners
✓ Corruption
✓
✓
Maintain good relationship with local
govt.
✓ Change in Law/Justice
Enforcement
✓
✓ Quota allocation
✓
Study carefully differential taxation-find
legal measures to reduce tax
✓
Transfer only ordinary technology
✓ Cultural Differences
✓
Hire native-language speaking employee
✓ Environmental Protection
✓
Adopt strict pollution control measures
✓ Public Image
✓
Public relation/charities/donations
✓ Force majeure
✓
Insure all insurable force majeure risks/adjust
tariff
Risk Response- Market Level
✓ Human Resource
✓
Offer training to new and existing staff
✓ Local Partner’s
Creditworthiness
✓
Have clear contractual terms/define clear
authority
✓ Corporate Fraud
✓
Adopt one accounting
standard/independent accountant
✓ Termination of JV
✓
Have comprehensive terms of default in
the contract
✓ Foreign Exchange and
Convertibility
✓
Use dual currency contracts
✓
Use other money transfer tools- forward
and swap that can hedge exchange rate
✓ Inflation and Interest Rates
✓
Obtain payment and performance bond
from international/local banks
✓ Market Demand
✓
Employ reputable third party consultant to
forecast market demand
✓ Competition
✓
Conduct market study and obtain exact
information of competitive projects
Risk Response- Project Level
✓ Cost Overrun
✓
Develop a clear plan, and control
schedule and cost
✓ Improper Design
✓
Introduce adjustment clauses in contract
to review plan and construability
✓ Low Construction
Productivity
✓
Undertake probability and sensitivity
analysis
✓ Site Safety
✓
Study and implement local accident
regulations stringently and effectively
✓
Get third party insurance for
compensation
✓ Improper Quality Control
✓
Implement ISO 9000 and get certification
✓ Improper Project
Management
✓
Hire competent project management
team
✓ Intellectual Property
Protection
✓
Exploit local legislation to get protection
against unauthorized use of confidential
information
An Example of Risk Register
Political Risk at Glance