Risks associated with megaprojects

PRESENTED BY: Bruce Dzenga DATE: July 2022

This Webinar is focused on major risks associated
with mega infrastructure projects given how prevalent
these are in the current portfolio of public
infrastructure investments.
Material risks associated with
Preamble megaprojects and mitigation Q&A
strategies (16 risks)

- Within the Project’s Control

- Outside the Project’s Control
- Within the Financier’s
Control

Consequences poor risk

Definitions
management in megaprojects
Mega infrastructure projects (MIPs)
Mega infrastructure projects (MIPs) are large-scale engineering facilities
such as transportation systems, water supply systems, energy systems, or
communication systems that provide basic public services for social
production, economic development, and residents’ livelihoods (Flyvbjerg,
2014).

In the South African context, the Framework for Infrastructure Delivery and
Procurement Management (FIDPM), defines a megaproject as any high
impact project whose construction and decommissioning has one or more of
the following characteristics:

• The total project implementation cost is likely to exceed R1.0bn;

• Involves proprietary/innovative new technology; and
• Require an Environmental Impact Assessment (EIA) or Water Use License
(WUL).
At least 3 features associated with MIPs are notable

MIPs are costly and require high amounts of labor, physical and financial
resources, and the total amount of project funding usually exceeds many
billions.

MIPs are strategic and public welfare, which generally are key projects
in the national or local government’s economic development plan, and
usually are commissioned by the government and delivered by
competent private contractors and suppliers.

MIPs have long-term impacts on the national or regional economy, civil

society, and natural environment, even affecting multiple generations in the
long term.
The 16 Risks

Operating risk
Within the (technical, cost, Engineering
Participant risk Completion risk
Project’s Control and risk
management) Environmental
risk

Political risk
Outside the Supply/inputs Infrastructure
Market risk
Project’s Control risk risk Force majeure
risk

Foreign
exchange risk
Within the
Interest rate
Financier’s Syndication risk Legal risk.
risk
Control
Means for mitigation
Contracting
• A party agrees to take responsibility over a certain issue on behalf of someone
else.

Trigger
•A step further from contracting in that parties agree in a contract that should a certain risk
materialise, actions will be triggered into force. If nothing happens, no action will be taken.

Financing
•Occurs when financial resources are set aside in anticipation for certain risks materialising. In the
event that risks materialise, the funds that have been set aside are called to cover the loss. Finance
is mostly used for mitigating completion risk and market risk.

Study
•Happens where market risk cannot be contracted readily, such as for telecoms, toll roads, or quality
specific production, then all the project financiers can do is to rely on studies and market projections.

Avoidance
•Is when action to complete risk aversion is taken in advance of a particular risk aspect. The usual
mechanism is to fulfil some obligation – financial, physical, or contractual – or to double up a risk
coverage by way, for example, through a guarantee, indemnity or in some instances, insurances
Risks Within the Project’s Control
 1. Operating Risk – Technical component

Description Mitigation Strategies Examples

Contract - (Technology
management, technology
warranty, quality assurance,
technology guarantee) Breakage and unplanned service
Operating risk is associated with
Trigger (Fleet assurance, outages, unavailability of spares,
uncertainty about the
business interruption Insurance, and poor workmanship are
performance of infrastructure
technology insurance) amongst the examples of
once it has been constructed.
Financing (Performance bond) technical risks
Study (Independent certification,
alternative technology,
technology curve).
 2. Operating Risk – Cost component

Description Mitigation Strategies Examples

Contract (Cost guarantee, sales Higher than expected costs and

Operating risk is associated with contract) inflation, technology challenges,
uncertainty about the Trigger (Economic test) and management components
performance of infrastructure Finance (cost subordination) resulting in higher operational
once it has been constructed. Study (Cost curves) costs and/or adverse project
Avoided (Cost waiver) output/throughput.
 3. Operating Risk – Management component

Description Mitigation Strategies Examples

Higher than expected costs and

Contract (Management contracts,
Operating risk is associated with inflation, technology challenges,
labour contracts, training
uncertainty about the performance and management components
contracts)
of infrastructure once it has been resulting in higher operational
Trigger (Key person insurance)
constructed. costs and/or adverse project
Study (Personnel screening)
output/throughput.
 4. Participant Risk

Description Mitigation Strategies Examples

Trigger (Deficiency
An insurance company to a
The credit of the participants agreement, share pledge,
project may fail to deliver on
and the risk of non- cross collateralisation, board
its obligations due to poor
performance under the project control, call option)
credit risk ratings or the
contracts or financing Study (Bankruptcy
collapse of a participating
agreements. remoteness, pre-
bank.
assignments)
 5. Completion Risk

Description Mitigation Strategies Examples

Contract (Turnkey construction

contract, multi-party turnkey
contracts, partnering charters/alliance Medupi and Kusile power plants
contracting) have been susceptible to
Also known as construction Trigger (Liquidated damages, delay completion risk in that they both
in start-up insurance, force majeure)
risk, refers to the risk that a failed to be completed on time
Finance (Default agreement,
project will not be able to pass bonding/guarantees, completion
due to poor development during
its completion test. guarantee, completion undertaking, the planning phase and they
overrun – standby facilities, debt: experienced significant cost
equity subscription) overruns.
Study (Independent completion
engineer, completion tests).
 6. Engineering Risk

Description Mitigation Strategies Examples

Medupi and Kusile power

Also called design risk, projects are prime examples of
engineering risk refers to the projects in South Africa that have
impact on project cashflow been susceptible to
from deficiencies in design or design/engineering risk. The lack
engineering. This risk is Trigger (Insurance) of full life cycle planning meant
prevalent in complex Study (Independent certification. that during construction,
engineering projects engineering designs were
employing first-of-a-kind incomplete and engineering risks
materialised. These projects
(FOAK) technologies such as
have been delayed by boiler
power stations.
design flaws.
Outside the Project’s Control
 7. Supply/Traffic/Reserve Risk

Description Mitigation Strategies Examples

A coal or natural gas fired power

Contract (Supply agreements, plant requires access and rights
The raw materials or input to supply undertakings, tolling to an uninterrupted supply of coal
a project change from those contracts, supply assurance) or natural gas. Water projects
assumed/projected. For a Trigger (Insurance, hedging) rely on good hydrology. Dam and
resources production project, Financing (Collateral) hydro power schemes are heavily
this is called reserves risk. Study (Supply studies, reliant on hydrology and constant
weighting). supply of water throughout the
year..
 8. Market Risk

Description Mitigation Strategies Examples

- Contract (Sales contracts,

The Guatrain has a patronage
market price, trading
guarantee as a mitigation
Changes to the amounts sold company financing,
strategy in cases where actual
or the price received which customer financing)
revenue underperforms the
impacts on gross revenue. - Finance (Tax exemption) minimum required total
Sometimes called sales or revenue as per the
revenue risk. - Study (Transport studies).
Concession Agreement.
- Avoided (Free on board
offtake).
 9. Infrastructure Risk

Description Mitigation Strategies Examples

- Contract (Infrastructure Infrastructure risk includes

contract, government aspects such as
commitments, Pooled interconnection, entrance, exit
Risk that negatively impacts infrastructure) ramps which are outside the
on project cashflows as a principal construction contract.
- Trigger (Hedging, contract
result of infrastructure For example, a power utility
for differences, make-
problems. Infrastructure risk is taking the power under a
up/deficiency agreements,
also called transportation risk. power purchase agreement
insurance)
fails to install the transmission
- Study (Market forecasts). line from the power station to
the grid.
 10. Environmental Risk

Description Mitigation Strategies Examples

- Contract (Environmental management,
Rehabilitation management/revenues)
Compliance with the National
- Trigger (Rehabilitation release, Environmental Management Act (NEMA).
emergency response, environmental There is a requirement to remove sulphur
warranty, environmental insurances) dioxide from exhaust flue gases of fossil
Economic or administrative fuel power plants and from the emissions of
- Financing (Rehabilitation guarantee,
consequence of slow or other sulphur oxide emitting processes.
pollution control bonds, rehabilitation
catastrophic environmental This has seen a rise in the adoption of
reserve)
renewable energy technologies. With
pollution.
- Study (Environmental impact respect to existing power stations, there is a
statement, environmental plan, Equator planned installation of Flue-gas
compliance). desulfurization units in some of these
stations.
- Avoided (Regulatory waiver, regulatory
purchase/trade physical waiver)
 11. Political Risk

Description Mitigation Strategies Examples

- Contract (Concession agreement, co-
financing, multi-party structures, partial
Political risk, also known as risk guarantee, partial credit guarantee,
country risks, is the risk that could market tie, countertrade) War or civil disturbance,
adversely affect a project’s insurrection, terrorism, protests,
- Trigger (Political risk insurance,
returns as a result of political currency inconvertibility agreements, expropriation, environmental
changes or instability in a country. foreign exchange devaluation, debt: activities, landowner actions, non-
Instability affecting investment equity swaps, tax indemnification) government activists, legal, and
returns could stem from a change - Financing (War and insurrection bureaucratic/approvals are
in government, legislative bodies, residual, cash escrow, prepaid political examples of pollical risks that
risk insurance premiums)
other foreign policymakers or could materialise.
military control. - Study (Prince chart).

- Avoided (Offshore proceeds account)

 12. Force Majeure Risk

Description Mitigation Strategies Examples

- Trigger (Deferral,
insurance, Negotiation) Examples include acts of man,
nature,
- Studies (Risk manager, governments/regulators, or
Arises due to events outside Safety measures) impersonal events. Terrorist
the control of the parties.
attacks on the Mozambique
LNG project in Cabo Delgado
province, Mozambique.
 13. Foreign Exchange Risk

Description Mitigation Strategies Examples

- Contract (Forward contracts,
Debt repayments and
parallel loans, barter)
dividends priced in foreign
- Trigger (Currency swap, exchange while revenues are
Foreign exchange risk arises exchange rate agreements)
generated in a local currency.
from a mismatch of the
- Avoided (Natural hedge, More pronounced in projects
currency of the revenues, commodity lending, consumer with a high portion of imported
operating costs, and the debt. price index lending, foreign components such as the
exchange tariff, Purchasing
proposed new nuclear build
power parity model, exchange
programme.
rate forecasts).
Within the Financier’s Control
 14. Syndication Risk

Description Mitigation Strategies Examples

- Contract (Fully underwritten, For the HK$3.3bn project
club underwriting, broad financing of the 700MW Shajiao B
syndication, UN syndication) project in China, the original 46
initial financing banks were
- Study (Information
expanded to 65 refinancing
Sometimes labelled the memorandum).
banks, with only a few
financing - Avoided (Equator syndicate, participants new to the project
syndicate Excel model, project finance business. The few new
or underwriting risk.
development plan, loan participants may have been a way
administration) to manage the risk of having
many participants; while the many
total participants reduces the risk
of one participant pulling out.
 15. Interest Rate Risk

Description Mitigation Strategies Examples

- Contract (Supplier credits,

leasing, hedging/swaps,
Also known as funding or natural hedge) If interest rates rise, for
escalation risk The impact on
- Trigger (Alternative instance, the value of a bond
project cashflow from higher
funding, interest protection or other fixed-income
interest costs or lack of
agreement, interest make- investment will decline.
availability of funds.
up agreement, bank-ended
interest).
 16. Legal Risk

Description Mitigation Strategies Examples

- Contract (Direct
agreements, legislation)
Documentary complexity is a
- Trigger (Title insurance) fact of project finance life.
Deals with more than 10,000
A risk that a defect in the - Study (Title searches, legal
pages are known. The legal
documentation will affect opinions, due diligence
system of a country may not
cashflow or debt service. ‘books’).
be adequate to cope with the
- Avoided (Parallel security complexity of project
structure, offshore security
finance.
structure, pre-transfer
arrangements)
16 risks: Cashflow matrix
16 risks: Cashflow matrix
Q&A
GTAC
Government Technical Advisory Centre
Private Bag X115
Pretoria 0001

240 Madiba Street, Pretoria 0002

info@gtac.gov.za | www.gtac.gov.za

5 July 2022