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S.S.G.B COLLEGE OF ENGG & TECH BSL 1

Chapter 1 : INTRODUCTION

Infrastructure development is the backbone of the economy and progress of any country.

Conventionally the central and state government used to provide funds for its construction

and provide the generated facilities to user (public) either free or at highly subsided rates. The

funds were provided from tax revenue through budget provisions. Apart from requirements of

huge financial services, the quality and efficiency of government created infrastructure used

to be low because of bureaucratic way of working and natural apathy and off take

governmental working.

Due to highly increased expenditure on establishment and diversion of public

financial resources towards short term, popular and politically important gains, the

infrastructure development was denied of resources. These demand which have high capital

requirement and have long gestation period, apart from highly risky ventures, hence even

private sector funding was not forthcoming.

Thus new techniques were required to develop for attracting private sector investment in

infrastructure projects. One such technique is BUILT-OPERATE-TRANSFER (BOT) and its

different variants. Under this scheme an infrastructure projects conceptualized by the

government/public. Bids are then invited from private sector to arrange funds, build the

facility and operate over a specified concession period collecting revenue as a toll from the

user to recover the invested capital plus an adequate return on the investment usually 15 to 20

percent. After the concession period the ownership of the created facility is transferred back

to the government. Therefore, the BOT scheme is a limited-recourse project financing

technique for implementing infrastructure projects by using private funding.


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Chapter 2 :INTRODUCTION:

The Literature survey carried out in this section consists of different aspects of risk involved

in BOT projects and they can be studied in following manner:

1. Risk-Defination

2. Risk Classification.

3. Risk Preception/Awareness

4. Project Life cycle

5. Risk life Cycle

6. Risk Assesment

7. Management Cycle

8. Risk response & Mitigation9. 3.1 INTRODUCTION10.

11.In many developing countries, rapid economic growth is outstripping infrastructure

supply. Governments in these countries are unable to fund vital infrastructure

development and rehabilitation, so they are increasingly turning to large international

firms as a source of funding through concession contracts such as Build-Operation-

Transfer (BOT). These firms generally have a greater credit standing and capacity to

finance the large scale projects. If procured properly, the BOT option presents a win-

win-win solution for governments, private sector firms, and the community at large.

From the governments perspective, private sector participation offers off balance-

sheet funding whilst bringing an added advantage of cost and resource efficiency to

the project. From the private sectors perspective, BOT projects present great

opportunities to expand market share and earn higher returns. Finally, thanks to a user

pays system, the community at large does not experience taxation increases.


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12.However, although globalisation has created greater opportunities for construction

companies to expand their market share abroad and earn higher returns, almost 15%

of the 225 global contractors have sustained losses on their international projects

(Diekmann, despite the fact that international projects are generally more profitable

than domestic projects. Such losses can mainly be attributed to the difficulties

experienced in assessing and evaluating the impact of non-financial (risk) factors on

international projects and more specifically on BOT projects in developing .

13.BOT projects are by nature long-term investments involving complex organisational

structures. Over the lifespan of these projects the legislative, political, social, market

and economic environment could all change significantly. This is especially the case

in developing countries, where the social, political and economic conditions are

unstable. Thus a high degree of risk and uncertainty surround BOT investment

opportunities in these countries and it is critical that adequate identification,

assessment, and evaluation of non-financial (risk) factors take place at the feasibility

stage.


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CHAPTER 4

4. DATA COLLECTION & ANALYSIS

4.1INTRODUCTION

This chapter deals with the details & information of causes & different types of risk

involved in the BOT projects considered for the studied, The data is collected from Mumbai

based Construction Company GAMMON INDIA LIMITED (minimum two projects are

taken to identify different financial risk involved in Project.

The factors that are highlighted in this section are risk during different stages of

projects such as gestation development-construction-operation termination stages. Details

of the project are collected from the two location and the details are discussed from the

project incharges of the project and key person to identify the different factors and various

terms involved in the project..


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4.2 DETAILS OF DATA COLLECTED

The data collected from the sites are as follows.

Project I-

Project Name: - Construction of twin flue Chimney 275mtr Ht.

Client :-Tata Projects Limited

Owner :-MAHAGENCO

Project Cost :166 Crs.

Location :Deepnagar ,Bhusawal.(MH)

Project II-

Project Name:-Construction of Multi flue Chimney 275 mtr Ht.

Client :L&T power Vadodara

Owner: MPGENCO

Project Cost :177crs

Location:Malwa,Shingaji TPS,Khandwa (MP)

4.3 DATA COLLECTED FOR FINANCIAL RISK OF PROJECTS

INTRODUCTION

Risks are nothing more than the variables or circumstances associated with the

implementation of a specific project that has the potential to adversely affect the development

of the project or the interests of participants, as the case may be. Risks include circumstances

or situations or situations, the existence or occurrence of which, will, in all reasonable

foresight, result in an adverse impact on any aspect of the implementation of the project.


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4.3.1RISKS INVOLVED IN DIFFERENT PROJECT STAGES.

It is also generally true of all infrastructure projects that the degree and nature of risks

will alter with regard to the stage of the project. The risks in various stages of a project are

discussed below. Chart 4.1

RISK STAGE OF PROJECT

% RISK

INVOLVED

(Project I)

% RISK

INVOLVED

(Project II)

Value

in Crs

( Project I)

Value

in Crs

( Project II)

Gestation Stage 5% 5% 8.30 8.85

Development Stage 15% 15% 24.90 26.55

Construction and The Start Up Stage 40% 40% 66.40 70.80

Operational Stage 25% 25% 41.50 44.25

Termination Stage 15% 15% 24.90 26.55

Table 4.1

5%

15%

40%

25%

15%

DIFFERENT

RISK INVOLVED IN BOT PROJECT STAGES

Gestation Stage

Development Stage

Construction and The Start Up

Stage


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TABLE 4.1 RISK DURING DIFFERENT STAGE OF PROJECT.

4.3..1 In the Gestation Stage

This is the crucial stage in the process of project implementation, the importance of

which is somewhat misjudged. If the research and the decisions to be undertaken at this stage

are faulty they will to have to be rectified at a later stage of development that would only be

more expensive. In order to verify the feasibility of the project and to enable a project to have

a sound foundation

In the gestation stage the following studies should be:

i. Identification and Analysis of the legal framework that would governthe project s


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ii. Commercial and Economic Feasibility analysis

iii. Environment and Social Impact

A preliminary study should be undertaken regarding the environment impact of

the project and the extent of the possible displacement of people, and requirements for

the habilitation of the persons likely to be displaced.

4.3.2 In the Development Stage

If necessary, the prospective sponsor has to identify suitable co-sponsors. The

proposal of the concerned prospective sponsor is accepted then theProject Vehicle has to be

incorporated.Chart 4.2

Certain Risks during Development Stage:

The most favored solution for mitigating risks at the development stage is generally

for the government to adopt transparent selection procedure (generally competitive bidding

process) on basis of well-defined and adequatelyprepared documents and data. From the

gestation stage itself thegovernment must associate itself with competent advisors in order


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to ensure that the bid documentation and data are reliable and stand the test of time and

examination.

4.3.3 In the Construction And The Start Up Stage

During the construction stage the risk associated with an infrastructure project are the

maximum. This is because at this stage, all the money required to commence the project has

already been drawn or committed for. The success of project completely depends upon the

ability of the contractors, associated in the construction of the facility, to complete their tasks

in a coordinated manner in accordance with the terms of the construction contract. What is

critical at this stage is that the construction of the facility should be completed within the time

period and costs projected for the construction of the concerned project facility. The facility

should comply with all the standards and specifications stipulated in the project document.

The risks associated with technology and used for the construction of the facility

essentially relate to obsolescence of technology, thereby resulting in a relatively poorer

quality infrastructure facility and change in construction costs due to alteration in the


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technology being used.

4.3.4 In the Operational Stage

During the operational phase of a project the risks are more clearly identifiable and relatively

lesser in degree.

Certain Risks during Operation Stage:

Generally speaking, the risks during the operational phase can be divided into

i. Operation risks,

ii. maintenance risks,

iii. revenue risks and

iv. Personnel risks.

The operating risks relate to conditions of operation of the facility, supply of raw

materials, distribution of off take, plant performance, levels and standards in operation of

plant, interruption of operations due to various reasons, fluctuation in costs associated with

continued operations of the facility and actual demand or usage of the facility. Chart 4.3


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4.3.5 In the Termination Stage

The risks associated with the termination stage of a project relate to the:

i. the very risk of termination of the concession and

ii. Risks associated with the transfer of the infrastructure facility to the grantor of

the concession.

Risk of Termination:

The risk of termination of the concession prior to the stipulated concession period is a

major and real risk that can result in the complete loss of all investment and loan facilities

extended to the project.

Chart :4.4

Risks during Transfer:

The concern for the grantor of the concession is that the facility should continue to

provide the service or commodity or the benefits even after the termination of the concession


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period and the resulting transfer of the facility to the granting authority The main risks that

may affect the transfer of the facility include:

i. method and timing of the transfer,

ii. condition of the facility at the time of transfer,

iii. production and environmental requirements at the time of transfer,

iv. obsolescence of technology at the time of transfer,

v. expense of any changes that have to be made to the facility at the time of transfer,

vi. Acceptance of the facility in its current state by the grantor of the concession at

the time of transfer and other related risks.

Transfer risks can be usually mitigated by stipulating standards of maintenance of the

facility which, if adhered to, through the concession period will ensure that the facility is

transferred in a condition that enables its use for a period of time after the termination of the

concession period

4.4. RISK IDENTIFICATION PROCESS

In any construction project, risks are unavoidable. Project participants are exposed to various

kinds of risk. One of the causes that lead to project failure is the inappropriate allocation of

risks to the various parties in the project. Risk management starts by the identification of the

various types of risk that could be encountered in a project. In order to identify the risks it is

essential to understand what each risk consists of and what the common causes for project

failure are. Understanding the causes for failure and the description of the various risks is a

prerequisite for an efficient risk identification, allocation, and mitigation.


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Chart 4.5

i) CAUSES FOR PROJECT FAILURE

CAUSES OF PROJECT FAILURES

PROJECT I -

Bhusawal

(In Crores)

PROJECT II -

Khandwa

(In Crores)

Capital cost overrun. 12.00 8.00

Technical failure. 9.93 0.50

Financial failure of the contractor 1.20 4.00

Government interference. 0.50 0.20


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Uninsured casualty losses. 0.40 0.00

Increased price or shortages of raw materials. 0.00 12.00

Technical obsolescence of the plant. 2.00 6.00

Loss of competitive position in the market place. 0.00 0.00

Expropriation. 1.40 3.20

Poor management. 2.20 1.20

TABLE 4.2 :CAUSES OF PROJECT FAILURE

4.5 COMMON FACTORS REQUIRED FOR SUCCESSFUL FINANCING OF

BOT PROJECT.


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The following is checklist that should be considered in order to achieve a successful

financing BOT package.

COMMONFACTORS REQUIREDFORCOMPARISION IN FINANCING OF BOT

PROJECT

PROJECT I

(RISK

FACTORS)

PROJECT II

(RISK

FACTORS)

A credit risk rather than equity risk is involved. 3 1

The cost of product or raw material to be used bythe project is assured. 2 3

A supply of energy at reasonable cost has been assured. 1 3

Building materials are available at the costs contemplated. 1 2

The contractor/operator is reliable. 2 1

Management personnel are experienced and reliable. 1 1

Contractual agreement among joint ventures partners, if any, is satisfactory. 3 2

A stable political environment exists; licences and permits are available. 3 2

Country risk is satisfactory. 1 1

Currency and foreign exchange risk have been addressed. 2 2

The key promoters have made an adequate equity contribution. 1 2

Adequate insurance coverage is contemplated. 1 3

Force majeure risk has been addressed. 1 2

Delay/Cost over-run risk has been addressed. 3 3


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The project will have an adequate ROE, ROI, and ROA for the investor 3 2

TABLE 4.3 :COMMON FACTORS REQUIRED FOR FINANCING OF PROJECT.

Study explains the criteria for a successful project financing mentioned above. Some

of these criteria may not apply for certain specific projects. The project sponsors

should tailor the criteria to each project case.

Aove chart defines different risk factor level involved intwo projects as follows:-

A. Credit risk -An objective of many project financing is high leverage of the debt to equity

ratios. However, more than a lending risk is involved when the borrower approaches the

lender. A spread in excess of about 300 points over libor is generally considered by most

project lenders as excessive lending risk is involved. Low credit risk makes it easier to raise

equity capital and loans for BOT projects. The usage of a reliable contractor consortium


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could improve the credit risk of the project. Project sponsors reduce this risk by providing

guarantees. This will be discussed in later sections.

B. Cost of product or raw material

Supply sources and contracts for feed stocks or raw material to be used by a project

must be assured at a cost consistent with the financial projections. Long-term take-or-pay

contracts are sometimes used to ensure a user a source of supply. Project dependents can use

a put-or-pay contract, in which the supplier is obligated to provide the product or service at

certain prices over a period of time.

C. Supply of energy at reasonable cost

A number of project financing got into trouble because of their failure to anticipate

future rising energy costs. Long term price contracts for feed stocks, coal or energy (with

appropriate escalation provision) can be used as a way of limiting this risk. Energy price

escalation should be carefully considered in the feasibility study of the project.

D. Availability of building materials

The actual cost of building material should be consistent with the estimated cost. The

ability to import building material and machinery should be established. Existing or possible

embargoes for political reasons must be considered.

E. Experience and reliability of the contractor and operator

The contractor must have technical expertise to complete the project. The contractor

should be financially strong. He should also be large enough to have the resources to solve


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any problem which might arise. Usually, lenders to a project require a contractor with an

established reputation for building similar projects. The operator must have the financial and

technical expertise to operate the project in accordance with the cost and production

specifications which form the basis for the financial feasibility of the project.

F. Experience and reliability of management personnel.

Good management personnel as well as experienced operating personnel are

needed to operate a project. The general management of a project company makes the basic

policy decisions, arranges the financing and is responsible for monitoring the project

company.

G. Contractual agreement among joint ventures partners, if any.

If the project is a joint venture, the agreements between the partners are of

considerable concern to lenders, who want assurance as to the identity of the companies and

entities which will own and operate the project throughout the life of the loan.

H. Stable political environment

The need for a stable political environment is a necessity for a successful project

financing. Permits must be readily available. It is very difficult to measure political stability.

There exist some rating agencies that describe a country's risks as described in the next

section. Sometimes, this information helps to assess political stability level.

I. Country risk

There should be no risk of expropriation. Country risk should be satisfactory.

Country risk is usually defined as a risk of a lender making a cross border loan to a private

company. Country risk problems occur when the host country is not in an economic position


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to permit transfer of amounts of currency for payment of interest and principal on foreign

debt to lenders. Sovereign risk should also be satisfactory. Sovereign risk differs from

country risk in that it refers to the risk of loan to a sovereign nation by a lender located in

another country. This has application in project finance where the sovereign nation is one of

the investors or joint ventures in the project. Country risk is determined by measuring country

credibility. Tables of country risks are produced by various organizations to measure a

country's credibility. An example of such rating is the EIU/Business Risk International rating

where countries are classified into four categories ranging from 'A' (Less risky) to 'E' (More

risky) based on the country's international standing. Another rating used is the one prepared

twice a year by "Institutional Investors" to assess country risk using a scale of 0 to 100.

J. Currency and foreign exchange risk

Currency risk arises where revenues, expenses, capital expenditures and loans are in

more than one currency, and therefore the project is subject to potential losses from currency

fluctuation. Careful analysis should be made of the expected cash flow of a project to

determine what currencies will be used to finance the project, including the host country

currency, and what currencies will be generated by the project. Hedging in the forward

currency market should be done where possible. Swaps can also be used to hedge foreign

exchange exposure. A multi-currency loan may help control this risk.

K. Adequate equity contribution by the key promoters

The key project sponsors or promoters must make equity contributions consistent with

their capability and risk of the project. Lenders will require the sponsors of the project to

have sufficient financial interest in the project so that it will difficult for the sponsors to

abandon or ignore the project. Usually, lenders require an equity contribution of 20% on

average as an indication of sponsors' commitment to the project.


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L. Adequate insurance coverage

An insurance coverage is important during construction and operation of the project.

This provides protection against risks. Usually insurance proceeds are assigned to lenders.

Loan agreements include clauses that determine how the to restore the project or to repay the

debt to the lenders in case of a casualty loss.

M. Force majeure risk

Force majeure risks results from events beyond the control of the parties in the

project. These events may include fire, flood, war, strike, expropriation and political

interference.

N. Cost over-run and construction delay risks

Cost Overrun risk occurs when the cost of construction or completion of a project

facility is larger than the original estimation. This creates a serious problem because the

ability of the expected revenues to cover operating costs and amortize debt is dependent upon

the assumed cost of the project. Overrun risk can be covered in a variety of ways: additional

capital bysponsors, standby credit facility, fixed price contracts, and sponsor's escrow funds

for completion. Adelay in completion of a project facility creates a serious problem. Interest

on the loan continues to run, thus raising the capitalized costs of the project. At the same

time, the expected revenue stream is delayed. Methods of handling cost of delay are the same

as for capital cost over-runs.

O. Adequate ROE, ROI, and ROA for the investor

The return on equity, return on investment, and return on assets are useful measures

used by lenders and investors in estimating the return in a BOT project. Although it is


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difficult to alter the risk of a project, the allocation of the various risks to the parties best able

to handle them reduces the project risk. Table 6.1 summarizes the major risks involved in

infrastructure projects. Different procurement methods involve different risk exposure as seen

in the table. The BOT model involve more risk than the traditional design-build (DB) and the

design-build-operate (DBO) models. Mainly, the more the involvement of the private sector

in the financing of the project, the greater is the exposure to risk. Therefore, in the BOT

model, it is very critical to consider the various types of risks in order to assure success of the

project. Also, the more the project is segmented, the less are the risks involved. The DB

model which is known as the direct funding segmented approach involves less risk than the

other models. The DBO model, which is the direct funding system approach, involves less

financing risks because it is funded by the public sector, but it involves other risks as

described in the table.


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CHAPTER 5

DISCUSSION & SUGGESTION

On the basis of above studies the following are the conclusion and recommendations.

5.1. DISCUSSION & SUGESSTION

1. For the project sponsors to structure a winning proposal based on the BOT approach a

number of prerequisites are required; strong government support, stable currency,

stable economy system and the project must be technically feasible and financially

viable.

2. Considerable co-operation between the government and the private sector institution

is essential. For each of the project participants to take risk, they are better suitable

commercially and politically.

3. Due to complexity of introducing and implementing BOT policies, an institutional

framework should be set up to plan, analyse, implement and process of BOT scheme.

4. Responsibility for construction cost and time over runs should lie with the contractor.


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5. The project sponsors must evaluate and allocate the financial, political and technical

risks to the various parties involved and each participant must have sufficient

contractual incentives and securities to be committed to the project.

6. The participation of private sector in the provision of infrastructure project has

potential of increasing the standard of living of the population. It stimulates supply

and improves the quality of service.

7. The participation is fraught with risks due to lack of experience or recent experience

of the parties regarding these systems, as well as the complexity of the relationships

among the parties.

8. The proper allocation of risks should be done among the parties. This should be done

properly and with great care.

9. Before awarding BOT project to any contractor, detail study about his history, his

capacity of projects of same scheme, his assets, any court cases pending against his

name, his bank statements, problems involved in his ongoing projects should be done.

10.Participation of private parties saves the funds of government which government can

use for social aspects and for development of country.

11.The foundation of successful financial structuring of an infrastructure project is to

structure its funding by providing the different classes of investor with instruments

that match risk/return characteristics best suited to their appetite or requirements.

12.Thus senior debt would have the highest debt service priority and would be best

secured; in ream it would for the longest debt maturity and have the lowest relative

interest spread.


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13. This category of debt would attract banks and other financial institutions.

Subordinated debt or mezzanine finance, possibly with equity kickers', and preferred

equity instruments, would pay more and would be attractive not only to bankers

financial institutions but possibly also to equipment vendors and financial investors.

14. Equity, apart from the sponsors or developer's holdings, could be held by constructor

financial investors, suppliers and off-take purchasers.

15.Once the financing structure is developed, the project company and investor may be

able to make use of and incorporate a number of techniques and instruments to

manage the various financial risks to which each is exposed.

16.The various recommendations given by us to overcome the financial risk in BOT

projects, as innovative financing are as follows.

Insurance

Future and Options

Swaps- Commodity Swaps, Commodity-Linked Loans and Commodity Linked

Bonds

Contingent Bonds

Convertible Bonds

Credit Derivatives.

Securitization

Equity Derivatives

Risks in Hedging

17.Use of above mentioned instruments is not extensive; worldwide and more so m

India. But they do give us an opportunity to mitigate some perceived risks, in their


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nascent stages; they require regulatory and legal changes. Also it requires a stable and

secondary market. Government has to play an important role in this.

SUMMARY TABLE FOR BOT RISK IS AS FOLLOWS TABLE 5.1

BOT RISK SUMMARY TABLE

Stage Risk Participant Mechanism

Development

stage

Technology

Risk

Sponsors

Equity

Subordinate Debt

Credit Risk Sponsors,Lendors Credit rating agency

Bid risk Sponsors Equity

Constructionstage

Completion

Risk

Contractors

Performance Gurantees

incentives

Sponsors

Turnkey Contracts

Contractors

Cost overrun

Risk

Sponsors Fixed price contract &

completion bondContractors

Performance

Risk

Sponsors Perfomance bond

Operationstage Cost overrun

Risk

Sponsors Fixed Price Contract

Performance O&M Equity,performance


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Risk Contractors gurantees

Equity Resale

Risk

Sponsors Subordinated Debt

Off take risk Sponsors

Take & Pay,Take or Pay,

Advance payment

Liability Risk

Insurance

company

Insurance Contracts


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5.2. CONCLUSION.

The conclusion have made on above data analysis for construction of chimney from Mumbai

based construction company two different projects of same nature Project I (Bhusawal) &

Project II (Malwa).The comparison is shown in previous chapters long with the pie charts &

comparision charts for different risk involved in the project with respect to different stages of

project.

1. As the above two case study demonstrates, project finance is a viable way to meet the

large capital commitments required to launch major projects in the world.

2. In addition, the need for project finance is expected to grow. The growing number of

project finance participants is evidence that the technique is efficient.

3. It is true that the risks are large; however they can be controlled and mitigated in an

efficient manner.

4. Therefore, the challenge for successful project finance is a correct allocation of risks

to the parties of the project that are best able to handle them.

5. In any BOT project, we should stress that a rigorous risk analysis is necessary before

a project is embarked upon in order to establish the financial and technical feasibility.

6. An understanding of the project risks leads to the formulation of better project plans.

Knowing the magnitude of the possible impact of risk factors,

7. the parties can seek better allocation of the risks through the agreement of suitable

contract clauses and other risk measures.

8. There is always a significant difference between the project risks sponsors believe

lenders should be willing to accept and those risks lenders are willing to accept.

9. Management and sponsors, by virtue of their status, tend to more naturally optimistic

and entrepreneurial and almost always find it frustrating to deal with naturally

cautious bankers (although the bankers would merely describe themselves as prudent.


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10.In conclusion, the BOT model is successful and is increasingly used in various

countries.

11. One major issue that should be carefully handled in BOT project financing is risk

management.

12. This should be done on a project by project basis.

13.The success or failure of any project is highly dependent on an efficient risk analysis,

risk sharing, and risk mitigation.


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