Project balance models including Spas and additional resource facilitation methods such as Private Public partnerships (Peps) re analyses from a lifestyle perspective, and in terms of their capacity to minimizes risk and provide adequate returns on investment. Additionally, case studies are cited to draw attention to successful finance models with a focus to incorporate these structures at Clean-O Pity Ltd. 1. 1 Overview This paper outlines the potential benefits of undertaking a Project Finance Partnership (PEP) to construct a new water treatment facility.
Risks discussed within this report are pertinent to this project and are of both Internal and external nature and must therefore be analyses extensively. This analysis will allow for determining the likelihood of each risk occurring, and therefore allow Clean-O Pity Ltd to reflect these risks In the chosen contract as a regulatory system to ensure successful delivery of the facility. Risks are also identified within the selected case study on the Sydney Cross City Tunnel (ACT), and its build own operate transfer (BOOT) type Public – Private Partnership (APP).
Proper assessment of risks, ensuring value for money and protection of public interests are essential elements in a APP agreement; and comprise the elements of due diligence necessary prior to commencement of any reject. In essence, this can only be achieved through optimal risk identification, assessment, allocation and management from a lifestyle perspective Non, 2010). Recommendations for Clean O and their sponsors are presented in the conclusion of this report and are weighed according to the fulfillment of objectives as outlined by Clean-O Pity Ltd.
The focus Is to provide the board with a framework for decision making as to proceed with the SSP Annihilative or not. 1. 1 2. 0 What is project finance Project finance is essentially a method of financing where the lender takes future turns from a project as a guarantee on a loan. In contrast, a traditional method of financing involves the debtor undertaking to transfer collateral to the lender in the case of default Non, 2010). In practice, most projects are financed by a combination of both traditional methods as well as by guarantee-backed loans.
Guarantees generally come In the form of a letter from the sponsor company to the lender undertaking to repay the loan. Project finance has become an Increasingly widespread mode of financing capital- and risk-intensive projects across a number of Industries, In evolving and emerging economies, and is certainly a technique that has proven 3. 0 Project Finance and Corporate Finance for Capital Intensive Projects Corporate finance typically involves private investors who provide financing in return for equity in a project company.
The sponsoring company (the company building the project) characteristically secures funds by demonstrating to lenders that it has adequate assets on its balance sheets. In the case of default, the lender is able to sell the company’s assets to recover its investment. In project finance, however, the payments of debt are not based on the assets on the sponsoring company’s balance sheet, but on the expected returns of the project once complete; anticipated project revenues are used to repay creditors and dividends to sponsors (Baker, 2011).
As investment and finance decisions are generally based on long-term future predictions or estimates of financial, technological or other variables, there are several factors the sponsor company must consider when determining whether to use a corporate or project finance structure Non, 2011). Considerations include the mount of capital needed, the calculable probability of risk occurring in each phase, the risks involved throughout the deliverables life-cycle, and the identity of the participants.
Furthermore, banks will place considerable emphasis on the reputation and financial standing of participants when considering whether to finance a deal or not. This forms part off risk management approach (Casanova and Beck, 2010). Moreover, the Project finance model significantly minimizes risk to the sponsoring company, compared to traditional finance methods, due to the fact the lender relies only on the returns generated by the project to repay the loan. Guarantees are limited, and the company’s assets are protected in the case of a default.
However, a sponsoring company can only use project finance where it can demonstrate that revenue streams from the completed project will be sufficient to repay the loan. As a result, therefore, two important considerations for this initiative are that it must offer returns on the money invested, and there must be sufficient transfer of risk to the private sector in order to isolate any risk to the project company (Admired et al). 3. Managing risk in project finance transactions The success of a project finance deal depends on a careful mapping of risks and on identifying the best strategies to manage risk.
In order to generate value for money, the risks must be transferred to the party best able to manage them (Arming). In the context of APP deals, it is important to note these projects tend to be more risky than other business activities (Sheen et al 2006). Risk can be defined as the probability that a particular adverse event occurs during a stated period of time or results from a particular challenge (Admired et al). Any activity or decision where the outcome is less than certain, therefore, can be risky. Risk management, consequently, is a way of making the future manageable.
Managing risks means developing tools and techniques to effectively avoid and repair the effects of risks from bid through construction phases and maintenance feasibility cost controls on a project should bring confidence to decision making, help to identify threats and opportunities, help manage interfaces between external parties, result in proactive management and improve compliance with relevant legislation. However, the failure of many APP projects, by and large can be attributed to improper risk identification, analysis and mitigation (Zoo, 2013).
Risk management relating to The Sydney Cross City Tunnel project will be discussed in more detail, and analyses in section 4 of this report. 4. 0 Overview Public-Private Partnerships (APP) Public Private Partnerships APP initiatives are project specific, and can be defined as a co-operative venture between the public and private sectors. They involve complex long-term contractual arrangement’s involving the provision of services that require he construction of infrastructure assets (Australian Dept. Of Finance and Administration [DEAF] 2006).
Sharing of risks and responsibilities between parties involved is essential as success ultimately depends on each party’s skills, capabilities, limitations and their ability to effectively manage the inherent risks. Risk transfer, whole-of-life costing, innovation, and asset utilization are usually stated as the value- for-money drivers for Peps Non, 2012). Typically, the government agency will sign a contract with a special purpose vehicle (SSP) which in turn sub-contracts the finance, sign, construction and maintenance (soft and hard), to companies often related to its shareholders (Admired et al, 2010).
Although there are many different participants in a APP transaction, the focus of this paper is on the government agency and the private party. Each party’s assumption and allocation of responsibility may differ and the partnership can form various contracts such as Build Operate Transfer (SOT), Build Own Operate Transfer (BOOT), Joint Ventures W), Operation and Management contracts (O&M) and Design and Construct (D&C) contracts as security packages for tot parties (Zoo, 2008). 4. Public-Private Partnerships in Australia Peps in Australia have typically been used to build infrastructure, including roads, rail, water and social infrastructure such as hospitals and educational facilities and make up around 10-15% of infrastructure spending in Australia (Property Council of Australia). However, although infrastructure expenditure has been relatively high as a percentage of economic activity, the coordinated development of infrastructure has been a major area of neglect Nonstop, 2012). Problems in Australia’s Peps have been assessed at 7% which is well above the international norm of 1%.
Problems include under-bidding, over optimistic forecasts and inadequate risk allocation Nonstop, 2012). Melbourne City Link and Sydney Eastern Distributor are considered successful projects. Similarly, in Brisbane the APP model incorporated in Brisbane Airport International Terminal expansion ($mm) and the Gold Coast University hospital ($1 . BIB) have proved to be successful. However, the Cross City Tunnel and Sydney airport railway link have been financial failures with both projects falling into receivership.
The Cross City Tunnel in Sydney is currently open to commuters and is 2. 1 km long running east-west between Darling Harbor and Restructure Bay. It is the result of a build own operate transfer (BOOT) type of APP between the Cross City Motorway Consortium (CM) and the New South Wales Government with a 30 year concession period after completion of construction (Zoo, 2008) . Private Sector partners included Flinger Berger GAG, Bloodstone Hornier Pity Ltd and Deutsche Bank GAG (NEWS Government Treasury, 2005) who were all contracted in order to fulfill the scope of the project.
Despite all foreseeable precautions amid the risks that may have prevailed on the project, the tunnel has since gone into receivership. This receivership is the result of underused (compared to predicated traffic volumes) and stamp duty issues with the current Government. Investors have lost a vast proportion of superannuation and alternative investments due to the absence of profit from the project. The construction of the tunnel itself was successful, and was completed almost one and a half months ahead of schedule; however, long term capital objectives of the project have not been met. The cost of the project was approximately $680 million. . 2 Risk Ignoring or failing to incorporate risk from inception and through the life-cycle of Peps can impact positively or negatively on outcomes, and can have a detrimental effect on stakeholder value (Baker, 2011). Success managing risk and uncertainty correlates highly with better outcomes in terms of time, cost and quality. Consequently, risk needs to be addressed in ways that include: risk identification; risk assessment; risk allocation; and risk management. The risks relating to project phases can be categorized as such: contract development and negotiation; instruction; finance; political and governance risks.
However, it is important to consider the direct cause and effect relationships within each identified risk Nonstop, 2010). Risk identification, as shown in Cross City Tunnel (ACT) was not done well. The following sections will outline the risks identified in ACT and provide a detailed synopsis in terms of pre and post construction risks, as well as risks common across both phases. 5. 2 Pre-Completion Risks: Project Planning The original predictions of traffic volumes in the tunnel were 35,000 vehicles per day ND increasing to 90,000 by the end of the first year of operation.
However, the project was not well received by the community and one month after opening the tunnel was utilities by only 20,000 motorists per day (Zoo, 2010). There are a number of direct risks that contributed to the low usage of the tunnel; the major over- estimation of demand for the tunnel illustrates this. Furthermore, inaccurate projections in several major economic infrastructure projects over the years have involved considerable errors which can be attributed to optimism bias Nonstop, 2010). 5. 2. 1 optimism Bias
Optimism Bias occurs in situations where optimism is used as a method of reasoning rather than qualitative and quantitative methods of Justification for measures of work outlined by a company (or individual estimating actual costs). Optimism Bias is tendency to underestimate costs, time and risks involved in a project whilst overestimating profit and/ or benefits . In this case the consultants to both sectors at the same time neglecting to consider the direct impact of road closures and diversions. For this reason, it is essential that estimates are completed with accuracy s the major focus rather than pure competitiveness.
Competitiveness is inevitably a vital component of successful business ventures; however, it does not make good business sense to be competitive to the point of enduring losses. 5. 2. 2 Construction Risk Risk transfer by means of nonofficial contracts is the most commonly used risk management strategy in project finance. Contractual arrangements offer a broad range of possibilities for allocating risks among stakeholders. The construction contract in ACT as a BOOT agreement effectively assigned all responsibilities and financial risk to the private party.
The contractor was responsible for bringing the project to practical completion according to design and specifications, and maintaining the tunnel for the 30 year concession period, before transferring the asset to the government. The actual construction of the ACT was a success. The contractor, Bloodstone Hornier completed the tunnel almost one and a half months ahead of schedule. The contract agreement provides incentive for the contracting company to honor the original agreement as outlined in the contract and to deliver the project on time, on budget and to the required quality.
For example, if the contractor fails to meet its obligations, it may be required to pay compensation to the project sponsors, often in the form of liquidated damages (Olds, typically assigned to lenders as part of their security package). Moreover, delay Olds, payable when the contractor fails to meet certain milestone dates, normally cover additional interest costs arising from the delay and may pay compensation to equity investors for lost income and fixed costs incurred (Private Sector 96). 5. Post Completion: Operating risk During the operational phase of the ACT, a number of risks became evident. The subsequent risks included: community backlash over road closures and traffic funneling; market risk due to the expensive toll and an effective boycott by motorists; and revenue risk due to the fact few motorists used the tunnel and paid the toll Nonstop, 2010). Market risk occurs when generated revenue is less than anticipated. In the ACT (and Sydney Airport Railway Link), failure was a result of excessive expectation of return on investment by the private company.
The expensive toll is the result of a 16 percent return on investment (ROI) budgeted by the private sector wrought the 30 year concession period, and as a result of an up-front $MM fee imposed by the government to gain construction permission and win the right-to- operate which effectively added an extra ICC on the toll price (Zoo, 2010). The Cam’s solution to mitigate the risk of people not using the tunnel was to effectively funnel the traffic into the tunnel by changing the existing road design and traffic directions, and as a result guaranteeing its usage (Zoo, 2010).
As a requirement of the private operator (CM), the Government agreed to make these changes involving closing ND changing a number of lanes and traffic directions to guarantee maximum revenue to the private sector (Zoo, 2010). This mitigation strategy it would seem was considered as part of the original contract and negotiation phase, and formed a key part of the agreement. The backlash in this case indicated insufficient attention had more, this risk could have been reduced if proper risk identification and analysis was conducted in the design stage (Zoo, 2011)..
In addition, maintenance of the asset presents an additional set of risks in terms of abatement risks and liquidated images. Operations and maintenance contracts (O&M) seek to mitigate these risks through either fixed price contracts or pass-through contracts, although in a BOOT type agreement as in ACT the cost of maintaining and operating the tunnel throughout the concession period is incorporated into the bid cost. In order to insure against Lad’s Construction All Risk Insurance (CAR) can be used. 5. Common Risks Financial risks are common to all sectors and projects, regardless of the finance model utilities and the risk mitigation strategies employed. These risks exist through al phases of a project, and can be defined as residual risk, or risks that might affect a project company’s ability to service and repay its financial obligations. For example, supply and output risks (as illustrated in the ACT) and price risks, which might affect net present value of cash flows , including exchange and interest rate fluctuations, will inevitably remain (Prestigious Pl 51).
In addition, unexpected changes in cash flows can affect the project company’s ability to repay costs, service debt, and dividends. Consequently, ignoring or failing to incorporate risk into the process can eave a detrimental effect on stakeholder value (Baker, 2011). This was the eventual outcome of the cause and effect relationships between the identified risks and subsequent risks outlined above, which occurred in the ACT; insolvency and cash flow risk eventually resulted in the company falling into the hands of an administrator and consequently into receivership Nonstop, 2010).
The risk management process defines strategies the SSP can use to mitigate the impact of risks on project cash flows. These include strong monitoring and reporting; adequate cash flow is essential in a project to meet the fixed payment schedules which are locked in. However in the case of ACT the market risks and low demand for the tunnel became impossible to mitigate. Another approach stipulates risk transfer as a means to mitigate risks through hedging, diversification and insurance (Pl 51). The project was financed ? % through equity and ? % by debt. 6. Conclusion As a result of the failure of the ACT, guidelines for assessing risk have been revised. It is now anticipated that risk be identified and assessed for the most part through a atria process involving 12 categories which include: site; design, construction, commissioning; sponsor; financial risks and benefits; operating risk and payment mechanism; market risk; network and interface risk; industrial relations; legislative and government policy risk; force measure; asset ownership risk; and, tax risk, all of mitigation of risk (NEWS Treasury 2006).
To ensure success in Project finance deals, or APP projects, it is important for all partners to manage the risks from a project life cycle perspective. This means identifying risks and assessing them in the earliest possible stage and allocating hem to the partners who are best able to manage them. Lessons learned in the ACT project indicate that, along with identifying probable risks, it is essential to also consider the cause and effect relationships that stem from each individual risk once realized.
Furthermore, it is important to monitor risks continuously and develop proactive risk respond strategies throughout the project lifestyle; identified risks should be weighed against the project’s anticipated cash flows and respective financial impacts on the repayment streams in order to protect the SSP. 7. Recommendations The decision made by Clean-O Pity Ltd as to proceed with the SSP or not will ultimately be made based on a risk-benefit assessment.
Based on our research, and on the case study outlined within this report, APP procurement is shown to clearly favor the top tier D&C Companies which are able to absorb the financial losses associated with a potential bid failure. There is no doubt, however, that bundling and private ownership combine to form a powerful incentive mechanism for generating cost savings over the whole life cycle of infrastructure assets.
