Finance risks
What are the Commercial risks?
▪ Revenue risks
(risk that revenues will not be as projected)
▪ Commercial viability
(is the project commercially sound?)
▪ Construction risks
(risk of overrun of project budget time planning)
▪ Operating risks
(operations not assured to be at projected level)
▪ Input supply risks
(e.g. supply of raw materials cannot be guaranteed)
▪ Environmental risk
(e.g. pollution risk; other effect on the surroundings, NIMBY)
What are the Macro-economic risks?
▪ Interest Rate Risks
(When the loan you agree to does not have a fixed rate until the project completion date)
▪ Inflation Risk
(Inflation is the trend that prices rise over time. Supplied sources without a fixed price are affected)
▪ Exchange Rate Risks
(Risks resulting from movements in the exchange rate between one currency and another)
▪ Refinancing Risk
(Refinancing your loans when the long-term interest rates goes up)
What are the Political/Regulatory risks?
▪ Political Risks
(Risks related to the relation to the Host Government where the project is located)
▪ Regulatory Risks
(Risks associated with government action, changes in the law)
How to mitigate Revenue Risks?
Commercial risk.
Risk that revenues will not be as projected.
1) Offtake agreement (Take or Pay):
The buyer is obligated to pay for a minimum quantity, whether they use the service/product or not.
e.g. some large transport ships are paid just to be there are the port, even if in the end they are not used.
2) Availability-Based Project Agreement (Usage Risk Borne by the Contracting Authority):
The SPV is guaranteed a fixed payment (toll, fare, or usage fee), which is not dependent on the actual level of usage by the public.
3) Credit Insurance (for SPV):
The SPV may choose to purchase credit insurance, incase the Offtaker or Contracting Authority fails to make the required payments as per their agreements.
How to mitigate Commercial Viability risks?
Commercial risk.
Involves whether the project is commercially sound.
1) Research market potential:
Is there already a market. (or analyse usage forecasts).
2) Competitor Analysis
How are they faring. What is their market position.
3) Proven technology?
Will what you want to build actually work.
4) Are structural changes envisioned for the market in which the project operates?
Will there be any additional costs.
5) Is the party guaranteeing the income (e.g. the offtaker/contracting authority) credit
worthy?
Can the contractors trust that they will get fully paid.
How to mitigate Construction risks?
Commercial risk.
Risks inside the construction process that affects the project
ability to be delivered on time and budget.
1) Contracting authority is responsible for making the construction site fully available to work in.
No old grannies getting in the way because they own land or smth.
2) Ensure the site condition is up to scratch.
Inspect the site before hand, or make pre-conditions before investing.
3) Contractors are not capable of executing the task they have been paid to do.
- Create a proper agreement.
- Define clear end product, minimum standards and specifications.
- Select only financially strong and experienced contractors.
- Guarantees from a third parties (e.g. a bank guarantee)y
- Escalating financial penalties
- Ongoing monitoring by experienced external party
- Acceptance survey by experienced external party at commissioning.
- Tight cost control.
How to mitigate Operating risks?
Commercial risk.
If operation is not at projected level.
1) Preference for only proven technologies with existing references.
2) Long term performance guarantee from EPC contractor.
3) Long term performance guarantee from the Sponsor.
How to mitigate Input supply risk?
Commercial risk.
e.g. Supply of raw materials cannot be guaranteed.
1) Creating a long-term “input supply contract”.
2) Increases in supply costs during project.
- Concluding fixed price contracts with its suppliers.
- Passing on the price risk to the customer.
- Make sure the supplier can still provide if costs increase (are they financially stable)
How to mitigate Environmental risks?
Commercial risk.
e.g. Pollution risk; other effects on the surroundings.
1) Preparing an Environmental Impact Assessment (EIA).
2) Project lenders have policies to ensure their clients adhere to minimum social and environmental standards.
3) Project lenders may subscribe to the “Equator Principles”...
- Rules for preparation of an Environmental and Social Management System.
- Rules for having an ongoing process for stakeholders engagement.
- A mechanism to deal with grievances.
- A requirement for an independent social and environmental review.
How to mitigate Interest rate risk?
Macro-economic risk.
When the loan you agree to does not have a fixed rate until the project completion date.
1) Negotiate project loans with fixed rate of interest.
2) Enter into “interest-rate swap”:
Basically you go from a floating rate (so based on changing interest rates) to a fixed rate. This can be beneficial if you prefer having a predictable rate (risk averse), even if it means you dont save on money if interest rates drop.
3) Pass on risk in the Offtake Agreement or Availability-Based Contract.
How to mitigate Inflation risk?
Macro-economic risk.
A sustained increase in the general price level of goods and services in an economy over a period of time.
1) Negotiate indexation in the price in offtake:
Adjust prices/payments on specific economic indicators, so basically if costs go up because of inflation, then so do the payments you are due.
2) Agreements/Availability-based contracts.
Paid based on the availability of the service rather than the volume of usage, so if inflation means less people use the service, then you still get paid for having provided the service.
How to mitigate Exchange rate risks?
Macro-economical risk.
Project costs and revenues settled in different currencies, where, if the exchange rate moves, the revenue may fall or costs may rise.
1) Forward Contracts:
A forward contract is an agreement to exchange one currency for another at a future date at a predetermined exchange rate.
2) Natural Hedging:
If your business has both foreign currency revenues and expenses, you can naturally hedge by matching the currencies (e.g. earn in euros and have expenses in euros).
3) Insurance:
Currency risk insurance can protect you against large, unforeseen currency fluctuations.
How to mitigate Political risks?
Political/Regulatory risk.
Risks related to the Host Government where the project is located.
1) Contract with the highest regime possible.
2) Involve multilateral development agency.
They are international financial institutions that provide financial and technical assistance to certain countries for development. They can help your project work in a less developed country.
3) Contract under international law.
How to mitigate Regulatory risk?
Political/Regulatory risk.
Risks associated with government action, changes in the law.
1) General legislation that allows for private ownership or control of the project and adequately protects private investment.
2) A clear legal and regulatory framework for the project’s operation.
3) Consistency of legal and regulatory policies.
4) Straightforward procedures for obtaining construction, operation, and financing permits.
5) The ability for the lenders to take and enforce security.