Project Risk Analysis

shyam Ji Mehrotra

Saturday, January 2, 201

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GLOSSARY
Loan syndication
Loan moratorium
Angel Investors
Private Equity
Financial closure
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Shyam Ji Mehrotra

January 2, 2016

Recap
What are key project parties?
What are different phases of project?
How lender satisfy itself that project is

bankable?
What is the purpose of ecological and

environmental impact analysis of the

project?
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Shyam Ji Mehrotra

January 2, 2016

What is risk?
Uncertainty about rains, flight delayed, income

not generated
When such events happens, it could result into

loss.
This is RISK
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Shyam Ji Mehrotra

January 2, 2016

Risk management defined

We may define risk as uncertainties resulting in

adverse outcome, adverse in relation to

planned objectives or expectations.
Financial risks are uncertainties in adverse
variations of profitability or outright losses.
Uncertainties associated with risk elements
impact the net cash flow of business or
investment. Under the impact of uncertainties,
variations in net cash flow take place. This
could be favorable or unfavorable. The
unfavorable impact is RISK of the business.
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Shyam Ji Mehrotra

January 2, 2016

Project risk analysis

Project finance entails formidable set of

risks
Financial advisor role is to structure finance
so that risks are mitigated to greater extent
Carve out risk in different category and
assign them to parties who can handle it
best

Shyam Ji Mehrotra

January 2, 2016

Risk mitigation pyramid

Shyam Ji Mehrotra

January 2, 2016

ASSESSING PROJECT RISK

Economic RISK
When a project is not able to generate

sufficient cash flow

Also known as debt servicing risk
Due to (a) decline in price of out put or (b)
increase in cost of raw material or other inputs
Risk mitigation
Off take agreement at prefixed prices for project period

( PPA for power projects or toll for road projects )

Do sensitivity analysis to determine economic viability
beyond doubt

Shyam Ji Mehrotra

Saturday, January 2, 201

6

ASSESSING PROJECT RISK

Economic RISK
Economic

Survey 2015 suggested that

giant power projects which company won
with unviable bids must be allowed to fail
to enforce discipline and penalize reckless
bidding
Survey says that some bidders assumed
that they can renegotiate contracts if
needed thus setting a bad precedent

Shyam Ji Mehrotra

Saturday, January 2, 201

6

ASSESSING PROJECT RISK

FINANCIAL RISK
Umbrella risk that cover variety of risks relating to

finance
Default risk ( buyer unable to honor commitment)
Interest rate risk ( increase in interest rates)
Default Risk mitigation
PPA with government company
Supplies backed by letter of credit

Interest rate risk mitigation

Traditional method
Fixed rate debt
Hedging
Interest rate derivatives like interest rate cap contracts ,

Interest rate swaps

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Shyam Ji Mehrotra

Saturday, January 2, 201

6

ASSESSING PROJECT RISK

Servicing of foreign debt

CURRENCY
RISK
Exchange rate volatility of Indian currency
Currency control by host government
Cross currency swap cost is quite significant

and very often disturb the viability

Risk Mitigation
Raising of Bonds in Indian Rupees
Auto hedging for export oriented projects
Borrowing in foreign currency to match cash outflow

of currency
Currency swaps
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Shyam Ji Mehrotra

Saturday, January 2, 201

6

ASSESSING PROJECT RISK

Embargo in international obligations /Sanction by

UN
POLITICAL
& Sovereign
Change in government policy
RISK
Impose new tax or levy retrospective tax
Impose restrictions in transfer of forex
Dabhol

power project by Enron as JV of GEC and Bectel

Enterprise of 2015 MW with project cost $2.8 billion after
investment of $ 800 million Maharastra government cancelled
the power purchase agreement (PPA)
Vodafone case- introduction of General Anti Avoidance Rule
(GAAR)
Greece Crisis: 1.8 Billion default to IMF on
June 30, 2015.
Further 3.5 billion Euro payment due in end July, 15. Greece is
shut out from financial market now. It is feared that it might
create global financial shock even harsher than Lehman bros.
2008.
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Shyam Ji Mehrotra

Saturday, January 2, 201

6

Vodafone case example of

political
risk
February
Vodafone bought 67%Hut stake in Hutch
2007

Essar for $1.1 billion

September
2007

Finding Hutch has bound up business in India,

taxmen demand Rs. 11000 crores tax from Vodafone
arguing that it should have deducted TDS

September
2010

Bombay High Court ruled in Taxmen favour and

Vodafone goes to Supreme Court

January
2012

Supreme Court rules in favour of Vodafone

May 2012

Then Finance Minister Pranab Mukherjee amended

IT Act to impose retrospective provision to tax
Vodafone Hutch like deals

February
2013

Vodafone gets another notice demanding Rs. 3200

crores alleging that it underpriced its shares issued
to Mauritius based parent company

April 2014
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Vodafone filed international arbitration against India

under India Neatherland bilateral investment
Shyam Ji Mehrotra
Januarytreaty
2, 2016

Retro Tax CAIRN ENERGY

ISSUE
13.03.201 Crain India received an order
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from Income Tax Dept. seeking
Rs. 20,495 crore for allegedly
failing to deduct withholding
tax on purported capital gain
made in 2006-07 to its former
parent Cairn UK Holding Ltd.
15.03.2015 Cairn energy advised that it is filing
notice of dispute under the UK India
bilateral investment treaty against
this order.
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Shyam Ji Mehrotra

January 2, 2016

ASSESSING PROJECT RISK

Risk mitigation
Bilateral agreements between government to
safeguards such risks
Political risk insurance through ECGC
International arbitration
Removal of sanction
Bail out by international financial system

POLITICAL
RISK

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Shyam Ji Mehrotra

& Sovereign

Saturday, January 2, 201

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ASSESSING PROJECT RISK

Aggressive

lobbying by environmental activists to

protect environment
Often voiced through political process
Forcing government to put restrictions on mining and
other infra projects
to take
forest, pollution,
environmental or ecological clearances
Example LAVASA project in Pune - allegedly bye passed
environmental and ecological norms

Environmental

RISK

850 Crores loan of banks became

NPA

Risk
Increase in project cost or cost of operations due project

redesign or huge cost of disposal of bye products or in

extreme cases abandoning of project
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Shyam Ji Mehrotra

Saturday, January 2, 201

6

ASSESSING PROJECT RISK

Competitive forces within industry poses

INDUSTRY
significant risk

RISK

Analysis is done from local and global

perspective
Prices of substitute product, input and out
put
Risk Mitigation:

Impact study present and prospective

commodity prices and supply position

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Forward price agreement or purchase

agreed for life of the project

Shyam Ji Mehrotra

January 2, 2016

ASSESSING PROJECT RISK

Contractors: Turn key projects, Performance

Completion
Risk
guarantee

Cost structure: Provision of contingency

Delay risk and contact items: Capacity to bear

time an cost over run

Technology risk: Terms of technology transfer
Mitigation of completion risk
Due diligence of contractors
Share completion risk to suppliers through turn key

contracts, contractual guarantees of manufactures

and performance guarantee
Provision for contingency
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Shyam Ji Mehrotra

Saturday, January 2, 201

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ASSESSING PROJECT RISK

Out of 183 mega projects ( over 1000 crores)

Completion
Risk
at the end of 2011-12,
86 were experiencing
time over run and 68 suffered cost over run
These projects are being implemented in
public sector in power (59), petroleum (33),
railways (33), road and high ways (21), coal
(9), Steel (6), Shipping and ports (6), Atomic
energy (5)
Initial cost of these project were Rs.5.86 lakh
crores and now raised to Rs. 6.8 lakh crores
implying 15.9% over run
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Shyam Ji Mehrotra

Saturday, January 2, 201

6

ASSESSING PROJECT RISK

Non availability of raw material or

Technology
resources say radiation short fall from
estimated values
Technology failure
Risk mitigation
Proper due diligence of natural resources
Comprehensive warranty by supplier of technology

for expected level of performance

Loss compensation by technology provider

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Shyam Ji Mehrotra

Saturday, January 2, 201

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Implication for project

financing

Risks may exceeds financial capacity of project

sponsor
Lender would like that business or economics
risk are properly mitigated before they agree to
finance
Lender may agree to bear financial risk but
would like to compensated by way of higher
interest rate
As an alternate, lender may like the
host
government to provide the guarantee where
social benefits justify cost or do the viability gap
funding
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Shyam Ji Mehrotra

January 2, 2016

Risk Allocation
A critical approach is to do risk sharing with

all parties of project through contractual

arrangement at lowest ultimate cost to the
project
Allocated

among parties who are

capable to bear
Known as assembling the transaction

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Shyam Ji Mehrotra

most

January 2, 2016

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