China: China Watch: Investment Risks on Global Megaprojects

The selection of a project delivery method is driven by cost, quality, time, and risk management. The risks faced by investors on large infrastructure projects in Asia and Southeast Asia are legion. They can be anticipated and they can be addressed, but while one can diminish risk or allocate risk, one cannot control all risk. The selection of project delivery method should be influenced by the amount and nature of the risks anticipated.

The current project options include:

• Design/Bid/Build (DBB)

• Design/Build (DB)

• Design/Build/Operate (DBO)

• Design/Build/Operate/Maintain (DBOM)

• Design/Build/Finance/Operate (DBFO)

• Build Operate Transfer (BOT)

• Build Own Operate Transfer (BOOT)

• Construction Manager at Risk

• Construction Manager at Fee

• EPC or Turnkey

Variations of the foregoing are used on projects and different delivery modes are used for differing project phases. For example, a project might be broken into three phases where the Owner is mostly concerned with having input in the first phase of design but for later phases would prefer less involvement.

DBB is the more traditional project delivery method, but because of experience with project delays and cost overruns, is now less favored. DB, DBOM and DBFO are increasingly being seen in water, wastewater, airports, government facilities, rail, and energy/power projects. The owner’s choice of project delivery method must be individual and should vary depending upon the host country, the nature of the project (type and size), and the time and cost anticipated, as well as the likelihood of changes to the project. The type of owner also plays a role: does the Owner have significant in-house construction management capability, what are the financing terms for the project, how soon does the project need to be completed, and how much input does the owner want to have in the design phase.

Traditionally, project risks can be categorized as follows:

• Social/Environmental Risk

• Host Country Risk

• Economic/Financial Risk

• Technical Risk

Social and environmental risks are often discounted and not seriously considered before commencement of a project. Large projects some times result in destruction of ecosystems, displacement of towns and people, loss of livelihood and jobs, and pollution of air, water and land. Construction of dams for hydroelectric power is one example of a project likely to encounter social and environmental risk. Mitigating these risks would tend toward a project delivery method that had greater owner involvement in the design phase, given that the owner or in-country partner will be more sensitive to these issues and in a better position to address them before they become a problem for the project as a whole.

Host country risk is well-documented and often a preliminary project consideration. Government instability, political violence, terrorist activity, and the risk of nationalization of assets are all significant issues for investors. The Dabhol power project was a prime example of a project that fell victim to change in the political environment. Regulatory regimes also influence risk. The absence of certainty for utility rates and ultimate return on investment also play a role. China’s energy sector currently struggles with this hindrance to foreign investment. In tandem with this, is the lack of a well-established legal framework in many countries and varying legal frameworks from country to country—for example, the law governing BOT projects may differ from country to country. In certain countries, owners may find it difficult to find a reliable BOOT contractor or the regulatory regime may make BOOT-type ownership and operation impossible.

Economic and financial risks also influence the choice of project delivery and the project documents. Certainly currency fluctuation plays a role in determining what portion of the project can be contracted for off-shore. In the power sector, Power Purchase Agreements frequently are in the currency of the host country, while financing is through international bodies utilizing foreign currency. Thus, currency fluctuation will impact return. Project financing will also differ depending upon the amount of risk the investor deems acceptable. DBFO may be attractive to in-country public and private owners while inbound contractors may find the financing too risky or too difficult to obtain.

Technical risk is the risk associated with physical construction, operation and maintenance of the facility. This risk is often escalated by lack of in-country experience. Projects delays associated with not knowing local requirements for safety and quality procedures, lack of knowledge of project procurement systems, lack of labor, lack of building materials, and failure to anticipate issues such as customs delays create risk to a project. Delays and disruption due to design changes, non-performance of subcontractors or suppliers, and other unanticipated problems on the job, can all lead to disputes with owners, subcontractors and vendors. Some of this risk can be overcome through in-country partnering and strong subcontracting but often, for the first foray in that particular country, that network does not yet exist. Design/Build with the right partner may be ideal to allocate some of these risks away from the Owner.

Regardless of the delivery method, the partners must have in-country experience and a network of reliable contacts and subcontractors. In my experience on international claims, I consistently see that the problems on projects, particularly technical problems in construction, are almost always the product of naiveté and lack of information and/or experience with that type of project in that jurisdiction. Smart partnering will lead to successful projects under most project delivery methods.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.