The final course of the specialization expands the knowledge of a construction project manager to include an understanding of economics and the mathematics of money, an essential component of every construction project. Topics covered include the time value of money, the definition and calculation of the types of interest rates, and the importance of Cash Flow Diagrams.
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Project Finance
Professor Bob Dewing discusses project finance and provides an overview of Global Project Finance. The roles of stakeholders in project finance is reviewed in depth.
Instructor, Department of Civil Engineering and Engineering Mechanics, Columbia University Director of Research and Founder, Global Leaders in Construction Management
The second of the two risk categories in risk and
risk allocation is the macro-economic risks.
These are financial and generally external.
Some of these would be inflation, interest rates, and foreign exchange.
Not all of them apply to all of the projects.
Is inflation a likely contribute to changes in cash flow in the project?
Or is the project indifferent to inflation?
Or is it in all the contracts to inflation index?
But in general, there will be a mismatch between some of the contract
parties of inflation, and the project needs to understand, and the project
financiers need to understand how they're going to manage the inflation risk.
Interest rate risks, it's settlement if issue with projects,
but in general projects have hedged out interest rate risk.
Most project financiers don't expect and
don't want projects to take interest rate risks.
Going back to the second tenant of
project financing to allocate those risks to parties best able to bear them.
Well, at the end of the day most of the contract parties can't manage
interest rate risks.
Occasionally maybe the government or
central bank may be a responsible party that could influence interest rate risk.
But in general, a much better solution is to have the investors
take the interest rate risk by having fixed rates of interest,
which is what a number of investors are looking for.
Or if their banks are financing it on a floating rate basis,
sign a hedging agreement with a part of the bank or
another institution that can manage that interest rate risk.
But interest rate risks in general shouldn't be taken by projects.
Projects are often financed cross border, and what are the foreign exchange risks?
They generally fall into convertibility and transferability.
And so on convertibility and transferability,
many projects keep the cash flows off shore.
And if they are export projects, and if they don't have
foreign exchange revenues, what are the opportunities for
mitigating the convertibility and transferability risks?
Sometimes currencies can be hedged, junior currencies from
smaller currencies often can be hedged long enough for projects.
So how does one manage that risk?
And no sort of cross border risks can sometimes be managed by
direct agreements with governments or central banks or
development banks, or just routing the financing through
financiers that have an ability to manage those risks.
But foreign exchange risks are something that projects routinely manage,
and there are parties that are capable of managing those.
And finally, we've got political risks.
These are a country and they are certainly external risks.
The investment risks in the country,if you put the capital in,
are you likely to be able to get the capital out?
Both currency, convertibility, and transferability?
Isthe project have a possibility of expropriation?
An expropriation is something that one should anticipate in every jurisdiction.
Governments and governmental entities can always expropriate a project.
The important part here is to understand what the compensation is in expropriation.
You'd like to see your capital back again.
The third tenet of project financing is term risk, not principal risk.
If there is an expropriation event, how do you get your capital back?
How do you avoid a principle risk?
Is the compensation within the country, and will it be paid?
Or can you buy sovereign risk insurance?
But an expropriation should be considered in every jurisdiction.
It doesn't matter whether it's developing or
are we see the expropriation is always a possibility.
And financiers should understand what their rights are, and
what their potential remedies are in an expropriation event.
War and civil disturbance is harder to deal with.
It's possible to get sovereign risk insurance for
some jurisdictions where war and civil disturbance is a legitimate and
possible risk, but that's not always the case.
And sometimes project finances have to accept
that they're going to take some war and civil disturbance risk.
Some of this possibly can be dealt with if it's short term with business interruption
insurance, and other sorts of insurance.
But at the end of the day, that risk generally falls back,
in worst possible case to project financiers, and sponsors would sometimes
recognize opportunity there to exercise their walk-away option.
And finally in this section here is the change of laws.
What is the regulatory environment like?
Is the government likely to support the regulatory environment, or
are they likely to change the regulatory environment?
Is the regulatory environment, if it is a question,
is it non-discriminatory, or is it possible that the government could be
discriminatory in their regulatory environment and
support one project versus one of the other projects?
And what are the remedies in a regulatory environment for breach of contract?
So you may have a contract,
an offtake contract under a certain regulatory environment, but
if the regulatory environment changes, what are the arrangements for
adjusting that contract if there is a change in regulatory environment?
Sometimes that responsibility goes to the offtaker or the supplier.
Sometimes it has to remain with the project.
Sometimes the government provides
compensation if there's a change in regulatory environment.
But it should be understood, if you're relying on a regulatory environment,
what the remedies are there.
So going back to our big picture
here of project finance structure,
let's look at the sponsors and
investors in the red box here.
This is the equity that drives a project.
What are sponsors in equity looking for in the project finance?
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Ibrahim Odeh, Ph.D., MBAInstructor, Department of Civil Engineering and Engineering Mechanics, Columbia University
