The Risk and the Cost of the Construction Project of the Power Station - Research Paper Example

The Government of Ruritania is the commissioner of the project for the construction of a hydroelectric power station. Amber Projects Company is the project company for the construction of the power station. Lexus Constructions is the construction company which has to design and build the power station. The electricity generated by the power station will be used by the neighboring state of Sealandia. BA is the bank which will be financing the project. Contracts have to be signed for the purpose of construction between various parties regarding risk management policies, the profit sharing, construction period etc. “Specific type of project agreement which forms the basis for project financing (such as a production sharing agreement, concession agreement, power purchase agreement or other form of off take agreement, etc.) presents unique risks which must be allocated amongst the project lenders, sponsors and project company parties to the project financing.” (Project Financing: Risk Allocation And Security Structure). Amber Projects Company floated tenders and Lexus Constructions Company was the construction company which was given the tender to design and build the power station. For assessing the risk and the cost of the construction project the correct form of the construction contract has to be pursued. Risk in the construction project determines the cost of construction of the project. The cost of constructing is inversely proportional to the risk that Amber Projects Company is ready to undertake. “The less business risk the owner wishes to assume, the higher the cost of construction and management. This follows the “risk-reward” motto for business.” (EPC/EPCM Definition and Comparison). The main purpose of Project Finance is identifying the risks associated with various sectors. Risks can be classified as financial, environmental, scientific, and political. A memorandum of understanding was signed between Amber Projects Company and Lexus Constructions Company and the duties and obligations of both the companies were made clear. The construction of this project is estimated to be 200 million dollars. Two forms of construction contracts are there, one is the EPC (Engineering, Procurement and Construction) while the other is EPCM (Engineering, Procurement and Construction Management). The contracts which needed to be signed between P and Lexus Constructions Company are regarding the supply of materials, the construction site contracts, the selection of suppliers etc. Since Govt. of Rirutania is ready to finance for the insufficient finance that is needed for completion of the project it is a risk bearer in the construction of the hydroelectric power station project which is an EPCM project. Since this is an EPCM project, it is easy for the Govt. of Rirutania to acquire post commissioning services. The machinery supply contract has to be bargained and signed between Govt. of Rirutania and the supplier with the support and guidance of Amber Projects Company. The construction site protection contract has to be signed between Amber Projects Company and Lexus Constructions Company. A major portion of the cost risks for the construction project has to be borne by the Govt. of Rirutania and has to bear all the legal expenses and so legal costs are higher for the Govt. of Rirutania. The Govt. of Rirutania’s administration expenses are also higher because the Govt. has appointed Amber Projects Company as the Project Company and Lexus Constructions Company as the construction company with a higher administration expenses. The Govt. of Rirutania also has to pay for the day to day expenses of both Amber Projects Company as well as Lexus Constructions Company. BA is the project lender in this project. Amber Projects Company appoints a project manager for the construction of the hydel power station. Lexus Constructions Company draws the plan as per the specifications provided by the Govt. of Rirutania. Amber Projects Company supervises the work done by Lexus Constructions Company. The risks borne by Lexus Constructions Company can be classified as technological risks. The technological risks borne by Lexus Constructions Company includes design risks, the site risks, the construction risks regarding the procedures adapted in constructing and the safety of laborers at the construction site. Lexus Constructions Company should draw such a design for the hydel power station from which maximum electricity can be generated and which is cost friendly with the minimum wastage of energy. “The risks related to technological problems are familiar to the design/construct professions which have some degree of control over this category. However, because of rapid advances in new technologies which present new problems to designers and constructors, technological risk has become greater in many instances.” (Effects of Project Risks on Organization). Lexus Constructions Company should supervise and check the site of construction so that there is no accidents and machines that work properly. Lexus Constructions Company should adopt a construction patterns which is suitable for the construction of a hydel power station. The safety of workers should always be considered while appointing people for the work. Contract risk i.e. the risk taken in the contract for construction and the insurance cover for the project are the two risks which have to be borne by the construction company. “Contract reviews and insurance facilitation are critical components on an effective risk mitigation and management program.” (Construction Risk). The risk which is borne by Amber Projects Company is mainly factors like instability in the financial markets, the communication risks, political risks. Amber Projects Company is the supervisor of the project and the controller of finance. Its main risk is regarding the assurance of each phase of the construction project that has been completed in time with the estimated cost. The instability in the financial market increases the price of materials needed for the construction. In Amber Projects Company there should be proper communication between the project managers and the site engineers as otherwise the project cannot be completed in time. Amber Projects Company should see to it that the civic protection regulation is not being violated, this is the environmental risk faced by Amber Projects Company. Amber Projects Company also faces financial risk due to high level of inflation and high interest rates; the project may not be able to complete within the stipulated cost and time. BA also bears considerable risk as a lender. Before lending; banks take into account the financial viability of the project, the government’s approach to the project, the project and the construction company’s goodwill record in constructing but still there are hidden market and industry risks which pose as risks to banks. “Banks as lenders are faced with the asset risks with the current magnitude of construction projects posing serious problems in the event of a misjudgment in lending.” (Kumar). Industrial risk is an obligatory component of every business. Like wise, the constructional industry is prone to frequent risks, generated by mass factors. Since the past few years, there has been substantial increase in the number of plants involved in hydro electric power stations projects. The major objective of risk management is to eliminate various risks associated in the nook and corner of the business as well as to considerably improve the profitability and the efficiency in the business. As a result, risk management plays an integral role in assuring the quality and services effectively and efficiently. Industrial risk in project companies and the constructional companies was pretty much unheard. The entire situation considerably changed, with many of the companies reporting critical issues such as underdeveloped product pipelines, product supply, huge competition, and delay in product launching, inability to retain talented employees & so on. In order to resolve these issues, companies have begun to adopt new risk management strategies. As a matter of fact, companies have expressed their willingness to review and update their approach towards risk management. As the projects are concerned, there are much of the demands that are associated with the clients, mostly they demand much on the health and safety aspects and the various levels of the risk that are associated with constructions and the accidents in the sites. There should be much caution in choosing the contractor and the supervisor in the construction and the much priority on the safety related aspect in the business. The training plays an important role in the business and they depend on the various contracting measures through which they have to be carried out. A good co-operation has to be taken out in the construction by the supervisors and by the construction owners in the business. Banks are also a major factor in the risk management and the assessment they provide with much thieving efforts in overcoming the risk management are associated with much of the capabilities and they have the rigorous way in monitoring and the assessment of the risk factor. The analysis of credit risk was limited to reviews of individual loans, which the banks kept in their books to maturity. The banks have stride hard to manage credit risk until early 1990s. The credit risk management today, involves both, loan reviews and portfolio analysis (Sen). Banks are the main source and a helping hand for the business in terms of financial reserves and the short term returns for the business. Even though they have much surety factors with them a lot of risks are associated with banks too. A practical starting point is to construct a framework for risk management considering the detail of the business activities the bank is involved in, analyzing and ranking the risks involved in the various businesses and deciding how much risk the bank should take. While the ‘headline’ categories in the risk management framework will be similar for all banks, the needs in both analysis and management will vary considerably for banks of different sizes and operating in markets of different stages of development (Puput). The contract between the companies is much vital in concern with organizations when they face various financial crisis and the bankruptcy. The considerable attraction has to be taken by various firms in the significant period of the crisis associated with them. The economic analysis of the contract is very important and depends on many assumptions that have a virtual contribution to the economic analysis of the contract. There are different proposed and associated contracts between that are required in the various services that are to be implemented. Different kind of the proposed agreement are between the large customer sets in terms of the retail mix and the non tariff services, and the small customers in terms of the tariff services, metered data etc are provided. There should be such lessening and the contracting of various kind of the proposal that are associated with the competition in the market and they are mainly to minimize the competition in the market and to evaluate the impact created by them. Social Contract: The company is to have the social contract between the state and the powers station, the company has the under written agreement between the organization and the state policies of the government. There are different terms and conditions in the government sector to be accepted. The main policies of the government include the surrendering of the certain percentage of the property or the finance as the token of surety, which is to be subjected to the change in time. The consideration of the demand from the government should be identified and the employees should be at a liberty in getting the policy approval, there should be also an identity number to be utilized for the various financial transactions. There should be agreement on the basis of the payment where, there should not be any liability from the government when they fail to hold the company. They should also give the acceptance to the government that they may hold the organization as they had failed in terms of financial obligations or liability to the firm in terms of the payments. Memorandum of Understanding (MoU) MOU is built on various factors of detached and “sets in place mechanisms to strengthen the existing collaborations that utilize the complementary expertise and capabilities.” (Purpose/Objectives/Goals1). Answer to Question (b) The security and other assurances of payment and performance of BA are likely to seek.  Power Services offered by the BA is paying attention to provide monetary explanation for a large variety of capability development or manufacture projects in marketplace. For example, distributed creation and demand part of organization to develop power competence and consistency for the customers. The power service set offers finances for projects varying in size from $1MM to $100MM and sometimes it offers more fiancés for constructing companies. Banks capacity to enhance the development of the construction of the project is the most straightforward and efficient means to hold the public as well as to lead the all the end projects at the same moment. ”In the past twenty years there has been a new wave of global interest in project finance as a tool for economic investment. Project finance helps finance new investment by structuring the financing around the project's own operating cash flow and assets, without additional sponsor guarantees. “ (Lessons of Experience No.7: Project Finance in Developing Countries). BA will integrate modern, high- presentation, ecological Know-hows to enhance the efficiency of residents and avoid waste and guarantee of ecological sustainability. To protect the payment and presentation of the responsibility, prevention of rights of negotiator to inquire about and also to get hold of precise performance of the BA, the projects are varying in size and also the projects are different according to terms and other aspects. So, the construction of the hydroelectric power station on the River Hydra in Ruritania, the BA will receives the full duty by guaranteeing and positioning the loan and other performance measures to properly build up. “The terms and conditions contained herein shall be governed and interpreted in accordance with the laws that may be determined by the Bank at its sole and absolute discretion. In the event of a dispute arising in relation to the use of the Online Service, it shall be resolved in accordance with the Clause 27 of the Terms and Conditions displayed and also The Bank reserves the right to alter, add to or cancel any or all of these Service Terms at any time by posting the relevant information on Bank’s web site and in the Banks' branches and other premises.” (Terms and Conditions for Baroda Connect Retail User). Power acquire contracts, project investments, renewable power, power division reorganization, power plan expansion, recommended task organization, monetary structuring, trade and risk examination, computer monetary model, equity assignment, and combined undertaking for hydroelectric power plan etc…are some of the aspect needed to undertake the construction of the projects. Power project financing knowledge has trained in the following areas, such as return and risk are not practically connected, surplus risk shall not be fixed by growing depositor return and additional return will not encourage investment and finally depositor have set return necessities. “For direct-payment bonds, the U S. Treasury makes a payment directly to the issuer in the amount of 35% of the total interest payable to investors, or 45%on Recovery Economic Development Bonds, which are a special category of the direct-payment BABs. For the tax credit bonds, the 35%subsidy is passed along directly to investors in the form of a federal tax credit” (Power shares Build America Bond Portfolio (BAB 3)). The project finance of infrastructure and business works is grounded on the finance gained and the income compared to other things. Normally, in the case of project finance, a number of parties like investors and banks provide the required loan and other persons involved in it. The finance received by the company will be normally the non-secure finances and are given from the incoming finances. The company will have the right of lien over the property and it will have to comply with all the formalities of the banks which provide the loan .and also other terms and conditions which are to be agreed upon between the parties of the contract. The power plants depend upon older engines and machines which causes pollution and the know-how is extremely complex to control and is time consuming. The contracts with regard to the construction of hydro electric power station are highly expensive compared to other contracts. Along with consistency and environment problems, it is tuff to get proper data and reports of irregular dealings in contracts, budgets and other course of actions arise. The contract with this regard has to include the entire venture from blueprint to transmission lines. An important constituent of the contract should consist of the financial dealings agreed upon by the parties with respect to the project. A Combined License Application has to be given in order to get the permission. “A COLA is a federal application filed with the U.S. Nuclear Regulatory Commission to request approval for construction and operation of a new nuclear plant.” (New Nuclear Generation- Frequently asked Questions). As per the Power Plant Siting Act, there is a requirement to present a Site Certification Application, which acts as a sanction for all district or national authorizations which does the evaluation work. It is obvious that the company will seek the finances for funding the construction since there is no guarantee that they are capable of raising the finance by itself because of the ambiguity of the finance market, larger size of the planned work and the heavy requirements. Even though the dealing is heavy, the banking sector will be ready to provide the required finance to support the construction by accepting the needed securities and bonds. The financial risk which may arise with this regard is also heavy. The terms of financing shall be decided by the different parties to the contract and all the terms and conditions shall be included within the contract. The financial agreements and contracts will be determined and made between the parties regarding the payment and also repayment of the amount. The sanction of BAis a prerequisite before seeking for other financial sources. The business promotion to a certain extent depends on the capacity to secure bonding ability. The energy segment is one among which novel money will be provided by the banks. The problem in project financing is that there are rumors with regard to financing of energy segments which arose due to the complexity in the project and the various dealings which is inherent as part of the project and criticisms occur like being less transparent, problems in budgeting and so on. The banks while providing the finance will give importance to the profit generated which can be a guarantee for the repaying of the debts. It should also be guaranteed that healthy environment practices will be followed by the company in its working. The bad effects caused to the surroundings have to be avoided and if it is not possible to avoid, it has to be assured that it shall be controlled and if any danger is caused, damages have to be provided by the company and it has to show community responsibility. In these transactions, the finance provider may provide the guarantee of its products; that is the power generated. The company which borrows will possess only the liberty of ownership and of operation of it. It should also be adherent to the policies and principles of the finance providing bank. “Project finance may take the form of financing of the construction of a new capital installation, or refinancing of an existing installation, with or without improvements. In such transactions, the lender is usually paid solely or almost exclusively out of the money generated by the contracts for the facility’s output, such as the electricity sold by a power plant. The borrower is usually an SPE (Special Purpose Entity) that is not permitted to perform any function other than developing, owning, and operating the installation. The consequence is that repayment depends primarily on the project’s cash flow and on the collateral value of the project’s assets.” (The Equator Principles). Since these projects help in the overall development of the nation, the World Bank has played an active role in promoting them. The banks will decide as to the interest rates to be paid by the borrowing company and also as to the maturity date of the loan which may vary. The details of the project have to be issued to the bank and the bank has the liberty to monitor the whole project. Time scale will be determined for the completion of the project within which the work has to be complete. Answer to Question c The R government is the promoter of the project and has floated their Company, P to oversee the construction of the project. Again, R is aware that there will be a shortfall between the amount B is prepared to lend and the total cost of the project and is prepared to provide loan finance to P to fund the gap between BA loan and the cost of the project. The issue that now occurs is the extent of R ‘s position as creditor in the event of the dissolution of Company P or its “bankruptcy” (The bankruptcy procedure). It could be reasonably argued that R having advance sums to meet the shortfall in bank debt loans could be treated as a secured creditor, in the event of winding up of P. But whether R would be treated as a preferential creditor remains is to be seen. There are different kinds of creditors that a corporate could nurture- Preferential, Secured, Unsecured and Ordinary Creditors. This classification is important under English insolvency laws since the ranking of the debts could determine the preference of their claims. In the event, all assets have been sold and the distribution to the creditors has begun. However, it is the Court which assumes final authority in the event of dissolution of business. “The whole of the property of the insolvent shall vest in the Court or its receiver and become divisible among the creditors. No creditor shall during the pendency of the insolvency proceedings have any remedy against the property of the insolvent with respect of the debt or commence any suit or other legal proceedings, except with the leave of the court and on such terms as the court may impose.” (Insolvency Law Regime). It is sometimes believed that, banks may assume floating charges over companies by way of security - not so much for the security for payment of their own debts, but because this ensures that no other agency will, ordinarily, lend to the company, thereby almost granting a monopoly in favour of the bank holding the floating charge on lending to the company. Perhaps, this case also follows the same lines. The principal bankers BA have a lien on the assets of the business by having advanced a lion’s share of the needed funds. However, since BA is not in a position to meet the full requirements; it has become necessary to seek the help of Government R, who had promised to bear the deficit amount between the actual cost of the project and the maximum that BA could advance to it. Thus, R could also have a floating charge on all assets and not a fixed charge. A floating charge ensures that it is secured not on one particular asset or assets, but generally on the totality of assets. A floating chare could be described as a “lien or mortgage on an asset that changes in quantity and/or value from time to time(such as an inventory) to secure the repayment of a loan.” (Floating charge). Under this scheme, there is no fixed charge on the assets in question and the dealing is done as in the usual course of business. In case of default, the floating charge depending upon several other conditions also crystallizes into fixed charge, as determined by the Court. Thus the floating charge is transformed into a fixed charge, depending upon the determination of the Court. Thus, it could well be within the realms of Government R to register a floating charge on all assets of the company in order to become a secured creditor and received “Official Receiver” determined payment in the event of dissolution of Company R. (Official receiver) Works Cited Project Financing: Risk Allocation And Security Structure. HG.org. 2003. Web. 20 Apr. 2010. . EPC/EPCM Definition and Comparison. Prodigy. 2006. Web. 20 Apr. 2010. . Effects of Project Risks on Organization. Organizing for Project Management. n.d. Web. 20 Apr. 2010. . Construction Risk. C-Risk. 2001. Web. 20 Apr. 2010. . Kumar, Manoj. Construction Insurance: Bridging Theory & Practice in Project Risks. Insurance Professional. 2010. Web. 20 Apr. 2010. . Sen, Prabir. An Overview of Credit Risk Management in the Banking Sector. Ezine articles. 2010. Web. 20 Apr. 2010. . Puput. Ebook Risk Management and Asset and Liability Management in Banks. Free PDF Ebooks Files @ Acrobat Planet .com. 2009. Web. 20 Apr. 2010. . Purpose/Objectives/Goals. Environmental Protection Agency: United States. 2008.1. Web. 20 Apr. 2010. . Lessons of Experience No.7: Project Finance in Developing Countries. IFC. 1999. Web. 20 Apr. 2010. . Terms and Conditions for Baroda Connect Retail User. Bank of Baroda. n.d. Web. 20 Apr. 2010. . Power shares Build America Bond Portfolio (BAB). Invesco Power shares. 2009. 3.Web. 20 Apr. 2010. .  New Nuclear Generation- Frequently asked Questions. FPL. 2010. Web. 20 Apr. 2010. . The Equator Principles. The Equator Principles. n.d. Web. 20 Apr. 2010. . The bankruptcy procedure. Desktop Lawyer. 2010. Web. 20 Apr. 2010. . Insolvency Law Regime. Insolvency Asia. n.d. Web. 20 Apr. 2010. . Floating charge. Business Dictionary.com. 2010.Web. 20 Apr. 2010. . Official receiver. Business Dictionary.com. 2010. Web. 20 Apr. 2010. . Read More