Risk Management Strategies

Journal of Management in Engineering.
Submitted July 3, 2012; accepted May 31, 2013;

posted ahead of print June 3, 2013. doi:10.1061/(ASCE)ME.1943-5479.0000225
Risk Management Strategies for Privatized Infrastructure Projects:
A Study of the Build-Operate-Transfer Approach in East Asia and
the Pacific
Namhun Lee1 and John E. Schaufelberger2

Downloaded from ascelibrary.org by Istanbul Universitesi on 08/09/13. Copyright ASCE. For personal use only; all rights reserved.
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ABSTRACT
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Private-public partnerships have been adopted for the development of public infrastructure to
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meet the growing demand for public services. Many Asian countries have used the build-
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operate-transfer (BOT) approach to develop pubic infrastructure projects. However, the
potential benefits of undertaking a BOT project are accompanied with corresponding risks from
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the private sector’s perspective. The objectives of this study are (1) to identify and discuss major
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risks inherent in the East Asian and Pacific region and (2) to propose risk management strategies
for future BOT projects to be successful. This paper reports the results of five case study
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analyses undertaken to review their primary risks and mitigated methods. In addition, this paper
proposes some strategies for future BOT projects. Two main categories of risks were analyzed:
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general risks and project-specific risks. Risk management strategies were suggested for each
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category of risk. The main finding of this study indicates that the private sector cannot be the
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only participant in risk management. The host government’s active support is the most essential
for the profitability and economic viability of a BOT project in the East Asian and Pacific region.
1
Assistant Professor, Department of Construction Management, East Carolina University,
Greenville, NC 27858-4353, USA. Email: leenam@ecu.edu
2
Professor, Department of Construction Management, University of Washington, Seattle, WA
98195-1610, USA. Email: jesbcon@uw.edu
Copyright 2013 by the American Society of Civil Engineers
J. Manage. Eng.
Journal of Management in Engineering. Submitted July 3, 2012; accepted May 31, 2013;
Keywords: Risk management; Private-public partnerships; Build-operate-transfer; Privatized
infrastructure; Project management
INTRODUCTION
Rapid economic growth in Asian countries has resulted in increased demand for
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development of additional infrastructure such as power plants, airports, highways, bridges, ports,
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tunnels, and water treatment plants. However, the demand for development of government-
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initiated infrastructure projects has far surpassed the availability of public financing in the East
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Asia and the Pacific region. To meet the growing demand for public services, many
governments have solicited private investments for public infrastructure projects by adopting the
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idea of privatization which grants the private sector the right to finance, design, and construct a
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specific infrastructure and operate it for a concession period (Menheere et al. 1996).
Over 70% of Asian privatized infrastructure projects have been developed by

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international sponsors (Kwak 2002). Most of these projects have been for power generation or
transportation. Unfortunately, about 30% of the privatized projects have had disappointing
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results (Kwak 2002). In many Asian countries, the build-operate-transfer (BOT) approach has
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been adopted to develop the needed infrastructure. The BOT approach has been considered the
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best way to reduce sovereign loans and improve a government’s credit rating. The governments
in Asia are able to promote foreign direct investments in their infrastructure projects through the
BOT approach. The private sector can enjoy high returns on investments from successful BOT
projects. However, the participation of private companies in a BOT project means the project
risks and the financial and administrative burden are transferred from the public sector to the
private sector. Therefore, it is essential for the private sector to understand the inherent risks
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associated with BOT projects in the East Asia and the Pacific region and to formulate
appropriate risk management strategies to deal with them.
RESEARCH BACKGROUND
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Basic Principles of the BOT Approach
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The “Build-Operate-Transfer” is a project delivery method that uses private investments
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to undertake the development and operation of public infrastructure traditionally administrated
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by the public sector (UNIDO 1996). The BOT approach may not be suitable for all types of
infrastructure privatization but can be considered a well-developed public-private partnership.

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Under the BOT approach, the private sector is responsible for financing and constructing
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infrastructure facilities and operating them for a pre-determined concession period. During the
concession period, the private sector collects revenues from operating the facilities to repay the
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project costs and make a profit. On expiration of the concession, the ownership of the facilities
is transferred to the host government at no cost.

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Investing in BOT project can be a highly complex and risky undertaking because of the
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requirement of large capital outlays, long lead-times, and major regulatory changes (Rubin and
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Wordes 1998). The private sector’s greatest concern is whether returns on investments can
justify the risks or not. Therefore, the following factors must be considered significant from the
outset: time to develop and negotiate, host government support, a suitable economic climate,
political stability, a stable legal and regulatory environment, and a foreign currency’s free
convertibility and remittance (UNIDO 1996). In addition, it is extremely important to
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understand the role of each party involved in a BOT project and the contractual relationships
among the participants for effective risk management.
Major Participants in BOT Projects
Project participants include the granting authority which is typically a government

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agency; the concessionaire; and one or more financial institutions (Tiong 1990a). The granting
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authority identifies project requirements, establishes the concession period, solicits tenders, and
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awards the contract. The concessionaire typically is a consortium or joint venture of
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engineering, construction, and venture capital firms and may include equity investors such as the
host government or institutional investors. Investment capital may come from commercial
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banks, insurance companies, or the sale of bonds. The general relationships among the project
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participants are shown in Figure 1. Constructors typically invest equity during the early phases
on the project, but often sell their own position upon the completion of construction. At the end
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of the concession period, all operating rights and operational responsibilities revert to the
granting authority.
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Basic Characteristics of BOT Projects

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BOT projects are highly risky undertakings because of many uncertainties involved in the
projects. These uncertainties may lead to unnecessary delays and cost overruns, turn a
potentially profitable project into an unprofitable one, and eventually result in suspension or
cancellation of the project. Some causes of BOT project failure are as follows: delays in
completion, cost overruns, technical failure, the concessionaire’s financial failure, expropriation
by the host government, poor management, and legislative or regulatory changes (Nevitt and
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Fabozzi 2000). Understanding these causes can be the key to the successful performance for
future BOT projects. Therefore, before undertaking a BOT project, one of the most important
tasks is the accurate identification, correct allocation, and optimal management of the potential
risks.
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Risk Management on BOT Projects
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Risk management is the discipline that identifies all risks in an environment, assesses
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their potential impact on critical performance measures, and employs direct and indirect means
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for either reducing the exposure of the underlying risks in project activities or shifting some of
the risks to third or external parties (Smith et al. 2006). The principal issue related to risk
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management is how to quantify and deal with the risks. Effective risk management demands the
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rapid and realistic forecasts of the future and the practical, reasonable, and cost-effective hedging
tools. In addition, it requires flexible attitudes and procedures since the accuracy of expectations
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decrease with time.

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Risks Inherent in BOT Projects

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Risk management starts with identification of the risks that could be encountered in BOT
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projects. As compared to other project delivery methods, it is more complicated to address the
risk issues in BOT projects because of the wider scope of work, the length of the concession
period, and the scope of contractual responsibilities undertaken by the concessionaire.
Furthermore, the risks inherent in the development of a BOT project can vary, depending on the
country and the project. Nevertheless, classifying the identifiable risks in meaningful categories
is useful for a systematic risk management (Al-Bahar and Crandall 1990). In general, the
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primary risks associated with a BOT project can be broadly grouped into two categories: general
risks and project-specific risks (Ng and Loosemore 2007).
General Risks
General risks are mainly related to macro-environmental factors of the host country such
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as the political environment, economic condition, the legal system, taxation, or fluctuations in
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currency exchange rate. Each country holds a unique set of general risks. The risks may
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severely affect the project’s viability during the entire lifetime of a BOT project. Therefore, it is
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extremely important to identify the risks thoroughly before undertaking a project, particularly in
a developing country. General risks can be subdivided into political risks, financial risks, and
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legal risks.
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Political risks are associated with the internal and external political situation of the host
country. These risks can be also classified into sovereign risks and instability risks. Sovereign
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risks include expropriation of assets by the government, restriction of operating freedom,
increased taxes or other financial penalties, constraints of the ability to repatriate profits, and any
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other government interference that could jeopardize a BOT project (Lang 1998). Instability risks
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are related to cancellation or revision of contracts and damage to property from terrorism or riot.
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In Asian developing countries, it is significant to mitigate political risks since major political
changes may often occur (Tam 1999).
Financial risks relate to the host country’s economic environment surrounding the
project. These risks include currency devaluation, foreign exchange fluctuations, fluctuations in
interest rate, and inflation. These risks should be mitigated for a BOT project in the East Asia
and Pacific region since revenues, expenses, capital expenditures, and loans are typically in more
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than one currency, which can directly affect the cost of debt service and the real value of the
projected revenue.
Legal risks result from changes in laws or regulations and immature legal systems that
may adversely affect the BOT undertakings. The host country’s changes in tax codes,
environmental regulations, labor regulations, import restrictions, and corporate regulations

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during a concession period may undermine the long-term viability of a BOT project.
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Project-Specific Risks
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Project-specific risks can be controlled by the private sector. These risks can be
classified into development, construction, and operation risks (Tiong 1996). First, development
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risks include defects in the request for proposal, planning and approval delays, errors in
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economic, environmental, or technological assessment, and rejection of the proposal by the
granting authority. Among these risks, bid risks may be the most important at this stage due to
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the loss of expenditures for various feasibility studies and preparations for the bid package.
Construction risks relate to delays in completion and cost overruns. Completion delays
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directly affects the generation of revenue since investors of the BOT project rely on income from
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the completed project to recover their investment. Cost overruns may impact the profitability of
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the project by increasing construction and financing costs. In addition, a possibility of force
majeure events and liability for the accident should be considered careful at this stage.
Operation risks relate to an increased cost of operation and maintenance and insufficient
revenue from the completed project. Market-based operation risks have two components:
demand risks and price risks. Demand risks result from the uncertainty of the demand for the
product or service provided by the completed project. Price risks are associated with the fees
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that can be charged for the product or service, which directly affects the project’s profitability
and economic viability. Regardless of actual operational costs, an unreasonable fee may be set
by the granting authority or due to competing facilities. Therefore, risk identification and
management through contractual agreements and arrangements are essential to success of BOT
projects.
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METHODOLOGY
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Case study analysis was selected to identify the unique or critical risks and develop risk
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mitigation strategies for BOT projects in East Asia and the Pacific. Table 1 presents five BOT
projects selected from various countries within the East Asia and Pacific region, considering
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their different levels of general risks. The selected projects have been classified into contract-
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based projects (e.g. power plants) and market-based projects (e.g. transportation systems) based
on the revenue types. These case study projects were analyzed to determine the primary risks the
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concessionaires faced, their mitigation methods, and the results obtained.

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CASE STUDY ANALYSES

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Laibin ‘B’ Power Plant, China
The Laibin ‘B’ power plant was the first state-approved privatized project in the Guangxi
province to be financed entirely by foreign investors and developed by a foreign company (Wang
and Tiong 2000). The risks associated with the Laibin ‘B’ project were evenly allocated through
the comprehensive and well-structured provisions in the project agreements such as concession
agreement, power purchase agreement, and fuel supply and transportation agreement shown in
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Figure 2. Hence, the risk management framework of this project became a benchmark for future
BOT power projects in China (Chan et al. 2005).
Project Analysis
Sovereign risks were managed effectively by considering them political force majeure
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under the concession agreement. In the event of the project’s termination resulting from political
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force majeure events, the Guangxi government guaranteed that loans from lenders would be
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repaid and the concessionaire would be compensated for the invested equities in accordance with
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the concession agreement. Legal risks were also mitigated through the concession agreement. In
case that the concessionaire is not able to fulfill its obligations because of any changes in laws,
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tax regulations, or environmental standards, the Guangxi government guaranteed that the costs
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resulting from such changes would be compensated.
Under the power purchase agreement, the price of electricity from the Laibin ‘B’ power
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plant would be denominated in RMB and divided into a fixed portion and a floating portion. To
mitigate variations in the currency’s exchange rate against the US dollar, the concessionaire
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obtained the right to adjust the floating portion on a monthly basis.

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The State Administration of Exchange Control approved the concessionaire’s right to

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convert and remit foreign currency and ensured that this right would not be affected by any
future adverse events. In addition, the concessionaire made an agreement with China Bank to
convert the concessionaire’s RMB receipts into US dollars.
The project rate of return for foreign investors in China had been indirectly limited to
about 15% by Chinese authorities. Because of this requirement, foreign investors were reluctant
to invest their money on this project, and the concessionaire had difficulty in obtaining funding.
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To assist the concessionaire in project financing, the Guangxi government agreed to mortgage or
transfer to the right to operate the facilities for purpose of financing. The concessionaire was
responsible for obtaining necessary approvals. The Guangxi government ensured that the State
Planning Commission and the Ministry of Power Industry would support the concessionaire in
obtaining necessary approvals smoothly. To confirm this, the concession agreement specified
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that an arbitrary denial or withdrawal of the necessary approvals was to be regarded as political
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force majeure.
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The concessionaire procured an additional US$ 40 million letter of standby credit in case
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of cost overruns and any contingencies during the construction stage. The concessionaire
purchased appropriate insurance policies to mitigate force majeure events. In addition, in case of
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force majeure events, the concession agreement specified that all the concessionaire’s obligations
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were to be suspended and the suspended days were to be compensated by extending milestone
dates and the concession period.

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The Guangxi government had insisted on negotiation of power rates every operating year
to control inflation, which made overall project revenues unpredictable. Thus, the adjustment of
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the price of electricity by the government was the most significant risk in the Laibin ‘B’ project
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since it might reduce the economic viability of the project. This risk was mitigated by agreeing
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that the concessionaire would propose the basis of the price structure, payment mechanism, and
price adjustment. This matter was approved by the Guangxi government and the State Planning
Commission and included in the power purchase agreement. In addition, a specific provision
stating that the central or provincial pricing bureau would comply with the pricing formula was
incorporated into the concession agreement. Under the fuel supply and transportation agreement,
the Guangxi Power Industry Bureau was obliged to purchase at least 63% of the plant’s capacity
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per operating year from the concessionaire. In addition, the Guangxi government guaranteed the
supply of fuel conformable to the specifications to the concessionaire. An analysis of the risks
and mitigation methods for the Laibin ‘B’ power plant project is summarized in Table 2.
Pagbilao Power Plant, Philippines

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The Pagbilao power plant is a large coal-fired thermal power plant. Competitive bids for
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the BOT contract were invited, and Hopewell Power Philippines Corp. was selected to finance,
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construct, and operate the electric generating plant for the concession period of 25 years (Lysy et
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al. 2000). Hopewell Power Philippines Corp. was required to develop and maintain the power
station, a bridge linking Pagbilao Grande Island to the main island, and a paved road necessary
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for the power plant. In addition, Hopewell Power Philippines Corp. was responsible for
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arranging the project financing and operating the Pagbilao power plant. Most risks associated
with this project were allocated to project participants through the contracts and agreements as
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shown in Figure 3. The Philippine government guaranteed that the Philippines National Power
Corp.’s obligations under the concession agreement would be performed.

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Project Analysis
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The Philippines government assumed responsibility for all tasks within the control of the
government, government authorities, and the Philippines National Power Corp. Under the
concession agreement, the Philippines National Power Corp. was obliged to provide Hopewell
Power Philippines Corp. with the project site, build transmission facilities connecting the plant to
the electric power grid, supply the fuel for the power station, and purchase the electricity
generated by the power plant throughout the operation period. In addition, the Philippines
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National Power Corp. was to purchase all the facilities of the power plant from Hopewell Power
Philippines Corp. if any political force majeure event impairs the project’s economic viability.
This obligation made it possible for Hopewell Power Philippines Corp. to efficiently deal with
any changes in Philippine laws or regulations.
In the concession agreement, the power price was structured in US dollars and Pesos
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during the concession period. In addition, the Philippines National Power Corp. was to pay a
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capacity fee and an energy fee to Hopewell Power Philippines Corp. every year. These fees were
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structured in two portions in US dollars and Pesos. In these ways, Hopewell Power Philippines
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Corp. could alleviate losses resulting from currency fluctuations to some extent.
When the Pagbilao power plant was first proposed, it met all national environmental
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standards required for such a large coal-burning power plant, and environmental inspectors
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confirmed Hopewell Power Philippines Corp.’s environmental plan. Nevertheless,
environmentalists and local community groups strongly forbade this project to be developed,
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insisting upon public interest, public safety, and public health (Lam 1999). There was a legal
battle challenging the proper issuance of the Environmental Compliance Certificate. To handle
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this protest, Hopewell Power Philippines Corp. had to not only expand the initial environmental
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plan but also spend 16% of the total project cost on pollution control.
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Under the turnkey contract, the construction consortium was entitled to an early
completion bonus if the construction could be completed ahead of schedule. On the other hand,
if construction delays and lack of plant performance occurred due to the fault of the construction
consortium, the turnkey contractors were to pay penalties and liquidated damages to Hopewell
Power Philippines Corp. To ensure that Hopewell Power Philippines Corp. could make the
payment under extremely adverse conditions, Hopewell Power Philippines Corp. procured a
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letter of standby credit amounting to US$ 16 million from the banking syndicate. In the event of
Hopewell Power Philippines Corp.’s funding insufficiency resulting from any breach or default
by the construction consortium, the turnkey contractors were to make subordinated loans up to
US$ 200 million to Hopewell Power Philippines Corp (Woodhouse 2005). These obligations
were guaranteed by their parent companies.

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The Pagbilao power plant was successfully completed ahead of schedule and within
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budget. However, the operation was delayed since transmission facilities connecting the
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Pagbilao power plant to the electric power grid were not available on time. In accordance with
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the concession agreement, all the costs resulting from this operation delay were compensated by
extending the concession period (Woodhouse 2005). An analysis of the risks and mitigation
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methods for the Pagbilao power plant project is summarized in Table 3.
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North-South Highway, Malaysia

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The North-South Highway (NSH) was the first private toll road project in Malaysia. This
project had been first developed by the Malaysian Highway Authority. However, due to
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financial difficulties, the government decided to complete the remaining work under the BOT
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approach. United Engineers Malaysian Bhd (UEM) was selected to complete the rest of the
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highway (500 km) and rehabilitate the existing road (370 km) (Fishbein and Babbar 1996). The
concession agreement was signed for the entire highway. UEM formed a multinational joint
venture of Projek Lebuhraya Utara-Selatan (PLUS) Berhad to undertake this project (Walker and
Smith 1995). Figure 4 shows the contractual structure of the NSH project.
Project Analysis
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The NSH project received the Malaysian government’s full support through an extensive
security package. The government assumed primary responsibility for traffic and revenues,
currency fluctuations, and political actions to attract project financing. Moreover, the
government provided substantial loans and financial guarantees to PLUS. Therefore, most of the
risks under the responsibility of PLUS were related to construction, force majeure, and tort
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liability.
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The Malaysian government provided PLUS with a hedge against foreign exchange and
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interest rate fluctuations by guaranteeing soft loans (Tiong 1990b). Each subcontractor was
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required to make an obligatory contribution (13% of the contract price) to equity financing. In
this way, the equity burden of PLUS was partially transferred to the subcontractors .
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The construction cost was initially estimated to be US$ 1.3 billion, but it enormously
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escalated to approximately US$ 3.2 billion due to design changes, local inflation, and difficult
terrain (Fishbein and Babbar 1996). This cost overrun risk could be shared with subcontractors
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by lump-sum construction contracts. In addition, the Malaysian government set aside a standby
credit (10% of the total project cost) for the NSH project.
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The Malaysian government and PLUS agreed to share force majeure risks through a
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guarantee of extending the concession period if any force majeure event occurred. The
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government also guaranteed minimum revenues to PLUS in case operation became disrupted or
temporarily suspended due to any force majeure events. These risks were also managed by
private insurance contracts.
PLUS was granted the right to collect all toll charges. However, an increase in toll rates
had to be approved by the Malaysian government. If project revenues fell below a predicted
target level for the first 17 years of operation, the government would provide standby financing
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to PLUS under the traffic volume supplement agreement (Tiong 1990b). Table 4 summarizes
the unique or critical risks and effective mitigation methods identified in this project.
High Speed Rail System, Taiwan
The Taiwan High Speed Rail (THSR) system project was the first BOT project in Taiwan
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and one of the largest privatized projects (in dollar terms) to be undertaken in Asia (Lu et al.
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2010). Taiwan High Speed Rail Co., Ltd., a consortium of five prominent local business groups,
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was selected to finance, design, construct, and operate the THSR project. The Ministry of
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Transportation and Communication (MOTC) and the consortium signed the concession
agreement (Ho 2004). Figure 5 shows the contractual structure of the THSR project.
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Project Analysis
In the concession agreement, the Taiwanese government guaranteed the loss resulting
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from policy changes to the consortium. This clause also made the Taiwanese government take
the political risk. Besides, the Taiwanese government guaranteed tax incentives during the
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operation phase to reduce the risk of change of policy. The consortium and the Taiwanese
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government agreed to establish a mediation committee for this project to negotiate and resolve
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disputes. Most of the risks related to delays in land acquisition, financing problems, and drawn-
out decision on the core systems, which were the main reasons why this project fell behind from
its initial schedule.
The MOTC was to be responsible for the preparatory tasks listed in the concession
agreement. Nevertheless, this obligation was not fulfilled as planned. The land acquisition for
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the THSR line was delayed and the losses resulting from this delay were as not compensated on
the grounds that a schedule for delivery of the land was not specified.
The consortium encountered difficulties to acquire sufficient loans for the THSR project.
The government played a key role in assisting the consortium in project financing. First, the
MOTC made a tripartite agreement with a banking syndicate. Under the tripartite agreement, the
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Taiwanese government deposited NT$ 240 billion (US$ 7.06 billion) into the banking syndicate
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(25 local banks) to provide the source of a syndicated loan (85.7% of the total required debt)
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(Sun 2000). Second, the Taiwanese government guaranteed to both the consortium and the
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banking syndicate that the government would take over the project and assume the debt
responsibility of the consortium if the project is terminated by the government or the consortium
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defaults. Finally, the Taiwanese government invested NT$ 8 billion (US$ 235.3 million) in the
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consortium’s equity.
The income risk was solely assumed by the consortium. In a typical market-based
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project, the host government subsidizes the concessionaire based on a minimum number of
passengers. However, the consortium was not subsidized by the Taiwanese government. Due to
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lack of confidence in returns on the project, the banking syndicate insisted on the following
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clause in the tripartite agreement: The equity to debt ratio was limited at 3 to 7. This clause
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resulted in the consortium’s failure of meeting its funding targets due to intensive capital
spending during the construction period.
The East Asian financial crisis in 1997 caused Taiwanese currency to be devaluated to
almost 30%. Fortunately, the main financial frame mainly consisted of domestic funds and the
revenues and loans were to be collected and repaid in Taiwanese currency. In addition, the
construction fees were to be paid all in Taiwan dollars. However, some expenses such as
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consulting fees, railway electrical sub-system construction, and imported materials were to be
paid in US dollars (more than US$ 2.8 billion). Ultimately, the devaluation of Taiwanese
currency resulted in the increase of project costs amounting to approximately US$ 500 million.
No one could predict such a financial crisis because the Taiwan economy had grown very
rapidly. Thus, the consortium did not have a strategy for handling potential currency fluctuation
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and was exposed to financial loss due to the significant devaluation of the local currency.
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The construction was delayed due to changes in building codes resulting from the
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earthquake in 1999 (THSRC 2009). To make matters worse, the decision on integrating
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European and Japanese technology and insufficient preparation for operations caused the
operation delay (Taipei Times 2005). Table 5 summarizes the primary risks and their mitigation
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methods reviewed in this project.
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Second Stage Expressway, Thailand

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The Second Stage Expressway (SSE) project is an extension of the First Stage
Expressway system developed by the Expressway and Rapid Transit Authority of Thailand
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(ETA) (Tam 1999). The ETA commissioned a detailed design of the SSE project. To lessen the
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citizens’ tax burden and make rapid progress, the ETA invited competitive bids for a BOT
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proposal and selected Bangkok Expressway Co., Ltd. (BECL), and signed the concession
agreement (Levy 1996). Figure 6 illustrates the contractual structure of the SSE project.
Project Analysis
The SSE project proceeded smoothly until the military coup d’etat in 1991. After the
change of regime by the coup d’etat, several problems were encountered due to different contract
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interpretations. The new government changed a land evaluation basis to gain popular support,
which resulted in an enormous increase of land acquisition cost. Consequently, the construction
work for sector B fell behind schedule because the ETA had financial difficulties in delivering
the land necessary for the sector B construction to BECL as planned. BECL claimed for the
damages, but the ETA refused to indemnify BECL for any expenses incurred.
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Even though the construction work for sectors A and C was completed, the completed
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route of about 20.4 kilometers could not be opened to traffic because of the following reasons:
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BECL required the ETA to set toll rates for the urban section to 30 Baht (US$ 1.40) in
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accordance with the concession agreement. However, two weeks before opening sectors A and
C, the new government insisted on lowering the predetermined toll rates from 30 Baht to 20 Baht
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(US$ 0.94). In response to this government action, BECL refused to open sectors A and C. The
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new government seized all assets of the completed expressway to ease the traffic crisis of the
Bangkok metropolitan area. BECL filed a claim against the new government in an international
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court. The court ordered opening these sectors at the toll rates as specified in the concession
agreement.
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All toll rates collected in the urban area were to be shared according to the revenue
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sharing proportions stipulated in the concession agreement. However, the ETA contended that
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this revenue sharing scheme was to be enforced when all the sectors were opened. BECL argued
that the SSE project’s substantial parts were already completed and the completion delay of
sector B was attributed to the ETA’s delay in delivering the land necessary for the sector B
construction. BECL’s appeal for the revenue sharing was not accepted.
Due to continual disputes between the ETA and BECL, BECL was faced with serious
financial difficulties. Lending institutions suspended BECL’s loan payments (Ogunlana 1999).
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Consequently, the new government expropriated this project. The SSE project was classified as
a failure from the private sector’s perspective (Zhang and Kumaraswamy 2001). No effective
risk mitigation methods were identified for this project.
FINDINGS AND DISCUSSIONS

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For effective risk management in future BOT projects, it is important to understand the
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risks encountered on previous projects and what mitigation strategies were adapted to manage
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those risks. One of the most important tasks for BOT projects’ successful performance is to
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measure and mitigate those risks prior to undertaking a BOT project. Table 6 shows the main
causes and consequences of risk mitigation failure analyzed from the case study projects
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discussed previously.
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Analysis of the case study projects indicates that the level of general risks depends on the
project location. Even though two similar projects are developed in the same country, the
C ted
general risks may be different depending on the extent of the host government’s support. It is
extremely difficult for the private sector to control the general risks. Therefore, the private
ot p
sector should maintain a good working relationship with the host government over the
N ce
concession period and even before the concession. Analysis of the case study projects suggests
Ac
adoption of the risk management strategies for general risks shown in Table 7.
Project-specific risks can be controlled by the private sector. For this reason, the project-
specific risks inherent in a BOT undertaking should be identified at the beginning of the project,
allocated to the party best able to control them, and mitigated by contractual agreements. The
nature of project-specific risks depends on the type of infrastructure project and its contractual
19
J. Manage. Eng.
framework. As mentioned earlier, these risks can be classified into development, construction,
and operation risks.
The private sector should assume most of the development stage risks. However, the
most effective strategy in managing development risks is to obtain the host government support
and active involvement in the project. During the construction stage of a BOT project, a large
t
ip
amount of money is consumed without generating any revenue. Hence, the private sector should
d cr
identify potential construction risks and carefully manage them. Operation risks are directly
te s
associated with the BOT project’s profitability and economic viability since project revenues are
di nu
collected during the operation period. Thus, operation risks should be carefully identified and
allocated to the party best able to manage them in a reasonable way.

ye a
Finally, this paper also categorizes BOT projects into two categories, contract-based
op M
projects and market-based projects, based on the revenue types. In market-based projects (e.g.
transportation systems), it is the most important to manage revenue risks carefully during the
C ted
operation period because such projects rely on market-based income (the actual number of
passengers). In contract-based projects (e.g. power plants), inflation risks should be managed
ot p
carefully since it is extremely difficult to forecast the cost escalation of fuel supply. Table 8
N ce
shows risk management strategies of project-specific risks identified from the analysis of the
Ac
case study projects.
CONCLUSIONS
BOT projects may not be successful because the concessionaire did not understand the
risks to be faced or failed to adopt appropriate mitigation strategies. From the case study
analyses, the main causes of failure in risk management were the host government’s
20
J. Manage. Eng.
interference, conflict of interest among parties, delays in the government agency support,
political force majeure, and immature legal systems of the host government. These risks must
be identified at an early stage of the BOT project development and managed through contractual
agreements and financial arrangements clearly specified in terms and conditions.
The BOT approach is considered one of the most appropriate delivery systems, especially
t
ip
when the government does not have sufficient funding to develop public infrastructure facilities.
d cr
The host government can maximize the benefits from the private sector’s investments, whereas
te s
the private sector can enjoy a high rate of return from a BOT project in spite of highly risky and
di nu
long-term investments. However, analysis of the case study projects indicates that the host
government’s support and active involvement will be indispensable for effective risk
ye a
management. In addition, both the public sector and the private sector must have collaborative
op M
working relationships to create win-win situations.
In conclusion, the private sector cannot be the only participant in risk management.
C ted
Without the host government’s active support, it may be extremely difficult to achieve the
profitability and the economic viability of a future BOT project in the East Asian and Pacific
ot p
region.
N ce
Ac
REFERENCES
Al-Bahar, J. and Crandall, K. (1990). “Systematic Risk Management Approach for Construction
Projects.” J. of Construction Engineering and Management, 116(3), 533–546.
Chan, W. T., Chen, C., Messner, J. I., and Chua, D. K. H. (2005). “Interface Management for
China’s Build-Operate-Transfer Projects.” J. of Construction Engineering and
Management, 131(6), 645-655.
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Fishbein, G. and Babbar, S. (1996). “Private Financing of Toll Roads.” World Bank’s RMC
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Ho, J. (2004, September 18). “THSRC Allays Fears of Gross Overspending.” Taipei Times.
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ip
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te s
Kwak, Y. H. (2002). “Analyzing Asian Infrastructure Development Privatization Market.” J. of
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Lam, P. T. I. (1999). “A Sectoral Review of Risks Associated with Major Infrastructure

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Lang, L. H. P. (1998). Project Financing in Asia: Advances in Finance, Investment and Banking.
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Levy, S. M. (1996). Build, Operate, Transfer: Paving the Way for Tomorrow’s Infrastructure.
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ot p
Lu, I., Guo, S., and Pan, Y. (2010). “Owner-Controlled Insurance Program and Construction
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Nevitt, P. K. and Fabozzi, F. J. (2000). Project Financing, 7th edn. Euromoney Publications,
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Ng, A. and Loosemore, M. (2007). “Risk Allocation in the Private Provision of Public
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ip
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Rubin, R. and Wordes, D. (1998). ”FEATURE: Risky Business.” J. Manage. Eng., 14(6), 36–43.
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Blackwell Science, Malden, MA.
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Taipei Times. (2005, August 10). “High-Speed Rail Delayed.” Retrieved May 17, 2012, from
http://www.taipeitimes.com/News/taiwan/archives/2005/08/10/2003267114
C ted
Taiwan High Speed Rail Corporation (THSRC). (2009).
http://www.thsrc.com.tw/en/about/ab_comp.asp (accessed May 17, 2012)

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Tam, C. M. (1999). “Build-Operate-Transfer Model for Infrastructure Developments in Asia:

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Reasons for Successes and Failures.” Int. J. of Project Management, 17(6), 377-382.
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Tiong, R. (1990a). ”Comparative Study of BOT Projects.” J. Manage. Eng., 6(1), 107–122.
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Economics, 8(3), 315-328.
Tiong, R. (1996). “CSFs in Competitive Tendering and Negotiation Model for BOT Projects.” J.
of Construction Engineering and Management, 122(3), 205-211.
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United Nations Industrial Development Organization (UNIDO). (1996). Guidelines for
Infrastructure Development through Build-Operate-Transfer (BOT) Projects. United
Nations Industrial Development Organization, Vienna.
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Approach. Thomas Telford, New York, NY.

t
ip
Wang, S. Q. and Tiong, L. K. (2000). “Case Study of Government Initiatives for PRC’s BOT
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Power Plant Project.” Int. J. of Project Management, 18(1), 69-78.
te s
Woodhouse, E. J. (2005). The IPP Experience in the Philippines, Retrieved May 13, 2012, from
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http://iis-db.stanford.edu/pubs/20816/PhilippinesIPP.pdf
Zhang, X. and Kumaraswamy, M. M. (2001). “Hong Kong Experience in Managing BOT

ye a
Projects.” J. of Construction Engineering and Management, 127(2), 154-162.
op M
C ted
ot p
N ce
Ac
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Figure Caption List:
Figure 1. Typical Relationships among BOT Project Participants
Figure 2. Contractual Structure of Laibin B Power Plant Project
Figure 3. Contractual Structure of Pagbilao Power Plant Project

t
ip
Figure 4. Contractual Structure of North-South Highway Project
d cr
Figure 5. Contractual Structure of Taiwan High Speed Rail Project
te s
Figure 6. Contractual Structure of Second Stage Expressway Project
di nu
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C ted
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J. Manage. Eng.
)LJXUH
Granting Authority
Facilities Contract with

Concession Agreement
Lenders Debt Repayment
Debt Limited Equity
Concessionaire
Equity
Contractor
Sponsors Dividends
Construction Costs
Facilities Operation Fees
Operator
Accepted Manuscript
Not Copyedited
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)LJXUH
Guangxi
Government
Guangxi Construction Guangxi Power
& Fuel Company Ltd. Industry Bureau
Concession
Agreement
Fuel Supply &
Transportation Agreement Power Purchase
Agreement
Project Company
Financing Construction Service &

Operation & Maintenance Agreements Equipment Supply Contracts
Agreement
Électricité de France Construction

International Lenders Consortium
Accepted Manuscript
Not Copyedited
J. Manage. Eng.
)LJXUH
The Philippines Hopewell Energy IFC CDC ADB

Government International Ltd.
Government Shareholders Agreement

Equity
Guarantees
Operation &
Concession Hopewell Maintenance Hopewell
National Agreement Agreement
Power Tileman
Power Corp. Philippines Power

C
Corp. S t
Systems Corp.
C
Sales
Trust & Retention
Revenue Construction Service &
Agreement Financing Agreement
Equipment Supply Contracts
Offshore Banking Construction

Escrow Account Repayment Syndicate Consortium
IFC: International Finance Corporation

ADB: Asian Development Bank
CDC: Commonwealth Development Corporation
Accepted Manuscript
Not Copyedited
J. Manage. Eng.
)LJXUH
Malaysian Concession
Government Agreement UEM
Joint Venture
Financing
Agreement
Agreement
Stock PLUS Financing

Lenders
Market Shareholding Agreement
Construction
Equity
Contracts
Subcontractors
Accepted Manuscript
Not Copyedited
J. Manage. Eng.
)LJXUH
Taiwanese
Tripartite
Government Agreement
(MOTC)
Independent
Mediation Consultant
Committee Concession
Agreements
Banking
Insurers Insurance Taiwan High

Contracts Speed Rail Co.,
Co Financing
Fi i Syndicate
Ltd. Agreements
Civil Work Contracts Core System Contract
Contractors Taiwan Shinkansen Co.
Accepted Manuscript
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)LJXUH
Thai Government
(ETA)
Traffic
Tolls Project Manager
(Kumagai Gumi)
Concession
Revenue Share Agreement
PM Agreement Construction
Service Agreement
Escrow Revenues
Accountt
A BECL
Trust & Retention Contractors
Agreement
Loan Financing Agreements Shareholders Agreement

Repayment
Lenders Investors
Accepted Manuscript
Not Copyedited
J. Manage. Eng.
7DEOH
Table 1. General Information of Case Study Projects
Project Est. Cost Concession

Project Scope Concessionaire
Name/Country (US$) Period
Contract-based projects
Électricité de France
Laibin ‘B’ power plant, 700 MW Coal-fired Power
International & GEC 616 Million 18 Years
China Plant
Alsthom
Pagbilao power plant, 700 MW Coal-fired Power Hopewell Power

933 Million 25 Years
Philippines Station Philippines Corp.
Market-based projects
North-south highway, United Engineers
870 km Highway 1.3 Billion 30 Years
Malaysia Malaysia
High speed rail system, 345 km High Speed Rail Taiwan High Speed
15.1 Billion 35 Years
Taiwan System Rail Corp., Ltd.
Second stage expressway, Bangkok Expressway
38.5 km Expressway 1.15 Billion 30 Years
Thailand Co., Ltd.
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J. Manage. Eng.
7DEOH
Table 2. Risks and Mitigation Methods for Laibin ‘B’ Power Plant Project
Risk Identified Mitigation Strategies

- Guarantee of repayments for loans and compensations for
Political force majeure
invested equities
Changes in laws and - Guarantee of compensations for the costs resulting from the
regulations changes
Fluctuations in foreign - Guarantee of the adjustment of the floating portion in the
exchange rate price of electricity

Foreign currency’s
convertibility and - Guarantee of the right to convert and remit foreign currency
remittance
Difficulty in project
- Support of government and government agencies
financing
Delays in necessary - Guarantee of assistance of Guangxi government, State
approvals Planning Commission, and Ministry of Power Industry
Cost overruns - Procurement of US$40 million letter of standby credit
- Purchase of appropriate insurance policies
Force majeure - Extension of milestone dates and the concession period to
compensate for suspended days
- Guarantee of supplying the fuel conformable to the
Supply risk
specifications
- Guarantee of complying with the pricing formula specified
in the power purchase agreement
Revenue risk
- Obligation to purchase at least 63% of the plant’s capacity
per operating year
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J. Manage. Eng.
7DEOH
Table 3. Risks and Mitigation Methods for Pagbilao Power Plant Project

- Government’s obligation to purchase all the facilities
Political force majeure
from the concessionaire
Fluctuations in foreign exchange - Power rates and fees structured in both US dollars
rate and local currency
Environmental concerns by the
- Amending the initial environmental plan
public
- Subordinated loans provided by the turnkey
Cost overruns contractors
- Procurement of a letter of standby credit
Completion delays - Early completion bonuses and liquidated damages
Supply risk - Guarantee of supplying the fuel
Revenue risk - Obligation to purchase the electricity
Operation delays caused by the
- Guarantee of Extension of the concession period
government
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J. Manage. Eng.
7DEOH
Table 4. Risks and Mitigation Methods for North-South Highway Project

Fluctuations in foreign
- Guarantee of soft loans against unanticipated fluctuations
exchange & interest rates
Lack of equity - Obligatory contributions to equity financing
- Lump-sum construction contracts
Cost overruns
- The Malaysian government’s standby credit
Completion delays - Early completion incentives & penalties

- Purchase of appropriate insurance policies
Political force majeure - Guarantee of Extension of the concession period
- Guarantee of minimum revenues
- Guarantee of providing any shortfall financing for the first 17
Revenue risks
years of operation
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J. Manage. Eng.
7DEOH
Table 5. Risks and Mitigation Methods for Taiwan High Speed Rail Project

- Guarantee of compensations for the loss resulting from policy changes
Political/regulatory
- Guarantee of tax incentives during the operation phase
changes
- Mediation Committee to negotiate and resolve disputes
Completion delays - Performance and completion bond
- The government’s investment in the consortium’s equity financing

Lack of Financing
- Tripartite agreement to secure the lender’s senior debt
Fluctuations in
- Main financial frame in the local currency
foreign exchange
Force Majeure - Purchase of appropriate insurance policies
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7DEOH
Table 6. Causes and Consequences of Risk Mitigation Failure in Case Study Projects
Identified Causes of
Case Project Consequences
Mitigation Failure
Pagbilao Environmentalists and local The concessionaire had to expand the initial environmental plan and
Power Plant, residents’ strong opposition also spend 16% of the total project cost on pollution control.
Philippines
High Speed Unclear contract clause Despite the government agency’s responsibility for land acquisition,
Rail Project, the concessionaire was not compensated for the losses resulting from
Taiwan delays in land acquisition.
No guarantee of a minimum Due to lack of confidence in returns on the project, the
number of passengers concessionaire had difficulty in project financing.
Changes in building codes The construction was delayed.
Changes in the core system The decision of switching the core system contractor led to
contractor insufficient preparations for operations caused the operation delay.
Negligence of currency Local currency devaluated almost 30%, which resulted in an increase
fluctuations of project costs amounting to approximately US$ 500 million.
Second Military coup d’etat The change of regime by the coup d’etat results in different contract
Stage interpretations on the concession agreement.
Expressway, Change in a land evaluation The cost of land acquisition was increased and the government
Thailand basis agency failed in delivering the land necessary for the construction.
Consequently, the construction work was delayed.
Unclear contract clause The concessionaire was not compensated for damages resulting from
delays in land acquisition.
Default of the government’s The operation of the completed expressway was delayed for four
agreement on toll rates months.
Default in the government’s The toll revenues collected in the urban area were not shared in
obligation to revenue sharing accordance with the revenue sharing scheme.
Continual disputes between The concessionaire faced serious financial difficulties and raised
the concessionaire and the tensions among parties.
government
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7DEOH
Table 7. Risk Management Strategies of General Risks
Identification Management Strategies

- Include the government agencies in equity or debt financing
- Include contractual provisions to bind the host government to pay
Sovereign risk
Political risks liquidated damages
- Establish a dispute resolution process
Instability risk - Purchase political force majeure insurance
- Include an adjustable portion in service fees to compensate for

foreign exchange fluctuations
- Obtain the host government’s guarantee of foreign currency
Foreign exchange risk
convertibility and remittance
Financial - Purchase financial instruments such as option contracts, forward
risks and futures contracts, or currency swaps
- Obtain fixed interest loans
Interest rate risk - Purchase financial instruments such as interest rate swap, interest
rate cap, or interest rate collar
Inflation risk - Add specify price escalation clauses to the contract
Changes in laws or - Obtain the host government’s guarantee of compensation for
regulations additional costs resulting from any changes in laws or regulations
Legal risks
- Obtain the host government’s guarantee of transparency in legal
Immature legal systems
procedures

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7DEOH
Table 8. Risk Management Strategies of Project-Specific Risks
Identification Management Strategies

- Establish a creditworthy consortium with technical and
Bid risk
managerial competence
Errors in feasibility studies - Employ independent consultants for careful feasibility studies
Development Credit risk - Obtain the host government’s support and active involvement
risks Local communities’ strong
- Make all administrative procedures transparent
opposition
- Obtain consistency in the host government’s BOT policies
Delay in approval risk
through all levels of government agencies
Construction difficulties - Request performance bonds from contractors
- Use lump-sum construction contracts
Cost overruns - Bind contractors to participate in project equity sharing
- Obtain standby credit as contingency
Construction
- Request completion bonds from contractors
risks
Completion risk - Add specific provisions for early completion incentives and
liquidated damages to contract
- Obtain the host government’s commitments and obligations
Force majeure
- Purchase proper insurance policies
- Require maintenance bonds and extended warranties for the
Performance risk facilities
- Add clauses of performance bonuses & penalties to the contract
- Obtain standby credit as contingency
Operation cost overruns
- Require operator’s guarantee for subordinated loans
- Obtain alternative supply sources as contingency
Supply risk
Operation - Include penalty provisions of the supplier’s default in the contract
risks - Obtain the host government’s guarantee for minimum purchase
agreement or revenue level
Revenue risk
- Include contractual provisions of compensation for damages by
any default in the host government’s obligations
- Charge the host government with obligations and responsibilities
Force majeure - Obtain standby credit as contingency
- Purchase proper insurance policies

Accepted Manuscript
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J. Manage. Eng.

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Journal of Management in Engineering.

Submitted July 3, 2012; accepted May 31, 2013;

Risk Management Strategies for Privatized Infrastructure Projects:

A Study of the Build-Operate-Transfer Approach in East Asia and

Namhun Lee1 and John E. Schaufelberger2

Copyright 2013 by the American Society of Civil Engineers

Keywords: Risk management; Private-public partnerships; Build-operate-transfer; Privatized

infrastructure; Project management

Over 70% of Asian privatized infrastructure projects have been developed by

Copyright 2013 by the American Society of Civil Engineers

appropriate risk management strategies to deal with them.

infrastructure privatization but can be considered a well-developed public-private partnership.

is transferred to the host government at no cost.

convertibility and remittance (UNIDO 1996). In addition, it is extremely important to

Copyright 2013 by the American Society of Civil Engineers

among the participants for effective risk management.

Major Participants in BOT Projects

Project participants include the granting authority which is typically a government

Basic Characteristics of BOT Projects

Copyright 2013 by the American Society of Civil Engineers

decrease with time.

Risks Inherent in BOT Projects

period, and the scope of contractual responsibilities undertaken by the concessionaire.

Copyright 2013 by the American Society of Civil Engineers

risks and project-specific risks (Ng and Loosemore 2007).

risks include expropriation of assets by the government, restriction of operating freedom,

changes may often occur (Tam 1999).

Copyright 2013 by the American Society of Civil Engineers

environmental regulations, labor regulations, import restrictions, and corporate regulations

Copyright 2013 by the American Society of Civil Engineers

concessionaires faced, their mitigation methods, and the results obtained.

CASE STUDY ANALYSES

Laibin ‘B’ Power Plant, China

Copyright 2013 by the American Society of Civil Engineers

BOT power projects in China (Chan et al. 2005).

obtained the right to adjust the floating portion on a monthly basis.

The State Administration of Exchange Control approved the concessionaire’s right to

convert the concessionaire’s RMB receipts into US dollars.

Copyright 2013 by the American Society of Civil Engineers

dates and the concession period.

Copyright 2013 by the American Society of Civil Engineers

Pagbilao Power Plant, Philippines

Corp.’s obligations under the concession agreement would be performed.

Copyright 2013 by the American Society of Civil Engineers

any changes in Philippine laws or regulations.

Copyright 2013 by the American Society of Civil Engineers

were guaranteed by their parent companies.

North-South Highway, Malaysia

Copyright 2013 by the American Society of Civil Engineers

private insurance contracts.

Copyright 2013 by the American Society of Civil Engineers

High Speed Rail System, Taiwan

its initial schedule.

Copyright 2013 by the American Society of Civil Engineers

spending during the construction period.

Copyright 2013 by the American Society of Civil Engineers

Second Stage Expressway, Thailand

Copyright 2013 by the American Society of Civil Engineers

Copyright 2013 by the American Society of Civil Engineers

risk mitigation methods were identified for this project.

FINDINGS AND DISCUSSIONS

Copyright 2013 by the American Society of Civil Engineers

and operation risks.