When it comes to investment, there is no such thing as a ‘good’ or ‘bad’ country, just a good or bad risk. Investors have significant influence over the risk profile of their investment and the development and implementation of an effective risk management strategy will raise the potential for success.
The particular challenge in devising a risk management strategy for infrastructure projects arises from the long tenors and multi-billion-dollar investment in high-value fixed assets. Such projects are highly visible and generally not extractable from a territory, therefore leaving them exposed to numerous political cycles and the uncertainties that these bring.
Managed effectively, infrastructure investments promote productivity and efficiency in both the public and private sectors and are an essential catalyst for economic growth. The economic life of much of this infrastructure is in the order of several decades and, for the investor, has the potential to generate a fairly stable, often inflation-linked, return.
RISK MANAGEMENT STRATEGY
Risk analysis must be about identifying challenges and understanding how risk may be anticipated and managed effectively to preserve the opportunity and returns offered by investment in an infrastructure project. The long-term nature of infrastructure investments requires a risk management strategy that reflects the uncertainty and range of risks that impact these projects over their life cycles. This strategy must incorporate the often competing interests of different stakeholders entering the project at different stages in the life cycle with different roles, responsibilities, risk-management capabilities and risk-bearing capacities.
Infrastructure projects change the environment in which they are situated and risk management strategies must evolve over time to accommodate the changing characteristics of the investment landscape they have created. Risks that manifest themselves in the latter stages of a project’s lifecycle are often caused in earlier stages and require a holistic approach to risk management that continuously evolves throughout the life of the project.
No amount of political risk insurance can ‘fix’ a bad contract, so the risk management process to mitigate political and payment risk begins early – at the structuring of contracts. It is imperative to identify key stakeholders and their respective interests. This does not just include financiers, but also the host government, sub-sovereign entities, local tribes or communities, project sponsors and NGOs. Active engagement will help establish a stable operating environment. Ensuring equitable reward sharing between the participants is essential as a major risk factor arises when participants perceive inequitable terms.
At the onset of your project, engage with non-governmental organisation (NGO) stakeholders; they will have local expertise that they can share with investors and liaise with local communities if required.
Engagement with multilaterals may bring some benefits. The World Bank, as a respected sovereign creditor, wields considerable influence in the event of a contractual dispute. Similarly, bilateral investment treaties can also offer some recourse, so check which governments have signed up to bodies like the International Centre for Settlement of Investment Disputes (ICSID).
Returns on infrastructure projects are usually derived from tariffs levied on the local population for service provision, which can be politically and economically sensitive. Investments in infrastructure projects are often made in hard currency while payments for the service provided are usually received in local currency. This creates currency inconvertibility and transfer risk in the conversion and remission of foreign currencies that host governments can manipulate and control.
The Argentinian financial crisis of 2001 is a case in point. In response to deteriorating economic conditions, an Argentine court issued an injunction preventing CMS Gas, a private company with a 29.42 percent share in a joint venture gas infrastructure project with the state-owned gas company, from paying tariffs in dollars with an adjustment for inflation. The case was taken to arbitration for claims of expropriation and discriminatory/arbitrary treatment. The same injunction led to a number of similar cases arising across the Argentine gas sector.
In contrast to natural resources projects which cater to the international commodities market, returns on infrastructure investments are reliant on revenues being generated by the local population through road tariffs, payment for power usage and such like.
In all countries the cost of public utilities is politically sensitive but in emerging economies where consumers are not accustomed to paying for utilities and real incomes are low, it is often a particularly combustible issue – just think of the large-scale protests which have been triggered in recent years by attempts to cut subsidies across the Middle East. When pressure mounts in this way and governments are called upon to reduce energy, water or public transport costs, private contractors involved in the provision of these services are left exposed to an array of political risks ranging from political violence, contractual agreement repudiation/renegotiation and nationalisation.
The most lucid example of this is the so-called Cochabamba Water War of 2000 when inhabitants of Bolivia’s third-largest city rallied against rising water prices following the privatisation of the municipal provider and ultimately forced the authorities to repeal the privatisation law and rescind a private consortium’s contract.
History was to repeat itself just five years later when rural peasants and the urban poor of La Paz and El Alto took to the streets to protest the privatisation of their cities’ water supply after prices were increased 35 percent by the private contractor. As in the case of Cochabamba, the Bolivian government was forced to cancel its contract with the private company.
In Puerto Rico, meanwhile, political pressure to deliver affordable electricity to the electorate has led the incumbent government to renegotiate six Power-Purchase Agreements (PPAs) which were signed by its predecessor. The operators of the solar power projects were accused of driving up the cost of electricity on the island until the Puerto Rico Electric Power Authority (Prepa) renegotiated six PPAs, shaving $63 million off its energy bill.
Elizabeth Stephens is head of credit and political risk advisory at JLT Speciality, the London-based provider of specialist insurance broking, risk management and claims consulting services