Introduction

The entire project took place against the backdrop of the global financial crisis, which
rocked financial markets from mid- 2007 to 2009. The ensuing tight credit
environment made the procurement of 100% committed funding prior to the final
bidding for such a huge project problematic, requiring Macquarie to use all of its
project finance experience and banking connections to ensure the deal closed
successfully.

PPP was chosen

In 2007 the Victoria state government called for expressions of interest (EOI) to
construct the worlds largest seawater reverse osmosis desalination plant under a
public-private partnership (PPP) to supply water to the city.

N Risk Owner Type

o
1 Commercial Risks
i Construction Risks: D&C to - Delay caused by bad weather, flooding: -
The first detailed due-diligence Thiess
question is whether the project Degrmont Construction at the Victoria desalination plant
can be completed on time, on was also delayed by Flooding which damaged
budget and to the required part of the construction works.
specificationthis question
obviously mainly revolves around - Workers strike: AquaSure was paying about
the risks inherent in the
construction process. 25% more than the industry norm to workers.
However, in November 2010, workers went on
strike following allegations of workplace spying
by strike-breaking operatives at the plant.And
workers only went back to work after the
company agreed to sack two managers in the
management team.

- Escalating costs: Leighton Holdings, the parent

company of Thiess, announced that it expected to
make just $6 million profit from the project, a
fraction of the anticipated A$288 million.

- Completion risk: Penalties in case of delay:

The plant was due to finish by December 2011,
with water delivery due by 30 June 2012, and the
 company faced penalties of A$1.8 million for
every day the water was not delivered.

Revenue Risks: The risk that the Financiers Cashflows risks: finance will only be available
Project Company may not earn sufficient where the operating cashflows of the project
revenue to service its operating costs and company are expected to provide a return on
debt, and produce an adequate return for investment. The cost being the government is at
investors, is at the heart of project risk because the government is only willing to pay
finance. (Yescombe, 2014, p.219) for default after 10 years.

Rising cost of energy: water from the

plant had to be pumped 86kms, requiring
approximately 92MW of energy, and the
interconnection of Melbourne and
regional water suppliers added to energy
demands. Rising energy costs would
hence feed directly into desalination costs.
Recycling water from treatment plants
closer to the city would be cheaper and
more environmentally friendly.

- The state also assumed the risk of higher

energy costs through a price-reset
mechanism to compensate AquaSure for
any increased energy costs.

Operating Risks: O&M - Availability-Based contracts

Degrmont But long-term usage risk can produce
Once the project has been Thiess problems for the Contracting Authority.
completed and is demonstrated Termination of a Project Agreement
to be operating to speci- fication, because the project is no longer
a new risk phase begins, that of required, or needs to be reduced in
long-term operation. Even if the scope, is a very expensive process,
Project Company has hedged reduced long-term flexibility can be a
many of its risks through a issue in a PPP Contract (Yescombe,
Project Agreement, some level of 2014, p.230)
operating risk is likely to be left Avaliability-Based contracts: From the Project
with the Project Company, and Companys point of view, the main
therefore this aspect of the risks, issue is likely to be the effect on the
and their cost consequences, are Contracting Authoritys budget of the
closely reviewed by lenders. long-term Contract Payments, i.e.
(230) whether the project is Affordable
(Yescombe, 2014, p.230)
- Unavailability of the plant or loss of water
quality could lead to an abatement of the service
 payment.

Maintenance and lifecycle costs: In a long

maintenance cycle there is a risk that short of cash
flow when these costs are to be paid. (234)

Risks for an offtaker / State

Contracting Authority: - The project is financially sound, with
appropriate costings, a sensible
An Offtaker/Contracting Authority financial structure, and reasonable
is of course taking the risk that returns for the Sponsors. The Offtaker/
Company may not succeed in Contracting Authoritys bid evaluation
constructing and operating the process (cf. 3.7.8) is very important in
project and as a result a public this respect. The lenders are
service may not be provided, or experienced in project finance,
the Offtaker/Contracting committed to the project.
Authority has to buy the product
or service more expensively from
elsewhere. Sponsors will not Reputation Risk
usually provide any support in
this respect, as any antees would - Lack of transparency: The government was
destroy the non-recourse charged with refusing to release all cost details of
structure of the project finance. the PPP: Lack of clarity and transparency around
in 9.5.11, the Construction the way decisions about water supplies were
Contractor is in a similar made, stating that poor institutional
position.) arrangements had led to over-investment in
desalination and the inability of these
arrangements to escape political interference. The
Brumby government defended its actions, saying
that the A$24 billion nominal figure was
equivalent to the net present value A$5.7 billion
that was publicly disclosed at the start of the
project.

2 Regulatory and Political Risks

Wider Political Risks: Investors Creeping Expropriation: politically motivated
In fact, few major projects can be and strike, Project Company personnel being accused
structured and financed without political Lenders of criminal offenses such as cor- ruption, or
backing. Political support from a high harassed generally
level is often necessary to enable a project In February and March 2011, strikes again
to be completed successfully;
Once the project is operating, continued delayed construction at the plant as conflicts
political support is needed. The project continued between site workers and the project
will be weakened if it becomes a political management.
football because it provides a handle for
the opposition to attack the government, A government has many ways to take action
or for a new government to try to undo
the deal agreed by the previous against a Project Company without spe- cifically
government, perhaps because it did not go repudiating contractual obligations. The
through a trans- parent (competitive)
public-procurement process or it produces cumulative effect of such actions may be to
very high returns for the investors, and so deprive the Project Company or its investors of
is open to charges, at best, of having been the real benefit of the proj- ect, even though each
favored unfairly, or, at worst, of
action, taken by itself, would not necessarily have
corruption.
So just as a project has to be this result. This is a creeping expropriation of
commercially viable (cf. 9.4), it must the project. (307)
also be politi- cally viable. The
fundamental issue is whether the project - The government being accused of
is seen as fair and ben- eficial to its overspending on the plant; possibly contract
users; if it is not, e.g. because the cost of annulation: Producing figures that showed that
its product or service is out of line with the project would cost Melbourne households
local costs or comparable projects, A$19.3 billion even if no water was sent to
investors and lenders cannot just rely on homes, and almost A$24 billion over 28 years if
Project Contracts and ignore this political the maximum 150GL of water was ordered,
aspect. And a high rate of return, which is
meant to compensate for risk, may - The decisions about Australias urban water
paradoxically increase the risk if it supply had been too political and not based on
becomes politi- cally unacceptable. social economics. Concluding that smaller
investments in sources other than desalination
This risk category includes issues would have been sufficient to maintain water
such as contract disputes, which security across Australias cities.
may have a political or
commercial background; it
illustrates that the dividing line
between commercial risks and
political risks is not a precise one.
(305)

Residual risks faced by the sponsors? (Aquasure was

sponsored by Degremont, Thiess and Thiess service and
Macquarie Capital)

- Termination fees: the state would also procure alternative funding for termination of
the project and payment of the relevant termination payment; or pay-out of the
balance of any un refinanced debt, etc.

Loss on default: The average recovery rate for projects which defaulted during the
construction phase was 65%, and during the operation phase was 83%, obviously
confirming the higher-risk nature of the former.
The average recovery rate for PPP/PFI projects (in both phases) was 84%. Overall
these figures confirm that project-finance is a low-risk business for lenders if
organized and structured following market best practices.
Given the long-term nature of these projects and the complexity associated, it is
difficult to identify all possible contingencies during project development. It is more
likely than not that the parties will need to renegotiate the contract to accommodate
these contingencies.

It is also possible that some of the projects may fail or may be terminated prior to the
projected term of the project, for failure by the private operator to perform their
obligations

There is no unlimited risk bearing private firms (and their lenders) will be cautious
about accepting major risks beyond their control, If they bear these risks then their
price for the service will reflect this.

Contract Mismatch
When the due-diligence process is being undertaken, it is easy to get bogged down in
the details of individual Project Contracts, and as a result miss risks that may arise
from incompatible provisions in different Project Contracts. Each Project Contract is
not self-contained, but affects the others, and the contracting structure of the project
must be reviewed as a whole. (248)